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State Street (NYSE:STT)

Q1 2012 Earnings Call

April 17, 2012 9:00 am ET

Executives

S. Kelley MacDonald -

Joseph L. Hooley - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Risk & Capital Committee

Edward J. Resch - Chief Financial Officer and Executive Vice President

Analysts

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Michael Mayo - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Brian Bedell - ISI Group Inc., Research Division

Andrew Marquardt - Evercore Partners Inc., Research Division

John W. Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Operator

Good morning, and welcome to State Street Corporation's First Quarter 2012 Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website at www.statestreet.com/stockholder.

This call is also being recorded for replay.

State Street's call is copyrighted. All rights are reserved. The call may not be recorded for rebroadcast or distribution in whole or in part without expressed written authorization from State Street, and the only authorized broadcast of this call is housed on State Street's website. [Operator Instructions]

Now, I'd like to introduce Kelley MacDonald, Senior Vice President for Investor Relations at State Street.

S. Kelley MacDonald

Before Jay Hooley, our Chairman, President and Chief Executive Officer; and Ed Resch, our Chief Financial Officer, begin their remarks, I'd like to remind you that during this call, we will be making forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in State Street's 2011 annual report on Form 10-K and its subsequent filings with the SEC.

We encourage you to review those filings, including the sections on Risk Factors, concerning any forward-looking statements we make today. Any such forward-looking statements speak only as of today, April 17, 2012, and the corporation does not undertake to revise such forward-looking statements to reflect events or changes after today.

I'd also like to remind you that you can find a slide presentation regarding the corporation's investment portfolio as well as our first quarter 2012 earnings news release, which includes reconciliations of non-GAAP measures referred to on this webcast, in the Investor Relations portion of our website.

Now I'll turn it over to Jay.

Joseph L. Hooley

Thanks, Kelley, and good morning. Overall, I believe we're off to a good start this year amid continued economic headwinds. First, we achieved solid growth in both fee and total revenue compared to the fourth quarter of 2011. Our earnings per share, however, were particularly impacted by the seasonal accounting effect on the first quarter of the annual equity incentive compensation for our retirement-eligible employees, as well as payroll taxes.

Second, we maintained strong new business momentum with $233 billion in assets to be serviced and net new business at SSgA.

Third, we received the results of the CCAR stress test released by the Federal Reserve in mid-March. As a result, we were able to increase our quarterly common stock dividend to $0.24 per share, consistent with its previous split-adjusted high.

In addition, our board approved a $1.8-billion common stock purchase plan, which we expect to begin to execute this month.

In addition to remarks about the first quarter results, this morning, I will address the economic outlook, our continuing success generating new business in core asset servicing and asset management, the ongoing progress of our Business Operations and Information Technology Transformation Program, as well as our strong capital position.

As markets improved in the first quarter, a number of our clients began putting their cash back to work. The level of excess deposits left on our balance sheet declined and the performance of our core business improved compared to the fourth quarter. At the same time, investors remained cautious, especially in view of continuing uncertainty in Europe.

We continue to control expenses. Other than compensation and employee benefits, all other expenses on an operating basis were held in check. The seasonal impact of equity-based incentive compensation for retirement-eligible employees was $76 million in the first quarter of 2012 compared to $40 million in the first quarter of 2011, an increase of $36 million or $0.05 per share.

We continue to add new business to the core franchise. Of the $233 billion in assets we won in the first quarter, about 2/3 were in the U.S. We had $10 billion in net new business at State Street Global Advisors. One notable planned reduction in SSgA assets was the $31 billion of asset redemptions from accounts we manage for the Department of the U.S. Treasury. Excluding this redemption, net new business at SSgA in the first quarter was $41 billion.

Among our larger new servicing mandates was an award for QSuper, an Australian superannuation fund with more than 500,000 members and over $32 billion of assets under management for which we'll provide a broad range of custody administration and accounting services. This new mandate further builds on our previous wins with Sunsuper in November 2011 and REST Industry Super in January 2011. State Street now services 3 of the top 10 superannuation funds in Australia.

The integration of the Intesa Securities Services acquisition has met our stated targets and this business continues to attract new wins. In fact, just recently, we've been appointed custodian to the Fondo Pensione Banco di Napoli, with EUR 700 billion pension fund for the employees of Banco di Napoli.

Also, the state of Washington renewed its agreement with us for servicing and securities finance for $80 billion in assets.

Regarding the timing of installations, during the first quarter, we installed $205 billion, $90 billion of which was awarded in the first quarter and $115 billion which was awarded in 2011.

Of the total business award in the first quarter, about $143 billion remains to be installed.

In the alternative asset servicing area, demand remains very strong. This quarter, we added 42 new mandates in our alternative investment services business and our alternative assets under administration increased from $816 billion as of December 31, 2011, to $895 billion as of March 31, 2012.

SSgA has been awarded new business from several U.S. public plans including those from Michigan, Nevada, Oklahoma, Indiana and Missouri.

Now let me share our outlook for the global economy. We expect the U.S. to continue its slow recovery with 2012 GDP growth slightly above 2%. Recent consumer confidence has improved slightly, but housing prices continue to slide as unemployment continues to be a challenge.

