Northern Trust Corporation
Q3 2007 Earnings Call Transcript

Published: 17 Oct 2007

[Operator:]

Good day everyone, and welcome to the Northern TrustCorporation's Third Quarter 2007 Earnings Conference Call. Today's call isbeing recorded. At this time, I would like to turn the call over to theDirector of Investor Relations, Bev Fleming for opening remarks andintroductions. Please go ahead, Bev.

[Bev Fleming:]

Thank you, Cynthia. Welcome to Northern Trust Corporation'sthird quarter 2007 earnings conference call. Whether you are participating intoday's conference call live or via replay, we sincerely appreciate you takingthe time to listen to Northern Trust's third quarter 2007 financial results. Joining me this morning are Steve Fradkin, our ChiefFinancial Officer, Aileen Blake, Controller, and Preeti Sullivan from ourInvestor Relations team. In addition, we are joined this morning by BillOsborn, Chairman and Chief Executive Officer, who will provide some openingremarks. For those of you who have not received our third quarterearnings press release or our financial trend report by e-mail this morning,they are both available on our website at northerntrust.com. In addition, thisOctober 17 call is being webcast live on northerntrust.com. The only authorizedrebroadcast of this call is the replay that will be available through October24. Northern Trust disclaims any continuing accuracy of the informationprovided in this call after today. Now for our Safe Harbor Statement. What wesay during today's conference call may include forward-looking statements whichare Northern Trust's current estimates or expectations of future events orfuture results. Actual results, of course, could differ materially from thoseindicated by these statements because the realization of those results issubject to many risks and uncertainties. I urge you to read our 2006 FinancialAnnual Report, and our periodic reports to the SEC for detailed informationabout factors that could affect actual results. Again, thank you for your time today. Let me now turn thecall over to Chairman and Chief Executive Officer, Bill Osborn. Bill?

[Bill Osborn:]

Thank you, Bev. First of all, I want to thank all of you forlistening to me and working with me over the last 12 plus years. I am in anoutside board meeting this morning and therefore I am going to make somecomments, and then I will be available this afternoon back at the bank, ifanyone wants to call me and ask me specific questions. But, let me first of allcomment on the fact that yesterday at our board meeting, the Board of Directorsapproved a succession plan where I will step down at the end of the year asChief Executive Officer, and Rick Waddell will assume the CEO role effectiveJanuary 1 of 2008. And I will remain Chairman of the Board, and I have not putdown and nor has the Board decided on any specific retirement date for me asChairman. My intention is to continue to work with the company and to befocused very much on client relationships, strategic issues that we are goingto continue to deal with, and doing whatever I can to help Rick and the rest ofthe management group. I've worked on this transition plan for well over 2 years,actually I started probably twelve and half years ago, but it's really beenaccelerating over the last couple years. And it's really driven at this time bythe fact that I think the company is in absolutely terrific shape. We havegreat momentum as you saw in our third quarter earnings and all of our businessyear-to-date. Our global franchise continues to expand. Our personal business,our high-net-worth business has been doing terrifically well, and I see it hasa lot of momentum. And we’ve got a great management group. This is really theissue, Rick is ready to go, he's chopping at the bit to take over, and aftertwelve and a half years, it’s time for me to get out of the way and let a grouptake over, that I know that will just drive us to greater heights. I willcontinue to be around to help out wherever I can, and I’m very, very confidentin the future of our organization. I know that Rick, and Steve, and the whole group willcontinue to have the very open dialogue that I've maintained with all of you,and I appreciate all, that you all have done to support me in the Northern.This is a very special organization, and I know that you'll continue to havethe same relationship with Rick as you have had with me, going forward. Now, I’m going to just turn this over to Steve, but I justwant to tell you again, if anyone has any specific questions, they can call me.I also want to mention, I know there is a lot of, there will be speculation. Iam in perfectly good health, the company is in great shape, and this isliterally a personal decision based on the fact that we have a great groupthat’s ready to go forward. And again, thanks very much, and I’m going to signoff now. Bye-bye.

[Steve Fradkin:]

