Oct 25, 2012
Executives
Alicia Charity - SVP and IR Jim Cracchiolo - Chairman and CEO Walter Berman - EVP and CFO
Analysts
Jay Gelb - Barclays Capital Eric Berg - RBC Capital Markets Suneet Kamath - UBS Thomas Gallagher - Credit Suisse Securities Alex Blostein - Goldman Sachs Jeff Schuman - KBW John Hall - Wells Fargo Securities John Nadel - Sterne Agee
Operator
Welcome to the third quarter 2012 earnings call. My name is Don 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 Alicia Charity.
You may begin.
Alicia Charity
Thank you. And welcome to Ameriprise Financial’s Third Quarter Earnings call.
On the call with me 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 on our website.
Some statements that we make on this call may be forward-looking, reflecting management’s expectations about future events and the 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.
As a reminder, we will be conducting our annual meeting with the financial community on November 14th at 9:00 AM. Meeting details can be found on our websites.
Now let me turn it over to Jim.
Jim Cracchiolo
Good morning everyone. Thanks for joining us for our third quarter earnings discussion.
I’ll begin by giving you a bit of my perspective on our results. Walter will cover more of the numbers and then we’ll take your questions.
Overall, we had a pretty good quarter. We delivered strong results in our advisory business including very good retail client net inflows.
We’re generating modest revenue growth even after the impact of low interest rates. At the same time we’re managing expenses appropriately and delivering double digit growth in operating EPS.
We continue to make good progress executing our strategy in our business metrics or sounds. We’re expanding our advisory client base.
Our advisor reports a strong in growing. Assets are up across the firm and we’re improving asset management flows in maintaining good annuity in insurance books.
Even with the benefit of rising equity markets over the past year, we continue to manage expenses appropriately given interest rate pressure. Earlier this year, we stepped up our reengineering efforts; we’re seeing the benefits now and continue to invest for growth.
Overall, Ameriprise continues to generate strong returns for our shareholders an important differentiator in today’s environment. Yesterday we announced a $0.45 per share dividend representing a 29% or $0.10 per share increase, the 5th increase since early 2010, in fact, we raised our dividend a 165% over that period.
Today our employed dividend yield is above 3% which puts us at the high end of the category for SMP financials. We also repurchased $340 million worth of our stock this quarter, totaling $1 billion so far this year.
And we announced a new $2 billion share repurchased program, as we accelerated our buybacks over the past two years. Through the third quarter, we returned a 138% of our operating earnings to shareholders.
Now let me talk about our advice and wealth management segment performance. Adjusting for investment income a year ago, we were able to grow underlying revenues by 3% and underlying earnings by 8% total retail client assets were up 18% to $345 billion aided by strong client inflows and equity market appreciation.
For example, net inflows into wrap accounts more than doubled from a year ago. As I mentioned, our reengineering is helping to fund our investment agenda.
Our new brokerage platform was one of our largest technology undertaking since spin off. We successfully moved our 10,000 advisors and more than 2.5 million client accounts to the new system.
This last conversion completes our transition efforts. Now we’re focused on helping our advisors access the benefits of the new system and we’re hearing good feedback from them.
You’ll see the related expenses decline accordingly in the coming quarters. You may have seen we're back on the air with our award winning advertising campaign featuring Tommy Lee Jones.
We feel that it is the right time to promote Ameriprise and strengthen consumers and advisors understanding of value proposition. We expect advertising expenses in the fourth quarter will increase from the third but will remain relatively consistent with last year's level.
I continue to hear positive feedback from our advisors. We got in how they feel about the company and the investments we’re making to help grow their businesses.
Retention and satisfaction rates for our tenure advisors are excellent. In regard to experience advisory recruit, our efforts here continue at a steady pace a 106 experienced advisors moved their business to the Ameriprise in the quarter.
The advisors joining Ameriprise or on average three times more productive that advisors through leave. Our plan is to continue to grow our advisor base gradually focus on adding productive advisors and maintaining higher retention.
In terms of productivity, operating net revenue per advisor was up slightly. We're seen good fee pay base business growth and increasing average assets per advisor.
But low rates are lower transactional volumes continue to pressure revenues. The third quarter also tends to be a slower quarter In terms of client activity and this year, clients and advisors have added concerns about the upcoming election and how our elected officials will address the fiscal cleft.
In terms of segment profitability, pre-tax operating margin was a strong 12.4%. This is good progress given the low rate environment and economic uncertainty that's because bank from the federal savings banks were non-depository trust company.
While we will no longer offer our proprietary banking products and services while helping clients transition to other leading providers. The disposition of our deposit and loan portfolios is underway and we will cease banking operations by the end of the year.
Final regulatory approvals are pending and Walter will speak more about the financial implications in a few minutes. Now let's move on to asset management.
In the quarter asset management delivered solid profitability improvement. Our asset growth reflects a rising equity markets and reengineering initiatives are taking hold.
Total assets under management for the segment was $461 billion of the 11% from a year ago. With regard to flows during the quarter, we experienced $3.5 billion of net outflows.
These were largely driven by Zurich related institutional outflows and outflows in hedge funds. Let me take you through the pieces.
In institutional, we talked to you about ongoing outflows from the close Zurich book and in the quarter, that number was about $1.1 billion. We also had about 900 million in outflows from the re-tender of their pension assets which we previously disclosed.
The underlying institutional results were essentially flat. We continue to see improvement in Columbia’s traditional third party business.
We’re winning good mandates and the pipeline remain solid. In alternatives, we experienced $1.6 billion in net outflows primarily related to the termination of the hedge fund portfolio manager.
