Who's the Vice Chairman and Chief Financial Officer of State Street Corp. Many of you know, State Street is one of the leading custody banks in the world, with assets of over $300 billion and a market cap of $32 billion. On a price-adjusted basis, adding back the AOCI into book value and tangible book value, they trade at about 1.3x book and 2x tangible and about 10.5x forward earnings. Some of you might remember Eric joined State Street back in 2016 as their CFO. He had a short stint over at Citizens, prior to that, he was with Citigroup for many years. Lastly, being the treasurer if I recall correctly. Well, Eric, thank you again for coming.
I always appreciate you taking some time out for us here.
My pleasure.
I'd like you to maybe start off with your opening comments.
I think my forward-looking statement courtesy of our general counsel, just to remind everyone before I get started, today's discussion may contain some forward-looking statements. You know that actual results may differ materially from those statements due to a number of important factors, including the risk factors in our Ten-K and our SEC filings. Our forward-looking statements speak only as of today. We may not update them even if our views change. With that, over to you.
Sure. Maybe we could just start off with a macro, question for you, Eric. You know, State Street is obviously very involved in the financial services business. What are you guys sensing in terms of when you look at the global markets, obviously, we started off a little stronger this year versus last year. Do you have a sense of which way it's going or what you guys are planning for with the global markets?
You know what? I think the way I describe it is we're from a business management standpoint, we're trying to be careful given the uncertainty. You know, equity markets were up nicely for the first, you know, 15, 20 days of the quarter, then have kinda tamped down. Global interest rates now seem like they're gonna be up and continue to move in that direction. You know, the whole notion of, well, they're gonna come up, they're gonna cut and have a soft landing seems to be off the table. I think when we look internally at our custodial data, right, the $38, $39 trillion that we have, we look at our PriceStats indicators, right? One of the areas of our group in markets.
You know, we see inflation slowing, but not at the pace that I think the market would have expected when you look at, you know, all the online pricing, which we churn through on a literally on a daily basis. You know, clearly there's more to come here. I think rates are moving as folks can tell in the last couple weeks. International rates continue to, you know, move upward. I think equity markets are trying to settle through, you know, how is this gonna play out and how is that gonna affect, you know, levered companies versus those that are more stable. I think from our standpoint, we'd rather go in with some conservativeness in how we manage the business.
You know, we're very focused on our client franchise, being out there with our clients, helping them with their immediate needs, servicing them well, looking for opportunities for growth. You know, private continues to grow for us as an example. At the same time, our productivity agenda, you know, remains unchanged, you know, and on plan because we feel like we need to both work on the top line growth and the expansion that we want as well as the earnings growth. Finally, I think we feel while we're, while we're conservative about the kind of range of economic environments, we do feel confident in our balance sheet and our capital position.
As we said, in December and again in January, we're quite comfortable returning quite a bit of capital to investors this year. We set up to $4.5 Billion according to our board authorization. You know, we've got quite a bit of confidence. We're on track, you know, to do that.
Yep. It's unique for the fee-based or trust banks, as you guys are often called, you and your peers, that in a recession, since you often don't have the exposure to credit, there's less of a risk there. If we were to go into a recessionary environment, what kind of risks are there? Again, it's not credit. Now, granted, I'm not assuming the markets will go down 30%, which would be a big risk. Any other thoughts about that?
I think there are a couple things that'll happen in a recessionary environment. The question really is what happens externally, then how does the Fed and the other central banks react, right? There's multiple layers that play out. I think from our standpoint, you know, we've got a $300 billion balance sheet, roughly, and on that, you know, just over $30 billion of loans. We're asset light, we're capital light, and our lending is actually typically to investment funds and mutual funds and, you know, collective funds is, you know, single A, double A. It's quite a pristine portfolio. We have a lot of confidence that that navigates through, you know, relatively well. We've got a range, obviously, but it'll navigate well.
I think from our perspective, you know, what happens next is, you know, what happens to the economic environment? Does that change the demand equation a little bit, right? Sometimes, you know, clients and companies hunker down.
Sometimes they have a tougher time economically, and they're like, "Hey, what can we do? Who can we turn to help, improve our cost position?" Sometimes that's an opportunity for us.
Some of our offerings because we, in many ways, can help them bring their costs down as we help them with their front office, their middle office, and back office operations, because that's what we do well, right? We bring scale to them. I think the question is what happens with equity markets? What happens with bond markets? That'll just literally go through our fee line, as you mentioned, because we've got exposure, just given how our pricing schedules are geared. There's the eventual question, what happens to the Fed and the other central banks? Do they cut? Do they stand pat? I think right now they're facing a fair amount of just ongoing inflation. You know, it's coming down some, but not at the pace.
