Apr 15, 2008
Executives
Kelley MacDonald - Senior Vice President, Investor Relations Ron Logue - Chairman and CEO Ed Resch – CFO
Analysts
Mike Mayo – Deutsche Bank Glenn Schorr – UBS Brian Foran – Goldman Sachs Ken Usdin – Bank of America Securities Brian Bedell – Merrill Lynch Thomas McCrohan - Janney Montgomery Scott Richard Bove – Punk Ziegel Robert Lee – KBW
Operator
Good morning and welcome to State Street Corporation first quarter call and webcast. [Operator Instructions] Now I’d like to introduce Kelley MacDonald, Senior Vice President for Investor Relations at State Street.
Kelley MacDonald
Good morning everyone. Before Ron Logue our Chairman and CEO and CFO, Ed Resch begin their remarks I’d like to remind you that during this call we may make forward looking statements relating to the corporations financial outlook and business environment, exposure to claims and the adequacy of its reserve among other things.
Actual results may differ materially from those indicated by these forward looking statements as a result of various important factors including those discussed in State Street’s 2007 Annual Report on Form 10-K and is subsequent filings with the SEC. We encourage you to review those filings including the sections on risk factors concerning any forward looking statements we may make today.
Any such forward looking statements speak only as of today, April 15, 2008, and the corporation does not undertake to revise such forward looking statements to reflect events or changes after today. In addition, information related to this webcast including information concerning and reconciliations of non-GAAP measures referred to in this webcast is available in the Investor Relations section of our website www.StateStreet.com/Stockholder under the heading annual reports and financial trends.
I’d also like to remind you that this morning we will be using several slides to illustrate some of the material that Ed Resch will present regarding the performance of the assets in the corporations investment portfolio and of the Commercial Paper conduit. You can access these from our website and some are also included as an addendum in our trends package.
Now I’ll turn the call over to Ron.
Ron Logue
Good morning everybody. Before we begin to review the results of the quarter let me give you my thoughts on the impact on State Street of the turmoil we’ve seen in the financial market in the past quarter.
I’ll provide an overview of the quarter and Ed will provide details behind our performance as well as some specific detail with respect to our investment portfolio and our asset backed Commercial Paper program. I’ll return to give our view on the outlook for the rest of 2008.
During the quarter, as I’m sure you are well aware, unprecedented illiquidity continued in the fixed income markets. At the end of the fourth quarter things seemed a little better but in February the markets froze up again and then equity markets declined rapidly to about 1,350 on average for the S&P, the point that we estimated on February 5th for the entire year.
It obviously remains to be seen where we’ll go from here but we are still assuming an average of about 1,350 for the S&P. At the same time the Fed has taken action to support the financial community, decreasing the rate at which banks can borrow and also cutting the Fed funds rate by 200 basis points in three meetings.
What’s been the impact of these events on us? First of all, and very importantly our core businesses remained strong, outperforming the markets on both the equity and fixed income sides.
Compared to the first quarter of 2007 our fee income grew 43% and was up 29% excluding the revenue from the acquired Investors Financial business and principally to our success in selling our products and services to new and existing customers. We strengthened our capital position with the issuance of $500 million of tier one qualified regulatory capital in the middle of January and of course, as you can see we supported our equity with strong net earnings.
Our trading business and our securities finance business both recorded significant increases compared to the prior year and the prior quarter. Net interest revenue also increased 92% compared to the prior years first quarter.
This quarter did not go without its challenges, however. Due to continuing illiquidity the mark to market on our investment portfolio increased as of March 31, which Ed will discuss in a few minutes.
We also saw an increase in the unrealized loss on the assets held by our conduits. The decline in equity valuations provided some headwind against growth both in asset servicing and asset management fee revenue as well.
Considering the decline in the equity markets both businesses performed well, fueled by net new business. State Street, this morning reported a strong quarter’s performance with increased revenue on nearly every line of the income statement when compared to the prior years first quarter.
Our total revenue increased more than 50% and our operating earnings per share excluding the merger and integration costs in the first quarter of 2008 were up 49% compared to the first quarter of 2007. Also excluding these costs we achieved 19.4% operating return on equity in the first quarter of 2008 compared to 17.4% in the first quarter of 2007.
We are off to a strong start in performing against our goals which, as you know, our growth and revenue of between 14% and 17%, growth in operating earnings per share of 10% to 15% and achieving an operating return on equity of 14% to 17%. Even excluding the revenue from Investor Financial, comparing the first quarter of 2008 with the first quarter of 2007 revenue grew 39%.
Also excluding the merger and integration costs in the first quarter of 2008 on an operating basis we achieved positive operating leverage of 810 basis points, our 14th consecutive quarter of positive operating leverage when measured on a year over year basis. Considering the market challenges we are pleased with the strong year over year growth in our core businesses, our asset servicing and asset management businesses including internationally.
On a year over year basis servicing fees increased 34% and management fees grew 7%. Those same market conditions also presented opportunities for over performance in foreign exchange and in securities finance as was true in the second half of 2007.
Foreign exchange revenue in the first quarter was up 74% compared to the first quarter of 2007 and securities finance revenue was up more than 200%. We’ve now completed the first nine months of the consolidation of Investors Financial and we remain confident that we will achieve our customer revenue retention target of 90%.
As you are no doubt aware, we have been servicing [Bockley] Global Investors since we acquired IBT last July and have been in discussions with them from that point about an ongoing servicing relationship. I’m pleased to announce that we have now finalized an agreement with [Bockley] Global Investors to continue our servicing relationship.
State Street will provide a wide range of investment operation services to BGI from our current locations that include Sacramento and Boston. This agreement follows a comprehensive review by BGI and they made their determination based upon the solution that would provide the most benefit to their clients and their shareholders.
Obviously we are thrilled with this development but as you can appreciate we won’t be discussing any further details beyond the facts that I’ve just outlined. We will not be commenting publicly from here on about BGI or the terms of our agreement.
As you can see from the press release issued this morning the performance of the business we acquired from Investors Financial was excellent and continues to exceed our expectations, adding $232 million in fully tax equivalent revenue in the first quarter from Investors Financial we reported a neutral result per share this quarter up from $0.01 dilution in the fourth quarter. We continue to expect the acquisition to be modestly accretive this year slightly ahead of our original plan.
The consolidation is proceeding according to plan. We have already converted almost 40% of the customer products.
We already have commitments from customers representing 91% of the annualized revenue. As customers convert we are removing costs while also providing access for those customers to a broad range of new products and services.