In Europe, the picture is mixed. In the U.K., GDP declined in the first quarter, consumer confidence eroded and the housing market weakened. Germany's rate of unemployment continues to decline, but retail sales in the first quarter were weak. Other Eurozone countries exhibited some consumer strength in the first quarter. And in Italy, wage inflation appears to be stabilizing. However, manufacturing overall appears to be in decline. The long-term refinancing operation by the ECB relieved some of the liquidity pressure in the region, but the debt status of Greece and Spain continues to weigh on the equity markets.

On balance, our cautious outlook is consistent with the moderate improvement in U.S. markets. However, we remain guarded, primarily due to European uncertainty, which can affect the U.S. recovery.

We continue to be on track in executing our Business Operations and Information Technology Transformation Program and expect to achieve approximately $94 million in annual pretax run rate savings this year, excluding restructuring charges. This brings the total annual run rate savings anticipated to be achieved since the inception of the program through the end of 2012 to approximately $180 million compared to the expense run rate in 2010, all else equal.

Returning capital to our shareholders has been a priority for us. As I mentioned earlier this morning, we're pleased that the Federal Reserve did not object to the increase both in our common stock dividend and in our common stock purchase program that we proposed. We believe the return of capital to our shareholders projected by our post-CCAR capital actions announced in March 2012 is among the highest among major financial institutions also executing on the corresponding post-CCAR announced capital actions.

Due to the strength of our capital position, we expect to be able to take these actions while retaining the flexibility to respond to future acquisition opportunities should they become available.

I'll now turn the call over to Ed, and then I'll return to make final remarks before I open the call to questions. Ed?

Edward J. Resch

Thank you, Jay, and good morning, everyone. This morning, I'll review 3 areas: first, the results for the first quarter; second, I'll summarize the performance of and outlook for the investment portfolio, as well as worldwide interest rates and the impact on our net interest margin; and finally, I'll review our strong capital ratios.

I'll present some of the more significant results comparing the first quarter of 2012 to the first quarter of 2011, as well as to the fourth quarter of 2011. And this morning, all of my comments will be based on our operating basis results as defined in today's earnings news release.

Fee revenue in the first quarter was approximately flat compared to the first quarter of 2011 and was up 7% from the fourth quarter. Compared to the first quarter of 2011, servicing fee revenue was down 2%. The decline in servicing fees from the first quarter of 2011 was due to the impact of weakness in non-U.S. markets in the second half of 2011 and mix changes, offset partially by net new business and a slight increase in the daily average of the S&P 500. Compared to the fourth quarter of 2011, servicing fees increased 2% due to higher average equity valuations and net new business.

Management fees were flat with the first quarter of 2011 and increased 17% from the fourth quarter due to higher month-end equity market valuations and net new business. We believe that the implementation of the LTRO in Europe had a positive impact on global investor sentiment, as we saw evidence of U.S. investors beginning to put cash back to work. During the quarter, our investment servicing clients began putting cash back into the market, albeit mostly into conservative short-term and fixed income investments.

At SSgA, we were awarded $10 billion of net new business, even after the planned $31-billion redemption by the Department of the U.S. Treasury.

Net new business was composed of 3 main elements: one, flows into ETFs, which had one of their best quarters, adding about $10.8 billion in net inflows. We also added about $8 billion net into institutional funds, primarily passive, and added net flows of $23 billion into cash strategies. Many of these cash flows went back into prime money market funds from U.S. government funds, reversing last quarter's trend. Our fee waivers declined about $2.4 million from $11.5 million in the fourth quarter of 2011 to $9.1 million in the first quarter of 2012.

Regarding trading services and securities finance. Trading services, in the first quarter of 2012, declined 7% compared to the first quarter of 2011, but were up 3% compared to the fourth quarter of 2011. Compared to the year ago quarter, first quarter foreign exchange revenue decreased 7% due primarily to lower volatility, partly offset by higher volumes. Brokerage and other fee revenue was down 8%, due primarily to lower transition management revenue. Compared to the fourth quarter, foreign exchange revenues decreased slightly and brokerage and other increased 7% due primarily to an improvement in revenue from transition management.

In foreign exchange, in the first quarter of 2012, the percentage of total foreign exchange revenue represented by indirect and direct foreign exchange services remained approximately consistent with the fourth quarter. We continue to expect, however, that some clients over time may choose to reduce indirect FX transactions in favor of other execution methods, either directly or through electronic trading.

Compared to the first quarter of 2011, securities finance revenue increased 47% in the first quarter of 2012 and was up 8% compared to the fourth quarter of 2011. Both increases were due primarily to higher spreads. In the first quarter of 2012, the average of one-month LIBOR to the Fed Funds effective rate was 14.4 basis points and the 3-month LIBOR to the Fed Funds effective rate was 39.9 basis points.

Securities on loan averaged $331 billion for the first quarter of 2012, down from $340 billion in the fourth quarter of 2011 and from $359 billion for the first quarter of 2011, both declines due to reduced demand. Average lendable assets for the first quarter of 2012 were about $2.36 trillion, up 1% from $2.34 trillion in the first quarter of 2011 and up 6% from $2.23 trillion in the fourth quarter of 2011.

As of March 31, 2012, the duration of the securities finance book was approximately 16 days, down from 21 days in the first quarter of 2011 and down from 17 days from the fourth quarter of 2011.

Processing fees and other revenue was up about $49 million in the first quarter of 2012 from the fourth quarter of 2011, due to the positive impact of fair value adjustments as we successfully exited our fixed income trading initiative. As you may recall, last quarter we announced the withdrawal from our fixed income trading initiative. And as of March 31, 2012, we have substantially closed out all trading positions.

