State Street Corp (XLF) Q4 2022 Earnings Call Transcript

Good morning and welcome to State Street Corporation’s Fourth Quarter and Full Year 2022 Earnings Conference Call and Webcast. Today’s discussion is being broadcasted live on State Street’s Web site at investors.statestreet.com. This conference call is also 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 Web site. 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 fourth quarter and full year 2022 earnings slide presentation, which is available for download in the Investor Relations section of our web site, investors.statestreet.com. Afterwards, we’ll be happy to take questions. During the Q&A, please limit yourself to two questions and then requeue. Before we get started, I would like to remind you that today’s presentation will include results presented on a basis that excludes or adjusts 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, also available in the IR section of our website. 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-K. 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.

Thank you Ilene and good morning everyone. 2022 was an unpredictable year for many of the world’s investors and the people they serve. Despite a market rebound in the fourth quarter, 2022 was the worst year for financial markets since the global financial crisis. Both fixed income and equity markets were impacted by the war in Ukraine and several macroeconomic headwinds including disruption of supply chains, price and wage inflation, dramatically higher global interest rates, U.S. dollar strength, and heightened fears of global economic recession which remain today. The uncertainty created by these factors contributed to a meaningful year-over-year decline in global financial markets as well as increased market volatility impacting flows. Despite these difficult macro conditions, State Street performed well. As a result, we continued to progress in 2022 towards achieving our medium term targets. Our durable 4Q and full year 2022 results were driven by a strategy underpinned by our relentless focus on innovation, the power of our distinct value proposition, and State Street’s diversified products and services, all of which continue to resonate with clients as demonstrated by yet another year of strong, organic net new servicing wins. As we continue to execute against our strategic agenda, we achieved a great deal in 2022. Slide 3 of our investor presentation shows our full year highlights and the progress we made towards achieving our strategic goals in 2022. In a challenging operating environment and compared to what was a very strong year for our business in 2021, we again delivered positive total operating leverage, pretax margin expansion, and a higher return on equity as you can see on the left of the slide. We drove continued business momentum, including $1.9 trillion of total new asset servicing wins, delivered total revenue growth, and demonstrated ongoing expense discipline in the face of inflationary pressures and our continued investment in the resiliency and capabilities of our businesses, as you can see on the right and bottom of the slide. While weaker average market levels created fee revenue headwinds for our investment servicing and asset management businesses in 2022, our balance sheet businesses combined with higher interest rates and our deposit strategy produced materially higher net interest income as compared to 2021. In addition, our foreign exchange trading services and front office software and data businesses produced double-digit year-over-year fee growth, manifesting the desired results of our investments in these businesses and demonstrating the revenue diversification of our business model. Turning to Slide 4 of our presentation, I will review our fourth quarter highlights. Business momentum was solid in the fourth quarter with new AUC/A asset servicing wins amounting to $434 billion driven by broad based wins across client segments. We reported two new alpha mandates in the quarter and expanded 12 existing alpha relationships, seven of which added additional back and middle office offerings. Helped by this sales performance our AUC/A installation backlog was $3.6 trillion at quarter end. At Global Advisors quarter end assets under management totaled $3.5 trillion, supported by another good quarter of ETF inflows. Turning to our fourth quarter financial performance, 4Q 2022 EPS was $1.91 or $2.07 excluding notable items, up 7% year-over-year or 4% higher year-over-year excluding notable items. The year-over-year EPS growth in a challenging market environment was supported by the resumption of common share repurchases in the fourth quarter as we focused on returning capital to our shareholders. Even in a year marked by economic and political disruptions, total revenue for the fourth quarter was the highest on record, increasing 3% year-over-year as lower total fee revenue was offset by very strong NII results which increased 63% relative to the year ago, primarily driven by higher global interest rates plus our balance sheet positioning and effective execution of our deposit management strategy. As we meaningfully invested in our people and business, we remain focused on expense discipline in the fourth quarter with total expenses down 3% year-over-year or flat year-over-year, excluding notable items, in part supported by the stronger U.S. dollar. This was achieved by our relentless and ongoing focus on operational productivity, simplification and automation. Turning to our balance sheet and capital, our CET1 capital ratio increased to a strong 13.6% at year end. Recognizing the importance of capital return to our shareholders and having already announced a 10% per share increase to our common stock dividend earlier in 2022, we resumed share repurchases in the fourth quarter, buying back a total of $1.5 billion of State Street's common stock. For 2023, it is our intention to return up to 200% of earnings in the form of common stock dividends and share repurchases, subject to market conditions and other factors. We expect our business mix, balance sheet strategy, and earnings momentum will enable us to do so while maintaining prudent capital ratios within our target range. Accordingly, as we announced this morning, our Board of Directors has authorized a new common stock purchase program of up to $4.5 billion through the end of 2023. To conclude my opening remarks, I am pleased to be reporting the third year in a row of pretax margin expansion and higher return on equity, which demonstrates the successful progress we have made towards achieving our financial goals. Now, let me hand the call over to Eric, who will take you through the quarter in more detail before I discuss our strategic priorities for 2023.

