Okay, thank you very much for joining us for our 1:00 P.M. session. We are very pleased to have with us today Eric Aboaf, Vice Chairman and Chief Financial Officer of State Street. Thanks so much for joining us.
My pleasure. Delighted to be here.
Super. Okay, so I just wanted to kick off with a question on how you're thinking about the macro environment.
Do you want me to start with my disclosure?
Oh, disclosures.
Because I think you may have one, too.
Oh, I have
We're lawyers. We respect them.
I have to go first, actually. You're right. For important disclosures, please see Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. The taking of photograph and the use of recording devices here today in this room is also not allowed. If you have any questions, please reach out to your Morgan Stanley sales representative.
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Thank you, Eric. So State Street is truly a global firm operating in more than 100 markets, and as a result, you do have a very comprehensive view of the world. So I'd just like to understand what you're seeing in the macro environment that's making you more excited. On the flip side, what's adding to uncertainty as you look around the world, and, and how does this view on the macro backdrop inform your strategic priorities for 2024 and beyond?
It's a great place to start, Betsy. I think, we see more positives than negatives right now in the macroeconomic, kind of environment, broadly defined. I think positives are, strong equity markets continue to, float upwards. That creates a good tailwind for, for our various businesses. We see investors as cautiously optimistic. That's important because we've been through a period where they put more cash on the sidelines. They've sat, waiting and watching, and that actually, has more of a headwind effect on our underlying activities, just based on how we, how we perform them, whether it's in the servicing or, trading areas or what have you. And then I think on the positive side, we're seeing some reasonable stability in rates, maybe a little bit of cutting in Europe, stability in the U.S.
You know, a bank like ours is relatively insulated from whether we're operating at rates at 5% or 4% or 3% or thereabout, and I think, to be honest, what we'd like to see is a little more of a yield curve, or less of an inversion, and we're seeing a little bit of that. We'll see if that, if that plays out. On the negatives or the areas for concern, just a couple. I think we are seeing this for this time period where a U.S. dollar dominance divergence is starting to play out. Strong dollar or weaker foreign currencies, does that put pressure on, on various, pension funds or emerging markets or what have you? Does that change the international amount of trade inflows?
That's kind of on our watchlist. We're, of course, continue to be vigilant on geopolitical risks. Those are everywhere and, you know, can crop up, and then obviously, you always worry about cyber or something happening a little bit out of the blue. The net of all that, though, is that we're leaning into growth. We continue to build on our service quality and everything we've done to, you know, sharpen our support of our clients, and that helps raise or keep retention at very high levels and actually puts us in a position where we avoid more and more RFPs and RFIs than we used to, right? So that's a positive.
We're leaning into our Alpha proposition, our private markets propositions, new feature functionality, which is bringing in new clients towards us, and so we feel like this is a good time to continue to reinvest in the franchise and drive the, the next, round of, growth. And then finally, there are particularly strong growth areas. We see rising demand for private market servicing, probably the biggest growth area, you know, growing. We think we can grow that 15% a year.
We've talked about that becoming a billion-dollar business for us. As we've built out Alpha, we do that front office, which is software-oriented, the middle and the back office. We've described that as a way to continue to drive growth in the franchise, and our strategic goal there is to build a software business that's $1 billion in size over the next five years. And so our view is this is a, this is a good time for us to continue to lean forward, and we're, we're optimistic in seeing some real momentum.
The $1 billion in privates that you referenced, is that also over a five-year period?
Yeah, that's right.
Okay.
That's right.
From what level today?
It's somewhere around $450 million.
Okay.
You know, just shy of $500 million. But the growth dynamics in that business, whether it's for the market, the market's probably growing at 10%+. We think we can grow 15%+, just given that it's a fragmented market, it's highly bespoke, it tends to be done. It's largely insourced still. The provider set has a mixed set of offerings, and so, you know, the differentiation we can bring to it, the feature functionality, and the sort of solid execution that we can bring put us in a position to build that out and really distinguish ourselves, and drive, I think, some real substantial growth over the coming years.
