Moving right along. Very pleased to have State Street. From the company, John Woods, Chief Financial Officer. John did this conference last year with a week or two into the job. This year, he's a year and two weeks into the job, so I get to grill him a bit more. John, maybe the best place to start, in July you laid out new medium-term targets for State Street, 35% pre-tax margin, 20% ROTCE. As you think about the path to achieving those targets, what gives you confidence in the ability to get there, and what did you see as the two or three most important drivers of success over the next several years?
Yeah, thanks, Jason. Really great to be here. Just one year into the job, just an incredible platform that we can talk about that we laid out our medium-term outlook in July. I think I'd start off with the global franchises that are part of State Street and drive State Street at scale. So whether it's the number two custodian in the world, number four asset manager in the world, number one FX provider to asset managers in the world as well out of our markets business. So pretty incredible collection there that really drives it. It all starts with that at the foundation and the core. I think the second one that I would highlight is some very distinctive strategic initiatives that we think will diversify and accelerate growth and returns over time.
We talked about our presence in the alternatives business, what we've got going for us, in terms of investing in digital and infrastructure and products, and then more recently, a lot of investment being put into the wealth services space. So that's the second one that comes to mind, just really strong strategic portfolio on top of the core. We did talk about transformation, which I think is something that allows us to invest in those strategic initiatives while still maintaining margins. I guess I'd hasten to also add, recent performance has been really strong. After basically new leadership over the past two, three, four years in each of our biggest businesses, you're just seeing some of that momentum really kicking in terms of the investments that they've made.
There were records set in the second quarter across all of our businesses, in one way or another. That momentum has been really good. If you just take a little step back, just a few years ago, our pre-tax margin was in the mid-20s. When you look at where we are now, it's basically low 30s. Just significant progress in a short period of time. I think you put all that together, and I'm feeling very good about our ability to deliver on those medium-term goals that we laid out in July. So yeah, those are the top ones that come to mind.
Maybe we could just double-click on a few topics you mentioned. Wealth services, digital assets, and alternatives.
Yeah.
Big strategic areas of focus for the firm. Just how are you positioning the business to capitalize on these initiatives, and where are you seeing the strongest potential to drive growth over the medium term?
Yeah. Maybe I'll do that in reverse order. I think because in the near term, I would say alternatives is the one that really is delivering. So you've got 15%-20% of our servicing fee revenues actually coming out of the alternatives business. And we're really investing to make that a platform business, and improving capabilities along the way. So, things like leading into a product where we would drive daily NAVs, as an example, in the alternative space, which is pretty typical in a traditional world, but not quite as typical in alternatives. So we're continuing to invest there. We've had a lot of success. The growth profile's attractive, the return profile's attractive. And so I'd say over the near term, that's the one that really contributes. The next one, if you think about digital products and infrastructure.
From an infrastructure standpoint, we launched our digital asset platform earlier this year, and we're continuing to invest there from an infrastructure standpoint where we're heading into a multi-chain capability in digital. So by the end of the year, we'll be in a public permissioned space from a blockchain standpoint, and we'll have public permissionless to follow. But we'll be in a multi-chain infrastructure. And we sit at the center of our clients' workflows, managing that kind of on-ramp, off-ramp between the traditional world and the digital world. I think where you're going to see that contribute is really just being relevant to our asset manager clients around the world, and continuing to see organic growth by making sure we can play that role over time. The last one that you mentioned, wealth, is the one that is really starting to gain momentum and gain steam.
It's not a huge driver of profitability today, like alternatives is, but I'd say over the medium term, you can really keep an eye on wealth being a needle mover. We started off with our Apex investment late last year, and that was driving back-office capabilities. We've recently announced a State Street integrated offering here in the U.S., and we've got a mandate from one of the largest RIAs in the U.S. to be an anchor client, and our front-to-back wealth services offering. We're extremely excited about that. We've got a pipeline building behind that as well. When you think about broadly the things that really drive that strategic initiatives portfolio is probably alternatives in the near term, digital throughout, and wealth picking up steam over the medium term.
