BlackRock, Inc.
Q1 2012 Earnings Call Transcript

Published: 18 Apr 2012

[Operator:]

Good morning. My name is Christie, and I will be your conference operator today. At this time, I would like to welcome everyone to the BlackRock Incorporated First Quarter 2012 Earnings Teleconference. Our hosts for today's call will be Chairman and Chief Executive Officer, Laurence D. Fink; Chief Financial Officer, Ann Marie Petach; and General Counsel, Matthew Mallow. [Operator Instructions] Thank you. Mr. Mallow, you may begin your conference.

[Matthew J. Mallow:]

Thanks very much. This is Matt Mallow. I am the General Counsel of BlackRock. And before Larry and Ann Marie make their remarks, let me point out that, during the course of this conference call, we may make a number of forward-looking statements. We call your attention to the fact that BlackRock's actual results may differ from these statements. BlackRock has filed with the SEC reports which list some of the factors that may cause our results to differ materially from any forward-looking statements we make today. And finally, BlackRock assumes no duty and you should not expect that we will undertake to update any forward-looking statements. So with that, I'll turn it over to Ann Marie.

[Ann Marie Petach:]

Thanks, Matt. Good morning, everyone. Uncertain markets continue in 2012. Markets began the year strong globally, buoyed by hopes for stability in Europe and positive economic data in the U.S. However, the mood remains fragile, and some of those initial gains have sold off as confidence and mood vary with each new data point. You can see that just in the last 2 days. The initial market improvements and investor activity supported BlackRock's strong first quarter results, with EPS up 7% compared to a year ago and 3% compared to the fourth quarter. Our financial performance highlights our strong focus on our clients' needs and our ability to work with them, supported by the breadth of our product set, our global presence and our unmatched risk tools. These strengths uniquely position us to meet the diverse needs of clients in this complex and ever-evolving market. As seen in our branding campaign, BlackRock is focusing on products and solutions that are especially important to investors in this environment, and this alignment with client needs is supporting our flows and our revenues. Our 5 client focus areas drove our net new revenue for the quarter. We expect them to be substantial contributors to organic revenue growth throughout 2012. At the same time, we saw the outflow of the previously identified $36 billion low-fee fixed income index mandate related to a single client who insourced the asset. The revenues associated with this mandate was about $4 million. Despite starting the year behind on high-water marks, strong performance in the first quarter allowed us to maintain stable performance fees compared to the first quarter of 2011. Our cost base is benefiting from actions we took in 2011 and supporting our margin. Supported by strong cash flow, the board approved the 9% increase in our first quarter dividend and increased our share repurchase authorization back up to 5 million shares. In the first quarter, we repurchased 648,000 shares for about $125 million. The key takeaway for me is that our breadth and diversity have positioned us well for organic growth and the ability to perform well in various market environments. With that, let me quickly walk you through the results. As I make my comments, I'll be referring to the slides in the supplement, which you can get from our website. And as usual, I'm going to be talking primarily about as-adjusted results. I've already talked about the trends, so I'm going to move us right ahead to Slide 3. Our first quarter operating margin was 38.6%. The margin improved sequentially when you adjust for 2 items. First of all, we had seasonally high performance fees in the fourth quarter of 2011. And second of all, the first quarter had seasonally high employment taxes. Sequentially, the margin reflected the benefits of the lower base comp resulting from the restructuring we did last year, though this is partially offset by a sequential increase in marketing associated with our commitment to the brand. Our comp-to-revenue ratio of 36.2% was consistent with the long-term range of 35% when you normalize for the seasonal payroll taxes. Taking a look at markets, as shown on Slide 4. The strong recovery in all global markets benefited every -- all asset classes since the fourth quarter, and you can see that on the right-hand column of the page. I'm focusing on average markets since the majority of our equity piece is priced daily. Then if you look at the second column in, although markets are up compared to the fourth quarter, compared to a year ago, the story is quite different. U.S. markets are up, on average, 3%, but world markets, as seen on MSCI, European markets, emerging markets, Asia markets are still between 4% and 9% below the first quarter 2011. As a result of the diversity of our equity business, about 1/2 of our equity AUM is tied to non-U.S. markets. These mixed market results obviously impacted our revenues compared to a year ago, so it created headwinds for us coming into the year, though new business with clients and other revenue strengths helped to buffer the headwinds associated with these market effects. I'll start with a comparison of results to a year ago then discuss results compared to the prior quarter. On Slide 6, you can see that earnings per share of $3.16 included $3.10 of operating earnings and $0.06 of nonoperating income. EPS benefited from growth in long-dated assets, expense discipline and share repurchases. The first quarter as-adjusted tax rate was 31.5%. This sequentially is a 0.5 point improvement and this reflected the positive effect of state and local tax legislation. And those benefits will continue for us, going forward. Operating earnings of $825 million, which you can see on Slide 7, reflected expense discipline and improvements in long-dated base fees. Our business model benefits from the first revenue sources. We've got a revenue slide laid out for you on Slide 8. First quarter revenues were $2,249,000,000. This includes about $2 billion of base fees, $80 million of performance fees and $123 million of BRS revenues. Flows into most long-dated products helped to drive growth in long-dated base fees. At the same time, low rates and regulatory uncertainty have been a drag on our cash products. As I mentioned before, strong performance in the first quarter allowed us to generate performance fees that were comparable to 2011. And while our performance varies by fund, the gap to high-water marks for some funds was eliminated completely and for other funds was narrowed to a couple of percentage points. We also continued to benefit from strong performance on our traditional products, which generated $28 million of the total performance fees. BlackRock Solutions and advisory revenues of $123 million were relatively stable compared to the first quarter of 2011. An almost 20% increase in our core line revenues was sufficient to offset, first of all, the non-recurrence of a larger segment in the first quarter of 2011 and, secondly, the successful disposition of assets from our advisory portfolios. The $49 billion decrease in advisory assets compared to a year ago was driven by dispositions, which have broadly benefited U.S. taxpayers. The appetite for BRS remains strong both on the lending and the advisory side, something Larry is going to talk more about. Despite the effects of negative world equity markets, first quarter base fees, which you can see on Slide 9, on long-dated assets are up compared to 2011. This is driven by clients putting assets into income, multi-asset and index products and to an improved sec lending environment. Just to note a few highlights. Revenues on multi-asset class products are up 11% compared to a year ago. And to put the growth of iShares revenues into perspective

