State Street Corp (XLF) Q1 2020 Earnings Call Transcript

Good morning, and welcome to State Street Corporation's First Quarter 2020 Earnings Conference Call and Webcast. Today's discussion is being broadcasted live on State Street's website at investors.statestreet.com. This conference call is being recorded for replay. State Street's conference call is copyrighted and all rights are reserved. This call may not be recorded for rebroadcast or distribution in whole or in part without the expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on the State Street's website. Now, I would like to introduce Ilene Fiszel Bieler, Global Head of Investor Relations at State Street.

Good morning and thank you all for joining us. On our call today, our CEO, Ron O'Hanley, will speak first. Then Eric Aboaf, our CFO, will take you through our first quarter 2020 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com. Afterwards, we will be happy to take questions. During the Q&A, please limit yourself to two questions and then re-queue. Before we get started, I would like to remind you that today's presentation will include results presented on a basis that exclude or adjust one or more items from GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation. In addition, today's presentation will contain forward-looking statements. Actual results may differ materially from those statements due to a variety of important factors such as those factors referenced in our discussion today and in our SEC filings, including the risk factors in our Form 10-Q. Our forward-looking statements speak only as of today, and we disclaim any obligation to update them even if our views change. Now, let me turn it over to Ron.

Thanks Ilene and good morning everyone. You will have seen that today, we released our first quarter earnings results. I am pleased with our performance during such turbulent times, and I am proud of our team members worldwide who achieved these results. The COVID-19 health crisis has necessitated a rapid curtailment of economic activity, which in turn has driven significant financial market volatility and a lack of liquidity in some fixed income markets. The markets in general and State Street specifically, have withstood the volatility well. Central banks moved quickly to help alleviate market stress and State Street's long-standing business continuity planning, supplemented by rapid innovation, has enabled us to operate, protect our employees, and serve our clients exceptionally well. Throughout this period, we have continued to execute against our strategy, which is reflected in our strong performance. Before discussing our quarterly financial performance, I want to review some of the actions that we have taken in support of our clients and to protect the safety of our global workforce, all while remaining focused on State Street's operational excellence, resiliency and business performance. Turning to slide three, I will outline some of the key aspects of State Street's response to the pandemic. As a global company operating in 29 countries, we have been addressing the coronavirus since its very inception with significant operations and approximately 3,000 employees in China, we had somewhat of a head start on adapting our global operating model to the rapidly changing needs of our clients as well as to the safety concerns of our approximately 39,000 employees across the globe. Our actions in response to this global health crisis have centered on maintaining employee safety and business continuity and resilience, while concurrently supporting our clients, the financial markets, and the broader economy. Let me start with our people. Here, our Senior Global Crisis Team has worked continuously since mid-January with local management and relevant authorities across the world to safeguard employee health and wellbeing. Our IT capabilities rapidly allowed us to add capacity for remote access solutions, while also maintaining cyber safety. And today, approximately 90% of our global workforce is working from home. We announced that through the end of the year, we suspended any workforce reductions other than for performance or conduct reasons in light of the COVID-19 crisis. I believe this is the right decision for our people, our clients and our communities. It aligns with our culture and values and reflects our financial strength. We are undertaking actions to offset the cost of this decision, which we will describe later in the presentation. Let me turn to our clients in the broader markets. The macroeconomic environment remains uncertain and the pace and timing of an economic recovery will influence investor behavior, financial market conditions, and our clients, who are the owners and managers of the world capital. State Street plays a central role in the infrastructure of the global financial system. This crisis has demonstrated our deep operational capabilities at a time of significantly increased business volumes. Our global operating model has enabled us to run split operations where we can efficiently transfer work with minimal disruption to client service at a time when we have seen a significant expansion in activity. For example, in March, we experienced a 50% increase in back-office transactions and an over 80% increase in middle office transactions. Similarly, valuation checks for NAV calculations due to significant asset price moves, which typically run at approximately $70,000 per day; it is high as $1 million per day at the height of the market volatility. Due to the scale and reach of the current COVID-19 crisis, asset owners and asset managers have been impacted globally with many struggling to cope with market disruptions, reduced workforces, limited access to normal workplace infrastructure, and continuing uncertainty. To assist these clients, we have focused on a number of priorities during the last few weeks. First, we have increased our level of client engagement and communication ensuring we better understand client needs and how we can rapidly assist them in this unique and challenging environment. Second, we are maintaining a state of operational readiness through increased IT resource capacity with strong and tested business continuity plans put into action, as I mentioned