Beyond the success of the Investors Financial consolidation some of the first quarter wins include, on the servicing side first from TIAA CREF we won $225 billion in assets for which we will provide custody, accounting and daily valuation for mutual funds and separate accounts and 529 plans as well as statutory accounting and unit value calculations for non-managed separate accounts. We also secured a new mandate from the Municipal Employee’s Retirement System of Michigan to provide a range of investment services including daily accounting and performance measurement for $6 billion in public fund assets.
Very importantly we renewed relationships for servicing assets with five public funds for a total of $186 billion in combined assets. The funds renewing their business include State Retirement and Pension System of Maryland, the University of California Regents Group, The Montana Board of Investments, the City of Philadelphia Board of Pensions and Retirement, and the Minnesota State Board of Investment a customer for over 20 years.
In addition, the State of Nebraska renewed a servicing mandate for $12 billion an agreement that we have held since 1995. We also retained the British Petroleum Pension Trustees Limited to continue providing custody, accounting, securities lending and performance measurement services to the funds approximately ₤14 billion in assets.
We’ve been servicing BP for over 20 years as well. State Street will provide custody, accounting, and fund administration for Five Scotiabank International Wealth Management Fund based in Cayman.
State Street is providing custody, fund accounting and investment management services to Scotiabank since February 2002. Expanded mandate State Street will now service approximately $4.54 billion Canadian Dollars in total assets for Scotiabank.
State Street International Financial Data Services our international transfer agency joint venture with EST have been appointed by Rensburg Fund Management to provide a range of service solutions for its UK Uni-trust Fund for approximately ₤1 billion in assets. We also had a joint win from ING Direct between Investor Services and SSGA.
Service three new ING Street Wise funds and manage four investment strategies for each of those funds. These wins plus many others totaled about $600 billion in assets serviced.
State Street Global Advisors also added significant new business as well. California Public Employees Retirement System renewed their contract with State Street Global Advisors for providing currency overlay strategies for $2.6 billion.
Los Angeles City Retirement System retained SSGA to manage a $701 million MSCI World X US Index Portfolio. SSGA was appointed by Universities Superannuation Scheme Limited to manage ₤100 hedge fund mandate.
The portfolio will be specifically tailored to meet US investment objectives and will be managed on a segregated basis by SSGA. Nestle Waters USA chose SSGA to provide target date funds as its qualified default investment alternative in its 401(K) plan.
Net new business at SSGA for the first quarter of 2008 totaled $69 billion. In the first quarter 51% of SSGA’s new business came from asset strategies, continuing emphasis for SSGA.
Let me now turn to our balance sheet for a minute. Net interest revenue and net interest margin again performed very well.
A 92% increase in fully taxable equivalent net interest revenue in the first quarter of 2008 compared to the first quarter of 2007. A net interest margin of 220 basis points in the first quarter of 2008.
Our investment portfolio is performing as expected. We have benefited from the recent actions of the Fed in cutting the Fed Funds Rate.
Ed will provide further details about these results and our outlook in a few minutes. With pressure from a decline in equity markets we will watch expenses carefully adding people primarily to support our growth outside the US and service new customers while managing our rate of expense growth against our revenue growth.
However, we will continue to invest in the technology needed to support new product development which we believe will continue to fuel our growth. We also continue to make investments in risk and compliance infrastructure as global regulatory requirements change.
Despite the turmoil in the markets over the past quarter I’m very pleased with State Street’s performance. Both growth in revenue as well as operating earnings per share.
Now I’ll turn the call over to Ed who will provide some of the details of our financial performance last quarter, further information about the performance of the assets in our investment portfolio and the Asset-Backed Commercial Paper Program.
Ed Resch
Good morning everyone. This quarter certainly underscored the strength of our business.
We reported strong growth in both fee and net interest revenue. Please note that all of the numbers I am presenting will include the results of the acquired Investors Financial Business for the fourth quarter of 2007 and the first quarter of 2008.
Our growth in Asset Servicing, Asset Management and Securities Finance revenue continues at a combined rate of about 43% compared to the first quarter of 2007. Trading Services revenue, particularly Securities Finance Revenue performed very well given the volatility in the market.
We continue to expand globally introducing new services to a broad base of customers. We also reported strong growth in debt interest revenue.
Obviously the positive trends I mentioned last quarter continued into this quarter as well as some additional benefit from the three cuts in the Fed Funds Rate this quarter. I’ll provide more detail on our net interest income and margin in the outlook for 2008 in a few minutes.
Our assets under custody at March 31, 2008, were $14.9 trillion compared to $12.3 trillion on March 31, 2007. Our assets under management stood at $2.0 trillion at the end of this quarter up from $1.8 trillion at March 31, 2007.
As Ron noted the business acquired from Investors Financial continue to perform well as we reported this morning total revenue in the first quarter of 2008 compared to the first quarter of 2007 including Investors Financial was up 52% and excluding Investors Financial total revenue was up 39%. Excluding variable expenses resulting from revenue growth in the first quarter of 2008 we saved an additional $59 million for cumulative expense savings of $140 million since the acquisition closed.
That’s an annual rate of $190 million. We are on track to achieve our annualized target of $350 million we set last February.
Due to continued strength in revenue growth from customers we acquired from Investors Financial we now expect the acquisition to be modestly accretive to our 2008 results. I hope you’ve had an opportunity to review our earnings press release distributed this morning.
Please review the financial statements included with our earnings press release and in our financial trends package on our website for detailed information on our financial results. Now to those results.
This morning all of my comments will be based on our operating basis results excluding the merger and integration costs associated with the acquisition of Investors Financial in the fourth quarter of 2007 and the first quarter of 2008 and the fourth quarter 2007 charge related to certain income strategies at State Street Global Advisors. On an operating basis earnings per share in the first quarter were $1.39 up 49% from $0.93 per share last year and up slightly from $1.38 in the fourth quarter.
Revenue on a fully taxable equivalent basis totaled $2.6 billion for the quarter an increase of 52.2% from last years first quarter compared with a 44.1% increase in expenses to $1.748 billion on an operating basis. Compared to the fourth quarter of 2007 revenue was up 4.2% and expenses on an operating basis increased 6%.
Return on equity on an operating basis was 19.4% in the first quarter up from 17.4% in the first quarter of 2007 and up from 18.7% in the fourth quarter. Servicing fees were up 34% from the first quarter of 2007 due to the additional revenue from Investors Financial customers as well as increases in new business from existing and new customers.
