Jul 19, 2011
Executives
Joseph Hooley - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Risk & Capital Committee S. Kelley MacDonald - Sr.
VP, IR Edward Resch - Chief Financial Officer and Executive Vice President
Analysts
Michael Mayo - CLSA Asia-Pacific Markets Brian Bedell - ISI Group Inc. Alexander Blostein - Goldman Sachs Group Inc.
John Stilmar - SunTrust Robinson Humphrey, Inc. Kenneth Usdin - Jefferies & Company, Inc.
Howard Chen - Crédit Suisse AG Glenn Schorr - Nomura Securities Co. Ltd.
Operator
Good morning, and welcome to State Street Corporation's Second Quarter 2011 Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website at www.statestreet.com/stockholder.
This call is being recorded for replay. State Street's call is copyrighted, all rights are reserved.
The call may not be recorded for rebroadcast or distribution, in whole or in part, without expressed written authorization from State Street, and the only authorized broadcast of this call is housed on State Street's website. At the end of today's presentation, we'll conduct a question-and-answer session.
[Operator Instructions] Now I'd like to introduce Kelley MacDonald, Senior Vice President for Investor Relations at State Street.
S. Kelley MacDonald
Thank you, Wes. Before Jay Hooley, our Chairman and Chief Executive Officer; and Ed Resch, our Chief Financial Officer, 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 by these forward-looking statements as a result of various important factors, including those discussed in State Street's 2010 annual report on Form 10-K and its subsequent filings with the SEC. We encourage you to review those filings, including the sections on Risk Factors concerning any forward-looking statements we make today.
Any such forward-looking statements speak only as of today, July 19, 2011, 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 the slide presentation regarding the corporation's investment portfolio as well as our second quarter 2011 earnings press release, which include reconciliations of non-GAAP measures referred to on this webcast, in the Investor Relations portion of our website.
Jay?
Joseph Hooley
Thanks, Kelley, and good morning. I'm pleased with what we've achieved in the first half of 2011, led by continued momentum in our Core Asset Servicing and Asset Management business and supported with second quarter by seasonal strength in securities finance.
This morning, we'll provide more detail behind the strength we're seeing in our core business, which is primarily driven by 3 competitive advantages. First, our global footprint, which is unmatched in the industry.
Second, our industry leadership in important growth areas such as alternative asset servicing, investment manager operations outsourcing and exchange traded funds. And third, our relentless commitment to continue to develop new solutions for our customers.
I also want to update you on our capital position. While we learn further details from the Basel Committee recently regarding the requirement for a capital buffer for global Systemically Important Financial Institution, which appears to be in a range of 0% to 2.5%, we still await requirements from the Federal Reserve may place on Systemically Important Financial Institutions in this country and to what extent State Street may be affected.
Our capital position remains strong in the second quarter, and we continue to believe we need to exceed the 2019 Basel III capital ratios today, as we understand the proposed rules. We initiated our share purchase program in the second quarter, buying about 4.9 million shares.
We also raised our regular dividend -- quarterly dividend to $0.18 per share. Due to the strength of our capital position, we were able to take these measures while retaining the flexibility to respond to appropriate acquisition opportunities, should they become available.
Regarding our recent acquisitions, the Investment Services business that we acquired from Intesa Sanpaolo in the Mourant International Finance Administration business continue to exceed the goals we've set. In addition, the acquisition of Bank of Ireland's Asset Management business continues to perform in line with our expectations.
Just this morning, in a press release, we updated our progress in executing our multiyear business operations in IT transformation program. We assigned expanded agreements with 2 long-standing service providers, IBM and Wipro, to provide maintenance support for our IT infrastructure.
As a result of these expanded relationships, approximately 320 non-client facing State Street IT employees will transition to become employees of either IBM or Wipro. Another 530 non-client facing IT employees will be provided with severance and outplacement service as their roles are eliminated over the course of the next 12 months.
By expanding our relationships with IBM and Wipro, we can strengthen the focus of our IT organization on research and development, while lowering the cost of IT maintenance support. This focus on research and development will extend our leading position in developing new products, especially those that focus on data and analytics.
We continue to meet all the financial parameters that we announced when we first launched the business operations in IT transformation program. In the second half of the year, we expect to record between $110 million and $130 million associated with the announcement made today.
As of June 30, 2011, we've recorded, in total, about $165 million due to headcount reductions and real estate consolidations associated with this program. We continue to expect to achieve modest savings from this program this year in pretax run rate savings of between $575 million and $625 million by the end of 2014, excluding the expected restructuring charges of between $400 million and $450 million.
We expect these savings to be approximately ratable over the next 3 years. Let me turn now to provide some highlights of the second quarter.
We achieved positive operating leverage, comparing the second and first quarters of 2011 on an operating basis. During the second quarter of 2011, we are awarded about $280 billion of new servicing mandates, which represent about 105 wins.
We've already installed about $130 billion of this business won in the second quarter and expect to install about $150 billion during the remainder of 2011. We continue to experience a broad range of wins in terms of products, service and geography.
Of the $280 billion we won in the second quarter, $185 billion or 66% were from the U.S., $95 billion or 34% were non-U.S. mandates, $41 billion from Europe and Middle Eastern customers, $49 billion from Asian clients and $5 billion from Canadian clients.
Significant new wins included servicing from mutual funds, wealth managers and hedge funds. In particular, F&C Asset Management, a leading investment manager in Europe, awarded us a long-term contract to provide investment manager operations outsourcing as well as custody, fund accounting, trustee services and securities lending.
In Europe, we're seeing increased demand for hedge fund servicing, investment manager operations outsource -- outsourcing and UCIT IV servicing. And in the Asia Pacific region, we've recently introduced a new hedge fund service offering in response to increased market demand.
From the Middle East and Africa, we generated $10 billion in new wins this quarter, particularly fueled by our strong position servicing the sovereign wealth fund sector. In the alternative servicing area, demand remains strong.
