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Ameriprise Financial Inc. (NYSE:AMP)

Q2 2012 Earnings Call

July 26, 2012 9:00 am ET

Executives

James Cracchiolo – Chairman, Chief Executive Officer

Walter Berman – Executive Vice President, Chief Financial Officer

Alicia Charity – Senior Vice President, Investor Relations

Analysts

Sumeet Kamath – UBS

Jay Gelb –Barclays

Alex Blostein – Goldman Sachs

Tom Gallagher – Credit Suisse

Eric Berg – RBC Capital Markets

John Nadel – Sterne Agee

Operator

Welcome to the second quarter 2012 earnings call. My name is Kim and I will be your operator for today’s call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded.

I will now turn the call over to Ms. Alicia Charity. Ms. Charity, you may begin.

Alicia Charity

Thank you and welcome to Ameriprise Financial’s Second Quarter Earnings call. With me on the call today are Jim Cracchiolo, Chairman and CEO, and Walter Berman, Chief Financial Officer. Following their remarks, we’ll be happy to take your questions.

During the call, you will hear references to various non-GAAP financial measures which we believe provide insight into the underlying performance of the Company’s operations. Reconciliation of the non-GAAP numbers to the respective GAAP numbers can be found in today’s materials available on our website.

Some statements that we make in this call may be forward-looking, reflecting management’s expectations about future events and operating plans and performance. These forward-looking statements speak only as of today’s date and involve a number of risks and uncertainties. A sample list of factors and risks that could cause actual results to be materially different from forward-looking statements can be found in today’s earnings release, our 2011 annual report to shareholders, or our 2011 10-K report. We undertake no obligation to update publicly or to revise these forward-looking statements.

And with that, I’ll turn it over to Jim.

James Cracchiolo

Good morning. Thank you for joining us for our second quarter earnings discussion. I’ll begin with my overview of our business performance for the quarter and then Walter will discuss our financial results in more detail. Afterwards, we’ll take your questions.

As we reported yesterday, our headline operating results were impacted by a few items, the largest of which relates to taxes in prior periods. Walter will explain these in more detail. If you exclude these items, EPS and return on equity would have been up nicely.

Overall, results in the quarter were solid despite the challenging market conditions and low interest rates that continue to pressure revenue levels which you are seeing across financial firms; and as you would expect, we are adjusting our expense levels to reflect this decline. We’re making good progress executing our strategy in helping our clients navigate a difficult market environment. Our business fundamentals are sound with solid traction in our advisory business, good client acquisition, and strong retail net flows.

In asset management, we’ve completed our integration of Columbia Management and together with Threadneedle have a global platform with strong performance and expanded distribution. In protection annuities, we maintained good books of business with strong risk management and underwriting. We continue to manage expenses prudently and our balance sheet and capital management underpin our firm. Meanwhile, we have the flexibility to invest for business growth and return significant capital to shareholders while maintaining the flexibility afforded by our free cash flow and large excess position.

During the quarter, we devoted $428 million to share repurchases and dividends. With the increased dividend we announced last quarter, our dividend yield is about 2.9%, which is at the higher end of our peer group. In fact, over the past six quarters we’ve returned more than 130% of our operating earnings to shareholders, putting us in the top quintile of financial companies in the S&P 500.

Now let’s review our business segment performance. First, advice and wealth management – we generated nice improvements in profitability in the quarter considering the market headwinds. Total retail client assets increased 4% year-over-year to $331 billion aided by strong client net inflows in the quarter. We’re continuing to invest in capabilities that will help our advisors reach more clients and serve existing clients more fully.

One of our largest investments is our new brokerage platform. It’s a multi-year project and its rollout has been successful. All our employee advisors and more than half of our franchisee advisors are working on the new platform with the remaining advisors making the switch later this quarter. While training will continue, the larger investments for this project will wrap up later this year.

We also continue to invest in our brand and have enhanced our web presence and online capabilities. Heardable Score, which measures online brand performance, ranked Ameriprise third in full-service investment brands online, topping many other large firms. Overall, we feel good about our brand positioning and consumer awareness.

With an established brand and strong value proposition, experienced advisor recruiting is going well. During the quarter, 91 experienced advisors with good books of business joined Ameriprise. Approximately 400 advisors have moved their business to Ameriprise over the past year, and we have seen a steady increase in the productivity levels of recruited advisors. I feel very good about the quality of the advisors who are joining Ameriprise and our efforts to bring them onboard. They have strong practices and share our values. In addition to our recruiting success, our long-tenured advisors remain highly satisfied, resulting in very strong retention rates.

In terms of productivity, operating net revenue per advisor was down slightly for the quarter, driven by the unease in the markets. We are increasingly working with clients and fee-based relationships, and our fee-based production increased by nearly double digits; however, as volatility spiked during the quarter, client transaction volumes declined.

As we invest in tools to help advisors grow their practices and improve their productivity, we still maintain a strong expense discipline. We ended the quarter with a pre-tax operating margin of 11.6%, up from 11.3% a year ago and 9.9% sequentially. Short-term interest rates continue to have a significant impact on our results and the industry. For example, for just the year-over-year period, low interest rates impacted profitability in the segment by 100 basis points.

As we move forward, we continue to focus on pulling the right levers to drive profitability improvements in a lower revenue growth environment. Earlier this month, you likely saw that we are transitioning our federal savings bank to a non-depository national trust bank. While we have grown the bank since launching it in 2006, it is a small part of our overall business. Unfortunately, Dodd-Frank does not distinguish between large consumer banks and companies with limited banking operations like Ameriprise. Once complete, we will no longer be considered a savings and loan holding company.