earlier. Third, we are providing a suite of liquidity solutions. State Street has a range of short-term cash investment options for our clients, including deposits, centrally clear repo and access to a full range of money market funds via our investment portal Fund Connect. Global Advisors also has a number of specialized cash strategies. In addition, our global credit finance team supports clients with overdraft capacity and committed lines of credit. We also stand ready to support the broader economy. State Street is actively assisting our clients to tap various Federal Reserve programs that support the flow of liquidity and credit, facilitating approximately 50% of money market mutual fund liquidity facility, or MMLF usage, while also serving as the custodian and accounting administrator for the commercial paper funding facility. Many clients appreciated that we worked closely with the Federal Reserve to set up the MMLF and enable clients to access liquidity even before it's fully operational, which helped clients stabilize their funds. As we look out over the longer term, the evolving needs of all of our clients are at the center of our strategy to continue to be our clients' essential partner and provide the technology and scale they need to grow when the current uncertainty dissipates and global macroeconomic conditions recover. We believe this crisis will only accelerate the desire of clients to outsource more of their operations and partner with a fully capable front-to-back provider like State Street. Turning to slide four, I am pleased by the direction and progress of our strategy as demonstrated by our strong first quarter performance. Relative to the prior year period, first quarter total revenue increased 5%, and on a sequential quarter basis, total revenue increased 1%. First quarter EPS was $1.62, up 37% year-over-year, and ROE was 10.9%. I am pleased to report that our first quarter pretax margin improved by over three percentage points to 25.6%, excluding notable items. Despite the unprecedented levels of equity market volatility during the first quarter, our results benefited from the relatively stable domestic equity market averages relative to the fourth quarter of 2019. Market averages were materially higher than the year ago period as a result of the dramatic global equity market sell-off in late 2018. Industry flows were positive in aggregate as investors move from long mutual fund positions into ETFs and money market bonds. At State Street, we saw a particularly strong recovery in U.S. flows relative to the first quarter of 2019. While FX volatility remained at low levels for the first half of the quarter, our results, ultimately, benefited from materially higher levels of FX volatility experienced during the latter half of the quarter and the market tumult associated with COVID-19. That volatility, plus our multi-year innovation investments, led to record FX results. First quarter NII benefited from significantly higher deposit levels as clients turn to us as part of their flight to quality, despite dramatic long and short end rate reductions. Assets under custody and administration fell 7% quarter-over-quarter to $31.9 trillion as a result of lower period end market levels. We saw a healthy level of new wins during the quarter, totaling $171 billion. Assets yet to be installed stood at $1.1 trillion at quarter end. At Global Advisors, assets under management fell 14% quarter-over-quarter to $2.7 trillion as a result of lower period end equity market levels. Global advisers recorded $39 billion of total net inflows during the first quarter, the highest quarter of net inflows in a year. Net inflows were driven by strong inflows in cash and good inflows in the institutional business, as clients turned to State Street's offerings in a time of turmoil. After experiencing net outflows in January and February, I would note that March was a particularly strong month for our ETF business, with our SPDR suite of ETF gathering more than $20 billion in net inflows. Aided by the integration of Charles River Development, we continue to see that our front-to-back Alpha platform strategy provides an attractive value proposition for our clients, and building on this remains a key focus for us in 2020. We signed a large sovereign wealth fund as a front-to-back client in quarter one. The front-to-back State Street Alpha pipeline is developing and advancing well with a good mix of deal sizes, functionality and scope. Turning to expenses, first quarter total expenses were down 1% relative to the year ago period, excluding notable items. We are building on the strong culture of expense management we successfully established during 2019, when we undertook significant actions to improve our operational efficiency and reduce expenses through a comprehensive firm-wide expense savings program. Today, we are more focused than ever on driving productivity improvements and automation benefits as we strengthen our operating model, even during this unprecedented period. In addition, as a result of the current environment and our decision to suspend workforce reductions, we are taking additional expense actions, including a hiring freeze for non-critical operational positions. We also continue to very carefully manage all discretionary expenses. To conclude, while we cannot predict the scope and duration of the pandemic and the associated economic impact, we will remain very focused on three core priorities. First, supporting our employees and our communities; second, providing service and operational excellence to our clients; and third, driving value for our shareholders. While the markets may be unpredictable, we are well prepared to navigate this volatility with a strong balance sheet, capital position and proven operational capabilities. We at State Street remain outward looking, globally connected and laser-focused on helping our clients achieve better investment outcomes for the people they serve. State Street has navigated through good times and bad times for our clients for over two centuries, and this moment will be no different. We stand ready to support our clients and our global workforce in any capacity we can. And with that, let me turn it over to Eric to take you through the quarter in more detail.

