State Street Corporation Update Call Transcript

Jan. 3.08 | About: State Street (STT)

State Street Corporation (NYSE:STT)

Update Call

January 3, 2008 8:30 am ET

Executives

Kelley MacDonald – IR

Ronald E. Logue – Chairmanand CEO

Edward J. Resch - CFO

Analysts

Glenn Schorr - UBS

Nancy Bush - NAB Research, LLC

Ken Usdin - Banc Of AmericaSecurities

Brian Bedell - Merrill Lynch

Gerard Cassidy - RBCCapital Markets

David Hilder - Bear Stearns

Betsy Graseck - Morgan Stanley

Operator

Good morning and welcome to State Street Corporation’sConference Call and webcast to discuss its reserve announcement. Today’s callis being broadcast live on State Street’swebsite at www.StateStreet.com/stockholder.

This call is also being recorded for replay. State Streetcall is copyrighted, allrights are reserved. Thecall may not berecorded or rebroadcast for distribution, inwhole or in part,without expressed written authorization from State Street. Theonly authorized broadcast of this call is housed on State Street’s website.

Now I would like to introduce Kelley MacDonald, Senior VicePresident for Investor Relations atState Street. Please goahead, ma’am.

Kelley MacDonald

Good morning, everyone. Before Ron Logue, our Chairmanand CEO, and CFO Ed Resch begin their remarks, I would like to remind you thatduring this call we may make forward-looking statements relating to thecorporation’s financial outlook, business environment, exposure to claims and theadequacy of its reserve, among other things. Actual results may differmaterially from those indicated by those forward-looking statements as aresult of various important factors, including those discussed inState Street’s 2006 annual report on Form10-K and its subsequent filings with theSEC.

We encourage you to review those filings, including thesections on risk factors concerning any forward-looking statements we may maketoday. Any such forward-looking statements speak only as of today, January 3, 2008 and thecorporation does not undertake to revise such forward-looking statements toreflect events or changesafter today.

Now I’ll turn thecall over to Ron.

Ronald E. Logue

Thank you, Kelley and good morning. We initiated this calltoday to explain adecision we’ve made to address legal exposures and other costs relating to theunderperformance during 2007 of asmall number of our active fixed income strategies managed atState Street Global Advisors. As aconsequence of theunprecedented events inthe credit marketsover the past sixmonths, these strategies were adversely affected by exposure to, and thelack of liquidity in, sub-prime mortgage markets.

First I’ll focus on what happened and why we aretaking the charge atthis time. Then I’ll talk about what we’ve done to make sure itdoes not happen again. I know charges like this arenot what you have come to expect from State Street,and I’m determined to avoid ithappening again.

Lastly, I’ll discuss theimpact on our 2007 performance and what we think about theeffect on 2008. Ed will then provide specific details on our expectations for thefourth quarter and thefull year 2007, as well as theimpact on our capital.

First let meaddress what happened. I amgoing to start with some metrics to give you asense of the scope of theissue. Active fixed income strategies represent less than 2% of the$2 trillion in assetsmanaged by SSGA. As we disclosed inthe third quarter10-Q, as of June 30, 2007,SSGA managed $222 billion infixed income assets; about $38 billion of which was inactive fixed income. As of September 30, 2007 SSGA managed $244 billion infixed income assets, of which $36 billion were actively managed.

Of theactive fixed income assets atJune 30, 2007 approximately$13.9 billion, or less than 1% of total assets under management, was inactive strategies that had holdings infinancial instruments collateralized by sub-prime mortgages. By September 30, 2007 this $13.9 billionhad declined to approximately $8.2 billion due to redemptions, transfers toother funds, and market conditions.

Sowhat drove this decline? Among other things, theportfolio managers of certain actively managed fixed income strategiesmaterially increased theexposure of these strategies to securities backed by sub-prime mortgages andshifted the weighting ofthese portfolios to more highly rated sub-prime instruments.

During thethird quarter, as liquidity and valuations of these securities -- including themore highly rated instruments -- came under increased pressure, theperformance of these strategies were adversely affected; insome cases, significantly.

This negative performance resulted inincreased redemption activity which worsened theliquidity issues incertain instances. Theunderperformance, which was greater than that typically associated with fixedincome funds, also caused anumber of clients to question whether theexecution of these strategies was consistent with their investment intent.