Importantly, our deposit and lending client value proposition won’t change. What will change is that it will be delivered through third parties. These are quality firms, and in many cases they had existing relationships with the bank. While our decision will impact the advice and wealth management segment due to the loss of revenue and good margin business, we anticipate using the additional capital flexibility to neutralize the EPS impact at the Ameriprise level by repurchasing our shares.

Now I’ll move on to asset management. In the quarter, asset management achieved consistent profitability in a tough market environment. Total assets under management for this segment were $446 billion, down 5% from a year ago, from net outflows and average weighted market depreciation. As I’ve mentioned, the second quarter marked the official completion of our integration of Columbia Management, a significant undertaking for the firm.

In terms of flows during the quarter, we experienced 6.6 billion of net outflows which were largely driven by the expected former parent company and large outflows from the sources we discussed last quarter. Walter will give you a detailed break-out in a few minutes.

As we look ahead, the large former parent company outflows at Columbia are largely behind us. The underlying business is sound. I feel very good about the progress we’re making. We’re headed in the right direction. At Columbia, we’re seeing steady progress in flows in our focused sales areas, despite significant market headwinds in the quarter. In institutional, our pipeline remains strong. Asset retention is excellent and we continue to deliver good win rates.

Earlier this week, the State of South Carolina announced that we will continue managing its 529 plan. At Threadneedle, the challenges facing the euro zone dampened investor sentiment and led to lower institutional funding rates. Even with the economic and market challenges in Europe, net flows from European retail investors were essentially flat for the quarter.

With the completion of the Columbia integration, we now have a strong global asset management platform. We have strong performance across product lines with 116 Morningstar four- and five-star rated funds. We have broad product lines and we’re launching new products where we see opportunity, including the Columbia Risk Allocation Fund we introduced last month, and we have extensive distribution in the United States and Europe and are working collaboratively to reach more clients and capture opportunities in Asia, the Middle East and other international markets.

As we move forward, we are focused on navigating the challenging environment and managing the business for profitable growth. Clearly, market conditions will continue to shape investor sentiment, assets and flows. While we expect flows to improve materially from what we experienced this quarter, we, like the industry, continue to face market challenges. That said, we have the right people, capabilities and strategy to achieve our long-term growth potential.

Now I’ll move on to annuities and protection. In annuities, we continue to balance the goals of offering clients products that help meet their income and protection needs while ensuring an appropriate risk profile and return for our shareholders. Ultimately, both the fixed and variable businesses are affected by a low interest rate environment, and we’re taking steps to further address the related risks. For example, we introduced a new variable annuity rider in May that incorporates a managed volatility fund. We stopped sales of certain guaranteed riders and we restricted add-on premiums for the VA in-force block. As you would expect, these decisions impacted variable annuity sales and net flows in the quarter. Net inflows in the Ameriprise channel were $94 million, which was down from a year ago and account balances remain flat at $65 billion. We’re training advisors on the new product features and expect lower sales through the balance of the year as we continue the training process.

On the fixed side, the asset and flow story has remained consistent as has the pressure of low rates. While we feel good about the characteristics of our fixed block, we are not adding to it, given the rate environment. Overall, the underlying annuity business is performing within our expectations.

In protection, we have good books of business that generate solid earnings and provide steady contributions to our diversified business. We’re continuing to help our legacy and new advisors work with clients to address their insurance needs. Total life insurance in force was $191 billion, which has been largely unchanged over the past several quarters given the industry-wide pressures. We’re seeing continued good lift in our universal life insurance which is more than offsetting slower sales in variable products. In total, VUL and UL sales were up 25% from a year ago.

In the auto and home business, similar to what you’ve seen in the industry, weather-related claims were reflected in second quarter earnings. That said, the business is doing well. We generated solid growth and profits in the quarter, and our policy count was up a steady 7%. To summarize, I feel very good about the risk characteristics and the long-term returns in our insurance and annuity businesses.

Overall, Ameriprise remains in a strong position. We’re making good progress and executing our strategy and helping people gain confidence in their financial future despite a very difficult environment. The economy in the U.S. is uncertain and clients are cautious. As Americans return from summer vacations, the election season will be in full swing and our economic issues will be fully debated. I expect individual and institutional uncertainty and caution will remain elevated for the foreseeable future, and there’s little relief from low interest rates.

At Ameriprise, we will continue to manage through this period consistent with how we managed the firm since we became a public company. Our business fundamentals are strong and our financial foundation is rock-solid. We have embedded an expense discipline and are realizing the benefits of our reengineering program to fund our growth investments and help contribute to the bottom line.

We are evolving our business mix to generate more of our earnings from less capital-demanding businesses with strong free cash flow that adds to our existing excess capital position and enhances the flexibility to redeploy capital opportunistically and drive shareholder return.

Now I’ll turn it over to Walter.

Walter Berman

Thank you, Jim. Our second quarter operating earnings per share of $1.13 included several significant discreet items which totaled $0.26 per share. This included a negative $0.18 from a tax item associated with securities lending activity where we received incomplete data from a third party. This resulted in the miscalculation of tax deductions in prior periods. Our tax department became aware of the discrepancy in the second quarter and we took action. We curtailed the activity associated with this securities lending and quantified the impact of the miscalculation. Going forward, we are confident this is behind us.