Thank you, Ron, and good morning, everyone. To start my review of our first quarter results, I’d like to go to slide five, where you can see we reported EPS of $1.62, which is a 37% increase year-over-year. On the top left panel, I want to highlight two items. First, our FX trading business had an exceptional quarter, generating revenues of $459 million due to record volumes and increased client demand, which I will discuss in more detail shortly. Second, we recorded a $36 million provision expense with a sequential increase mainly driven by the effects of COVID-19 on our economic forecast. On the top right panel, we had $11 million in expected pretax acquisition and restructuring charges, primarily related to Charles River, as well as $9 million in after-tax costs associated with the redemption of our Series C preferred securities. On the bottom left panel, we present our quarterly results, excluding notable items for those interested in the underlying trends. I would also note that we generated positive operating leverage in the first quarter, improving our pretax margin year-over-year. Turning to slide six, AUC/A levels decreased by 2% year-on-year and 7% quarter-on-quarter. The year-over-year decrease in AUC/A was impacted by a previously announced client transition that had a negligible effect on revenues. The quarter-on-quarter decline was mainly due to lower end-of-period equity market levels. Approximately half of our AUC/A is reported on a one-month lag, so some impact from the equity sell-off in March has not yet been reflected. AUM levels decreased by 4% year-on-year and 14% quarter-on-quarter to $2.7 trillion, mainly driven by lower end-of-period market levels, though strong net inflows occurred over both periods. Despite the challenging market conditions for asset managers in the first quarter, State Street Global Advisors saw net inflows of $39 billion, primarily from cash and institutional sources. Breaking down the first quarter AUM trends, it was a comparison of January and February versus March; after experiencing modest net outflows in the first two months, Global Advisors saw strong inflows of about $45 billion in March, including $27 billion in cash inflows and $23 billion in ETFs. Global Advisors received over $10 billion in March alone into SPY, our leading S&P 500 ETF and the largest in its category. Moving to slide seven, servicing fees rose by 3% year-on-year as the core business continued to recover momentum but were down 1% quarter-on-quarter due to lower equity markets. As Ron mentioned, our investment services business experienced significantly elevated client activity and inflows during the quarter, especially in March, and managed this activity with minimal service disruptions. During this challenging environment, clients recognized the value of our scale and capabilities more than ever. Many asset manager clients expressed appreciation for our partnership and for the efforts of our investment servicing business to ensure that fund investors can buy, sell, and monitor their fund performance accurately and in a timely manner. In the bottom right panel, we have included sales performance indicators that highlight this dynamic. AUC/A wins totaled $131 billion in the first quarter, with several deals emerging in late March. While we anticipate a near-term slowdown in sales, the assets to be installed as of the first quarter-end are strong at $1.1 trillion, and we still expect fee pressure to remain moderate as it has in recent quarters. Turning to slide eight, let’s explore other fee revenue lines. First quarter management fees were up 7% year-on-year but down 3% quarter-on-quarter due to lower average market levels and changes in product mix away from higher fee institutional products, partially offset by positive changes in ETF mix. As I noted earlier, FX trading services surged by 64% year-on-year and 68% quarter-on-quarter, as the business experienced record volumes and heightened client demand due to market volatility amid the COVID-19 pandemic, a topic I will elaborate on shortly. Securities finance revenues decreased by 22% year-on-year, attributable to a shift in investor asset mix towards lower spread fixed income assets and hedge fund deleveraging in foreign markets, which reduced enhanced custody demand. Revenues also fell by 17% quarter-on-quarter due to similar reasons. Finally, software and processing fees dropped 41% year-on-year and 49% quarter-on-quarter. This line includes certain business revenues such as CRD software fees, along with other variable items, such as the amortization of tax-advantaged investments, certain currency translation impacts, and adjustments related to employee long-term incentive plans. These other items resulted in a $65 million negative impact this quarter, contrasting with the usual small positive. On slide nine, we want to provide additional insights into the exceptional quarter for our FX trading franchise. For several quarters, we have noted that our FX business has faced historically low volatility levels, but we have been concentrated on expanding our client base and increasing our market share while reinvesting in our platforms. This quarter, we were well-positioned to support our clients' needs as volumes and volatility surged due to the COVID-19 pandemic, leading to heightened client demand across our various FX trading venues. The FX sales and trading business, encompassing direct FX and custody FX, experienced a 40% rise in volumes compared to average levels, while our FX trading platforms, including FX Connect and Currenex, recorded a 50% increase in volumes during the same timeframe. On the right side of the page, we have highlighted the most recent Euromoney rankings for the FX business, including its top ranking for real money asset managers for two consecutive years, showcasing the depth and breadth of this critical franchise. On slide 10, you’ll find a five-quarter summary of CRD’s stand-alone revenue and pretax income. For the first quarter, CRD generated revenue of $100 million, reflecting a 1% year-on-year increase but a 21% quarter-on-quarter decline. I remind you that there is a lumpiness associated with ASC 606 revenue recognition standards, so it's essential not to over-interpret any one quarter’s results. We do anticipate some disruption and adjustments in professional services fees in the upcoming months due to currently limited on-site activity. On the right panel, we’ve provided insight into the momentum in the business and the progress of the integration. We remain confident in the revenue and cost synergy goals outlined at the time of acquisition. Turning to slide 11, NII decreased by 1% year-on-year but increased by 4% quarter-on-quarter. The sequential rise in NII was primarily driven by higher deposit balances and one-time favorable market effects of around $20 million, somewhat offset by long-term debt issuance costs. Average assets rose as average deposits increased by 10% quarter-on-quarter from Q4 2019, and period-end deposits surged by 41% quarter-over-quarter due to a wave of flight-to-quality client deposits in late March, particularly from asset managers. We were positioned to support our clients during this time. Although we saw deposit levels decrease slightly in April, they remain high compared to Q4 2019 levels. End-of-period assets increased by $27 billion as we assisted clients in accessing the Fed’s new money market mutual fund liquidity facility. State Street facilitated over 50% of the MMLF volume, demonstrating our leadership in supporting clients and the efficient functioning of markets. On slide 12, we’ve provided details regarding our loan portfolio and the company’s allowance for credit losses. State Street’s loan portfolio is comparatively small, generally around 10% of average assets and comprises high-quality, conservatively underwritten fund finance, leveraged loans, commercial real estate, and municipal loans. On the right panel, we have offered additional details about the loan book and its characteristics. As of the first quarter, approximately 91% of the book is investment-grade, with 84% of on-balance sheet exposure rated as investment-grade and 98% of off-balance sheet. The leveraged loan portfolio of about $4 billion has limited exposure to cyclical factors currently in focus and holds an average rating of BB, stronger than the traditional index. Compared to Q4 2019, average loans increased by 12%, while period-end loans rose