Thank you, Bill, and good morning, everyone. Let me extendmy welcome to all of you listening Northern Trust Corporation's third quarter2007 earnings conference call. Now, before I provide you with an overview ofour third quarter performance, let me offer just a few comments on themanagement changes announced yesterday, and just discussed with you by Bill. I hope that all of you will join me in congratulating Rick Waddell,our new Chief Executive Officer, effective January 1, 2008. As many of you know, Rick is a32 year veteran of Northern Trust with a very diversified experienced set,expanding our banking, private client, strategic planning, wealth management,institutional, and more recently, investment businesses. Rick has worked for Northern Trust, both in a headquarterscontext and from outside Chicago.And we are delighted to have someone with his breadth of experience andknowledge of Northern Trust, serving as our next CEO. I would also like to take a moment to offer a few commentson behalf of the management team, with respect to Bill Osborn's decision tostep down as CEO, while remaining Chairman of the Board, again all effectiveJanuary 1. Bill has been a true leader and steward of Northern TrustCorporation, not only during his twelve years as Chief Executive Officer, butalso across his entire 37 year career. At a time when the conventional wisdomsaid, that size and consolidation were the watchwords for banks, and that onlythe big would survive, Bill executed large scale M&A transaction and filedahead with industry leading growth rates on an organic basis. When people said that he led a small mid-westerninstitution, Bill defied them by building a premium national wealth managementfranchise in the United States, that now serves approximately 20% ofthe Forbes 400 Wealthiest America. When critics said that he ran a greatcompany, but that the organization would never be able to compete globally, heled the company in a transformation that took it from earning approximately 7%of its net income from international activities in 1992 to approximately 35% in2006. The vast majority of which again, was done organically. When some said that he was too conservative with the balancesheet, and should take more risk, he ignored their admonitions and avoided thepitfalls of one-time items and restatements that others experienced. And when people told him that it was either corporateperformance or philanthropy, but that the two could not coexist, he ignoredthem yet again and consistently led the Company in making still in profitcontributions equal to approximately 1.5% of pretax profits per year, inaddition to the countless hours of his own time and energy, that he spends oncivic issues, all while the Company still performed at the highest levelsrelative to others in it's peer group. On behalf of all of his colleagues and friends here in Chicago, across thecountry and around the world, I want to thank Bill for his incredible and indeliblecontributions to Northern Trust. We look forward to his continuing work as CEOfor the remainder of 2007 and his counsel as Chairman of the Board of Directorsthereafter. With that, let's move into a discussion of our third quarterperformance. Earlier this morning Northern Trust reported very strong thirdquarter 2007 earnings of $0.93 per share, an increase of 26% compared to the$0.74 that we reported in the third quarter of 2006. Net income equaled the quarterly record of $208 millionrepresenting an increase of 27% year-over-year. This was our eleventhconsecutive quarter of double-digit, year-over-year growth in earnings pershare, and our tenth consecutive quarter of double-digit year-over-year growthin net income. Accumulation of client assets under custody and assets undermanagement was robust. Assets under custody equaled a record $4.1 trillion onSeptember 30, representing an increase of 24% compared with one year ago. Assets that we manage on behalf of our clients experiencedstrong growth as well, equaling $761 billion at September 30th, up 14% comparedwith the year ago. Now we have organized our earnings call today into threesections

[Operator:]

Thank you, sir. (Operator Instructions). We will take ourfirst question from Mike Mayo with Deutsche Bank. Please go ahead.

[Mike Mayo:]

Good afternoon.

[Steve Fradkin:]

Hi Mike.

[Mike Mayo:]

Just some questions on the one-timers, you mentioned rightoff at that, the tax benefit and the sale of the CME shares, it seems like thecouple of other items. Outside services, it was up $6 million, should weconsider that core or was that temporary?

[Steve Fradkin:]

You're with me, Mike.

[Mike Mayo:]

I am really just trying to see if there's any unusually highexpenses that might go away?

[Steve Fradkin:]

No, I think, Mike, obviously, the CME is one-time, the taxrate was one-time, but there was nothing dramatic that comes to my mind thatwould be additive to that.

[Bev Fleming:]

And Mike, when we do have items that we know that you allwould consider as one-time, we do try to disclose that in that upfront sectionof our call. So, had we had any other items that we felt, you should be awareof, we would have mentioned them during the call.

[Mike Mayo:]

Okay. Andother income being down $6 million from the second quarter?

[Bev Fleming:]

Well, we gave some of the detail, Mike there, during theprepared remarks. We did so Mike.

[Steve Fradkin:]

I don't think there is anything to add.

[Mike Mayo:]

And you spent a lot of time on securities lending, if wewere thinking about normalizing that, how might we go about that?

[Steve Fradkin:]

Well, I think Mike, as I said on securities lending, youreally have to understand this constructive and mark-to-market fund versus aconstant dollar NAV and there are a variety of guidelines that drive theappropriateness of when one would have one structure versus another, but I wantto emphasize understanding that vehicle structure really is critical becausethe mark-to-market fund is fully transparent. And if you had the same holdingsin a custom account, a non-mark-to-market fund, we would have reporteddramatically, different results. So, for example, our holding in the mark-to-market fund, ifyou had the exact same holding, exact same profile, and put those in a customaccount, our securities lending results would have increased by approximately70%, compared to what we reported, which was a 19% year-over-year decline. So, Imean it’s a very dramatic point that needs to be understood.

[Bev Fleming:]

The other point that I would make, Mike, is, it’s difficult,I think for any of us to “normalize” the securities lending. Keep in mind that,typically the third quarter would have seen a decrease from the second quarter,which is typically the seasonal peak, and of course, as you saw it, some ofpeers, that didn’t happen, because it affected the market environment was sotumultuous in the third quarter. So, it’s difficult to normalize when you arecoming off of such a tumultuous period.