According to Hedge Fund Research, hedge fund assets passed the $2 trillion level in the first quarter of 2011 with the launch of nearly 300 new funds. And according to Preqin, the average hedge fund allocation from public pension plans has increased to nearly 7%, up from 3.6% in 2007.
This quarter, we had a 38 new mandates in our Alternative Investment Servicing business, and our assets under administration increased from $772 billion as of March 31, 2011, to $789 billion as of June 30, 2011. In the second quarter, SSgA had negative net flows of $27 billion, but this is primarily due to the U.S.
Treasury redeeming investments over the year. Without the Treasury redemptions, net flows would have been $10 billion positive this quarter.
Gross new mandates totaled $141 billion in the second quarter, of which $30 billion is scheduled to be installed later this year. The SSgA wins are globally diversed and represent a variety of investment strategies: $53 billion from the U.S., $50 billion from Europe and the Middle East and $16 billion from Asia, as well as $22 billion from Canada.
Continuing a theme from recent quarters, most of the new business came from passive and ETF strategies. Of note, however, is a large active equity mandate we won from AP2 in Sweden.
This win was won after we acquired the Bank of Ireland's Active Management business. Overall, I'm encouraged by our continued success in driving new business growth and would expect this trend to continue, given a considerable new business pipeline that exist across the different business lines.
One of the main ingredients that fuels our new business success is our ongoing investment in new product development. Some of the new products introduced in the second quarter include a collateral tracking product that monitors, aggregates and reconciles actual collateral movements and reports on all pledged and posted collateral positions and locations.
It's most useful to large global asset managers and into the exposure monitor available through mystatestreet.com that provides a 360-degree view of an institutional investor's daily exposure to legal entities, that's counter parties and issuers, across a wide range of their investment activities. Also we're developing a product called Springboard that extends the capability of mystatestreet.com to mobile users as an app to an iPad.
We believe it's the only all-in-one information delivery platform that will be available to institutional investors shortly. In addition, this year we've introduced 24 ETF products, including 14 new ETFs in Europe.
We also launched 2 ETFs that provide diversified access to emerging market government debt, one of which was in the U.S., the other which was in Europe. Let me now share our view on the current economic environment.
The recovery in the United States is slower than the second quarter, affected by continued weakness in housing prices, as well as a weak labor market and lackluster demand from the consumer. Market economists are now forecasting real annualized GDP growth in the U.S.
of about 2.6% for 2011 with a slight acceleration in the second half of the year. In addition, despite the supportive actions of the European Central Bank, the potential of default in Greece hangs over the European market and may affect the peripheral countries such as Portugal, Spain and Italy.
Japanese industrial activity seems to be recovering from the tragic events of March, but the outlook is for little growth in 2011. And in addition, there's growing unease in the global market about the pending U.S.
Government debt ceiling. Let me now turn the call over to Ed, who'll provide further detail about our financial performance in the second quarter, and then I'll return to provide closing comments, and then we'll open the call for questions.
Ed?
Edward Resch
Thank you, Jay, and good morning, everyone. This morning, I'll review 3 areas.
First, the results for the second quarter. Second, the investment portfolio, investment decisions we made in the second quarter as well as our outlook for worldwide interest rates and the impact on our net interest margin.
And finally, I'll review our strong capital position. First, the results of the second quarter of 2011 compared with the second quarter of 2010 and the first quarter of 2011.
This morning, all of my comments will be based on our operating basis results as defined in today's earnings news release. First, the general overview of the second quarter of 2011 compared with the second quarter of 2010.
The growth in core revenue was due primarily to the 3 acquisitions as well as the growth in new business and improved equity markets. Securities finance revenue was up due to a higher spread as well as the impact of the European issuers' increasing dividends this year compared to the past few second quarters.
The increase in net interest revenue was primarily due to the near full-quarter effect of the increase in rates from the ECB that occurred in early April and the growth of client deposits added in connection with the Intesa acquisition. Trading services revenue was down about 5% from the prior-year second quarter, primarily based on weaker foreign exchange revenue.
Revenues from brokerage and other trading services were flat. Turning to expenses.
They increased about 20% from the second quarter of 2010, primarily due to the impact of the reduction in incentive compensation in that quarter related to the securities lending charge. In addition, the second quarter of 2011 included merit increases, the ongoing impact of the 3 acquisitions and contract employee cost associated with the business operations and IT transformation program.
We earned $0.96 per share on an operating basis, a 3% increase from $0.93 per share in the second quarter of 2010 on a revenue increase of about 14%. Now for a detailed look at the results of the second quarter compared to the first quarter of 2011.
Our Servicing fee revenue increased by 3% due to net new business installed as well as the slightly higher average equity valuation. Asset management revenue increased 6% due to the impact of net new business as well as slightly favorable average month-end equity valuations.
Providing further details on trading services and securities finance. Foreign exchange revenue increased 6% compared to the first quarter of 2011, primarily due to higher volumes and slightly higher volatilities.
Brokerage in other revenue was flat with the first quarter. Compared to the first quarter of 2011, securities finance revenue in the second quarter of 2011 increased 108% to $137 million due to seasonality.
As usual, we expect these revenues to decline in the third quarter compared to the second quarter. Securities on loan averaged $379 billion for the second quarter of 2011, up from $359 billion for the first quarter of 2011 and down from $421 billion for the second quarter of 2010.
Average lendable assets for the second quarter of 2011 were about $2.37 trillion, up slightly from $2.34 trillion in the first quarter of 2011 and from $2.2 trillion in the second quarter of 2010. As of June 30, 2011, the duration of the securities finance book was approximately 18 days, down from 21 days in the first quarter of 2011 and up slightly from 17 days in the second quarter of 2010.
Processing fees and other revenue decreased 24% from the first quarter of 2011. The decline is primarily due to lower revenue from joint ventures and structured products.