Operating-basis net interest revenue of $607 million increased about 5% in the first quarter of 2012 compared with the fourth quarter of 2011, primarily due to higher yields on fixed income securities in the investment portfolio and higher spreads on floating-rate securities.

In the first quarter, excess deposit at the Federal Reserve and other central banks averaged about $18 billion compared to $23 billion in the fourth quarter. We continue to expect the excess deposits to trend down on average for the full year 2012. Including the excess deposits, operating-basis net interest margin was 152 basis points in the first quarter of 2012, compared to 140 basis points in the fourth quarter of 2011.

Now turning to expenses. Compared to the first quarter of 2011, compensation and benefit costs were up $90 million or 9%, primarily due to the $36-million effect of changes in employee demographics on equity-based compensation for retirement-eligible employees, with the remainder of the increase resulting primarily from merit increases and employees added as part of new business and acquisitions.

Our compensation and benefits expenses increased 22% or $192 million from the fourth quarter of 2011 to approximately $1.064 billion, due primarily to the seasonal accounting impact of annual equity-based compensation for our retirement-eligible employees and additional payroll taxes, which together accounted for $105 million of the increase.

In the first quarter of 2012, compensation and benefit expenses were approximately 44.3% of total operating-basis revenue, up from 38.1% in the fourth quarter. For the full year, we continue to target a reduction of the ratio of compensation and benefits to total operating-basis revenue by about 100 basis points compared to the 40.2% ratio we had in 2011.

Other expenses were $244 million, up 6% compared to the first quarter of 2011, due primarily to higher regulatory costs, and were down 11% compared to the fourth quarter, primarily due to lower professional fees and lower securities processing costs.

As Jay said, our Business Operations and Information Technology Transformation Program is proceeding as planned. We continue to expect the amount of annual pretax run rate savings for 2012 to be approximately $94 million compared to the pretax run rate in 2010, all else equal.

In our operating-basis expenses, we incurred $22 million of nonrecurring costs relating to the program, consisting of $17 million in salaries and benefits and $5 million in several other expense lines on the income statement. As you may recall, we have previously indicated that we expect our nonrecurring costs to peak in 2012 at an average of about $25 million per quarter.

Now let me turn to the investment portfolio. Our investment portfolio as of March 31, 2012, of $113.7 billion increased about $4 billion compared to December 31, 2011.

During the first quarter, we invested about $9.2 billion in highly rated securities at an average price of $103.28 and with an average yield of 2.34% and a duration of approximately 2.90 years. Our primary investments during the quarter were in agency mortgage-backed securities, which represented $4.3 billion of new purchases at an average price of $105.60 with an average yield of 2.93%.

In the first quarter, we have opportunistically invested ahead of this year's plan given the environment. The aggregate net unrealized after-tax loss in our available-for-sale and held-to-maturity portfolios as of March 31, 2012, was $81 million compared to a net unrealized after-tax loss of $374 million as of December 31, 2011. The improvement in the net unrealized after-tax position compared to December 31, 2011, was due primarily to tighter spreads, offset partially by higher rates.

In our investment portfolio presentation, we've updated the data through quarter end for you to review. As of March 31, 2012, our portfolio was 89% AAA or AA rated. The duration of the investment portfolio was 1.57 years at March 31, 2012, up from 1.49 years at December 31, 2011, due primarily to our purchase of agency mortgage-backed securities during the first quarter. The duration gap of the entire balance sheet was 0.49 years, up from 0.36 years at December 31, 2011, and this duration gap is in line with our internal guidelines. As of -- excuse me, March 31, 2012, 58% of our investment portfolio was invested in floating-rate securities and 42% in fixed-rate securities.

Regarding European assets. We have no direct sovereign debt exposure to the peripheral countries of Greece, Spain, Portugal, Italy or Ireland in our investment portfolio. Of our non-U.S. assets, we hold about $1.2 billion in securities from those peripheral countries, primarily RMBS and all floating-rate securities. And they are comprised of about $500 million from Italy; $400 million from Spain; and about $100 million each from Ireland, Greece and Portugal. All are performing within expectations and remain current as to principal and interest.

On Page 7 of the investment portfolio presentation, we list all of our non-U.S. investments and show the average rating as well as the asset types we hold. Our primary non-U.S. holdings are British, Australian, German, Canadian and Netherlands securities, totaling 92% on the non-U.S. investment portfolio.

At SSgA, our Eurozone exposure in the investment funds is consistent with client mandates. We hold the non-U.S. fixed income portfolios at their benchmark weightings and our actively managed cash portfolios have no exposure to the peripheral countries.

Regarding pretax conduit-related accretions. Looking forward, we expect to record a total of about $1.1 billion in interest revenue from April 1, 2012, forward through the remaining lot -- terms of the former conduit securities, excluding the approximately $49 million we recorded in the first quarter of 2012. These expectations are based on numerous assumptions, including holding the securities to maturity, anticipated prepayment speeds, credit quality and sales.

Now for our outlook for net interest margin. First of all, let me emphasize that we continue to believe that we should invest through the cycle and we also intend to invest primarily in highly rated AAA or AA agency mortgage-backed and asset-backed securities.