Theissues have resulted infive civil suits, including three class action claims. Given these issues, andour desire to fully respond to customer concerns, following theend of the thirdquarter we undertook afurther review of allactively managed fixed income strategies atSSGA that were exposed to sub-prime investments.

Based on our review and ongoing discussions with customerswho were invested inthese strategies, we have now determined that accounting requirements, prudenceand our goal of providing as much financial transparency as possible require theestablishment of a reserveto address legal exposure.

First and foremost, State Streetvalues its reputation as atrusted fiduciary to institutions around theworld. We fully recognize thecritical importance of preserving this reputation with our customers. As such,we are determined toaddress customer concerns where and to theextent merited by theparticular circumstances.

However, I want to beclear here: we will continue to defend ourselves vigorously againstinappropriate claims, including those that seek recovery of investment lossesarising solely from changesin market conditions. We’veworked with our legal and accounting advisors sothat this reserve is set atthe appropriate level,is well supported and is expected to beadequate to cover our liability.

Let menow address the stepswe have taken to prevent asimilar occurrence in thefuture. In taking thischarge and establishing thereserve we have carefully reviewed theportions of our business, both inSSGA and more broadly, that have been, or may potentially be, impacted by theliquidity crisis in thefixed income markets. While we cannot predict future developments inthat marketplace, we areconfident that we have identified and aremanaging the knownliquidity risks throughout our company.

Ed will later update theperformance of our asset-backed commercial paper conduits and our investmentportfolio, which we discussed insome detail on thethird quarter conference call.

We have avoided any sub-prime investments inour money market products and have none of this exposure inour U.S.registered or unregistered money market products. Our global markets and oursecurities finance businesses remain strong and our investor servicing businesshas not been adverselyaffected by disruption inthe fixed incomemarkets.

WithinSSGA, we have taken steps to build upon our experienced management team and putthe issues in the active fixed income fundsbehind us. We also announced today that Jim Phalen has been named Interim CEOwhile we conduct asearch for a permanentCEO for SSGA. Jim is along-time State Streetsenior executive and member of our operating group, who spent five years insenior roles at SSGA.About a year ago, Iasked Jim to take on anew role leading our investment servicing and trading and research businessesglobally, based out of London.

Healso chaired withMark Lazberger of SSGA, our European and AsiaPacific executive boards that determine strategy for these important regions.Jim has adeep knowledge of thebusiness and importantly, SSGA’s customers. Hewill work closely with SSGA’s management team to ensure that theleadership transition is effective, as smoothly as possible, and that itis very much business as usual for our customers.

Now as we announced inNovember, we have appointed anew Chief Investment Officer for Fixed Income and appointed CIOs for our otherasset classes. Theindividuals heading these asset classes have combined experience of more than100 years.

As we have done for thepast several years, we areand will continue to increase our investment inSSGA’s risk and compliance personnel and infrastructure. This is not just aboutpeople though; it isalso about policies and procedures. As acautionary measure, we arealso undertaking asystematic review of therisk, compliance and control infrastructure across thebroad array of SSGA’s products and its operations to help protect us againstany future negative surprises, and we arebeing aided in thisreview by experienced, third party consultants.

We have also closed certain funds or modified theinvestment policies of theactive fixed income strategies that were exposed to sub-prime markets andsuffered significant losses during thethird quarter. Theinvestors have either set up separate accounts to manage their funds, or theyhave redeemed their assets or transferred their assets to other SSGA funds. We arenot abandoning theactive fixed income space and we arecommitted to rebuilding both theteam and the productline.

As you may have read, several fixed income investmentprofessionals left State Streetin November. Whilethese are personalactions which we will not comment on, we intend to add to teams that manage ouractive fixed income strategies. We also have adeep bench to drawfrom, evidenced by how quickly we appointed Mark Marinella as thefixed income CIO.

Now let mecomment on the impacton 2007 results. When we announced theresults of the thirdquarter, we indicated that in2007 we expected to perform above our ranges for operating earnings pershare, operating revenue and operating return on equity, excluding theimpact of the investorsfinancial merger and integration costs. As you may recall, those ranges aregrowth in operatingearnings per share of10% to 15%, growth inoperating revenue of 20% to 22% and operating return on equity of 14% to 17%.