We don't see any real action on their part.
Yeah. Just speaking of the equity and fixed income markets for a moment, can you remind us the exposures? I mean, if equity markets were to go up or down by a certain percent versus fixed income, are you more impacted by the equity activity in the markets versus fixed income? Maybe just share a little color there.
Yeah. In the scheme of things, our custodial book-
Yeah .
-right, is tilted a little more towards equities than fixed income relative to some of our, some of the industry. That's partly how we grew up.
Right
The kind of clients we served.
Yeah.
As the equity markets move up, we do particularly well. As they go the other way, you know, we it comes down a bit. The equity market or market sensitivity of our book.
Yeah
is about 60% now of fees. Why is that? Because over time, we've kind of simplified the fee structure for our clients, and they like that our fees are aligned with how they earn fees.
Right
-which is on an AUM basis. The rough gearing. I'll say it's rough because.
Right
it's not every quarter or every year, but, about a 10% change in equity markets up or down will flow through our servicing fee lines by about 3 percentage points, is kind of the rough order of magnitude. I think what we have found in particular over the last year or two, but we saw it, I'll say, four or five years ago and further back, is as equity markets go up and down, we also sometimes have a nice offset in our currency trading operations or finance operations because there's more activity in the market-based areas than in the traditional custodial areas. We've actually had more diversification over the years.
Right.
Last year, for example, servicing fees and management fees were down year-on-year because equity and bond markets were both down.
Right.
No, no surprise. On the other hand, our software revenues and our FX trading revenues were both up, you know, in the double digits.
Mm.
Right? Which creates nice ballast and offset. You know, that's that. We like that because it creates, you know, the opportunities for us to continue to grow even through recessions.
Sure. Speaking of your businesses, maybe you can share with us, your outlook for the first quarter? Any updates or updates to the full year of what you're thinking in these lines of businesses?
Sure. it's still early-.
Oh, yeah.
Right, for the year. Let me try put a little bit of texture on the first quarter.
Sure.
Share with you, how things are playing out, just given some of the moving pieces, and I'll say the uncertain economic environment that you described because, you know, quarter to date, on a macro level, equity markets are slightly better than we had expected. I say that on average because the averages matter for us. Let me just go through the P&L.
Sure
kind of area by area. first, we now expect first quarter fee revenue-
Yes
outlook on an ex notables basis, to be towards the better end of our prior outlook range, which was down 1%-2% quarter-on-quarter. Obviously was down because equity markets on average are still down even though the point to points, you know, feel better.
Yes.
That's with servicing fees expected to come in at the better end of the prior range.
Yep
of up 1%-2%, and management fees expected to show a slight improvement over the better end of the prior range of down 1%-2%. Some slight adjustments. A little more texture as a reminder. 4Q revenue included a $23 million of notable revenue recoveries.
Yep
you know, reported on the FX trading revenue line, which is excluded from the outlook.
Right.
This benefit is obviously not gonna recur in the first quarter, so you got to keep that in mind. Additionally, I would say that we had a larger than usual on-premise revenue in front office software and data in both the first quarter of last year and the fourth quarter of last year, which impacts the compares.
Right.
We don't expect to see that this quarter. As a result, you know, first quarter software and processing fees, you know, will be lower than a year ago.
Right.
Kind of timing as you go through the year. That's fee revenues. We continue to expect NII to be flattish quarter-on-quarter.
Yep.
You know, I'd kind of remind everyone that there's lots going on in NII, as you'd expect. We've saw the seasonal uptick in deposits from 3Q to 4Q. We're also seeing the seasonal downtick in deposits from 4Q to 1Q.
Right.
Right? As you'd expect. You know, average deposits are coming in roughly in keeping, you know, with that, with that trend. Then, two other areas on expenses, ex-notables. We expect first quarter to be slightly higher than our prior guide and come in at about 3% on a year-over-year basis. The uptick there is primarily driven by some timing on vendor credits.
Mm-hmm.
in the technology, area, that we now expect to receive in second quarter instead of first quarter, as well as some higher, headcount, largely due to lower than expected attrition.
Right
over the last few months. All that said, you know, we expect no change to our full year productivity and expense, guide.
Got it.
Finally, because everyone always cares about the tax man, you know, we expect first quarter tax rate to be slightly higher than 21%, though still expect the full year guide to be the same as we've previously made.
Very good. When you look at the investment services businesses, can you update us on the flattish growth, you know, when you look at it? How should we look at the new business wins in that business? When you win new business, how much comes from existing customers versus just an onboarding of a completely new client?