[Steve Fradkin:]

The other thing I will add, Mike, to that, because I’m sure,you or someone else would have the question is, when you think about the timingof the recruitment of that yield, that is going to be very difficult topredict. And it’s impossible for me to predict exactly how quickly that’s goingto happen because you need the credit markets to stabilize, but I guess what Iwould say, without giving forward-looking guidance which we don’t give, is thatwith all those caveats noted, and assuming that there is no change inimpairments or anything like that, we would estimate that the yield on themark-to-market fund would reflect positive marks as we progress from nowthrough 2008. So, sometime over the next 18 months, the headwind that we got onmark-to-markets this quarter will be recouped as we move into 2008.

[Mike Mayo:]

So, we do not long to wait to see that?

[Steve Fradkin:]

No. Again, I cannot predict with pinpoint accuracy, butthat’s our best guess at this point in time.

[Mike Mayo:]

And then, just one separate question on the processingbusiness, good revenue growth, but the revenue growth is almost twice as fastas the growth in assets under custody linked quarter. Just wondered, if you hadany color on that, and you are operating in a consolidating world. Are youseeing any benefits from that and also the international growth withinprocessing?

[Steve Fradkin:]

That’s about half hour question. But, what I would say Mikeis, look, we feel terrific about our asset servicing business and the growthrates there, and have no apology for the success that we have had in keepingand aggregating new clients on that front. Pipelines remain strong,international growth as in past quarter has been strong. As to the asset management business, we feel very good aboutthe growth this quarter on the assets under management front. You are correctin noting that the rate of growth, if you want to compare that to our assets undercustody differs, but remember, you have a vastly different asset allocationparadigm for our managed assets. So, I think it' being a relatively smallequity asset manager, I think it’s a mistake to impute market growth to ourassets under management growth. But we feel good about the growth this quarter.

[Mike Mayo:]

And international?

[Steve Fradkin:]

International continues to be terrific, global custodyassets up 31% year-over-year, pipelines are strong, had a great win with Stateof Tennessee, which was a $29 billion public fund and tempo is consistent withpast quarters.

[Mike Mayo:]

And pipelines are strong. Do you ever quantify that as someof your competitors do?

[Steve Fradkin:]

No, we don't give any metrics on number of clients in thepipeline or profits in the pipeline or dollar value. But we continue to feelvery good and as you said the market is consolidating, there is a small groupof players there. So, there is I think plenty of opportunities for all of us.

[Mike Mayo:]

Alright. Thank you.

[Steve Fradkin:]

You're welcome.

[Operator:]

We will take our next question from Mark Fitzgibbon withSandler O'Neill. Please go ahead.

[Mark Fitzgibbon:]

Thank you for taking my question. First let me echo mycongratulations to Bill and Rick on their new roles. Steve, I wanted to firstjust ask the securities lending question in different way. How much would youestimate that one mark-to-market fund affected the securities lending line inthis quarter?

[Steve Fradkin:]

Well, again Mark if you think about it, we reported resultsthat were down 19% year-over-year. If you impute and this is rough math, but ifyou take the exact same holdings as resided in that fund and their status andyou put them in a custom account, which is not mark-to-market, that resultwould have swung us from being down 19% to up 70%. So the transparency of amark-to-market fund had a dramatic affect on reported result. And again, Ithink the key point here is absence impaired holdings or a change in what weknow, is that that should be a tail win for us, again difficult to predictexactly when it will hit, but it should strengthen our securities lendingresults over the next 15 months or so.

[Mark Fitzgibbon:]

Okay. Andthen the second question, I had relates to assets under management which weredown, I think about $5 billion or 1% linked quarter, was that a function ofperformance within the products or was it a function of fund flows or fundoutflows actually?

[Steve Fradkin:]

Sorry. The assets under management was really just afunction of the securities lending collateral and the de-leveraging that wesaw. So, it wasn't really what you might think of this traditional core assetmanagement.

[Mark Fitzgibbon:]

Okay.

[Bev Fleming:]

Mark, if you take securities lending out of the total assetsunder management, the sequential growth goes from a decline as you mentioned of5% to actually an increase of 2.4%. And I am sure that the Equity 500 was up a littleless than 2%, and we are not exclusively equity managers. So, I think actuallywe feel quite good about that, when you take into account the de-leveragingphenomenon in securities lending.

[Mark Fitzgibbon:]

Okay. Andthen, also I noticed your non-U.S. loans have risen fairly rapidly, and arejust approaching $2 billion now. Could you give us a sense for the kind ofloans that you are making outside the U.S?

[Steve Fradkin:]

A lot of that Mark, relates to the fund administration businessthat we acquired several years ago from FSG. These are liquidity lines. Theseare not traditional, if you will corporate loans. These are all attendant tothe business we undertake with fund managers. So, it's a very, very cleanportfolio and one that we are very comfortable with.

[Mark Fitzgibbon:]

And the last question is, I wondered if you can give us asense for what the pipeline looks like in the C&IS business, is itincreasing, decreasing, stable and maybe where is that coming from?