We liquidated the funding manager and experienced outflows and strategies where he was an analyst. We have a solid team in place and we recently added two new members.
I feel very good about their ability to move forward from here. Overall, retail flows were much improved for a year ago.
European retail investors have regained confidence and we experienced strong net inflows at Threadneedle. And at Columbia, retail equity flows remains under pressure consistent with the industry.
We also continue to have outflows and funds managed by a third party sub-advisor and in our value and restructuring fund. That said, we experienced an improvement in net flows namely into fixed income funds and in certain equity categories such as equity income.
The underlying business is strong and I feel very good about the progress we’re making. Columbia and Threadneedle are generating consistently strong investment performance.
We have broad product lines, renewed wholesaling strength and improved flows, and we continue to build new relationships both here in the United States and internationally. As we moved forward, we’ll continue to focus on navigating the challenging environment and managing the business for profitable growth.
Our business fundamentals are solid. We’re making good progress and we’re focused on leveraging our global business model.
Now move on to annuities and protection. Walter will address the unlocking impacts on our financials and I’ll speak to the business.
Let’s start with annuities. Total variable annuity assets increased 15% to $68 billion due to market appreciation.
Sales and flows have remained low as clients and advisors are learning more about our new managed volatility product, and we began to see a slight uptick in sales towards the end of the quarter. On the fixed side, the asset and flow story hasn’t changed.
We feel good about the characteristics of our fixed annuity block, but aren’t adding to it given the rate environment. Overall, the underlying annuity business is performing well and generating good consistent returns.
In protection, our business continues to be a solid steady contributor complementing on more equity sensitive businesses. We continue to help our advisors understand the benefits insurance products provide to me client needs comprehensively.
It’s a core component of both our consumer and advisor value propositions. While our life insurance books remains at $191 billion, the UL DUL product mix is becoming what balances we continue to expand our universal life business.
We have launched a refresh VUL product during the quarter and continue to see good sales in our index UL book. In auto and home, our business results improved nicely.
We generated solid premium growth and profits in the quarter and claims returned to more normal levels. In addition, our policy camp was up a steady 8%.
In closing, I'll leave you with this. Despite the uncertain environment and pressure from low interest rates, our results were solid.
I feel good about the quarter. The business is operating well.
We’re increasing our core client base, strengthening our advisor force and growing assets overall. Our focus remains on executing our strategy, driving improvements in the business and achieving strong results in a low-revenue growth environment.
As we enter the fourth quarter, the U.S. elections and pending fiscal cleft are taking center stage.
Important decisions will be made in the coming weeks and we’re working closely with our clients and advisors to help them navigate this environment. Walter.
Walter Berman
Thank you Jim, our third quarter operating net revenue of 2.5 billion was marginally higher than last year but included several disclosed items. Our underlying revenue growth was strong at 3%.
Excluding our non-cash unlocking and the additional investment income we recognized last year. Underlying revenue growth was driven by equity market appreciation and stronger advisor client flows.
These were partially offset by asset management outflows and the low interest rate environment. As you can see on page four, both pre-tax operating earnings and operating earnings per diluted share grew nicely in the quarter.
Pre-tax operating earnings grew 4% to 397 million. Adjusting for disclosed items, earnings grew over 7% versus last year.
Pre-tax operating earnings in the asset management and advice and wealth management segments comprise 60% of total operating earnings ex the corporate segment. Excluding the impact of the unlocking, earnings from asset management and advice and wealth management were 52% of the total.
Operating EPS growth outpaced operating earnings up $0.11 year-over-year or 14% after adjusting for disclosed items. This reflects our share repurchase activity of over 1.2 billion over the last year.
Our strong balance sheet fundamentals and substantial excess capital generation have enabled us to return such a high level capital to shareholders. Turning to slide five, we delivered a solid 15.4% return on equity in the quarter which is within our long term target of 15% to 18%.
Return on equity was impacted by unlocking as well as the second quarter on usual tax item. Excluding these two items, return on equity would have been 16.5% this quarter.
We returned 460 million to shareholders from dividends and share repurchase in third quarter, about a 140% of operating earnings. At the same time our excess capital position remains at 2 billion plus due to our earnings growth and reduction in required capital.
Our balance sheet fundamentals remain strong. We had 3.3 billion of cash and equivalents at the end of the quarter, with 800 million of free cash and more than 800 million in high quality short duration securities at the parent company.
Our variable annuity hedge program continues to be approximate 95% effective. Resource-wise estimated RBC ratio was 514% and finally, we have a high quality, well diversified investment portfolio that continues to perform well.
The portfolio was adding net unrealized gain of $3.1 billion with gross unrealized losses of less than 200 million. As part of the liquidation of the assets in the bank, we sold the portfolio of higher risk residential mortgage back securities which improves the risk profile of the investment portfolio.
In advice wealth management, we delivered another quarter of good financial performance. Pre-tax operating earnings were up to 8% and margins grew 60 basis points versus last year after excluding the additional investment income recognized a year ago.
Operating net revenue was up 2% from last year. And excluding the additional investment income recognized in 2011, revenue was up 3% year-over-year.
Our topline growth in advice and wealth management was driven by 18% growth in client assets from market appreciation and experienced advisor recruiting which was offset by slow transaction based activity consistent with the industry. We completed the implementation of the new brokerage platform in the third quarter and the expense associated with it came in on target.
These expenses should decline moderately in fourth quarter. It will be offset by a bit higher advertising expense.
Turning to next slide, we are on track with our process to exit the bank. In accordance with the plan we filed with the OCC, we began disposing our bank deposits and loans in the third quarter and we are on track to end-bank operations by year end.
