Eaton Vance Corp. Q1 2008 Earnings Call Transcript

Eaton Vance Corporation (EV)

Q2 FY08 Earnings Call

May 21, 2008, 11:00 AM ET

Executives

Daniel C. Cataldo - VP of Financial Planning and Analysis

Thomas E. Faust Jr. - Chairman, President and CEO

Robert J. Whelan - CFO

Analysts

Ken Worthington - JPMorgan

Cynthia Mayer - Merrill lynch

Robert Lee - Keefe, Bruyette & Woods

Presentation

Operator

Greetings and welcome to the Eaton Vance Second Quarter Fiscal Year 2008 Earnings Release. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder this conference is being recorded.

It is now my pleasure to introduce your host Mr. Dan Cataldo, Vice President of Financial Planning and Analysis. Thank you, Mr. Cataldo, you may begin.

Daniel C. Cataldo - Vice President of Financial Planning and Analysis

Good morning and welcome to our second quarter of fiscal 2008 earnings call and webcast. With me this morning are Tom Faust, Chairman and CEO; Bob Whelan, CFO; and Laurie Hylton our Chief Accounting Officer.

Tom and Bob will comment on the quarter and then we will address your questions. The full earnings release and charts we will be referring to during the call are available on our website eatonvance.com under the heading Press Releases.

We need to begin with the reminder that today's presentation contains forward-looking statements about our business and financial results. The actual results may differ from those projected due to risks and uncertainties in our operations and business including but not limited to those discussed in our SEC filings. These filings including our 2007 annual report in Form 10-K are available on our website or on request without charge.

I will now turn the call over to Tom.

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Good morning and thanks for joining us. I am happy to report that we had an excellent quarter in terms of both financial performance and business fundamentals against the backdrop of volatile equity market and continued turmoil in the credit market. We maintained high profitability despite pressures on revenues from the recent market decline and felt strong underlying growth in our business franchise.

I'll let Bob elaborate on the financial performance in a moment. But first I'll spend some time with assessing our business results.

Assets under management at the end of our second fiscal quarter were $159.1 billion. This represents a decline of the 2% from the beginning of the fiscal year, a period in which the S&P 500 was down 10.6% and an increase of 4% from the end of the first quarter. Over the past 12 months our assets has grown 6% a period over which the S&P was down 6.5%. The stability in growth of our assets over these timeframe is a testament to our diversified investment offering, excellent investment performance and powerful distribution organization, all of which have an ale about to generate strong growth in that sales in a challenging environment.

Gross sales and other inflows of $11.7 billion for the quarter and $23.4 billion for the first six months, put us on pace to match last year's record sales result, which would mean we were able to make up for $10 billion year-over-year decline in closed-end fund sales with increased sales of other products. We're especially proud of our strong sales results in light of the pressures our income products have faced as a result of the disruption in the credit market.

Net inflows were $4.9 billion in the second quarter, one of our best net core quarter's ever. Redemptions and other outflows declined by $1.3 billion, or 16% from the first quarter as investor unease abated with improving market. This quarter's net flow translates to a 13% annualized internal growth rate while the net flows for the first six months represents an 11% annualized internal growth rate.

Over the past several months, some have speculated the pressures on our closed-end bank loan and municipal bond fund franchises would cause our above market internal growth to deteriorate. I am happy to say that our strong ongoing core numbers show that speculations have been misplaced, as growth in other parts of our business had more than compensated for areas of relative weakness. Please refer to the PowerPoint slide 1 through 7 for more about our assets under management, growth in net flows, asset mix and growth rates.

I'll now give you a bit more color on our specific lines of business, investment performance and distribution development. Starting with our core fund business, gross fund sales for this quarter were our best ever. This can be seen on slide 8 this shows that we sold over $6 billion in the quarter roughly $2 billion a month. Encouraging, we saw better balance in the first quarter between equity fixed income and bank loan sales and these strong trends have continued so far in May. It is no secret that much of the current success we are seeing in our core fund business is the result of strong flows into our large cap value products as show on slide 9.

Large cap value has become a major franchise for us and this is an area where we should continue to do well. There is no doubt that large cap value as an asset class will continue to hold significant position and portfolio allocation strategy and a routed performance there continues to stand out against other value managers. Large cap value has been a great story for us and when... one that we look to replicate in other areas. In equity income for example, we are on our way to becoming a market leader. This investment discipline plays nicely in to the retiring baby boomers needs for both current income capital growth overtime and we believe there is great potential here.

You may have also heard us talk more relative value [ph] about our growth equity products. We have a number of talented growth managers and several strong performing funds rated four or five stars by Morningstar, but they it is still quite small in terms of managed assets in the growth category. We believe we have numerous equity capabilities that are ready to plug into our distribution platform to develop additional franchise products following the footsteps of our success in large cap value.

