Apr 20, 2010
Executives
Kelley MacDonald – Senior Vice President Investor Relations Joseph Hooley – President, Chief Executive Officer Edward Resch – Chief Financial Officer
Analysts
Ken Usdin – Bank of America Brian Foran – Goldman Sachs Betsy Graseck – Morgan Stanley Glenn Schorr – UBS Howard Chen – Credit Suisse Michael Mayo – CLSA Brian Bedell – ISI Group Greg Ketron – Citigroup
Operator
Welcome to State Street Corporation’s first quarter 2010 call and webcast. Today’s discussion is being broadcast live on State Street’s website at www.statestreet.com/stockholder.
This call is also being recorded for replay. Statestreet’s call is copyrighted.
All rights are reserved. The call may not be recorded or rebroadcast for distribution in whole or in part with express written authorization from State Street and the only authorized broadcast of this call is housed on State Street’s website.
(Operator Instructions) I’d like to introduce Kelley MacDonald – Senior Vice President for Investor Relations at State Street.
Kelley MacDonald
Good morning. Before Joe Hooley our President and Chief Executive and Chief Financial Officer Ed Resch, begin their remarks, I’d like to remind you that during this call we will be making forward-looking statements.
Actual results may differ materially from those indicated y these forward-looking statements as a result of various important factors including those discussed in State Street’s 2009 annual report on Form 10-K and its subsequent filings with the SEC. We encourage you to review those filings including the section on risk factors concerning any forward-looking statements we make today.
Any such forward-looking statements speak only as of today, April 20, 2010 and the Corporation does not undertake to revise such forward-looking statements to reflect events or changes after today. I’d also like to remind you that you can find a slide presentation regarding the Corporation’s investment portfolio as well as our first quarter earnings press release, which includes reconciliations of non-GAAP measures referred to on this webcast in the investor relations portion of our website as referenced in our press release this morning.
Joseph Hooley
Thank you Kelly and good morning. I’ll begin with some general comments about our financial results and the operating environment as we begin 2010.
Then I’ll hand it over to Ed who will provide a more detailed financial perspective. I’ll make some concluding remarks and then both of us will be happy to take your questions.
The first quarter of 2010 represents a continuation of what we saw at the end of 2009 with the economy showing steady signs of recovery, the equity markets showing signs of life and a continuation of low levels of interest rates around the world. This environment provides good opportunity for our core fee based businesses, but has continued to constrain our market driven revenues; most notably, net interest revenue, securities, finance and foreign exchange.
During the quarter, we continued to build on a very strong capital position as evidenced by the capital ratios at quarter end with tier one risk based capital at 18.1%, our leverage ratio at 9% and our tangible common equity at 7.5%. Let me now walk through our results.
I’ll describe our operating basis results, which exclude discount accretion resulting from the consolidation of the conduits in the second quarter of 2009 as well as merger and integration costs. Our Service Fee and Asset Management Fee revenue, or core revenue, increased in double digits compared to a year ago and over fee revenue increased 8%.
These results were driven by the impact of rising equity market valuations as well as business installations. Comparing the first quarter of 2010 with the fourth quarter of 2009, Servicing Fee revenue was nearly flat due to a stronger U.S.
dollar and lower volumes offset partially by new business and the impact of higher average equity valuations. Asset Management Fee revenue declined about 2% due primarily to lower performance fees in the first quarter of 2010.
We’re still installing a backlog of business we won in the second half of 2009 as well as new business won to date in 2010. These conversions will take several quarters to install due to their size and complexity.
Our operating basis earnings per share increased from $0.71 in the fourth quarter of 2009 to $0.75 in the first quarter of 2010. Revenue growth of about 1.6% was balanced with tight cost discipline, resulting in expense growth of about .6%, resulting in 100 basis points of positive operating leverage.
The credit markets continue to stabilize, contributing to the improvement in the unrealized after tax losses in our investment portfolio, now at about $1.4 billion, down from $5.4 billion a year ago. We closed the Mourant acquisition in early April, a transaction which will, we believe, make us number one in the world in servicing alternative investment assets.
We expect this acquisition to be slightly accretive to earnings this year, excluding merger and integration costs. We expect to close the acquisition of Intesa Sanpaolo Security Services business later this quarter.
Upon completion, this acquisition will firmly establish us as the leading servicer in Italy and enhances our already strong position in the offshore market of Luxembourg. We expect this acquisition to be modestly accretive to earnings this year excluding merger and integration costs.
As we expected, and noted on our fourth quarter call, we continue to experience weakness in market driven revenues. The Trading Service revenue continues to be constrained as foreign exchange volatility has not improved, nor have volumes compared with the fourth quarter.
Cross border trading is weak; in particular, cross border equities have lagged the market recovery. Our Securities Finance business experienced slightly increased volumes compared with the previous quarter with average loans outstanding of about $412 billion in the first quarter of 2010.
However, we saw further compression in spread between Fed funds ad three month LIBOR from the end of the quarter from 14 basis points to about 12 basis points as of March 31, 2010, which put additional pressure on Securities Finance revenues. The continued worldwide interest rate environment is also impacting our net interest revenue.
On a fully tax equivalent basis and excluding discount accretion, net interest revenue in the first quarter declined 18% from the first quarter of 2009 and was down 4% from the fourth quarter of 2009. These declines were primarily due to the effect of high yielding securities maturing, or paying down and being replaced with lower yielding assets.