Under GAAP, earnings pershare for 2007 is now expected to bebetween $3.42 and $3.45 pershare and return on equity is expected to beapproximately 13%. I would like to mention that our 2007 earnings pershare excluding just themerger and integration costs and thetax adjustment in2006, but not theimpact of the reserve wouldstill be up about 10%,the lower end of therange we provided last February.

On anoperating basis, that is excluding theimpact of the reserve,the merger andintegration costs associated with our acquisition of Investors Financial inJuly 2007, and theeffect of the $65million or $0.20 pershare of 2006 tax adjustments, we continue to expect earnings pershare to be between$4.54 and $4.57 and thereturn on equity to beapproximately 17.5%, both above theranges provided on October 16, 2007.

This full year earnings pershare outlook on anoperating basis compares to theresults of 2006 of $3.46 pershare. We continue to expect to exceed theyear-over-year revenue growth range provided of 20% to 22%. Infact, as we announced this morning, we now expect our revenue to growin excess of 30% in2007.

Now before I turn thecall over to Ed, let meremind you of thestrength of our corebusiness. As I noted on our third quarter earnings conference call, therecent market volatility hascreated some opportunities for us intrading and in securitiesfinance. Our balance sheet strategies continue to payoff for us as our net interest income through ninemonths was up 47%, compared to thefirst nine months of2006, and our net interest margin was 161 basis points through ninemonths, up 39 basis points from 122 basis points through thefirst nine months of2006.

As I mentioned on thethird quarter call, we won$825 billion in assetsin our servicingbusiness in thethird quarter, which positively affected revenue inthe fourth quarter of2007 and will positively affect revenue inthe first two quartersof 2008. We also won$26 billion in assets innet new business at SSGAduring the thirdquarter.

On theservicing side, in thefirst two months of thefourth quarter we wonapproximately $250 billion inassets. On themanagement side, we wonapproximately $17 billion inassets. Due to thestrong growth in our corebusiness lines, as well as continued expansion of net interest margin andstrength in tradingservices, we continue to bevery comfortable about achieving our long-term financial goals in2008. On our fourth quarter 2007 earnings call on January 15, I’ll provideadditional guidance regarding our 2008 financial goals.

Now, let meturn the call over toEd, who will provide more detail as to thefinancial impact of decision.

Edward J. Resch

Thank you, Ron and good morning. First, regarding theearnings, we expect to seecontinued strength inour core businesses,both asset servicing and asset management and we expect operating earnings pershare to improve about 50% over theprior year’s fourth quarter. Volatility inthe market shouldprovide some strength inboth foreign exchangeand in securitiesfinance compared to theprior year’s fourth quarter as well.

Net interest income should also improve significantlyagainst last year’s fourth quarter and also improve indouble-digits when compared to this year’s third quarter.

Excluding thecharge and the mergerand integration costs in2007, we expect to again achieve positive operating leverage on ayear-over-year basis as well as on asequential quarter basis.

Both fee revenue and net interest revenue appear on track tobe strong, fueled by thenew business wins we’ve announced over thepast year, so weexpect to perform above 20% to 22% range of revenue growth we establishedfollowing theacquisition of Investors Financial. Specifically, we expect revenue to increasemore than 30% compared to 2006. We expect our effective tax ratefor the year to be35% on an operatingbasis.

Sowhile the impact onour fourth quarter GAAP results will besignificant, we expect to perform above thetop of the ranges foroperating earnings pershare and operating return on equity as we have defined them. As Ron indicated,we expect operating earnings pershare for 2007 to bebetween $4.54 and $4.57, up about 30% from operating earnings in2006.

Let meadd just a little moreinformation about theconsolidation of Investors Financial. TheInvestors Financial business continues to perform very well; infact, above the levelof our deal model. Due to strong revenue performance, we continue to expectdilution per sharefrom the acquisition in2007 to be about$0.06, down from theoriginal $0.14 dilution pershare.

Theconsolidation continues on schedule. Theconversion of customer accounts is about 25% complete. As we indicated on thethird quarter call, we continue to expect to retain atleast 90% of therevenue. Even with this charge, State Streetwill only be slightlybelow the middle ofour target leverage ratio range. We have metwith our regulators inthe rating agenciesabout the reserve andreviewed our capital plans with them.