Got it. You've also spoken about the power of the core franchises across investment services, investment management markets, and the benefits of this One State Street. Just how does that show up in practice today, and where can connecting the businesses more tightly drive the greatest incremental value over the medium term?
Yeah. The way I think about that is you think about our top three businesses, and I look at it as the intersection between those businesses and our top client segments. You've got investment services, investment management and markets, and then you think about the client segments that we want to serve. It's asset managers, traditional and alternative asset owners, and wealth managers and intermediaries. When you think about asset managers, that's our kind of collaboration primarily between investment services and markets. So where you see investment services with the front-to-back capabilities serving asset managers, but institutional-grade markets capabilities from a liquidity and financing perspective, that where we go to market together. Investment management provides distribution capabilities as well as supporting fund launches for other asset managers.
That's kind of an exciting way to think about on a day-to-day basis, how we serve the asset manager client base. When I flip over to asset owners, same capabilities port over from investment services and investment management. But you think about from a One State Street standpoint, where a bigger part of the story is the investment management capabilities, where whether it's ETFs, portfolio construction, you basically have indexing, multi-strategy, outsourced CIO. A very rich portfolio of products that the investment management business provides to asset owners. But nevertheless, we also can bring, again, institutional-grade markets capabilities for liquidity and financing to the table at the same time. So on a day-to-day basis, you see that playing out with asset managers and asset owners. I think the third one, and I alluded to this a little earlier, the third one being wealth managers and intermediaries.
I would look at that as not only a customer segment, but also, as I mentioned, one of our top initiatives. It is probably one of the clearest examples of One State Street, really, and certainly one of the more recent, more exciting ones, where each of the businesses has a big role to play. Investment services, as I mentioned, we have launched a front-to-back capability with CRD Wealth supporting the front office. We have the State Street capabilities in the back office where we have that resident within State Street proper, but also supported by Apex. So very exciting in terms of that investment services approach.
But increasingly, these wealth intermediaries appreciate the institutional-grade capabilities that we bring from a liquidity and financing perspective that we can, at the same time, support them with, and then all of the investment management products in the wealth space from a distribution standpoint and products. I should hasten to add, I think approximately 30% of our investment management AUM outstanding comes from the wealth channel. So you look at that, and it is really exciting from a One State Street standpoint. Rounding things out, I will circle back to alternatives where I already mentioned what we are doing from an investment services standpoint, but investment management as well, partnering with alternative asset managers to actually distribute private markets products and get greater access to that.
In the digital space, all the capabilities I already mentioned, but I would add to that investment management's tokenized money market fund launches that they recently did, and they also launched a stablecoin reserve money market fund that targets stablecoin issuers. So just to wrap all that up, One State Street on a day-to-day basis is very exciting, but these recent initiatives are all examples of One State Street at work, whether it is alternatives, digital, or wealth.
Very comprehensive.
Yeah. I am excited about it. Yeah.
You talked about AI as an important part of the kind of the transformation agenda. Can you talk to where you are in terms of implementation, where you see the greatest opportunities to improve productivity, enhance client outcomes, and just create capacity for future growth?
Yeah. I would put it in a couple of buckets. The first one that comes to mind would be the developer productivity from an AI standpoint. That one is pretty straightforward and tangible. We have referenced 30%-40% productivity expected out of the developer community within State Street. That comes from code generation, modernizing legacy code, as well as vulnerability assessments, which is increasingly an incredibly important capability to have in-house. That is the first leg of it. I think the second leg, when I think about the rest of the employee base. We have invested in this in a significant way recently. So much so that the AI-enabled workforce that we track, which is not just day-to-day access to things like Copilot, but more sophisticated tools, has grown significantly over just the last couple of quarters. I think we classify over 80% of our employees as being AI-enabled.