Great. I do want to ask a little bit about the balance sheet, deposits, higher for longer implications for NII, the usual suspects.
All right, where do we start?
Let's get this out of the way, right? Okay, so turning to the balance sheet, State Street saw strong deposit balances in 1Q, and that did help to improve your full-year NII guide relative to the January call. And I guess I'm wondering, how are deposit balances trending this quarter? There's only a few weeks left to go. And then how is it trending in non-interest-bearing deposits? And is that, should we expect that as a percentage of total to track down from where it is today at 12%?
Let me, let me take each of those parts of the question
Okay.
Betsy, because they both, they both matter. You know, we continue to see, I think, healthy levels of deposits on our balance sheet. If you remember, a few quarters ago, we were hoping to be at $200 billion-$210 billion. We've been closer to $215 billion-$220 billion over the last quarter or two, and deposits have stabilized more or less at that area. Part of it is just the deep engagement we've been having with clients. And our view is there's different deposits. Clients put deposits with us for different reasons, usually across a stack. You know, some for transactional reasons, some for discretionary and earnings reasons, some for liquidity. I mean, there's a number of different reasons they'll leave deposits with us.
And then sometimes they'll do repos, sometimes they'll do money market sweeps. There's a whole sort of what I've described historically as the cash cascade. And what we've found is just engaging with our clients about deposits makes a big difference, because they know we're there for them, they know we have a broad variety of different offerings. And that's, I think that's put us in a position where deposit balances have continued at this, you know, level of around the first quarter amounts of $219 billion, which is what we printed as the average. And as that happens, what we've found is it's actually helped across the deposit stack. Remember, we have the range of different deposit levels. On non-interest-bearing, we continue to see the rotation away from non-interest-bearing.
It's slower than it used to be. You know, we had periods a year and a half ago where we might have had when we had the peak amount of non-interest-bearing deposits was $50 billion. You know, we had quarters when we would shed $7 billion a pop. We had last year, first half of last year, we were shedding $5 billion per quarter. This year it's been, it's been slowing down. It was down about $3 billion from 4Q to 1Q. We're looking at another $2.5 billion, you know, ish, maybe $3 billion into the second quarter. And I think we'll continue to see a little more erosion.
You know, that would probably take us down into the mid-20s, you know, the $25 billion-ish range, in the second quarter or thereabouts. And then, you know, we're expecting a little more erosion and then probably some stabilization, in the second half of the year, somewhere above the $20 billion dollar range, but it's just hard to call. Just hard to call.
That's being made up for by interest-bearing deposits?
Yeah, because in truth, remember, clients need to leave deposits with us. Those deposits are handling the trillions of transactional flows that they're running through our pipes, that we're executing for them. What they don't want to do is have too much in deposits, so they have cash just lying around unused, but they also don't want to overdraw their balances. And then they also have to be careful about their intraday positions
Right
and have deposit balances for there. So the deposits need to sit someplace, and our view is, as long as they sit with us and it's reasonably economic, we're quite supportive.
Is QT having any impact on the deposit picture here?
I think, early on, when the Fed started to tighten its balance sheet, you know, we started to see an impact of QT, but that would've been, you know, 6-12 months ago, maybe even more. I think once they started to reduce their overnight reverse repo operation which effectively is like being a repo counterparty for asset managers, who are the clients we serve, by the way.
Right.
Right? So they were an intermediary, a competitor, so to speak, and I say that, you know, in a nice way. As they brought down that operation, they were effectively quantitative, they were easing, right? While they were tightening their own balance sheet. So they were having offsetting effects. I think now that's, you know, probably gonna continue to run down, is my guess, so that still has a bit of an easing effect. They've slowed down their tightening, and so we've seen, I think, the last four, five, six months, more stability in total deposits in the system, and we don't see their tightening as being particularly impactful at this point.
I mean, it seems like we've gotten to, I'll call it, an equilibrium when it comes to deposits and deposit levels in the system.
