Okay, wonderful. Thank you, everybody, for joining us. We'll get started with our next session. I'd like to welcome Eric Aboaf, State Street's Vice Chairman and CFO. State Street is one of the largest global asset servicing and asset management firms, with over $40 trillion in assets under custody and administration and $3.7 trillion of assets under management.
While 2023 has clearly been a turbulent year for the markets broadly and capital markets in particular, State Street is starting to see a meaningful improvement in service and sales and some signs of stabilization in net interest income, all while controlling expense as well and returning substantial amount of capital to shareholders via share repurchases. Eric will make a few prepared comments, and then we'll jump into Q&A. So great to see you. Thank you for being here. Podium is yours.
Thanks, Alex, and good morning, everyone. Just a reminder to our audience that today's discussion may contain some forward-looking statements, and the actual results may differ materially from those statements due to a variety of important factors, including the risk factors in the Form 10-K and our other SEC filings. Our forward-looking statements speak only as of today, and we may not update them even if our views change. So, with that, this morning, I'd like to make some brief opening remarks on some of our key areas of focus, after which I'll hand it back to Alex for Q&A.
As we approach the end of a turbulent year and turn our thoughts to the coming year, we're intensely focused at State Street on executing our growth strategy, achieving a number of meaningful fee revenue and productivity goals, which will position our long-term business for long-term success. And finally, driving positive fee operating leverage in 2024. Back in September, we outlined four areas of our investment services strategy that we expect will enhance our ability to drive organic fee revenue growth. Those actions include driving market share gains across key regions and products, increasing our back-office custody wins and Alpha wins, and accelerating our onboarding backlog to drive faster growth and creating further scale in our private markets businesses.
To make these areas and efforts measurable, we've introduced servicing fee sales targets of $300 million this year and $350 million-$400 million in 2024, which provides an external benchmark that all of you, as our investors, can track and give us line of sight to 2%-3% organic fee, servicing fee revenue growth upon full installation. With that frame of reference, we're pleased with the $91 million of servicing fee revenue wins that we achieved in the third quarter and are working towards our goal of increasing sales this year. We also expect to see private markets year-on-year fee revenue growth of 15% in 2024, faster Alpha onboardings, and an increased focus on traditional back-office wins.
In the third quarter, in fact, 90% of our wins were in the back-office products, which demonstrates tangible progress on our back-office strategy. Now, let me turn to our multi-year transformation journey to drive increased productivity, which helps us both to improve our business processes and to drive margin performance, and is where I'd like to spend the bulk of my time today. Our productivity actions will play a key role in our plan to achieve positive fee operating leverage in 2024 and provide long-term efficiency for State Street and benefits for our clients. We continue to make progress across the three key productivity pillars that we outlined last September: simplifying our operating model, reengineering and automating our processes, and optimizing resources in order to create efficiencies.
Let me provide a few examples of some of the work currently underway as we pivot to the next phase of productivity, particularly in our operations area, which we call global delivery. On simplifying our operations, we expect to achieve sustained productivity changes in two ways, which will enable us to further enhance our client service model. First, consolidating and integrating joint venture operations, and second, increasing span of control and consolidating subscale operations. Regarding the first action, as we announced in the third quarter, as part of our ongoing transformation and productivity initiatives, we're streamlining our operations in India and have now assumed full ownership of our India operations joint venture with the Atos Group. We also just announced earlier this week that we intend a similar undertaking with our joint venture with HCL. As you would expect, consolidating these joint ventures will increase our headcount.
However, these costs are already in our expense base today, reported under our comp and benefits expense line items. Importantly, these consolidations will enable us to unlock productivity in the years ahead, generate immediate savings and lower operating costs. The consolidation will be a catalyst for significant improvements in our operating and operations globally. In terms of increasing our span of control, we plan to go from the current management span of control of one to five to a more streamlined span of control of one to eight, thus flattening the management organizational structure. The reduction in organizational layers will facilitate faster decision-making, while also increasing employee engagement and development opportunities by co-locating smaller operations teams and further improve our response times and client service levels.