You know, it's a fair question, what I described is the large majority comes from existing clients. Why is that? 'Cause, you know, we've got a 225-year history. We've, you know, in custody and accounting, we've been, you know, a lead player over the last, you know, whatever, 40, 50 years, let's say. I'll say we do some amount of activity with almost all the large and medium-sized clients.
Yeah.
Right. In a way, you know, for us, it's really a share of wallet opportunity. You know, the existing clients generate 70%, 80%, 90% of new business. You know, there's 10%, 20%, 30% occasionally that comes from new to new, which is good too. What I'd say is that, the intensity of our coverage activity is what really matters, right? Our Global Clients Division, for example, our largest 60 clients have a coverage force dedicated to them. They account for nearly 60% of our revenues, right? It's quite concentrated. There, you know, our share of wallet's about 35%.
Mm-hmm.
Right? As the CFO, I look at that and say, there's 65% opportunity with folks we know.
Right.
that's the hard work we do every day, which is how do we serve clients with excellence on the 35%
Right.
-share of wallet that we, that we have with them. Then over time, you know, how do we expand that, consolidate business, go from the back office custody to middle office and the front office, or bring a broader range of services to them.
Yep. In fact, on those 35%, is there a concentration of products that people use, and what are some of the opportunities to sell incremental products, you know, to that group of customers you know so well?
You know, historically, we've tried to count the products, and I think over time, we've come to the view that there are dozens of products and sub-products that we offer our clients. The old-fashioned, you know, count the products of are there 10 or 20 or 30 products per client is not as helpful as it's been.
Sure.
I think maybe, many years ago. I think what we have found over the last, you know, four or five years is really engaging with clients around do we serve them in the back office, custody and accounting? There are variants to that, performance analytics and so forth, right? Let's call that custody and accounting broadly defined. Do we then serve them in the middle office, right, which is their, you know, operations. The asset manager's operations we call the middle office.
Right.
Do we serve them in the front office, right? Their order management system, whether it's, you know, a Charles River or many times they have a homegrown, you know, potpourri of technology systems, and that's everything from portfolio construction to order management.
Yeah.
What we found over time is working with clients for back office only and sharing with them the other areas is the real opportunity. In some cases, as we bought Charles River, for example, we've got clients who are on Charles River and never did custody accounting with us. It's kind of the, it's the opposite side of the coin. It's really in our minds, those three areas: front office, middle office, and back office. How much have they consolidated with each one of those with you? How much of those do we offer? I think that's the way we think about the product arrays.
I think the one, bit of text I'd add to that is over time, data has become more important and data flows, and sometimes that's embedded in front, middle, and back.
Right.
Sometimes it's an additional service if you have just the back office with us, but you need us to connect in a more industrious and value-added way to your existing front office system. We may include a data layer as well as part of our, what I'll describe as a software offering.
Yeah. No, very helpful. You've in the past showed us or shared with us, I think that the nature of the custody business has always been pricing pressure. I think if I remember correctly, you guys kind of target about $1.5 trillion of new custody assets just to kind of neutralize that pressure, everything else being constant. Ron last year pointed out that you started to approach clients about price increases, which was very different. That had not happened before. Can you give us an update and share with us how that's going? What, how is that proceeding?
Yeah. We've made some progress on pricing, but I'd say it's a tactic and part of the toolkit, not something that we do across the board.
Right.
You know, pricing in this industry has a certain cadence, a certain competitiveness. We wanna stay within that range.
Right.
Deliver good value to clients. What we have found is that there are areas where I would describe them as supply-constrained areas. You know, private market servicing, bank loan servicing, complicated, manually intense for anyone who provides them, not just us. Less platform systems oriented, but we're, you know, building up the.
Yeah.
We're adding technology to these areas, and there's a lot of growth, right? Whether it's the fundraising of the private equity firms, the credit firms, the infrastructure funds, and so forth. So we've got a supply-demand imbalance, and that's where we've gone to a series of clients saying, "Look, for us to deliver the service excellence that you want, given your growth, the limited capacity the market has, we need to adjust pricing somewhat so that we can put the best people in front of you, we can hire, we can retain." You know, we've done that kind of work on pricing in private. It's a couple other very tactical areas with a few hundred clients.
I'd say it's not, it's not gonna, you know, make an enormous difference, you know, at the top of the house, but it's a way for us to preserve margin.
Sure.
Right? Where we're seeing wage inflation on one hand, because that's what happens with those supply-constrained areas. you know, we need to find a way to, you know, in with clients collaboratively make it up. I think the good news is, clients understand, right? They've seen their own turnover-
Right.