And then last on this point, before we move to a guidance question, is just on the State Street's sensitivity to higher for longer. Obviously, the current forward curve has shifted a few times since January 1.
A few. A few, yeah.
How should investors view State Street's NII sensitivity to higher for longer rates?
I'd describe us as relatively neutral, and I say that because there are a number of different measures. You know, we describe NII sensitivity, which is over a one-year time period, and on that basis, we're neutral in the U.S., we're slightly open to rising rates in Europe. It's a little bit of the configuration of our balance sheet and the kind of the asset and liability mix that we have in different parts of the world. But if you look over a two- or three-year time horizon, relatively neutral, and we like it that way. You know, we're not trying to run a big position at the top of the house one way or the other. We found it helpful to be in this relatively neutral position. Why?
Because we've got an inverted yield curve, so you can make money both on the front end, and you can protect NII with some amount of maturity. But, you know, that costs you some money. So there's a bit of a mix effect going on, and so I'd describe it as roughly neutral over, you know, a year or two.
Okay. Now, on NII, you did raise your guidance back in April
Yes
for the full year of 2024.
Yes.
I was wondering: How is net interest income shaping up this quarter, and is there any other guidance you'd like to share for the second quarter?
So maybe it's a good time just to do the breadth of guidance-
Right
And I'll cover NII as part of that because I think it, you know, it factors in, in a way that, that'll make sense. I think, as we said, our expectations are broadly in line with where we were in April in terms of, of guidance, although there are always some moving parts, and let me, let me go through them. For context, at a macro level, daily average global equity markets remain strong, and at this point in the quarter, are roughly at our expectations back from April. Remember, they were up, they were down, they're back, they're back up, and so we're roughly in that, in that zone.
At the same time, FX volatility and spreads are somewhat more muted than what we had previously expected, and specials activity in securities lending continues to be light. And at the same time, client volumes are generally a bit higher, as we've seen, you know, some of that, client confidence that I, that I described. And then while the Fed continues to hold rates steady, we have seen a reduction in the pace of quantitative tightening, so that's, that's been, you know, beneficial in deposits. But, you know, slightly so. And just last week, we saw the ECB, I was about to say start to cut, but I think I'll say cut once because that, that may be all she, all they wrote for, for a bit. So anyway, a fair amount of dynamic activity, right? It's a fair amount of movement.
Given these factors, we now expect 2Q fee revenues to be up more like about 1% quarter on quarter, which is slightly below our prior outlook of up 1.5%-2% sequentially. Primarily reflected the muted FX volatility and muted equity specials activities and levels that I mentioned just a moment ago. However, this should generally be offset by our 2Q NII coming in towards the better end of our range of down 2%-5% quarter on quarter, as the deposit levels that I just mentioned have been relatively healthy quarter to date and more in line with first quarter. So taken together, our revenue outlook is broadly in line with our prior expectations.
Expenses are expected to come in within our previous range of up 2%-2.5% sequentially, perhaps towards the higher end, but generally in line. Still early to be sure. We're got one more month to print. And I would remind everyone that our expense outlook excludes both first quarter seasonal costs and the notable items that we have. And then, of course, with a few weeks left to go in the quarter, and we still need to see how those play out, you know, but overall, I think we're consistent with what we said in April, back on the top line business momentum and the expense guidance as well.
Okay, great. And tax rate stays the same?
Yep.
22%. Super. All right.
Yep, just, same as where we were in April.
Okay. So let's dig into some of the businesses and some of the drivers of that. Just starting off with asset services business, clearly
Okay
the major driver here. You have yet to be installed business, right? That had been running at something like $4 trillion or hit a peak there, and now it's running at around $2.6 trillion. At the same time, I think you've been talking about implementing a little bit more rapidly. So the yet to be installed business, should we be expecting that that will be implemented maybe at a faster pace than had been the case years ago?
Yes, and the way I think about it is in a couple ways. I think for context, you know, 2.6 trillion at the end of second quarter to be installed, and about $300 million of servicing fee revenues. So both matter, right? Volumes and actually the fees. I think the background here is that as we started to sell the Alpha proposition several years back, or I should say, when we designed it, developed it, and then started selling it, it was broad-based, as you'd expect, front office, middle office, back office.