To deliver these productivity efforts, we expect to take a charge in the fourth quarter of approximately $175 million-$200 million, attributable to severance costs, primarily related to about 1,500 headcount reductions. This will be a notable item in 4Q, but with an expected average payback of under six quarters for each action, with actions beginning at the start of 2024. Roughly two-thirds of the payback will be realized by the end of 2024. Next, we will continue to build on the successful reengineering and automation efforts through further standardization, redesign automation of our processes. These efforts are expected to be further enhanced and accelerated as our new State Street COO more fully integrates our technology capabilities into our operational processes.
Finally, we're still optimizing our resources, which includes realigning new and existing resources to higher growth areas, workload rebalancing to improve employee productivity, in addition to rationalizing the level of third-party spend. As we look to 2024, taken together, we feel confident that our continued emphasis on our strategic priorities to serve our clients, drive organic servicing fee growth, as well as the next phase of productivity that I just outlined, will help us to achieve positive fee operating leverage in the coming year. With that, I'm going to go turn it back over to Alex for tonight.
Great, Eric, thank you so much. I appreciate it. So, decent amount of things to unpack there, maybe starting with the servicing business. And, I really appreciate you guys providing incremental color. I think the comment that you probably got from a lot of investors over the years is that, the custody bank as a business, is more opaque than it should be. And so, you know, providing extra stats around sales and the efforts you guys are doing is definitely helpful from a revenue perspective, not just from an asset, the asset perspective. So, you just talked about changes in sales organization, so let's dig deeper into that a little bit. So 2024, you're targeting $350 million-$400 million range in sales in terms of revenues.
That's almost a 7% growth on a gross basis on your kind of installed base, so obviously very healthy improvement. What's changed? So what is driving and, you know, this kind of improvement, and more importantly, how do you think about sustainability of that kind of growth sales revenue momentum beyond 2024?
Yeah, Alex, I'd describe it this way. There have been years, if you go back five, six, seven years, when we've had more robust sales. And so, part of this is adjusting and, you know, shaping our sales capacity for the current environment, the current competitive environment, our current product set, and also, you know, our organization. I think the biggest things that we're doing that are different is could be described this way. First, there are some leadership changes that we've made, putting all of sales coverage, really parts of client service, that front end, in under a Chief Commercial Officer, right? Who can really bring those units together.
Mm-hmm.
Secondly, we've actually built out and learned how the organization structures, and capabilities, and incentive plans that we've had in Europe and Asia, which have been particularly fruitful.
Mm-hmm.
We've begun to bring those imports into the U.S. And, you know, we've learned on compensation, for example, is we need very defined incentive plans for sales, but the client executive and relationship management need a related, you know, net new revenue growth set of incentives that then can really bring the focus of State Street to those clients. We've realized that there is some administrative work that we can offload from the sales force and actually centralize right inside sales versus front sales. And so there's a series of changes that we've made that we think will sharpen what we're doing. The envelope of all that is the product offering, right, that we have, which is a combination of traditional back office and Alpha.
Yep.
That, you know, is incredibly powerful with our clients. And what we've learned there is that as we lead with Alpha, we need to make sure that the back office comes early in those deals.
Mm-hmm.
That is part of the package, not a potentially, or maybe, or afterwards, because that actually can be installed actually faster than any other part of the offering, and has the right, margin characteristics for us to then make the full Alpha offering really viable for both us and for our clients. So, how we sell, Alpha, you know, top down from, you know, Ron's role, our Chief Commercial Officer's role, our client executive's role, and our, Alpha product team's role, is really shifting to actually be a, a fulsome sell and one that actually includes the, the, the back office as a predicate and often as the beginning of the of the installation as opposed to the back end.
So, you know, some organizational changes, and then I think there is some leveraging of our distinguishing product and functionality capabilities that we have that are unique in the market. And actually then building off of some of those successes, because we've had areas of success there that we've seen, for example, in Europe, it's been particularly strong. We've talked about in Asia, and making sure that we have that across all of our regions and key segments.
I got you. Let's talk about the other side of the coin, which is retention of business. Again, it's a strategic priority for you guys because even though 6%-7% organic kind of growth sales is great, but you got to retain the back book, and you put out some targets there as well. I think you said you're aiming for a 97% retention up from 96%, which has been, I guess, kind of historical average.
So walk us through kind of key initiatives aimed at improving retention rates, maybe discuss some of the issues that drove elevated level of some of the exits in recent years, and as a kind of follow-up to that, I think we should just hit on price as well, because will higher retention come potentially with more pricing pressure? Or are you still baking in about that 2% price pressure kind of point over time in the growth algorithm?