We had net realized losses of 62 million in the quarter associated with the sale of assets; however, we would generate a net gain that will more than offset this in the fourth quarter. We are working with both federal and state regulators and we are awaiting final approval for our bank transition.
We have incurred the majority of the non-operating expenses associated with the bank transition which will be approximately $20 million excluding the impact of the interest rate hitch. In the fourth quarter, advisor of management segment pretax operating earnings will decline by approximate 13 million from exiting the bank which translates into about 100 base points of margin.
In 2013, the annual impact to earnings will be approximate $60 million. We anticipate this impact will be neutralized from an EPS perspective by the end of 2013.
We expect to redeploy the capital freed up from the bank transition which will be above our guidance of returning 90 to a 100% of earnings next year. Turning to asset management, we saw a strong earnings in the quarter, up 30% to a 155 million.
This was largely due to equity market depreciation, 7 million of accelerated head from performances and good expense management. The earnings growth also reflect the impact of outflows as well as the industry shift towards fixed income from equity which has a lower fee.
We saw a similar trend with our adjusted pretax operating margin which increased to 37.6% in the quarter. As Jim said, investment performance remains strong with a 116 four and five star Morning Star rated funds.
Let’s turn to flows on slide nine. Overall asset flows improved in the quarter.
Like the industry we continue to see inflows and fixed incomes and outflows and equity. Retail flows were slightly positives or meaningful improvement in retail flows at Threadneedle offset by outflows at Columbia.
While Columbia continued to have out flows in the value and restructuring fund and then the funds managed by a third party supervisor. The trends in both of these improved in the quarter.
In institutional, flows were neutral in the period excluding the activity exert. We had outflows of 1.1 billion from the close block of insurance assets at Threadneedle and we lost about 900 million of previously announced pension assets that were recently re-tended.
Alternative net outflows 1.6 billion as Jim already discussed. Turning to annuities, earnings were within expectation excluding the impact associated with several disclosed IMC as you see on slide ten.
The negative unlocking impact of variable annuities largely from the lower near term interest spread assumptions. Fixed annuities had a variable locking.
As the impact of lower rates on policy holder persistency more than offset spread compression from lower interest spread assumptions. Variable annuity operating earnings were 31 million in the quarter, down from 60 million a year ago.
Excluding disclosed items, variable annuity earnings were 91 million up 15% year-over-year driven by account value growth. Fixed annuities operating earnings declined to 60 million.
Excluding the disclosed items, earnings were 46 million, down 23% from a year ago due to spread compression. This was consistent with our expectation given this low rate environment.
And protection of pre-tax operating earnings increased 89 million year-over-year. The annual non-cash unlocking was unfavorable 13 million, primarily from lower gains on reinsurance contracts due to favorable mortality experience.
However, earnings in the segment were down 5% excluding unlocking and other disclosed items. Results were strong in auto and home.
We continued to see strong policy growth at 8% along with improved loss experience compared to last year. Offsetting improved auto and home results were lower long term care earnings.
Long-term care was impacted by the low rate environment as well as hard claims. While long-term care claims were higher than a year ago, they remain within an acceptable range.
We continued to monitor our long-term care block and our increasing rates as appropriate. Turning to slide 12, we returned 416 million to shareholders in the quarter.
We’re a 144% of operating earnings. We also announced a 29% increase in our quarterly shareholder dividend to $0.45 per share.
This will bring our dividend yield to 3.2% based upon yesterday’s closing share price and it is consistent with our strategy to continue increase the mix of capital returns to shareholders via dividends. In the quarter, we repurchased 6 million shares for $340 million and had 482 million of share buyback remaining under the current authorization.
Based upon this, the board will authorize an additional 2 billion of share buyback through the end of 2014. In 2013, we expect to return more than 100% of earnings to shareholders as we redeploy approximately 375 million that will be freed up from the bank transition.
The ability to return capital shareholders is driven by our strong excess capital position, generation of free cash flow and strong our balance sheet fundamentals. These factors provide a foundation that uniquely positions us to perform while across market environment and have additional capital flexibility.
With that, I will open it up to your questions.
Operator
Thank you. We will now begin the question and answer session.
(Operator Instructions). Our first question comes from Alex Blostein from Goldman Sachs.
Please go ahead. Alex, please go ahead.
Okay, I’m going to go on to the second question. Our next question comes from Jay Gelb from Barclays.
Please go ahead.
Jay Gelb - Barclays Capital
First on slide seven where you talk about the $13 million impact from transitioning out of the bank unit. Do you expect that to be included in operating earnings or is that more of a below the line item?
Walter Berman
It’s operating earnings.
Jay Gelb - Barclays Capital
The other question I have was on asset management. When you updated guidance for this year on the second quarter call you were looking at the 18-19% pretax margin level where 19.3% year to date, so I just want to confirm that there is nothing we’d expect to see in fourth quarter that might pull that down but in fact that you’d probably be (inaudible) your guidance.
Walter Berman
Pretty much on the trend line.
Jay Gelb - Barclays Capital
Okay and then finally the risk base. I’m sorry, go ahead Walter.
Walter Berman
When anticipating its price.
Jay Gelb - Barclays Capital
And then finally on river source the 514% risk based capital ratio, where do you feel the normalized RBC ratio should be taking in to account your excess capital plans?
Walter Berman
Yes as we indicated. We would try to get that under 500 and it should stay in this range, a tad under again depending on there’s a lot of moving parts to that.
So if you can’t necessarily control and again this is an estimate. We do the final at the end of the year, but I would say in this range which you should anticipate.
Jay Gelb - Barclays Capital
To the substantial amount of excess capital, where else is that being driven from?