-spike in certain areas. You know, as long as it's done in an open way and, you know, highly communicative way, by and large, we've gotten good engagement. We'll continue to look for pockets like that where we feel there's a need and a reasonable ask.
Right.
You know, an engagement we can make.
Yep. In terms of that neutralizing the pricing pressure with the new wins, how challenging is it to bring in that new business, you know, the assets under custody? Is it more challenging when markets are going down or markets going up, or is it just always a competitive business?
There are a couple ways to think about that. I think when the markets are up or down within, you know, 10, 15 percentage points.
Sure.
There's not a lot of difference. I think, you know, there are three or five year contracts that are rolling over.
Sure.
You know, industry contracts where we may bid, it may be a relationship we're developing. I think there, you know, I think the asset managers, broadly, the asset owners, the insurers, you know, five or 10 years ago, were, you know, felt quite good. I think now they've become, I'll say, more economically sensitive.
Yeah.
Just given the pressure on their own fees. I think through thick or thin, there's an interest in, you know, where can a custodian or a custodian with a front, middle, and back offering.
help and support them in their, both their economic objectives and their effectiveness objectives.
Sure.
Let them focus on what they're great at. I think that plays out, you know, both in up markets and down markets, and we see that demand continuing. I think from our perspective, you know, we've had several good years of wins. Last year was $1.009 trillion against our $1.005 trillion target. As CFO, I'd like it to be even higher.
Sure.
you know, we work towards that. The year before, $3.5 Trillion.
Sure.
Now we have a backlog of $3.7 trillion-$3.8 trillion, which is almost 10% of our book.
Yeah.
Right? That's sitting on the, you know, bringing across-
Sure.
the finish line, contracts have been signed, but now it's about implementation. Some of that is the work we need to do to implement and onboard. Some of it is the work clients need to do.
Sure.
We've been very focused not only on continuing to sell at that pace, but onboard the revenues. Those together.
you know, I think provide the basis for growth.
You mentioned a moment ago about the three to five-year kind of contracts, you know, that may come up for rebid. How important is that, you know, because two years ago, that number was gigantic, as you just said? Is that a component of if you have $20 trillion of assets to be bid on for the industry in 2083, how does that play into the wins? Is that a key component to the wins story? Is what comes up for rebidding?
I think to some extent. You know, in core custody, there's a certain amount that's gonna come up each year. It's, you know, core custody can be three, four, five year contracts.
Right.
Your own will come up. You know, that'll be whatever, a third to one-fifth of our contracts. There's also a third to one-fifth of all the contracts that are out there in the industry that all our peers have. Remember, we have, I don't know, 10% of the world's assets.
Yes.
-that we custody for. There's another 90% out there that we're looking at where can we make a differential case that State Street is the better provider.
Sure.
There's certainly opportunity there. I think what we're finding increasingly, though, is that there are opportunities to help our clients, not just with core custody and accounting, which have a certain cadence of three to five years. When we engage, especially at the C-suite, right, with this front to back offering-
Right.
from Charles River to the middle office to the back office, that's new and that's different.
It's an ecosystem that. You know, we're the only ones who can provide a full ecosystem that we can invest in and thus, deliver on in a unique way. Those, what we find appealing are their, the engagement is not just with the head of operations.
Sure.
That person's important, but it's also with the CIO.
Sure.
CFO, so my counterpart, COO, and CEO.
Yeah.
Right? Those are different. What we find is those, as we contract them, and this is, you know, a big part of our $3.8 trillion backlog is of this front, middle, and back. Those contracts are five, seven, 10 years.
Oh, yes.
in maturity as opposed to the old three to five.
Right.
We're starting to create a different environment, and we think that creates over time for clients a stability, right? 'Cause they don't wanna make these changes that often. For us, a stickiness...
Right
you know, that matters and can help create more stability for both our core revenue activities as well as an ability to grow off of that an even better way.
I wanna go back and pivot to your comments about the stock repurchase program. It was a $4.5 billion authorization that you mentioned. Where are you in terms of what percent of that might be completed? Once it is completed, is there a thought that maybe you go back for another stock repurchase program? What's your thinking on that?
Well, there are a couple pieces to this. I think to start, you know, we've got higher than usual capital.
Yeah
levels right now. Part of that was that equity raise.
Sure.
Part of it is we've accreted capital...
-over the last, you know, year and a half. You know, we did a $1.5 billion buyback in the fourth quarter. We have an authorization for up to $4.5 billion for this year. We said we'd do it at pace. We'd said, you know, we do a little more at the beginning of the year just to get going. We'd like a little bit of, you know, you want some consistency-
Sure
in the marketplace. There are some, you know, there are some caps, you know, with the New York Stock Exchange rules that we.