Whereas a few years ago, our equity business was primarily in tax managed product, we believe we are well on our way to building a broad based equity business, with strong competitive position in all channels, including the large defined benefit and declined contribution retirement market share in the U.S. as well as offshore. Our fixed income fund growth sales and other inflows of $1.6 billion in the second quarter were up slightly from the prior quarter, while redemptions slowed.

Still there are municipal bond funds remain strong representing approximately two-thirds of our total fixed income inflow. Although the short term performance of our municipal bond funds is like the peer group, our long-term performance continues to excel. The Eaton Vance International municipal funds, our largest municipal bond fund by far continues to rank them on the top funds in its peer group over the past 5 and 10 years and has an overall five star rating from Morningstar.

As we mentioned on the last call, we believe that continued sales momentum of our municipal bond funds in light of the muni market dislocations and our weak comparative short-term performance, faced with the confident that financial advisors and their clients have an our approach to the municipal market. We continue to manage all of our municipal funds, opened and closed-end with the same relative value approach that has served our clients well over the long term and that confidence that it will serve them well in the future.

Turning to bank loan funds. We had modest net outflows of $73 million this quarter compared to net outflows of $930 million last quarter. These results lead us to believe that we are seeing the peak in retail bank loan redemptions as market have stabilized following unprecedented declines in loan prices in the first quarter of 2008. As we've said before we believe the loan price decline seen in the first quarter were more of a reflection of imbalance of the supply over demand than a concern over credit quality.

Over the past several weeks we've started to see some of the excess defined loans being taken up resulting in a nice value in prices. Loans are now trading at roughly $0.92 on the dollar versus the recent lows in the 87 to 88 range. Loan default rates currently stand at approximately 1.5%. All the price... the core rates will likely rise as the period of economic weakness lengthens, we continue to believe that loans are in expensive at today's prices and represents good long term value.

Our comment on some of our strong fund performance, but if you refer to slides 10, 11 and 12, you will see a list of our equity and income funds that are currently rated four or five stars by Morningstar for at least one class of shares. It is a broad group of funds that covers a diverse group of investment discipline, a big reason why we've been able to continue to raise assets in the stock market environment.

We've also shown on slide 13, the percentage of our fund assets that are in funds that have beaten Lipper peer group averages over 3, 5 and 10 years. The fact that 91% of our fund assets have beaten their peer group averages over the past decade, its testimony to the soundness of our investment approach and the strength of our investment teams across multiple disciplines.

In our closed-end fund business, market trading discounts for common shares have narrowed by fair amount since the end of the calendar year. A handful of our funds have even traded premiums in recent weeks. The average discount across all of our closed-end funds was 5% at the end of the fiscal quarter versus 9% at December 31. Although its premature to consider new closed-end fund launches at this time, the market certainly looks more promising than it did three months ago. We haven't given up on the idea of getting back into the new Asian [ph] market by the end of this year.

As many of you will know much of our attention to closed-end fund areas have been devoted to restoring liquidity for holders of our funds auction preferred shares. Consistent with the broader market for auction rate securities, in mid February our 29 closed-end funds with outstanding APS began experiencing unsuccessful auctions. This meant that the normal means for providing liquidity to APS holders was no longer functioning.

For instance Eaton Vance has been working with other market participants to restore liquidity to APS holders and to provide alternative sources of leverage to our closed-end fund. This exercise is a quite challenge because any proposed solution must be determined to be in the best interest of common shareholders as well as holders of the APS and because the availability of replacement financing has been constrained by the ongoing credit crunch. Certain proposed solutions also involve material issues of security laws [ph] with have taken time to identify and resolve.

Bookings declined and implement effective solutions has been a major focus of retention over the past three months for the management of Eaton Vance the independent trustees of our fund and our outside advisors and business partners. Although there are still work to be done, I am pleased to share the progress we have made today. When the auction rate securities liquidity prices broke in February, our closed-end fund at approximately $5 billion of outstanding APS.

For instance we've announced three separate APS redemptions that have restored approximately $3.1 billion of liquidity to APS holders with another approximately $200 million of announced APS redemptions to be completed by next week. Replacement financing for the funds have been provided by bank and commercial paper facility borrowings and through creation of tender option bonds by certain municipal funds, none of the funds has been required to delever and the cost of replacement financing is expected over time, lower than the total cost of APS based on the maximum rates that applied to successful auctions.