Walter Berman
The majority of excess capital is actually in corporate at this stage and there is obviously this excess capital in the life company, but it’s throughout all the other subs, but the majority of that is now resident and corporate
Operator
Thank you. Our next question comes from Eric Berg from RBC Capital Markets.
Please go ahead.
Eric Berg - RBC Capital Markets
I am finally going to handle for a sort of what the exposure is at this point in Connecticut with the manager, and the situation with the manager who retired, at the Marsico funds and in California whether there is going to be sort of ongoing fallout from the decision to let go that PM out there. Could you address each of these three issues, the Connecticut situation, the Denver situation and the California situation quantifying as precisely as you can and feel comfortable the ongoing exposure there?
Thank you.
Walter Berman
Okay, let me start with the value and restructuring. Gentleman retired early in the year, in the second quarter and we have continued to experience some of the outflows because a number of those funds as you would imagine are on platforms and models.
And so, as they come up for review etcetera sometimes, they reevaluate because the manager has changed, and so, we think that is starting to come down. We would expect that it gets less and less as we go forward in that regard.
Regarding Marsico, the PM changed and again, what our experience is, is model changes now on some of the platforms as they reevaluate those funds. We think that Marisco has stabilized their position in regard to their funds and activities.
Having said that, they’re still up for a review when you have a change like that. And in regard to the hedge funds, we feel pretty much we have experienced the outflows that will occur there with the manager change and we feel if anything, as we settle that down hopefully we’ll start to get some inflows back in next year in that regard.
But, it’s unfortunate as you go through some of the manager changes etcetera, you have model changes that are occur in review, and those things sometimes last a bit longer, then you would think the change has occurred, why isn’t it over. And that’s what we’re experiencing and hopefully we could continue to deal with that effectively as we get fund flows into other of our retail funds and get more of our funds on these model portfolio platforms and that’s what we've working hard to do because we do have good funds with good performance.
We just got to get that more known out there in relationship to the ones that were on the platforms.
Eric Berg - RBC Capital Markets
Could I ask a second and final question of sort of a related nature. In the past you have discussed a hold in your product line of areas where you need to develop.
It’s surprising because Columbia is a big and complex organization. I would have think every products would have been checked.
But where do you stand right now in terms of your product bracket? It’s broad but is it complete?
Walter Berman
Yes, I think Eric as we have evaluated and we’ll discuss this a bit more at our financial community meeting. We do have a broad product set with good product with good performance and it’s unfortunate that a lot of the areas that we have been really strong in are not necessarily in, in the flow category right now particularly in equities.
We have been garnering a very large share in our dividend and opportunity funds things such as that are more equity income related. In regard to the places where we haven't played as well are things like and that's what we've been working on to ensure, because we’re putting our talent together in the product areas is things like global bonds, emerging market debt, things such as that, that have garnered some logic flows, strategic allocation on a multi-asset basis.
Now we think we actually have some good product that we've been gearing and building the track records for and positioning and repositioning and we'll discuss that a bit more in two weeks but if you look at where large inflows have come from, those were some of the categories. Even in the fixed income, we actually have gone in good flows in places like high yield etcetera.
We do have good intermediate funds but some of the things that have been selling have been positioned a bit differently and we're working on that. So, again we can't dictate that that's where the flows will stay but we do have to ensure that we have a good product in those categories as we maintain the categories that we are strong with and hopefully as things rotate back in will be situated well.
Operator
Thank you our next question comes from Suneet Kamath, please go ahead from UBS
Suneet Kamath - UBS
I had two questions, I wanted to start with advise and wealth. Looking at the experienced advisor recruits, it seems like that number keep ticking up.
I think you're analyzing over 400 this year versus something like 337 last year. So I guess the question is, can you talk a little bit about the compensation packages associated with these recruits.
Just looking at the headlines we're seeing a lot of teams kind of move firms. So I imagine that things are pretty competitive, but can you just talk about how these compensation programs compare to say what we have seen in the past, sort of directionally and I have a follow up.
Jim Cracchiolo
When we go to, what we’re doing, yes, we have a good and consistent pipeline. We have ramped up our efforts a little more fully around the country and we’re recruiting now, not just into the employee section but also into the franchisee area as well.
In regard to the packages, the reason for us to increase mainly is because we’re recruiting more, I would call a higher level advisors in, but on a relative sense we’re necessarily playing in some of the categories and the ratios that you’ve been seeing out in the marketplace. Our packages we think are competitive but at the same time it’s also the type of advisor that we’re trying attract that would help them build and grow.
And in addition to that, we’ve set it up in a way that as they produce they can actually achieve the higher, what I would call transition comp on the bank end. So we feel very comfortable about that.
Our returns are still very good and appropriate. I would say the rates have gone up mainly because we’ve been recruiting more higher level productivity where you would always see the skill up in that regard.
But I would still say it’s not to the points that I’ve been seeing in the industry as well.
Suneet Kamath - UBS
Got it, and are we seeing the sort of the pickup in productivity from the folks that you started recruiting, I guess back in 2010. I know in the past you’ve talked about, I don’t know if it was a 12 month or 24 month time period before, these guys are really on-boarded.
Can you give a sense of where we are based on the folks that you’ve already brought in?
Jim Cracchiolo
Yes, we track that very closely and we do it on a vantage basis. So as we add more people of course the newer people have less over and produce less, but as you go through the vantages of one, two and three years.
On average we are very successful in bringing over a majority of their assets and books of what they’ve identified and what we have chatted with them and agreed to on the type of the arrangement. The second thing that occurs is that they then transfer over and then takes them anywhere from one to three years to fully ramp up depending on the type of book, the type of activity, product set and where they are located in regard to an employee versus a franchisee.