Theprincipal ratio that we manage to is atier 1 leverage ratio.We will continue to target for both thecorporation and thebank to be slightlyabove the high end ofour range of 5.25% and 5.75%. For thecorporation, we expect thetier 1 leverage ratioto be inthe range of 5.2% to5.3%, and the bank’s tier1 leverage ratio to bein therange of 5.4% to 5.5% as of December 31 and we expect thecorporation’s tangible common equity ratio to bebetween 3.4% and 3.5%.

We arein theprocess of evaluating over thenext few weeks thespecifics of raising non-dilutive tier1 qualified capital. We will obviously update you as we reach adecision. This expected capital raising, plus thecapital generated from retained earnings, should put us ina strong position by thesecond quarter of 2008. I remind you that thecorporation’s tier 1capital ratio stood at11.65% at September 30, 2007 and we expect itto be inthe range of 11.3% to11.4% as of December 31, 2007after the impact of thecharge. We expect thebank’s tier 1 capitalratio to be inthe range of 11.3% to11.4%.

We expect our balance sheet to growslightly, primarily based on growth incustomer deposits as well as theincreased level of liquidity we carried inresponse to market conditions which occurred inthe quarter.

I will update you ingeneral about theperformance of theasset-backed commercial paper issued by our conduits, as well as theperformance of theinvestment portfolio, since I assume those two areas areon your minds. First, thecommercial paper hascontinued to attract liquidity inthe marketplace atincreased spreads compared to earlier in2007, but not as high as thespreads we experienced inAugust and early September. Theoverall asset quality and diversification of theconduit portfolio hasnot changedmaterially from thedata we disclosed in thethird quarter 10-Q and on thethird quarter conference call.

Atthis time, we believe that we donot need to consolidate theconduits. As of theyear end, State Street hadfunded $2 million incommercial paper, down from $730 million we held on September 30, 2007 and also down from the$222 million we funded as of October 15, 2007.

Our investment portfolio is performing as expected,particularly that portion of theportfolio which is invested inasset-backed securities collateralized by sub-prime mortgages. As of year end,those securities totaled $6.3 billion of which 72% areAAA-rated and 28% areAA-rated. Due to paydowns, we have credit enhancement of 40% on thesesecurities.

We have experienced no ratings downgrades to thesesecurities; however, five securities -- or $25 million intotal -- have been placed on watch for downgrade due to recent rating agencyconcerns regarding certain financial guarantors.

Sowe’re confident about managing our capital position, theperformance of our investment portfolio and theadministration of our conduit program. Our operating results areexpected to be verystrong for both thefourth quarter and thefull year.

Now I’ll turn thecall back to Ron.

Ronald E. Logue

Thank you, Ed. I hope during our comments today we havegiven you a sense ofwhat happened within asmall number of our actively managed fixed income strategies which result inthis charge; what we aredoing to help prevent thereoccurrence of issues such as this and what we seeas the outlook for2007 and 2008.

But before we moveto your questions, I want to make one other comment. I strongly believe that thetime to assess themeasure of a companyis not when things aregoing well, but how itperforms when faced with adversity. Now thekey judgment, inmy opinion, is how does acompany deal with its issues and face its challenges. Theway we face such adifficulty at State Street is to follow thevalues that are atthe coreof our company.

These arevalues that we consistently communicate within and outside our company and arerepresented by thefour constituencies we serve. You have heard metalk about them before: our shareholders, our customers, our employees, and ourcommunity. Our actions with regard to allfour of these constituencies areguided by doing what is right.

We need to beopen and transparent with our shareholders. We need to befair to our customers. We need to judge theperformance of our employees accurately and we always need to give back to thecommunities where we live.

It’s through these actions, even during times of difficulty,that will sustain thelong-term financial performance and growth of this company. Soin keeping with thisbelief, we arecommitted to addressing theissues that have been identified within our fixed income strategies ina manner that isbalanced, responsible and fair and that helps us put these issues firmly behindus, because we have somuch momentum right now and we need to take advantage of it.

Ed and I arenow happy to take your questions.

Question-and-AnswerSession

Operator

(Operator Instructions) Our first question comes from GlennSchorr - UBS.

Glenn Schorr - UBS

What’s thedistinction between agood claim versus not agood claim? In otherwords, you made aclear comment about defending vigorously against drops inmarket valuation. I guess I’m just missing… you know, theassets were so bigand now they aresmaller. They fell due to anover-concentration inassets. Either theassets belong in theportfolio or not. I guess I’m missinghow you come up with $618 million pre-tax reserve to begin with.