Yes
stay well clear of. That's, that's going along, you know, on pace. It'll continue through the quarter and through the year. Then I think what we move into, because we're such a capital-generating company, you know, and we're asset light back to the, you know, smaller size of our, you know, markets book or our lending book. You know, we've committed to returning, you know, 80% or more of the capital we generate to investors through dividends and buybacks every year. What we'll do is, you know, as we get through this authorization, we'll see exactly where we are at the end of the year. That'll be a natural time for us to engage with the board.
Sure.
Obviously keep in mind of what else is coming, you know, economic environment getting better or maybe not, you know, to your point. Got to see what might be coming in 2024, 2025, right? It's really in 25, I think that Basel III endgame plays out, so we need to see what that means for the industry.
Sure.
We, you know, given that we're a capital light, you know, our intention is to return, you know, in a typical year, you know, 80% or more of the earnings to investors through capital return.
Which is obviously quite strong. Just coming back to that Basel III endgame When should we expect, you know, them to announce, "Here it is, you..." I thought it was about now, but I could be wrong. Is it any day now, or is it first half of this year, or any end year?
You know, we've heard different things. I think we like you probably monitor the speeches of the Fed governors and some of the other senior policymakers.
Yeah.
The OCC and the FDIC, right?
Sure.
They do this together. It sounds like it's could be late spring, it could be summertime.
Yep.
You know, is, you know, some, you know, sometime it seems like the middle of this year is what we've heard more recently. Our, you know, what we're doing, as you'd expect with the rest of the industry, you know, the CFOs do this, the CROs do this, is, you know, what do we know so far? You know, there's kind of elements of the Basel III endgame that have been disclosed over the last almost five years.
Right. Right.
With the quantitative impact study done many years ago, but it's stale. You know, we're trying to navigate through what this looks like.
Sure.
I think from our perspective, you know, it seems like there'll be more capital in the banking system. That's what our, you know, we hear from policymakers. We're, you know, we've got real time, I think, as well.
Yes.
You know, implementation date of 2025. Sometimes there's even a phase in, we'll see.
Yeah. Speaking of capital ratios, can you remind us the binding constraint, you know, I believe the CET1, could that ever change, or what would make? I thought at one time it was more of a leverage ratio for you folks some years back, but I could be wrong on that.
Yeah, it's changed. There was a time where the leverage ratio was the preeminent constraint for the trust and custody banks until some of the rules were adjusted. Because even our policymakers felt like, "Hey, that's not the signal." They want the leverage ratio to be a backstop.
Yeah. Sure
not the primary metric. You know, the most important metric for us, typically, I'll say, is CET1.
Right.
We manage that quite actively. We've got a target range we wanna operate into or above that range.
Sure.
Which is why I want to bring, get capital back to shareholders. From time to time, leverage or SLR could come into play. We tend to have a few more levers there. Sometimes it depends on where we are in the cycle. I'd say typically CET1 with some occasional movement on the others that we manage through.
Yeah. Just as though we're running out of time, I do wanna ask one last question just about have you seen the impact of quantitative tightening on your deposits? It even though I know the Fed is doing it I don't know if it's hit the system as hard as maybe we would have all thought by now.
No, we certainly have. I mean, since they began, you know, last summer-
Yeah
you know, they've actively been reducing their balance sheet. you know, we saw deposits come off some, to some extent because of higher rates, to some extent because of quantitative tightening. We saw deposits come off from their peaks of, you know, $230 billion for us, have come to the, you know, $200 billion into the teens.
Yep.
Right? We think that'll continue. It's partly embedded in our guide. I think part of what we're trying to distill is we know deposits tend to have a seasonal uptick in 4Q.
Yeah.
That tends to offset-
Right
A seasonal downtick in first quarter, which we're seeing. It's really hard to read, to be honest. You know, tax season and risk on, risk off, flows with our clients, locally or internationally. We wanna be careful. You know, we have a view that we can, you know, we'll navigate, you know, through the deposit environment, but it's hard to read every month.
Right.
I'd like to take, you know, one quarter at a time, to be honest with it.
Yeah.
I think what we have seen, which is comforting, even with deposits sometimes being running a little higher or running a little lower in either of those scenarios, we've seen good NII performance, partly 'cause it's inversely related...
Yeah
-to, to interest rates, right? Deposit balances. You know, we've... You know, we'll see. More to come on this one. I think every month you call in for earnings, I bet you'll ask this question, and we'll share more updates as we go.
There you go. Well, Eric, I wish I could ask more questions, but we've run out of time. It's always a pleasure, and please join me in a round of applause for thanking him. Good night.