But we have seen consistent ramp-ups, consistent with our models and our payback schemes. Within a 24-month period as an example, we get about 98% of their assets under management from the beginning.
Now, they might not be at 98% in productivity because as you know, based on certain clients and certain activities and certain types of transactions that they might have sold in the past, you don’t necessarily replicate that immediately with market conditions. But we are seeing a consistent nice ramp up with our models.
We feel very good about it, that’s we’re consistently deploying resources to bring in people.
Suneet Kamath - UBS
Got it and my second question is for Walter. Just on the excess capital.
If I go back over the past couple of quarters, it seems like the excess capital number is consistently been 2 billion plus despite the fact that your payout ratios has been well over 100%. So it seems like the reason is that required capital is going down.
So I was just wondering if you could really help us understand what is going on underneath the surface that keeps that excess capital position static despite the fact that your payout ratio has been so high, thanks.
Walter Berman
Sure. First what has happened there, we have the market, has certain impacted this quarter and looking at CTU98 (ph) that has lowered our requirement.
We’ve also so re-bounced some of our investments as certainly as we exit the bank which is also result in a lower requirement and over the last year we’ve been working on our hedges to make them more effective from standpoint from a capital standpoint and that work will continue and that is primarily the focus also as we get the mixed shift in the business coming in more onto the asset management and advice wealth management, that certainly requires less capital. So we’re seeing a track on our new activity in the amount of capital required on that and we’re working on getting our basic requirement down primarily in the hedging area and use of our hedges in the state capital area.
Suneet Kamath - UBS
But should we expect that two plus billion now to start to grade down assuming that you’re paying 90 to 100% of earnings in terms of payout and then in the bank capital should we start to see that number coming down?
Walter Berman
No again, plus is not define from that standpoint but the (inaudible) know because I think we are with the amount of activity and the amount of capital required as we’re adding it in the mix, as I look in the near term I think we should be able to preserve that, again depending on how the level of buyback that we executed upon.
Operator
Thank you. Our next question comes from Thomas Gallagher from Credit Suisse.
Please go ahead.
Thomas Gallagher - Credit Suisse Securities
Walter, first one for you on advice and wealth, have you all already received the benefit of the fall-off in IT spend in that area. I know there 1Q, the expense level was elevated.
If I look back to the run rate this quarter versus back to 1Q, we've had a $60 million reduction. Is it safe to assume we've gotten that full benefit of the fall off already or is there still more to come?
Walter Berman
As we indicated, I think Jim indicated that we implemented the system in the third quarter. There is still expense that will be us for a quarter or two as it trails off, but it will trial off and as it relates to training and certainly giving up in our service delivery capability.
So on that basis we will still incur expenses in the fourth quarter. And in the first quarter, the expense will start decreasing.
You should not see a dramatic change, but it will start coming off.
Thomas Gallagher - Credit Suisse Securities
But Walter, if we look at apples-to-apples versus the expense run rate from 3Q sale if there is going to be a trail off of expenses through the end of 1Q, order of magnitude, are we talking about something that will be material offset to the, we’ll call it $50 million or so of lost earnings as a result of the bank sale. Is it material relative to that $50 million when you think about by 2Q of next year or is it not that material?
Walter Berman
If you are talking about from the standpoint as it relates to the $50 million we talked about as related to the lower expense once the system was fully integrated.
Jim Cracchiolo
Yes, what we have is if you saw in the first quarter of this year, we’ve had a lot of expenses, we had to complete a lot of the development for the conversion in the second and third quarter. In the second and third quarter to Walter’s point, we had a lot of expense for the training and the service deliver to actually migrate over the accounts and support that activity including through clearing.
And so what we are now doing is winding down the systems caused carrying the two systems because the development was done, that was heavy in the first part of the year. And we’re winding down to Walter’s point more of the service delivery and the training support cost and that will gradually come off over time as people get ramped up more fully on the systems.
What I would say to your point is, we’re not going to fully offset the bank margin because that’s roughly about 15 million a quarter, but we should as you as saw in the third quarter coming from the second quarter, that sort of run rate of reduction in G&A we think will continue probably through the next two quarter or so in that regard. So we’re going to bring down average the expenses for the whole migration over the course of the next year particularly in the first two quarters of next year.
On an apples-to-apples basis it is less than 15 million per quarter for the bank because we started to achieve some of that savings already in the third quarter if you look at the third quarter below the second quarter, second quarter below first some. So some of that was in there but there's still a remaining piece of that per quarter.
Thomas Gallagher - Credit Suisse Securities
Okay, okay Jim that’s clear. So if I look at the delta from the 2Q to Q3 was $7 million is that, so you're saying directionally it could be about that amount?
Jim Cracchiolo
I think that's what we should see for another quarter and then maybe it will be a bit less than that instead of first and second. So there will be a bit more.
I'm just saying it would have offset fully if we didn’t take some of our expenses down in the third quarter of this year which we did.
Thomas Gallagher - Credit Suisse Securities
Okay, so if I understand you numerically, by the time we get into 2Q of next year you might have half the two thirds of the lost earnings offset by lower expenses?
Jim Cracchiolo
Yes, I would say if you can count yet the fourth quarter including in that, yes, probably along those lines but I think Walter can probably do some calibrations and let you know a little clearer when we do the FCM.
Thomas Gallagher - Credit Suisse Securities
The next question I had is just on long term care. I know it’s a small revenue line for you all but you lost a little bit of money in the quarter on it and I guess my question is, should we be worried at all or if you guys done a reserve adequacy analysis and/or a DAC review related to that business.
only because my understanding is that with the FAS60 accounting and the way it works, when you move into loss recognition territory, that typically precipitates a reserve view type of test and a DAC test, so if you could just comment on that, that will be helpful.