Ronald E. Logue

Let memaybe answer thequestion two ways, and let mefirst say thatobviously, I’m going to talk somewhat ingeneral terms, because we arestill in litigation, soI have to do that. ButI also want to try and beas transparent as I can here.

Thereserve first of allwas built from thebottom up, customer by customer, working very closely with our legal andaccounting partners as you might imagine and we spent along time presentingwhat that is. Probably thebest way I can differentiate, if that’s theright word, is to talk alittle bit about theprocess itself.

Portfolio managers make investment decisions. TheCIOs, as you might imagine, review and approve those decisions. Aninvestment committee periodically reviews, generally, those decisions. Overlayingall of that there is arisk and compliance process to ensure that those investment decisions areproper and consistent with customer guidelines. There can begray areas there from time to time and inmany cases, it’s very clear and very obvious and well-communicated as to whatwas happening; and insome other cases, it’s not as clear.

That’s probably thebiggest distinction, Glenn, that I can explain. On those situations, what isimportant for us to dois to listen very carefully to thecustomer concerns and very carefully understand and try to determine what thoseissues are and as Isaid, be fair. That’s thebiggest distinction.

Glenn Schorr - UBS

I getthat. That’s very helpful. I appreciate that. Is there any insurance that weshould be thinkingabout?

Ronald E. Logue

There is insurance, it’s not included inthe reserve foraccounting reasons, but we dohave insurance and we would expect that we would getsome claims back on insurance.

Glenn Schorr - UBS

That’s something that we will just wait on over time, Iguess?

Ronald E. Logue

Yes, that’s right.

Glenn Schorr - UBS

We arelooking at afourth quarter that could have been around $1.40. That’s well above where we allwere guesstimating. I know we had agood volatile quarter soI am guessing FX and seclending were strong, but you made comments also about net interest income updouble-digits versus last quarter. That, plus just good corebusiness momentum, that’s how we getto the overage, thosefour components?

Ronald E. Logue

Obviously, trading insecurities finance were very strong just like they were inthe third quarter,that we talked about, Glenn. But thefundamental business is extremely strong being driven by significant net newbusiness at $825billion. The feeincome is very, very strong, and will berecurring into thefirst half of ’08 sothere is a lot ofstrength there, and obviously there continues to besignificant strength inNIR and I would expect that would continue.

Operator

And our next question comes from Nancy Bush - NAB Research,LLC.

Nancy Bush - NABResearch, LLC

You said that you areconducting a reviewnow of risk management inSSGA. Do you have anypreliminary observations about where perhaps risk management or oversight wasflawed in this wholesub-prime crisis debacle? Is itsimply a matter of themarkets? If you could just expand on your preliminary thoughts on that, I wouldappreciate it.

Ronald E. Logue

Themarkets obviously led to some of that. From what we can seehere, as we sit here today itstill seems to beisolated into theactive fixed income areas. Processes arein place. I think what we need to dois obviously because of thefact that markets aredifferent now and probably aregoing to stay different, then we obviously have to redouble our efforts thereand enhance those policies and procedures.

Ayear ago atthis time I don’t think we would have ever considered 100% liquidity as anissue. So theissue here I think is one of looking atthe new marketrealities and making sure that we have inplace enhanced risk and compliance issues to deal with those realities. I thinkthat’s the biglesson learned here for us, and probably for many others.

Nancy Bush - NABResearch, LLC

This is happening; I mean, there is obviously headline riskhere. Thank God this is happening inthe midst of atime when thefundamentals are quitestrong, but there is continued headline risk and it’s happening ata time when there is abig integration goingon at one of yourcompetitors.

What areyou doing? Are youfinding that you have to doanything extra special to make sure this does not impact your prospects for winningnew business from what’s going on inthe industry?

Ronald E. Logue

Well obviously one of thereasons we are doingthis is to get thisbehind us, to eliminate some of thedistractions, but more importantly I think that theintegrations that aregoing on at our competitors,and here ourselves have to dowith asset servicing, not asset management, sothey are prettydistinct and separate, soI don’t see any issuethere.

I think theproof of the pudding isthe fact that we won$825 billion in thethird quarter and in thefirst two months of thefourth quarter another $250 billion, which is fairly significant.

Operator

Your next question comes from Ken Usdin - Banc Of AmericaSecurities.