Turning to new business, in the first quarter of 2010 we added $164 billion in assets to be serviced and in April this month to date, we won an additional $155 billion in assets, including a large investment manger operations outsourcing mandate from Pinebridge Investments as well as a very large win from a state pension fund. Within Asset Management, net customer cash flows including customer wins and losses were modestly negative.
This decline however, was more than offset by appreciation of assets under management with total assets under management remaining in excess of $1.9 trillion at March 31, 2010. Taken together, these wins combined with the installation backlog from prior period sales, as well as continued pipeline strength, give us confidence in the ongoing growth of our core business in 2010.
We continue to see growth in servicing for alternative asset management. This quarter, prior to our acquisition of Mourant, we added 12 new customers.
As of March 31, 2010 our asset service and alternative investments have grown to $474 billion. With the only April acquisition of Mourant, they are now approximately $613 billion.
Some of our investment servicing wins in the first quarter included the State of Ohio, who had awarded State Street three mandates to provide services for $23 billion in international assets in the Ohio Public Employees Retirement system, the Ohio Police and Fire pension system and the State Teachers retirement system. Charles Schwab, a customer of State Street since 2005 has appointed State Street to service its newly launched family of exchange-traded funds with custody fund accounting, fund administration and transfer agent services.
Wellington West Asset Management of Canada, appointed State Street to provide a range of investment services including fund accounting, fund administration, custody and trustee services, for a group of new funds being launched by Wellington West. Legg Mason Global Asset Management expanded its relationship with State Street with the award of fund administration and custody services for its U.K.
domiciled assets. In addition, State Street has been retained by British Airways Pension Trustee’s, a client since 1997 to continue to service its $14 billion pound U.K.
pension fund. State Street Global Advisors during the quarter added new mandates including the Colorado Fire and Police Pension Association who has hired State Street Global Advisors to handle a $450 million global equity mandate.
An Australian State Government Pension Fund awarded us a $3.9 billion Aussie mandate across three index strategies manage a tax aware basis. And, State Street was reconfirmed as one of AP7’s passive managers, increasing assets managed from $1.7 billion to $3.5 billion.
Now turning to expenses, we continue to control head count only adding employees for new business and product development initiatives. In the current environment, we’re highly focused on keeping a tight control over expenses.
The increase in salaries and benefits expense reflect a level of incentive compensation consistent with our outlook for the year. In the first quarter of 2009, as part of our PCE improvement plan, we did not accrue for discretionary cash incentive compensation.
As always, incentive compensation is subject to company performance. Before I hand the call to Ed, let me make a few comments now on the broader economic environment.
The U.S. economy does appear to be working its way through a slow, or as some have termed, saucer shaped recovery.
Consumer confidence appears to be returning to the market. Unemployment has declined slightly during the past two quarters.
Housing prices are beginning to stabilize, but the headwinds are still there. The absolute level of unemployment still remains at a high level and central banks around the world continue to maintain interest rates at low levels.
The early indications of recovery, as evidenced by the rising markets, give us some confidence that the trend in market driven revenue will begin to improve to more normalized levels later this year or early next year. Let me now turn the call over to Ed who will provide further detail about our financial performance in the first quarter and provide comments reflecting our outlook for the remainder of 2010.
Edward Resch
Thank you Jay, and good morning everyone. This morning I’ll review three areas; first, the results of the first quarter, second, the improvement in the unrealized losses in the investment portfolio and the overall performance of the portfolio as well as our outlook for net interest margin in 2010, and third, a review of our strong capital position.
This morning all of my comments will be based on our operating basis results as defined in today’s earnings news release. Comparing the first quarter of 2010 with the first quarter of 2009, Servicing revenue increased 15% and Management Fee revenue was up 25% primarily due to an increase in average equity market valuations as well as new business wins.
Servicing Fees declined slightly compared to the fourth quarter of 2009 due to a stronger U.S. dollar and lower volumes, offset partially by new business and higher daily average equity market valuations.
Management Fees declined compared to the fourth quarter due to lower performance fees in the first quarter of 2010. Market driven revenue continues to be weak.
Foreign exchange revenue declined compared to the first quarter of 2009 due to lower volatility, offset partially by higher volumes. Compared to the fourth quarter of 2009, foreign exchange revenue declined due to both lower volumes and lower volatility.
Brokerage and other revenue which is reported as part of Trading Services doubled when compared to the first quarter of 2009 due to higher revenue from electronic trading. Also in the first quarter of 2009, a lower valuation on several securities held in the trading account impacted revenue in that quarter negatively.
It was down about 14% compared to the fourth quarter of 2009 due primarily to lower revenue from transition management. We had $412 billion of average securities on loan in the first quarter of 2010, compared with $398 billion of securities in this first quarter of 2009 and $409 billion of securities in the fourth quarter.
Securities finance revenue declined from the relatively strong first quarter of 2009 by 60%. We continue to experience compression in spreads in the first quarter of 2010 compared with the first quarter of 2009.
The Fed funds to three month LIBOR spread at the end of the first quarter of 2009 was about 105 basis points, but it ended the first quarter of 2010 at approximately 12 basis points. Compared to the fourth quarter of 2009, we saw continued compression of about two basis points from the 14 basis points at the end of the fourth quarter.