Net interest revenue increased slightly, about 1% in the second quarter of 2011 compared with the first quarter of 2011, primarily due to an increase in client deposits and lower funding costs. The net interest margin in the second quarter of 2011 was 161 basis points, down 5 basis points from 166 basis points in the first quarter.
Including conduit-related discount accretion of $51 million in the second quarter of 2011, net interest margin was 176 basis points compared to 185 basis points in the first quarter of 2011. As of June 30, 2011, of the approximately $1.25 billion in conduit-related discount accretion we expect to accrete into interest revenue over the remaining terms of the assets, we continue to expect about $200 million, including the $130 million in the first half of 2011, to accrete in 2011.
Of course, a significant number of assumptions go into our estimate of future discount accretion over the remaining lives of the assets, including that we hold the securities to maturity, estimated prepayment speeds, expected future credit losses across various asset classes and sales. In the second quarter of 2011, we recorded about $62 million in net gains from sales of available-for-sale securities and separately about $35 million of OTTI resulting in $27 million of net gains related to investment securities.
The OTTI was primarily due to continuing weakening in the housing market. We maintained tight control on expenses due to continuing uncertainty in the global markets.
However, our salaries and benefits expenses increased 4% or $35 million from the first quarter of 2011 to approximately $1 billion due, primarily, to merit increases that went into effect on the 1st of April and increased contract employee costs associated with the business operations in IT transformation program. Other expenses increased about 5% to $243 million due primarily to increased regulatory costs.
Our operating basis effective tax rate for the second quarter was 27.5%, down from 28.0% in the first quarter of 2011, due to a favorable geographic mix of earnings. We expect the operating basis effective tax rate in 2011 to be slightly below 28%.
Now let me turn to the investment portfolio. Our investment portfolio as of June 30, 2011, increased about $2.5 billion to $106.4 billion compared to March 31, 2011.
During the second quarter, we invested about $16.3 billion in highly rated securities at an average price of $100.35 and with an average yield of 1.01% and a duration of approximately 1.25 years. The $16.3 billion was primarily composed of the following securities, 95% of which are AAA rated: $8.9 billion in U.S.
Treasury securities; $1.2 billion in agency mortgage-backed securities; $4.9 billion in asset-backed securities, including about $1.5 billion of foreign RMBS, which is mostly U.K. and Dutch issuances; about $1.9 billion in securities backed by credit card receivables; and about $0.6 billion in student loans.
The remainder was invested in smaller amounts in various asset classes. The aggregate net unrealized after-tax loss in our available-for-sale and held-to-maturity portfolios as of June 30, 2011, was $94 million, an improvement of $258 million from March 31, 2011 and an improvement of about $410 million from December 31, 2010.
The improvement in the net unrealized after-tax position compared to March 31, 2011, was due primarily to lower rates, partially offset by wider spreads. In our investment portfolio slide presentation, we have updated the data through quarter end for you to review.
As of June 30, 2011, our portfolio was 90% AAA or AA rated. Compared to the first -- the end of the 2011 first quarter, the duration of the investment portfolio was about 1.33 years, down from 1.59 years at March 31, 2011, due to the sale of longer dated fixed rate securities and the purchase of floating rate securities.
The duration gap of the entire balance sheet is 0.28 years, down from 0.40 years at March 31, 2011, due primarily to the shorter portfolio. Despite additional downgrades of certain of our securities from major rating agencies, the effect on our investment portfolio was not meaningful, and the securities affected are performing well.
The majority of the downgrades were in a non-agency MBS asset class. I'll now review some of the assumptions we used in determining our 2011 outlook for net interest revenue and net interest margin.
We continue to believe we should invest through the cycle and to invest in U.S. Treasury securities and very highly rated agency mortgage-backed securities and asset-backed securities.
As of June 30, 2011, 60% of our investment portfolio was invested in floating-rate securities, and 40% in fixed-rate securities. We continue to expect our net interest margin in 2011 to be in the 160 to 165 basis point range, down from the level of 168 basis points achieved in 2010.
Should rates continue to decline, we still expect our net interest margin to be under slight pressure, so that it may average nearer to the lower end of the 160 to 165 basis point range. Our assumptions include that the ECB incrementally increases rates a total of 75 basis points in 2011, the first 25 of which occurred on April 7, 2011, and the second 25 of which on July 7, 2011; that the Bank of England raises rates by 25 basis points near the end of 2011; that the Federal Reserve keeps the overnight Fed funds rate at 25 basis points for all 2011; and that the yield curve retains its current steepness.
Another key assumption affecting our outlook for revenue in 2011 is that we continue to expect the S&P 500 to average about 1265 in 2011, up about 11% from 1140, the average in 2010. Finally, I'll briefly review our capital ratios.
In the second quarter, State Street Corporation's capital ratios under Basel I remained very strong. As of June 30, 2011, our total capital ratio stood at 20.7%.
Our Tier 1 leverage ratio stood at 8.6%. Our Tier 1 capital ratio stood at 18.9%.
Our TCE ratio was 7.3%, and our Tier 1 common ratio was 16.8%. Based on our understanding of the Basel III regulations and the information published by the Basel Committee, we estimate our capital ratios under Basel III, as of June 30, 2011, to be -- our total capital ratio to be 14.6%, our Tier 1 leverage ratio to be 6.3%, our Tier 1 capital ratio to be 12.9% and our Tier 1 common ratio to be 11.8%.
In conclusion, as we complete the first half of 2011, the economic outlook has deteriorated from the beginning of the year, and we continue to face headwinds from the low interest rate environment. However, we are pleased with our operating basis results for the first half of 2011.
These results testify to the strength of our revenue in servicing and investment management as well as our success in managing net interest revenue and our ability to control expenses. Now I'll turn the call over to Jay to conclude our remarks.
Joseph Hooley
Thanks, Ed. The momentum of new business wins continued in the second quarter, as you heard.
