Everyone, we have our second fireside chat with State Street Corp. Joining me is their CFO and Vice Chairman, Eric Aboaf. As many of you know, Eric joined State Street back in 2016. He had a short stint over at Citizens Financial prior to that, and then before joining Citizens, he was with Citigroup for a number of years. Many of you know that State Street's our 10th largest bank in the United States, with assets of almost $300 billion. It has $42 trillion of assets under custody, and it drives 78% of its total revenue from non-interest income, which differentiates it from a traditional bank. In the fourth quarter, it put up an ROTCE of about 18.8%. So Eric, thank you for joining us. Maybe we can start off with s-
Gerard, just to-
Sure
... satisfy-
Yeah, I'm sorry, yes.
... our legal requirements.
Go ahead.
I'm gonna remind everyone before I get started, today's discussion may contain some forward-looking statements, and as you know, the actual results may differ materially from those statements due to any number of important factors, including the risk factors in our 10-K and other SEC Filings. Our forward-looking statements speak only as of today. We may not update them, even if our views change, and with that, back to the Q&A. Thank you.
Thank you. You remind me of the guy, the FedEx commercial guy from 20 years ago, talking a mile a minute.
Are you saying I'm old, man?
One of the key strategies for, or successes for State Street is winning new business on the servicing fee side. You attained your $300 million in servicing fee wins last year. You're looking to up that a little bit to $350 million-$400 million this year. Can you speak to the areas you're currently seeing the most success, and are there segments where you have to have opportunities to gain more traction?
Sure, Gerard. I think the context is important here. Last year was a good year on sales, about $300 million of sales in our servicing business. The years before that were in the $200-$250 million a year, and, you know, what we've really come to terms with is for us to grow organically at the pace we'd like to, this, in this business, yeah, we need sales of $350-$400 million, and that is what the goal is for this year.
Right.
And, you know, what's nice is we're on that positive trajectory with how we finished last year and finished strong. There are really a couple areas of emphasis, and then maybe I'll describe a little bit of what the pipeline looks like. Areas of emphasis are around back office custody, right?
Yeah.
That's the core of what we do. It's the highest variable contribution to State Street. And just you've got to focus on the core traditional as well as the new and exciting-
Yeah
... and that balance matters. In terms of the new and exciting and high growth areas, private markets, I'd describe as a market that we think is growing, you know, 10%-15% a year from a servicing fee side.
Yeah.
We think we can expand at a rate of 15%+ in that market this year and in the coming years, and see that as a way to kinda average up the growth of rate of State Street. And then Alpha is another area. Alpha has been a real success for us. It's been the tip of our spear as we sell front, middle, and back with Charles River, the middle office services, and the back office custody. And, you know, we've been selling five or six Alpha deals a year. We're taking that up to six to eight this year, and in fact, our end targets are even higher than that-
Mm
... because, we know, we think there's real, real opportunity, but we think we can deliver on that, and that, that creates growth across our franchise, whether it's software, middle office, or, or back office. You know, so far so good. It's been a good start to the year. I think, clients are continuing to be interested and engaged at the C-suite level in particular. CIOs, you know, are inventorying their stock of systems and realize a lot of it is old, crumbling, on-prem, and they're looking for better. And they wanna see the benefits of data aggregation more and more, and that really comes from this front-to-back offering.
Mm-hmm.
So the areas of growth, you know, in addition to privates and Alpha, I think I described regionally.
Right.
Europe was very strong last year, continues to have a very strong momentum in the in our pipelines. The Middle East, important area. It's actually, we're gonna have our April board meeting in the Middle East-
Mm
... this year, and that'll be an opportunity for many of us to go visit with our clients, and our board members to visit with our clients. And we've got sovereign wealth funds there that have a real capacity both in servicing asset management, everything we trading everything we offer. And then North America is coming around. We were clear that we felt we've underperformed in North America last year, and you know, over the last, I'd say two years. We're seeing a stronger pipeline.
We've got clients that are interested in expanding what we do for them, and others who, in some cases, do very little business with us and are saying, "Hey, let me consider a change," given what we at State Street can offer. So, a strong pipeline, and, you know, we're optimistic. We're feeling confident in being able to deliver this higher revenue growth, and with higher revenue growth, or I'm sorry, with higher sales growth, then we can, as we install that, we get higher revenue growth and get the momentum that we'd like to see.
Yep. You touched on Alpha, and obviously you and Ron have talked about it for a number of years. Can you walk us through, you know, from those beginning days to where you are now? Do you think we're at an inflection point where customers are now more comfortable with that full front-to-back, you know, model that you're offering them?