Thank you, Ron and good morning everyone. Before I begin my review of our fourth quarter and full year 2022 results, let me briefly discuss some of the notable items we recognized in the quarter outlined on Slide 5. First, we recognized acquisition and restructuring costs, including wind down expenses related to the Brown Brothers Investor Services acquisition transaction, which we are no longer pursuing. Second, we recognized $70 million of repositioning costs consisting of an employee severance charge of $50 million to eliminate approximately 200 middle and senior manager positions, largely related to our investment services business as we continue to streamline our organizational structure. We also recognized $20 million of occupancy charge in the quarter to help us further shrink our occupancy costs. We expect these actions to generate a total run rate savings of roughly $100 million. Lastly, we recognized the benefit of $23 million in the quarter related to the settlement proceeds from a 2018 FX benchmark litigation resolution, which is reflected in the FX trading services GAAP revenue line. Taken together, we recognized notable items of $78 million pretax, or $0.16 a share. Now, turning to Slide 6, I'll begin my review of both our fourth quarter 2022 and full year 2022 results. As you can see on the top left of the table, despite the dynamic and challenging operating environment, the diversity and durability of our business model allowed us to finish the fourth quarter with solid results. Total revenue for the quarter increased 3% year-over-year or 5% year-over-year, excluding notable items, as lower fee revenue was more than offset by robust NII growth of 63%, which I'll spend more time discussing later in today's presentation. We also continued to demonstrate prudent expense management, which enabled us to deliver positive operating leverage in the quarter and pretax margin is up more than four percentage points year-on-year, while ROE is up more than a percentage point this quarter as well. On the right side of the slide, we show our full year 2022 performance. Notwithstanding the challenging operating environment, we saw in 2022 for the year, I am quite pleased that we again delivered positive operating leverage and nearly a percentage point improvement in pretax margin. As Ron mentioned, it has been three consecutive years of margin expansion and ROE improvement. Turning to Slide 7, during the quarter we saw period end AUC/A decrease by 16% on a year-on-year basis, but increased 3% sequentially. Year-on-year the decrease in AUC/A was largely driven by continued lower period end market levels across both equity and fixed income markets globally, a previously disclosed client transition, and the negative impact of currency translation, partially offset by net new business installations. Quarter-on-quarter AUC/A increased as a result of higher quarter end equity market levels and the positive impact of currency translation. At Global Advisors, we saw similar dynamics play out. Period end AUM decreased 16% year-on-year and increased 7% sequentially. The year-on-year decline in AUM was largely driven by lower period end market levels, some institutional net outflows, and the negative impact of currency translation, which was partially offset by $22 billion of net inflows in our SPDR ETF business. Quarter-on-quarter, the increase in AUM was primarily due to higher quarter end market levels, ETF net inflows, and the positive impact of currency translation, partially offset by cash net outflows. Turning to Slide 8, on the left side of the page, you'll see fourth quarter total servicing fees down 13% year-on-year, largely driven by lower average market levels, lower client activity adjustments and flows, normal pricing headwinds, and the negative impact of currency translation, partially offset by net new business. Excluding the impact of the currency translation, servicing fees were down 10% year-on-year. Sequentially, total servicing fees were down 1%, primarily as a result of the client activity adjustments and flows. On the bottom panel of this page, we've included some sales performance indicators which highlights the good business momentum we again saw in the quarter. As you can see, AUC/A wins in the fourth quarter totaled a solid $434 billion driven by strong broad based traditional wins across client segments and regions, including expanding relationships with existing alpha clients. At quarter-end AUC/A won but yet to be installed totaled $3.6 trillion, with alpha representing a healthy portion, which again reflects the unique value proposition of our strategy. Turning to Slide 9, fourth quarter management fees were $457 million down 14% year-on-year, primarily reflecting lower average market levels and the negative impact of currency translation, which represented about two percentage point headwind. Quarter-on-quarter management fees were down 3%, largely due to equity and fixed income market headwinds. As you can see on the bottom right of the slide, notwithstanding the difficult and uncertain macroeconomic backdrop in the year, our franchise remains well positioned as evidenced by our continued strong business momentum. In ETFs we saw solid full year net inflows in the U.S. with continued momentum and market share gains in the SPDR low cost equity and fixed income segments. In our institutional business, there's a