Bank Of New York Mellon Corp (BK) — Q4 2015 Earnings Call Transcript

Thank you, Nicole and thank you everyone for joining us. As Nicole mentioned, we are reporting our fourth quarter and full year 2015 earnings. With us today are Gerald Hassell, our Chairman and CEO; Todd Gibbons, our CFO, as well as members of our executive leadership team. Our fourth quarter earnings materials include a financial highlights presentation that will be referred to in the discussion of our results and can be found on the Investor Relations section of our website. Before Gerald and Todd begin, let me take a moment to remind you that our remarks today may include forward-looking statements. Actual results may differ materially from those indicated or implied by our forward-looking statements as a result of various factors. These factors include those identified in the cautionary statement in the earnings press release, the financial highlights presentation and those identified in our documents filed with the SEC that are available on our website bnymellon.com. Forward-looking statements made on this call today speak only as of today, January 21, 2015 and we will not update forward-looking statements. As a final note, we plan to file our 2015 10-K on February 26th. Now, I would like to turn the call over to Gerald Hassell. Gerald?

Great. Thanks, Valerie and welcome everyone. Thanks for joining us this morning. Our fourth quarter results capped off what I think was a very good year. We demonstrated that our strategic plan has positioned us well to perform in all operating environments. Even with geopolitical instability, emerging market weakness, higher regulatory compliance requirements and low interest rates, we executed on our strategic priorities and focused on what was within our control. For the full year, EPS was up 19%, total revenue was up 2% while total expenses were down 2%, resulting in more than 400 basis points of positive operating leverage. Net interest revenue was up 5% and we improved our pre-tax operating margin to 31%. And finally, our return on tangible common equity was a very healthy 21%. So, we are on track to achieve our three-year goals, targets which call for healthy earnings growth, not reliant on improved market conditions. So, turning to the fourth quarter itself, adjusted earnings per share was $0.68 and that excludes $0.11 per share for the impact of the previously disclosed impairment charge related to a recent court decision, which Todd will discuss in more detail in a moment, and litigation and restructuring charges. That puts earnings per share up 17% year-over-year on an adjusted basis. For the quarter, again on an adjusted basis, total revenue was up 2%, total expense was down 2%, and we generated over 300 basis points of positive operating leverage, mainly driven by our business improvement process. Net interest revenue was up 7% year-over-year and our return on tangible common equity was 19% for the quarter. Now looking at our progress against our strategic priorities, as I said in the past, our first priority is driving profitable revenue growth. We have heightened focus on disciplined revenue growth, which means paying particular attention to our clients, profitability, and shareholder value versus gross revenues and market share. During 2015, we made progress on a number of different fronts. We are focused on deepening our client relationships by leveraging our expertise and determining how we can add further value to them and increase the acceptance rates of our services. At the same time, we’re also examining each business and service that we offer to ensure that we are receiving value for what we deliver. The strategic platform investments we’ve been making continue to pay off. We’ve been able to create efficiencies and savings for us, and in many cases, for our clients as well. We are now in the early stages of rolling out our new platform NEXEN, which will deliver additional functionality and capabilities to all of our clients. On investment management, we extended our liability driven investment strategy into the U.S. market through our Cutwater acquisition. Our U.S. retail and wealth management initiatives continue to add to our new business platform. This week, we announced our plan to acquire Silicon Valley wealth manager Atherton Lane Advisers, which has $2.7 billion of assets under management. This investment further strengthens our footprint in one of the fastest growing U.S. wealth markets. And we’re also pleased to welcome them to the BNY Mellon team. And in the U.S. retail space, we had success with the Spanish global fixed income strategy, which was the highest growth product in Morningstar’s world bond category in 2015. And in the markets group, we continued to enhance our collateral management systems and foreign exchange trading platforms, all to drive efficiencies, capture more volume, and improve the opportunities