They were down slightly from the fourth quarter due entirely to the decline in market valuation offset partially by growth in net new business. Management fees were up 7% from the first quarter of 2007 due primarily to net new business partially offset by a declining performance fees and the impact of a decline in the equity markets.
Management fee revenue was down 6% from the fourth quarter again due primarily to a 10% decline in equity markets and lower performance fees. Performance fees were about $7 million down from $15 million a year ago and down from $21 million in the fourth quarter of 2007.
Based on our strong securities finance business we saw continuing strength in the cash and money market assets under management up 5% from last years first quarter and up 8% from the fourth quarter. We saw an 8.4% decline from the fourth quarter of 2007 or a little less than $100 billion in the equity assets less than the 10% decline in quarter end equity valuations.
Fixed income assets increased about 6% a rate higher than the market averages. Higher volumes and stronger volatility in our foreign exchange business drove the 74% increase in foreign exchange trading revenue compared with the first quarter of 2007.
Foreign exchange revenue was up 5% from the fourth quarter due primarily to increased volatility partially offset by a decline in volumes. Brokerage and other fees were up $33 million or 49% to $101 million in the previous years first quarter.
This increase was due primarily to $22 million in fees from the Currenex business which was acquired in March 2007 as well as increases in the non-US transition management business. Brokerage and other fee revenue were slightly higher than the fourth quarter of 2007.
Also, due to the fixed income market disruptions we saw continued demand for securities finance in the first quarter. Securities Finance revenue was up 209% from last years first quarter due primarily to improved spreads and was up 18% compared to last years fourth quarter also due primarily to improved spreads following significant actions by the Fed.
We had $644 billion in average securities on loan and the duration on the securities lending book was 26 days. Processing and other fees declined 26% from the prior years first quarter and decreased slightly from the fourth quarter.
The reason for this result is that we recorded a loss of $11.6 million on the purchase of $850 million of AAA assets except for one security which was rated AA from two of our conduits under a liquidity asset purchase agreement. Due to the market volatility we recorded approximately $12 million of mark to market adjustments.
Economically we do not expect the loss and therefore we expect to recover this adjustment as the assets mature. In addition, conduit related revenue of $11.6 million was lower compared to the first quarter or the fourth quarter of 2007 down $14 million from the first quarter and down $2.4 million from the fourth quarter.
Net interest revenue on a fully taxable equivalent basis increased from the first quarter 2007 by $311 million or 92% from $337 million to $648 million and was up $75 million from the fourth quarter. In addition, compared to the first quarter of 2007 net interest margin of 220 basis points was up 75 basis points from the first quarter of 2007 and was up 25 basis points from the fourth quarter of 2007.
Some of the trends that benefited us in the first quarter compared to the year ago quarter include improved spreads on our portfolio caused primarily by the lower cost funding due to the recent actions by the Federal Reserve. The impact of additional revenue from the acquired Investors Financial business and increased transaction deposits from non-US customers.
Compared to the fourth quarter of 2007 and the first quarter of 2008 we benefited from the improved spreads due to the recent actions by the Fed offset partially by a slight change in customer mix. Now let me turn to the investment portfolio.
The average investment portfolio increased from $65.6 billion to $73.3 billion during the first quarter from the year ago quarter and was down from $75.9 billion in the fourth quarter of 2007. Mortgage backed securities in the first quarter of 2008 represented about 40% or $29 billion of the average investment portfolio.
Floating rate asset backed securities in the first quarter 2008 represented about 33% of the average investment portfolio or $24.1 billion. We believe this portfolio overall is conservatively structured and well seasoned.
The portfolio has been performing well, has been withstanding the market stresses and is well diversified. If you look at slide two in the Investment Portfolio slide package on the website you can see the ratings of the portfolio over time.
Ninety fourth percent are AAA and AA similar to year ended 2007. Eighty seven percent are AAA and 7% are AA.
Four percent are rated A and 1% are rated BBB. No securities are rated below BBB.
A lot has been said over the past few months and quarters regarding the extraordinary events impacting the fixed income markets. These are not ordinary times and these are not orderly markets.
Despite the high credit quality of the investment portfolio the illiquidity in the marketplace and resulting prices affecting fixed income securities have caused the unrealized pre-tax loss on our portfolio to increase to $3.2 billion at March 31, 2008, up from an unrealized pre-tax loss of $1.1 billion at December 31, 2007 and an unrealized pre-tax loss of $309 million a year ago. We believe that these prices are not reflective of the underlying value of the securities.
Several examples will help me illustrate that point. Look at the element of the portfolio we hold in student loans, about $9.2 billion, the vast majority about 90% of which is covered by a 97% federal government guarantee.
At December 31, 2007, these securities were trading at 98% of par. Today they are trading at 92% of par.
There has been no significant change in the credit quality of the securities so what are the markets telling us? I think that the market is confirming that it is illiquid.
In fact, there are few buyers or few sellers at this price. Or look at the 18 sub-prime securities that the rating agencies put on credit watch at the end of January.
They just recently reaffirmed the ratings on 17 of these leaving only one unwatched due to its down grade of the insurance wrap provider. They are all rated AA but are priced between 40% and 89% of par at March month end.
These are just two examples of the impact that the current market dislocations and sporadic for selling have had on market prices for investment grade bonds. We continue to believe that our portfolio is not at risk of permanent impairment and is not currently other than temporarily impaired.
We base this belief on the result of the extensive credit analysis that we have performed and continue to perform in the portfolio and believe that we will cover the principle at maturity. I’d like to stop here and provide you a deeper look into the securities within the portfolio.
If you would turn to slide three in the Investment Portfolio slide package you can see some of the data I am presenting. First, 15 securities have been downgraded as of March 31, 2008; these 15 securities do not include those securities that were downgraded based on downgrades of the insurance wrap provider.
Based on the total number of securities downgraded by the rating agencies during the past two quarters we believe the number of rating agency actions affecting our securities is very modest and is a testimony to the quality of the assets in our portfolio. Lastly, I’ll address the asset backed securities that are collateralized by first liens sub-prime mortgages, a portfolio which I have been commenting on since the second quarter of last year.
This section of the portfolio has a $933 million unrealized pre-tax loss at March 31, 2008, which is about one third of the total unrealized pre-tax mark to market loss for the entire portfolio. If you turn to slide four and five, first of all the portfolio has performed as we have expected.
Our portfolio of asset backed securities collateralized by sub-prime mortgages is $5.9 billion as of March 31, 2008, down from $6.2 billion as of December 31, 2007. Seventy percent of the portfolio was rated AAA and the remaining 30% is rated AA.