As a result, we achieved strong revenue growth. At the same time, we're very mindful of the various global economic challenges, and so we have been and will continue to be focused on expenses.
As we reported to you earlier this morning, we're making progress in executing our business operations in IT transformation program. The 2 new agreements we signed recently with IBM and Wipro represent important milestones in the program's implementation.
We generated a modest amount of savings in the second quarter from the program and expect to accelerate as we begin our work with these 2 partners. Our capital position remained strong during the quarter, positioning us well for new capital standards and maintaining flexibility with the right acquisition presents itself.
Overall, I think we've performed well during the first half of the year. And as we have continued to execute our strategy, we're adjusting to this challenging environment.
Now Ed and I are happy to take your questions.
Operator
[Operator Instructions] Your first question comes from Howard Chen of Crédit Suisse.
Howard Chen - Crédit Suisse AG
Jay, in your comments, you mentioned the concerns increase and a broader peripheral Europe. We're just hoping you could kind of weigh some of the pluses and minuses for the franchise.
The plus side, I know you've done acquisitions in the region before, obviously, and on the negative side, maybe thoughts about some of the counterparty risks as you see it.
Joseph Hooley
Sure, Howard. Let me weigh in, and I'll ask Ed to chip in too.
Well, from the standpoint of the situation in Europe peripheral countries, most notably, we don't have any direct sovereign exposure, so that's point one, I guess, on our portfolio. I can let Ed comment a little bit more on some other business exposure we might have in Europe.
I'd say, generally, we're concerned and cautious and watching it closely. I think, from a counterparty credit standpoint, we have been monitoring for several quarters now the situation in Europe and tend to have counterparty credits focused in the larger, better credits in Europe.
And that's not a recent change, that's been that way for the last year. We focused intensely on collateral arrangements to make sure that we're well positioned against the better credits in Europe from a bank standpoint and also that we're watching it carefully so that if something goes against us, we're able to respond.
So I'd say that's the monitoring process that we have in place. I feel pretty comfortable about that.
To the other side of the equation, I think, two points I'd make. One is that the question often comes up.
It came up last year on Italy as we're making the Intesa acquisition: How did the events in Europe affect our core business? I think we continue to see, with some exceptions, savings rates, stable, if not improving, so that's really what drives the core of our business.
So core business-wise, I don't see the events in Europe affecting servicing or management fees in a meaningful way. I think the other question, I think, you're probably indirectly asking is the whole consolidation/acquisition scenario in Europe, and I think that's still under pretty close watch.
We would expect that, as the European banks recapitalize or deal with capital deficit, should they have them, that they'll look at peripheral businesses and, potentially, there'll be opportunities for us. The screen that we put on that situation is, first and foremost, it has to be strategic.
So it has to be either in a market that we don't have exposure to or a product that we don't have access to at the moment. And it has to have the right economics associated with it.
So we continue to impose a pretty high economic accrual rate on acquisitions that we're considering. So having said all that, I think we're optimistic that we're well covered on the downside and that there will be opportunities that will emerge out of Europe as a result of the current crisis.
Ed, I don't know if I...
Edward Resch
Yes, let me give you a couple of additional facts relative to the investment portfolio, Howard, which may amplify some of what Jay said. And as you said, there's no sovereign exposure to the peripheral countries in the portfolio.
We do have RMBS positions. They're concentrated in the U.K., Netherlands and Germany.
They total about $17 billion in total. They have about 0.5 year duration on average, and they're 90% overall AAA rated, 5% AA rated.
We do have some immaterial exposure to RMBS in the peripheral countries. In Greece, Portugal and Ireland, there's nothing more than $150 million in RMBS positions, and in Italy, in Spain, it's slightly higher than that.
Overall, we feel very comfortable for the investment portfolio's position, given the European situation. And just one further comment now for the bank placements, non-Central Bank European deposits of a little bit over $6 billion.
These are normal course-type deposits that we always place. They're with the large banks, Deutsche's, Standard Chartered, HSBC, BNP.
So overall, again, to amplify what Jay said, we feel comfortable with where we are in terms of our assets relative to Europe.
Howard Chen - Crédit Suisse AG
And sorry if I missed this in the prepared remarks, but could you just update us on the new business pipeline and thoughts on -- just broad thoughts on timing of event installation?
Joseph Hooley
Yes, we didn't comment other than broadly, Howard. We did comment on the $280 billion that we booked in the second quarter, and I think half of that was installed, half of that, it's to be installed in the remainder of the year.
But I would say, consistently, and I emphasize, that the makeup of the sole business is pretty diversified. We continue to see opportunities across the board.
So our pipelines are, I'd say, above average. And I'd also say that our success ratio in deals that we're very interested in is quite high.
Howard Chen - Crédit Suisse AG
Helpful. And then, Ed, one final one on the numbers.
It looks like your Basel III, RWA saw 8% during the quarter, and on a Basel I basis is up 6%. I guess I'm wondering, what's specifically driving that Basel III reduction?
And what's specifically driving the delta on a B1 versus B3?
Edward Resch
Yes, the driver on Basel III, Howard, is that the securitization reduction positions that we have, have declined fairly dramatically. That is largely due to us getting some securities that were previously not rated and subject to the deduction actually rated.
And that's the main contributing factor to that. I would also point out that, overall, would be improvement in the mark.
That drove the very significant increase in the Tier 1 common ratio, up to 11.8%.
Howard Chen - Crédit Suisse AG
And just on that point, Ed, do you see more opportunity to get things rated and continue to drive down that RWA figure?
Edward Resch
Well, we're working on it. I wouldn't expect it to be of the same magnitude that we've already achieved.
There's some incremental positions that we're in the process of attempting to get rated. But probably, most of that improvement is behind us from that perspective, Howard.
Operator
Your next question comes from Glenn Schorr of Nomura.
Glenn Schorr - Nomura Securities Co. Ltd.