Jim Cracchiolo
The answer is yes. In the third quarter we did do reserve review and we felt that the reserve was adequate from that standpoint.
And nothing was necessary to take down and so we’re certainly monitoring the situation. As we indicated claims were up.
We made an adjustment on an IBN hour, but we are putting in our rate increases and we feel that at this time certainly based upon review it was not necessary to make a change.
Thomas Gallagher - Credit Suisse Securities
Okay and my last question is just on the hedge fund outflows, Jim can you provide a little more color on what happened there? Were those client redemptions as a result of an employee departure?
Was that the seller men decided to give money back as a result of it, and also what are the assets remaining with that hedge fund team? Only asking because typically in situations that I've seen in the past like this, once you have substantial outflows with a particular team, those can last a bit longer.
But anyway if you could provide a little more color on that?
Jim Cracchiolo
Okay, when we terminated the manager, as you know, as people are invested in various hedges and particularly as you go into a period where we fought with the various market situations, people evaluate that and sometimes they do remove that money if you allow them to do so which we do. We have the funds open.
We want them to make informed decisions there. And so as they had notified us, they did pull the assets there.
They will evaluate that over the next number of periods to see. But that’s exactly what had occurred.
It’s not that we gave the money back. They wanted to take it out at this point in time.
We have a good team still there led by Paul Wick and we have added back some additional talent to Paul’s team. We feel that Paul has had an excellent track record over the years and that he is very much focused on continuing to maintain his performance and I think as we do that, we should hopefully garner some flows in the future.
And so that’s really the situation. It was unfortunate, but at the same time we think appropriate.
Operator
Thank you. Our next question comes from Alex Blostein, Goldman Sachs.
Please go ahead.
Alex Blostein - Goldman Sachs
I wanted to go back, to AW on for one second. Jim can you talk about I guess competitive dynamics in the marketplace today.
Clearly your head account growth has been very good. Where are you seeing incremental phase coming in from?
Is it predominantly wire houses or are you seeing it from other kind of more regional players? And then more importantly, the way you guys thinking about structure in the compensation arrangement for the new financial advisors.
How does that differ from I guess your current pool of (inaudible).
Jim Cracchiolo
So overall we’re seeing increased activity and consistent activity from a number of different places. We’re seeing people continue to join us from the wire houses in a very focused way.
We’re also seeing now people joining us from some of the regionals and even if you are the independence as we look at in particularly into our franchise or channel and so we feel like our story is getting out there in the marketplace. We’re actually having good conversations and people are becoming more familiar with us.
We used to be known as the quite company that didn’t necessary understand who we work fully, and I think we’re starting to make the right noise out in the marketplace and positioning so that we are getting on more radar screens. From that perspective, as people are becoming more familiar and as we’ve attracted more people over so they understand what we’re able to do and who we are.
We are seeing bigger and bigger produces as well becoming interested in us. So I think that we’ll continue at this point in time and I feel good about it.
As far as the packages are concerned, I know there is a lot of headlines out there and those headlines are particularly focused in the industry on the million dollar plus producers and I think there is a bit more competition out there particularly in the wires for those people. that’s not necessarily the territory we’re playing in and very clearly I think if people are choosing to come here, they’re choosing to come for more of the value proposition, the culture, the type of positioning we have in the marketplace versus moving to another wire.
And so again, we feel good about our ability to do this and more of an appropriate economic fashion. We’re not going to appeal to all people and we’re not going to appeal to those they just want a big check and that’s good.
We actually prefer not to. So we feel good about where we are and what’s we’re attracting and helping those people come over and helping them to actually take up a stronger advice value proposition.
Alex Blostein - Goldman Sachs
Great and then two on asset management. Jim, first one for you on the institutional business, I know there is I guess little bit of noise whether these one of cut of outflows, but when you look at the pipeline and we talked about it last couple of quarters performance is really good, your year numbers are solid across a margin product, can you give us a sense of how big of the pipeline is for you guys of potential wins and when and what’s the pace of I guess those assets coming into the run rate?
Jim Cracchiolo
Well I think we’re also going to try to cover this in a bit more detail in two weeks. Ted Truscott will be actually discussing the various flows and our distribution activities and the various products.
What I would say here is this, our institutional pipeline is good and strong. it doesn’t mean we’re not going lose some of the stuff that we had in the past as you experienced, but as we said, with the large hump a lot of Bank of America activities, there is still (inaudible) but again we mentioned as 1.5 billion, it’s not a lot of money.
We’re going to have some lumpiness like as we said from things like the Marsico or the VNR, things that are on various platforms as they continue to migrate out or get settled. But, even retail, we are starting to feel good.
I mean our sales are actually a bit up and we look at market gains in our focused area are positive. But we need to get more of that.
We need to get on more platforms, more intermediate recognized full deployments we have versus some of names of firms out there and we are working hard. Threadneedle has actually come back in a good way.
Now Europe that has settled down a little, hopefully we’ll continue that way but we see retails flows came back very nicely and institutional flows are very good. I mean it doesn’t look that way once you get to Zurich but we’re always going to have a $1 billion a quarter with Zurich.
I mean the pension fund tender was the one that we identified because we have more call it the pensions and have it diversify. But if you take that out, Threadneedle was in a nice positive position this quarter, and Columbia who’s unfortunately with the hedge fund.
But Columbia I mean, our institutional funds neutralized that including some of the portfolio platform changes and then the retail, more than half of the outflows were in those just two fund category, the VNR and (inaudible). So, I think we’re making progress.
This is not still a great time where everything is in inflows but listen, we've got a good underlying platforms. People were working hard.