That is driving the ability to convert that into certainly more efficient knowledge retrieval, data extraction, analysis, et cetera. But it is playing out in products and client experiences as well. Example. From a product standpoint, I would say our data intelligence product, PriceStats, now has AI-enriched data incorporated in it. It helps to anticipate inflation readings, increasingly important for our clients to think through. So that is AI-enabled from a product standpoint. From other client experiences, we are a huge cash transaction processor, as you know, and we are wringing out a significant amount of manual interfaces where, whether it is sanction screening or reconciliations and auto-matching, reducing manual interventions, so it increases controls and speed of delivery for clients. So that is very exciting. Maybe the last thing I will close it out with is we did launch our agentic platform internally earlier this year.
That, plus the end-to-end process redesign work that we're doing in the transformation space, that's underpinning the confidence in that transformation journey as well. Our transformation journey is process-led, but it is AI-enabled.
Got it. When we look at the market backdrop, we've seen a mix of market volatility, changing rate expectations, dynamic equity markets. I guess, as we sit here today, how has the operating environment compared to your expectations coming into the year, and what are you watching most closely as we head into year-end?
Well, things have changed a fair bit. When we were-
Today
thinking about things at the end of 2025, early 2026, and just equity markets were around 6,800, 6,900. Our assumptions today, if you fast-forward, are more like 76, 7,700 is end of August, where you look out the window here. It's about what our assumptions are for the rest of the year. That's changed a lot. I think outlooks from street firms, which I think kind of get updated, might even imply 8,000, but our assumption is 76, 7,700 in the equity markets. I've got to jump to the rate markets again. Earlier in the year, I think we were thinking about cuts. You fast-forward to where we are today, where there may be as many as three or four hikes incorporated into the outlook for the Fed. It's not just the Fed. The European Central Bank is in a similar place.
I think we had the ECB on hold this year, and they have already hiked once, and I think there is three more hikes in the outlook even for the ECB. I think the idea that we would be continuing on the easing cycle has really pivoted to more of a higher for longer outlook, and not just on the short end. I think that we had the 10-year coming in probably 4.25 or so at the end of 2026, and it looks like that is over 5% today. Very different backdrop when it comes to the equity markets and rates. I would say that those things tend to be tailwinds for us. Higher equity markets, if you add in higher rates, we are asset sensitive, both within the U.S. and in Europe, and outside the U.S., generally.
I would also add that there are a lot going on that we are keeping an eye on for the rest of the year. Volatility, midterms, keeping an eye on what is going on with geopolitics and all of that stuff. But higher volatility tends to be somewhat of a tailwind for us as well. Kind of constructive outlook for the rest of the year.
You know the next question. In July, you raised your outlook for 2026 following strong performance in the first half of the year. We are getting close to the end of the third quarter. Against the backdrop we are discussing, just any thoughts on how the business is tracking relative to your expectations?
Yeah. Pretty good momentum there. Things playing out very well, and I will make a few comments about where we are seeing this come out. Just from a headline standpoint, I think about fee revenues. I think we are going to see that come in basically a little better than where we had 2026 before. So maybe something along the lines of 13%-14% range versus the original 12%-13% from a fee standpoint. NII, we had it originally at around 14%-15%. I think we are going to see that coming in towards the upper end of that range. So feeling very good on the revenue story. Expenses come in slightly higher in reaction to some of that revenue and other factors. When you put all that together for the year, I think in July, we mentioned that we would come in around 500 basis points of operating leverage.
That probably plays out to be slightly higher based upon those forces from a 2026 standpoint. Maybe just as what we're seeing in the quarter, I could add to that. In the quarter, I'd say that a good way to think about it is pretty stable quarter-over-quarter, and somewhat across the board. So whether it's fees, NII or expenses, you could kind of look at 3Q versus 2Q, seeing stability there. A couple of themes on the fee side of things, doing a little better in the servicing and management fee space, maybe as an offset to some moderation in the markets business. Those are a continuation of expectations that we had in July. As I mentioned, stability on the expense side of things.