I'll now review some of the assumptions we used in determining our 2012 outlook for net interest revenue and net interest margin. We believe that the Federal Reserve will leave interest rates on hold through the end of 2014, that the ECB has cut rates to 100 basis points and we expect them to hold at that level through the end of 2012. If the ECB rate declines further, we estimate NIR would decline by between $20 million and $25 million on an annual basis for each 25-basis-point reduction. We believe the Bank of England will hold its base rate at 50 basis points through 2012. We project a potential reduction of 25 basis points in that rate by the Bank of England would lower net interest revenue by about $5 million annually.

Based on these rate assumptions and our first quarter results, if our client deposits return toward more normal levels, our net interest margin for the full year 2012 will likely be in the upper half of our 145- to 155-basis-point range.

Finally, I'll briefly review our capital ratios. In the first quarter, State Street Corporation's capital ratios under Basel I remained very strong. As of March 31, 2012, our total capital ratio stood at 20.6%, our Tier 1 leverage ratio stood at 7.8%, our Tier 1 capital ratio stood at 19.1%, our TCE ratio was 7.5% and our Tier 1 common ratio was 17.1%.

Based on our understanding of the Basel III regulations and the information published by the Basel Committee and the Federal Reserve, we estimate our capital ratios under Basel III as of March 31, 2012, to be total capital ratio, 16.0%; our Tier 1 leverage ratio to be 6.2%; our Tier 1 capital ratio to be 14.4%; and our Tier 1 common ratio to be 13.2%.

We were pleased with the results of our CCAR submission and with the return of capital we are projecting to make to our shareholders.

So in conclusion, while we are beginning to see signs of improvement, particularly in the U.S. economy, the global economic outlook has continued to be uncertain. The LTRO has improved liquidity in the European banks, but it has also restrained growth in new issuances. We still face a low interest rate environment, new regulatory requirements and increased compliance costs. We need to continue to drive fee revenue growth while maintaining cost controls, and we intend to reduce the compensation-to-revenue ratio in 2012 compared to 2011 and also to continue to execute on our Business Operations and Information Technology Transformation Program.

And now, I'll turn the call over to Jay to conclude our remarks.

Joseph L. Hooley

Thanks, Ed. While we're encouraged by the early signs that investor confidence in the U.S. is rebuilding, we remain cautious, especially around the uncertain environment in Europe. During the first quarter, the momentum in our core business returned. The increase in the core business was supported by the installations of new business won last year and new business wins in the first quarter. The flows into SSgA in the first quarter were very encouraging.

I'm also pleased with the growth in our ETF assets, which exceeded $300 billion as of March 31, 2012, up more than 12% from December 31, 2011.

We intend to continue to exercise expense control and to successfully execute on our Business Operations and Information Technology Transformation Program.

Our capital position remains strong, allowing us to return capital to our shareholders in the form of increased common stock dividends and a substantial increase in our common stock purchase program.

Our outlook of cautious optimism for 2012 is restrained by the continued uncertainty in Europe. However, our pipeline of new business potential is very healthy and we expect to contribute to further growth in 2012.

Now Ed and I are prepared to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Ken Usdin with Jefferies.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Ed, I was wondering if you can just kind of walk us through the comp guidance. This quarter, comp revenues ratio was even -- we had the 105 and then plus a lot of excess, so it was more like 44%. So to get down to that low 39s, got to presume a well-below 39% comp-to-revenues ratio over the next few quarters. So I was wondering if you can help us understand what else either comes out of the comp ratio on the expense side. And also, should we imply that there's also a meaningful step-up in revenues expected? It just seems like a pretty big, big leap to get down to 39% full year.

Edward J. Resch

Well, I mean, it's what we're targeting, Ken. And you're right. I mean it is largely predicated on revenue. We said at Investor Day that assuming revenue grew modestly, that would be our target for the year, to bring it down to around 39.2% for the full year. We -- obviously, we're cognizant of the first quarter step-up, which is just timing, when we made that comment in February. We're proceeding with the ops and IT transformation as we indicated on the call and we're going to target around 39.2%, plus or minus a bit, even recognizing the first quarter step-up, which was significant because of the early retirement accounting.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay. And then secondarily, just wanted to tease out a couple of the transaction-based areas. It looks, on the surface, that it was a soft volume quarter, yet you guys did really well in terms of total trading fees. Sec lending was up sequentially. Can you talk about what you saw in terms of -- was it market share gains? Or was there anything specific to the types of transaction that you guys enjoyed?

Joseph L. Hooley

I would say a few things, Ken. The trading was up 3% sequential quarter. And the -- I would say the drivers were foreign exchange, pretty good performance against lowering volatility in the quarter. I think that was a question of just volumes. We saw our volumes go up Q4 to Q1. I think it's just the result of whether you can interpret share gains out of that. It's hard in that market. But we're pleased with the volume growth to offset the volatility shortfall. The brokerage line, I think it was up 7% sequential quarters. Transition management, which is, again, hard to get market share data in that segment of the market, but we think we're performing pretty well as far as capturing our share of transition. And then securities finance was really more a story of largely holding on to current outstanding and the LIBOR -- the 3-month LIBOR increase. So I think that roughly covers the transitional line items in the quarter.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay, that's helpful. And then asset management had a really strong rebound. I'm just wondering how much of that was just the market, which we can kind of tease out, versus the re-risking that had gone against you last quarter? And I guess it's a question for custody as well. Just the amount of re-risking. Where are we in that kind of -- it was a kind of a sharp decline in the fourth. And how did it re-base as we came to the first?