Turning to operating results in the quarter, our segment business fundamentals and performance were good despite the challenges we face from volatile equity markets and declining interest rates, which I will discuss in detail later. We had three notable milestones in the quarter: the Columbia Management integration was completed within expectations, we announced our plans to transition our bank to a non-depository national trust bank, which I will discuss later, and we completed a major phase of transitioning advisors to the new brokerage platform. In addition, we returned 428 million of capital to shareholders and maintained a strong balance sheet position.

As you can see on Page 4, both revenues and earnings per share were affected by the current low rates and the volatile market situation. Net revenues were also lower on a year-over-year basis by 27 million, reflecting the gain we had last year when we unwound an interest rate hedge. Earnings per share were also lower on a year-over-year basis from the interest rate hedge and $0.26 per share of unusual items in the quarter. Specifically, $0.18 per share was related to the tax items I just mentioned. The remaining $0.08 per share was from the market impact on DAC and DSIC, catastrophe losses above expected levels, and the guaranty fund assessments primarily related to Executive Life of New York. Excluding these one-time items, earnings per share grew nicely, primarily reflecting the high level of share repurchase over the last 12 months.

Turning to return on equity on Slide 5, this was also impacted by the aforementioned unusual items in the period. The tax item in the quarter reduced ROE by approximately 50 basis points and the other discreet items reduced it by approximately 20 basis points. Even in the difficult environment, if adjusted for unusual items in the quarter, our ROE would have been 15.9% which is consistent with last quarter.

The low interest rate environment continues to put pressure on our results. As you are aware, rates have continued to decline in 2012. As a result, we updated our estimate of the earnings impact over the next couple of years. Overall, we believe it is manageable. Our current estimate for 2012 is that after-tax earnings will be about $55 million lower than last year, which is about $20 million higher than our original estimate in the third quarter of 2011 and higher than what I indicated last quarter. Given how rates moved last year, about two-thirds of the estimated impact has already been realized in the first half of the year. In 2013, low rates will reduce after-tax earnings by an additional $40 million. In 2014, our rough estimate indicates that the incremental impact will be less than $10 million after-tax. We will be re-pricing a large block of fixed annuities that are currently at a 1.5% guaranteed minimum interest rate, which will allow us to improve our spreads on this block of business.

In advice and wealth management, we demonstrate strong underlying fundamentals, as Jim indicated, so our focus is on margins in the quarter, which increased to 11.6% despite the headwinds we faced from the markets and the $10 million impact from lower year-over-year interest rates. We are realizing the benefits of our strong expense discipline while still making important investments for the longer term business growth.

Based on the low interest rates and market volatility, we now expect margins to be in the 11 to 11.5% range for the full year; however, the expense management initiatives we previously outlined are on track and will accelerate in the fourth quarter as the brokerage platform project is completed. The bank exit in the fourth quarter will have a minimal impact to margins.

On Slide 8, I will provide some additional information on our bank exit. Earlier this month, we announced our plans to change our banking subsidiary by year-end, subject to regulatory approval. As Jim said, this structure is more appropriate for our business mix and will give us more capital flexibility. There will be approximately $20 million of non-operating expenses in 2012 and early 2013. In addition, the transition frees up about 375 million in capital on a net balance basis. Other balance sheet impacts are nominal.

We estimate that this will reduce AWM earnings by 45 to $50 million in 2013 and decreased margins by 80 to 100 basis points on an annualized basis. At the enterprise level, we anticipate that the impact to earnings per share will be immaterial as we redeploy the excess capital to shareholders through share repurchase throughout 2013.

Turning to asset management, we are feeling the impact from outflows we experienced last year, the industry shift from equity to fixed income, as well as the lower equity markets. We are making good progress on managing expenses to partially offset revenue pressures. On a sequential basis, earnings were stable despite market volatility and reflect good expense controls. We completed the Columbia integration and are well positioned to grow this global business as we go forward. As Jim said, the fundamentals around distribution and performance remain strong.

In the near term, market conditions will keep margins at our current level for the full year or 33 to 34% on an adjusted basis, and 18 to 19% on an operating basis. This is a change from what we provided last quarter primarily because of weak equity market performance in the quarter.

Now let’s look more closely at asset management flows on Slide 10. I wanted to provide an update on the large anticipated outflows primarily at Columbia that we discussed last quarter. Last quarter, we expected to see 4.7 billion of outflows from former parent 401K, Balboa Insurance, and the loss of the New York 529 plan. Our actual results were in line with these expectations, with some acceleration in outflows from Balboa Insurance assets. $1.5 billion of AWM remains from Balboa and we expect these outflows over the next few quarters. Aside from these assets, we expect these large former parent company outflows are behind us.

We continue to see about 900 million of outflows in our value and restructuring fund due to the retirement of the portfolio manager earlier this year. It appears that this trend is now slowing. We also saw continued outflows from a third party sub-advisor in the quarter. Outflows in the closed block of insurance assets at Threadneedle represented the majority of Threadneedle’s outflows in the period. As we look ahead to flows in the second half of the year, we are mindful that this is a challenging environment, as Jim described.\

Turning to annuities, earnings were also pressured by the operating environment. DAC adjustments and several other items, including payments of the guaranty funds associated with Executive Life in New York. Together, these reduced segment pre-tax operating earnings. Variable annuity operating earnings were 83 million in the quarter, down from 88 million a year ago. Results included unfavorable impacts from low interest rates and the market impact on DAC, partially offset by the fee increase on living benefit riders and lower distribution expenses. For fixed annuities, operating earnings declined to 33 million, reflecting the 17 million from lower spreads and a $14 million unfavorable item from valuation model changes.