Average lendable assets for the first quarter of 2010 were about $2.3 trillion flat with the fourth quarter of 2009 and up about 34% from $1.7 trillion in the first quarter of 2009. As of March 31, 2010, the duration of the securities finance book was approximately 21 days, down from 25 days in the fourth quarter of 2009, reflecting continued conservatism in the lenders investment guidelines.
While the quarter’s results in foreign exchange and securities finance were not as strong as we anticipated at the beginning of the quarter, our expectation is that volumes and volatilities in foreign exchange and spreads and securities lending will modestly improve through the remainder of 2010. Now for the remaining items in the income statement.
Compared to the first quarter of 2009, processing and other fee revenue of $120 million increased 145% and doubled from the fourth quarter of 2009, both increases due primarily to a gain from an early buy out of a legacy leasing transaction and improved revenue from structured products. Operating basis net interest revenue declined about 18% from the first quarter of 2009 due primarily to the continuing impact of low interest rates worldwide and compressed spreads on our normalized balance sheet.
Due to the strain caused by the financial crisis in 2008 and 2009, our balance sheet continues to have abnormally high levels of customer deposits at the end of the first quarter of 2009. Compared to the fourth quarter of 2009, operating basis net interest revenue declined 4% due to lower yields on newly purchased securities that were replacing securities with higher yields that were maturing or paying down.
Operating basis net interest margin of 162 basis points, which excludes discount accretion, was up one basis point from the fourth quarter of 2009 on the same basis. Including discount accretion of $212 million, and $230 million respectively, net interest margin in the first quarter of 2010 was 234 basis points compared to 235 basis points in the fourth quarter of 2009.
In the first quarter of 2010, we recorded about $192 million in net gains from sales of securities, and separately, about $97 million OTTI, resulting in $95 million of net gains related to investments and securities. The OTTI was primarily due to increases in expected future credit losses in U.S.
non-agency mortgage backed securities. We sold securities during the quarter in order to take advantage of what we viewed as favorable valuations.
The net gains from securities sold were approximately half from sales of about $2.9 billion in securities from the legacy investment portfolio. The other half of the gains were from sales of about $657 million from former conduit securities.
The sales of the former conduit securities were executed due to both favorable valuations as well as to de-risk the balance sheet. I’d like to recap where we are relative to future discount accretion.
As of December 31, 2009, we expected about $4.6 billion to accrete in interest income over the remaining lives of the assets. We continue to believe that $850 million will not accrete into net interest revenue due to credit.
There has been no change in our view relative to credit. We earned $212 million of discount accretion in the first quarter.
The discount accretion that we will forego from the sales of conduit securities in the first quarter on which we had a gain of approximately $100 million is $140 million. And lastly, future discount accretion is expected to decline by approximately $100 million due to the dollar’s strength in the first quarter.
So as of March 31, 2010, we now have about $4.1 billion left to accrete through the income statement over the remaining lives of the assets. Also, we now expect about $800 million to accrete in 2010 and $600 million to accrete in 2011, down from our earlier expectations due to slower pre-payments which account for about 50% of the declines, and foregone accretion on sales which account for the other 50% of the decline.
As you are undoubtedly aware, a significant number of assumptions go into the estimate of future discount accretion, including estimate pre-payments, expected future credit losses across various asset classes, sales and assumption that securities are held to maturity. Regarding operating basis expenses, first quarter expenses increased 22% compared to the first quarter of 2009 and increased .6% from the fourth quarter of 2009.
The primary reason for the increase compared to the first quarter of 2009 was the 21% increase in salaries and benefits expenses due to primarily to the accrual of incentive compensation in the first quarter of 2010 as well as increased benefit costs. Of course the accrual of incentive compensation is subject to company performance.
There was no discretionary cash incentive compensation accrued in the first quarter of 2009 in order to support our TCE improvement plan. Salaries and benefits expense increased 12% compared to the fourth quarter of 2009.
In the first quarter of 2010, the primary reason for the significant increase was the impact of prior year’s equity awards. Another item affecting the increase in expenses in the first quarter comparison was the 71% increase in other expenses from a very low level in the first quarter of 2009.
In that quarter, securities processing costs were abnormally low. Compared to the fourth quarter of 2009, other expenses declines 26% due to lower expenses following the cost of a legal settlement in the f fourth quarter of 2009.
Also included in other expenses in the first quarter of 2010, was a $25 million benefit for insurance recovery that we received. Transaction processing increased $22 million or 17% compared to the first quarter of 2009 due to higher volumes in asset servicing.
No other item in operating expenses increased or declined meaningfully either on a sequential quarter or year over year basis. Now let me turn to the investment portfolio.
The size of the average investment portfolio in the first quarter increased about $25 billion to $94.8 billion compared to the first quarter of 2009. This increase is due primarily to the consolidation of the conduit assets in May 2009 with a fair value then of approximately $16.6 billion as well as the continuing execution of our reinvestment strategy, offset partially by maturities and the sales of selected securities.