by 23%, mainly due to elevated client overdrafts as we facilitated higher trading and FX settlement activities in March. These overdrafts have since decreased in April. In the bottom left panel, the total allowance for credit losses rose by $35 million to $124 million, reflecting additional reserves largely related to the effects of the COVID-19 pandemic on the end-of-March economic forecast. On slide 13, we have presented our expenses this quarter, excluding notable items, to make the underlying trends clearly visible. Our Q1 2020 expenses, excluding notable and seasonal items, decreased by 2% year-over-year due to resource discipline and reengineering efforts and were down 2% quarter-on-quarter, primarily due to timing in foundation funding, reduced travel, and lower professional expenses. We continue to advance various investments and optimization savings initiatives that will help us navigate the extraordinary market conditions and achieve our expense goals. We are making progress in reducing compensation and benefits costs, occupancy costs, and other expenses, while IT costs are unpredictable but are also on track. Given the potential impact of the COVID-19 pandemic on revenue, we need to take further action on expenses and now anticipate a reduction of 1% to 2% for the full year. This will be challenging, but we've accelerated our plans and will adapt as necessary. First, as Ron mentioned earlier, for the rest of the year, unless the crisis resolves sooner, we will halt most workforce reductions. We also implemented a hiring freeze for non-essential positions. Second, we see opportunities to further cut non-compensation expenses, such as occupancy, contractors, travel, and other professional fees. Third, we will be prudent regarding necessary reinvestments to spur growth. Lastly, we will adjust our strategies as the situation evolves. On slide 14, you can see that we maintained solid capital and liquidity levels during the first quarter, with our standardized CET1 ratio ending at 10.7%, while our LCR ratio remained stable quarter-on-quarter. Our SLR and Tier 1 leverage ratios stood at 5.4% and 6.1%, respectively, with the sequential decline largely attributable to an influx of flight-to-quality client deposits. We have the capacity to support client activity under both ratios, especially given that the SLR would have been 7.1% had Section 402 been implemented on April 1. During the quarter, we returned approximately $683 million in capital to shareholders, including $500 million in share repurchases before we coordinated with other members of the Financial Services Forum to temporarily suspend our repurchases in the second quarter. We remain confident in our robust capital levels and our ongoing ability to utilize our balance sheet to support our clients, financial markets, and the broader economy. Turning to slide 15, we summarize our first quarter results. Throughout this crisis, we have differentiated ourselves by proactively reaching out to assist clients during difficult times. Our ability to endure heightened volatility and execute record volumes without sacrificing service has built goodwill with our clients as we look toward the future post-COVID-19. However, the potential duration and severity of the COVID-19 pandemic's impact on the economy have introduced uncertainty into our operating environment. This uncertainty adds a higher level of variability to our financial outlook. Nonetheless, I’d like to share our expectations for the remainder of 2020 based on certain assumptions. While we consider these reasonable, there is a wide range of possibilities regarding how the COVID-19 pandemic might unfold and the scale of its economic effects. The expectations we provide today reflect one possible outcome and do not encompass the full range of potential scenarios. Considering the challenging economic situation in the second quarter, we anticipate that global central banks will keep short-term rates low and that long-term rates will rise to around 80 basis points by year-end. We expect equity levels in the second quarter to be consistent with March averages and possibly improve in the second half of the year, resulting in lower average equity market levels for 2020 compared to 2019. Given these adjustments to the economic outlook, we currently expect a year-over-year decrease of 1% to 2% in fee revenue for the full year 2020. Analyzing the components of our fee revenue, starting with servicing fees, we expect a decline of 1% to 3%, mainly due to lower-than-anticipated market averages. While the servicing business shows good underlying strength and momentum, we may experience a temporary slowdown in the sales pipeline as clients adapt to the new operating environment. Regarding management fees, we now anticipate a year-over-year decline of 3% to 5%, contingent on equity market performance. This outlook factors in the zero interest rate environment, which may necessitate fee waivers for money market funds, potentially impacting our business by approximately $10 million to $40 million, primarily in the second half of the year. Our market businesses will be influenced by trading conditions. We expect that the initial surge in FX trading revenues will taper off, along with reduced market volumes and volatility; meanwhile, securities finance will continue to feel the effects of decreased leverage. For software and processing fees, we remain optimistic about the synergies from the CRD acquisition. However, the uncertainty and operational challenges brought about by the COVID-19 pandemic may lead to delays in go-live projects and a slowdown for professional services at several current CRD clients. As a result, we now expect CRD revenue to experience a mid-single-digit percentage increase year-over-year for the full year 2020. We anticipate software and processing fees, excluding CRD, to be around $60 million to $70 million per quarter for the remainder of the year, unless further significant market-related adjustments arise. For the second quarter of 2020, we foresee a sequential decline in overall fee revenue of 5% to 9% as a result of significantly lower equity market levels. Servicing fees are projected towards the minus 5% end of the range, management fees towards the minus 9% end, factoring in some reversion in trading revenues. Regarding NII, we still expect a drop of about 10% year-over-year for the full year 2020, primarily due to the impact of lower rates and strong performance in the first quarter. For the second quarter, we currently anticipate NII to decline by approximately 11% quarter-on-quarter, excluding episodic items, driven by the full impact of lower rates. We expect NII to stabilize by the fourth quarter. In terms of expenses, even during this unprecedented period, we remain focused on driving sustainable productivity improvements and benefits from automation. We now expect full-year expenses, excluding notable items, to decline by 1% to 2%, surpassing our original plan for a 1% reduction, as previously indicated. Concerning our provision expense, the second-quarter results will be influenced by updated economic forecasts incorporated into our new CECL models, along with any specific reserves. At the end of March, we considered various factors across a range of scenarios for our general reserve. In our dominant scenario, we projected a 12% drop in Q2 GDP and a 2% decline for full-year GDP. Had we shifted to a different scenario with a full-year GDP of minus 6%, we would have built an additional $50 million in reserves. While this is a simplification and there are many crucial variables, it highlights the sensitivity of the CECL reserving process to potential economic conditions. Regarding taxes, we expect our tax rate for the full year to fall within the previously indicated range of 17% to 19%, though some discrete items are likely to decrease that rate by about four percentage points in the second quarter. Lastly, we have included our previously disclosed medium-term financial targets in our earnings presentation today, as we believe they remain relevant. However, the onset of the COVID-19 pandemic and the significant uncertainty regarding its effects raise questions about when we might achieve those targets, which were established on a run-rate basis for 2022. At this point, we are not altering the timeline but will continue to closely monitor the anticipated impact of COVID-19 going forward. With that, I will hand the call back to Ron.