[Laurence Douglas Fink:]

Good morning, everyone. Thank you, Ann Marie. Before I talk about 2012 and the first quarter and going forward, it probably makes sense for me to reflect on how we guided to 2012 and talk about 2011 a little bit. The volatility we saw in 2011 really froze many, many clients worldwide. Cash buildup is -- grew up throughout 2011. Investing in bonds, short-term bonds, as a means to preserve wealth was a norm for most investors worldwide. And we saw, as an overall portfolio in 2011, pronounced derisking. Although the markets had risk on, risk off, risk on, risk off, I would say the preponderance of invested -- investors worldwide added more cash in short-term bonds over the course of 2011 than they did in some incremental investing in more risk-on products. We certainly also saw in 2011 more barbelling strategies; going into beta products, index and ETFs; and going into alternatives. And it was the uncertainty of -- from the U.S. in terms of our management of our deficits and our fiscal discipline and which was essentially the lows from the latter part of the second quarter going into the third quarter. And then we had the European crisis really coming to a real crisis in the third and fourth quarter last year. We began to see stability in the world as the U.S. economy started showing some rays of hope that there was stability. But more importantly, the actions from the ECB with their long-term financing vehicle, LTRO, that provided the necessary liquidity to stabilize Europe. And from that, we then began to see clients starting to focus on how derisked they were. And then going into 2012, we certainly saw large-scale clients moving from cash positions into longer-dated bonds, into credit type of products, into dividend-like equity products, all the types of themes that we are focused on in our campaign. And so overall, we saw some re-risking into the market. However, if you think about the internal generation of cash, I would still say the fears of the investor still is more overwhelming than the hope for a better future. So we -- despite the rally in global equities from its lows, I would still qualify the market to be quite fragile. Attitudes are basically on the borderline of pessimism than optimism. And also, we are seeing this in -- from our perspective, with CEO behavior. We're still seeing most companies being very risk-adverse. I think we're going to see in the first quarter above-forecast earnings. Essentially, the reason for that is everybody is for -- is overlaying a overall view of pessimism, not optimism. And we are actually seeing performance better than that pessimistic view, and therefore, we're seeing in terms of corporate earnings, more exceeds than misses. But as we enter the second quarter, I still believe there's a great deal of uncertainty ahead of us. It is very hard for investors and CEOs and politicians to decipher between the good news and the bad news. It's very difficult for investors to have truly a long-term view. And so this growth in investing in bonds continues, cash buildup continues mostly through bank deposits, less than money market funds, as an industry. And so I don't believe that the future is much different than it has been, but it is remarkable to think about how strong equity markets were in the first quarter, with just some incremental investing in equities. This is why, as I said October last year, as I said February this year, I still believe in equities more than ever before because we witnessed, with just some small investing, a pretty substantial rally in the equity markets. And that just is a great sign of how derisked people are. And as you look back in the first quarter, we saw large-scale repurchase of stocks from corporations, a very modest calendar of IPOs. And so as we enter the second quarter, the outstanding of equities in the world is less today than it was in January 1. And so it is -- so we're seeing CEO behavior purchasing shares back, raising dividends, all fundamentally strong foundations for a better equity market. But let us be clear