[Steve Fradkin:]

I think the pipeline is terrific. And we have attempts toimply a level of precision on increasing, decreasing, relative to last quarter.But I'd say, it's very strong, we've got a lot of great activities. Greatopportunities, they are all around the globe. They cross a wide array ofsegments. And I think that's one of the things you got to think about. You gotto think about the whole world, opportunities in virtually every country. Yougot to thing about the wide array of segments from insurance companies, tofoundations, to endowments, to fund managers, to pension funds, a whole host ofopportunities. And then you have to think in terms of the relatively smallnumber of firms globally that are equipped to serve those opportunities. And Ithink, when you look at it in that construct you can understand just how bigthe opportunities are, I think for all of us.

[Bev Fleming:]

And Mark if I could add one point on your question about ournon-U.S loan portfolio, when we issue our 10-Q in a few weeks, we include atable on loans and one of the things that you'll see in the table and you wouldhave seen in the past is that, included in that non-U.S line item in additionto what you would consider to be traditional lending as Steve described, wouldbe short-term advances associated with processing of Custody assets. So, andthat you will see when we issue our 10-Q that that line item, short durationadvances actually was a significant driver of the growth in non-U.S loans.

[Steve Fradkin:]

So, there is a traditional overdraft phenomenon associatedwith being custodians to these funds.

[Mark Fitzgibbon:]

Thank you.

[Steve Fradkin:]

Welcome.

[Operator:]

We will take our next question from Jason Goldberg withLehman Brothers. Please go ahead.

[Jason Goldberg:]

Thank you. You mentioned security process related charges,it standardizes [quite to], that you guys are not doing something on timelybasis and can you quantify that?

[Steve Fradkin:]

Sure. Jason, we have as you know, we process trillions andbillions and at any given point. Though there is a lot of automation and a lotof high quality, there will be losses associated with mis-processing,mis-input, not timely handling a corporate action or what not, and so, we did havea modest degree of that this quarter. It's a normal part of the business, youcan't get away from it but, and we'll go and system starts. So, that is anaspect that we had to deal with this quarter, but I don't look at it as a majorfactor in anyways signaling a trend.

[Jason Goldberg:]

Okay. You don't care to quantify it?

[Steve Fradkin:]

No, we're not quantifying it.

[Jason Goldberg:]

And then you mentioned the Wealth Management, that'sthroughout this quarter it sounded like?

[Steve Fradkin:]

Sorry. Say that again Jason.

[Jason Goldberg:]

You mentioned an adjustment in the Wealth Management line orit sounds like may be it was a throughout or something you can expand on?

[Steve Fradkin:]

It was just a prior period adjustment to what we have, theinstance that comes to mind, we had a client come-in very late in the secondquarter and we misquoted them in terms of assets under management versus assetsunder custody, we caught it after we had released results. So, it's just aprior period adjustment to what we had said last quarter. I think the key pointJason is, you wouldn't want to look at the reported downdraft sequentially asindicative with the trend because it's just an adjustment.

[Jason Goldberg:]

Got you. And then, I guess any thoughts on eliminating themark-to-market funds from your sec lending offerings?

[Steve Fradkin:]

This is a client-driven decision, if clients want to be in apooled vehicle with this kind of profile, it really has to be a mark-to-marketfund. So there is not a lot of discretion. To the extent that if you want to bein a fund with this characteristic, you couldn't make this account, if youcouldn't appropriately make this accounts to dollar NAV. The question would be,do clients want separate accounts, rather than participating in a pooledvehicle? And obviously if they do want that, we would be happy to accommodatethem. But again, I think you would want to look closely, if this is a timingphenomenon.

[Jason Goldberg:]

Got you. And then, also, if I guess what would be thenormalized, I guess tax-rate I know the last couple of quarters a bit -- havebeen a bit, at not the normal?

[Steve Fradkin:]

Well, we’ve traditionally been at 35% plus or minus tax-rate,as you may recall back in 2006 we talked about the implementation of APB 23 andhow that would likely on average overtime bring it down a point. We've beenlower than that more recently. Again in this quarter at 30.8%, but we also havethis, the one time state tax benefit. So, I don't know that I can give youabsolute guidance on that.

[Bev Fleming:]

The one thing that you can do Jason, is you can adjust the30.8% for the $5 million tax law change impact and that would get you to 32.5%for the quarter. So, it would be appropriate to remove that $5 million fromyour thinking going forward because that was affected by just this tax lawchange.

[Steve Fradkin:]

And again, this is going to move around a bit, because ofthe growth in our -- to the extent that our international business rose at amore rapid rate and the business in those tax beneficial jurisdictions thatwill have a more dramatic effect. So, there will be a little bit of movement inthe tax-rate.

[Jason Goldberg -Lehman Brothers:]

Okay, and then just lastly, I guess year-to-date theoperating leverage is running at bit negative, you guys have a long history ofpositive operating leverage, particularly when the markets are higher, and Iguess you have just any just thoughts around expense management?