Ken Usdin - Banc Of America Securities

You mentioned about being very confident about achievingyour long-term goals in2008. I just want to make sure that I amthinking about this theright way. Would that imply that you areexpecting to be withinyour typical growth range goals on anoperating basis versus the$4.54 to $4.57, just using EPS as one of thethree goals? Is that what you’re saying?

Ronald E. Logue

What we’re saying is we expect to beback on a GAAP basis –well not on a GAAPbasis, but we expect to beback on an operatingbasis.

Ken Usdin - Banc Of America Securities

Soyou still expect to begrowing on anoperating basis within your long-term growth ranges in2008, even after this very strong result that you’re posting for ‘07?

Edward J. Resch

Just one added comment there, which is that because we onlyhad IFIN for half ayear this year in ’07we’ll be adjustingupward our long-term revenue growth goal to reflect thefact we’ll have a fullyear of IFIN in2008. But other than that, absolutely; thequestion is do weexpect, long term, to bewithin our long-term financial goals for 2008.

Ken Usdin - Banc Of America Securities

As far as thefourth quarter concerns this extremely strong result, obviously you mentioned thecontinued strength and thevolatility on thevolume side of FX and sec lending. Is there some of that you think doesn’trecur? Does this really correspond to theenvironment? How much doyou think that this heightened volatility type of environment is going tocontinue as well?

Edward J. Resch

I think that really depends on what happens inthe markets goingforward. I would sayif there is a gradualeasing in thecredit markets over time that absent any other variable, that I would expectthat those two business wouldn’t continue to beat thesame levels.

Ken Usdin - Banc Of America Securities

Can you walk us through how the$618 million gets to $279 million and how you net out thetaxes and theincentive comp against thepre-tax charge?

Edward J. Resch

We start with our bottom-up analysis that Ron I think tookeverybody through and come up with anumber of $600 million. To that, we add some other expenses, which arebasically severance and professional costs associated with thereserve that gets you to the$618 million. Based on theway that our incentive compensation formulas work, there is aneffective reduction to incentive compensation of about 25% of thegross reserves, socall that $151 million. That gives you $467 million. And then you tax effectthat at our marginal rateof about 40% and that brings you down to $279 million after tax effect and thattranslates into $0.71 inthe fourth quarter.

Ken Usdin - Banc Of America Securities

So thecomp, essentially, and therelated revenues come out of expenses?

Edward J. Resch

Yes.

Ken Usdin - Banc Of America Securities

Sothat’s incentive comp that was previously accrued that gets reversed or just asa net to thecharge?

Edward J. Resch

No, it’s on two lines, Ken. Thecomp is reflected on salaries and benefits and thecharge is reflected as other, soit’s not netted on our income statement, although there is areduction inpreviously accrued incentive comp.

Ken Usdin - Banc Of America Securities

Thego-forward impact of this is also just revenues within apiece of SSGA?

Ronald E. Logue

Yes. I mean, SSGA continues to perform extremely well. Justyesterday I read aReuters article that said SSGA had thehighest inflows for themonth of November, I think itwas $6.1 billion. ETFs areextremely strong, active equities continue to beextremely strong. SSGA continues to perform and attract significant inflows.

Operator

Your next question comes from Brian Bedell - Merrill Lynch.

Brian Bedell - Merrill Lynch

Just to zero inon a couple of thedrivers for 4Q. Ed, you said net interest income was up double-digits 3Q to 4Q-- is that not annualized?

Edward J. Resch

That’s just thepercentage increase.

Brian Bedell -Merrill Lynch

Yes, but you’re not annualizing that number, correct?

Edward J. Resch

No.

Brian Bedell -Merrill Lynch

Is that more due to anexpansion or due to growth inthe balance sheet?

Edward J. Resch

It’s more due to net interest margin expansion. I meanbasically in thefourth quarter, what we had inthe third quarter,Brian, I mean thefourth quarter margin will bein therange of 195 or so andthe full year will bearound 170 basis points. Sothere’s margin expansion driven by alittle bit bigger balance sheet driven by theforeign transaction deposit flows that we’ve talked alot about.

Brian Bedell -Merrill Lynch

Doyou think that 195 is sustainable into ‘08?

Edward J. Resch

Well, it’s atthe high end of theguidance that I talked about on thethird quarter call and I’d like to reserve further comments about ‘08 until ourearnings call or even our investor day. But we arestanding by the 185 to195 range we set for ’08 for now.