Thanks, Eric. Operator, we can now open the call for questions.

Your first question comes from Alex Blostein with Goldman Sachs. Your line is open.

Great. Good morning, everybody. Eric, thanks for the updated detailed guidance. I guess first question maybe around deposits. So below March levels, but above, I guess, you said fourth quarter, obviously, it's a really wide spread there. So, maybe just give us a flavor for where deposits currently stay in April, sort of on average? And then importantly, as you guys think about the capacity to absorb any additional deposits or sustain the current levels, how should we think of that with respect to your capital leverage ratios? How much lower you guys would be able to take that?

Alex, this is Eric. I want to touch on the deposits and provide some insights on the trends. As you may recall, our overall deposit levels were around $165 billion in the fourth quarter. In January and February, they remained consistent with those averages. However, we observed a significant increase at the start of March. In the first half of March, our average total deposits were about $185 billion, and the second half saw a jump to $235 billion, contributing to higher averages for the quarter. Our total at the end of the period exceeded $250 billion, and we maintained that deposit level for about a week at the close of the quarter. Currently, deposits are hovering around $200 billion to $210 billion, which is still substantial and denotes a cautious approach. We are witnessing a trend of clients prioritizing quality, and we are here to support them. We do anticipate a decline in deposits, but we are unsure of the pace and whether there will be an upswing. What I can say is that our current deposits are enabling us to meet our clients' needs; we are assisting with overdrafts, deposits, repos, and supporting them with Federal Reserve facilities. We are glad to provide that support. Regarding our capacity, as mentioned in my previous remarks, we have sufficient capacity at these deposit levels to assist our clients. Our capital ratios, including the SLR after the April 1 adjustment, are quite robust, sitting at around 7% compared to the 5% requirement. Our Tier 1 leverage also remained strong this quarter against a 4% minimum. There's some range to consider, although it's not unlimited. However, we believe that if deposits stay at their current levels of $200 billion to $210 billion, we are well-positioned to meet our clients' needs.