for future revenue growth. And our second priority is executing on our business improvement process. We’ve been meeting or exceeding our business process goals and are on target to achieve the structural cost reductions that we shared at Investor Day in October of 2014. During 2015, we simplified and automated global processes, optimized and streamlined our technology infrastructure, and shrank our real estate portfolio. During the fourth quarter, we took a number of additional actions to improve the Company’s business and financial performance. Let me give you a couple of examples. We are implementing robotics and machine learning to eliminate repetitive non-value-added work, enabling a quicker automated process while reducing wasted costs. We completed three proofs of concept, all demonstrating a high degree of accuracy and processing, reducing transactional processing time, and eliminating manual steps, all of which enables us to redeploy resources to activities that create greater value for our clients. Last quarter, I mentioned the new client pricing strategy group that we created to analyze and measure service delivery costs to better align our costs with client pricing. This group is now reviewing balance sheet related business practices such as overdraft as well as manual transaction activities, a new strategy around physical securities as well as standardizing pricing across our business units. We’re also continuing to build out our global delivery centers in lower-cost locations to allow for further expansion and position migration. And we moved over 230 full-time staff positions to global delivery centers during the quarter and more than a thousand full-time positions in 2015. And we’ve also begun to implement a bring-your-own-device strategy reducing the number of data terminals across the Company and have cut back redundant price increases. These efforts, large and small are part of our continuous, comprehensive and sustainable process to create efficiencies and savings consistent with our continuous improvement culture. Our third priority centers on being a strong, safe, trusted counterparty. During 2015, we reduced and simplified our counterparty exposures, invested in and focused on compliance, risk management and control functions, examined and enhanced our vendor management practices following the SunGard incident, incorporating lessons learned and sharing those with our clients, and made significant investments in our resolution and recovery plans. We also introduced a more robust data governance framework that will strengthen our data collection and analytical capabilities, which is important in meeting all of our regulatory requirements globally. And lastly, we demonstrated our strong business recovery capability in response to the historic flooding in Chennai, India, where we have thousands of employees. Our fourth priority involves generating excess capital and deploying it effectively and wisely. We remain focused on maintaining a strong balance sheet as well as capital and liquidity positions while returning value to our shareholders. So, in accordance with our 2015 capital plan which authorized us to repurchase up to $3.1 billion of our stock, we repurchased $431 million in shares and distributed $188 million in dividends during the quarter. For the full year, we repurchased approximately $2.4 billion in shares and distributed more than $760 million in dividends. Over the last four years, we have reduced our shares outstanding by 13%, which is among the best in the industry. And from a regulatory ratio standpoint, all of our key capital ratios improved as we move toward full compliance. This quarter, our CET1 ratio under the fully phased-in advanced approach, improved to 9.5%, and we increased our supplementary leverage ratio to 4.9%. We also remain in full compliance with the liquidity coverage ratio which became effective in 2015 for the full phase-in period that extends through and 2017. We remain very confident that we will be in full compliance with all of the regulatory ratio requirements at the time of or ahead of the required dates. And our fifth priority is to attract, develop and retain top talent. We have continued to focus on investing in our people; we have refreshed the tools and processes we use to manage, grow and get the most of our talent. And we are seeing the benefits of prioritizing talent, as reflected in our financial performance. So, as we look ahead, given the rocky start to the year in the financial markets, we expect our business improvement process to be increasingly critical to our results going forward. We remain confident that our strategy and relentless focus on the execution of our priorities will enable us to achieve the three-year financial targets we shared on Investor Day and importantly, deliver value-added services and solutions to our clients. So with that, let me turn it over to Todd.