[Operator:]

[Operator Instructions] Your first question comes from the line of Glenn Schorr of Nomura.

[Glenn Schorr:]

I guess the first question I have is -- Larry just mentioned the $3 billion or plus of free cash flow. The 72% payout was bigger than where you had been running the last, call it, 2 years. And just curious on if that's a high level of payout that we should expect or if 50 is your best guesstimate going forward, as you'd indicated in the past.

[Laurence Douglas Fink:]

No. Well, no. What -- the 70-odd percent is a combination of stock repurchases and dividend. Our payout ratio of dividend is going to be between 40% and 50%. I don't want it ever to be higher. But last year, I think we paid out 120-something percent. I don't want to -- yes, it's in terms of -- so I expect it to -- I think, to be very frank, we expect to use our free cash flow opportunistically up to the board approval in terms of utilizing that free cash flow to do whatever is necessary to support a robust stock.

[Glenn Schorr:]

Fair enough. On the trading system, just curious on the basic principles of it. Is it a similar crossing network that you see in some of the equity markets where trades get done when there are same security, same price at the same time, trades crossing at the same time? And can you pre-load pre-existing trades and underneath the covers, so to speak, and wait for them to be hit? Just curious on how it's going to actually work.

[Laurence Douglas Fink:]

I believe that is the design. That is the design of the platform. Right now, it is obviously crossing and all that as we get more and more players on it. There is going to be some transparency where the underlying desires of sellers and buyers will be.

[Glenn Schorr:]

Got it. One other question on -- the new product pipeline has been good, and you've been able to consistently launch new funds. I think you launched 4 new fixed income ETFs in April. So I guess the question is -- there's been some attention in the press to credit ETFs in terms of providing -- of promoting volatility in the markets. I'm just curious if it's gotten any regulator attention and how you feel about that because it's obviously a big growth business.

[Laurence Douglas Fink:]

There's certainly regulatories -- reviews on all things related to ETFs at the moment. Much of it in the Europe has to do with router-based [ph] ETFs. There is obviously reviews by the FCC in the freeze in terms of leverage ETFs. They're not allowing new ETFs with any leverage to be created until they have a full review. Specifically in terms of credit ETFs, I'm not aware of any inquiry from any specific regulator. Matt?

[Matthew J. Mallow:]

No, I'm not aware of any, either.

[Laurence Douglas Fink:]

So look, I believe there is greater and greater demand for credit. Whether you see that in separate accounts with -- or you see it in -- or you see that in ETFs, ETFs just gives you more transparency and clarity where the market's going. But I don't think ETFs are adding any more volatility than when you see large-scale demand in any one product, whether it is a -- in physical-based securities separate account or through a publicly traded vehicle like an ETF. I cannot understand why somebody would say the ETF creates more volatility than demand than any other physical-based separate account. So I don't understand that noise, if there is such noise, and I'll just leave it at that.