Sure. Let's pull them apart. So, retention has always been part of our DNA and what we do. We did have a period, really during the COVID era, right, where we had more turnover of staff. It was harder to work remotely. We had, you know, we all had that attrition, and trying to find the right staff to do the right amount of work or the right type of work as we grew was harder and harder. And that actually created some impact on our clients and impact on us in a way that we couldn't serve them quite as well as we would have liked. I think we've gotten past that, which is why our retention now is back up to the 97% versus, you know, the 96% that it fell to. You know, percentage point matters in our business.
Sure.
Right? It's another version of a percentage point of organic growth.
Yep.
So that was the most recent element that we had to navigate around tactically. Now, the more systemic effects or elements that help drive high retention rate are really twofold. It's about client service on one hand, and how we do client service, with whom, how effective it is, how well we can connect the right experts to clients, right? On questions they have or needs they have or you know, just the daily NAV process, the functionality that they see. And then it's from product.
Mm-hmm.
Really, product and functionality, making sure that's always distinguished. And, you know, that's an area that we're always innovating on. You know, one of the initiatives we've taken, for example, recently, as I've just mentioned, is to consolidate some of our joint venture operations. Why? Because they actually would create multiple layers before you got to clients.
Yep.
Right? And there were too many handoffs in the process.
Mm-hmm.
And in fact, the other part of managing and delayering and actually flattening part of the organization is so that we can have the right client service experts directly connected with our clients, as opposed to having a set of handoffs. So, you know, client service is an art. It's an art, especially in a very complex business with very many products, multiple geographies, different legal entity sets that clients are operating in. But it's one that we've mastered, but we think we can keep getting better at.
Mm-hmm.
That'll tighten the relationships. Product feature functionality is something we continue to invest in, whether it's with Charles River, whether it's with Alpha, whether it's back office custody functionality. You know, every year, you're adding a little more, either to keep up or to differentiate yourself versus peers. And then finally, I think, retention comes from the offering that we solidify with our clients. You know, we talk about our Alpha offering front to back.
Yep.
Right? Those tend to have longer tenured deals longer maturity deals. They tend to, we expect, will roll over with even more frequency and be even higher in terms of retention, because at that point, we're so embedded with our clients and what we have to offer. So that's the approach, and I think, to be honest, the success we've had on retention, you know. And, you know, our goal is to maintain it at this 97% level, which we think is, you know, both important and, you know, something that we can continue to do.
Yep. And I guess in terms of pricing, so, would the pricing level also play a role in the ability to retain, or pricing is what it is, and the retention efforts are really just functionality-driven and so we don't need to talk about it?
Yeah. I describe pricing as table stakes.
Yeah.
You know, clients, especially the clients that we have, you know, medium-term and long-term relationships with, want a, want a fair price.
Mm-hmm.
They want to make sure that, you know, we are conscious of their economic situations, but they also don't want to switch, right? They don't really want to switch, just for switching's sake.
Yeah.
In many ways, pricing, in our minds, is table stakes for what we do, and we just need to make sure that, you know, we're current on market practices. We've got a lot of data on that and transparency, and we'll continue to manage that, I think, in a healthy way, as we have.
Yep. Let's talk about private markets for a couple minutes.
Okay.
It's an important strategic growth priority for you. You highlighted 15%, maybe over 15% growth in those fees for the firm into 2024. Walk us through kind of your medium-term outlook for this business. What differentiates State Street versus competitors? We obviously all talked about private markets, and Nasdaq has grown substantially. Where do you typically play? Are these the larger players that you're trying to sell into, medium, smaller players? Just give us a little more lay of the land of what that business looks for you guys.
Sure. Let me, let me start kind of outside in, as you've, as you've described, right? The private market servicing business is a $6-$7 billion, you know, revenue pool out there, so it's large. Right now, you know, private market servicing for us is about 7% or 8% of our, of our servicing fees. It's a large market space. We think it's growing at 10%-15%. You get slightly different indications from different areas. What it's characterized by is it's still largely fragmented.
Yep.