Thanks Gerald and good morning everyone. My commentary will follow the financial highlights document, will start with slide seven. Before I walk you through the details of the financial results, let me provide you with an overview of the court decision that Gerald noted which resulted in a fourth quarter after-tax impairment charge of $0.10. The charge resulted from the Seventh Circuit Court of Appeals decision related to a $312 million secured loan we had to Sentinel Management Group, which filed for bankruptcy in 2007. Following a favorable December 2014 decision in our favor by Federal Court finding that our lien against Sentinel was valid, we received payment of the outstanding principal and interest on the loan. Subsequently, the bankruptcy trustee appealed the decision and the appellate court invalidated our lien on the collateral that supported the loan. The impact of this decision is that we will have an unsecured claim in the Sentinel bankruptcy. As a result, we took an impairment charge in the fourth quarter of $170 million on the pretax basis or $106 million after tax, representing our estimate of the probable losses. Turning now to our fourth quarter results and the financial highlights document, we will start with slide seven. I’ll focus on our non-GAAP or operating results for the quarter and the year-over-year comparisons. On an operating basis, our fourth quarter EPS was $0.68 that’s up 17% versus the year ago. On a year-over-year basis, fourth quarter revenue was up 2%, expenses down 2%, and we had 308 basis points of positive operating leverage. As we’ve noted in prior quarters, the strength of the U.S. dollar continues to impact results negatively for revenue and positively for expenses. Net impact from currency translation is minimal, however, to our overall consolidated financial results. Adjusted for the dollar, revenue would have been up approximately 3% and expenses a little less than 1%. However, our investment management business is impacted more significantly from the strength of the dollar as a significant component of investment management revenue is from non-U.S. dollar sources. If you reference page six of our earnings release, you will see the two currencies that impact investment management the most; it’s the pound and the euro, and they were down 4% and 12% respectively against the U.S. dollar. Income before taxes was up 10% year-over-year on an adjusted basis. On a year-over-year basis, our pretax margin increased approximately 200 basis points to 30% in the fourth quarter. Return on tangible common equity was 19% for the quarter. Now moving to slide 10, that details our operating results for the full year; you can see the 2% revenue growth and 2% decline year-over-year in expenses as Gerald mentioned that resulted in 420 basis points of positive operating leverage. Income before taxes grew 12%, EPS up 19%. On a constant currency basis, revenue was up 5%, expenses were up 1%. Slide 11 illustrates key metrics of our performance that demonstrate solid execution of our strategic priorities in 2015. You can see the four quadrants here. EPS up 19%; non-interest expense down; pre-tax operating margin expanded nearly 300 basis points; and return on tangible common equity is also up 300 basis points to 21%. Slide 12 shows our consolidated fee and other revenue. Asset servicing fees were up 1% year-over-year, down 2% sequentially. The year-over-year increase primarily reflects growth in global collateral services, broker-dealer services, and higher securities lending revenue, which is partially offset by the unfavorable impact of the stronger dollar. The sequential decrease primarily reflects lower client activity. Clearing services fees were down 2% year-over-year and sequentially. Both decreases were primarily driven by industry consolidation as three large clients had transitioned to self-clearing firms. Partially mitigating this impact is the new businesses we are onboarding from a competitor who exited the business and through a combination of net new business and expense control. We expect clearing to be pre-tax income neutral in 2016. Issuer service fees were up 3% year-over-year and down 36% sequentially. The year-over-year increase primarily reflects net new business and lower money market fee waivers in Corporate Trust that was offset a bit by the stronger dollar. The sequential decrease primarily reflects seasonality in DRs. As we’ve noted in prior quarters, our Corporate Trust performance has been improving; this quarter it was a positive contributor to our growth. Treasury services fees were down 6% year-over-year and flat sequentially. The year-over-year decrease primarily reflects higher compensating balance credits and lower volumes. Fourth quarter investment management and performance fees were down 2% year-over-year that would have been up 1% on a constant currency basis. And that was driven by higher performance fees and a slight reduction in money market fee waivers, partially offset by lower equity markets. Sequentially, investment management and performance fees increased 4% and that’s primarily due to the normal performance fees seasonality. Performance fees were $55 million and that compared to $40 million a year ago, driven by stronger performance across a wide breadth of strategies including a sharp increase in equity long-only fees. FX and other trading revenue on a consolidated basis was up 15% year-over-year and it was down 