Eaton Vance is the leadership in restoring liquidity through auction rate securities holders as shown on slide 14. Of the $64 billion of closed-end fund auction rate securities that were outstanding at the time the crisis broke, our funds represented just less than 8%, through yesterday the Eaton Vance funds accounted for over 42% of the total amount that closed-end fund auction rate securities redemption. And our completed redemption rate at 53% is more then 10 times data of all our competitors combine.

We were the first closed-end funds sponsors to complete redemption of equity fund APS, the first began redeeming pack loan income fund APS and so far the only fund group to retain municipal income fund APS. Please note that the redemption total shown on slide 14, are for completed redemptions only and do not take into account announced plans for future redemption of auction rate securities.

Overall we've made a lot of progress in tackling the APS liquidity issue, as I said earlier, there is still work to be done. Some of you may have seen the announcement yesterday that Eaton Vance is developing a new type of security for issuance by our closed-end fund that we call liquidity protected preferred shares or LPP shares and is filed in the no-action letter with the SEC to address certain associated security law issues.

Like APS, LPP shares or floating rate preferred stock instrument to be used by closed-end funds is a source of financial leverage. LPP shares is different from APS, however, and that they would be supported by the unconditional purchase obligation of the designated liquidity provider and should be eligible for purchase by money market funds. Although filing of no-action letter is just one step in our longer development process we are hopeful that the LPP shares can be brought to market and will prove a cost effective new form of leverage that our funds can use to redeem the balance of their outstanding APS.

Throughout the APS liquidity prices, we have approached this issue much the same way we approached the development of new product and new investment strategy, that is use our end [ph] annuity our nimbleness [ph] our result and lots of hard work, till we have a solution, in this case liquidity for our clients. We understand that the interruption in APS liquidity resulting from the breakdown of the auction market has cost profound distress for many holders of our APS. We continue to work to restore liquidity to our remaining APS holders as quickly as possible.

Turning now to the separate account business, we had another great quarter in retail managed accounts and our institutional high network also delivered strong results. The momentum in our retail managed accounts business continued with $2.6 billion in growth sales and $1.7 billion in net sales for the quarter. Both exceeded last quarter's record results by a wide margin. Sales were well diversified among large cap value tax managed core, international equity, municipal bond and overlay strategies.

The growth we have experienced in retail managed accounts assets and sales is shown on slide 15 and 16. For institutional and high network businesses combined for growth inflows of $2.1 billion and net inflows of nearly $1 billion for the quarter, while the current metric high-net-worth family office business accounted for the majority of flows Eaton Vance institutional initiatives contributed over $400 million in new business. This team has structured emerging markets or step [ph] values in large growth discipline.

Beyond the success in funding new business our institutional effort continues to make good progress in terms of number and quality in final [ph] presentations made and our win ratios in those competition. We believe we are well positioned for future growth in our institutional business.

While the investment performance over the last year at Atlanta and Fox is yet to translate to meaningful new business for either company. To give you some example that just how good the relative performance is Atlanta's high quality large cap growth composites, VPS and D500 by over a 1000 basis points and there were also 1000 growth and they expand [ph] almost 600 basis points for the year ended 3-31-08.

Fox's large cap value composite has outperformed the S&P 500 by 275 basis points and were also 1000 value index by more than 750 basis points over the same period. Performance in small cap, is also been very strong, in both Fox and Atlanta. We are confident that with continued good performance it should only be a matter of time before they close file.

Slide 17 and 18 break down our institutional assets under management by company and major investment discipline. On a distribution front, we are very encouraged with the momentum that is building in the retail sales organization. As you know, Matt Witkos, joined us just over a year ago, take over retail distribution and much has been accomplished under his leadership including the restructuring of the organization to better align our capabilities with the needs of our business partners.

The formation of a wealth management solutions group, to support the marketing and the company's products and services tailored to the high networks marketplace. The build out of a business intelligence unit to take advantage of available market data, to better focus our sales efforts. A rewrite of the incentive compensation system to better align the corporate [ph] of our sales force with overall corporate goal.

A hiring of an experienced DCIO public advisory sales manager to capitalize on opportunities and to define contribution in investment only in sub advisory markets and the addition of Chief Marketing Officer to better establish the advanced brand in the marketplace. Although its too early to know if all of Matt's initiatives will be successful the early returns are very encouraging and give us every indication that we are on the right track.

I would now like to turn the call over to Bob Whelan to review the financial results in more detail.

Robert J. Whelan - Chief Financial Officer

Thank you, Tom and good morning everyone. As Tom noted earlier this quarter's financial performance was very strong in light of the drop in assets under management due to volatile market conditions in the first quarter. You will remember we had a great growth in net inflows in Q1 but experienced approximately $12 billion of market depreciation in that quarter.