Three of the securities have been downgraded, again, a very small number in light of the downgrades issued by the rating agencies over the last few quarters. We have a 41% average credit enhancement based on the structure itself which gives us confidence that these securities will mature par.
You can see this credit enhancement grow over time with pay-downs that we’ve received. Last March the credit enhancement was 34% which is increased to the 41% I mentioned as of March 31.
This means that even if every mortgage backing and asset were to default we would not lose one dollar and deliver recovery rate for those assets fell below 59%. Further, we believe the assets are well diversified by Vintage Geography an originator.
As I just noted the negative mark to market on this portion of the portfolio has increased to about $933 million with no securities on credit watch. Since so many securities in the category have been downgraded industry wide over the past two quarters we have confidence that our credit process at State Street has served us well to date and that we expect these securities to mature at par.
However, during the quarter we recorded $11.5 million in other than temporary impairment which was one asset backed security collateralized by home equity lines of credit and wrapped by Figic as the insurance provider. Based on our credit analysis of the underlying collateral and our assessment of the wrap provider we concluded that a portion of the fair value decline was attributable to credit and therefore we wrote the securities down to its current fair value.
If you review slides six through eight you can also get some further detail about the monoline coverage we have on the portfolio. Mostly in the municipal bond book.
Note that our overall rating will decline only slightly from 94% to 92% if all the wraps were simultaneously removed. The last line gives you a breakdown of the assets by wrap provider where you can see that 99% of the coverage is due to the municipal bond investments usually a very high performing asset class.
In conclusion of my remarks on the unrealized mark to market loss in the securities portfolio why do we have such confidence in our portfolio when many other are writing down assets? We are very selective in the assets we buy and put these choices through a rigorous credit process.
On an ongoing basis we monitor the performance of these securities and have found them all to be performing well. Our investment portfolio consists of securities with significant levels of structural credit enhancement which provides protection against difficult economic environments.
I hope my remarks have given you some comfort in our portfolio so you can understand the source of our confidence. As to our outlook for interest revenue for the remainder of 2008.
In February, I commented that due to the actions of the Fed in January we were increasing our outlook for 2008. I said that we expected net interest margin to be between 2.0% and 2.10% and that the Fed would hold steady at Fed Funds Rate of 2.5%.
Obviously the Fed has been more aggressive in cutting the Fed Funds Rate that we expected and so now we believe that the US rates will be 2% by year end. Due to the current market environment we still believe that an interest margin will be between 2% and 2.1% however it may trend toward the upper end of that range.
This outlook for the year assumes that growth in non-US transaction balances may moderate from the levels we have seen in 2007 but we maintain the existing favorable mix of customer liabilities and an expectation that the investment portfolio will re-price as about 7 billion older fixed rate securities mature in 2008 but these will be reinvested at lower rates than the 2007 maturities carried. Also, I should mention that we are not purchasing securities in any significant amount right now as we are continuing to increase our liquidity in the face of the current market disruption.
Future rate cuts from the Fed will help us but the benefit may tail off in early 2009. In February we provided an outlook that the ECB will be at about 3.5% by year end and the Bank of England will reduce rates to about 4.75%.
We still believe these are realistic estimates. These declining rates in Europe we feel will reduce our spreads and as the US Fed stops cutting rates the benefits we have been enjoying will abate and so in the second half of the year we may not see the net interest margin that we’ve enjoyed this quarter.
Lastly, we expect the average ’08 balance sheet to be roughly flat with the average balance sheet in the fourth quarter 2007. Our duration gap has not changed significantly from year end.
Our assets are almost 12 months and our liabilities are eight months. The investment portfolio duration is about one year seven months up slightly from the fourth quarter 2007 and from the first quarter 2007.
I will now turn back to expenses. As a reminder I am speaking about expenses on an operating basis.
Salaries and benefits expenses increased 44% compared to the first quarter 2007 due primarily to the impact of incentive compensation as a result of improved performance, the impact of additional staff from Investors Financial as well as staff added to service new business wins. Compared to the fourth quarter 2007 salaries and benefits expense increased 14% primarily for incentive compensation due to improved performance and higher benefits costs partially offset by reductions in Investors Financials staff.
Transaction processing expenses increased 26% compared to the year ago quarter due primarily to the acquisition of Investors Financial as well as increased volumes in the asset servicing and trading business and declined 12% from the fourth quarter of 2007 due primarily to receipt of a depository rebate. Occupancy expense increased 17% from the first quarter of 2007 due primarily to the costs associated with Investors Financial and was up 3% from the fourth quarter of 2007 due to investments to support new business particularly in Europe.
Other expenses were up 106% compared to the year ago quarter primarily due to higher professional fees, increased securities processing costs and the impact of the amortization expense associated with the acquisitions we completed in 2007. They were down 6% compared to the fourth quarter 2007 primarily due to lower Investors Financial costs and lower securities processing costs.
Our tax rate for the first quarter was 34.0% down from 35.0% in the first quarter of 2007. We expect our tax rate for all of 2008 to be about 34%.
Let me review in detail the capital structure at State Street. The principle capital ratio that we manage to is the tier one leverage ratio.
We have historically targeted between 5.25% and 5.75% but given the market environment we expect our leverage ratio to grow to a level above the top of the range in order to preserve flexibility in what appears to be a continuing volatile market. At March 31, 2008, our tier one leverage ratio stand at 6.08% up from 5.26% as of December 31, 2007.
The increase was driven by the issuance of $500 million of tier one capital in mid January, our strong net earnings offset partially by growth in average assets. Our tangible common equity ratio is 2.92% down from 3.49% at December 31, 2007.
Our tangible common equity grew approximately $764 million in the first quarter largely from retained earnings; employee based stock compensation and the amortization of intangibles. However, the growth was more than offset by the after tax increase in the FAS 115 mark in addition to the lower level tangible common equity period end total assets grew by about $12 billion.
Next let me review the impact of the assets held in the conduits in relation to our capital. Our out website we have provided an update to the slide we presented on the third and fourth quarter calls.
In the interest of time I will not discuss them in detail today but suggest that you review these to update your knowledge as to the Commercial Paper Conduit Program at State Street. I will however, refer to slides two through five.
As I stated last quarter we created this program in 1992 primarily to address customer requests for high quality, highly rated Commercial Paper. The conduits have never suffered a credit loss in any asset they purchased, evidence of a strong credit discipline that I just referred to.