3% sequentially. FX revenue of $165 million was flat year-over-year, down 8% sequentially. Year-over-year, we saw lower standing instruction volumes and lower volatility which were offset by higher volumes in other trading programs. Also included is the impact of hedging activities of foreign currency placements. The sequential decrease primarily reflects lower volumes and volatility and seasonally lower deposit receipts related activity and that was partially offset by the hedging activity for foreign currency placements. Other trading revenue increased to $8 million compared with the trading loss of $14 million in a year ago quarter and a loss of $1 million in Q3. The year-over-year increase primarily reflects the losses on hedging activities within one of the investment management boutiques that we recorded in the fourth quarter of last year. Financing-related fees increased 19% to $51 million compared to the year ago quarter and decreased 28% sequentially. The year-over-year increase primarily reflects higher fees related to tri-party repo activity. In the second quarter, we noted that some of our clients could moderate their usage or possibly find alternative sources for this financing in the future; we actually did end to see this take place during the fourth quarter. The sequential decrease primarily reflects lower underwriting fees and the impact of lower fees related to the superior secured intraday credit I just mentioned. Investment and other income of $93 million compared with $78 million in the year ago quarter and $59 million in the third quarter. The year-over-year increase primarily reflects higher other income related to termination fees in our clearing business and that was associated with the client transitions that we mentioned, as well as seed capital gains and that’s partially offset by lower asset-related gains and lease gains. The sequential increase in investment and other income primarily reflects higher asset-related gains, income from corporate and bank-owned life insurance, and other income related to clearing termination fees partially offset by lease residual losses. Slide 13 shows the drivers of our investment management performance that should help explain the underlying business. Assets under management of $1.63 trillion were down 4% year-over-year, driven by stronger dollar and lower equity markets, and they were flat sequentially. We had long-term outflows of $11 billion, $16 billion out of index funds and $5 billion into active funds. Additionally, we had $2 billion of short-term cash flows. For the full year, we had long-term outflows of $17 billion, mainly in equity and index investments, partially offset by flows into LDIs and alternatives. Our wealth management and U.S. intermediary expansion initiatives continue to show some progress. Wealth management loans were up 21%, deposits were up 6%. In addition, we announced the acquisition of the Silicon Valley wealth manager, there is AUM of $2.7 billion and 700 high net worth clients, an investment that expands our presence in this fast-growing market. In U.S. intermediary, we had strong performance in a number of investment strategies, bringing to organic growth rates that exceeded their Morningstar categories. Turning to our investment services metrics on slide 14, assets under custody and administration at quarter end were $28.9 trillion, up 1% or $400 billion year-over-year, reflecting net new business, partially offset by the unfavorable impact of a stronger U.S. dollar and lower market values. On a constant currency basis, year-over-year growth would have been up approximately 3%. Linked quarter, AUC/A was also up $400 billion. We estimate total new assets under custody and administration business wins are $49 billion in the fourth quarter. And that gives us a total of $1.2 trillion of new business wins during the year. Fourth quarter net new business was below average. Just as a reminder AUC/A wins are episodic and they can vary from quarter to quarter. Our pipelines continue to look healthy. And as we’ve discussed, our strategy has been to prioritize organic growth by deepening our existing client relationships and selectively adding new businesses instead of simply growing market share. Now looking at some other metrics for investment services, the market value of securities on loan at period end was down 4%; average loans grew 4% while average deposits were down slightly. Our broker-dealer metric of average tri-party repo balances grew 2%; the clearing metrics were mixed; DARTS volume in large long-term mutual fund assets were down, while active accounts were up modestly. The net decline in sponsored DR program reflects our continued focus on exiting low activity programs. Turning to net interest revenue on slide 15, you will see that NIR on a fully taxable equivalent basis was up 7% versus the year ago quarter and it was flat from the third quarter. The year-over-year increase in NIR reflects higher yields due to a shift out of cash into securities and loans as well as lower interest expense on deposits. While the volume of earning assets declined 2%, their yield increased 6 basis points year-over-year and the yield on interest-bearing deposits decreased to 2 basis points. Sequentially, NIR was flat. Our net interest margin for the quarter was 99 basis points, 8 basis points higher than the year ago quarter and 1 basis point higher than the prior quarter. Deposits were down $9 billion sequentially