So I appreciate all the color around Europe, I just want to see if those comments are inclusive of what the SEC lending portfolios might be exposed to?
Edward Resch
I'll give you some detail on the SEC lending, which -- all my comments previously, Glenn, were on the portfolio and the [indiscernible] position that we have on balance sheet. So in terms of SSgA securities lending and cash portfolios, okay, we have no exposure to sovereign debted peripheral countries in those portfolios.
And we have no exposure in U.S. 2a-7 registered funds to banks in peripheral countries.
We have a small amount of exposure to -- in non-U.S. registered funds to banks in peripheral countries, around $3 billion in Italy and a little over $1 billion in Spain.
The maturities are short, a little bit over 2 months on average. And in terms of SSgA's fixed income exposure, we own fixed income instruments at the benchmark weighting, okay?
So overall, we feel like we have a pretty well-diversified mix of assets with the most credit-worthy entities. We're comforted somewhat by the relatively positive outcome of the European stress test.
And SSgA is in a, we believe, a fairly good position relative to the European situation.
Glenn Schorr - Nomura Securities Co. Ltd.
And this is a hard one, but maybe just trend-wise. For SEC lending, you obviously get a big bump up on the quarter.
Any way to break out what is the seasonal normal course of business component versus some commentary on the underlying trends, new clients leverage reinvestment portfolio?
Joseph Hooley
It is a hard one. I think, probably, the best indicator would be backward-looking sequential quarter to see what the second quarter bump looked like in years past.
I would say that the underlying metrics of the business remained stable, if not slightly improved. You saw the on-loan numbers go up a little bit, spreads move a little bit and pretty stable.
So I'd say stable to slightly up as far as the core business metrics. But from a financial modeling, I think, it's probably -- the best way to do that is to look backward and look at how the second quarter peaks.
Glenn Schorr - Nomura Securities Co. Ltd.
And, Jay, maybe just one last one, a big picture question of -- so you got good new business trends, you have some revenue growth, you're controlling the expenses so you got the positive operating leverage. Put all that together, that's pretty reasonable story.
I've always scratched my head on how much capital you have to run with and what that means for an ROE because decent quarter, and you put up a 10% ROE, maybe -- am I looking at the wrong metrics? How do you think about the business on want qualifies as adequate returns or good returns?
Joseph Hooley
Yes. I'll scratch my head, but I have -- I share your frustration on that.
We're -- we still -- the question is really the equity question, which is: How much capital should a trust bank be required to hold to execute its business model? And I think that quickly gets bound up in Basel, Basel III, SIFI, G-SIFI and the most encouraging point around that is, I think, the issue seems to be clarifying.
I think once we get to the point where we know what capital we'll need to hold, if we're at SIFI if there's a top-off charge, then we'll be able to zero in on what we are managing to as far as a return on equity. So I -- you probably know most of that, I wish I could be more insightful.
Meanwhile, we're modeling different scenarios, recognizing that investors need a reasonable return. And so we're -- part of the effort you see around our expense reductions, not only short-term, but structural expense reductions, are aligned around making sure that once the capital question clears, we can deliver a good return on capital to shareholders.
Glenn Schorr - Nomura Securities Co. Ltd.
Do you have any idea on timing on the SIFI comments? Because I thought we would get something out for comment like soon like in the next week because the rules had to be in place by October, is that right?
Joseph Hooley
Yes. I don't think there's a date certain for the rules to be in place.
I think the sequence has been in a little bit of global local Basel put out. When I interpret the 0% to 2.5% to be a global SIFI top-up, I think the Fed and other governments around the world need to weigh in and interpret that for their set of banks.
My best guess, Glenn, would be end of year, and that's just me guessing based on talking to different regulators.
Operator
Your next question comes from Kenneth Usdin of Jefferies.
Kenneth Usdin - Jefferies & Company, Inc.
So understanding that you did show positive operating leverage in the quarter, but I just wanted to dig into the comp line and your outlook a little bit more. There were definitely some things in the first quarter that didn't recur, and then you mentioned the salary increase in the second quarter.
But I'm wondering, can you clarify how much was the step-up in the restructuring-related costs? And is that, in fact, obviously coming in ahead of the cost saves?
I'm just wondering and even related to the plan, are you spending ahead of the saves? And then how do we expect that to really to layer in over time?
And it seems like expenses were still a little bit higher than many people expected.
Joseph Hooley
Yes, Ken, let me ask Ed to give you a little color on that, break that down.
Edward Resch
Yes. The spending relative to the contract employees that I referred to, Ken, for the of ops in IT transformation work is, sometimes, and this quarter is one of those times, ahead of the saves, okay?
So we will have periods of time, and all of this is included in our comments on what we expect to get out of the program over the years, we will have periods of time where some expenses are increased in order to execute on the program. And to put that in term -- in dollar terms for you, in the first quarter, that was about $15 million for first to second quarter, okay?
So that's a large piece of the ramp-up from Q1 to Q2. So that will happen, and when it happens, we'll obviously talk about it in the periods in which it happens.
Kenneth Usdin - Jefferies & Company, Inc.
So is this going to be even building from here? Can you give us just a little help in terms of -- I think you generally had said that, over the course of the year, it will be net positive, but clearly, it's net negative in the second quarter.
So just -- does it become net positive in the third or in the fourth quarter incrementally?
Edward Resch
Overall, relative to the program for this year, it does, yes, because we're going to have net -- a slightly net savings to the company. As we get into 2012 and beyond, it will be even more so because we'll be generating more savings by the actions that we're taking in excess of any ramp we have in expenses to execute the program, okay?
Kenneth Usdin - Jefferies & Company, Inc.
And my second question just relates also just the comp. Comp to revenue still closer to 41 than to that longer-term goal you have of 40.
I know you never have pinned it necessarily on a point-to-point. But can you just talk us through how you think about comp to revenues?