Got it. That's helpful detail. Thanks for that. And then my second question is around CRD. So, revenue is about $100 million in the first quarter that's up only 1%, I guess, year-over-year. I think that business has been growing in the kind of high single-digit range, and you guys are obviously hoping to increase that further. So, is that sort of the impact of COVID-19 already playing out in the first quarter results? And that's really kind of the slowdown? Or is there something else going on? And I guess, as you look at the pipeline and the front-to-back wins that you guys have been highlighting over the last couple of quarters, any way to help us frame kind of the revenue backlog in that part of the business in timing to recognize it, understanding that, obviously, the current events could move that timing up and down, but just hoping to get some flavor there? Thanks.

Alex, let me start by saying that we are very pleased with the impact that CRD is having on our business. The front-to-back pipeline continues to grow, and having CRD as part of that toolbox is valuable. As I have mentioned before, sometimes we don’t achieve a full front-to-back solution, but we still establish built-out relationships or even new relationships. For instance, we announced a front-to-back win this quarter, which was with a client that was not already using CRD or State Street. Overall, this enhances State Street’s value proposition. As Eric pointed out, reported revenues are highly sensitive to accounting rules and the timing of our deliverables. Changes in delivery schedules or project details can affect when we recognize revenue. Despite this, CRD remains a crucial and strategic part of our business, driving new activity and contributing to our profitable back office. Our position has not changed, and it is strategically important to us. Eric can discuss the financial impact related to your question.

Sure, Alex, this is Eric. The quarterly revenues tend to fluctuate quite a bit. Just to remind you, a midsized client can generate $5 million to $10 million for us when they go live with an on-premise installation. Smaller clients typically bring in $1 million to $3 million. With a revenue base of $100 million, this can lead to significant variations in growth rates, both positive and negative, so I wouldn't read too much into those numbers. We've started to assess the expected revenues for the business this year. Unlike our servicing fee business, this business requires more on-site work. On-site co-development for integrating our platform with asset managers involves professional services that may also face delays due to remote work situations, and we anticipate that go-live dates might be extended. While we don't expect any issues with the projects, we do see some delays in go-live timelines. We're looking at revenue growth of around 5% to 6%, revising our earlier expectation of low-double-digits growth. We believe this adjustment is primarily due to timing rather than the underlying business performance. The pipeline for CRD remains healthy, consistent with levels from a few months ago, and we feel the interest from clients in securing mandates is stronger than ever.

Great. Thanks for taking the questions.

Next question comes from Glenn Schorr with Evercore. Your line is open.

Hi, thanks. I have a quick question about the loan book. I appreciate what you mentioned regarding the underwriting environment and the potential for a more challenging situation in the second quarter. I'm trying to analyze the composition of the loan book; fund finance and overdrafts don't concern me much, and I suspect that not much of the reserves are allocated to those areas. Can we say that the majority of the reserving is directed towards the $4 billion leveraged loans and the $2 billion commercial real estate? I'm also interested in more context regarding the quality of those portfolios. While what you shared seems positive, the percentages you mentioned start to add up in terms of reserving. That's all.

Glenn, it's Eric. I believe you have the right perspective on the loan book, which comprises 10% of our total assets and is well diversified both across and within categories. Fund finance, as you highlighted, primarily involves capital call finance loans backed by some of the world's top investors, making it an appealing area for us that has seen significant growth. We will take some extra time to discuss leveraged loans due to the current environment, and I'll address that shortly. Commercial real estate overdrafts are quite straightforward. You are correct in assuming that the majority of our reserves are allocated to the leveraged loan segment. We feel reasonably confident about this portfolio, although individual occurrences may arise. It primarily consists of higher-quality loans, with an average rating of about BB, compared to the index average of single B, indicating a significant difference in quality. We have been monitoring market prices for this book, which tend to be six to seven points higher than the average leveraged loan index, showcasing its strong performance thus far. The portfolio is well diversified, lacking significant exposure to any unusual sectors like oil and gas. We believe it will perform effectively in this period. Ultimately, it represents a relatively high-quality segment of leveraged lending, and with a total of $4 billion, we expect it to contribute positively to the overall picture for the company.

Cool. I appreciate the perspective. One follow-up on just NII, overall. So keeping it at down 10 as the thought process for the year, but the deposit book is a lot more. I'm just curious a lot of the deposits come in, in non-interest bearing. And so we'll see how long they sit there, but they're going to hang out for a little while, at least. I'm just curious, I know rates think, but we knew the rates were interesting. I'm curious why NII, with a greater deposit base wouldn't be a little bit less bad?