on average; that was the expected response to the Fed’s first rate move. Our models continue to estimate some additional loss of deposits as the Fed continues to raise rates, as implied by the forward curve at year-end and then increasing in line with our Investor Day goals. Turning to slide 16, you will see that non-interest expense on an adjusted basis declined 2% year-over-year and was flat sequentially. Year-over-year increase in non-interest expense reflects lower expenses in all categories except staff expense. Now, there are few expense items that were both positive and negative to earnings that I’d like to call out and I think it will help give you a bit of context. Staff expenses grew by 4% year-over-year and that’s reflecting severance cost of approximately $55 million in ongoing support of our business improvement process and an adjustment of roughly $30 million related to updated information received from an administrator of health care benefits, all that was partially offset by the impact of curtailing the U.S. pension plan earlier in the year. Decrease in other expenses primarily reflects adjustments of approximately $35 million to our estimate for bank assessment charges. And that estimate included the European single resolution fund and was partially offset by higher asset-based taxes. Factoring in these items, we once again showed strong expense control. Turning to capital on slide 17, fully phased-in common equity tier 1 ratio increased by 20 basis points to 9.50, that was driven by lower risk-weighted assets as capital was about flat. Our supplementary leverage ratio increased to 4.9% this quarter, principally due to a reduction in our balance sheet as well as reduction in off-balance sheet exposures. A couple of other notes about the quarter from our press release, as you will see in the release on page three, the effective tax rate was 20.1%, which is approximately 5% lower than our previous guidance. The rate is lower approximately 3% due to the impact of the impairment charge that I mentioned at the beginning of my comments and approximately 2% lower, driven by the benefit of a more favorable geographic mix of earnings and a little higher tax-exempt income. On page 11, you will see some investment securities portfolio highlights. At quarter-end, our net unrealized pre-tax gain on our portfolio was $357 million that compared to $1.05 billion at the end of September, the difference in value is principally due to the increase in interest rates. Before I wrap up, let me summarize several items that I’ve discussed in this quarter. As we’d indicated, the impairment and litigation charges resulted in a $0.11 charge, and we’re negatively impacted by increased compensation costs driven by severance and health care cost adjustments that I just spoke about that amounted to be about 5%. On the benefit side, we benefited by reduced bank assessment charges, lower tax rate, and termination fees related to our clearing businesses which added about $0.06 to earnings. These items in aggregate had a negative impact of about $0.10 in the fourth quarter to our reported earnings. Now, I’d like to provide you with a few points to factor into your thinking about 2016. As you know, we’ve been planning and managing to the flat rate scenario as outlined at our Investor Day in late 2014. Now that the Fed has increased rates, we’re using the forward rate curve assumptions. The rate increases obviously are positive for us, but we are still facing global economic and geopolitical challenges as evidenced by the market’s sharp decline year-to-date. As a result, we are cautious about how this set of challenges will impact the Fed thinking about future rate increases. Additionally, we are concerned about the equity market performance impact on our organization. With that said, let me provide you with our current thinking as we look ahead to the first quarter and the full year. We expect a modest increase in NIR and NIM in the first quarter. With respect to the recapture of money market fee waivers, we continue to expect to recover 70% with the 50 basis-point increase in rates; 25 of that increase has already occurred. On expenses, our goal is to keep expense growth flat in 2016. However, higher rates will eliminate fee waivers and that will drive the higher distribution expenses. Largely as a result of the higher distribution expense, we expect the total expense growth to be in the range of 1% to 2% next year. In the first quarter, we expect to see a $15 million increase in the bank assessment charges and it should run at that for the full year. And we would expect staff expense to be impacted in the first quarter by the acceleration of long-term incentive compensation expense for retiree-eligible employees that typically takes place in the first quarter. We expect our tax rate for the full year to be approximately 25% to 26%. We expect to continue to repurchase shares under our current authorization, both in Q1 and Q2. Our repurchase for the second half of the year will be contingent upon the Federal Reserve not objecting to our CCAR request later this year. We think our performance, both in the quarter and throughout 2015 underscores that our strategic plan has positioned us well to perform in some tough operating environments. We are focused on our strategic priorities; we’re executing on them; and we remain on track to achieve our three-year goals. With that, let me hand it back to Gerald.