During the first quarter we invested about $7.3 billion in highly rated securities at an average price of 101.05 and with an average yield of 2.72% and a duration of approximately 2.34 years. Those $7.3 billion are primarily comprised of the following securities, 93% of which are rated AAA; $3.4 billion in agency mortgage backed securities, $2.9 billion in asset backed securities including about $1.3 billion of foreign RNBS, and about $.5 billion backed by credit card receivables, $700 million in student loans and $300 million in auto, $100 million in commercial mortgage backed securities and $900 million in corporate and municipal bonds.
The aggregate unrealized after tax losses and our available for sale and held to maturity portfolios as of March 31, 2010 were $1.4 billion, an improvement of about $4.4 billion or 75% from March 31, 2009 and an improvement of about $851 million or about 37% from December 31, 2009. These unrealized losses after tax have further improved through last Friday to approximately $1.1 billion.
In our investment portfolio slide presentation, we have updated the data through quarter end for you to review. As of March 31, 2010, our portfolio was 80.2% AAA or AA rated, similar to December 31, 2009.
The duration of the investment portfolio is about 1.27 years, down slightly from the fourth quarter as well as from the first quarter of 2009. The increase in the number of downgrades from the fourth quarter resulted primarily from a continuing trend for downgrades in non-U.S.
RBS securities as well as further reductions in rating subsequently to those already noted in earlier quarters. The amount of discount accretion included in net interest revenue in the first quarter was $212 million.
Given the improved financial environment in the first quarter, we reduced our excess liquidity by about $3.9 billion. At period end, our excess liquidity totaled about $19 billion due principally to customer behaviour.
I will now provide some of the assumptions we used in confirming our 2010 outlook for net interest revenue and net interest margin. We continue to execute on the portfolio reinvestment plan that we adopted in the second half of 2009.
We intend to reinvest about 80% to 85% of the approximately $15 billion in assets due to mature or pay down in 2010. Of the $7.3 billion that we purchased, $2.3 billion was due to replacing securities that we sold and $5 billion was due to securities maturing or paying down.
We intend to continue to invest in highly rated agency mortgage backed securities and highly rated asset backed securities. We expect to invest the acquired customer deposits from the proposed acquisition of Intesa Sanpaolo Securities Services business in Euro denominated sovereign government bonds and bank placements.
We expect our net interest margin, including the impact of the Intesa acquisition, but excluding conduit discount accretion to be between 150 and 160 basis points on average for the year. We continue to expect the Bank of England rate to remain at 50 basis points for the year and we continue to expect the ECB rate to remain at 100 basis points throughout the rest of the year, and we continue to expect the Fed to keep the overnight Fed funds rate at 25 basis points for all of 2010.
We further expect earning assets to increase between 6% to 8% from the average in 2009, primarily due to the expected acquisition of Intesa’s Security Services business. We expect the S&P 500 to average about 1125 in 2010, up about 19% from 948 which was the average in 2009.
Lastly, I’ll review our capital ratios. In the first quarter, State Street Corporation’s capital ratios continued to improve such that as of March 31, 2010 compared to December 31, 2009, our tier one leverage ratio stood at 9.0%, up from 8.5% and our tier one capital ratio stood at 18.1% up from 17.7%.
In the first quarter we improved our TCE ratio from 6.6% at December 31, 2009, to 7.5% at March 31, 2010. The majority of this quarterly improvement came from price improvement in the investment portfolio and organic capital generation, and the resulting return on equity on an operating basis, was 10%.
We expect all of our capital ratios to continue to be strong, including following the anticipated acquisition of Intesa Sanpaolo Securities Services business expected to close later this quarter pending regulatory approval and other closing conditions. So in conclusion, we believe we strengthened the company through our actions in 2009.
This year we expect to derive benefits from those actions, and we remain highly focuses on executing our plan. Now, I’ll turn the call over to Jay to conclude our remarks.
Joseph Hooley
Thanks, Ed. So while we remain committed to our long term financial goals, we continue to believe 2010 will be a transition year, a year in which we transition to a more normalized environment.
We continue to expect our 2010 operating basis earnings per share to be slightly above the $3.32 operating basis earnings per share in 2009. As I outlined for you in the fourth quarter call in January, I have established a series of objectives that support the achievement of our long term financial goals of 8% to 12% growth in operating revenue, 10% to 15% growth in operating earnings per share, and the achievement of 14% to 17% operating return on equity.
Fueling the achievement of these objectives which include doubling our non-U.S. revenue over the next five years and expanding our market share is a number of macro trends such as globalization, outsourcing and consolidation.
We’re well positioned to take advantage of these trends and they are already driving our business today. The organic growth in our core business, combined with the impact of the two acquisitions, Intesa Sanpaolo Security Services business and Mourant International Finance Administration, are expected to fuel our growth in 2010.
As you may remember from our December announcements of these two transactions, we expected about $100 million in annualized revenues from Mourant and about $425 million in annualized revenue from Intesa Sanpalo. In addition, we expect organic growth in the servicing side to continue from high growth areas such as alternative investments servicing and international markets.
Our pipeline is strong with the larger mandates expected to convert over the second half of 2010. As I outlined earlier, our core business growth is also supported by our large wins announced last year that are still in the process of conversion.
In asset management, State Street Global Advisors continues to position itself to benefit from the increased demand from DC plans and ETF products. So while we face some challenges in the short term, I believe we are calibrating the business within a slowly improving environment in order to address these challenges, while positioning State Street for continued growth in the future.