I'd articulate that 2Q was 10 quarters in a row of positive operating leverage, and 3Q is going to be the 11th. I'm very excited about that and feeling good about the outlook there.
A lot to unpack. Let's start on NII. Continue to outperform expectations.
Yeah.
Maybe delve in a bit and just talk about deposits, what you're seeing there, and just kind of what gives you confidence in the durability of the trends we've seen, and maybe just the most importance of drivers of NII performance this year, and just how you're thinking about planning into next year.
Yeah. Just to maybe unpack that, starting with balance sheet and interest-earning assets tends to grow highly correlated with deposit growth. We saw pretty strong deposit growth in the second quarter versus the first quarter, and articulated an expectation of deposits being in the neighborhood of $270 billion for the year. I think that's still a pretty good number. That does imply growth in the second half compared to the first half. We're seeing good trends in the deposit portfolio that really allows us to think about interest-earning asset growth in 2026 being a tailwind for NII. That's really the main driver and contributor to the upper end of the range of getting closer to 15%. Net interest margin is going to be range-bound in the 110- 115 basis point range.
Those are some of the, I think, forces you'll see play out that are supporting that upper end of 14%-15% from an NII standpoint. Broadly the expectation over time and over the medium term is for some of that growth to continue on the interest-earning asset side of things, and for net interest margin to really migrate towards the higher end of that 110- 115 range over the medium term.
Helpful. You mentioned Apex earlier where you have a minority investment and partnership with. I think it was this quarter you announced an acquisition to expand your servicing business in Latin America. Just as you think about future opportunities, what makes an acquisition or partnership attractive to State Street? What role does M&A play? Maybe just talk about your appetite for bolt-ons and larger things.
Yeah. Really, I'll comment on this, too. I will start that when we think about allocating capital, we start with the strategy roadmap. That's where it all begins. The emphasis there is to allocate capital to organic deployment for driving that strategic roadmap over time. I talked about the things that we're excited about, whether it's alts, digital wealth, and also supporting our global network. So it begins there. But from time to time, when we see the opportunity to actually accelerate capabilities, we'll think about some transactions to help move us down that path in an attractive manner. Starting with Apex, we're really excited about the wealth services opportunity and serving the wealth intermediary and wealth manager client segment. The ability to create a digitally native front-to-back capability to support that customer segment was really exciting.
The first step in that was creating that partnership with Apex. The next step in that was really what I mentioned earlier in terms of integrating that within State Street, so now that is an integrated State Street offering that we lead with, and signing up an anchor client there. Very excited about that. It is all part of a combination of organic and some inorganic activity to actually move that strategic roadmap down the path. Then, yes, we are excited about the transaction we announced with Santander and CACEIS to acquire their joint venture in Latin America. Our global asset management clients have business operations around the world, including Latin America, and we were not at scale down there. This creates a scaled servicing capability that is attractive and accretive from a growth and return standpoint.
From that standpoint, we feel really good about that puzzle piece as part of the global network and infrastructure. Broadly, we start off with the focus on organic deployment of capital and being very disciplined when it comes to smaller transactions like bolt-ons.
Got it. You have historically talked to 80% payout ratio. You have talked about it for this year as well, as well as looking out. Just given strong capital ratios, this improving regulatory backdrop, is 80% the right level for State Street? Just how do you think about prioritizing capital deployment plus dividend, share buyback, reinvestment in the businesses, and some of the strategic opportunities you just talked about?
Yeah. I think it is a good point. Roughly 80% is a good yardstick that we plan against, and we mentioned that was the planning expectation not only for 2026, but also over the medium term. I think what it does is that it starts off with the expectation that we are going to return a majority of the capital generated in any given year to our investors, so first and foremost.