[Glenn Schorr:]

Okay. And here's a last one, it's just on margin. There's always a bunch of moving parts, and obviously, the first quarter has the performance fee give back. But given higher asset levels and what's clear, expense control, even in the face of the marketing campaign. Any reason to think that margins won't be in and around that 39% level that you've been in for a long time?

[Laurence Douglas Fink:]

I see no reason why, over the course of the year, margins will be consistent as they were last year. 39% is a good benchmark, 39.5%. Whatever that comes in, it should be a good benchmark. I just want to overlay the issue around regulatory issues, I was trying to be very specific on that. Regulation costs a lot of money. And so I don't want to -- I'm not here to tell you we're lowering our margin expectations, so I'm not saying that, but I am saying that we are spending a great deal of time on making sure we're compliant. And I don't believe this could be a onetime cost that's going to be very large. Once we get it routinized onto the system, it will certainly -- certainly, once we get it on the system, costs will be less. But it really depends on how we are going to be regulated and how many more people do we need to interface with regulators as regulation of asset managers increases across the board. But at this moment, I am not saying it's going to have any major impact on margins.

[Operator:]

Your next question comes from the line of Craig Siegenthaler of Crédit Suisse.

[Craig Siegenthaler:]

Larry, if we look at the core institutional pipeline, the sequential change there, I'm wondering if you can just comment on kind of what drove the decline there if we back out the $36 billion mandate. And also, are you seeing a mix shift in your institutional clients into ETFs out of passive mandates?

[Laurence Douglas Fink:]

There's no question. You're seeing, for those institutions who are adding beta for tactical purposes they're doing -- a lot of institutions are using ETFs. A couple of sovereign wealth funds who historically used index funds are now using ETFs. And so yes, there is a change in mix, but it's not entirely. And our pipeline, I don't think it's sequentially that much lower, what, $24 billion. But we -- keep in mind, we are not forecasting ETFs, as you suggested, or retail in those flows and -- but there are -- you're seeing behavior change with some institutions going in using ETFs because they value liquidity more than the cost of the -- than the asset management fee. Obviously, for those clients who believe that they're going to be sitting with a beta exposure over a period of time, they will go into index funds with lower fees. But to get that liquidity, we are seeing, as I said, like, some sovereign wealth funds are using ETFs more extensively.

[Craig Siegenthaler:]

And then on sec lending fees, the second quarter is always your seasonally strong quarter for these fees. So if we think about the changes in rates over the last year and really kind of what hedge fund activity is doing, which it seems to be another driver, how should we think about the step-up in sec lending fees, which flows through management fees in the second quarter?

[Laurence Douglas Fink:]

Well, we had obviously a very good first quarter on this. We are seeing more hedged fund shorting stocks, looking for shares. So utilization was up in the first quarter, we -- and we still see utilization strong in the second quarter. And quite frankly, in a very short end of the curve, there's a yield curve. It's only a few basis points, but there is a yield curve at the very shortest period, a point of the -- and so a combination of utilization rates and then some yield curve. And the very shortest point of the yield curve has allowed sec lending fees to grow. Ann Marie, do you have any comments related to the first or second quarter?

[Ann Marie Petach:]

I think that's good. We see both the seasonal effect and then some of those hopefully more secular trends both helping those revenues.

[Operator:]

Your next question comes from the line of Marc Irizarry of Goldman Sachs.

[Marc S. Irizarry:]

Maybe you guys can talk about just the insourcing this quarter. When you look across your AUM, is there some more of that low-fee index-oriented mandates that might be at risk as you look forward?

[Laurence Douglas Fink:]

No, we don't know of any.

[Marc S. Irizarry:]

And then on -- Larry, on the world of fixed income in terms of the barbelling between alpha and beta strategies, if you will, can you just talk a little bit about what's happening in core and core plus and just how important credit is becoming in institutional allocations?