[Steve Fradkin:]

Well, I think essentially we were neutral this quarter 19%revenue growth, 19% expense growth, I think if you -- depending on whatadjustments you want to make, I think we are modestly positive year-to-date,but you are right the operating leverage is much closer to neutral than it isto significantly positive. I guess on the expense front Jason, I would offer acouple of observations. One, remember that we have a fair amount of volumeassociated growth; we've got a lot of activity sub-custody fees, sub-advisorfees. So, as our assets grow as we win new clients, we are just, that is partof the scenario that we have to deal with. We've also brought on a fair number of staff, you're seeingour headcount is up 11% year-over-year and the overall, not withstanding thethird quarter turmoil, the competition for talent has been high and that drivessome of our expense. And we are continuing to invest on a variety of fronts incapabilities, if you look at our back and middle office outsourcing, if youlook at our pooling, you look at derivatives, alternative asset processing andalike, some of the things we are doing on the technology, our geographicexpansion, our expansion in India. So, as always, we are trying to balance the expense growthwithin the construct of our revenue profile and so far, I think we've got itwhere we wanted to be. But, it is not as positive as we've been in the pastquarters, but again we look at that as a time and space thing and we feel nowis the right time to do some things that are going to help our clients and themarket opportunities that we are seeing.

[Jason Goldberg -Lehman Brothers:]

That's helpful. Thank you.

[Operator:]

We will take our next question from Glenn Schorr with UBS.Please go ahead.

[Glenn Schorr:]

Thank you. Just one quickie, that the yield on PFS assets asin perfect as the calculation it is, but assets are growing at a lot quickerpace than the revenues. I am just curious on how much would you attribute thattowards things like open architecture versus specific products that clients aremore interested in these days?

[Steve Fradkin:]

I think Glenn, you have to remember that our PFS assetsinclude the wealth management, in fact the wealth management being the very,very large end of the market. And so when you try and look at the sort of themanaged asset equation, it's going to get skewed a bit because when we bring onthese very large wealth management clients, while we almost always are managingsome assets, it’s a relatively smaller proportion. When you manage money for $5million client, you tend to manage all of it directly or through openarchitecture. When you take on a $5 billion client, we manage -- haveinvestment management fees for 15% to 20%. So I think if I understand the rootof your question, the phenomenon you're seeing is the dramatic growth in ourassets under custody, driven by our wealth management franchise.

[Glenn Schorr:]

Is it fair to say, then the real question becomes, is thelike-for-like margin stable enough? In other words, within wealth managementspecifically the yield on incremental assets, similar to what's on the booksfor other wealth management customers?

[Steve Fradkin:]

I don’t have the signs in front of me, so I am just going togive you a directional observation. But we have not seen in our PFS business adegradation at all of the pre-tax profit margin. Now, again you have toremember some of it gets skewed because using the wealth management example, youcan take on a very large family that has a very significant single stockconcentration, and so the assets can go up quiet dramatically. But the feeswon't go up as dramatically and they may be affected in part by a single stockconcentration as well. So if you look at our pre-tax profit margins at thecorporate level, at the segment level they've been rock solid and consistent soI don't see any degradation at this point.

[Glenn Schorr:]

Okay that’s helpful, thank you.

[Steve Fradkin:]

Welcome.

[Operator:]

We'll take our next question from Gerard Cassidy with RBCCapital Markets. Please go ahead.

[Gerard Cassidy:]

Thank you, and good afternoon, Steve.

[Steve Fradkin:]

Hi, Gerard.

[Gerard Cassidy:]

Can you guys give us any color on how the foreign exchangemarkets are behaving so far in this month, I know it’s early, only a couple ofweeks, but are you guys seeing any follow through on increased volatility involumes like you saw in the third quarter?

[Steve Fradkin:]

Well, you know I don't really have any comments on thefourth quarter. What I would say is A, we had a terrific third quarter results,$92 million up, 74%. I think all of you know 74% year-over-year and 14%sequentially, all of you know that that was a very unusual phenomenon relativeto history. Just to put that, Gerard, in context for you, in 1998, our fullyear foreign exchange trading results were in the $100 million to $304 millionrange. So really a very, very strong quarter and you just oppose it sequentially,if you look at the last six years, on average we have seen a 23% decline fromsecond quarter to third quarter in foreign exchange, as compared with our 14%increase. So, it was very unusual period, August was clearly a significantcontributor to that, but we'll have to see, you know its a very difficult lineto predict. So we'll have to see what everyone wants to do in the fourthquarter. Gerard Cassidy - RBC Capital Markets Sure. Wasn't there a period, I don't know if it was '04,where we had this happen once before the third quarter outdid the secondquarter, because traditionally as you pointed out, everybody's foreign exchangerevenues dropped in this quarter meaning your competitors and yourself. Ithought this happened once before?

[Steve Fradkin:]

I don't have the data going back. It certainly can happenand as you know there is a lot of variability around foreign exchange in anygiven quarter. But I think it's fair to say on average over time all of youtake a summer holiday and it slows things down for us. This quarter that wasnot the case and it was not the case in a pretty significant way.

[Gerard Cassidy:]

Okay, and the second question was; I know you address theCME Group stock gains. Is there still more on your books, unrealized gains inthat particular security or ownership position?

[Steve Fradkin:]

Yes. We continue to own about 13,000 shares rather of theCME Group stocks.

[Gerard Cassidy:]

Okay. Thank you.

[Steve Fradkin:]

Welcome.

[Operator:]

We will take our next question from Tom McCrohan with JanneyMontgomery Scott. Please go ahead.