Right? There's no dominant player, no player's got more than, you know, even 10% share. You know, most, I think all of them have less, in fact. And it's one that's highly enforced, right? So in a way, it's a classic business that we participated in. You know, over the last year, as much was, much like core custody. Core custody used to be insourced, it used to be fragmented, and over time it's gotten consolidated, by us and other providers. So there's a real attractiveness to it in all of you. And you all know the, you know, level of growth and expectations that, that you see in that marketplace. You know, from our standpoint, we've got tremendous client access to those who need private markets and alternative servicing, right? On one hand, you've got the alternative players, you know, some large and public, some medium, some smaller.
Yep.
And we know them all, right? And we usually do something for someone, right? And then you've got the traditional players that have increasingly barbelled, right? And, you know, some of them have $1 trillion in total assets, but they might have $100 billion of alternatives, and, you know, to complement their other $900 billion more traditional activities. And so we have very significant client access, all the way up through the C-suite in just about all of the alternative providers. And I say it that way because it's not as if we're going after just the medium-sized ones or just the alts only players. It's actually a really wide range of clients that we serve today.
Mm-hmm.
And then in terms of, you know, client prospects, we generally know and do something for just about everyone out there. In terms of differentiation, this is what's shifting in the market, and I think where there is a, I'll call it a race to differentiate even more.
Mm-hmm.
The historical base of differentiation is around client service. Why? Because we're serving a set of highly bespoke and customized structures.
Yep.
Those are often structures that are very different between, you know, private credit, infrastructure, real estate, private equity. You can keep going. Regionally, they're different because of the legal structures.
Mm-hmm.
And so it's been around, putting people at work in a systematic manner, but very customized, right? And so over time, the innovation that we've been doing is to take areas of alternative.
Yeah.
You know, private credit is, is the one where, we're, we're probably the most advanced in today, and, literally, automating more and more of those processes, right? And making them systemic, in a way that they become scalable. Because the challenge our clients have is not, can someone do their servicing today? It's if they're in high growth mode, and some of them are growing 20%-30% a year right? Can they, can they get the servicing they need two years from now and three years from now? And what we're finding, to be honest, is, these clients, they don't want to be in the servicing business of their alternative assets.
Yeah.
Why? Because it's actually, it's ballooning their headcount base.
Yeah.
It's, it's creating a different kind of organization that they're, you know, that they're not as interested in, in... They, they want to focus on what they're good at, right? And so there's a real opportunity here, but over time, it'll be around service and technology automation. And you know, we're, we're in the best position, we're in the pole position, to be honest, to be able to do that. And what we're doing is doing it area by area, because it's at that level that you can really make a difference, and differentiate yourself and accelerate growth.
Because they just, you know, maybe piggyback on that a little bit. A lot of alt managers are obviously venturing out into the wealth channel. Over time, that might require more standardization, and it feels more like a traditional product, right? Which you guys obviously dominate the typical mutual fund and ETF landscape. Does that accelerate your prospects when you look at your pipeline? Are you talking to a lot of the firms that are launching a, you know, next version of non-traded BDC, non-traded REIT, interval fund? Is that the bulk of your pipeline, or there are other things that may be less related to that?
That's absolutely part of our pipeline. It's actually what is making the business growth prospects even more attractive. To be honest, one of the ways that we differentiate ourselves is we're having a lot of discussions with those alternative providers about those sorts of products.
Right.
Right? And they look at us not just as a custodian, but with many of them, we're having very senior conversation about, "Hey, can we jointly launch interval funds," right? That have liquidity and illiquid characteristics, you know, built in. Why? Because we are one of the largest index providers. So there's both a relationship set of discussions that we have, right? About co-creating and co-developing products and launching and using each other's distribution forces. And then when it comes to servicing, I think the democratization of the alternative products is actually one which then, you know, forces the need for the technology development. And in some ways, you know, because we spend a quarter of our expenses each year, right? We spend $2 billion a year on technology.
Yeah.
Right? We've got both the resources, we've got the know-how, we've got the capabilities and the functionality and to build the functionality that's necessary. I think the kind of the wealth evolution of those products or to kind of, you know, broad-based wealth clients, and even to just high net worth or affluent clients, is going to continue to accelerate the needs for servicing, because it just can't be done in the old-fashioned way anymore.
Right.
And that, to us, creates yet another, you know, impetus for change. And it creates an impetus for refined and new servicing products, and it creates an impetus for more and more of these alternative providers to say: Look, you know what? I need someone else to do this servicing stuff because it's become so capital intensive, it's become so scale-driven that I'd rather focus on what I'm great at, which is investing.