This quarter we continue to build on our distribution momentum with gross flows of $11.7 billion equaling our best quarter ever if you exclude closed-end fund offerings and net flows of $4.9 billion. We added another $1 billion in market appreciation and $300 billion of cash management assets, for a net increase in AUM of $6.2 billion. We are reporting earnings of $0.43 per diluted share in the second quarter of 2008 versus $0.17 in the second quarter of 2007. As a reminder, our second quarter fiscal, 2007 earnings will reduced by approximately $0.25 per diluted share due to closed-end fund related expenses.

Second quarter 2008 results reflect a $2.8 million minority interest reversal of cumulative stock-based compensation previously allocated to minority shareholders, or approximately $0.015 on a per share basis. As we have said in the past we think an appropriate measure to analyze our financial results is by looking at adjusted operating income. The metric we use internally to assess our run rate of business momentum. As a reminder, that figure starts with operating income as reported and subtracts four items which includes closed-end structuring fees, payments to terminate closed-end fund trail, stock-based compensation and accelerated amortization or impairment.

As illustrated on slide 19, our adjusted operating income increased to $105 million in Q2 2008, from $91 million in the same period 2007, an increase of 16%. Our adjusted operating margin increased to 38.4% in the quarter, from 34.9% in the same quarter 2007, and represent the slight margin improvement sequentially from our first quarter adjusted margin of 38.3%. As mentioned, assets under management increased in the quarter to $159.1 billion, from $150 billion in the second quarter of 2007, an increase of 6% from $9.1 billion.

Average assets under management increased 7% from $142.8 billion in Q2 2007 to $153.3 billion in the second quarter 2008. Revenues increased to $273 million from $260 million an increase of 5% quarter-over-quarter with assets under management at $159.1 billion at quarter end, we began the third quarter with assets of $5.8 billion greater than the average for the second quarter.

Our overall effective fee rate which includes investment advisory and administration fees as well as distribution and service fees dropped slightly from 72.9 basis points in the year ago quarter to 71.3 basis points reflecting a drop in distribution revenues related to the decline in B share assets under management, offset partially by slightly higher investment advisory effective fee rates which increased from 52 basis points to 52.6 basis points quarter-over-quarter.

On a sequential quarter basis, our overall effective fee rate dropped from 73.4 basis points to 71.3 basis points. This drop was primarily the result of three factors. First, the second quarter had a fewer number of days than the first quarter. 90 versus 92 which impact distribution revenues in some fund management fees. Second, a change in mix between fund AUM and separate account AUM that is lower yielding, separate account assets grew faster than fund assets. And lastly, the continued decline in B share AUM as a percentage of total AUM.

Investment advisory and administrative fees increased to $201.7 million, from $185.4 million, with 9% in the second quarter 2008 over the same period a year earlier. The increase is due to 7.4% increase in average assets under management and the higher investment advisory effective fee rate discussed earlier.

Operating expenses declined 21% to $177.3 million from $223.9 million in the second quarter of 2007, largely due to the one time expenses related to closed-end structure impairments in Q2, 2007.

Compensation expense decreased 5% to $75.2 million year-over-year, reflecting a number of factors, most notably the $8.1 million of incentive compensation expense related to our record $5.9 billion closed-end fund offering in Q2, 2007 and not recurring in Q2, 2008. This was offset by higher base compensation and benefits cost associated with a 12% increase in headcount and in increase in our overall bonus accruals inline with gross and adjusted operating income year-over-year.

On a sequential basis, we saw a decline in compensation expense of 8% from $81.9 million to $75.2 million due primarily to a decrease in stock-based compensation expense, a decrease in bonus accruals given the slight sequential drop in adjusted operating earnings, an overall drop at retail fund distribution and incentive compensation as a result of changes in overall incentive compensation plan and severance related expenses in Q1 not recurring in Q2 2008.

Interest income increased to $2.7 million, from $2.1 million in Q2 2007, an increase of 33% due to an increase in average cash on short-term investment balances. We also saw an increase in interest expense from essentially no expense in Q2 2007 to approximately $8.4 million in Q2 2008 reflecting our $500 million, 6.5% coupon, 10-year senior note offering which we completed in September of 2007.

Net income increased to $53.2 million in the second quarter, compared to $23.1 million in the same quarter last year. Our effective tax rate for the second quarter declined to 37.4% versus 38.5% in the second quarter of 2007. This quarter's effective tax rate was impacted by the adjustment to minority interest mentioned earlier and detailed in the press release. We would expect it to return to a more normalized rate of 39% in future quarters. And total headcount for Eaton Vance and all of our affiliates at the end of the second quarter was 1,025 employees versus 918 last year, an increase of approximately 12%.