Thanks, Todd. And Nicole, I think we can now open it up for questions.

Good morning. Thanks for taking the questions. So, on the expense front, thanks Todd for walking through some of the one-timers that impacted the results. How should we think about the go forward or the direct jumping off point, based on some of that noise that we saw here in the fourth quarter?

Yes, I would reduce the category run rates by approximately the amount I mentioned.

Okay. The specific numbers you gave, offsets and upward pressure, were the right numbers to rebase and then come up with the baseline starting point, right?

I think that’s a fair start, Brennan.

Okay, great. Thanks a lot. And then thinking about the clearing headwind, how should we think about that rolling into next quarter; what’s the right way to think about the revenue? Because I know that I think you had said at a conference that there might be some further headwind here in 1Q, maybe their timing of when the clients came off in 4Q might not have been fully reflected in the 4Q run rate. So, how should we think about that coming into 1Q from here?

Yes, I think that’s right. Maybe Brian Shea can take it on, Brian?

Yes, the pressure on clearing revenue is mainly due to the exits of a few large clients, particularly Barclays and Credit Suisse, from the U.S. wealth management market. Barclays left in the middle of the fourth quarter, while Credit Suisse started their exit during that same quarter, so they are partially gone. We expect to see continued pressure on fee revenue in clearing services for the next few quarters. However, this could be partially balanced by a very successful year in new business for clearing services in 2015, as we gained several high-quality clients after a major competitor exited the market. These new clients typically contribute less to fee revenue and are more focused on balance sheet and lending activities, which will help offset the fee decline and contribute to growth in net interest income instead. Additionally, we are experiencing strong growth in the RIA custody and prime business, and Pershing is set to benefit significantly from the restoration of fee waivers as interest rates rise, which will also aid in revenue. In the meantime, we are maintaining strong expense discipline in the clearing business and, as Todd mentioned, we believe we can keep pre-tax income stable in 2016 despite the pressure on fee revenue.

Okay, Brian. Thanks for that. So basically, are you saying that the revenue headwind that we saw axing out the new business wins, right, just focusing on that first, should sustain for another couple of quarters and then you’ve got the offsets that you highlighted picking up from there?

Yes, partially offsetting that with NII growth and some of the fees from the JP Morgan more clients offsetting. But I think there will be pressure on the fee line specifically for the next couple of quarters and we’ll work hard to manage the expenses to make sure the PTI impact is neutralized.

So, just picking up on the clearing question, just want to make sure that we kind of put that question a bit. Are all the clients or all the transactions in the wealth management space as sort of been announced over the second half of 2015 or any kind of like reflected in the guidance, because I think some of them are closing later in 2016?

Yes.

So, should we expect another kind of step down in fees in the second half of ‘16 or everything is already reflected from the clients that exited in 4Q?

No. So, it’s a good point. There has been another large U.S. wealth manager that’s announced the exit; it’s another global SIFI that’s announced their exit from the U.S. wealth management business. That transition out will probably take place in the fourth quarter of ‘16. So, that’s not positive. On the other side of that though, we continue to have a strong pipeline of new business in clearing services. And frankly, we have a number of self-clearing firms that are considering outsourcing their clearing. So, I hope that we are able to attract some significant new business that offsets that potential loss or the likely loss in the fourth quarter.

And then Todd, shifting gears a little bit onto the balance sheet. It looks like if you kind of move across the buckets on the yield side, doesn’t seem like many have them moved, I guess just as obviously the Fed hiked later in the quarter. Help us understand maybe just kind of the run rate of what the NIM we should look for starting 2016, assuming no further rate hikes, and kind of your expectation for the balance sheet, just kind of trying to rightsize NII outlook for 2016 versus 2015?

Yes. We would expect modest growth. I think one of the frustrating things that you’ve seen the 25 basis-point increase in the short rates and long rates have actually come down. So, the reinvestment activity is not going to benefit what we would have modeled or some percentage of the reinvestment. So, we would expect balances to come down a little bit, NIM to widen and overall net interest revenue to show a little bit of growth.

I just wanted to ask about the energy exposure in your C&I loan book. I think outstanding is $500 million, but there is another $5 billion unfunded commitments. So, I was wondering maybe if you could characterize the customers you’re lending to, speak to covenants or other protections against those lenders drawing down lines of credit, if they get stressed, and then just generally your sense of whether this exposure is something to be concerned about?

Most of the exposure in the energy sector is to investment grade names. We primarily have integrated firms, along with some pipeline and refining companies, and a small amount in exploration and production, but these are all high-quality names. At this point, we believe it’s a well-supported growth area. There may be some changes in credit quality, but I do not anticipate any losses.

And then at your Investor Day a little over a year ago, I think you laid out the path to SLR compliance that you’re targeting year-end 2017. Since then, you’ve added 30 basis points; I think the total you’re hoping for is 250 to 350 basis points of improvement. So, I wonder how you’re thinking about accelerating the path there as we get closer to the phase-in date. And I think the biggest piece of the plan was deposit reduction. So what’s the contingency plan given that rates, I mean you said yourself that you might not expect anymore rate hikes. So there is no help there.