The answer is yes, and I'd say it in a couple ways-
Yeah
... we've reached an inflection point. I think early on, you know, we had several mid-sized clients that kind of partnered it and said, "Yeah, can you just take all this stuff? We're just tired of it.
Yeah.
So there was that kind of reaction, and so we had Charles River, the middle office, the back office, and consolidated. And, you know, these were clients with $200 billion of assets under management. These are, these are substantial clients. Then I think in 2020, 2021 , we had a couple trillion-dollar deals that we announced for, for Alpha, and what we found there, and, some of these clients have been public, is that they were effectively co-development partners.
Yeah.
Because the kind of connecting that Front Office to the Middle Office and to the Back Office is easy to talk about on paper, but it's a lot harder to do when you've got, you know, the full range of products and geographies that an asset manager is offering. I think what has evolved since then and what's changed is we've become much clearer about what the proposition is because that co-development had been done, has been done, right? Especially with the largest, most complex organizations. So now Alpha is much more of a menu and set of modules. It's a lot clearer to a client what they need you to change, so it's a way for us to, you know, test their commitment.
Like qualifying a sales, you know, a prospect into a real, you know, likely client, is that they're willing to make the internal changes of processes, systems, and, approaches. And what that's done is also give us real manuals for how do we, once we sell, implement it more quickly, and that's attractive to clients. They wanna actually get on with it.
Sure.
They know it takes time, but they want to get on with it. So we've reached an inflection from, I think, a clarity of the proposition. I don't say simplicity 'cause nothing's simple to implement in these areas, but the pathway to implementation is really clear now. And the examples of how we've done it are now, you know, very well regarded in the marketplace.
Yeah.
You know, we got 24 forward , two things. One is we've taken up our sales target for Alpha, you know, 6-8 this year, and I think, you know, I'd like to do better than that, that my budget calls for better. But, you know, I'm trying to be, you know, careful and conservative with, with all of you. But, you know, we'll, we'll see the, how we do. And then the other thing that we found with Alpha is that, not only are we emphasizing the sale of the front, middle, and back office, but how, we...
What we agree with a client has changed in the sense of early on it's, "Let me work on the front office or the middle office, your pain points, and then you'll bring custody along." Now, we've done it, and that ends up with a backloaded revenue kind of implementation. We've actually turned that the other way and said, "Look, Alpha is so precious to you as clients, you have to bring custody on early, and then we'll work through the other pieces." And that gives us a way to actually bring on a client, and instead of having a tail of higher revenues, we can bring revenues on more earlier on in the process.
So I'd say we're at an inflection point in terms of more Alpha deals, and I think ones that are even more revenue accretive to us from a timeframe standpoint. We're seeing clients respond.
Yeah. So it sounds like with Alpha, you don't necessarily have to be an existing custody client with State Street. You, you can actually bring in new clients with the Alpha product and then tie custody to it as well.
That's right. I think you've got to... When you step back, remember, we're responsible for custodying, you know, enormous percentage of the world's assets, right? And we have relationships with a large majority of the top, call it, 100 asset managers and asset owners. It's, we do something for most of them. There are situations where they don't do custody with us or a small amount of custody-
Mm.
... and that's attractive for us, 'cause then there's a whole offering, front, middle, and back office custody, kind of that comes together. And that's an attractive segment for us. And then there are other groups of clients where we might, you know, have, I don't know, 35% share of wallet of custody and we don't have their middle office, or we may have Charles River in there, but not the, you know, a different share of the back office, right? There's all sorts of mixes out there, and what Alpha allows us to do with those clients say, "Look, let's actually work with you to knit together the front, middle, and back." And the effect of that is to take our share wallet up for the client.
Yeah.
'Cause we'd love the client where we might have had 30% share wallet, and now we got 50% or 60% or 70% or 80%, because in a way, we can really serve that client as a superb partner, and they can take full advantage of the offering.
Now, in terms of implementing the Alpha products for the clients, is it all bespoke, or is there some commonality between the, you know, the clients that you build—it's a chassis that you then build on the individual client needs?
Early on, it was bespoke-
Yeah
... and that's what we've really modularized.
Yeah.
So I think it's much more of a chassis, as you describe, with modules that fit in. And so that works well with, you know, equity funds, mutual funds, offshore funds, and blockers. So we've got all the pieces, the core pieces, the institutional funds, the CITs, and so forth. The areas where it's still new fertile ground, right, because it's not a, you know, modular everywhere, let's be honest, is in the alternative space.