Turning to protection, pre-tax operating earnings improved year-over-year by 17 million to 109 million. Results were strong in life and health. We have favorable life and disability claims experience in the quarter which were somewhat offset by unfavorable long-term care results. We also released a $9 million life insurance IBNR reserve in the quarter.

Our auto and home business remains strong with policy growth at 7%. Catastrophe losses were 17 million in the quarter, which was 8 million above our expected levels of claims. In the period last year, our catastrophe losses were $15 million, which was $11 million above our expected level of claims.

Now let’s turn to our balance sheet, which remains very strong. Our high-quality investment portfolio continues to perform well with only $8 million of impairments in the quarter. We had minimal European exposure with no holdings of sovereign debt or financial institutions in financially troubled European countries. Our hedge program remains over 95% effective and greatly reduces the risk associated with our variable annuity business. We have 2 billion-plus of excess capital and 1.1 billion of free cash across the company. The life company had an estimated RBC ratio of approximately 525%.

Taking a closer look at capital returned to shareholders, in the quarter we continued to return significant capital to shareholders and have paid out 134% year-to-date. As of the market close yesterday, our dividend yield was a strong 2.9%. We repurchased $350 million of common stock and paid $78 million in dividends this quarter. Going forward, we plan to return the majority of our earnings to shareholders, gradually increasing the mix between dividends and repurchases.

In closing, Ameriprise continues to perform well despite a very challenging revenue environment. This speaks to the resilience of our business model and our expense management discipline. Our business mix continues to generate significant free cash flow, which we are returning to shareholders, and our excess capital position gives us enhanced flexibility.

With that, I will open it up to your questions.

Question and Answer Session

Operator

Thank you. We will now begin the question and answer session. [Operator instructions]

And at this time, we have a question from Sumeet Kamath from UBS. Please go ahead.

Sumeet Kamath – UBS

Thank you and good morning. I wanted to start with the revised guidance for advice and wealth of 11 to 11.5. If I go back to last quarter’s conference call, Walter, I think—you know, I was just reading it just now, and the phrase that you were using was definitely achievable. I think you said it’s not a walk in the park, but certainly the definitely achievable suggested some level of confidence. Obviously this quarter the margin snapped up pretty nicely, so I guess I’m trying to figure out what exactly has changed in your thinking today versus what you saw in the first quarter, so I’ll start there.

Walter Berman

I think the main thing, if you take at look at why I said it was achievable was because of the expense and the trajectory on the revenue at that time. Since that time, we’ve seen the market come off and certainly there has been continued impact on the transactional activities. We still believe it’s achievable – within the 11 and 11.5 – and we’re just going to move on through it. The plans are working, and I think coming off the 12 is not really that big a deal when you’re talking about a situation that’s changed as much as it was when last discussed.

Sumeet Kamath – UBS

Okay. I mean, I guess if you just kind of do the math, you’re running at 10.7, I think, first half; so that would put you—to get to sort of 11, 11.5, I think that’d kind of put your second half at around 12. So it kind of feels like maybe you just can’t overcome the tough first quarter where you were at 9.9. Is that a reasonable read?

Walter Berman

Yeah, I think your read is right. I don’t know if I would go as high on second half, but certainly the second half will have an improvement factor.

Sumeet Kamath – UBS

Okay. And just to be clear, this 11 to 11.5 excludes the impact of exiting the bank since you’re going to have the bank for most of this year, so as we think about 2013, sort of the starting point is something like 10.1 to 10.6, and if that’s correct, I’m just wondering what the game plan is to try to get that margin higher, and where do you think it could go as we think about 2013?

Walter Berman

All right, so there is a very marginal impact in ’12, okay, as it relates to the bank. It was just taking place in the fourth quarter. And always incorporated in the ’12 was the bank, and really it’s a phenomenon of it’s revenue to PTI relationships, which is quite high because of the net revenue calculation of interest less this deposit base expense that you have on the credit. I think certainly we have, as Jim has said and we have said, we have momentum and we certainly look at the numbers and give guidance as it relates to the positioning; but the business is in good shape. It is generating good margin, and we certainly have the fundamentals, we feel, in control. So I’m not prepared to come up with a number right now, but certainly that would have to be factored because that was actually part of it when we actually came up with the 12.

James Cracchiolo

Sumeet, this is Jim. I think overall if we look at the underlying aspects of the AWM business, nothing actually has changed from even a year ago. In fact, I would probably say that we’ve been able to manage through even a more difficult market with better margins overall, and I think to the end of the year, we continue to see the improvement on the expense side, as we said. I think the only real change is that the markets are a bit more volatile. People are a little more concerned as we go out of the year. Unemployment is a little higher, so as you would imagine, people are holding a bit more cash. Transactions are a bit down from what we were running at when things started to show the improvement.

Interest rates, short-term rates from last year have come down. I mean, it was 10 million just in the first quarter. There is a bit more in the first quarter, second quarter was 10 million. That alone is 100 basis points just in the quarter, and year-to-date it’s probably over 100 basis points. So those are things that, again, we didn’t fully understand some of the impact of that when we chatted in November, and the change from April really is just due to the transaction revenue. You’re right that we still think that the second half of the year will be closer to the 12 or a bit over, depending on the quarter, depending on activities. But as we look out, the bank itself has added margin, and when we take that out, it will adjust the overall margin rate.