One of the things that we've decided to do is we've sharpened it, and it's become increasingly valuable, is made a commitment that we'd always bring custody in with the front to back offering, and actually get custody converted first. Why? Because for clients, it's easier. Some of the other aspects take longer. And then for us, it's valuable because custody, you know, has very healthy margins and is attractive to our franchise. So we've shifted the way we sell, contract, and plan our installations. Beyond that, within the core Alpha offering, which is front, middle, and back, so it has breadth, depth, and complexity by definition. We've done a number of things to actually speed the implementation process. First, we've actually further defined the product proposition, right?
Earlier on, we were co-developing with clients, you know, but that's years behind us now. The proposition's been sharpened in each of its pieces. It's become more modularized so that clients can and we can implement different pieces at different stages more quickly. And then it's come with, I think, a sharper understanding with our clients about what we need to do and what they need to do, right? So the client agreements are that much stronger in terms of what we both need to do, because they need to unwind processes and unwind systems, and we need to install processes and install systems.
And the harmonization of that coming together over typically a 24 to 36-month process takes some time. And then lastly, you know, we've done what you'd expect, is we've continued to build our talent and our experience base to do it smoothly and effectively. Some of that's detailed work planning, some of that's the type of people that actually can bring this together, and so that's been another piece. All told, we see that as accelerating our implementations, and that's important because you've seen us, on one hand, say we're going to accelerate implementations. We've also said we're raising our sales targets.
Right? Our sales targets were, you know, sales last year, about $300 million servicing fee sales. We said $350 million-$400 million this year. The only way we're going to deliver on that is to not only sell more, but implement more and actually drive that, you know, that positive dynamic.
So, is that $350 million-$400 million for 2024?
That's right.
Right. So you expect some acceleration from here, given that, I believe, 1Q was $67 million. Is that right, of servicing fee wins?
That's right, and there's always a little bit of seasonality, there's always a little bit of lumpiness quarter and quarter, but we've got, you know, good visibility into 2Q. We've got a strong pipeline, as you'd expect. And even looking back at first quarter, you know, we had a nice breadth of wins. We had a nice breadth between North America and Europe, nice breadth of asset manager wins and private markets wins, right? And so we're feeling that the client coverage organization is really working well effectively with our clients, both at the C-suite level down, and then down deep into the organizations that we work with, and see good momentum there.
Okay. You did mention that custody has healthy margins which I'm sure some listeners might have had their ears perked with that, because
Right
long debate for many decades on, "Hey, is in custody margins under pressure?" So maybe you could explain the healthy margin.
Yeah, here's what I'd describe is that every product we have, just, you know, it's just generally true, has a fully loaded margin and a variable contribution margin. And you know, on average, our products, you know, come in with fully loaded margins in the high 20%-almost 30%. That's what we'd like to. And that's part of our medium-term target. What we find is some of our products are more fixed cost versus variable cost oriented. Custody, high fixed cost product, so you sell an extra custodial product, and the variable contribution is very high, and that's what I meant by that statement. You know, middle office processing, still manually intensive. Private markets processing, still manually intensive. They have lower variable contributions, but they still have decent fully loaded margins.
And so it gets to how we're growing and where we're growing, and it's part of that kind of economic, you know, balance of trade that we want to do with clients and the way we want to price our services.
Okay, that's very clear, and also nice to have scale, right?
Yes.
That's also helping you on that.
You know, when you're the second largest custodian globally, you know, you have $44 trillion of assets under custody, you know, that's where we can distinguish ourselves. You know, the next 1-6 percentage points of growth over, you know, the coming quarters, you know, can fall to the bottom line.
Separately on fees, we already talked through quite a few of the drivers there. I'm wondering, how is the implementation of T+1 settlement in the U.S. equity market, you know, impacting your opportunities in your fee lines that are related to that?