Glenn, this is Eric. You made a good point. I won’t reiterate the five-letter word you mentioned. However, the current interest rates set by the Central Bank, particularly the IOER, are notably low at just 10 basis points. This means whether we accept a deposit with no interest or one with a slight return, the difference in spread is minimal. Consequently, while these deposits appear on our balance sheet, allowing us to lend against them and support our other financial activities, they are largely temporary. Their value is significantly reduced compared to previous periods. In the first quarter, deposits were valued at around 100 basis points on average. However, in the second quarter, we anticipate that the value of deposits will drop considerably to closer to 10 basis points. This represents a substantial difference in magnitude. Therefore, while we may experience an influx of deposits, they are not expected to be particularly profitable this time around.

I got it. I appreciate it and thanks for all the guidance. Thanks.

Your next question comes from Brennan Hawken with UBS. Your line is open.

Good morning. Thanks for taking my questions. Just wanted to dig in a little bit on your expectation on trading revenue. I know you referenced, Eric, that you expect it to subside. But can you help us with magnitude? How should we think about the potential decline from what you did in Q1? Are you really just sort of expecting it to revert back to what we saw kind of like last year run rate? Or how should we calibrate? And what should we watch for as the year progresses?

That's a great question, and it's not easy to answer definitively. However, I can share our current perspective on forecasting and the potential scenarios. We believe that by May and June, barring any major changes in the environment, FX volumes will return to pre-crisis levels. We expect these levels to continue into the third and fourth quarters. This is all based on the assumption that equity, bond, and global markets remain stable, which is difficult to predict. If there are further declines in health or economic conditions, we could revert to previous circumstances, something we hope to avoid. That said, there are various outcomes to consider. We might see higher volumes if we experience a similar situation as in March. Additionally, we have ongoing factors like Brexit and the U.S. elections, along with other political and economic events that could influence the market. Given these uncertainties, we prefer to be cautious with our FX forecasts, acknowledging that there could be some positive surprises. Ultimately, we'll have to monitor the situation and adjust accordingly as developments occur.

Thank you for that information. Regarding Glenn's question about the loan book, I appreciate the additional details. The main concerns here are with fund finance and overdraft. Could you discuss any exposure you might have in the fund finance segment to mortgage REITs? What aspects of this segment cause your risk managers to feel uneasy? It's important to recognize that during challenging market conditions, concerns may not always be where you expect them to be, and surprises can arise. How do you approach the management of that book, and what measures do you take to prevent a situation like we saw in a previous cycle, where assets that seemed secure suddenly became liabilities that had to be addressed?

Yes, Brennan, it's Eric. Let me provide some details on the $13 billion of fund finance and our perspective on it. Over the past month, our finance, risk, and business teams have intensified our oversight and monitoring processes. In fund finance, the largest component is capital call financing, which involves lines of credit to prominent investors globally, structured on a fund-by-fund basis. Each fund has a group of investors behind it, and we work to ensure a diversified set of leads for these investors to minimize any concentration risk. This requires careful management as we expand this portfolio to avoid unknown concentrations and keep them within acceptable limits on an individual investor basis since that's where we have recourse. The next area within fund finance involves the 40 Act liquidity funds, which allow a certain degree of leverage as outlined in the 40 Act regulations, including specific limits on this leverage. Our focus here is on monitoring the underlying asset pool, which is akin to margin lending, assessing the size of lines, and managing constraints through limit structures. This includes daily monitoring of leverage and margining, especially in these volatile times where close attention to underlying collateral is critical. The smallest segment within fund finance is the BDCs, representing just over $1 billion, typically involving BDCs with BBB-rated underlying loans. Here, the key factors are the diversification of BDCs, which are sourced from leading alternative asset managers, and ensuring we support our largest clients with size limits and ongoing monitoring. Each of these areas operates differently and requires varying levels of oversight. Our process, while simpler than many banks, includes monitoring for any significant margin changes, which may prompt inquiries about adjusting covenants. This can escalate quickly, so we must respond proactively. We sometimes make adjustments, including asking borrowers to reduce their leverage or our exposure to them. We have established protocols for monitoring and intervention that we follow regularly. I’ll pause here to provide that context.

Yes, thanks. That's great additional color. Appreciate it.

Your line is open, Ken Usdin with Jefferies.

Good morning. Could you elaborate on your comments regarding CRD and mention that the cycle there might be slower? Specifically, in relation to the regular servicing conversations you're having with clients and the changes we're all experiencing, how are those discussions progressing? What is your approach to sales cycles and moving forward with ongoing engagements while also pursuing new business? Thank you.