But one of the things that’s very important to understand in that decision was it does free up a lot of capital, and a capital requirement that would have gone up a lot. And I think as other institutions that have banking business and spread business in their AWM business, it’s going to be a change from where it was where that margin was not as driven by capital-intensive activities, and that will change. So we think it was the right decision, and so on a margin-adjusted basis, I don’t think that we’re going to have any concerns to continue to make the progress. Having said that, it does take a certain amount out of the margin base because the earnings in the bank did contribute to that margin.

So I hope that helps clarify, and I think Walter can lay that out in a little more detail as we go forward.

Sumeet Kamath – UBS

No, that’s helpful. And again, I agree that the trade-off between a point of margin and sort of capital flexibility in terms of buyback is a trade-off that I would support as well.

Just a quick follow-up on flows – the past couple quarters, we’ve been hearing about the institutional pipeline at Columbia being very strong and building, and I get some of the moving pieces this quarter in terms of former parent stuff. But even I back that out of the flows, it kind of looks sort of flattish. I guess I’m just wondering when are we going to see that institutional pipeline start coming through in terms of turning those outflows into inflows. Thanks.

James Cracchiolo

Well, as we looked at the pipeline from last year, the pipeline has grown nicely. Now, I think what has occurred in the pipeline is it’s sort of leveled off based on, again, the market situation over the last quarter or so. Having said that, it hasn’t fallen, and as we look at the win rates and the percentages, it’s still doing quite well. Having said that, we do have those redemptions that come in.

Now part of the flow situation on the redemptions are things like the VNR fund and things like that, that are in there, part of the Bank America pension fund activity. So we had the outflows. Part of that goes institutional, part retail.

I would just say that I think we’re holding our own in this market. I think we’re getting more of our product out there with a broader, what I would call a line-up of institutions. But things do take time, in a sense, to get some of the newer categories that we once did not sell into the institutional pipeline. Having said that, we don’t see any negative, and as I speak to our institutional sales group, they actually feel pretty good about it. So I think part of it is timing. Funding rates as well – I mean, just as in Europe, we were having some good wins institutional, and then some of the funding rates just sort of dry up a little bit or are put on hold. And so I do believe this environment does affect some of that activity, but I have not received any change from my people as far as what they’re seeing right now. But the environment does have its effect.

Sumeet Kamath – UBS

Okay, thank you.

Operator

Thank you. Our next question come from Jay Gelb from Barclays. Please go ahead.

Jay Gelb – Barclays

Thanks and good morning. For the buyback related to the capital release from the bank transition, should we consider that 375 over and above what you would typically do in 2013, i.e. 100% of earnings?

Walter Berman

Actually, okay – it’s Walter. Based on current plans, we would intend, as we indicated in the release, that we would offset the impact and that would presume that, again, depending on the circumstances that we would deploy that.

Jay Gelb – Barclays

Right, but it would be over and above your typical buyback, correct? I just wanted to clarify that.

Walter Berman

Yes. (Talkover), so therefore yes, we would be over and above typical.

Jay Gelb – Barclays

Okay. And Walter, what gives you confidence in the ability to hit the target margins, particularly in asset and wealth as well as asset management? What’s the risk of not achieving those?

Walter Berman

Well as Jim said, the key foundation element is we are managing the expenses. We’ve done that. We’re going through the conversion, and the conversion expense will start tailing off in the fourth quarter. And the other reengineering, we’re getting the improvement in the run rate, so we have a solid positioning on that.

The flexibility items or the non-controllable items are the interest rates, as Jim mentioned, which again were at the low point. If you look back, certainly as we get into the beginning of the year, we thought it would certainly be much higher; and then it’s the transaction, the environment, and the other situation. So that is—clearly on the controllables, we feel comfortable and we are getting good productivity, and the question is where the markets are and the environment.

Again, in asset management, good control of the expenses. I think performance is excellent, and we are getting traction on the distribution side. So for the things we control, we’re managing it and I think we’re getting good positioning.

Jay Gelb – Barclays

Okay. And then on a separate issue, can you give us a sense of what the standalone return on equity is on the auto and home business?

Walter Berman

Standalone return in the auto/home business is—

Jay Gelb – Barclays

So not for the overall protection unit, but—

Walter Berman

It’s around—figure between around 12 and 15%. And again, remember it’s coming through now and it’s actually—it went through the situation, it improved, and actually on its current trajectory that, I would say, is the low base of it, and it’s on good positioning to the higher middle teens.

Jay Gelb – Barclays

Okay, thank you.

Operator

Thank you. Our next question comes from Blostein from Goldman Sachs. Please go ahead.

Alex Blostein – Goldman Sachs

Hey guys, good morning. Wanted to follow up, Walter, on your comments around the bank and I guess the timing. So when you think about the freed up capital - $375 million – and you guys redeploying that into the buyback, I just want to clarify – that is on top of your kind of normal buyback that you keep doing, and also what do you think is the timing of that? So, you know, if you guys—is this this year’s event or is it next year’s event? Are you guys going to kind of spread it around over the next couple of quarters? How should we think about that.