So far, we have observed that when looking at the average balance sheet instead of the spot balance sheet, we see some fluctuations, but it's the average that influences the ratio. In the last quarter, we experienced a $9 billion decrease in balances, which was a swift reaction to the rate changes we encountered. Additionally, we've noticed a further decline of approximately $8 billion this year. We had initially estimated a $20 billion reduction following the first rate adjustment, and if we see further changes, we anticipate a range of reductions between $40 billion to $70 billion as we move towards a more typical scenario. Should that not occur, we have prioritized our entire balance sheet and may need to take action regarding the less valuable deposits. Currently, we don't feel an urgency to rush into compliance. We are accumulating capital, having built around $800 million in a year, even with a possibly full payout ratio. If the balance sheet shrinks, we can also take additional steps to manage it effectively, and we believe we can navigate ourselves towards a reasonable rate without needing to take exceptional measures with our clients.

Just one more on clearing, just to be clear on that. So, I think Brian or Todd, you were saying, you expect pre-tax profit for the clearing business in total to be flat from 2015 to 2016, do I have that right?

That’s correct, Brian.

I can add something for you. The clearing fees make up about 12% of our total revenues, which is what we're discussing. It has been experiencing decent growth in the range of 5% to 6%. The team has done a commendable job managing our expenses and adapting to the consolidation we've observed in the industry recently. Therefore, it may experience a pause in its growth over the year.

It was good color from Brian on the fee dynamics there but maybe if I can just dovetail into the money market fee waivers, obviously 70% coming off of two hikes. What percentage do you think you will get at a full run rate on just the one hike and do you really need to wait to like get through 1Q and into 2Q to see that?

I think it’s just the beginning here; it’s fairly linear. So, we right now the behaviors we are seeing are consistent with what we had projected. So, we’re seeing it now.

Okay.

And it didn’t show up very much in the fourth quarter, yes, we saw a little bit on the asset management side and a little bit in the corporate trust side. Pershing tends to lag in the fee waiver abatement. So, we do think that there is always some acceleration into the first quarter.

Fair enough. And maybe just then switching to the asset management business, maybe if Curtis is there, if he can comment on the acquisition. I guess more broadly on the potential for making more acquisitions for the business, given the recent declines in valuations and just comment on sovereign wealth spending exposure across the franchise?

We are very excited about the acquisition we announced yesterday of Atherton Lane. It aligns with our strategy in wealth management, which involves entering a market. We already have a team in San Francisco and Palo Alto, and we've been working there for some time. The goal is to find a firm that culturally fits with us and has a solid client base, like the 700 clients Atherton Lane has, in a rapidly growing economy. This firm shares our holistic approach to client needs, which includes everything from financial planning to generational wealth transfer, trusts, insurance, and investments. By bringing Atherton Lane into our fold, we will combine them with the sixth largest asset management firm in the world and all of BNY Mellon's banking capabilities. They are eager to grow their firm, which they have successfully built since 2005, to the next level as part of our global franchise. We followed a similar strategy in Chicago with Talon in 2011 and in Toronto with I(3) in 2010. This approach allows us to establish a presence and then leverage our institution's resources for the clients in that area. We are keen to explore more acquisitions in other markets where we see significant potential to enhance our capabilities and serve clients better. We are very careful not only about the acquisition terms but also about ensuring cultural compatibility, which takes time to identify and confirm. This is a systematic process for us.

Do you see more opportunities, given the valuation to clients; I guess I would say, is there pipeline significant?

Yes. So, I think that we’re certainly spending time looking for other opportunities like Atherton Lane. So, I want to balance this, so yes, we would love to find other opportunities like that in other markets. And we look at them all the time. It’s one of the great things is we’re connected, Brian talked about Pershing and the rest of our Company has a lot of insight into high-quality RI firms around the country. So, we’re always monitoring it like a scouting report as to who would be a good fit, who culturally is positioned and yes, we absolutely would love it. We also want to make sure that we execute because we want to make sure every time we do one of these that it works for both the acquiring party and their clients.

And just the sovereign wealth fund exposure in the institutional segment?