The reason why we are leaving that capacity there, that other 20%, is just to reflect the fact that we have very attractive opportunities in a number of our businesses to deploy capital for the benefit of our client segments and our customers. For example, in the markets business, we have a leading FX capability that does absorb capital. But being the number one FX provider to asset managers and continuing down that path does have some capital needs.
That capital that gets deployed is accretive from a return standpoint and is really part of the overall ecosystem in terms of supporting asset managers. The other side of the ledger, we have some attractive opportunities from a lending perspective. You see, we will also support the asset management space, both traditional and alternative, in providing access to the balance sheet, connected with our servicing capabilities. That ecosystem is also very accretive. Just having a growth mindset and staying on the path to continuing to grow the platform, we think that it's valuable to have some ability to use some of that capital strength in order to support customers. Then lastly, from time to time, as you mentioned, we'll see the opportunity for some bolt-ons.
That's why we tend to use that 80/20 as a good planning expectation in any given year, which could deviate depending upon the opportunities that may ebb and flow that I articulated.
You mentioned earlier that this third quarter will be the 11th straight quarter of positive operating leverage. You're going to exceed 500 basis points of positive operating leverage for the year. Just maybe as you put together the kind of 2027 budget, and thinking at expenses, maybe just talk to how you balance investing for the future, driving further profitability improvement. How are you thinking about operating leverage target for next year? Then where things are really good, just how do you kind of pivot if maybe next year the environment becomes less favorable?
Yeah. Broadly, we have scenario-based planning. If we see some base case expectations, I think we talked about in July in terms of making progress over time. We talked about the transformation program supporting our strategic initiatives, as well as allowing us to continue to contribute to pre-tax margin over the medium term.
The scenario-based planning, whether it's a blue sky outcome where we might maybe lean in a bit, we also have gray sky scenarios that would allow us to nevertheless continue to invest in the crown jewel strategic initiatives through downturns, because we do think that's important that when and if you have a downturn, you may tap the brakes on certain marginal investing, but you really need to protect the core so that you have momentum coming out of those downturns and don't see yourself in an air pocket of strategic capabilities as things become a little better and those downturns pass. We do a scenario-based planning. I think you'd see us leaning in on transformation-related capacity to invest in order to continue to have an attractive margin progression over time, delivering against that medium-term outlook that we articulated.
I guess you talked about this billion-dollar transformation benefits on the last quarter's earnings call. Is that the right number? What should we be watching to see if you're on target for that? Maybe expand upon the biggest pieces of it and how'd you come up with it?
Yeah. I think when you look at that over a three or four-year period and break that down, that's a pretty solid mid to high single digit creation of productivity based upon the expense base. I think we said we would get to that level by the end of 2029. On a run rate basis, you start seeing that in a year four of an outlook. Pretty solid productivity expectation when you think about it top-down. We did build it bottoms up across four overall pillars. The first is an end-to-end process redesign of our business processes and our supporting operating model across the whole company. We're migrating to a product platform approach, which is very cross-functionally driven and underpinned by an agile delivery mechanism.
That's the first pillar of it, and you're going to see re-engineering and significant efficiencies in productivity coming out of that first pillar. The second one is technology modernization. Fewer applications, bigger footprint in the cloud. The third is data. Fewer data lakes, and much more efficient access to data throughout the platform. The last one is more of the traditional kind of blocking and tackling from an efficiency perspective, third party spend, managing through organizational design, and those kinds of things. Those are the four pillars that underpin the $1 billion. $750 of that's on the productivity side coming out of expenses, and then you have the $250 coming out of revenue in terms of product launches and that kind of thing as well.
Feeling good about that calibration and seeing that productivity begin to ramp over the medium term is what would give you the signal that we're on track to deliver by the end of 2029.
Got it. Earlier, we were talking about digital assets. Maybe we spend a little bit more on that. I think it's something that we're trying to, I guess, continue to grapple with as it's still in the early stages. Just as you look out, I guess, what are you hearing from clients? Where is demand? I know we're in the early innings. I guess, how do you just see this evolving? What are the biggest opportunities for State Street?