And again, this $15 million delta is going to be a piece of that. But I guess, what's you're broader expectation on that if we think about a -- should we be thinking about a 40% on a full year basis?
Or is it just trending above again because of these costs?
Edward Resch
Yes, I mean, our thinking long-term, Ken, is that it should be around that 40% level. Again, we may have periods or even a year where it's above.
We've had some years where it's below. But our thinking is that it should be around that level, so this year is no exception to that.
I would think we trend down. We've trended down from the first quarter, which was 41.8% down this quarter to 40.8%, so 100 basis points down on that.
And our thinking really hasn't changed.
Kenneth Usdin - Jefferies & Company, Inc.
Okay. And then my last question, just on expenses.
You mentioned the regulatory-related cost step-ups. Can you dig -- can you just give us a little bit more color in terms of what explicitly are those costs?
And also if there's any litigation-related costs in other, as well, as you think about the lawsuits that are outstanding?
Edward Resch
Yes, nothing incremental relative to litigation. I mean, we have legal expenses that we incur every quarter, but there's nothing outstanding in this quarter versus the first.
I'd say the 2 main drivers of the regulatory costs that we're talking about is, number one, the new FDIC kicked in effective April 1. And that is a modest uptick for us on a quarter-by-quarter basis over the year.
If you remember, we originally thought perhaps it would be even greater than what it turned out to be, but there's still a modest uptick, and that is part of the increase sequential quarter. And then the other piece of it is professional services consulting fees that we've incurred incrementally for Dodd-Frank implementation analysis.
We, like others, have a lot of work going on, trying to figure out what it precisely means for us. We're using consultants to do that.
And then we have some professional services costs associated with the operations and IT transformation program. So FDIC and consulting costs are the 2 main drivers of Other.
Joseph Hooley
Hey, Ken, let me just go backwards for a minute on the selling and benefits, this might be helpful. We, based on your collective questions, we continue to think about how better to portray the IT and ops transformation program.
And we're going to be coming back to you with some thoughts over the next few quarters. But the 1,400 headcount reduction that we announced in December, about 2/3 of those employees have left the organization, 1/3 yet to leave, largely will happen in the second half of this year.
Of the 850 that we announced this morning, 320 of which moved to vendor partners and the other 500 exit the organization. The 320 will probably move over the next 3 to 6 months.
The 520 will largely be laddered in throughout the 2012, concluding in 2013. That just gives you some other sense of how the costs will decline as employees leave the organization.
Operator
Your next question comes from Alex Blostein of Goldman Sachs.
Alexander Blostein - Goldman Sachs Group Inc.
I just want to go back to comp, maybe ask it slightly differently. So if we look at the first quarter number, I think you guys mentioned before there was about $56 million of kind of one-offs seasonal costs in there.
So if you exclude that, you're looking at $918 million or so last quarter. It's still a pretty significant step-up, I think, on a link quarter basis.
So maybe can you just, within that $1 billion, can you just break down how much of that was the merit increase? And then I guess you said $15 million was the extra outsourcing folks.
And then when we think about the next few quarters, is that $15 million going to start dropping off? Or is that going to be sort of the same level?
Edward Resch
I think that, that $15 million will probably be in the range of $10 million to $15 million over the remainder of the year per quarter, and that's an estimate at this point. So there's a certain level of run rate especially earlier on as we're ramping this year for execution on the project.
But to give you the other element of the quarter-to-quarter increase, our merit increases were in the range of $20 million, in fact, for the quarter. So the $20 million plus the $15 million is for the contractors is the increase for the quarter.
Alexander Blostein - Goldman Sachs Group Inc.
Got it. Also it just feels like historically, the quarters you guys had a big securities lending gain like you did this quarter.
Obviously all of that is a very high margin revenue. So I guess just a little bit surprising that more of that did not flow through to the bottom line this quarter.
Edward Resch
Well, again, I think we've talked about a couple of the main drivers of the expense increase, the salaries and benefits line that I just touched on and the other expenses. Those are the main elements on the expense side.
We had transaction processing increase, 7% linked quarter, but that's actually a good thing. That demonstrates volume increases, and that's reflective of increased revenue in the top line.
So that's a net positive to the NIBT. You have to remember too that securities finance at a $137 million for the quarter is, while it's up significantly over the first quarter, that's a relatively modest level of achievement, given what that business has historically performed.
Alexander Blostein - Goldman Sachs Group Inc.
Great. Okay, maybe shifting gears a little bit.
Jay, could you talk about the momentum you guys are seeing in the asset management business. I think you gave out kind of like a net flow number of $10 billion excluding some of the Treasury run-off.
But I was hoping you could maybe break it down by bucket, equity, fixed income, what you guys are seeing on a product level?
Joseph Hooley
Let me see if we can pull that information up. So I would say it's really not distinctive across asset classes, ETFs, fixed income, equities, pretty much contributed evenly to the increase.
I would say maybe one comment would be the re-risking that we began to see in the latter half of '10 and beginning of '11 seems to have subsided. So passive, cash, passives through ETFs seems to be the trend more recently and I guess would be consistent with what feels like a declining confidence in the investors, in the investor world.
And if that helps?
Alexander Blostein - Goldman Sachs Group Inc.
That's helpful. And then just one more for me.
On the buybacks, it sounds like you guys bought back about 5 million shares in the quarter. Can you talk about the timing of that?
Because obviously the average diluted share count did not really tick down, so was it really just all happened in the back, like in the back half of the quarter? And how should we think about the buyback into the second half?
Edward Resch
Yes. We started in mid-May, so your suspicion is correct.
So we'll have obviously the full quarter effect in Q3 of what we bought back in Q2. I would also point out that one of the reasons why average shares may not have gone down as much as you would have thought was because we had to get the effect of the employee-related compensation issuances that we made in the calculation.
Operator
The next question comes from Brian Bedell of ISI.