Joseph L. Hooley

Yes, let me -- I'll start that and Ed can jump in as well. Very pleased with SSgA performance in the first quarter, up 17% sequential quarter -- on a sequential quarter basis. And it was really a combination of both the markets, which is the obvious point, and very good net new business growth. So if you exclude that Treasury redemption, which was planned, $41 billion in net new flows in the first quarter, which is as strong a quarter as we've had in a while. Highlighted by ETF, we continue to talk about ETF as a focus and a theme for us. We continue to add new products. We saw -- I think it was $8 billion in new flows in the first quarter into ETFs, as well as passive. So I'd say on the -- let me come to servicing fees and then comment about the risking. On the servicing fee side, a little bit of a different story. We were up -- service fees were up 2% sequentially. You'll recall back at the end of the last call, we talked a little bit about the de-risking in the last half of 2011. We saw that start to come back in the first quarter, but it was -- frankly, it was more back-end quarter loaded than front-end quarter loaded, so I think the service fee line reflects that more than the asset management fee line. In the re-risking, Ed mentioned this in his comments, it was a little bit less than one might expect and that was mostly in the fixed income instruments. So we really didn't see a move back, and this is broad strokes, back to cross-border and emerging markets. But we did see good intra-quarter flows into the servicing line. Does that help?

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

That's great, Jay. And just one final little thing. The processing and other improvement, it was $49 million. I'm just wondering if you can tell us how much of that $49 million was the actual kind of recapture of the fixed income marks.

Edward J. Resch

Virtually the entire delta, Ken.

Operator

Your next question comes from the line of Glenn Schorr with Nomura.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

So, look, the LTRO was mostly a good thing for everybody involved. But I get a sense that it slowed down the deleveraging process and the business unit rationalization. And I think for a while now, you and we all have gotten a sense that there would be business freed up and maybe some consolidation on the heels of this. Has that just come to a halt as well, given the LTRO and the time that it buys some of these institutions?

Joseph L. Hooley

Yes, Ken -- I mean, sorry, Glenn. I would say that it has slowed it down, so I think that your question, I think, is pointed at custody consolidation in Europe. And we -- so the European banks, many European banks were under capital pressure and there's been a slow move towards recapitalize. I think there are some deadlines upcoming in 2012 which may create a stimulus for that. I think the one thing that we observed, not universally but in several cases, is that European banks who had custody books of business in 2011 were very concerned about funding and liquidity. And the custody banks, even though it might not be strategic with any universal banks, provide a stable source of funding. And therefore, I think there was a little bit of a slowdown. So you could say the LTRO potentially relieved that, with funding being provided by the ECB, maybe less pressure on the core funding. We would hope if that sustains itself, that it might unlock some of those properties in Europe. Haven't seen any recent evidence, but would expect that over time you'd see that.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

So you still have expectations of the bigger trend of consolidation?

Joseph L. Hooley

Absolutely.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

Okay. One more strategy question. In asset management land, you're clearly on pole position in passive land. And I just thought we'd revisit State Street's, I guess, expectations or aspirations on the active side. And you have more capital than you have approval for, so you've got a big buyback coming. But just thoughts on the active side of asset management business.

Joseph L. Hooley

Yes, I think we -- our asset management business is probably somewhat misunderstood and that there's a fair amount of quantitative active within that $2-trillion-ish pool of assets that we manage. And we think that's a growing segment, the quant active scientific, if you can use those terms. With regard to kind of fundamental active, we have very little. As you recall, we acquired Bank of Ireland's Asset Management business, which gave us a little bit of fundamental active. That's been a good transaction for us. We've been able to leverage our institutional distribution to grow that. We'll continue to selectively look at different asset classes, whether they be active or fundamental active, as I interpret your question, or other places where we have gaps. I think that as I look at the franchise, as you point out, it's got a solid footing in the passive space. I think ETFs gives us another vehicle to create a little bit more product creativity within asset management. And I think we also have, as a core competency, great institutional distribution and some emerging intermediary distribution through the ETFs. So if we can, through acquisition, was your question, selectively acquire asset classes that we think we can leverage up and distribute through our distribution system, we think that would be a smart thing to do.

Glenn Schorr - Nomura Securities Co. Ltd., Research Division

Super. One last one, and just a numbers question for Ed. On the deposit outflow side, I totally get the environment thawing and therefore some of that money that was parked with you for safety reasons goes out. Can you just talk through what percentage of that piece of the business you think you're through? And then maybe the rate differentials so we can back into our own NIM estimates between the core deposits that you have and those temporary deposits?

Edward J. Resch

Yes, I mean, our thinking for the year, Glenn, full year 2012, is that we basically have the excess deposits that we had in the fourth quarter. So from $23 billion on average down to, let's say, around $11 billion or so for the full year, okay? And it was predicated on that, that we gave you the 145 to 155 and said that -- for NIM guidance, and said that if the deposits stuck around longer, we'd be toward the lower end of that range. And obviously, the converse is true. If they leave more quickly, we'll probably be toward the higher end of that range. So I'd say moving from $23 billion down to $18 billion, we're maybe 1/3 to 1/2 of the way there based on our expectations for the full year. But it can move around, obviously, depending on sentiment. But it seemed like there was some thawing, some improvement, as you note, in the first quarter.