Now I would like to highlight some of our efforts to improve our capital management and efficiency. We made a conscious effort in the second quarter to manage our balance sheet very comparatively given the equity in private market challenges and the related impact on our assets under management in the first quarter. This conservative posture reflects our intent to continue to maintain a very sound balance sheet and accomplish several capital management objectives, which include maximizing our financial flexibility at a time when credit is scarce, maintaining our strong investment grade credit ratings and having sufficient capital and cash to split various market opportunities. These market opportunities might include a potential price development to our feed activities as well as possible M&A opportunities which we continue to explore as we've done historically as appropriate. As a result we temporarily slowed our share repurchase program in the second quarter relative to prior quarter share repurchase activity.

Cash, cash equivalents and short term investments increased to $351 million on April 30, 2008 from $347 million on January 31, 2008. All of our short-term investments are in conservative and highly liquid instrument. Currently, there is no outstanding balance on our $200 million corporate line of credit facility. Ending equity at April 30th of $184 million compares to ending equity of $143 million at January 31, 2008.

As we have historically done, we continue to return capital to shareholders. As slide 20 indicates, we've paid a $0.15 dividend or approximately $17 million in the second quarter. In closing, our financial conditions has never been better and we are well positioned for continued profitable growth.

We would now like to take your questions.

Question And Answer

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Ken Worthington with JPMorgan. Please proceed with your question.

Ken Worthington - JPMorgan

Hi good morning couple of questions first, to follow up on the capital management question, you told us the rationale for the plan of action in the previous quarter as we start to look forward, do you continue to feel given the markets somewhat of a recovery, that course of action should be followed over the next couple of quarters, do you feel like the balance sheet is where you want it to be such that you would likely return to the market to purchase more stock.

Robert J. Whelan - Chief Financial Officer

I think we see, what happened in the first quarter as the drop in assets, assets having a potential impact on EBITDA caused us to pause as well as the objective of maintaining our strong credit ratings. As I mentioned in the... as I was just speaking, we ended the quarter with higher assets under management which should translate into higher revenues going forward. So, I think we will likely pick up the pace in terms of share repurchases. If you go back to 2006 and 2007, we repurchased approximately 40 million per quarter in '06, 50 in '07. I am not sure we will return right away to those levels, because I think this credit price, it still has a bit to go. But I would suspect it will be more than we put on this quarter.

Ken Worthington - JPMorgan

Okay, thank you. In terms of product development, it is an election year, it looks like there is a reasonably good chance that there will be changes in tax rates next year, what are your thoughts on product development in the tax managed area?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

We certainly pay [ph] attention to the product environment and I think are aware of the budgetary pressures and likelihood that at some point we are likely to see tax increases. Frankly, we don't see a real need for out of new product we have... we introduced in the late 90s and in the early part of this decade a full family of tax managed product, those have been in the market for a number of years and in many cases we have excellent performance.

But I don't think the change for us will involve necessarily meaning new product but more likely will involve in an increased marketing focus on existing tax managed products that are already in the market. And having said that, we don't know what new tax legislation might look like, there maybe opportunities to for tax favored investment. Certainly the last time tax policy was changed meaningfully with respect to investment. The impact on our business was primarily that it opened up a new category of investment for qualified dividend bond. So we don't quite what's going to happen in terms of policy but we do think it's quite likely that the focus of investor's on tax issues will be significantly elevated over the next 5 to 10 years then it has been over the last several years.

Ken Worthington - JPMorgan

Okay thank you. And then lastly on auction rate securities, it seems like you move very quickly here and likely build some goodwill with third party distribution. To what extent have you been able to leverage that goodwill to create maybe new sales relationships or new third party relationships with brokers who might not have sold Eaton Vance funds in the past? Has there been an impact there or might, just totally fishing?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

No I think its real, I think people recognize broadly in the broker dealer community and certainly among holders of auction preferreds that Eaton Vance has been a leader here in terms of stepping up and taking action and being aggressive and from our standpoint in response to this situation, we think there is some goodwill, its very hard to measure. We certainly the number of phone calls and the number of products, that our sales people have got and as they made around following our redemption announcement suggest that it is helping our business, but it's not something that we can measure very concisely.

Ken Worthington - JPMorgan

Thank you very much.

Operator

Thank you. Our next question comes from the line of Craig Siegenthaler with Credit Suisse. Please proceed with your question.

Unidentified Analyst

Hi this Mike Sorenski [ph] filling in for Craig. Couple of questions, for Parametric, you disclosed the fee rates for retail and institutional managed accounts?

Robert J. Whelan - Chief Financial Officer

Yes. They have two major strategies as you know, with their core equity product, which is the higher fee business and that's in the 30 basis point range. To the extent, they are providing overlay management that's for lower fee business generally in the 18 basis points range.