Yeah, I'd say the first part of that answer is implementing T+1 was table stakes for any custodian.
Right.
Because this was really about helping our clients, prepare for the notion that they have to trade and settle within one day instead of two days, you know, which is a historical anachronism, to be honest. And there are two ways to do that. One is to tighten the client custodial bank process. The other way is just to pre-fund with a lot of cash and end up with a bunch of overdrafts. Neither of which we or clients wanted. So there's a lot of work that went through our custodial group with our clients in partnership to actually streamline their processes, become prepared for that new transactional structure. And you know, all this happened, you know, over a holiday weekend, as they tend to do.
Canada went first, the U.S. second, and I think it was quite smooth as a result. In terms of business opportunities, I think there are really two. One is, anytime you go through a tough set of circumstances with clients, T+1, you know, there was worries.
You do it smoothly, you build up your reputation, and I think we were able to do that. That'll come back to help us over time, right? It's the, you know, the stronger reputation means that, you know, a couple fewer RFPs or more confidence that we should expand our share of wallet with clients. The other one that is more tactical and maybe immediately remunerative is for our FX trading franchise, right? Because as you, as a client transacts with one day, they actually, if they're buying or selling a corporate bond or an equity in an emerging market or a foreign jurisdiction, then they actually need to transact the foreign exchange at the same time.
And so part of what we did is we introduced a new service offering called StreetFX that let them do that literally with T+1 in view. And that's been a nice way to get out ahead of clients and help them. It creates a little more revenue in the FX books and, you know, a net positive for the franchise.
Okay, great. I would also think there might be a little bit more outsourcing that clients choose to do with T+1. Is that part of the opportunity set?
It is. You know, back in February, we closed on an outsourced trading acquisition that solidified our position and in offering outsourced trading , and so now we can do outsourced trading typically for mid-size asset managers right? Who are too small to run global trading desks, or who, you know, want to run trading desks in one product that they're perhaps they're strongest in, but they don't want to do it in, you know, all of FX and equities and fixed income and, you know, equity futures and derivatives and so forth. And so we can provide that kind of offering. And as T+1 comes through, it's becoming harder and harder for them to actually deliver on what they need to do from
a trading desk standpoint. So it's another, it's another driver of opportunity. You know, outsourced trading , we've seen the estimates of $600 million revenue market growing at 20%-30% per year. And to us, it's about serving our clients even more broadly. In a way, State Street grew, grew up as an outsourcer of custody, of middle office, of the front office, order management system. outsourced trading , either for mid-size asset managers is a growth opportunity, or for some of the largest asset managers who know that the last three or four trading desks out of 20 that they run, right, are in scale. And so it's become a, it's become a relationship opportunity with them as well.
Okay, thank you for that. I'm going to turn to expenses now. Two questions. Let's start with the first one, is I believe the expense guide for this year is 2.5%. It could be a little higher if revenues punch out and, you know, but that would be a good reason. Anyway, 2.5% is less than 3%, which was last year's 2023 expense growth year-on-year. I realize that this improvement is coming from productivity savings, right? I think you mentioned a 1.7 times increase in productivity savings. So could you help us understand what's driving those productivity savings? Is there any, y ou know, what, what's left to harvest?
You know, I'm thinking back, Betsy, that we started our journey on productivity back in 2019. Right? And, I think you had, you had asked me about it back then, and the question we got after the year, the first year, is are you gonna how are you gonna do it again? After the second year, people asked, "Well, how are you gonna do it again?
Oh, here we are.
And now we're continuing to ask, which is a good question, but I think part of the point I'd make is that we found ways to actually tackle productivity in different ways over time, and have really built it into our culture, into our planning process. You know, I don't do budgets anymore with, "What are your expenses last year and this year?" My budgeting right now is, you know, what are your inflationary events like merit? How much are you investing? What's the size of your productivity? And then, just what are your expenses likely to be for next year? So it's kind of become a part of what we've done. I think there are a couple categories that are particularly large this year in terms of expense productivity. I think first, we've announced the consolidation of two of these India joint ventures.