Brian Bedell - ISI Group Inc.
Maybe if -- going back to the comp issue and then also maybe the restructuring charges, if you can talk a little bit about maybe just sort of quantifying where the $165 million of implementation expenses are hitting on the P&L, Ed. And then, the $110 million to $130 million that you announced this morning, that part of the $400 million, $450 million, is that correct?
Edward Resch
I'm sorry, Brian, I didn't hear the second part of that.
Brian Bedell - ISI Group Inc.
Yes, I'm sorry, I'm going to get off my headset. The $400 million -- the $110 million to $130 million that you announced this morning, that's part of the $400 million to $450 million, correct?
Edward Resch
That's correct.
Brian Bedell - ISI Group Inc.
Right, right. So the $165 million that you talked about in the first half so far in terms of what you spent, so...
Edward Resch
Brian, if I can interject, okay? The $165 million is a life-to-date number, if you will.
$155 million was taken last year, and there's been $10 million taken as restructuring charges in the first half of 2011. So that's $165 million in 2011.
And it's showing as a one-line item.
Brian Bedell - ISI Group Inc.
Okay. So the implementation costs, like you said, on the staff line, about $10 million to $15 million, are we going to run around about $10 million to $15 million a quarter over the next couple of quarters, is that correct?
Edward Resch
Yes. Yes.
Brian Bedell - ISI Group Inc.
Okay. And then you do expect net savings for the full year so just going back to, I guess, the third and the fourth quarter run rates on that, is that mostly fourth quarter loaded?
Or do you think we'll start to see some net savings in the third quarter?
Edward Resch
Probably more towards the end of the year, more back-loaded this year. But I mean again we're talking about what we call -- we've termed and estimate to be modest savings this year overall.
Brian Bedell - ISI Group Inc.
Right, right. So as we move into 2012 though, I mean, that -- I mean, what you think you would see a pretty significant improvement in the comp to revenue ratio, I mean, assuming revenue trends have sort of normalized -- it shouldn't be normalized, but maybe if we have this type of a macro environment even moving into 2012, given that sort of the implementation cost versus the savings, shouldn't we see that comp to revenue ratio improve significantly from the...
Edward Resch
All else equal, Brian, relative to this ops in IT transformation project, yes. A lot of the benefit that we expect to see will manifest itself in the salary and benefit line.
Brian Bedell - ISI Group Inc.
Right, okay. So that $15 million run rate will obviously come way down significantly?
Edward Resch
Yes, I mean, yes, we have some costs that we're incurring that we're calling operating costs. They're included in all of our numbers, and we view them as temporary costs, okay?
We're ramping up. We have some potential overlap during the period of implementation.
And those costs, once the project moves along, will go away.
Brian Bedell - ISI Group Inc.
Right, okay. And the $110 million to $130 million is the second half that fall in the restructuring line, is that correct?
Edward Resch
Yes, that's correct.
Brian Bedell - ISI Group Inc.
Right, okay. Okay, great.
And then just a couple of other things. On the new business conversions, the 280 that you've won and the 150 that's converted in the -- that is to be converted in the second half, I guess, from the F&C deal, has any of that been converted yet?
Or is that all in that 150?
Joseph Hooley
No, that's all in the back-end loaded portion, second half of the year.
Brian Bedell - ISI Group Inc.
Okay. And do you expect to conclude the F&C integration by the end of the year or some of that in 2012?
Joseph Hooley
Yes, I think, substantially, Brian, it should be concluded.
Brian Bedell - ISI Group Inc.
Okay, okay. And then end-of-period share count and the comments on plans for buybacks versus what you got approved for from the Fed, I guess, in the second half.
Joseph Hooley
I think we're in an annual cycle based on the stress test, and so I think the buybacks that the Board has approved, what we plan to execute through the end of this year, and then I think we'll queue up again for a set of stress analysis and capital request as we exit the year and enter 2012. I think that feels like the cycle that we're in with the regulator.
Brian Bedell - ISI Group Inc.
Right, okay. And then just so the end-of-period share count...
Edward Resch
What is it?
Brian Bedell - ISI Group Inc.
Yes, yes, exactly.
Edward Resch
Hold on. 501?
Brian Bedell - ISI Group Inc.
501?
Joseph Hooley
Yes, that's, I think that's what we reported, Brian.
Edward Resch
501.
Operator
Your next question comes from John Stilmar of SunTrust.
John Stilmar - SunTrust Robinson Humphrey, Inc.
Just a quick question for you with regards to momentum of the ability to reprice. You guys just went through a very successful win with CalPERS, and they selected you all, and if you look to the transcripts, obviously, one of the things that was talked about was pricing of that new business.
And it seemed to be much better than sort of the other competitors. The question I have is simply one of the thesis that we've laid out for a long time is that we're increasing pricing to cover for lower activity fees such as FX and SEC lending.
Is that trend still happening? And without getting into specifics because I'm sure you won't with CalPERS, but is the trend at least in terms of -- are such wins because of the low-cost approach to pricing more a reflection of you being -- potentially a service for being an incumbent?
I'm just wondering because it seemed like some of these counterflows of information seemed a little bit different. I was wondering if you could provide a little more clarity on that.
Joseph Hooley
Yes, let me take a shot, John. One, we are thrilled to have CalPERS as an ongoing customer.
They're a wonderful investment manager. They challenge us as evidenced by their resigning.
I'm pretty pleased with what we do and where we're heading. I wouldn't put a lot of credence into a lot of the stuff you read in the press about pricing, competitive deal.
We're pleased with where it came out. I think to your, I guess, to your other question, the environment has changed, the world knows that securities lending isn't driving up the economic benefit that it once was nor is NIR.
So I'd say, in new deals, whether as incumbent or as a bidder, it feels like pricing is getting a little better, at least. The recognition that the traditional components of revenue have shifted.