Unidentified Analyst

Okay. And regarding to munis the performance you think is the major driver of the recent muni bond flows and talking about the protocol environment again. If there were a democratic President that increased cap gains and high network taxes could we assume would be safe to say that we keep better flows in to tax efficient strategies or pick-up?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Okay, in the muni I think it's a couple of things that are being going on. One is, yield and particularly relative yield back to the point that relative to some taxable investment in general but particularly versus treasury munis were looking and continue to look quite attractive. I would say the primary attractiveness of munis has not been their recent total return performance so much as on compared yield basis how they stack up today versus a taxable instrument. Relative to other muni managers I think Eaton Vance is recognized as a leader here, and we've been able to continue to maintain that reputation even though frankly in short run our performance has been pretty core on a relative basis which reflects some differences in our strategy somewhat longer average duration which we used to protect income and also some hedging versus treasuries which of course was not affective in this environment when treasury is so dramatically outperform muni, but we think we're positioned for us now back-in both absolute and relative performance as municipals performed better versus taxable infringements which they have been doing over the last several weeks.

In terms of our outlook for product and what we think will happen post of action as I said a few minutes a ago, I think it is likely that tax rates will be going up. I think the positive impact on our product line will be felt most like not only on equity side but potentially also on the muni side that in an environment of higher tax rate people pay more attention to taxes and after tax return, and Eaton Vance is a recognizable leader in terms of both tax managed equities and tax sufficient income product, so we certainly think in that environment that if our performance holds out to which we expect it will that we will benefit from that change in the political scene.

Unidentified Analyst

Okay, thank you very much.

Operator

Thank you. Our next question comes from the line of Cynthia Mayer with Merrill lynch, please proceed with your question.

Cynthia Mayer - Merrill lynch

Hi, good morning. I am just wondering if you could give a little more color on the comp, you said that decline sequentially because a combination of a decrease in equity comp and a decrease in bonus accruals inline with operating income. And I am wondering the decrease in equity comp is that going to continue and is that also just a reaction to the operating environment or something else, and overall is the comp to revenues ratio sustainable here?

Robert J. Whelan - Chief Financial Officer

Sure. Cynthia, sequentially total compensation first quarter $82 million, second quarter roughly $75 million, but few factors there, we have a bump in stock-based compensation typically in the first quarter more so than other quarters. So we're seeing some relief in the second quarter from that approximately I would say $3 million. The other thing that happened in the second quarter is that we didn't have severance that we had in the first quarter recurring that was another factor. And the third thing that came into play was that we... as you know we revised our compensation... our incentive compensation plan in terms of how we pay wholesaler. So, starting to see some of that impact playing out in the second quarter relative to the first quarter.

Cynthia Mayer - Merrill lynch

Does that mean that in terms of comps to revenues ratio, the change in how you compensate wholesalers is there more about to come I mean could we see the comps to revenues ratio drop even further?

Robert J. Whelan - Chief Financial Officer

I think this is a pretty good month although its very early in terms of the changes that have happened in the compensation plans. The results are playing out as we expected.

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

But the compensation changes were made effective I believe February 1st, that we would have gotten a full quarters worth of effective data.

Cynthia Mayer - Merrill lynch

Okay great.

Robert J. Whelan - Chief Financial Officer

That's right, and Cynthia just keep in mind that there is a variable component so the bonus accrual which is based upon growth in operating income.

Cynthia Mayer - Merrill lynch

Okay. A variable component to the... that would be for the cash part right, or is to both the cash and the equity?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

No, that would be the cash accrual.

Cynthia Mayer - Merrill lynch

The cash accrual?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

The equity variability is just due to the first quarter phenomenon that Bob mentioned.

Cynthia Mayer - Merrill lynch

Right Okay great, thanks for clarifying that. And then just to circle back to the Parametric fees, that over lays about 18 basis points. So can you tell us in this quarter, Parametric obviously had really strong quarter? What was the total of the overlay flows in this quarter?

Robert J. Whelan - Chief Financial Officer

Well we don't have the break down between their overlay in the core business but its roughly evenly distributed I would say between the two certainly one doesn't dwarf the other.

Cynthia Mayer - Merrill lynch

Have they both been having the same rapid growth rate or is overlay growing faster than core? And what do you think the outlook is for the... overlay versus core?

Robert J. Whelan - Chief Financial Officer

I think the outlook is for both are very strong and I would not say that one is growing, one segment is growing rapidly to any significant degree over the other.