[Tom McCrohan:]

Hi Steve. Hi Bev.

[Steve Fradkin:]

Hi Tom.

[Bev Fleming:]

Hi Tom.

[Tom McCrohan:]

I've a question on India. When do you think we willstart to see, or you'll start to see some of the benefits from moving more ofyour staff to India?With staff costs up 18% year-over-year, I was kind of wondering when you'regoing to see the growth rates in staff costs come down a little bit?

[Steve Fradkin:]

Well, I think Tom, we are already seeing the benefits of Indiain terms of a stable workforce, in terms of a talented workforce, in terms ofour primary mission which was to have an operation center in the time zone asopposed to replacing staff elsewhere. So we feel very, very good about India.It has been an incredible success story for us and we anticipate that that willcontinue to be a growth area for us. So, in terms of the overall growth picture the other thingTom to remember is that Indiathough it's successful, though it's growing and though it's important is not areplacement for operating in London, Chicago, New York,LA and many other expensive centers. So as our business grows, we still needtalented people in what I'll call more expensive places and we have to hirethem. So, I would not encourage you to look at India as a direct offset for staffelsewhere. Our staff is growing everywhere around the world, its just growingin Indiafaster.

[Tom McCrohan:]

Okay, well just trying to get a read on your thoughts kindof longer term capability to generate operating leverage. Is this kind of a newmodel where staff cost, because the fight for talent is so fierce in those kindof geographies you talked about and the skill levels you need to justpermanently become more of this one sophisticated though. You're just paying aheck a lot more for people you have to run your fund administration business,assets management that's what we're kind of seeing and they're going to be afactor over the next couple of years.

[Steve Fradkin:]

Well, Tom, I think we go through lots of cycles both withinquarters and across years. And I guess my response would be, as always we aretrying to balance the revenue and expense equation. And I think we've done avery good job of that historically. We won't get it every quarter, we won't getit every year, but certainly 16 out of 19 years we've done it. And year-to-datedepending on how you want to do your calculation, I think we are right therethus far. But it is fair to say we are continuing to invest in the business. We had a top line revenue growth of 19% and we are workinghard to keep up with the demands of those clients and what they need. So restassured we are very mindful of the balance that we want to have. Its one of ourstrategic financial targets on average overtime across cycles, whateverterminology you want to use and we are working to manage to it. But it can't bethe only thing that we think about in managing the business. So, you know, Indiais a piece of that but certainly not all of it.

[Tom McCrohan:]

That's great. And then just on business disruptions, I thinkI want to ask a follow-up, have you seen any new business wins this quarter asa consequence of or is a benefit of some of the industry merger and acquisitionactivity both on a high network side and the client side?

[Steve Fradkin:]

Well, I can't speak for the client's reason as to why, so Iwould [be lows] to make that attribution. What I'd say is, we continue to likeour position demographically without disruption. From what I've seen I can seesome clients that have moved, my guess is, if not exclusively because ofdisruption but that's probably wasn't additive. But you know there hasn't beena sea-change in the environment and as we've talked about in the past calls, wewouldn't expect that. We expect this to the extent that disruption is additivetask, we expect it to happen over time, one client at a time. So I think thereare some anecdotes that I can point to but it's not a wholesale sea-change.

[Tom McCrohan:]

Fair enough. Thank you.

[Steve Fradkin:]

You're welcome.

[Operator:]

We will take our next question from Robert Lee with KBW.Please go ahead.

[Robert Lee:]

Thanks, good afternoon.

[Steve Fradkin:]

Hi, Rob.

[Robert Lee:]

Hey. Two quick questions, the risk of beating a dead horsethe Sec lending. Understanding how it should reverse over time, I am assumingthat depends on that taken to that is the assumption that the 10 or soinvestors in that fund maintain there investments and don't choose to liquidatein which case it ends up sort of -respectively locking in the lower values?

[Steve Fradkin:]

That's correct. You would need that to happen and you wouldof course you need to not have any impairments on any of the holdings. I thinkon the client dimension of that, these are sophisticated clients thatunderstand that phenomenon and I can't speak for them but, that's an accuratestatement.

[Robert Lee:]

Okay. And secondly, and I apologize if you had addressedthis before. But, can you talk a little bit about Fed rate cut? And how weshould be thinking about your net interest margin, if the Fed is pursing on thecourse of cutting Fed funds rate, would it have much of an impact or you'rerelatively neutral at this point?

[Steve Fradkin:]

We think on an annualized basis Rob, that it would berelatively neutral. We're short, we're relatively well matched and so, when youlook at it on an annualized basis, it's not a significant driver for us.

[Robert Lee:]

Okay, great. That was it, thank you very much.

[Steve Fradkin:]

Thank you, Rob.

[Operator:]

We will take our next question from Brian Bedell withMerrill Lynch. Please go ahead.

[Brian Bedell -Merrill Lynch:]

Hi. Good afternoon .Most of my question have been asked,answered. But, just on the sec lending once again. Steve, you said, actually ifI heard you right, you said about a 70% increase year-over-year, if it were notfor the markdown on the book?