We’re continuing to fill out the areas that we are not necessarily well-known for that we think we can be in those areas. We’ll go over that a bit more but I am feeling pretty good about it.
I mean we've got work to do. So this is not like declaring victory at any sense, but I think we've got over the hump and at the same time I think we've got a good platform and we are generating pretty good margins and profitability from it.
We have an investment performance as maintaining itself.
Alex Blostein - Goldman Sachs
And then Walter just one for you on also on asset management. So taking into account what the outflows you had in the alternative business, I guess if you look at the whole complex, how much in a AUM do you guys have right now that’s kind of performance eligible and how are those assets performing this year?
Walter Berman
The performance has actually been okay. I mean, in both of the health and in the tax side and I am not sure on the fund side, I am not sure if we’ve bet over a $1 billion is what is the funds.
Alex Blostein - Goldman Sachs
Over a $1 billion and the funds are the just all of across everything.
Walter Berman
Are you talking about the hedge funds, its probably concentrated in the two areas that I mentioned.
Operator
Thank you. Our next question comes from Jeff Schuman from KBW, please go ahead.
Jeff Schuman - KBW
I guess I want to do a little bit of hair splitting. One page seven, regarding the transition on the bank, it says neutral EPS impact in 2013.
I think in Walter's comments, he said neutral by the end of 2013. I guess the difference is not immaterial to estimates.
Which is kind of the more accurate expectations?
Walter Berman
Obviously we will engage, redeploy the capitals. Obviously the capital is still in bank this quarter, in the fourth quarter.
But commencing in the first quarter of next year we will redeploy. We’re not intending to match exactly on the earnings that are coming out of the bank but by the end, our target was to neutralize effectively for the year the impact of that all from an EPS standpoint.
Jeff Schuman - KBW
Okay so not matching by quarter but when on a full year basis pretty much neutral that?
Walter Berman
That's what you should expect yes.
Jeff Schuman - KBW
And then going back to the loss of the alternative assets, I mean a 1.5 billion of outflows, isn't that a big number relative to the size of the complex but if you've often pointed out historically not all assets are in equally some of the Zurich assets you lose probably you don’t earn much presumably the alternatives earned probably your best earning assets. I mean is the loss of these assets material enough that we should think about it in our numbers or just how well did you earn on those assets?
Walter Berman
These were earning assets, obviously higher than Zurich had mentioned, but again, its manageable, it will impact us obviously in fourth quarter a bit but from that standpoint, we believe we will be able to build it back but I would say it certainly has a higher profitability factor than some of the ones we've been talking about we've been losing from the bank but again its manageable.
Jeff Schuman - KBW
And lastly you've given us some directional guidance on the ad spend, I think you're up sequentially maybe flat year-over-year but we don’t really have great visibility into what the ad spend is. I mean should we just assume that corporate DNA is kind of flat year over year or how do we account specifically for the ad-spending given the limited visibility?
Walter Berman
We’re pretty much on track versus what we spend. It does get split between corporate and AWM.
Obviously there’s a lot of institution enterprise advertising, and in the fourth quarter we have heavy ad versus the third quarter. It will increase in the fourth quarter.
Jeff Schuman - KBW
The corporate G&A or just the ads been pieced within that?
Walter Berman
No, in the corporate G&A, a piece of it goes into corporate G&A and then obviously a portion is in AWM.
Operator
Our next question comes from John Hall from Wells Fargo Securities. Please go ahead.
John Hall - Wells Fargo Securities
Jim I have a question about M&A, obviously capital is building here, and you have done a couple of successful transactions, Columbia and Threadneedle and characteristics of both of those transactions where that they had large books of legacy asset that created some outflows over time and continued to. I guess given your experiences with each of those properties, what are your thoughts as you look at other properties out there that may have similar legacy asset characteristic?
Jim Cracchiolo
Well as you know, if you are going to buy an entity that’s attached to any larger entity, particularly that’s in the financial space, you are going to have assets that may have been attached. So if asset managers around by banks or insurers etcetera, you’re actually going to have legacy assets.
I think as we think about those legacy assets, we always and just like we did with Columbia, we thought about what the net value is of what you will be purchasing, how long those assets would live for and then what’s the sort of the value that you would be left with after enduring. So we do evaluate those things and if it’s still a good opportunity for us based on combination of value and what that would add to us over time, we will definitely still consider it.
If you find that there is an independent entity then in most cases, you don’t have those legacy assets, but you still may have larger institutional contracts or other things that would still have to be evaluated if there is a change of ownership. What we do is look at the value of the entity fully with those assets incorporated and what happens if you maintain to more loose them to come up with evaluation and that’s what we would do and even though I’m sitting with the capital as we said, when we don’t see things, we buy more of our stock back and raise our dividend etcetera and that’s what we’ll continue to do.
We’re not just looking to spend the capital on assets that are out there. There are assets out there but we have looked at various ones and again, we look at we’re going to be left with in the end to decide whether it would be appropriate for us.
So we’re not opposed to that. I think what I would do in the future is if I did an asset like that again I would help to be as clear as I can with you to understand what that outflow may be so that we understood, it.
But it would be to really buy what would be underneath it that would maintain and live rather than just what you would buy in a transition basis. I hope that answers your question and that’s what we tried to do with Columbia and we think we are pretty good with that having said that, you still live with the outflows for periods of time.
John Hall - Wells Fargo Securities
And just as a follow up on the increase to the dividend, are you managing to some set payout ratio in future that you’re trying to get to?