I look forward to meeting with many of you at our investor and analyst forum which is scheduled for May 5 in New York. And now, Ed and I are happy to take your questions.
Operator
(Operator Instructions) Your first question comes from Ken Usdin – Bank of America.
Ken Usdin – Bank of America
I’m just wondering if you could help us understand with the onetime leasing gain and then I think you said there was another $25 million benefit this quarter that helped the bottom line earnings. Could you just talk us through how you exactly get from this quarter’s run rate up through the guidance and as part of that, can you help us quantify how much the acquisitions might help on a penny’s basis?
Edward Resch
First, in terms of the acquisitions, we said modestly. So that’s probably less than $0.05 for the full year.
In terms of the onetime gains, and the benefit that you referred to in the insurance line, we’re including both of those in our comments about the full year guidance. However, given what Jay said about the anticipated strengthening in the rest of the year, certainly on the asset servicing side given the pipeline and the installations that are in process, those are significant drivers to our underlying confidence in being able to achieve the full year EPS guidance that we’ve talked about.
Ken Usdin – Bank of America
Would that also include the securities gains as well, like as a likelihood in the future?
Edward Resch
Well our comment today are basically reiterating what we said on the fourth quarter call, include the securities gains that we’ve taken through the first quarter yes. It’s really hard to predict and in fact, we don’t budget or forecast securities gains going forward.
They’re episodic. They’re based on what the market presents and how we think about particular securities at a given point in time.
So our going forward comments do not include any incremental securities gains in our thinking.
Ken Usdin – Bank of America
My second question is just regarding the net interest margin. You talked to a 150, 160 range with Intesa for the full year.
Can you talk about how you exit the year once that’s run rated and also can you just remind us of the impact of rising rates and how that works through?
Edward Resch
We actually anticipate the margin to decline a bit as we work through the year based on our assumption that administered rates stay low for most of the year, so I’d expect we’d be toward the lower end of the 150 to 160 range as we exit the year. But the full year we expect to be in that 150 to160 range.
In terms of the effect of rising rates, we’re still in the same position that we’ve been in for a long time which is that slowly rising rates benefit us, and by slowly rising again, we define that as 25 basis points a quarter on the Fed funds rate. Obviously the pace with which the rates increase, the shape of the curve and the path to get from where we are to where we end up is a huge determinate of what the ultimate NIR and NIM performance is, but our expectation is that if in fact rates slowly rise, once the Fed stops increasing rates, we’d see a benefit to both NIR and NIM all else equal.
Operator
You're next question comes from Brian Foran – Goldman Sachs.
Brian Foran – Goldman Sachs
I know it’s difficult to talk about a normal sec lending revenue line item given how much its moved but are there any bounds you can put around it and maybe within that, when we look at the historical ratio, sec lending revenues to collateral, I think its averaged about 14 basis points over the past decade. Is that still a reasonable ball park to think about has client risk appetites changed sufficiently that somehow structurally different going forward?
Joseph Hooley
I think the factors in securities lending, we’ve talked about before but it’s important to repeat them. One is the on loan balances.
You’ve seen the customers continue to support securities lending as a means to increase yield for their portfolios. We saw some pick up quarter to quarter in that.
The second factor is the Fed fund, the three month LIBOR rate, and while in the fourth quarter we thought we had troughed, we down a little bit lower although recently that ratio has come up close to 30 basis points, so we’ve seen some improvement in that. I would say on the customers risk profile, we haven’t see a lot of desire to go out and get more riskier in the collateral investments and I assume, just an assumption that over time as people get comfortable with some of the income generated from securities lending based on spreads widening out a bit that you’ll see over time some more risk taking.
But it’s hard to know where that’s going to get to, although it does feel like we’re once again at a trough.
Brian Foran – Goldman Sachs
If I could follow up on the comments about the strong dollar impact, you have as we look at Page 14 in your supplement just what the headwind was from the dollar on AUC or AUM or both?
Edward Resch
A good proxy for that would be to look at the impact on the servicing fee line of the strong dollar which was about 1%, so in the range of a little less than $10 million for the quarter.
Operator
You're next question comes from Betsy Graseck – Morgan Stanley.
Betsy Graseck – Morgan Stanley
I have a question on the securities formerly known as conduit. Could you give us a sense of the time for these to roll off as the portfolio is currently composed and then could you also give us some color on how you decided what you were going to sell and just so we can get a sense as to whether or not you’re going to continue to do that going forward.
Edward Resch
In terms of the conduit, we still are of the view that about two-thirds of the discount accretion will come back in the first five years subsequent to consolidation, so we’re almost a year post consolidation. So that’s still valid, and that’s a proxy obviously for the maturity or the expected maturities of those conduit securities.
The remaining one-third though will take a fair amount of time. I think you should be thinking about it in terms of seven, eight, nine years out depending on the ultimate performance of the securities.
How we think about the sales of conduit securities is really two-fold. One, it’s a question of market prices, and we’ve obviously had a pretty strong rally over the last couple of quarters in the fixed income markets and we’ve seen some securities that we think have been traded above what our view of fair value for them is, so they’re a potential candidate.