Brian Bedell -Merrill Lynch

On thefee lines, the $825billion that you won, was only part of that infourth quarter and you aresaying more is being converted inthe first half?

Ronald E. Logue

Just aportion of that, Brian, is inthe fourth quarter. Youwill see, I would think amajority of theremainder, reflected infirst and second quarter fee numbers.

Brian Bedell -Merrill Lynch

Sowe continue to have atail end from that influx of $250 billion that you wonduring this quarter?

Ronald E. Logue

Correct.

Brian Bedell -Merrill Lynch

Did you say$66 billion in net newassets won atSSGA in thefourth quarter?

Ronald E. Logue

There was aReuters article inthat came out yesterday that I saw.

Brian Bedell -Merrill Lynch

Itwas $6.1 billion.

Ronald E. Logue

$6.1 billion innet inflows.

Brian Bedell -Merrill Lynch

Right. That’s your mutual funds, right? But doyou have an SSGA netflow?

Ronald E. Logue

That was SSGA.

Brian Bedell -Merrill Lynch

Yes, but they arereferring to mutual funds inthat one.

Ronald E. Logue

EPS is probably thebiggest piece of that. I haven’t looked atthe numbersspecifically to seehow it’s broken down, but my bet, itwould be significantlyskewed towards EPS.

Brian Bedell -Merrill Lynch

Is foreign exchangehigher in thefourth quarter than itwas in thethird quarter?

Ronald E. Logue

Yes.

Edward J. Resch

Yes. Double-digits.

Brian Bedell -Merrill Lynch

Double-digits, not annualized.

Edward J. Resch

Nope.

Brian Bedell - MerrillLynch

Going back to thecompensation charge, itsounds like if we exclude thecharge, thecompensation that you will report inthe fourth quarter is anormalized compensation number, is that correct?

Edward J. Resch

Well, itwould be normalizedgiven the strongperformance that thecompany had for 2007, yes, based on our compensation plans.

Brian Bedell -Merrill Lynch

So thetax benefit that you’re getting is not that large, I guess? Itlooked like originally there was avery large tax benefit because of theway we were applying that 279 to the618, but what you’re saying is $150 million of that --

Ronald E. Logue

Just 40% of thenet.

Brian Bedell -Merrill Lynch

So the$140 million, roughly 4Q07 is acore operatingearnings run ratethat’s essentially sustainable depending on how themarket conditions go, of course, but basically we should beusing that 140 as apretty good guide for quarterly earnings power, is that correct?

Ronald E. Logue

I’m not clear, Brian, on the$140 million that you’re referring to. Could you repeat that please?

Brian Bedell -Merrill Lynch

Backing out theIFIN charges and the$0.71, your operating earnings would beabout $139 million to $140 million?

Edward J. Resch

Yes.

Brian Bedell -Merrill Lynch

What I was thinking prior to this call was that there was alarge reduction in thecompensation, but that’s actually included inthe charge. Soin other words, that $139million to $142 million is actually agood quarterly run rateto go from?

Ronald E. Logue

Well yes, given therevenue strength that we experienced inthe fourth quarter,yes.

Brian Bedell -Merrill Lynch

Yes, and nothing unusual inthat number with regards to compensation?

Ronald E. Logue

No, not atall; just the normalcompensation that would go with therevenue strength that we’ve talked about inthe quarter.

Brian Bedell -Merrill Lynch

I think to Ken’s question for 2008, we should beusing something around the454 to 457 ranges for ‘07 base and then if you’re inwith your long-term goals of 10% to 15%, we should begrowing that between 10% and 15%?

Ronald E. Logue

Yes.

Brian Bedell -Merrill Lynch

On the$618 million, you guys explained itpretty well, but I was alittle surprised by thesize of that charge relative to thelegal exposures that we’ve seen sofar; Prudential was $80 million and you had afew other suits inthere. But it seemslike you arecapitulating on that but yet you aresaying that you did plan to defend itvigorously. Do youexpect some of this to bereversed in 2008 asyou defend itsuccessfully?

Ronald E. Logue

Brian, we’re not going to talk about any individual claim,but obviously it’s going to depend on themerits of each of these claims. We’re not capitulating on anything.

Brian Bedell -Merrill Lynch

You’re just being conservative and reserving for it?