continued momentum in defined contribution with $48 billion of inflows in the full year, including target date franchise net inflows of $21 billion, offset by industry wide outflows in Institutional Index products. In our cash franchise, we still gained 60 basis points of market share in money market funds in 2022, even though first half inflows reversed in the fourth quarter. On Slide 10, you see the strength of our diverse revenue growth engines with both FX trading services and software and processing up double-digit teens year-on-year in a difficult year. Relative to the period a year ago, fourth quarter FX trading services revenue ex-notables was up 15%, primarily reflecting higher FX spreads partially offset by lower FX volumes. Our global FX franchise was able to effectively monetize the less liquid market environment which was driven by sharp moves in the U.S. dollar. Sequentially FX trading services revenue ex-notables was up 8%, mainly due to higher direct and indirect revenue. Securities finance performance in the fourth quarter was more muted with revenues up 1% year-on-year. Sequentially revenues were down 6%, mainly reflecting downward pressure on spreads due to lower special activity and year-end re-risking activity by clients. Fourth quarter software and processing fees were up 16% year-on-year and 17% sequentially, primarily driven by higher front office software and data revenues associated with CRD, which were up 28% year-on-year and 25% sequentially. Lending fees for the quarter were down 10% year-on-year, primarily due to changes in product mix and flat quarter-on-quarter. Finally, other fee revenue of $18 million in the fourth quarter was flattish year-on-year and up $23 million quarter-on-quarter, largely due to the absence of negative market related adjustments. Moving to Slide 11, on the left panel you'll see fourth quarter front office software and data revenue increased 28% year-on-year, primarily driven by multiple on-premise renewals and continued growth in software enabled revenue associated with new client implementations and client conversions to our cloud based SaaS platform environment. Turning to some of the front office and Alpha business metrics on the right panel, the $21 million of new bookings in the quarter was once again well diversified across client segments, including asset owners, wealth and private markets as well as across asset classes, particularly in fixed income. Front office revenue, backlog and pipeline remains healthy, giving us confidence in the future growth of this business. As for Alpha, we are pleased to report two new Alpha mandate wins this quarter in the insurance and asset owner client segments. Now turning to Slide 12, fourth quarter NII increased 63% year-on-year and 20% sequentially to $791 million. The year-on-year increase was largely due to higher short and long term market interest rates and proactive balance sheet positioning, partially offset by lower deposits. We have a well-constructed balance sheet including both U.S. and foreign client deposits, a scale of sponsored repo franchise, and high quality loan and investment portfolio that was consciously configured to benefit from rising global rates. Sequentially, the increase in NII performance was primarily driven by higher global market rates working through our balance sheet. On the right of this slide, we show our average balance sheet during the fourth quarter. Year-on-year average assets declined 6% and increased 3% sequentially, primarily due to deposit levels as well as currency translation impacts. The U.S. client deposit beta, excluding some new deposit initiatives was about 65% to 70% during the fourth quarter. Foreign deposit betas for the quarter were much lower in the 20% to 50% range depending on currency. Our international footprint continues to be an advantage. Total average deposits were up sequentially. We saw sequential quarter reduction in non-interest bearing deposits of 5% which was more than offset by higher NII accretive interest bearing deposits that will help support high quality client loan growth and selective expansion of the investment portfolio. Turning to Slide 13, fourth quarter expenses excluding notable items were once again proactively managed in light of a tough fee revenue environment and flat year-on-year or up approximately 3% adjusted for currency translation. We have been carefully executing on our continued productivity and optimization savings efforts which generated approximately $90 million in year-on-year gross savings for the quarter or approximately $320 million for 2022, achieving near the top end of our full year expense optimization guidance of 3% to 4%. These savings enabled us to drive positive operating leverage and pretax margin expansion, which while partially offsetting continued wage inflation headwinds and continued investments in strategic parts of the company, including alpha, private markets, technology, and operations automation. On a line by line basis compared to 4Q 2021 compensation employee benefits were down 1% as the impact of currency translation and lower incentive compensation was partially offset by higher salary increases associated with nearly 6% wage inflation and higher headcount. Headcount increased 9%, primarily in our global hubs as we added operations personnel to support growth areas such as alpha and private markets, invested in technology