Secondly, we look at the securities in the conduit that are in that favorable position and decide whether or not the gain that we could generate is appropriate given the amount of foregone discount accretion that such a sale would generated. And in the first quarter in total as I said, we gave up undiscounted $140 million of future discount accretion, and we booked $100 million roughly of gains on those securities, and we thought that on a net present value basis, that made a lot of sense for us to do.
And lastly, we look at it from the standpoint of risk reduction. The conduit securities as you may recall in general were of lower credit quality than the investment portfolio – still pretty high quality but not up the level of the investment portfolio.
Some of those securities on a risk reduction basis, we decided to sell in the first quarter. So you put all three of those things together, and that’s how we think about it.
Going forward, it’s hard to say. We don’t have any plan as I said in response to an earlier question, to necessarily sell any legacy portfolio securities or conduit securities.
It’s episodic. It’s based on the market events and our view of those credits and those securities at that time.
Betsy Graseck – Morgan Stanley
So you did what you though – so based on the market you do what you wanted to do for first quarter. It’s not like you’re parsing this out over time.
Edward Resch
No. It’s really opportunistic and again, as I said, based on the discount accretion give up and our view of potential risk reduction to the overall portfolio.
Betsy Graseck – Morgan Stanley
Separately on expense ratio, I think you touched on this in your prepared comments, but maybe just give us a little bit of color as to how much of the expense ratio hike this quarter is pre-investing for some of the flows you’re anticipating coming in and if there’s any kind of guidance or color as to what you are expecting to manage your expense ratio to going forward.
Edward Resch
I would say that the expense level that we ran at in the first quarter were generally in line with the overall business levels that we’ve seen. I can’t point to anything that is getting ahead of something or make an investment in anticipation of something.
I’d say it’s kind of a steady state level of investment. We’re running our technology budget in line with what we expected which was in the range of 20% to 25% of operating expenses for the full year in the quarter.
The big driver in terms of expenses in the first quarter was the incentive comp accrual which we talked about again, year over year and sequentially.
Betsy Graseck – Morgan Stanley
So that should normalize as you go into the second quarter.
Edward Resch
Yes.
Operator
You're next question comes from Glenn Schorr – UBS.
Glenn Schorr – UBS
On FX was down a little bit but I thought the active trader segment was reasonably active and I’m just curious how current X performed versus whatever you’d call the core business.
Joseph Hooley
Ed can give you the specifics but you’re right. The electronic trading volumes continue to be pretty robust.
Edward Resch
On a volume basis, which is a good indication, sequential quarter current X showed volume increase of 11%, year over year about 64%. So pretty robust.
Glenn Schorr – UBS
I guess the answer is it’s not a big enough piece of the pie to fully offset.
Edward Resch
That’s true.
Glenn Schorr – UBS
I apologize if you disclosed earlier, but did you say anything about flows in asset management?
Joseph Hooley
We said flows sequentially were slightly down Q4 to Q1, and year over year we’re up 15%.
Glenn Schorr – UBS
Weighted on EPS side?
Joseph Hooley
Really a mix. I’d say what we’ve seen in the first quarter is a little bit of a slow down on the passive side which ran at pretty high levels last year.
A little slow down passive. ETF continues to grow nicely.
Cash has slowed down a little bit. What we’ve started to see, one of the asset classes that has been slow or underperforming for the last couple of years for the whole industry is active quant and we’ve started to see some early signs of improvement in that asset class which is encouraging, but more or less it’s the passive, still but slow down ETF continuing, cash slow down a little bit and started to see signs of life in some of the active strategies.
Glenn Schorr – UBS
There’s obviously a lot of tension in CVLM these days. I’m curious if you can just give us a reminder of what role you play as collateral manager, how big, how many deals and how, what level of involvement you’ve had with the ongoing sweeping investigations for CVLM.
Joseph Hooley
As far as CVO’s, we’re not a sponsor. We don’t structure CVO’s, nor do we sell CVO’s to investors so might surmise that that’s where most of the interest is.
We do act as a collateral manager with respect to CVO’s. We do that only unaffiliated sponsors, and if you were to look at that, I think it’s about $2 billion that we act as a collateral manager for, but again, we don’t sponsor, structure or sell CVO’s.
Glenn Schorr – UBS
Are any of those that you’re a collateral manager going through any high level investigation with the regulators?
Joseph Hooley
No.
Glenn Schorr – UBS
FX lawsuit – is there an update? Have there been others, and I’m specifically asking is there an update on the California one, the one in Washington and have there been others brought since?
Joseph Hooley
No real update. California we consider as ongoing litigation.
As we pointed out I think previously as well as in the regulatory filings we’ve had a handful of inquiries from other Attorneys General that have just been increased. Haven’t turned anything that’s worth of reporting, so I would say kind of no change from prior quarter.
Operator
You're next question comes from Howard Chen – Credit Suisse.
Howard Chen – Credit Suisse
A follow up on securities funding. Where are we in the discussion of sec lending gates being lowered and how do you think about that with respect to the broader asset servicing competitive landscape?
Joseph Hooley
I would say that as you’d expect, the net asset values of the underlying collateral pools have improved substantially. I think in aggregate north of $0.99 right now, so good improvement.
We’ve always maintained a practice of allowing people to exit for normal course events, paying dividends, things like that, and we’re working through, as is I think the industry, how we lower those gates in a way that gives customers more liquidity and does it in a measured way.