Right
... Alpha for the, for the, for alternatives. Because what we have is we've got a number of managers who've got everything from old-fashioned active mutual funds to ETFs to institutional funds, and then they have alternatives. And that CIO or chief risk officer wants to see their entire data-
Mm
... aligned in one place, and so we've started to build out Alpha for privates, right? To bring in that data, which comes in a different kind of shape and size, into the data architecture. So that's a good example of where I think it's still in development. We signed our first Alpha for private market clients in the fourth quarter, and there's more to come, and over time we'll modularize that, right? But right now, it's in development client by client, and in some ways it lets us sharpen the offering, make it better, figure out what is scalable, and then it lets us roll it out, you know, in a wave.
Speaking of the private markets, you've in the past pointed out it's more manually intensive to service that market, but you tend to get commensurate pricing for that. What's the outlook for that area, especially now that you have your first Alpha client from privates?
You know, we're, we're bullish on the private market servicing because it's, in some ways it feels like custody, core traditional custody did, I don't know, I want to say 10 years ago.
Right.
It's fragmented, like there's no dominant player who's got, you know, 50% market share. You know, we're number one or two, depending on how you count. We've got maybe 15% share of market. It's hard to tell 'cause it's less well defined. It is a marketplace with a lot of specialized verticals-
Mm
... real estate, infrastructure, private equity, and so forth. And in some ways, there's a regional cut to each of those, and they have... Right? And then to be honest, privates is exciting and really fits our client profile in a double manner. First, we have privates through the private market firms, right, and the multi-line firms who have big private asset businesses. But we also serve asset owners, right? And asset owners are often the ones who invest in the private markets, and we may be doing custody for asset owners.
So in some ways we're on both sides, you know, of privates, and that to us is exciting because it helps us sharpen the service offering in the first place for both the kind of provider and the end investor. It is highly, you know, manual still. There are no standardized systems. The waterfalls are complicated. The structures have sidecars. You know, everything's been invented here, and but in truth, what clients are looking for is who's gonna invest and invest consistently and intensely in this area because many of them are trying to democratize privates-
Mm
... meaning they need the servicing functionality, but they need it for smaller and smaller fund units, right, and investment in LP units. And that's something that State Street is terrific at, taking a market that's kind of complex and over time systematizing it. And so, you know, as we talked about our investments for the year, it's a big part of our investment, area. And you know, our view is, just with what we do today, we can grow 15%, you know, per year in privates on the servicing side. You know, I'd like to see if we can, you know, build on that year after year after year and make it a bigger part of our business-
Right
... so that there's a real area of growth over and above the traditional activity-
Right
... which grows more in the, you know, low to mid-single digits.
Right. Maybe we could shift over, Eric, to the outlook for the first quarter. It's obviously the markets have started off strong this year, the equity markets in particular. Now there appears to be maybe fewer interest rate cuts coming this year, this year, if the forward curve is better at forecasting today than it was in January. What's the outlook? Any updates for the quarter or the year that you'd like to share with us?
Yeah, I appreciate it. We've now closed two months of the, of the quarter, so we got one month left, but we have some, some sense for where we're coming out. Maybe to start on the points you've made, you know, on a macro level, as you mentioned, quarter to date equity markets have been a bit better than expected-
Right
... you know, better than expected back in January. At the same time, we've seen FX volatility continues to trend downwards-
Mm
...and less specials activity at the same time. So there are some ups and downs, depending on what part of the business. In terms of rates, we're now seeing an expectation of 3-4 rate cuts. You know, we'll see what happens. We monitor that in the U.S. and internationally at the same time. So, we'll see how that plays out, and we still plan on the forward curve at this point. So there are puts and takes in the macro environment, but we believe it's a net positive to our fee operating leverage for the quarter.
Yes.
Let me describe that. Given the factors, we now expect our first quarter fee revenue outlook to be a bit better, now up 2%-2.5% year-over-year, relative to the prior outlook of up just 2%, so a bit better. Servicing fees are expected to be in line with the prior guide of +1%. Management fees are expected to show an improvement above the better end of the prior range of up 7%-8%. And we still expect front office software and data to be up over 20% year-over-year, you know, largely due to the increase in SaaS, new business conversions, and renewals. So, good, good momentum.