Operator

Your next question comes from the line of Alex Blostein with Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

I just wanted to follow up on your comments on capital. So it looks like you guys are returning 100% of earnings roughly. Still lots of excess capital, even if you kind of compare that 13% to your sort of self-imposed 10% capital ratio. How should we think about deployment, I guess, of that excess, because it feels like you can continue to do 100% of earnings and still grow capital? So should we be thinking special dividend or something like that? Or this is just kind of like excess capital for potential acquisitions in the future.

Joseph L. Hooley

I think the way you should look at it, Alex, is that we want to have some capacity to execute on acquisitions in a world that we think is going to deliver attractive opportunities. Whether it's the European banking situation, whether it's selectively in the asset management world, we think we're well situated to maintain that flexibility. And we think by increasing the dividend and authorizing -- the board authorizing a buyback, we're providing some relief to shareholders. On the other hand, we think it's prudent to stay flexible given what's likely to be an opportunistic future from the standpoint of acquisitions. And we think we struck that balance.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Got you. Ed, one for you on expenses. So it looks like the clean number this quarter was probably around $1.7 billion. Can you walk us through, with cost cuts coming through probably in a bigger way towards the back half of the year, how we should think about the progression of that kind of $1.7-billion expenses total run rate currently into the second half, between growth in the business plus the net savings coming through?

Edward J. Resch

Yes, $1.7 billion is taking out the early retirement accounting effect, Alex. Is that what you're -- I'm assuming there.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Yes, because that's really seasonal, first quarter thing, right?

Edward J. Resch

Yes, right. I mean, we're assuming that the business will grow this year. We haven't put a revenue guideline out there for you, as you know. We are assuming some level of growth, so there'll be some related expense growth associated with that. And that's factored into our progression for the year. We also expect, as we noted, to get in about another $90 million, $94 million of savings from the ops and IT program. That will be principally in the -- as a reduction to salary and benefits line, which is part of our planning for moving that comp-to-revenue ratio down over the year. So I mean the progression from the starting point of $1.7 billion, as you said, is really a function of what the revenue growth is. I mean, we have, as I said, plans to grow the company. We're not planning on staying flat or down for the year. But I mean, it's hard to give you even a range for the year based on the potential variability of what the revenue outcome is. But I would say that if you started at $1.7 billion, you'll be probably looking at tracking up a little bit from that as we assume our revenue growth comes in per quarter.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Right, so up slightly despite the fact that the savings will be coming through in a bigger way towards the back half?

Edward J. Resch

Yes, I think, net -- yes, that's our thinking, again assuming that revenue grows modestly for the year, as we said. And that's consistent with our thinking on the comp-to-revenue ratio again.

Operator

Your next question comes from the line of Mike Mayo with CLSA.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

Just looking out, do you expect the usual strength in securities lending in the second quarter?

Joseph L. Hooley

Yes, we would -- we don't see anything that caused us to believe we won't see that cyclical second quarter, positive cyclical second quarter.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

And you have the new buyback authorization and shares were flat. So what's going on there? Why not be more aggressive?

Edward J. Resch

We didn't buy any shares back in the first quarter, Mike.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

And what sort of pace do you expect to have? Again, you have new authorization. If you think your stock's inexpensive, wouldn't you be buying aggressively? Or how do you think about buying back stock?

Edward J. Resch

Well, I mean, we can't get too far into our plans for that. But we're going to -- the way to look at the buyback is the remaining 3 quarters of this year and then the first quarter next year, which is the new piece of the program for this year versus last year. So for the remainder of this year, the plan is around $1.35 billion of stock to be bought back, with the remainder in the first quarter of next year. That was the program that we put out. And we'll act opportunistically within the constraints of the marketplace...

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

You can't front-load it?

Edward J. Resch

Well, I mean there are requirements to -- based on volume, as you know, and there's also the particulars of the plan that we submitted to the Fed and the Fed did not object to it. So it's not something where we can just all decide if we wanted to, to front-load it to an extremely large degree, let's say that.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

And then switching gears. You've said in the past you're a big beneficiary of higher equity markets and the S&P was up 10%, depending how you look at it. Your assets under custody were up 7% and the custody fees were up only 2%. That seems like awful a sequential increase in the custody fees relative to the market and your assets under your custody. So what's happening there?

Joseph L. Hooley

Yes, I think it's -- probably the best explanation for that, Mike, is the re-risking which underlies the issue of servicing fees and growth. We actually saw intra-quarter growth from front to back. And so I think the 2% probably is light if you were to average the back end of the quarter.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

So second quarter should be better due to some sort of lag impact?

Joseph L. Hooley

Yes, I mean I think if you assume that equity markets keep the same pace as the first quarter, you'd expect that there is some lag effect which would filter into the second quarter.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

Even if there is a lag effect, that still doesn't seem like it's keeping pace with the market.

Joseph L. Hooley

Yes, we have broadly -- I mean, it's hard to pick a line item. But we say 10% equity markets, 2% revenue growth on a total basis. And that -- so you look at the asset management side of the business and we're up 17% sequentially. So 2% seems a little light, but I don't think extraordinarily light given the trend, intra-quarter, that I mentioned.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

And then, lastly, the comp ratio. I mean, you're 44% in the first quarter and you're looking for 39% for the year. So should we look at 37% or 38% in the second quarter? And are you looking for an absolute reduction in personnel expenses? Because I don't recall this being overly dependent on revenue growth and now I'm hearing Ed say, well, we need revenue growth to meet our comp rate. And there's a general concern that the customers of State Street are treated well and the employees are treated well, but the shareholders aren't. And today, the market's up over 100. You're the only stock down and so I think there's a general concern about getting the comp and expenses in line. So can you give any reassurances that they will be?