Howard Chen – Credit Suisse
On the conduit, can you speak to how much capital that business is tying up today and your expectations more long term for staying or not staying within that business? Just trying to get a feel for whether that capital comes back to the shareholders etc.
Edward Resch
We’re really not in the conduit business post consolidation. We do in fact have securities issued, asset backed commercial paper issued which is a very attractive source of funding for us, and as long as it continues to be that, we’ll continue to do it.
But that’s more of a just a legal mechanic where we are issuing through the conduit. So we don’t consider that as a business akin to what we had before we consolidated.
In terms of the capital, I would say a good way to think about it is probably to think about it in TCE and apply 5% against the consolidated assets, so round terms, probably $750 million to $800 million, but that’s more a function of just the capital supporting that element of the conduit securities that are now in the portfolio. So I think the overall capital question is really a function of how our balance sheet grows and what we do on the asset side in terms of investing those customer deposits ultimately.
Howard Chen – Credit Suisse
To follow up on capital, clearly it continues to build very nicely. Just hoping to get your latest thoughts on how you hope to manage that over time and maybe one thing that you have started to do again is start to look at acquisitions, so maybe outlook for further acquisitions.
Joseph Hooley
You’re right, we do continue to build capital and anticipate we’ll continue to. We said, and I continue to believe that a priority is to reinstate the dividend.
Now we’re I think all in a place where we’re looking for a little more guidance from regulators. We would hope to get some further clarity on that by the end of the year, but that’s pending.
So that aside, I guess the use of capital, I’ve said before and I continue to believe that particularly in the asset servicing business that we’ll see further consolidation and you continue to see evidence of that, not just in our acquisitions but in other acquisitions made within the industry. I think if you play out the capital story, particularly in places like Europe as capital levels are clarified with regard to the banking industry, I think you’re likely to see more non core custody businesses come up for sale.
So I continue to believe that one good deployment of future capital will be acting on consolidation in the asset servicing industry. We always look at that assuming post insight from regulators that we have excess capital vis a vis share buy backs.
So those are the three dimensions, and I think given as a priority, I think acquisition is still an active part of our strategy which I think will play out over the next several years and share buyback is obviously the other alternative.
Operator
You're next question comes from Michael Mayo – CLSA.
Michael Mayo – CLSA
Can you clarify the unrealized securities losses are where now and where were they at the end of the quarter and how it improved so much? Have I got the numbers right?
Edward Resch
As of last Friday, they were at $1.1 billion after tax and as of the end of the quarter, March, it was $1.4 billion after tax.
Michael Mayo – CLSA
Why are you still comfortable earning $3.32 core for this year or more because if you take your number and you stripped out securities gains, you could be instead of $0.75 you could be $0.65 and you have to get $0.85 for the last three quarters so how do we get from $0.65 excluding securities gains up to an $0.85 number for the last three quarters. You said acquisitions could add a few cents, but you said the incentive comp accruals, that goes down so that’s two factors.
Could you just outline the other reasons. And if you’re not comfortable you could always lower your guidance now.
Joseph Hooley
I think the confidence largely is anchored around the core business story. The core business, servicing asset management, I think between the backlog of installation, the current period sales which I referenced $155 billion in assets that we have closed just this month, combined with prospective view of pipeline, gives us good confidence in the momentum of the core business.
Added to the that the acquisitions both Mourant which is closed and Intesa which we anticipate closing this quarter, give us good confidence and good sense that core revenues will run well through the course of the year. So that’s really the anchor for confidence in the revenue line.
We also – Ed pointed out, it’s worth mentioning again, that in the market driven revenues securities finance and foreign exchange, we would expect some improvement in those lines toward the back end of the year based on in the case of foreign exchange, I think you could look to segments like mutual funds. As mutual fund investors move more towards equities and cross border equities, we would expect to see some positive reflection in foreign exchange.
In securities lending, we’ve seen some recent improvements and spreads. So it’s really anchored around the core with some anticipated improvement toward the back end of the year and market revenues, and good control on expenses.
Michael Mayo – CLSA
You’re confident you’ll exceed the $3.32 for this year. We shouldn’t look for revision downward at your investor day in a couple of months?
Joseph Hooley
Based on what we know today and the things that I just mentioned we are confident and at the investor day in May, we’ll push that out a little further not only in multiple years but also give you a little more sense of current year.
Michael Mayo – CLSA
What’s your confidence that this quarter marks the low point for the year? I mean first quarter is kind of the low point if we strip out securities gains, are you super confident that it only gets better from here?
Joseph Hooley
I think the only thing I would say is that when you look at some of the core revenues the quarter to quarter flatness, I would expect, I think that’s more of a timing issue, so if you look at that as timing, that’s one way to project forward.
Michael Mayo – CLSA
Foreign exchange, are you losing market there or what’s going on?
Joseph Hooley
We don’t believe we are. That’s a hard metric to follow given the breadth of the market, but we continue not to see an effect of a lawsuit, if that is where your question is going.
It’s more a matter of volumes and volatility and cross border asset flows.
Operator
You're next question comes from Brian Bedell – ISI Group.
Brian Bedell – ISI Group
Just to zone in on the servicing fees a little bit more granularly. Flat this quarter.
I understand you’ve been installing business and I think you do expect that to take longer. Are you referring mostly to the Morgan Stanley piece?