[Steve Fradkin:]

That's correct.

[Brian Bedell -Merrill Lynch:]

So, it was about $36 million in additional Sec lendingrevenues. So that would have been depending on what kind of operating marginyou're putting on that, get a $0.08 or $0.09 of EPS this quarter?

[Steve Fradkin:]

But why, I won't do that math for you but I'd say, yes itwould've dramatically changed results.

[Brian Bedell -Merrill Lynch:]

Right. And given you by my calculations well over another100 additional basis points of operating leverage. But, what you're saying isover the next 18 months, is when those securities within that pool mature. Isthat correct?

[Steve Fradkin:]

Well, I think what we believe is that over the next and --again, this is not, its sounds more pinpoint then it is, but we believe thatover the next 15 months or so we would see the head win that we experiencedthis quarter become a tail win. Again to Rob's point, that assumes that theclients don't lead the fund and force us to realize losses and it assumes thatno credit degradation, no default on any of the securities. But, yes, difficultto predict but over the next 15 months or so.

[Brian Bedell -Merrill Lynch:]

Right. So, if they were to redeem that and you realizedabout it, you have already marked them down, so you would not realizeadditional losses, you mean that the market hasn’t changed?

[Steve Fradkin:]

I believe that's correct.

[Brian Bedell -Merrill Lynch:]

Okay. And then secondly, just given that that your normalrun rate was closer to $70 million in the quarter would suggest that, onceagain there is several cents of EPS that we would back into your normalized runrate. I know it's very difficult to predict Sec lending quarter-by-quarterinclude, this quarter was strong but clearly your core trend's run rate issignificantly higher than that?

[Steve Fradkin:]

Well again, we don't give guidance so I can't help you withthat, but what I can say is, as I tried to suggest you, the construct of thisvehicle is critically important to understand the accounting. And if you justlook at the headline, but don't understand why it happens, you might have in myview at least the wrong contexts around at least what we think is going on forus and perhaps for others.

[Brian Bedell -Merrill Lynch:]

Right. But, I guess the other question would be, given thatthis does create volatility in your Sec lending business, just having amark-to-market fund is it something that you would consider either letting arun down, so that you don't have that option anymore for client or you juststick with treasuries or is it something that you could keep, you keep going?

[Steve Fradkin:]

Well, I think couple of points on that Brian. One, rememberthis was an extremely, extremely unusual period. We haven’t, we've hadvolatility in other quarters, but it hasn't manifested itself as dramatically.So, I think you do probably have an outlier in terms of the event. Two, itsclient driven, if clients want to be in a pooled vehicle with this kind ofprofile, it has to be mark-to-market. So, we could only do that if clients saidto us, we want a custom account, we don’t want to be in pooled vehicles andobviously if they did we would be happy to help them with that.

[Brian Bedell -Merrill Lynch:]

Right, but your client shared in the loss, and in this aswell, is that correct?

[Steve Fradkin:]

Correct.

[Brian Bedell -Merrill Lynch:]

Right. So, may be going forward may be still the client willuse this type of product I would think?

[Steve Fradkin:]

I am not sure about that, I think these are prettysophisticated clients. They understand what happened with credit spread andagain, I am imputing across a number of people, but I think most of themunderstand that this and believe that this will revert and are comfortable withthat.

[Brian Bedell -Merrill Lynch:]

Right. I will get that back. Okay. Just a couple question,some questions have that were asked before, did you say there was a $3 millionloss in other operating income on the sale of the equipment from Isle of Man in third quarter?

[Steve Fradkin:]

We had a, $3 million last quarter and we had a very modest,I would say it was about $1 million this quarter in addition to that.

[Brian Bedell -Merrill Lynch:]

In other operating income.

[Steve Fradkin:]

Yes.

[Brian Bedell -Merrill Lynch:]

Right okay. And then similar things with other operatingexpenses, does include some of the charges for the securities processingactivities. I know, you didn’t want to frame that, but clearly the $4 millionincrease was at least partially due to that. I would assume?

[Steve Fradkin:]

That’s correct.

[Brian Bedell -Merrill Lynch:]

Right, okay.

[Steve Fradkin:]

And again, that’s, obviously we don't want any, or if wehave them, we want them to be as small as possible but you just can't processtrillions, billions and millions of transactions, and never have any of that,so that's something we are still.

[Brian Bedell -Merrill Lynch:]

Are part of the business trends of the trade, and then doyou, you talked about some small sub-prime positions in portfolios. Can youjust elaborate on that? Are these portfolios on the balance sheet or are thesein investment management products?

[Steve Fradkin:]

Our sub-prime, if you step back and look at it, Brian, froma corporate level on this total picture, sub-prime is extremely modest and notof concern. On the credit front loan portfolio, no direct exposure to anyamount of line broker or originator or sub-prime mortgages, and we have noexposure to any organization whose business is exclusively in sub-primelending. If you look at the securities portfolio, the balance sheet, oursub-prime exposure is really relative to the overall investment portfolio isminimal. And the holdings that we do have, are of sub-prime asset backedsecurities. They are at the front end of the capital structure, very shortaverage lives from our vantage point not at all of a concern. And then, within our asset management business, we have veryto minimum exposure in our active equity mutual funds and separate accounts, nodiscernible exposure in our fixed income mutual funds or separate accounts. So,we feel very, very comfortable with, and we don't like the environment thatit’s causing, but from a corporate standpoint, we just don't see it as a majorissue for us.