[Laurence Douglas Fink:]

Well, you're -- it's very hard for extension pension liabilities to meet their liability needs with -- without having some type of income in credit strategies. But they're not going to -- they're certainly not going to do it in duration anymore with even long end being just so low in yields. So we are seeing across the board a very strong interest in credit types of strategies. We're seeing increased interest in hedge fund-like strategies in fixed income and in credit. But your -- core strategies with the treasury market being so dominant in core strategies, you're seeing more core plus interest and more credit-oriented strategies across the board, more strategies that are global in nature, emerging markets in nature. So you're seeing institutions really reflect on how they are going to maneuver out of core strategies over the course of the next 2 years. Now obviously, for those who have the luxury of having their assets and liabilities pretty matched, owning bonds is a very sensible thing to do. And that -- and so I'm not trying to suggest across the board owning fixed income or owning in treasuries is not a thing to do. Unfortunately, so many of our pension funds are sitting with very large underfunded liabilities, and they're all addressing it. And this is another reason why we're seeing more interest in dividend-related strategies, too. So it's not -- we're looking for other strategies that can produce income and, obviously, try to reduce as much beta exposure as you can. But I think, Marc, we're going to be living with this for a couple of years, in this low-rate environment. And unfortunately, this low-rate environment is a real tax on savers, on pension funds. And it's a real question, can these organizations tolerate for a couple more years? And to sit in bonds and core strategies for the next few years, is that the sensible thing to do? Obviously, your -- if you're incredibly risk-adverse, that might be the sensible thing to do, but it comes at a cost. And we are trying to identify to our clients, at -- what type of cost this is going to have on these organizations. As we heard earlier this -- in the first quarter, the average pension fund had greater mismatches as a result of market performance last year, as we saw lower rates, also their liabilities went up and their -- the value of their assets went down. So it's not a pretty picture.

[Operator:]

Your next question comes from the line of Cynthia Mayer of Bank of America Merrill Lynch.

[Cynthia Mayer:]

I apologize if you’ve mentioned this, but are you guys still targeting a comp-to-revenues ratio around 34.5% or 35%?

[Ann Marie Petach:]

Yes, we're still in that 35% range. It's a little higher in the first quarter because you get your annual bonus payment-related payroll taxes all hitting you there. So it's always a little higher in the first quarter.

[Cynthia Mayer:]

Got it, okay. And then on the move to the physically backed ETFs overseas, do you feel as though that still has room to go, that you could still gain more share there? Or has that pretty much run its course at this point?

[Laurence Douglas Fink:]

I'm not sure we’re going to gain more share, but I don't think it's run its course. I think more and more people are looking at physical-based ETFs there. There is -- and we even saw one of our -- one of the derivative-based ETF players translate its business into physical base. And so I don't think it's run its course because I do believe most buyers are going to be looking for physical-based products. And I think that awareness has been getting more apparent. Obviously, we have 55% market share in Europe and so the last thing I'm going to do is forecast a higher market share.

[Operator:]

Your next question comes from the line of Matt Kelly of Morgan Stanley.

[Matthew Kelley:]

So Larry, you'd mentioned that the discussions you were having with clients on alternative products has never been stronger. I think you said a kind of similar commentary to prior quarter and showing up in your flows a little bit more this quarter. So just wondering if you could segment your client base a little bit for the alternative interest. So which institutional clients are most interested, least interested? And how are they thinking about barbelling?

[Laurence Douglas Fink:]

It's -- I don't -- we are winning guys with the retail platforms in -- within your organization. We have a couple of alternative strategies through the Morgan Stanley Smith Barney platform. But institutionally, really it's across the board where we're having dialogue. I would say, our penetration with foundation endowments is growing. We're seeing more participation there. We are seeing more asset opportunities with pension plans, especially in Europe. EMEA has been a very strong growth area. Hopefully, we're going to be closing one of our private equity types of strategies, a lot of participation in that in Europe. And so it is growing worldwide, our penetration is particularly strong with smaller institutions. And -- but there's not one area or one type of client that I could suggest to you that is looking to add alternatives with BlackRock. But it's -- I can say, geographically, Europe has been a particularly large area of growth for us.

[Matthew Kelley:]

So one follow-up from me. Just curious to get your thoughts on what we need for retail investors to truly reengage in equity mutual funds. I know you said that the markets are still skittish, and I'm sure you feel like -- the clients feel like they've been burned a couple of times in the market. So what do you think we really need?