Due to illiquidity in the market and pursuant to the terms of the liquidity asset purchase agreement between State Street Bank and Trust and the conduits we were required to purchase $850 million in assets from the conduits and brought them on to our balance sheet during the first quarter. This purchase was not due to a credit event, i.e.
not triggered by default or downgrade of any underlying conduit securities but simply due to wider spreads in the asset backed commercial paper caused by illiquidity. These assets are primarily backed by residential mortgages and student loans and all are rated AAA except for one which is rated AA.
We classified the in the available for sale portfolio and as you may recall from our earlier presentation they are floating rate assets. We firmly believe these are high quality assets and like the other securities in our investment portfolio we expect them to mature at par.
As I explained previously this caused a small pre-tax loss of about $12 million which flowed through our income statement in the processing and other fee revenue line. We believe this amount will come back to us as the assets mature in the future.
The first slide in the Asset-Backed Commercial Paper Group illustrates my point. Here you can see the assets by rating and State Streets conduit program as of March 31, 2008, on the left compared with the Moody’s Multi-seller Bank Index as of December 31, 2007 on the right, the last date for which data is available.
As you can see here the numbers did not change that much from what we disclosed last quarter. For State Street’s conduit program the three categories of AAA, AA, and A represent 82% of the total.
Seven percent is rated BBB and the remaining 11% is non-rated. Whereas the data from the Moody’s Multi-seller Bank Group shown in the graph on the right has 34% rated AAA, AA, A, 24% rated BBB, BB, B, and 41% is not rated with one percent noted as other.
While State Street holds essentially no assets rated below BBB or investment grade the peer group of major multi-seller banks hold 12%. None of the assets in our conduits are sub-prime nor are there any structured investment vehicles in the conduit program.
The point of this detail is to provide you data that will help you differentiate generally between the Commercial Paper issued by our conduit and that of other programs. Now turn to slide three in the Asset-Backed Commercial Paper Package.
Here I update the data I presented on February 5th on our investor and analyst day. As you can see the unrealized loss on the conduits investments as of March 31, 2008, if we had to consolidate all of them on our balance sheet is about $1.5 billion after tax.
Again, reflective of the issues I mentioned in connection with the unrealized negative mark on the investment portfolio. The assets continue to have a weighted average maturity of about four years and the paper has a weighted average maturity of 16 days down from 20 days at December 31.
As of March 31, we had funded about $292 million of our own asset-backed Commercial Paper on our balance sheet. Also, 39 of the assets in the conduits have been downgraded and about 112 securities have been put on credit watch.
These actions are primarily due to downgrades of the insurance providers mostly in Australia. Further to my point that we do not rely on insurance wrapper to define the quality of the underlying assets.
About $3.3 billion or 12% of the assets in the conduits are wrapped by a diverse group of monoline insurers. Slide four in the Asset-Backed Commercial Paper slide package provides a breakdown of the diversity and asset type and the provider by name of insurer.
What happened in the first quarter? Overall, in an uncertain market our asset backed Commercial Paper program continued to perform well.
We believe that the quality of the conduit assets continue to be a major point of differentiation for us. As I just explained we believe the resulting mark to market loss on the purchase of the small portion of the conduits assets in the first quarter will come back to us as the assets mature.
On slide five we provide some data showing the impact of consolidation of all the conduit assets on to our balance sheet. As you can see, assuming no management action on our part the impact on our leverage ratio would be about 109 basis points from 6.08% to 4.99% and on intangible common equity ratio about 132 basis points from 2.92% to 1.60%.
We obviously would have taken action prior to quarter end if we had believed any consolidation event was imminent for March 31. From a funding standpoint the risk of consolidation is included in our contingency funding plan.
We believe that we can access multiple sources of liquidity to fund any asset purchases from the conduits. Our sources of this liquidity include borrowing from the overnight inter-bank or repurchase markets issuing corporate Commercial Paper, issuing bank CD’s and time deposits and/or accessing the Fed discount window.
As we did in the second half of 2007 in the first quarter we continue to carry incremental liquidity given the market environment. In the first quarter the conduits also issued about $20 million in incremental subordinated debt to provide additional first loss protection.
In addition, as I explained earlier we purchased about $850 million in conduit assets under the existing liquidity asset purchase agreements. Neither of these actions affected our conclusion that we are not required to consolidate the conduits at March 31 under current accounting guidance.
Regarding the size of the entire conduit program, as you may remember it was $29.2 billion as of September 30, 2007, and it stood at $28.8 billion as of December 31, 2007, and it stands at $28.3 billion as March 31, 2008. In the asset-backed Commercial Paper section of the slide I also have included some supplementary slides which are updated from previous presentations and which list the type of assets and the country of origin of the assets as well as some details of our program for your reference later.
Overall the first quarter provided a very good start to the year in what were and continue to be challenging markets. We hope that the information we have provided about our balance sheet and our conduit program has been helpful.
I have also updated the information we presented at our investor and analyst day in February in order to help you better understand State Street. Now I’ll turn the call back to Ron who will provide a general outlook for 2008.
Ron Logue
As I said in last quarters call I believe that the momentum we establish in 2007 plus the resiliency that enables us to manage through market turmoil will provide opportunities for us in 2008. In the midst of a decline in equity valuations our asset servicing and asset management businesses performed very well.
Each growing compared to the prior years first quarter. The drivers for this performance remain our strong international presence and our ability to cross sell into our existing and acquired customer base.
Our strong position in our trading business and in securities finance continues to benefit our results during unprecedented illiquidity in the fixed income market. Our net interest revenue also looks to be a reliable source of income at least well into 2008, although the benefit would diminish as the Fed either starts cutting rates or begins to tighten.
We also announced two senior appointments last week. First, Scott Powers was named CEO of State Street Global Advisors reporting to me.
Scott will join SSGA from Old Mutual US where he was CEO of the US operating unit of London based Old Mutual PLC. He will serve on our operating group, our senior most strategy and policy making team, he has a significant commitment to client service as considerable experience in managing a large quantitative and active investment management organization.
Additionally, Scott has a strong global perspective. He is committed to building on the depth of talent and experience of SSGA’s leadership team.
Also joining our operating group is Maureen Miskovic who is joining State Street as our Chief Risk Officer also reporting to me. Maureen has an extensive background in risk and treasury, both at Lehman Brothers where she was Chief Risk Officer and a member of the investment and diversity committees as well as at Morgan Stanley where she served as treasurer in London, responsible for capital planning, bank relations and cash management for their European and Indian businesses.
With our considerable global growth over the past five years we created this roll in order to advance the strategy for our risk organization at a time of unprecedented complexity and change within the financial services industry. Maureen was formerly a director of State Street and stepped down from that role to join our staff.