[Brian Bedell -Merrill Lynch:]

Alright great. That's helpful. And then, just on the, interms of the NIM expansion in the quarter, I know the money market as theyields went up pretty significantly, in line quite sort of the major driver,the yields going from 450 to 487. What was the major lead, sort of the maincause of that?

[Steve Fradkin:]

We had on the NIM, I guess first you got to go back andremember that in the second quarter we had reduced our net interest income byabout $7 million, because of the adoption of FSP 13-2, the Leveraged Leasematter. So, you've got to remember that that was the first half year effectdegradation in the first quarter. So, if you adjusted that, we reported a netinterest margin of 1.58 in the first quarter, it would have been, sorry, in thesecond quarter, it would have been 1.61, and then, so I think that was aprominent aspect of the differential.

[Brian Bedell -Merrill Lynch:]

Right. But you still got a pretty good yield jump on yourmoney market assets, it would be in that specific line is there more allocationto [buy broad-based] products within that?

[Bev Fleming:]

The money market assets on our balance sheet, Brian, arepredominately time deposits with foreign banks. So you would be seeing impactof those, the Euro and the Sterlingin there.

[Brian Bedell -Merrill Lynch:]

Okay. So that's good then with the Fed environment, right?Because then, if you have any kind of extension of duration with time deposits,especially if they are at international yield and then you have the Fed cuttingrates late in the quarter that could reduce your liability funding in certainareas on the funding sides, while your asset yields periodically woulddepreciate as much. So, that should bode well for clearing.

[Steve Fradkin:]

But remember, our duration is still pretty short. Brian Bedell - Merrill Lynch Yeah. I know, I was just looking for the near-termdirectional impact. I know, you don't typically give color on future directionof NIM. But I'm just trying to get a sense of that. Okay, great. And then, justlast on the tax rate, same lending there, I know you don't give guidance onthat, but what is the case -- it seems like your tax rate has been trendingdown, and that has been driven by a greater business in internationaljurisdictions which might have lower tax rate. What would be the case for thetax rate going up? Is there any kind of good case for that or should weconsider your growing international business overtime, it's growing at a morerapid rate than your USbusiness as positive for potential decline in the tax rate over time?

[Steve Fradkin:]

Yeah. The tax rate is going to move around, but I thinkBrian you've got it right. At the end of the day, the driver of the -- forgetthis quarter, but just on an average, more recently, the driver of the declinehas been our adoption of APB 23, and the growth of our international businesswhich is consistent with that. So, difficult to predict exactly where it wouldland, but we did say that when we adopted in 2006, that we thoughtdirectionally it would improve our tax rate overtime and that certainly seemsto be the case. Brian Bedell - Merrill Lynch Great. Thanks very much.

[Steve Fradkin:]

You're welcome.

[Bev Fleming:]

Cynthia, if there is anybody in the queue I think we'veprobably got time for may be one more and then we'll let people get back towork.

[Operator:]

And we do have one final participant in the queue. And wewill take our last question from Ken Usdin with Banc of America Securities.Please go ahead. Ken Usdin - Banc of America Securities Thanks. Hey guys, I promise to make it real quick.

[Steve Fradkin:]

Thank you. Ken Usdin - Banc of AmericaSecurities Two quick ones. First of all, just on the credit front,you've build the reserve a little bit through the last couple of quarters. NPAjust fell down. I am just wondering, any migration strength that you are seeinglike in the 7-8 buckets or any change in the quality of the portfoliounderneath that's causing a fruition?

[Steve Fradkin:]

The answer is no. Our 7 and 8 rated loans -- we are at $76million at quarter end, compared with 75 last quarter. So, we have not had asignificant change in the view there. Ken Usdin - Banc of AmericaSecurities Okay. And the second one is just on the institutional assetmanagement front, was the sec lending collateral decline, the sole reason forAUMs to be down sequentially?

[Steve Fradkin:]

Yes.

[Ken Usdin:]

Okay. And any color on just how fund flows were in theinstitutional asset management business ex-sec lending?

[Steve Fradkin:]

Well, we don't do fund flows like the mutual fund company,but if you took out that degradation, our institutional assets under managementwere up little over 2% exactly.

[Bev Fleming:]

And we talked about short duration and quantitative beingthe two drivers there. Ken Usdin - Banc of AmericaSecurities Yes, right. Okay, great. That's what I was looking for.Thanks again.

[Steve Fradkin:]

Okay. Well, thank you all. It's been a long call. Weappreciate your listening in and your questions and we look forward to givingyou an update at our next quarterly conference call. Have a great day.

[Operator:]

Ladies and gentlemen, this will conclude today's conferencecall. We do thank you for your participation and you may disconnect at thistime.