The background on that is we had split our operations between our own operations and our joint venture operations, and so that is really a catalyst to actually drive the next round of simplification and standardization that we're embarking upon, let alone taking the margin out of a JV structure. And so there's some real benefits there, and I think that's a catalyst for change. We continue to be automating and simplifying and standardizing our processes. You know, we disclosed back in February that we'd reduced our non-standard processes, you know, by 7%-10%, and we're doing that again this year. So trying to take stuff that's complex and simplifying it makes it more efficient. And then finally, just how we deploy our resources globally.
You know, more and more of our resources that are operational in nature, we're stretching the spans of control. And in operations, we described how, you know, spans are moving from 5 to 1 to 8 to 1. And part of that is really the effect of actually that process standardization, and part of it is just how we appropriately resource. All that said, what we've found is better processes lead to fewer errors, more standard processes, you know, more satisfied clients. And so a lot of this is coming together, both in improving service and quality, and lowering our costs over time.
Can you remind us what your tech budget is today? I think, last year was just north of $2 billion.
Yeah, it's grown since I originally made that statement, so it's almost $2.5 billion in size-
Okay
out of the $9 billion expense base that we have.
Okay. Just turning to capital. Wanted to understand how you're thinking about just excess capital utilization and how that feeds into buyback outlook. You know, part of the reason I understand we don't have Basel III and all that, so I'm not gonna ask you what your excess capital dollars are at this stage. But you know, you do have a targeted, what is it, 100% payout ratio? And last year was a little higher at 200%. So as you sit here today and think about CCAR that's coming up, and the earnings generation rate that you've got, how would you suggest to investors how they should think about your buyback trajectory here, over the course of the rest of this year?
Yeah, the way we've described it, you know, in our medium-term targets, is returning, you know, more than 80% of earnings to per year to investors, and that was what we would typically do. Last year, as you said, it was multiples of that
Because of our excess capital position. This year, we said it'd be around 100% of earnings between the buyback and the dividend. And we've begun that process in the first quarter, but we're also managing quarter to quarter, right? What are the levels of RWA that we have? We have some fluctuations. We've just got to be careful with the economic and external environment. We're leaning positive, but we've got, you know, some of the risks we want to be careful around. But that, that's the. The guidance is, as we had said it, around, you know, 100% of earnings back, as capital back to shareholders for the full year.
When you say leaning positive, what are you referring to there?
I think back to, you know, positive equity markets perhaps some positive investor sentiment about putting more cash to work. We think it's a good time in general, but, you know, we've all watched, you know, geopolitics, economics change, and now, you know, we've had a whole set of elections right, to speak of around the world, and some of those may create more stability, and some of those may create more instability, and so there's always more to watch.
And then on CCAR, it's coming up. It looks similar to last year, year on year. So does it make sense to expect a flat SCB, or, you know, are there things going on that we should be thinking the SCB could creep up?
For us, we've had a relatively flat SCB for the last few years
Right.
and we don't expect a lot of change. You know, we have a fairly simple balance sheet when it comes from a CCAR standpoint. And like you said, the stress tests are roughly in line with the past. Notwithstanding that there are some experimental ones that we've also been processing, as you'd expect us to, and the Fed will. But we're. The SCB, we think, is roughly in line with what it's been in the past, and it'll stay in that zone.
Okay, great. So last question: What do you see as the biggest fee opportunity outside of core custody?
I think for us, because core custody is really around, you know, the core institutional fund, collective fund, mutual fund, and ETF. I think outside of that, I'd actually say there are two. I'd say there's the administrative services around private markets, is probably the single biggest servicing opportunity that we have in front of us, and that we can really distinguish ourselves with. And then the other one is, to be honest, software. In a way, we've redefined what the custody offering has been over the last five years since we bought Charles River into something that is really a mix of servicing and software, and each of those can be large businesses in and of themselves.
As you described earlier.
As I described earlier.
Yes. Thank you so much, Eric, for joining us today.
Good. My pleasure.