Yes, Ken, the level of engagement remains high and has continued to be high, even during the last month with almost everyone in the world working from home. In fact, a new significant situation developed right in the middle of all this that we've started to work through. The underlying themes remain focused on improving and lowering the costs for asset managers or asset owners. They are looking to enhance their operations and outsource tasks that are not crucial to their investments but are essential for achieving better outcomes for both their clients and themselves. What's changed now is the operational stress that many managers have faced, as they were not prepared for work from home, especially on a global scale. This has acted as a catalyst for what we see as fundamental enterprise outsourcing. Our new business line, which includes both new business and business to be installed, remains quite high, indicating that the business is moving away from just single products to multiple initiatives and offerings for our clients. We anticipate this trend to continue. The need to outsource is becoming more pronounced, with clients facing outdated systems that require upgrades, while other highly successful managers and asset owners recognize that even though they could handle certain tasks, it may not be the best use of their time. They want to scale and partner with someone who can support them. We see this trend continuing, and likely accelerating.

I want to emphasize that our revenues this year are primarily driven by last year’s bookings and achievements, particularly regarding the installation process. So far, we are satisfied with the ongoing implementation. Our onboarding team has been actively working through the end of March to onboard several significant clients on time. As we are now in mid-April, we have a clear view of the remainder of the month and are not observing any major delays. If we can navigate through March and April smoothly, that should be advantageous. Typically, businesses tend to be installed according to schedule because it is necessary. There is the previous provider that must be replaced, and considerable preparation has been completed. Consequently, we have observed good progress on the onboarding front, which is crucial as that is when the revenues typically start to accumulate.

Understood.

I'd just add that on the commercial paper markets, we continue to see good activity, and it will have an impact on the funding markets back end.

Thank you.

Sure, you bet. Thanks, Ken.

Next question comes from Mike Mayo with Wells Fargo. Your line is open.

Hi. Ron, can you talk about the trade-off of basically offense versus defense, the tone that you're sending to the company? When I think of offense, I think of long-term market share, helping out the government, being part of the solution, like you're doing with the money market. Maybe more help as the Fed expands its balance sheet, gaining share versus smaller competitors by doing a little bit extra. When I think of defense, I think of short-term hunker down, live to quite another day, like what you're doing more for employees, you're not buying back stock. And then maybe even for clients, if they're not making you as much money, still kind of living with that. So how do you think about that trade-off in this unusual world?

It can't be one or the other. However, over the past year or so, we've gained a strong understanding of our expenses, not only in terms of cost but also in how we manage them and productivity. You'll notice that our approach is primarily proactive. Regarding our clients, we have engaged in exceptional levels of communication and support. The transition to working from home prompted our team to double and triple their efforts to assist clients, which will yield benefits for years to come. In the short term, we need to focus on protecting our employees' physical and mental well-being, and we believe we have taken appropriate measures in that regard without sacrificing any long-term opportunities for ourselves and our shareholders.

And as it relates to clients, you mentioned the rotation out of emerging markets, historically; an emerging markets equity fund would generate higher custody fees than a plain vanilla bond portfolio. So, if people move out of high-risk into lower-risk, wouldn't that hurt fees to assets under custody? And maybe you're doing a little bit extra for clients, even though you're not getting paid as much?

Yes, in the short-term, that's what they are focusing on. There's a significant shift towards cash, but considering the returns investors are receiving and the level of stimulus, both monetary and increasingly fiscal, that is being implemented, I believe the long-term trend will likely favor risk assets, especially equities, to deliver better returns. During this uncertain and previously uncharted period, we may not see much activity in the short-term until more clarity emerges. However, the conditions are favorable, with substantial monetary stimulus, ample cash in the system, and low interest rates, indicating a potential return to risk-taking at the right moment.

And then, one more follow-up, Eric, just looking for any insights you might have about what's happening in Asia or outside the U.S. that could provide additional context for the U.S. market. What percentage of your workforce is based in Asia compared to the U.S.? Are there any other trends or insights you can share, considering your presence in multiple countries?

Yes. Our operation in Hangzhou, China, serves as a great example of what we might expect globally. We received approval to start bringing employees back in mid-March, and we are currently operating at about 75% to 80% capacity. We have carefully monitored this process and have not crowded the office space too much. Testing facilities have been established at the entrance, and while employees initially wore masks, the work environment is now much more typical. This situation is likely to continue as long as there aren't any new outbreaks. In other parts of Asia, the return to work is not progressing as quickly, and guidelines are fluctuating with periodic outbreaks. This unpredictable recovery will mean that businesses and governments will need to react differently based on what they’ve learned from places like Singapore and Hong Kong, where responses are targeted rather than blanket measures. For instance, Singapore has recently imposed new restrictions on restaurants but did not require employees to work from home. Therefore, we can expect a gradual recovery over time but with some interruptions as outbreaks occur, until we achieve better testing capabilities and widespread vaccine availability.

That's great. And how many employees you have in China because that's a fascinating specific, 75% to 80% are back to work in China?

3,000 in China, the vast majority of them, 2,800 in our Hangzhou facility.

Great. Thank you.

This concludes today's conference call. You may now disconnect.