talent, and insourced certain functions. There was also a portion of the headcount increase associated with some hiring catch up post COVID. We expect headcount to increase more modestly in 2023. Information systems and communications expenses were down 5% due to benefits from our insourcing efforts and continued vendor pricing optimization, partially offset by technology and infrastructure investments. Transaction processing was up 1%, mainly reflecting higher broker fees and market data costs, partially offset by lower sub custody costs related to lower equity market levels. Occupancy was down 17% largely due to an episodic lease back real estate transaction associated with the sale of our data centers which was worth approximately $12 million. And other expenses were up 12%, primarily reflecting higher professional fees and travel costs. Moving to Slide 14, on the left side of the slide we show the evolution of our CET1 and Tier 1 leverage ratios followed by our capital trends on the right of the slide. As you can see, we continue to navigate the operating environment with strong capital levels relative to our requirements. At quarter end, standardized CET1 ratio of 13.6% increased 40 basis points quarter-on-quarter, primarily driven by episodically lower RWA, partially offset by the resumption of share repurchases in the quarter. With respect to RWA's, it's worth noting that we saw unusually low RWA this quarter worth about $10 billion, largely driven by our markets, businesses and some specific currency factors. We would anticipate a similar amount of normalization of RWA in the $10 billion to $15 billion range going into first quarter. Our Tier 1 leverage ratio of 6% at quarter end, was down 40 basis points quarter-on-quarter, mainly due to the resumption of share repurchases in fourth quarter. We were quite pleased to return $1.7 billion to shareholders in the quarter, consisting of a $1.5 billion of common share repurchases and $220 million in common stock dividends. Lastly, as Ron mentioned earlier, we announced this morning that our Board of Directors has authorized a new common stock repurchase program of up to $4.5 billion through the end of 2023. And as I said in December, we expect to execute this buyback at pace and get back to our target ranges for both CET1 and Tier 1 leverage market conditions and other factors dependent. Turning to Slide 15, let me cover our full year 2023 outlook as well as provide some thoughts on the first quarter, both of which have significant potential for variability given the macro environment we're operating in. In terms of our current macro expectations, as we stand here today, we expect some point to point growth in global equity markets in 2023, which equates to global equity markets being down about 2 percentage points year-on-year on a full year average basis. Our rate outlook for 2023 largely aligned with the forward curve, which I would note is moving continuously. However, we currently expect to reach peak rates of 5% for Fed funds, 3.25% at the ECB, and 4.5% at the Bank of England. As for currency translation, we expect the U.S. dollar to be modestly stronger than the major currencies on average, but less than what we saw last year. As such, currency translation is likely to have a 0.5 percentage point or less impact on both revenues and expenses. In light of the macro factors I just laid out, we currently expect that full year total fee revenue will be flat to up 1% ex-notable items with servicing fees likely flattish and management fees down a bit, largely due to a modest reclassification of revenue, other fees, and NII. Regarding the first quarter of 2023, we currently expect fee revenue to be down 1% to 2% ex-notable items on a sequential quarter basis, given some normalization of foreign exchange market volatility that impacts our trading business with servicing fees expected to be up 1% to 2% and management fees expected to be down 1% to 2%. We expect full year 2023 NII to be up about 20% on a year-over-year basis after a very strong 2022. This is dependent of course on the outcome of rate hikes and deposit mix and levels. After a significant step up in fourth quarter 2022 NII, we expect first quarter 2023 to be flattish. And after the first quarter of 2023, we expect to see a 1% to 2% sequential quarterly attenuation of NII throughout the remainder of 2023, then with stabilization expected in 2024. Turning to expenses, as you can see in the walk, we expect expenses ex-notables will be up 3.5% to 4% on a nominal basis in 2023, driven partially by wage and inflationary pressures and continued investment in the business and our people, while still driving positive operating leverage. You can also see on the walk that for a full year 2023, we expect gross savings of approximately 3%, which will help offset inflationary pressures and variable costs and ongoing investments in areas like private markets and alpha and further automation. Regarding the first quarter of 2023, on a year-over-year basis, we expect expenses ex-notable items to be up about 2%. Finally, taxes should be in the 19% to 20% range for 2023. This outlook would deliver a fourth consecutive year of margin expansion and advances us towards our medium term target goal of 30%, as well as deliver positive operating leverage and strong EPS growth for our shareholders. And with that, let me hand the call back to Ron.