It’s been an interesting year. There have been many articles about sovereign wealth funds. During our Investor Day, we mentioned that we are the second largest manager of sovereign wealth fund assets, which means we have a significant number of clients in this area. A large part of the assets we manage are indexed. As Todd and Gerald mentioned regarding our flows, a substantial portion of our outflows for this quarter and the year has been from indexed-related assets, where the fees are relatively low. You can clearly see our outflows in the indexed assets for the year. While I can't discuss specific clients or their activities, this aligns with the trends we've observed in the industry.

Todd, can you discuss the core businesses? I understand that excluding market impacts, the servicing business excluding securities lending was a bit weak. You mentioned in the press release that activity was low this quarter across the assets as well. Please provide your outlook for growth in servicing fees, excluding securities lending, and how much the lower activity has affected this line this quarter.

And you also need to factor in the impact of the currency a bit of the stronger dollar because there are a fair amount of non-dollar revenues. So that’s costing us somewhere between 200 basis points and 300 basis points in revenues.

Sequentially, Todd?

Not sequentially, sequentially it’s almost neutral. So it’s not a big impact sequentially.

Ken, I think one way to look at it is revenue growth is a challenge. I mean look at everyone across the marketplace, trying to generate significant revenue growth is a challenge for everybody. We are winning in the places that we want to. We would certainly like to deepen our client relationships and provide more services to many of our existing clients. And I think we have a great solution set to offer. And so that’s one of our key priorities is doing more within existing client base with a great set of value-added services and solutions. But revenue growth is tough and that’s why we’ve said and remain incredibly diligent on the expense side. And that remains a focus and we still think we have more opportunities there. And that’s what really propelled our earnings growth this year. And it’s going to be one of the reasons for our success in 2016. So yes, it’s a bit soft, we acknowledge that. We are redoubling our efforts on our client relationships but we’ve got to pay a lot of attention to the expense base to deliver the earnings that you all are looking for and that we are looking for.

Yes. And just on that point about operating leverage, again the market environment is going to make this a tough one to answer. But how much additional flexibility do you have on the expense base, if the environment doesn’t quite pan out; can you commit to getting operating leverage? I know it’s tough given where the start of the year is but how much flexibility do you think you have on top of the actions taken to continue to ratchet down expenses further?

Why don’t I start that one and Brian then you might add. Brian has really been leading a significant component of our business improvement process. We still see a number of additional things that can generate some additional cost benefits. I must admit that fruit’s probably a little higher on the three but there is still a fair amount of fruit. We’re seeing our infrastructure cost continue to come down, we are using more automation tools, we’ve got things like bringing our own device that Gerald alluded to, some of these are smaller dollars versus others, and our real estate strategy I think is paying off. We’ve got ahead of where we thought we would be this year as we moved out of one lawsuit faster than we could and that brought our guidance for expenses in the occupancy space down and we reviewed our guidance because of that. We also see other real estate strategies that could add a bit. We see opportunity in some of our market data, actually probably find cheaper sources of market data and more appropriate, so we got better tools in place to determine who is using what and how we can deliver better services that are less costly. I don’t Brian you have anything to add to that.

Yes, I believe we are increasingly focusing on our major strategic projects and investments by relying more on our internal team and developing our capabilities whenever there is a sustainable need. This approach reduces our dependence on contractors and consultants. One key aspect is the ongoing IT application development in-sourcing, which not only cuts consultant costs but also enhances our speed to market and productivity. Overall, our focus is on managing various elements of these expenses.

Maybe just one more on expenses, I know that outside services came down pretty nicely year-over-year. If you could give some color on that in terms of how much of that is sort of core services, like outsourcing, basically headcount replacement versus more traditional pro-services like legal and technology, and the trends and the outlook there.

Yes, we are definitely trying to move away from relying on outside services, especially in areas where we can handle things internally. This shift is evident in both our legal and temporary service functions. We monitor this closely. Whenever an outside service has been in place for a while, we get a notification to assess why it’s still being used and why we haven't brought it in-house. Brian, you may want to add your insights, as you've been involved in many aspects of this.

Yes, I think we’re continuing to build a culture focused on achieving appropriate returns on investments. There are definitely areas where we are very aware of the potential benefits when determining the next steps for any initiative. If we find a reason to delay some projects, we will certainly take a step back and review them. We are also moving forward with evaluating all of our expenditures, which will help us make activity-based decisions in the future.