We continue to expect NII to be in line with our prior guide of flat to down 3% quarter-on-quarter, with total deposits largely coming in as expected over the first two months of the quarter. Though, as we've said before, deposits are just difficult to predict in this environment, and, you know, we take it month by month and, obviously, update as we can. Before I move to expenses, I would note that while our overall credit book remains high quality and quite healthy, relative to the $20 million in provisions that we saw last quarter, we expect to take a provision in the first quarter of between $25-$35 million, largely due to two CRE names, as we just, you know, work through the economic environment.
On expenses ex notables, we continue to effectively control costs and expect first quarter to be slightly better than our prior guide, and come in at the better end of our previous range of up 1%-1.5% year-over-year. Then lastly, we expect the first quarter tax rate to be about a point higher than the high end of our full year range of 21%-22%, but we still expect the full year tax guide to remain the same as our previous guide, so we've got some quarterly variability. Finally, I would remind everyone of the guide I gave last week regarding our preferred equity shares.
Yep.
We would expect to see roughly a $10 million and $15 million increase in one-time preferred costs in the first and second quarter, respectively, relative to the approximately $40 million that we had at the end of last year. And then we'll revert to around $40 million per quarter going forward, starting in the third quarter with dividends subject to board approval, as you'd expect.
Coming back to interest rates for a moment, we've been through a period here, when you think back pre-pandemic, you know, then we hit the pandemic, we go back to 0%, then we go up to over 5%. Can you share with us, you know, as we go forward, in an environment you would ideally prefer... I mean, is it a steeper yield curve with maybe the short end coming down to 3%, long end staying at 4%-4.5%? What's... If you had a magic wand, Eric, what, what would you paint as your ideal environment for State Street?
The way I would describe that, Gerard, is that we'd like just to see consistency in our NII.
Mm-hmm.
In truth, our NII should grow in line with our fee growth, our medium-term targets of 4%-5%, right? Because as we bring on custody business, custody accounts come with deposits, and deposits are part of the client P&L and the balance of trade that we have with clients. For that to be healthy, because we've seen the bookends now, right?
Right.
We were in that zero-rate environment for a while. We saw kind of the rise, you know, 4 or 5 years ago, then a collapse in rates back to zero, then this, you know, faster than we've seen rise in, you know, in a couple decades. What would be, I'll say, better, because there's nothing perfect when it comes to interest rates, is we'd like to see some moderate levels of rates that we can count on. And that's not zero, and it's probably not 5% in this economy, but, you know, 3%-4% prevailing rates, that'd be, that'd be healthy. We'd like to see at least not an inverted yield curve.
Mm-hmm.
You can see I'm setting my expectations, self-expectations carefully. We'd like to see some slope to the yield curve. That'd be appropriate over time, and that would give us some ability to actually earn based on the maturity spectrum. We'd like to see a little bit of volatility and convexity premium in the agency mortgage-backed space, just because we invest in that, given it's government guaranteed and very low risk weights. And then internationally, we'd like to just see a range of rate curves, you know, across the euro market, pound sterling, Aussie dollar, and so forth.
Because, you know, we do business in every one of those currencies, and we have an ability to actually shift our investment portfolio between currencies and take advantage of the basis advantages, so that would be helpful as well. So anyway, that's what I would describe as a better environment, and we'll see. You know, it'll be interesting to see whether the back end of the curve sticks to where it is as the Fed begins to cut three or four times. We'll have to see what happens in Europe and Asia as well, but time will tell.
Yep. Can you frame out, you mentioned earlier that the best growth last year was in Europe. You're holding your annual meeting in the Middle East. Well, when you frame out the different central banks, is there any way of weighting that, you know, the Fed's actions are 70% or 80% most impactful to you versus the ECB? Is there any way of framing that out on who's the most important and, how it might affect you, you folks?
Yeah, we've with our investor relations team, I think, has done a very nice job with our business teams to actually map out our balance sheet-
Yes
... across currencies. And so you got a dollar, we show an abbreviated dollar, a balance sheet, euro, sterling, and then you get the all other. You know, the U.S. is 60%-65% of the balance sheet.
Got it.
But you have, you know, 30%-35% in the foreign currencies.
Mm.
And then, you know, sometimes what'll happen is the asset side of the balance sheet could be, you know, even more foreign currency or less so-
Sure
... depending on where we see the relative opportunities. We do seem to sense that in the developed markets, the U.S. Fed is leading. It's leading on the way up, and it-
Sure
... feels like it may lead on the way down, and that's a barometer for, for other central banks to move.
Mm.
They're looking at purchasing parity and so forth. In the emerging markets, it's a little less clear. There, you know, the emerging market currency rate levels, which also matter to us, right? Because that's where we do real servicing in those areas.
Mm.