Cynthia Mayer - Merrill lynch

Okay. And I guess one more question on overlay what is their performance measured against? How would you be able to... how do you go out and sell this versus peers and if they ever did run to performance issues, how would we be able to track that?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

I think its mostly a client satisfaction measure of performance it is not... there is certainly some attempt to track the performance in an investment tentative [ph] performance of the account, do versus the underlying weighted average of the model that they're feeding into the overall strategy because under an overlay structure the trade execution is actually done in our case by Parametric by the overlay provider. There is an investment component, but I think more than anything else the measure of performance is quality of service measure as opposed to an investment performance measured.

Robert J. Whelan - Chief Financial Officer

I think it's quite to note the overlay is around $6 billion of Parametric's total so, its around 25% and while its getting a lot of attention, its just one product in their suite of products.

Cynthia Mayer - Merrill lynch

Okay and I guess just one sort of long range question on managed accounts. If the sellers of managed accounts were to go to a system sort of more of a unified account system where they could use managers who had developed the back office system, I guess where you see that process and do you see that as a threat at all to your sales your long range sales of managed accounts, management services?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Of course the override business would be a direct beneficiary of that assuming that the Parametric had win overlay type business because that's the model you described was involved someone taking responsibility for operations and trading and reporting. And in some cases for the very largest broker dealer, that's been something they have taken in house. But for mid size and smaller and some cases even the very largest broker dealers those have been services that have been outsourced to the life of Parametric and we believe the largest player in that business.

So I think it cuts both ways, the trend toward providing model only generally involve lower levels of compensation to the model provider than if they were doing everything including the trading, but they are certainly significant cost that go on with providing those other services and currently not clear which is the more profitable model for Eaton Vance or other people that are... that do both. So I think we are... other than to Parametric relatively agnostic to whether we provide a model or whether we do the actual trading in the managed account world, obviously we care about with the relative fee rates in there but I think on balance, because we have Parametric as an important part of our overall F&A [ph] business. We see ourselves likely net beneficiaries of that trend as it plays out.

Cynthia Mayer - Merrill lynch

Okay and just one last question. What's the outlook for institutional bank loan products at this point?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

I think it's pretty good. We've seen... I would say little or no redemption activity from institutions, I think... better than retail investors, institutional investors appreciate that these are truly extraordinary times in the bank loans fund at marketplace and that there are extraordinary opportunities from current levels of pricing. So clients have stayed with us. We have... we did a launch back in the first quarter an opportunity fund, to take advantage of relative weakness in the market and we are certainly open to the idea of doing more of those types of product. But it's been on, I think that's surprisingly big in some respect surprisingly steady customer response to occur as very different stage in the evolution of the bank loan market but I think those who'd know the asset class and our historical risk returns to the asset class, view this as a really a time of extraordinary opportunity and that both allowed us to keep the best bulk of our existing clients as well to continue to add new institutional clients, all through this period of weakness.

Cynthia Mayer - Merrill lynch

Okay, thank you so much.

Operator

Thank you. Our next question comes from the line of Robert Lee with KBW. Please proceed with your question.

Robert Lee - Keefe, Bruyette & Woods

Hi. Good morning everyone.

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Good morning.

Robert Lee - Keefe, Bruyette & Woods

Couple of quick questions, may be speaking with the managed account business, it appears from your perspective and being one... I guess if you look back historically, there has been any number of competitors that have been able to grow that business in a pretty rapidly prepare time only these kind of reverse course also fairly rapidly. What is there... may be the Parametric, maybe the diversity of closed, is there anything about kind of your business that you think could make it, I guess less volatile compared to with some competitors have experienced over time.

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Well, I think we've emphasized that ours is not... our success is not based on a single product and I think that's been historical gain of some competitors who have seen big growth and then big relative growth, that has been in a single performance sensitive product as we mentioned by our F&A business is based on a quite broader range of product, our own large cap value from management of Boston [ph], tax managed core from Parametric, our muni capability overlay. We are out to represent an internationally ADR products, we call equal [ph] global advisors.

So there are number of different products that are forming the basis for our growth there I think it's my work emphasizing that the Parametric products both the tax managed core as well as overlay don't compete on a performance basis in a traditional sense. Ultimately they do have to perform, but the tax managed core is essentially a passive strategy where you're seeking to replicate it and identify index on a pre-tax basis and to outperform on an after tax basis through a process of managed tax loss harvesting. We need to perform there as well but it's a different kind of performance pressure and is typically faced by an active manager similarly with overlay business, it is a performance sensitive business but it's not the relative investment performance that drives success. But really what we think separates us from other players who run quickly and then as you said fall on quickly as the diversity of our business both by different types of product and by different underlying drivers of the business, in other words it's not all, investment performance driven.