Walter Berman

Okay, so let me be clear – it’s our intention beyond the circumstance, it will be over and above. Again, if you look at—we talked about neutralizing or trying to certainly offset through the purchase—utilization of the capital, the earnings that were lost from the bank, so that would—you should assume—you know, again, we look at the opportunities with the stock and other things of that nature, so we don’t get to any set time frame but certainly we’re trying to be guided by trying to neutralize the impact of the lost profitability associated with the bank. So on that basis, we gave you the numbers of somewhere between 45 and $50 million pre-tax, and that, you should assume, is spread reasonably equally over the year.

Alex Blostein – Goldman Sachs

Okay. And just I guess from the technical perspective, if that does, say, make you use up your buyback authorization sooner, what’s your flexibility on going back to the Board and asking for a bigger buyback? Is that a quarterly event?

Walter Berman

As we start approaching it, we certainly go back and demonstrate to the Board our ability to do that, so we have degrees of flexibility to present to the Board to get additional authorization.

Alex Blostein – Goldman Sachs

Excellent. And then shifting gears a little bit to AWM, it sounds like the pipeline of employee advisors is still pretty strong, and we’re seeing that, frankly, across the industry where the wire houses continue to lose some share. Can you quantify the productivity of advisors that are coming in or the ones that you currently see in the pipeline versus your current book of business?

James Cracchiolo

The average production of the people we’re recruiting over the last few quarters has actually been higher than the recruits that we did even previously, and we are finding that they are coming in with larger books of business. Now, against our entire system, including the averages of the franchisee system, they’re probably in that realm of productivity. If we look at the employee system, they’re on average a bit higher because, as you know, we still have some of the legacy novices further developing there. But we believe that the level that we’re recruiting at now actually will give us a nice productivity lift as we continue to move forward raising the average of the employee system and in line with our franchisee system.

Alex Blostein – Goldman Sachs

Got it. And just a last one from me – Jim, in the past you talked about the level of frustration with the valuation in the stock. Is there any strategic options that you guys could potentially consider that would unlock some of the shareholder value?

James Cracchiolo

You know, as I look at the company today, the thing that I would just say right now is I know we’re in a little difficult market, but when I compare the valuation against other companies and I look at the earnings, I look at even the continued growth of those businesses over the last number of years and the profitability, I actually think we are undervalued to a large extent, even if I look at the annuity insurance business, based on the quality of that book and that it’s a proprietary book and system, and the returns that we achieve on that.

So listen – I think over time it’s going to be recognized. I do believe we are making the right amount of changes, so there is something that you can say as well – can you take something out of it and sell it, et cetera, and would that change you? Yes, I think it could, but I don’t think you’d get the right value in this marketplace today, and in some cases it depends on who you sell to, whether you feel as comfortable with what you have in the end because even on the insurance book, you have your obligations out there.

So I actually feel what we’re doing will get us to a much more, what I would call less capital intensive mix over time, and the growth that we are seeing in some of our businesses and the capabilities we’ve put in. You know, if I look at asset management just as an example, I know we look at some of the flows quarter to quarter; but if you go back two years and look at what we had and what we have today as an asset management business, it’s materially different and the value we achieve there through that acquisition and integration, we have a great platform today – a wide mix of product, good performance, wider distribution, international and domestic. And our AWM business, I would match up against anyone in the growth there over the last number of years, and even the margins and profitability.

So our annuity business has held up really well. Our hedging is good. We don’t have exposure based on how we actually managed that book and hedged it all through its growth, and our protection book is all proprietary and excellent in that regard. So yeah, we could make some changes, probably not in this environment; but having said that, I think the strategy we have will unlock that value and migrate us to, I think, a bit more of a higher PE business over time. And as anything else, I think we’re all frustrated a little bit with the market, and so that frustration compounds the activity. But I feel really good about it, and even though I don’t like this environment, I think it does affect us and I would like the business to show greater levels of growth. I feel like we’re making, to Walter’s point, what we can do as the controllable to continue to improve the underlying value of the company, and in time maybe it will be recognized.

Alex Blostein – Goldman Sachs

Got it. Thanks.

Operator

Thank you. Our next question comes from Tom Gallagher from Credit Suisse. Please go ahead.

Tom Gallagher – Credit Suisse

Thanks. First question for Walter – you had mentioned your Dodd-Frank interpretation in terms of the change in bank capital rules. When you mention that your assessment of required capital would have gone up a lot from the 375 million, what order of magnitude were you talking about there? I would assume it would have to be substantial for you to have made this decision. You know, were you looking at doubling or tripling of required capital, just to give us range, order of magnitude?

And then related to that, can you talk about any potential risks to actually exiting the current structure, or do you expect that you’re going to be able to get this done without any angst?

Walter Berman

Okay, let me start with the second part. It’s a big undertaking, but I think we’ve done our planning and I think we had the necessary valuations done and operational capabilities put in place. We are targeting to do that through—once we get regulatory approval in the fourth quarter, and I think we see everything working as of now and we feel confident that it will take place subject, again, to regulatory approval.

As relates to capital, it’s a fairly fluid situation, so therefore you’re evaluating it but certainly different signaling from it, if you headed to the various Basel conventions and how it would be applied, it would be a substantial capital impact because you were a depository-taking institution on the entire institution. That was certainly where it seemed like it was leaning, and so therefore we looked at this and started evaluating to put in place and ensure that we can provide the capabilities to our customers and do this in the most effective way, and that’s what has taken place. But we felt it would be a fairly substantial impact on the other businesses that, in some respects, could make us non-competitive.