Yeah. I think as I mentioned, we think about being at the intersection of all of these workflows for our clients and providing that seamless on-ramp and off-ramp between the traditional world and the digital world. Where we're seeing our clients get really excited is in the early use cases, is really around collateral management and unlocking the economic value of collateral movement and flexibility. So tokenized money market funds. Where money market funds are not eligible collateral, this unlocks that on behalf of our clients, number one.
I think secondly, the other big one that we think about is facilitating new distribution channels for our asset managers, where on-chain distribution of assets for a customer base that prefers to operate or have the flexibility to operate in the digital world and on blockchain is the second big one that we're following our clients and being the infrastructure that allows them to do that seamlessly. As I mentioned, this is just going to be table stakes. So the asset management space is going to need to operate in all likelihood for the foreseeable future in a hybrid approach from both traditional rails and on digital rails. We're going to be there to support them in doing that. It's going to be quite some time before we see how that plays out in terms of digital versus traditional rails.
But we think it's a hybrid approach for the foreseeable future, and we're investing in the infrastructure and product capability to power it.
We've talked about at the onset, we started with kind of your medium targets. I know they're kind of three- to five-year targets. Just what are the most important milestones we should watch over the next 12- 18 months as maybe leading indicators that you're on track to achieve that 35% pretax margin, mid-20s ROTCE?
Yeah. I would say I would go back to the core franchise again and keep an eye on organic fee growth is an important driver of where we were. If you look at item I may reference, if you look in the second quarter, and if you strip out market tailwinds and FX tailwinds from where things are going, and we certainly benefit from all that. Even if you exclude all of that, you look at that operating leverage is, and I talked in July about over time, 100- 150 basis points is what we're talking about in terms of over the medium term to deliver that 35% pretax margin. We delivered exactly that in the second quarter, stripping out all of the market stuff. So I think keeping an eye on our organic fee growth is one of the important drivers ex markets.
I think the other one is continuing to see the benefits of NII as an important part of that story. As I mentioned, we expect NII to grow in the low single digits range over the medium term driven by the expected growth that we'll see in deposits, et cetera. I should correct that. So the NII we expect is low to mid-single digits. The balance sheet growth is low single digits. Keeping an eye on continuing to grow deposits over time as well as seeing our net interest margin starting to migrate towards the upper end of that range. That's the revenue story. On the expense side of things, just seeing us continuing to be able to advance our capabilities from a strategic initiatives portfolio perspective while still growing that productivity and getting to that $750 million of productivity that underpins that billion.
Those are the things that we are excited about that I think will be emblematic of being able to provide that positive operating leverage even ex markets that will underpin getting to that medium-term outlook that we are excited about from July.
In the waning minutes. You have been at State Street a year. Biggest positive surprise. Biggest, I don't want to say negative surprise, but biggest not positive surprise.
Maybe they will posit this right. The global presence and the interconnected businesses that we have around the world and the quality of our customer base is just incredible. 95 of the top 100 asset managers in the world are clients of State Street. 85 of the top 100 asset owners are clients of State Street around the world. It is just really impressive and just a premier client base with an incredible global network. From outside the building, and we all look at State Street, you can think about it in one way. After a year of being inside the building and seeing it operate, it is just an incredibly positive feeling to be part of this franchise. That is the first one. I would say that on the other side of the ledger, and I think that quickly becomes a positive as these often do.
The opportunity from a strategic initiatives perspective and from a transformations perspective, it is probably a little bigger than I thought it was going to be. We grabbed the wheel on that and leaned in and put a transformation acceleration program together to basically pull that lever over the medium term. But yeah, that was probably a little bit of a surprise in terms of how big that opportunity was going to be coming in from a year ago.
Great. On that note, please join me in thanking John for his time today.