Jim Cracchiolo
What we have said right now is in combination, we wanted to return roughly as our starting point about 90% of our earnings to the investor based on where we are at capital position of free cash flow. With that we are trying to rebalance it a bit more to have the mix a bit more in the dividends as investors have expressed that interest and that’s why over the last two years, we have raised the dividend 165%.
So we’re over a 3% yield, which we like at this point based upon the interest that’s there in the marketplace. We’re not managing to a 3% we’re managing more to an overall payout ratio that we would give back to the investors between dividend and buyback.
We’re not going to chase it up and down but we will look for a steady amount of dividend and a steady amount that we can have an increase. That’s what we actually tried to do since we’ve been public.
There is only one year that we didn’t raise our dividend and I more than made up for with the five increases over the last two years. and so we tried to maintain our dividend so that we wouldn’t cut it and we manage that to be a certain level of cash that we feel very comfortable with and at the same time, we would like to continue to grow the dividends over time consistent with that, but we did increase it a bit more than we would have thought in the past because of what we think the combination interest in our cash flow is today.
John Hall - Wells Fargo Securities
Great and just one final thing on the bank and the decision process there to pull capital away from the bank is partly return oriented and partly regulatorily oriented. I was wondering if you could sort of draw a dotted line to what you’re doing in the bank, to your thoughts on whether you are thinking about things around your fixed annuity lack of business where that’s a market that there is an awful lot of external interest in.
Jim Cracchiolo
Well, the bank decision is really driven based upon, I think the combination of the pressure that would be - we only had a small banking institution and the bank would subject the entire entity to certain other requirements that we didn’t necessarily see as reasonable and appropriate at this point in time. For the bank itself, we had a no issue or concern about the regulatory requirements for it.
It was more of how that would subject the entire institution and limit our abilities to operate in the businesses that we are, because we are heavily regulated in those businesses to begin with. So that was really the decision.
It wasn’t just to free up that capital. In the end it does free up that capital and based on again, that it was a smaller institution and the amount of capital we had in it.
It sort of offsets the earnings that we had in that at this point in time. The fixed annuity book, we have looked at the various things that are out in the marketplace.
We actually generate a nice return on that book. Yes, it is running off a bit.
At the end of the day we've evaluated those alternatives and we don’t think that would be favorable for us. But Walter can comment a bit more on that but we constantly look at alternatives but we felt that we’re in a better position than what others may have that are needed to sell that off.
Walter Berman
The only thing I have to say is that we certainly do evaluate that from Jim’s standpoint but the returns that have been provided even if the runoff have been, actually within our targeted ranges, and so we don’t need the capital, it certainly generates its earnings and it’s the portfolio that supports it is match quite well and we feel quite comfortable with the exposure profile.
Operator
Thank you. Our last question comes from John Nadel from Sterne Agee.
Please go ahead.
John Nadel - Sterne Agee
Just first a quick comment Jim for you in the board and I don't want to typically say something like this, especially because I am not allowed to invest in your company, but there is not a single company I cover that’s doing a better job of returning capital to shareholder. So, I applaud you for continuing to deliver on that commitment.
I do have two questions for you on asset management, its starting with the one Jeff Schuman's question, as the makeshift in the overall asset or AUM with fixed income a larger share, the pie equities at least a little bit lower than it has been the norm and more recently with the hedge fund outflow or hedge fund closing the alternatives are lower, how should we think about the impact, how should we size the impact on the overall fee rate for that segment?
Jim Cracchiolo
I think what I would say here is, we have seen a bit more as you have mentioned of the shift in some of the flows between fixed and equity. Having said that, the markets again, it depends on where the markets are holding, but the market increase says or set that a little bit and you saw a nice rise in the total assets particularly in equities.
What I can't predict and I don’t know if you can, maybe our elections and what happens in Washington to get the economy going will be a positive but my belief is that over time there is so much money that have shifted the fixed income at one point, the interest rates start to move, the economy picks up. There has to be a shift back because otherwise you're not going to be balanced correctly either as a retailer or institutional investor but right now it has shifted, Walter I don't know if you can give them a perspective on what that looks like or you will in two weeks?
Walter Berman
I think Ted will cover but there has been a shift and the fixed income obviously has a lower earnings profile for us and the shift I guess is, if you look at it, its maybe 20% of the 25% of the market depreciation. Obviously it’s an industry where it is shifting and there are other things that the team is doing to improve them all.
Its revenue from reengineering.
John Nadel - Sterne Agee
Can I ask you so is the margin, I think it's very clear that the margin on alternatives is higher. is the margin on equities versus fixed income also higher?
Walter Berman
Yes.
John Nadel - Sterne Agee
Okay and then I guess Jim, I did notice, its only modest but there was a slight downtick In the quarter, in the number of four and five star rated funds, given that in the overall industry pressure on flows as you just discussed, I'm just wondering and maybe this is more for two weeks from now, what outlook you can provide as far as your expectation for flows going forward, particularly Columbia retail.
Jim Cracchiolo
Right on the number of funds I think we're pretty stable. I don’t know if it moved by one or two or something but I think we’re pretty consistent and stable in that regard.
I would say we will try to give you a flavor for how we’re thinking about, our distribution and flow activity. What I can't predict, to be very honest is, again will equities come back, when will it come back, what categories are most important right now.
We know that in certain of the categories, we've been winning some good business. I think what's offsetting or some of the things that we mentioned to you, and there is some other categories that give big inflows that we haven't played in.
But I actually feel like we are in a reasonably good situation but there is a lot more that we can continue to do and we’re working hard to do that. So why don’t we leave it from two weeks from now and that will be a better way for us to sort of lay that out and take some of your questions.
Operator
Thank you ladies and gentlemen. This concludes today’s conference.
Thank you for participating. You may now disconnect.