Tom Gallagher – Credit Suisse

Got it. And I guess as I think about your advice and wealth management post-this transaction going forward, is it fair to say that right now, you’ve got a little bit of a mix between fee and spread – mainly fee, but then there’s a spread component. Are we going to have any spread-based component of earnings left in advice and wealth management post-this transaction?

Walter Berman

Sure we will. We have the sweep account where there’s $14 billion. That obviously creates a substantial opportunity for us as the short rates change. We also have the certificate company which has about $3 billion, $3.5 billion in it. It’s been with us, actually, more than I can remember – it got here before I did. And those are excellent opportunities, and it’s certainly an important product for our customer base.

Tom Gallagher – Credit Suisse

Got it. And Jim, can you comment on just the balance that you’re thinking about right now in terms of capital deployment between the M&A environment, buybacks and dividends?

James Cracchiolo

Yeah, I would say as we left last year, based on what we thought may be some good properties out there, I was probably a bit more enthusiastic on the M&A front. Based on looking at some of those various properties, et cetera, I’m probably not as enthusiastic, as you can see – we haven’t really done anything. And from that perspective, we’ve been picking up the buyback a bit more and raising the dividend; and as Walter said, we’re going to continue to look at the dividend and the buyback mix. We have over the last six quarters gone from even the idea of what we said about returning roughly all of our earnings, 130% of our earnings, and we’ve sort of picked that up again.

So at this point in time, I would probably say we’re leaning more in the return to shareholders rather than the acquisition. I’m not saying that something might not come along that might be good, appropriate for us strategically or of value; but we do have the capital on hand to do that and still maintain a good level of buyback and dividend increases. So that’s the way I would probably look at it, and again, it’s always a situation that changes a little bit. But one of the things that we—you know, in this market situation with our stock where it is, it’s a good price.

Tom Gallagher – Credit Suisse

Got it, thanks.

Operator

Thank you. Our next question comes from Eric Berg from RBC Capital Markets. Please go ahead.

Eric Berg – RBC Capital Markets

Thanks very much. Good morning. My first question relates to the decision to change the legal format of your financial institution. I purposely say change the legal format because (audio interference) institution business, you’re changing, as I understand it, the legal entity or the legal nature of it. So my question is what are the specific businesses that you will be leaving that you would otherwise have been in that will result in this loss of 45 to $50 million pre-tax in earnings? What won’t you—go ahead, I’m sorry.

James Cracchiolo

The only business that we’re leaving is the banking business as a depository institution. So in the bank, we developed the bank, it was a national chartered bank. It takes deposits as well as makes loans. Some of those loans, we kept on balance sheet; some we sold off balance sheet, like mortgages, et cetera. In that regard, if we maintain that legal entity status, we are a savings and loan holding company under the new regulations, and that causes us to be subject as a legal entity to certain capital requirements that go sometimes beyond what that legal entity itself. So not only do the capital requirements for the legal entity go up, but it may affect the rest of the institution as well. And again, the signal coming out in the various capital requirements that you’re starting to see be made public, as we evaluated that fully, we didn’t think it would be appropriate for us to subject the entire entity for the businesses we’re in. We’d rather have the ability to grow those businesses as they are currently set up.

So the only thing we’re changing is that we’re moving the bank charter to a national trust charter so we can still do trust services. It won’t have the extra capital requirements per se; it’s just for that business, appropriate. And it gives us the ability to continue to build the businesses as we have in the past. And so that’s it – nothing else has changed. We’re not leaving any other businesses outside of the banking business.

Eric Berg – RBC Capital Markets

Okay. My second question relates to—go ahead, Walter.

Walter Berman

Yeah, I just wanted to say we are still going to be offering the services, it will just be through third parties so the capabilities to our customer base is still there.

Eric Berg – RBC Capital Markets

Right, I understand. Thank you. My second question relates to your outlook for margins in your asset management business. You’re saying that—I think you said in your prepared remarks and your slides that you anticipate margins for the full year to be consistent with those in the first half of the year. But of course, and a question – isn’t that entirely dependent on what happens in the market in the second half of this year? I mean, it’s still quite early – we haven’t finished the first month of the third quarter. I’m trying to understand if you’re telling me that there’s been a modest degradation in the margins from your original expectations that sort of is unlikely to be reversed, irrespective of what happens in the market, or will margins for the full year very much be a function of what the market does in the second half of the year?

Walter Berman

I think, Eric, what we are saying is this – when we, and to be very fair for you, is when we actually gave you the idea of the margins, we were in a certain market situation with the idea that markets would appreciate, okay? And so to be very honest, as the first quarter – and you’ve even asked the questions that said, well, why are you coming off? What’s changed in your margin outlook? And so what has changed is the environment a bit more. Equity markets have come down a lot. Volatility has affected flows and client activity, and the same thing in the asset management business. I mean, we run a lot of equity assets, and so with the market depreciating a bit, it does impact that margin. It goes right to the margin and the bottom line.

So yes, we have adjusted that based on those market conditions. Also, the effect that those market conditions have on equity flows, I don’t think—again, as we looked at the beginning of the year, I think the whole industry, including us, would say, hey, it looks like equity asset flows are starting to pick up again – that’s good. I think you have seen just again in the second quarter that flows have really been in fixed income. And so that exactly is the reason – fixed income products don’t have as high margins as equity, even if you do get the flows, and the mix does cause a depreciation if the markets are down against the entire—you know, if we look at the large base of equity assets.