Ronald E. Logue

We’re just trying to put itbehind us.

Operator

Your next question comes from Gerard Cassidy - RBCCapital Markets.

Gerard Cassidy - RBC Capital Markets

You mentioned that you thought that the2007 revenues could exceed 30% growth over 2006. If you back out theInvestors Financial, what kind of growth doyou think you guys would have recorded to take into account thepurchase accounting?

Ronald E. Logue

It’s significant, actually Ed hasthose numbers.

Edward J. Resch

TheInvestors Financial acquisition contributes about seven percentage points ofour year-over-year revenue growth. State Street without Investors Financial, ifyou will, if we start with a30% level of revenue growth would beabout 23%.

Gerard Cassidy - RBC Capital Markets

Should we expect then inthe second half of‘08, because we will have afull 12 months of Investors Financial that on apercentage basis you could seea deceleration becauseyou don’t have theInvestors Financial inthe first half of ‘07?

Ronald E. Logue

Itreally depends on how well we sell inthe first half of ‘08as well. Right now our pipelines arepretty full so I feelpretty good in termsof our ability to sell inthe first half of ‘08and install in thesecond half of ‘08 which is what we usually try and do.

Gerard Cassidy - RBC Capital Markets

Interms of this growth, areyou seeing more income from non-U.S. areas over inEurope and other places, or is theU.S. as strongas ever?

Ronald E. Logue

Well, if I could characterize thethird quarter growth, alot of that was U.S.and a couple bigtakeaways – that may bean anomaly, but -- thenon-U.S. growth hascontinued to be strongconsistently, quarter after quarter. Iwould expect that would continue, especially AsiaPacific.

Gerard Cassidy - RBC Capital Markets

You mentioned thebig takeaways. Is thatfrom companies that arenot as focused on this business, or is itmore due to an integrationof maybe one of your competitors?

Ronald E. Logue

I can’t comment on thenames, but they were from some of our bigcompetitors.

Operator

Your next question comes from David Hilder - Bear Stearns.

David Hilder - Bear Stearns

Could you just provide somethoughts on your reason for proceeding with capital raising?

Ronald E. Logue

Yes, we’re evaluating what we aregoing to do, specifically. Themode that we are inis one of being conservative from acapital standpoint; I think we have talked about that for thelast half of ’07. That is going to continue going into our thinking aboutcapital as we go into ‘08, given that themarkets in our viewanyway have not yet returned to their Q2 levels of stability, sowe are playing itconservative. We arenot thinking about itas a capital raisingof significant size, but we areconsidering possibly raising some tier1 qualifying capital just to hold through our ratios as we moveinto the firstquarter.

David Hilder - BearStearns

Just alittle more detail, is that because you expect significant balance sheet growthor is it really movingtowards a differenttarget capital ratio, given some of thereviews that Ron talked about?

Edward J. Resch

We arenot anticipating asignificant balance sheet growth; we’re expecting thebalance sheet in ‘08to grow inline with customer deposit growth which we areexpecting to be fairlymoderate.

But we arethinking about raising thequalifying capital, again inorder to run at alevel on our leverage ratio higher than the5.75 which I’ve said is our long-term goal, thetop end of it. So, if we’re running atabout 6% on theleverage ratio, 6% inorder to beconservative, I think that’s where we want to beand that’s why we’re thinking about raising thecapital, basically to replace thecharge that we just talked about on this call.

David Hilder - BearStearns

Ron, is there anything you can tell us about thestatus of the Prudentialaction?

Ronald E. Logue

No, there really isn’t. There hasn’t been alot of action there, right now atall on that. I can’tcomment on any specific one.

Operator

Your next question comes from Betsy Graseck - MorganStanley.

Betsy Graseck -Morgan Stanley

Just as afollow-up on the lastquestion on capital raising, doyour new expectations for ‘08 take into consideration theinterest expense associated with expected capital raisings?

Ronald E. Logue

Yes, itdoes.

Operator

Atthis time it doesappear that we have no further questions. Mr. Logue, I will turn thecall back over to you for additional or closing remarks.

Ronald E. Logue

I have no other closing remarks. I look forward to speakingwith you all on ourearnings call in acouple of weeks and I think we will beable to provide some more information atthat time.

I also look forward to talking to you allat our investors day inFebruary. We will, again, talk to you ina couple of weeks.Thank you very much for attending thecall on such short notice as well.

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