We collect deposits in many of those emerging markets or higher growth markets. There it tends to be a little more dependent on inflationary expectations. And then to be honest, the health of the and confidence in the global asset managers investing in emerging markets, that demonstrates a, I'll call it a risk on kind of environment, and that's good for us, too.
Sure.
You know?
Sure.
That's part of what we'd like to see was interest rates kind of settle into a rhythm is, you know, does cash come off the sidelines? That'll help our asset management business. That helps our trading business, because then we're facilitating the currency translation or hedging or what have you, and we still see a lot of cash on the sidelines. In truth, the thing I'd like to see in 2024 is enough confidence. Now, you know, there's always political, economic disturbances and so forth. That's probably the biggest holdback, but confidence in economic growth-
Sure
... because that means investors are looking around the world and taking advantage of everything State Street can do, and we, you know, we can support them in that and monetize at the same time.
Sure. Coming back to the balance sheet and deposits, custody banks generally, State Street included, have a different deposit base than some of our regional or even the large money center banks, not having obviously a consumer, interest, non-interest-bearing checking account customer. If they start, or when they start cutting rates, how quickly would you envision you being able to, you know, cut your rates, meaning the deposit beta now, if you will, on the downside, how quickly should we see that take place?
Gerard, you know, we've as rates rose, right, you know, betas-
Oh, yeah
... you know, we lag rate rises in, you know, with clients, so we had to catch up, right?
Yeah.
That's kind of the normal course of events. And so you had a kind of a, you know, low beta to higher beta, and even now we kind of continue to have a little bit of this catch-up going on. As rates get cut, and we all saw some mix shift, right?
Yeah
... between different pricing tiers. Our perspective and belief in plans are that betas, as rates get cut, will be relatively symmetric to where they were on the upswing, but symmetric by, I'll call it, currency and pricing tier.
Mm.
So remember in deposits, we've got non-interest bearing, at least in the U.S., then we have interest-bearing, very transactional, I'll call them very standardized rates. Those are pretty modest, where there's enormous transaction flows, and it's a way for a client to cover their overdrafts and support the balance sheet usage they take. Then there's, you know, some higher rates, a little like money market rates or some exception rates or some initiative rates. So there are different tiers, and, you know, with sophisticated clients, we tend to have a breadth of their deposits in different tiers, 'cause that's what they deserve to have, right?
Sure.
They have deposits for different categories of their needs. And so what we'll tend to find is that beta should actually be relatively symmetric on the way up and down within those tiers. What we don't really know is how, you know, we'll see some deposit mix across tiers-
Right
... or across geographies. That's, you know, we saw some of that. That'll be the uncertainty, but I'd say relatively symmetric, and, you know, we'll see. We wanna be fair with our clients. It's a... They've learned, and we have reestablished that NII is part of the economic environment, relationship with a client.
Right.
Fees matter, NII matters, client profitability, and in truth, clients want us to be a strong partner and a lasting partner.
Sure.
They know we need to earn a reasonable amount-
Right
... so that we can continue to reinvest in our business, and that tends to be a healthy partnership.
Good. As we finish up here, maybe one last quick question just on capital and what's, you know, the CCAR, we've got the scenarios. How do you view that for State Street? And then any comments on Basel III Endgame, what you're thinking there as well?
Yeah. CCAR's come out as you've seen, and you've even written about, you know, relatively in line with last year. I think the exploratory scenarios that the Fed has been very healthy, right?
Sure.
Some of that is the result of the, you know, regional bank situation and challenges that we saw, you know, last March.
Right.
And so you're expecting them to do that. In fact, we do a lot of that internal scenarioing, too. So we think that's a healthy way to run a financial system and are, you know, obviously filing the reports that we need to, but roughly in line. Basel III Endgame, you know, as we said, if the headline number, list price for State Street is up about 15%.
Right.
For others, it's 30%-40%, so we're feeling. We're not feeling unlucky. But we'll see. You know, there are a lot of changes coming through. I think there's been a lot of healthy debate down in Washington, across the political spectrum even-
Right
... Congress has been involved. So we expect it to be, you know, less than list price. But we'll just have to see. We originally expected something this summer. I don't know if that's on track. I don't know if they're gonna do something before or after the elections. You just don't know, and but we're optimistic, and either way, we can navigate Basel III. It's not a big deal for us.
Yeah.
In truth, it will actually encourage us in a couple areas where it actually makes the risk weights more economic to kind of reinvest and support our clients even further, and so we're optimistic.
That's good. We've run out of time. Please join me in a round of applause, thanking-