Yeah, that makes perfect sense. Great. Let's touch on the second kind of big theme you hit on, which is driving more operating leverage in the business in a more kind of systematic way. So let's talk about expenses for a second. On the last call, and you reiterated it just now, you're looking to drive positive fee operating leverage again into 2024. I think that implies a fairly modest pace of expense growth again next year. I don't know, reasonably 1%-2%, maybe something in that range. So can you talk us through the ability to sustain this kind of positive fee operating leverage model more, you know, more systemically, right?
Like, if you think beyond 2024, what are you doing in the business to kind of let, let that roll beyond, you know, the charges you guys are taking this quarter, and that's going to drive some efficiencies? But beyond 2024, is that something - does, does something change in the business model to enable you to do that more consistently?
Yeah. I think you've seen the way I describe it is, you've seen us launch what I describe as a wave of productivity initiatives and transformation initiatives, you know, dating back really to 2019, right? And, you know, now, you know, we're three, four, five years into it, and each year you've seen us re-up, right?
Yeah.
Part of that comes from we've really changed the DNA of the company to say, "Look, we're a large manufacturer almost.
Mm-hmm.
Right? A servicing player." And so over time, we actually need to roll down that scale curve, right, and get the efficiencies that are necessary to continue to serve our clients. How we do that has evolved, right? You know, when we started, it was around the you know the very top layer of the company and the you know the senior bureaucracy we had created. Then we did a lot of work around third-party vendors and using our purchasing power more effectively and thoughtfully, and that created a set of opportunities. You know, real estate, right, was very important as a driver. And you know so each year there's kind of a new area.
Mm-hmm.
I think what I'd describe to you is, Then we go back to some of the original ones and say, "You know, what's the next stage of Whether it was vendor, or real estate, or layers that are important. So that's why I think we have a lot of confidence that we can continue on for multiple years in fact, just as part of our business model.
Yeah.
I think the other is that over time, what we've been doing more and more of is automation, and engineering, and redesigning of processes.
Mm-hmm.
Because that's actually where you get the most sustained changes, and those are ones that actually help us from an efficiency standpoint, but they help our clients because our clients then get the best of State Street nearly instantly right? As opposed to with a bunch of handoffs, and checks, and balances that make sure it works. And that's where we're spending more and more of our time. The reason I described the joint venture consolidations is that, you know, we built those up as we grew over the last 15 years. But what we've realized is that it created a set of separate and processes with big handoff points.
Mm-hmm.
Right? And then groups checking other's groups, as opposed to a more systematic, you know, process. And I can go into, you know, loan accounting, recons, different elements of, you know, what we do, in core accounting, and every one of those had a set of steps that had big breaks. And so, you know, with the consolidation, it lets us actually take the operations area and pull it back apart and then reconstitute it.
Mm-hmm.
That, that'll be not a one-year effort. That'll be really a three-year effort, but with a very substantial benefit in the first year. But that'll come from full process redesign. This consolidating our joint ventures is really the catalyst for letting us do that, I won't say once and for all, but in a real dramatic way that we've been inhibited, in or been restricted on until now.
Got it. Okay. So, let's zoom in a little bit to Q4. Given the time of the year, maybe spend a couple of minutes giving us an update on how you're thinking about the quarter. You guys always give a lot of specific guidance, so I'll let you take it away.
I think I'll take that as a compliment.
Yeah.
But, let me update you with some a little bit of background as we're in the midst of. You know, we've just closed the books for November. We still have another full month to go. I'd say that our outlook for the fourth quarter is stable in aggregate, but I'd make a couple of observations just to help with some of the line items in the area. As you think about our guidance on a year-on-year basis and excluding notable items, as usual, we currently expect total fee revenue to be flat to down slightly, with some puts and takes on some of the line items relative to our prior guide. So let me just itemize those.
We expect that servicing fees will be in line with our previous guide, of roughly flat year-over-year, reflecting higher average equity markets, offset by a little client activity, and then the expected normalization of pricing, which we noted earlier this year.
Mm-hmm.