And so I see at least stability, if not, some slight improvement there. And we're firming up our position in several of these deals to make sure that we have deals that make economic sense.
We've even seen more recently, largely on the back of a customer relationship that had a securities lending dependency, some fee increases. So I would say, I know don't if that's helpful to your question but I would say, if anything, it's feeling a little firmer, getting a little better both sides of the table, understand that the trough created by low interest rates, NIR and securities lending, most notably.
John Stilmar - SunTrust Robinson Humphrey, Inc.
Okay. And then busting on the concept of competition revenues, just a question with across your platform, is volatility in the global markets itself accelerate some of the investment outsourcing opportunities that you had?
Or is it more of we'd like a more accommodating environment where asset prices move up? Which is a better environment for your platform to grow revenues at least given that you provide a lot of -- a broader array of consulting or back office support?
I'm just curious as to which one of those environments is most opportune for revenue growth.
Joseph Hooley
Yes, I think both is the answer. We've got the 10%, 2% market-to-revenue equation, which I think still generally holds up.
So market growth upwards provides the 10%, 2% equation to revenues. The volatility more specifically affects foreign exchange trading, probably most notably less so securities lending, less so the core servicing or Asset Management business.
So I guess, hearing that explanation, we'd rather see asset prices go up over time. The volatility would have a more direct connect to the foreign exchange and some of the other trading-related businesses.
John Stilmar - SunTrust Robinson Humphrey, Inc.
And maybe volatility was a poor choice of words, but does the angst about global growth accelerate investment outsourcing in back office? It sounds that we could start to see if we are in a prolonged period of sort of low asset growth that back office and some of the middle office wins that you've have could start to accelerate, given the pressure on operating margins of the asset managers?
Joseph Hooley
Absolutely. And I would say it cuts several ways.
It cuts against the need to, if you're an asset manager making expenditures for compliance or risk management, it cuts against -- markets, until recently, have performed pretty well. It's pretty uneven, if you look across the asset management landscape, and several folks aren't getting flows or stable if not have downward pressure on their AUMs.
And so they're desperate to find ways to rationalize their cost base. So all those factors have and, I predict, will continue to drive outsourcing activity, and you've seen that over several of the recent quarters.
That's what's driving the pipeline, and that's what's driving a good deal of new business activity.
John Stilmar - SunTrust Robinson Humphrey, Inc.
Okay. And my very last question, and I apologies for beating a dead horse, but going back to salaries and employees' benefits and relative to your revenues, I understand the idea of investing to be able for the cost initiatives.
Is there a point in which when you can look out forward? Or is this the quarter in which we have that comp to revenue zenith?
Is that a kind of a peak? I know you've always kind of targeted the 40% range.
But it sounds like, with your cost initiatives, you're going to be potentially below that. And it seems to me that part of the momentum that you're advocating for us on the expense line item is for the actual dollar cost savings.
So I'm wondering is this a zenith and really how should we start to move forward? Or when can we expect that peak, and what's sort of relative flow?
Joseph Hooley
Yes, let me try that one. I don't know if it's a zenith or a peak, but certainly, as we get through the second half of the year, we would expect the salary and benefit-to-revenue relationship improve.
And that was a smaller increment as we exit the year. And I think that's what Ed is getting at with the first quarter, the second quarter slight improvement.
We'd expect some slight improvement as we get to the end of the year. I think, importantly, the IT and ops transformation plan, roughly we would expect $200 million in savings in '12, '13 and '14.
I think you can expect that, particularly in '12, that gets a little back-end loaded, and that's the result of whether it is implementing or executing the transition of staff to IBM and Wipro today, whether it's the time it takes to exit staff who are associated with that activity. And then it's also embedded in our IT and ops transformation plan and some movement of staff to a lower cost environment.
When you do that, there's a redundancy of costs that you incur for a quarter as you transition staff to, let's say, Poland. You ramp up in Poland, and then it takes a quarter for you to ramp down.
So some of this front-end loading of expense are things like that. So I don't know if that gives you some time sequence of second quarter, end-of-year expectations for '12, '13 and '14 and some of the underpinnings of for that.
Operator
And our final question comes from Mike Mayo CLSA.
Michael Mayo - CLSA Asia-Pacific Markets
So expenses in the second half, are they likely to be up or down, with everything that you said or flat?
Joseph Hooley
My commentary was more on the salary and comp line. Ed, take a look at some numbers here.
Michael Mayo - CLSA Asia-Pacific Markets
I guess what I'm asking is the IT project should be additive this year and so far it looks like it's not additive.
Joseph Hooley
Yes, I think that's fair.
Michael Mayo - CLSA Asia-Pacific Markets
Is your confidence the same or is it a little bit less about it being additive this year?
Joseph Hooley
I have confidence it will be additive this year, slightly.
Michael Mayo - CLSA Asia-Pacific Markets
Okay, which means we should see more significant benefit in the third and fourth quarters to offset the first half front loading of expenses.
Edward Resch
Yes, Mike, I think generally, second half, in the range of flat, maybe up a little bit but flat, flattish.
Michael Mayo - CLSA Asia-Pacific Markets
Okay. And then my question, we've heard a lot about new business wins.
You've had a lot of new business wins. You've talked about them but then we see assets under custody up only 1%.
And I'm wondering if there's something unique add to that number this quarter. Or why isn't it up more?
I mean, you can't have big increases every quarter but you'd thought it might have been up more after hearing your positive comments last quarter?
Joseph Hooley
I think it's largely mix, Mike. The investment operations outsourcing asset, for instance, wouldn't necessarily have custody associated with it, yet it's revenue-driving.
So I don't think there's anything unusual in the quarter. Sometimes the mix drives higher custody growth, sometimes less so.
So I think that will wrap up the second quarter call. We look forward to talking to everybody at the end of the third quarter.
Thanks.
Operator
And ladies and gentlemen, that concludes our conference call for this morning. We appreciate your time.
You may now disconnect.