Joseph Hooley
I think in the fourth quarter we reported $500 billion, in that range of new business on the servicing side. There tends to be some lumpy deals, some big deals that have characteristics that require multi-quarter installations, Morgan Stanley being among those.
Brian Bedell – ISI Group
Should we in layering that in, in the model for 2010 where I think before we were thinking about a first half installation, basically complete by the second quarter, would you say this is now coming in more during, over the course of the entire year?
Joseph Hooley
I would look at the ’09 sales as coming in more in the second and third quarter. We talked about the deals closed in the first quarter and then those in April which are more than $300 billion, so those should layer in through the remaining quarters of the year.
Brian Bedell – ISI Group
The $155 billion that you just mentioned about this month, is that in addition to the $164 billion?
Joseph Hooley
Yes it is. I just figured I’d give the significance even though it’s after quarter end, but in the month it’s worth mentioning.
Brian Bedell – ISI Group
That’s new, asset servicing business won, is that correct?
Joseph Hooley
Correct.
Brian Bedell – ISI Group
On the management fee line I would have expected that to go up a little bit given your big passive fixed income win in the fourth quarter, but were there more performance fees, I’m sorry less performance fees in the first quarter versus fourth quarter?
Joseph Hooley
That was the big factor there, the performance fees, less in the first quarter.
Brian Bedell – ISI Group
I guess if we could talk about obviously securities lending will pick up in the second quarter from a seasonal aspect. Do you expect seasonal tax albatross season to help the second quarter, is that correct?
Joseph Hooley
Yes we do.
Brian Bedell – ISI Group
Going on to the expenses, on the comp line, if we could just talk a little bit more about how we see that going forward. I calculate about a 44% comp to revenue ratio and the denominator of that is stripping out the securities gain and stripping out discount accretion with which I assume you’re not paying compensation on.
So we’re at a 44% level and I know you had said in the past you kind of target around a 40% level. Should we expect it to revert back to that starting in the second quarter or are we operating at a higher level for awhile?
Edward Resch
Our expectation for the year is in that 40% range, and that’s full year comp to revenue, a little bit higher. We included the securities gains, I included the securities gains in the calculation for the first quarter, but I would say for the full year our expectation is to be in that 40% range as we have been in prior years.
Brian Bedell – ISI Group
So we should see a sequential decline in comp absent the acquisition of course.
Edward Resch
Yes.
Brian Bedell – ISI Group
In thinking about the full year $3.32 plus guidance, sounds like obviously the Intesa business is much higher operating profit margin than your core business. That should help.
Should we think about Mourant as similar on the operating margin equation? I know it’s much smaller.
Edward Resch
I gave an answer to an earlier question in the call which was that in terms of EPS, I said both of those should be thought of as being in the range of 5% or so, $0.05 or so excuse me, for the year. That’s what we meant by modestly accretive.
Operator
You're next question comes from Greg Ketron – Citigroup.
Greg Ketron – Citigroup
I know you’ve been talking about this in bits and pieces through the call, but when you look back at 2009 you had about $1.1 trillion in assets under custody and as you look at this year, it sounds like you’ve got some good early successes this year plus installations that come online. Any sense for what that number could be?
Are your expectations similar to that, more or less for 2010?
Joseph Hooley
The $1.1 trillion just to be clear was business won versus business installed and then again, the $168 billion and $165 billion year to date would be business won not installed, so there’s some difference between that. One thing I can point to is that I think we continue to be well placed to look to outsourcing more middle office, more back office that we continue to see investment management firms in particular, consolidating with single providers, so given our position, I think we’ve evidence, we’ve talked about Legg Mason for instance moving their U.K.
business to us. So I think between consolidating positions with customers, a deeper level of outsourcing, combined with continued robust activity outside of the U.S., and alternatives, which the alternative story is one of growth, but it’s also one of I think some regulatory and client pressure pushing more alternative mangers to outsource to a third party, all give us pretty good confidence that we’re in a zone where there’s quite a bit of activity going on, and I think competitively we’re pretty well positioned and we do a good job when a piece of business is up for bid and succeeding with it.
So I can’t give you a number but I can give you a sense that I think that the trends that have brought us the $1.1 trillion last year and the $300 billion this year continue in place.
Greg Ketron – Citigroup
On the Intesa deal, when you look at future revenue enhancement opportunities and I know you’ve talked about your existing client base, maybe having 16 or 17 different products that they buy from State Street, do you look at Intesa in the same way and if you do does it look like there’s potential opportunity to increase the number of products substantially as you work through that deal?
Joseph Hooley
Absolutely. It’s a trend whether it was IBT or Deutsche Bank or IFS, once we go in and start to deal with the customers, in this case the Intesa acquisition, we’re likely to find multiple ways we can cross sell or expand those relationships, so we do view that as one of the values in the acquisition.
Greg Ketron – Citigroup
Is there any number that you put on the potential revenue enhancement over the $425 million revenue base?
Joseph Hooley
I think it’s early. We’ve got some exposure to the customers, but it will take some time to mention that.
I would expect it to be not unlike the Deutsche acquisition or IDT though.
Kelley MacDonald
Phyllis, we need to conclude.
Operator
Thank you. This concludes today’s State Street Corporation’s first quarter 2010 call and webcast.