Management fees are expected to increase approximately 2% year-on-year, which is better than our previous expectations for roughly flattish performance, primarily reflecting higher equity markets. Our tradings and markets businesses, we now anticipate a more pronounced year-on-year decline in revenues as compared to our initial expectations, reflecting subdued market volatility, which we see as relatively industry-wide. Software and processing fees should be up about 10% year-over-year, reflecting the timing of some on-premise renewals and expected new SaaS installations. We think that the other fee revenue line will come in slightly above the higher end of the $30 million-$40 million range in the fourth quarter. In regards to NII, well, we have a few more weeks to go.
At this point, we now expect fourth quarter NII towards the higher end of our $550 million-$600 million range, as non-interest-bearing deposit rotation repricing are moving a bit slower than initially expected in the quarter. This year, as we've moved through the credit cycle, there have been some puts and takes with provisions. In this quarter, we expect it to be around $20 million. Turning to expenses, we remain laser-focused on controlling costs in the current environment and continue to expect relatively flat quarter-over-quarter expenses on an ex-notables basis. And lastly, we currently expect our 4Q effective tax rate ex-notables to come in 1-2 points below our prior guidance of approximately 22%.
Great. Awesome. Super helpful. Let's unpack that a little bit, but maybe talk about 2024 while we're at it, and I'm not sure if you are ready to give us a full-fledged guide in the S. But even just kind of thinking philosophically, you talked about NII being at the higher end of that, you know, $550 million-$600 million range. Obviously, the rate curve is really all over the map, right?
Yeah.
So it's really hard to know exactly where things will fall out, but does that upper end of the range still hold, knowing what we know today?
You know, it's early. It's early to be definitive about 2024.
Yeah.
You know, we're doing a lot of preparation for our January call. You know, the current indications are positive for NII. But we'd like to see, to be honest, a few more months of stability in deposit levels that, you know, before calling it definitive.
Yeah.
So, I think we're comfortable with our previous statements.
Yeah.
And you've described them fairly.
Yeah.
But, you know, we're we're at an inflection point with regard to rates, with regard to non-interest-bearing balances. You know, we've seen them float down again this quarter, but a little more slowly than we had expected.
Yeah.
You know, but we want to kind of see how that plays out, and the same thing with total deposits. So yeah, we're, I think we're getting closer to having a good understanding of next year, but it's still a little early, and I'd rather actually just give guidance or clarity on where we are today and give some indications of what we're, what we're seeing along the lines that I've described.
And the slower rotation in non-interest-bearing deposit that you just highlighted, do you think that's just largely a timing thing?
Right.
Or you're just getting more granularity and more sort of, you know, kind of feedback maybe from your customers, to get more confidence that we're closer to the trough in this rotation?
I think it's both. It's just, it's hard to unpack it, you know, month by month to be honest. And so, you know, we had expected $3 billion-$4 billion of reductions in non-interest-bearing, where we're not even seeing, you know, half of that movement yet.
Yeah.
But, you know, and we have lots of data on a, you know, specific client positions, negotiations, discussions, and then, on the other hand, we've got 30,000, you know deposit accounts that we've got. We've got, you know, our machine learning tools navigating through those. So, but it's a mix, it feels like. It does. I don't think we're in a position where we were a couple quarters ago.
Mm-hmm.
Right? Where you know, the declines were rapid right? Which just were offsetting the increases that we saw, you know, a year and a half ago.
Sure.
Right? So I think, you know, we're watching this evolution and are seeing with a little more confidence what to look out for. You know, I think we're comfortable with the guidance we've gave until now, and you know, we'll take it from there.
Okay. We have a couple seconds left, but I'll squeeze another question on buybacks. Expectations for Q4, but also, you guys continue to be in a really healthy excess capital position. Is there any early thoughts you have for 2024 in terms of share repurchases?
I think, you know, we clearly had to do some catch-up on buybacks this year.
Sure.
That was important to us and to many of our shareholders, and we thought we proceeded that at pace, you know, including at the start of the year. I think next year is really around our medium-term target approach that we've taken. You know, 80% of earnings should go back to shareholders, and 80% or more of earnings should go back to shareholders in the form of capital buybacks and dividends. You know, obviously, we've got to be careful what's the environment look like, what are the external factors, right? There's always a set of those.
Yep.
But we'd like to get back to our medium-term kind of target approach, which we think is very healthy set of both, you know, capital trajectory.
Great. All right, Eric, thank you very much. Thanks for being here.