Specifically regarding our outlook for 2008 we expect our earnings per share on an operating basis excluding merger and integration costs to increase 10% to 15% compared to the 2007 operating basis results of $4.57 per share. We expect our revenue to increase between 14% and 17% including Investors Financial up from our traditional goal of 8% to 12%.
We expect our operating return on equity to be between 14% and 17%. I realize that we achieved above these levels in the first quarter but in the second half of the year we anticipate the comparisons will be more challenging and so for now we will stick to our outlook of achieving at the middle of the range.
We begin 2008 with momentum from the strong 2007 operating results from both State Street and the acquired Investors Financial business and with our consolidation of Investors Financial exceeding expectations. Our core businesses are performing well fueled by continued new business wins and a strong pipeline and we are planning now for the eventuality of lower market driven revenue relative to the higher levels we have experienced in the last two quarters due to unprecedented market conditions.
With that Ed and I will be happy to take your questions now.
Operator
[Operator Instructions] Your first question is from the line of Mike Mayo with Deutsche Bank.
Mike Mayo – Deutsche Bank
Just a little more color on keeping the midpoint of your 10% to 15% EPS growth and as you pointed out you exceeded first quarter expectations you highlighted new servicing which I think totaled about 4% of your total servicing. You saying that Investors Financial is now accretive so are you seeing tangible evidence of this slow down that you expect because the only information you gave us was the margins might go from 220 down to 210 or a bit below.
Anything else that’s on your mind.
Ron Logue
We are not seeing any tangible evidence of any slow down. I think it’s quite frankly just our conservative nature not knowing what’s happened and the unprecedented events in the marketplace which I would say we are doing two things.
We are being very cognizant of that and we are planning for a reduction in the market driven revenue. We are working a lot on the expense side.
We just think the later half of the year may be a little bit more difficult from a comparison point of view and we want to be in a position where we can still generate positive operating leverage albeit not 810 basis points but positive operating leverage. It’s more of not knowing what we don’t know.
Mike Mayo – Deutsche Bank
The transaction processing services revenue there was a $22 million decline, is that a one quarter decline and then it bounces back or is that something we should view as permanent?
Ron Logue
It’s probably more of a one quarter decline. I think that’s where the DTC rebate was if I’m not mistaken.
Mike Mayo – Deutsche Bank
The other income related to conduits you said that’s $12 million that should come back too?
Ron Logue
I guess it depends on the market.
Ed Resch
We took the hit and we have the assets, we said they are virtually all AAA assets and we expect them to mature at par. They are performing well and if we are right in that statement the loss that we took of about $12 million will come back to us over time.
Mike Mayo – Deutsche Bank
That’s another $34 million that would come back from the first quarter. Are you really being that conservative?
Ed Resch
The last point that I addressed will not all come back in this year. It depends on the maturity of the assets.
It will be over time.
Mike Mayo – Deutsche Bank
As far as Investors Financial you retained 91% of the revenues, I assume that includes Barkley’s?
Ron Logue
Its does, yes.
Mike Mayo – Deutsche Bank
It’s been a few months since you had this acquisition now so should we think of that as a final number or close to final?
Ron Logue
I don’t know if we are going to declare victory right now but we are close.
Mike Mayo – Deutsche Bank
Lastly, when we look at the press release the unrealized securities losses seem to have gone up $1 billion and on this call you said it went up $2 billion. Are there offsets or am I reading something wrong?
Ed Resch
We were talking about two unrealized losses on the investment portfolio that went from $1.1 billion to $3.2 billion and the other was relative to the conduits and that went from about $900 million pre-tax to about $2.5 billion pre-tax. Two separate discussions.
Operator
Your next question is from the line of Glenn Schorr with UBS.
Glenn Schorr – UBS
In terms of the $850 of assets brought on from the conduit can you just review again what triggers that and how that’s different from all the other assets that are inside the conduit?
Ed Resch
The relationship between the conduit and State Street Bank and Trust is one where State Street Bank and Trust has provided the conduits what are called liquidity asset purchase agreements and those allow the administrator of the conduits to require State Street to buy assets from the conduits at the conduits carrying value. They have the ability to do that based on certain conditions one of which is that they see illiquidity in the Commercial Paper market so the way to solve that problem is to sell assets and therefore not have to fund those assets in the marketplace.
Glenn Schorr – UBS
The bottom line is if some of the CT doesn’t roll you could blow out some assets or bring it on balance sheet, you brought it on balance sheet because you thought the assets were money good.
Ed Resch
Exactly right.
Glenn Schorr – UBS
In terms of the comment on the new business wins, from your comments it sounds like you are including renewals retentions inside the new business win number. If that is correct, can you break out what’s new new versus what’s retained?
Ron Logue
No, we are not including the renewals.
Glenn Schorr – UBS
Good, so the 600 is 600 good new win number. I’m not sure you mentioned it but I’m assuming that the BGI has a new contract in place; could you say how long that contract is in place for?
Ron Logue
All I can say is its long term.
Operator
Your next question is from the line of Brian Foran with Goldman Sachs.
Brian Foran – Goldman Sachs
If I got the math right I think you implied about $700 million of the unrealized losses are from student loans and then about $900 million is from sub-prime MBS, can you break out what the rest of that would be by product?
Ron Logue
You are right, pre-tax as of March 31, $700 million, let me just run them down for you. I’ll exclude the treasuries and agencies that are positive territory.
Mortgage backed about $700, foreign mortgage backed about $200, credit cards about $200, CMBS $150, CLO $100 and sub-prime about $950, all pre-tax.
Operator
Your next question is from the line of Ken Usdin with Bank of America Securities.
Ken Usdin – Bank of America Securities
I was wondering if you could walk us through again the NIM guidance. With 200 basis points this quarter the NIM up 25 basis points to 220 can you walk us through how the 200 basis points and its perspective cuts would help at least the second quarter and what actually would happen to really get it down all the way to a 2% level to continue to think its only 200 to 210 for the full year.
I want to understand the mechanisms and when you would expect that the turn relative to the end of the US cut cycle.
Ed Resch
The things that gave us the strength this quarter are the things we are worried about disappearing going forward. That’s why we suggested that we think for the full year we are probably toward the high end so let’s say 210 for this discussion.
The things that could impact us from 220 in the first quarter to 210 for the full year are slow Fed rate cuts. We don’t see the depth to the Fed rate cuts that existed in the first quarter going forward for any period of time.