[Laurence Douglas Fink:]

Oh my gosh. Look, I think we -- it's all a confidence game. It's a confidence game from our politicians, we need leadership. It's a confidence game with our CEOs, we need leadership. It's confidence from the FAs to give people more confidence. In the United States, I think, as we see a stabilization in housing, which we expect to see next year, that will be a foundation for growing confidence. But the issues of trying to navigate this European situation, I think it's frightening for a lot of people just don't understand. As we are trying to show in our branding initiative that there is a huge cost of doing nothing, and we have to educate more and more people, by doing nothing and market timing, that is not a good answer. And we need to really engage everybody in talking about what type of -- in terms of individuals, what type of pool money do you need upon retirement? And how are you going to achieve that, earning very little sustaining cash? And the question is, does -- the noise of today, does that have any impact on a 30-year objective? And unfortunately, as we watch financial news on television and listening to it on the radio and reading it in print, through blogs, it's all about minutia and day-to-day strategies. And so it actually accelerates the short term-ism, but as advisors, we have to focus on focusing what the -- what your needs are, and that's what we're trying to do not with just retail -- with mutual fund buyers but we're trying to do that institutionally worldwide. And it's very important for us to do that.

[Operator:]

Your next question comes from the line of Michael Carrier of Deutsche Bank.

[Michael Carrier:]

Ann Marie, just on the expenses, so G&A, a bit lower. You mentioned the marketing. I think you said, this quarter it's around $15 million. And I just want to make sure we had that right. So if we run rate that, would it be another $30 million for the second quarter? And then, I guess, on the flip side, when I look at the comp, any way to size up the payroll tax impact? Because that will obviously moderate and provide some offset there.

[Ann Marie Petach:]

Yes. I can take those all offline, but the payroll was broadly about 27 and the marketing is directionally correct. I'll talk to you more.

[Michael Carrier:]

Okay. And then, Larry, if you look at recent, like, trends in the institutional part of the business and you compare that to, say, like, the past 10 years, like, what is the level of activity, meaning engagement, making decisions? Because it seems like the flows are improving but it still seems like, industry-wide, there's still a lot of uncertainty. And then just one follow-up on that trading platform. Just, if we do go the route where Volcker is more draconian, then in a good scenario for you guys and your clients, what do you guys anticipate being, like, the max of your ability to internalize, like, meaning the percentage of the volume?

[Laurence Douglas Fink:]

To answer your first part of the question related to the activity of dialogue. Dialogue has never been stronger, but it takes a lot more time to try to get clients to move. So their behavior is more of -- one of reluctance, of fear, trepidation. But the dialogue is probably more unique than ever before. But more importantly, the dialogue is different. 10 years ago, dialogue was on a core strategy

[Operator:]

Your next question comes from the line of Bill Katz of Citigroup.

[Neil Stratton:]

This is actually Neil, filling in. Larry, I was wondering if you could give us your thoughts today on money market reform and the likely outcomes.

[Laurence Douglas Fink:]

We believe money market reform should be a fire way [ph]. We believe the industry has been reluctant to change. We need to be working with the SEC on money market reform. I've had dialogues with some of our fellow asset managers to work together on money market reform, working with the SEC. It is our position that if we do not work together with the SEC on money market reform, the FSOC committee will make it for us. And so we have been much more aggressive on addressing money market reform. We believe it's necessary for this industry to begin growing again. As we witness, the industry is shrinking every quarter. We have been isolated, though, with that opinion. We have been remarkably one of the only firms to aggressively believe that we need money market reform, working with the SEC to a sensible industry- and client-oriented solution. And so -- but I must say, in recent weeks, we have, through our dialogue, offline dialogues, with other firms, I believe there's a good opportunity in front of us to work with the SEC for money market reform. Hence, we avoid the FSOC telling us what money market reform will do to us. That's it? Good. Thanks, everyone. Thanks for a good quarter, everyone at the firm. I look forward to talking to you at the next quarter. Talk to you later.

[Operator:]

This concludes today's teleconference. You may now disconnect.