Joseph L. Hooley

I think -- let me start with that and Ed can jump in. I think that I'd point to 2011, which was really the first year that the IT and ops really had an effect. And we were able to drive the comp-to-revenue ratio down, very focused on it. In the first quarter, we have the seasonal expense, which we've spoken about. So I think between internal focus, execution of IT and ops, which we have high confidence in, we think with moderate revenue growth, we should be able to drive that down again this year.

Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division

Okay. And Ed was going to follow up or...

Joseph L. Hooley

Sure.

Edward J. Resch

Yes, I mean I'd just repeat what I said earlier, Mike. I mean, I think that the math, depending on what level of revenue you want to pick, is in the right range. I think the earlier question was somebody saying 39% in future quarters. But clearly, it's got to be below 40% in a meaningful way to drive to 39.2% for the full year. It's something that we're focused on. And as Jay said, it's something that we delivered on last year. If you recall, the sequential quarter decline in the comp-to-revenue ratio was something that we targeted and we delivered and we brought it to 39.2% -- I'm sorry, 40.2% for the full year. So it's something that we believe we're going to get. And relative to my statement about revenue, I mean revenue, obviously, is a piece of the function here. So my only comment there is that if revenue were, for some reason, and we don't anticipate this to be soft, okay, in a meaningful sort of way, that revenue would be a significant challenge for us to get for the full year. But again, we don't anticipate revenue being soft and we are planning on modest growth and will drive to the 40 -- the 39.2% approximately for the full year.

Operator

Your next question comes from the line of Brian Bedell with ISI Group.

Brian Bedell - ISI Group Inc., Research Division

Jay, can you talk a little bit more about the investment servicing? Obviously, the lower yield on the asset -- on the custody and administered assets is, to some degree, a factor of the revenue mix that you alluded to. And you also implied that it's getting better as we move to the back half -- back end of the quarter into second quarter. But can you also comment on to what degree pricing or through servicing mix impacted that? And when I say servicing mix, I mean mid-office versus custody mandates and things like that.

Joseph L. Hooley

Yes, sure, Brian. Let me try to give you a little color. From a mix standpoint, nothing really extraordinary. We commented on the Australian superannuation business where we've made nice strides in the last 6 months. That's kind of a typical mix. We also had a big deal around real estate administration. Again, shouldn't have been a real change in mix. So I don't think mix was dramatically different within the quarter. I think that there was the lag effect of when people were re-risking. I think that had some effect. And regarding pricing, I would say that we continue to, almost quarter-to-quarter, get more aggressive or more aligned around pricing strategies with our customers. So in the last couple of quarters, you've seen some effect, but we would expect that as we continue to make sure that all of our relationships are appropriately priced, that pricing will be a -- more of a factor in time. So I don't think you can point to the quarter and say pricing was a factor, but I would leave with you the notion that we're pretty focused on pricing and we would expect over time to that -- for that to be a contributing positive.

Brian Bedell - ISI Group Inc., Research Division

So as we move through the year, if we think about a little bit of re-risking in the business mix, maybe a little bit of sort of sequential traction in pricing, we should expect that revenue yield on administered assets to improve as we move through the year?

Joseph L. Hooley

Yes, I would say, again, all else equal, we continue to see good markets. All of those things. The mix may be a little lesser effect. But other than that, yes, I think that's probably a fair assumption.

Brian Bedell - ISI Group Inc., Research Division

Okay, great. And then on the FX business, you mentioned that obviously this is a strong quarter and very consistent on the indirect versus the direct, but you do expect a headwind. Any way to frame what type of headwind we should expect? I know it's almost impossible to do on a quarter-to-quarter basis, but, say, over -- on an annualized basis over the next 1 to 2 years? This is the headwind from moving from -- from clients moving from direct to -- or indirect to direct, rather.

Joseph L. Hooley

Let me give you the strategic response to that and then if Ed has anything, he can add. Our strategy has been to -- we've got a broad range of FX offerings, and -- is to drive volume. And we can drive volume not only in existing customers, but in -- in existing servicing customers, but in non-servicing customers because of the variation of foreign exchange offerings that we have. So I think you can see some of that in the first quarter where we're driving volume in the case of this quarter outrunning volatility changes. We would hope over time that, in the mix shift from indirect to direct or other electronic means, that we could overrun -- outrun that with volume. So that's what we're attempting to do. And, Ed, I don't know if you'd...

Edward J. Resch

Yes, just on indirect, Brian, it's clearly something that we're focused on, as are other people, given the publicity around it. We had a $4-million to $5-million sequential quarter decline in Q3 -- in Q4 from Q3. This quarter, actually, the indirect revenue picked up to bit. So there's no -- there's clearly no evidence of a trend from Q4 to Q1. But it is something that we're monitoring. The business overall, though, is performing pretty well and we'll keep you posted as to if any trends from a client standpoint develop.

Brian Bedell - ISI Group Inc., Research Division

Okay, great. That's helpful. And then just on the processing fees, Ed. I think we were thinking about $70 million being a normalized run rate on a quarterly basis after the fourth quarter $25-million write-down. And obviously, we're much higher than that in this first quarter. What should we think about for a normalized run rate over the next 3 quarters?