We see starting of foreign rate cuts which have a negative effect to us. Remember we said that if the foreign rates, principle the Sterling and Euro were to decline that would be a drag on our net interest revenue and net interest margin and we are seeing some of that.
Additionally as the assets re-price that are maturing, there are about $7 billion of fixed rate securities maturing this year remaining the proceeds will be reinvested at the lower rates. In addition to that we are being very conservative in terms of our reinvestment because of the current market environment that we see ourselves in.
You put all of that together for the last nine months of the year that’s why we think that the full year NIM will be around 210.
Ken Usdin – Bank of America Securities
As always and has been for the last couple quarters some of that conservatism is based on the absence of things that have continue to keep longer than expected anyways?
Ed Resch
Yes.
Ken Usdin – Bank of America Securities
Even though rates are slowing the rate of cuts is there not a lagging benefit of just the pull through from what’s already happened into the future.
Ed Resch
Sure, it’s about a quarter.
Ken Usdin – Bank of America Securities
My other question quickly relates to the conduits and the sub-prime. I well understood all your points about money good assets.
Is time at all a function of any decision to either have to bring assets on to the balance sheet from the conduit or mark as other than temporary impaired any of the sub-prime assets? Is any elongation of time…?
Ed Resch
Yes, we are talking about related concepts but in some ways very important differences exist between the accounting that we are required to apply to the investment portfolio versus the accounting that we are required to apply to the conduit. They are related.
Time certainly does matter, the notion on the portfolio the question we ask is the portfolio other than temporarily impaired, are there securities that we believe will not be performing and we will suffer a credit loss on. The answer to the question is yes relative to a security we have to write it down as a fair value at the time we determine that.
We did that one security this quarter. The longer the market stays disrupted and the longer prices stay low the more potential there is for impairments going forward all else equal.
Right now in the quarter we felt that we only needed to impair the one security given that we could conclude that there were not expected losses in the investment portfolio. Related on the conduit the models that support our FIN46 analysis which determine whether we have to consolidate or not have a credit element to them in addition to a basis risk element.
The credit element has a similar concept that I just described in terms of the accounting theory whereby we need to make sure that the model that we use reflects current market expectations. The longer the market stays disrupted the greater the pressure is on the credit element of the FIN46 model.
Operator
[Operator Instructions] Your next question is from the line of Brian Bedell with Merrill Lynch.
Brian Bedell – Merrill Lynch
Can you tell me how comfortable you are with your current capital position given the market stress and liquidity we are seeing and what brought on to the balance sheet and taken against your OCI, to what degree you would be willing to come back and do another debt offering to bolster your capital position?
Ed Resch
We are comfortable with where we are; obviously our capital position is something that we monitor all the time. We don’t have any plans at this point to come to market with another offering.
It is something that we constantly talk about. Obviously the widening of the unrealized losses in the first quarter from year end is something that we are on top of.
We said coming into the year that we were going to be conservative and build up capital. We’ve clearly done that, however the rate of widening of the unrealized loss on the portfolio specifically has outstripped our capital generation for the quarter.
You’d think it was an extraordinary quarter in that regard but it is something we are looking at. The one element of our ratios that we are particularly focused on is our tangible common equity ratio.
We need to rebuild that. We build tangible common equity, we build that ratio at 40 to 50 basis points a quarter and in a normal quarter.
If the portfolio mark did not change at all in the second quarter we would expect to see a 40 to 50 basis point improvement in our TCE ratio.
Brian Bedell – Merrill Lynch
What are your goals, your target ratio range on the tangible common?
Ed Resch
Four and a quarter, we’d like to be.
Brian Bedell – Merrill Lynch
How quickly do you think you can get back to that level?
Ed Resch
If you assume that the portfolio mark does not change at all we’d be in two or three quarters above the 4% level. Again, that’s all else equal.
Brian Bedell – Merrill Lynch
You were saying something else before I interrupted you, I’m sorry.
Ed Resch
I think I was just concluding my comment.
Brian Bedell – Merrill Lynch
If we could talk about the net interest income, remind me again of what you were saying about average earning assets for the full year outlook relative to the first quarter levels.
Ed Resch
We said we expected the full year ’08 average balance sheet to be about what it was on average for the fourth quarter. We had about $12 billion above where we thought we would be at first quarter end given very strong customer deposit flows.
Brian Bedell – Merrill Lynch
On new business, can you talk about the timeline of conversion of the $600 million of new business?
Ron Logue
It is being converted as we speak. It will go into the second quarter.
Brian Bedell – Merrill Lynch
That quickly, all of the $600 million in the second quarter. So that will come on to the P&L pretty quickly.
The $800 billion that you won in the fourth quarter where do we stand on conversion?
Ron Logue
Most of that converted.
Brian Bedell – Merrill Lynch
Already in the first quarter run rate or still some in the second quarter?
Ron Logue
Yes.
Brian Bedell – Merrill Lynch
Does the BGI contract change your outlook at all; did that impact your IFIN dilution guidance at all?
Ron Logue
No
Brian Bedell – Merrill Lynch
That wasn’t different from your expectation.
Ron Logue
No, that was assumed.
Operator
Your next question is from the line of Thomas McCrohan with Janney Montgomery Scott.
Thomas McCrohan - Janney Montgomery Scott
I have a follow up on the comment which you first addressed on the BGI renewal it was pretty important to you guys. Ed, you had mentioned in your prepared remarks that you issued additional first loss notes can you remind me what the dollar amount was of those additional notes and what the interest rate was for those notes?
Ed Resch
It was $20 million across the two large conduits so the Australian conduits were not part of that raise and the rate that we paid was commensurate with the market rate for those types of instruments. It was above 20%.
Thomas McCrohan - Janney Montgomery Scott
Going into the quarter it was about $32 million first loss notes, so you increased it from $32 million to $52 million?
Ed Resch
Yes, that’s correct.
Thomas McCrohan - Janney Montgomery Scott
The models that you are talking about related to the accounting on whether or not you have to consolidate this is that what triggers whether or not to issue the additional first loss notes?
Ed Resch
Yes, the purpose of the additional note issuance was to give ourselves more cushion in the FIN46 model specifically from a credit perspective.
Thomas McCrohan - Janney Montgomery Scott
Its fair to say that its hard to envision this conduit ever being consolidated given that its been such an awful environment, you have obvious buyers for first loss notes if you want to issue some more paper. Is there a simple way to articulate and what instance would you ever have to consolidate this because it seems like worse case was this quarter, maybe there’s more of a down side and in that event you just sold $20 million of additional first loss notes and you are able to keep this thing off your balance sheet.