Robert Lee - Keefe, Bruyette & Woods

Okay, great and maybe a follow-up question or two. I guess Bob you'd talked a little bit in terms of capital management and you raised the topic of... as always we are looking at M&A peak times [ph] it comes up, could you maybe refresh us on... in that regard where you see priorities maybe I think in the past international has been more... in the place?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

I think our general acquisition strategy has been one to be opportunistic. We are... we don't see a compelling need to grow any particular area. There are certainly areas of interest for us, one of those Rob you identified will be international equity. We've also have capabilities in lots of areas that we would like to augment in various ways certainly fixed income but we've got swings in other areas but also hold on our product line certain areas were essentially more focused on alpha generating areas like high yield and bank loan and emerging market and currencies and have a relatively small business in terms of core fixed income that's something that potentially we would like to grow with the right opportunity presented itself.

But again no compelling need we feel strategically to acquire anything to our areas where we want to grow all of those areas we believe we have the capability to grow overtime internally it's the question of whether we can grow more quickly and more efficiently through the acquisitions. We have an ongoing effort. We're focused on number of different areas, but its primarily driven by what we see in the market as potential opportunities around.

Robert Lee - Keefe, Bruyette & Woods

Okay, and maybe one last question on the ETF business, some of your competitors feels like have it identified ETF is being bit more of a competitive threat may be compared to have roll a bit of couple of years back, I mean can you may be... what you are thinking on that how do you view ETF as kind of threat or is there anything... how would you combat that how... what are your thoughts there?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Just think about ETF in a couple of different respects, one is APS are... in the process of changing at the margin but ETF are essentially in that product. And so part of the competition from ETF for traditional active manager, it's an active versus manager, active versus passive competition. If you are not able to beat your benchmark, if the benchmark returns can be purchase efficiently in the market through an APS, your probably going to feel some competition from the ETF.

Fortunately we've been able to perform very well across the broad range of asset classes, and frankly we don't see a lot of competition today in our business from ETF. The only thing about ETF is that they are a quite convenient and efficient and also tax efficient way to deliver return. Again today it is primarily with the focus on passive strategies but there have been an initial approvals just in the last quarter of some active ETF strategies with quite significant constraint. But we are certainly open to using or exploring the use of the ETF technology, the ETF vehicle as a way of providing our value added equity and income product services in an efficient and tax efficient structure.

So our interest in ETF is primarily and not focused on index strategies but active strategy consistent of our historical focus and current focus on active management for the vast bulk of our business, very interesting exciting area which I personally follow quite closely, but in terms of effect on our business today I'd say its pretty limited. There are certainly advisors who traditionally who made up their business primarily by lying active strategies who moved over to using ETF increasingly. I suppose in that sense there is competition but its pretty indirect. I think there is still large opportunities throughout than traditional asset management, they are driven by our ability to provide strong relevant performance as long as we are doing that we don't see thing squeeze out of the market by ETF.

Robert Lee - Keefe, Bruyette & Woods

Okay. And then one last question on a closed-end funds your press release yesterday that and as you mentioned the new leverage structure you are trying to get exemptions on I am just curious you think that how long is that kind of process usually taken on understanding the closed-end funds when those close right now but do you think that's kind of instrumental to getting that approval to one there is an opportunity, being able to actually come to market?

Thomas E. Faust Jr. - Chairman, President and Chief Executive Officer

Couple of thoughts there. Our view is generally, that for us or anybody else we make significant progress in terms of bringing new closed-end funds to market. We need to see more progress in terms of addressing the auction preferred issue. So the focus of our innovation and time in the closed-end fund area is very much more focused on redeeming auction preferred than it is on redeeming the products.

In terms of the regulatory environment you asked to call how long it usually takes to get a no-action letter. I think in effect, which is what we requested a couple of days ago. I think it is not very relevant here, because the usual has been quite set aside. This issue of auction preferred securities and providing liquidity to holders of auction preferred securities is one that very much has the attention of regulators in Washington and we've been seeing really quite extraordinary co-operation in terms of working with us to go through the issues and whatever the normal timeframe is for issuing no-action letters we think that that will be substantially accelerated in addressing our particular letter, probably just tied obviously we can't hold the SEC to a particular timeframe, but we think it will be consistent with their aggressive response to have a relatively quick approval of this, assuming that that's ultimately their decision.

Robert Lee - Keefe, Bruyette & Woods

Right, great, thank you very much.

Operator

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Cataldo for closing comments.

Daniel C. Cataldo - Vice President of Financial Planning and Analysis

Thank you for joining us today. We hope you agree with us that we feel is a very strong quarter and we look forward to many more. Thank you.

Operator

This concludes today's teleconference, you may disconnect your lines at this time. Thank for your participation.

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