Edward J. Resch

Yes, I mean that number, as we've said many times, can move around. But I think if you're thinking in the range of $70 million to $75 million for kind of a "normalized level" for that line, that's probably a good range to pick, Brian.

Operator

Your next question comes from the line of Andrew Marquardt with Evercore Partners.

Andrew Marquardt - Evercore Partners Inc., Research Division

I just want to go back to the processing fee line that moved around this quarter. It was up $49 million. But then last quarter, if I recall correctly, there were some markdowns on some of those securities. So how should we think about that as kind of a good kind of run rate number, because some of that won't stay around obviously?

Edward J. Resch

Well, I mean, it was all related to our decision to exit a fixed income trading initiative that we had looked at in the last couple of years, Andrew. So on a go-forward basis, given that we're done with the exit, there should be no effect to that line for those types of market value adjustments.

Andrew Marquardt - Evercore Partners Inc., Research Division

Right. But then last quarter, it was unusually low, if I recall, in the fourth quarter, right?

Edward J. Resch

Right.

Andrew Marquardt - Evercore Partners Inc., Research Division

So if we adjust for that and adjust for the upward revisions this quarter, based on kind of the -- my quick take on it, it looks like kind of in the mid-70s or low 70s should be kind of a good run rate. Is that fair? Or am I missing something in terms of...

Edward J. Resch

Yes, yes -- no, that is fair. I just answered that to a question previously. But yes, I think if you strip out the fourth quarter and first quarter impact of this exiting that we undertook, yes, $70 million to $75 million is probably a good estimate for that line on a normalized basis. I mean that line can move around, as we've said. But that's probably a good range.

Andrew Marquardt - Evercore Partners Inc., Research Division

Got it. And then just to back up a little bit on -- a lot of focus obviously on expenses this quarter and going forward, but -- in your comp revenue target. But can you just give us a sense of kind of overall this year, is it achievable? Or is it possible to achieve positive operating leverage in this environment, given we're still not into kind of the heavy lifting on the IT cloud initiative yet? Or do we have to wait until next year?

Edward J. Resch

Yes, again, I think it's, in large part, a function of how the revenue picture unfolds for the full year. And as we've said, if revenue does not grow in a robust way, operating leverage will be a difficult thing for us to achieve, with obviously the opposite being true, that if revenue grows 10-plus, 12-plus percent on an annual basis, the operating leverage should move rather easily onto the page. So I think it's too early to say what our prediction is for the full year, Andrew, but at a relatively modest level of revenue growth, I think it's fair to say that operating leverage will be difficult to achieve on a full year basis, assuming the market-driven revenues continue to be in something of a trough.

Operator

And our final question comes from the line of John Stilmar with SunTrust.

John W. Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Gentlemen, just with regards to your operating expense initiatives. One of the things that you've talked about is not just the dollars of expense savings and the potential operating leverage past 2012, but also new business wins that could drive the top line. Are you seeing evidence that -- or can you share with us progress, at least in terms of potential new business wins or new areas, that we might think about for the top line because of capabilities and functionality that you've created from your operating expense initiatives?

Joseph L. Hooley

Yes, John, we have started to see some of that. In fact, this quarter, we introduced a couple of new products. They tend to be data- and analytics-oriented new products and services, which were enabled based on moving to the cloud environment. So I think it's early days. But the evidence is quite strong that in the cloud environment, we'll be able to not only improve the speed with which we deliver new services, but the flexibility around information and analytics services which are in great demand by our customers. We should be able to be a little bit more creative and innovative on the information side. And we did introduce, I think, 2 products, in particular, in the first quarter that fit that bill. So I think, appropriately, the IT and ops transformation is focused on executing against the cost saves. But your question just -- does draw out a point, which is we think it's transformational because we think that we're doing something that no one else in this custody group is doing and it will, over time, enable us to differentiate more on the product side, and we see evidence of that.

John W. Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then I guess your answer dovetails back into my second question, which is many of us analysts -- and we've repeatedly asked on this call. The yield or fees per assets under custody, which, for lack of a better term, has shown less of volatility during down markets and doesn't necessarily trend up as well during bullish markets, which leads me to think that the services business or the custody business has a greater proportion of fees that aren't necessarily tied directly to assets. If that's -- one, would you agree that over the past 2 years or so that there's been a greater composition of custody revenues that aren't necessarily tied to assets? And if so, how should we think about that unfolding for the next couple of years?

Joseph L. Hooley

And when you say -- are you isolating servicing fees or overall fees?

John W. Stilmar - SunTrust Robinson Humphrey, Inc., Research Division

Just the asset custody fees, fees per AUC.

Joseph L. Hooley

Yes, it's -- unfortunately, the mix is so varied, whether it's alternative, whether it's long-only, whether it's U.S., non-U.S., whether it has a middle office component. It's hard to isolate those variables to give you a clear direction on that. Our strategy is to, as you know, by our 80% of new revenues coming from existing customers, to cross-sell a wide variety of products and services. And we think over time, if we do that and customers are successful and assets grow, not only will we be the beneficiary of the revenue growth, but we can also further penetrate some of the transactional service fees. But it's hard to isolate specifically for that question. Thanks, John. We look forward to talking to all of you at the end of the second quarter call. Thanks.

Operator

This does conclude today's conference call. You may now disconnect.

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