Under what conditions would you ever have to consolidate this?
Ed Resch
First of all the market for these types of notes is not infinite. There is a double edge sword effect if I can call it that by issuing those notes and that affect is to raise the expenses of running the conduit because of the coupon on that debt.
You have to balance off the economics of raising the data assuming there was a market for it against the ongoing requirement for the conduits to operate at a profit. The interest expense on the sub-debt goes against the spread that the conduit earns on the assets against the Commercial Paper costs.
Additionally I would never want to say never to that question. I could conjure up a scenario where there was even more significant credit disruption in the market place with significant levels of downgrades that could flow through to our conduit FIN46 model and significantly stress the credit element of the model.
You are right, the first quarter was very challenging and we in part issued the notes to make sure that we got through it as of March 31. I would not say there is no scenario into which the conduits could be required to be consolidated.
Thomas McCrohan - Janney Montgomery Scott
To confirm, this is the first quarter in the last five that you’ve had an issue for the conduits, that issue of additional first loss notes, I want to confirm that?
Ed Resch
That’s correct.
Thomas McCrohan - Janney Montgomery Scott
The investors that bought the notes are they the same universe that were holders of the initial $32 million of first loss notes?
Ed Resch
They were in part and there were some new investors also that came in.
Thomas McCrohan - Janney Montgomery Scott
It sounds like you are saying the only way you have to consolidate this is if there are no buyers of additional first loss notes?
Ed Resch
You have to have no buyers, you’d have to have a very significant negative credit event like I just described with significant downgrades, for example or you could have the accounting rules change.
Operator
You have a follow up question from the line of Brian Foran with Goldman Sachs.
Brian Foran – Goldman Sachs
How the $3.2 billion of unrealized losses is being derived, i.e. model versus mark to actual cash bids something like that and any sense of if it is mark to model for any of these products what it would be if you were marking to the cash bids?
Ed Resch
The marking on the conduits is…
Brian Foran – Goldman Sachs
I’m sorry, on the portfolio.
Ed Resch
The portfolio is 99% from interactive data corp. It’s a pricing service that we use and have used for pricing portfolio assets.
It is under PHAS157 a level two pricing source. There is very little if any mark to model in evaluating the portfolio assets.
Brian Foran – Goldman Sachs
From the standpoint of capital should we think about the unrealized loss in the portfolio as well as the unrealized loss in the conduit as core related events, i.e. if you had the kind of credit event you are describing that would make you take the conduit on to balance sheet wouldn’t that also be the type of credit event that would make you realize some of these losses?
If that’s a fair way to think about it what could be the worse case for the tier one leverage in that kind of scenario?
Ed Resch
I think it is a fair way to think about it. I think that the risk relative to the conduits I just described of a credit event, significant credit downgrades coincide with impairment risks relative to the assets in the investment portfolio.
We’ve tried to portray some of the scenarios that on a pro-forma basis in the slides again there are a lot of assumptions underlying those numbers not the least of which is that we did not take any management action in advance of March 31 in anticipation of any of these adverse events occurring. We do have some ability to react to anticipated capital events and get the ratios back in a stronger position than we presented on a pro-forma basis in those slides.
Brian Foran – Goldman Sachs
Lastly, is your comment on the conduit interpreted as if it becomes unprofitable to keep the conduit off balance sheet even though you could issue the short term paper to fund it, i.e. spreads stay wide enough that the conduit doesn’t make any money even if it could stay off balance sheet.
Does that then prompt a decision to bring it on balance sheet even if there is a big capital impact or are you just saying that there is a scenario where you’d rethink how much sense it makes to have the conduit if it’s permanently not profitable or marginally profitable?
Ed Resch
The fact that the conduit would stay off balance sheet is the requirement to do that is that the conduits over the longer term are profitable. We could not fund the conduits in a negative cash flow or a negative profit position for a period of time and keep them off balance sheet.
Operator
Your next question is from the line of Richard Bove with Punk Ziegel.
Richard Bove – Punk Ziegel
There’s a conflict in the way you gentlemen opened up the meeting and what investors are hearing, the stock is now down 6.5 points roughly speaking and I think it’s for three reasons. One, if you look on page eight of your quarterly financial trends package you chose virtually every category of assets and custody assets under management is down on a sequential basis.
Two, you suggested that the second half might be weaker than the first half. And three, it’s apparent from the questions that most people feel that your earnings are overstated because you haven’t handled the conduit properly from their perspective.
I’m wondering, given the dramatic negative reaction to this conference call what defense, so to speak, does the company have relative to why the accountants have agreed with it, why the regulators presumably have agreed with you in terms of your accounting treatment and do you really expect the second half to be that bad, the stock is now down 7.25 points what can you say that would suggest that this market reaction is perhaps inappropriate?
Ron Logue
Let me address three questions, I think the issue was the assets on the custody, equity and fixed income valuations for the quarter. I wouldn’t read too much into that.
In terms of the last half of the year, what we are doing is just we are being characterized as we normally are, being conservative. We have a lot of market driven revenue that’s been driving the first quarter.
What we have to do is prepare for more orderly markets and what’s important, what you need to look at is the fundamental business, it’s very strong. Our sense is when markets come back that we are still going to have that very strong revenue growth from the fundamental business.
However, we don’t know when that’s going to happen and I think as a company, it’s important for us to plan for the worst case scenarios not the best case scenarios. That has helped us for 14 straight quarters to deliver positive operating leverage.
We are going to continue to do that. I don’t know what’s going to happen in the latter half of the year but I’ve got to prepare for worse times as opposed to good times and not plan and hope for the same kind of benefits that we’ve been getting recently.
In terms of the conduits in the portfolio we keep coming back to the same thing, the credit quality in the portfolio is very strong, evidenced by the few downgrades vis-à-vis the other downgrades in the industry. We and our accounting firm and others feel very strong that the quality in those portfolios are very high and there’s not a need to do any of that.
Operator
Your final question is from the line of Robert Lee with KBW.
Robert Lee – KBW
Most of my questions have been answered but I still have one. There has been some, this relates to City Street, there have been some reports on some trade rags that you and City have put City Street on the block and the extent it would, from the numbers being thrown around in the press would result in a least a couple hundred million dollars of proceeds it seems.
Is that something you can comment on, along those lines are there any kind of ancillary businesses that you would think about exiting if there was an opportunity to get out of them at a reasonable price and raise some incremental capital?
Ron Logue
I really can’t comment on any of that.
Operator
There are no further questions at this time. Are there any closing remarks?
Ron Logue
No, thank you.