In the AWM business, it really is the client activity coming out and the lower interest rates, and so those are the only two changes. So even as I look at third quarter, I think we’ll be in similar type of margin ranges, but the fourth quarter we see—if things just continue to hold, the pickup—because as we said, some of the expenses will go away in the systems that will start to boost the margin in again.

So it is very hard to put that as a finite to your point, which is very accurate, that we don’t know the market conditions for the next quarters. The only thing we can say is based on what we’re seeing today, we hope they will get better; but if they don’t, we are just trying to give you a little better of what that would mean.

Eric Berg – RBC Capital Markets

And I guess just one final point that just came into my head that I wanted to ask you – would it be right to say that margins in the asset management business in the third quarter are really not independent of margin activity in the second quarter, that the quarters are linked in the sense that if you start from a lower—if you start the third quarter from a lower base than you had anticipated because the second quarter was poor, that’s going to influence third quarter margins. Am I thinking about the economics and the relationship between the quarters correctly?

James Cracchiolo

Absolutely, because your asset base starts at a lower level and therefore your fees start to be booked consistently from that. It just doesn’t get booked at the end of the quarter wherever the market ends.

Eric Berg – RBC Capital Markets

Thank you.

Operator

Thank you. Once again, if you’d like to ask a question, please press star then one on your touchtone phone. And at this time, we have a question from John Nadel from Sterne Agee. Please go ahead.

John Nadel – Sterne Agee

Hi, good morning. I want to follow up a little bit on the asset management margin, and I’m going to use the GAAP margin that I guess in the first half of the year is slightly over 18%. I’m just thinking about that margin versus, for instance, the margin on a core basis ex-some of the one-timers in 2011, which I think was about 18.8%. You know, the market’s up on average about 6% in the first half of this year – the equity market – versus the full year last year, and your average assets are up about 2% in the first half of this year versus the full year last year, yet your margin is down about 70 basis points and it doesn’t sound like it’s going to get much higher from there. So I guess I’m sort of struggling with the same thing Eric is in that I’m just trying to understand where the scale benefits are here and the integration saves. I don’t—I’m struggling with that.

Walter Berman

Okay. It’s Walter. Let me start with certainly if you use the S&P, you would say that the market is up 3% on average for the half a year, but unfortunately our asset base isn’t really geared to the S&P exclusively, so we use a weighted equity index and that is actually down. That’s down 1%, so I think that is part of your delta situation that you have from that standpoint, and that is putting pressure on the margins because you have also had to shift, as Jim said, from equities to fixed, which is there. And as we also mentioned, this is the first quarter we have the impact of the 529 plan from New York.

So we do believe we’re tracking, and expense reengineering and revenue reengineering will be coming through, so we think we are on track. Certainly the market has been problematic, the mix has been problematic from that standpoint, so we think it’s understandable and we are able to calibrate, and we feel we’re tracking within our expectations.

John Nadel – Sterne Agee

Okay. And then just—I’m not sure if you addressed this earlier, and maybe the answer is none, but just a quick question on—so it sounds like all of the previously highlighted one-time type large outflows have now taken place, with maybe some remaining from Balboa. I’m just wondering—is that correct?

Walter Berman

That is correct. There’s about 1.5 billion left on Balboa.

John Nadel – Sterne Agee

Okay, and just the question is, is there any new sizeable or one-time type mandates that you’ve either won or lost? I know you mentioned South Carolina’s 529 plan, but anything else to think about as we look forward?

Walter Berman

Again, there has been—certainly some of the mandates being funded are less, and nothing that I would say is sizeable at this stage. But because the market has certainly impacted the level that we had, certainly Middle East mandates come in at a lesser level, and there have been some—there are certainly outflows. But the issue is at this stage, we’re just tracking it.

John Nadel – Sterne Agee

Okay. All right, thank you very much.

Operator

Thank you. This concludes the time that we have for our question and answer session. I will now turn the call back to Jim Cracchiolo for closing remarks.

James Cracchiolo

Thank you. First of all, we appreciate you listening in this morning as well as for your questions. If there are any other follow-up questions or information that you need, please contact Alicia and Chad and they’ll walk you through or give you some additional information that will help you.

As I said—listen, we’re in a fluid situation with the markets, et cetera. Having said that, I think we’re in a good situation in the underlying business. I can’t with accuracy predict quarter to quarter, and that’s not my job. What is my job is to continue to, with my team, keep navigating the environment in a good, strong way, which I think we have been over the last number of years, and we feel good about our ability to do that. We do see—even though it’s not as apparent, we do see good progress being made in each of the businesses. We would like to see the flows in the asset management business improve, but I do believe part of it is getting over the hump with the integration, which we have now. We will still experience some challenges – ins and outs with the flows. We run a very large business with a number of different venues, but having said that, I think we’re gaining some underlying traction. I think it’s feeling positive in that sense and we’ve got a solid core now from which we can build.

And in regard to our other businesses, I do believe in this environment there’s always concern, particularly around some of the protection-type businesses, but I would say to you that we feel very confident and comfortable with the businesses we have, with the books that we put on, with the client behavior that we have; and we feel particularly based on our capital position and hedging and strategy that we’re in good shape.

So thank you and we’ll continue to keep our focus, and if there’s anything else that you may need to know, please contact us. Have a great day.

Operator

Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.

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