Thanks, Eric. As we enter 2023, we see an uncertain environment. On the positive side, many supply chains have been repaired, the outlook for energy supply is better than anticipated, particularly in Europe, and developed world inflation may have peaked. We expect continued rising interest rates in the short term, but at a slower pace. The most significant known risks are geopolitical, including the Russia-Ukraine war, China from an economic performance and policy perspective, and the United States as it approaches its debt ceiling. Turning to Slide 17, even with another year of economic and geopolitical uncertainty ahead of us, we continue to be very clear in our strategic priorities for 2023 focusing on what we can control. We plan to deliver further growth, drive innovation, and continue to enhance shareholder value as we further progress State Street towards its medium term targets. First, we are targeting further improvements in our business growth and profitability by leveraging State Street’s alpha value proposition and enhancing its private markets capabilities. As we aim to become the leading investment servicing platform and enterprise outsource solutions provider in the industry, we intend to maintain and extend our leadership positions in a number of key businesses. In global markets, we aim to expand wallet share as a leading provider of liquidity, financing, and research solutions to investment professionals. At Global Advisors, we aim to build on our strengths in areas such as ETFs and cash, while organically accelerating growth efforts in fast growing segments where we can win. Second, as we have over the past several years, we must continue to transform the way we work by driving increased productivity and efficiency throughout our organization as we build out a simplified, scalable, configurable end-to-end operating model. As we lead with client service excellence, productivity will become a core differentiator of our value proposition. Third, we must continue to build a higher performing organization. We are strengthening execution skills and increasing accountability, thereby fostering an even more results oriented culture required for future growth. Our fourth priority is supported by and the intended outcome of the first three priorities and is aimed at achieving our financial goals, meaning another year of positive operating leverage, margin expansion, and higher returns. To conclude, supported by our distinctive value proposition and diversified offerings, as well as our ability to manage State Street through challenging environments, I believe that we will be able to execute on each of these strategic priorities in 2023 as we advance towards achieving our financial goals, all while being an essential partner to the world's investors and the people they serve. And with that operator, we can now open the call for questions.

Thank you, sir. Your first question comes from Glenn Schorr of Evercore. Please go ahead.

Hi, thank you very much. I like the NII outlook, I want to ask you a question on that. You've been a big beneficiary of higher rates. I'm curious on the deposit side, down almost 10% year-on-year in the quarter, but actually up a drop sequentially. I wanted to think about or could you tell us what you're thinking about that you have a stable outlook for 2023 for deposits, we've seen a lot of fear in the banks in deposit runoff and betas and attrition and so curious what gives you that confidence for the flat deposits for the year, thanks?

Glenn, it's Eric. We've navigated through interest rate cycles before, and so we have a fair amount of internal data. And we also have an engagement with our clients that really understands the multiple avenues for them of putting their cash. Clients broadly with us have $1 trillion of cash, some of that's in deposits, some of that's in our sponsored repo program. Some of that's in our Global Advisors money market complex, some of it's in our suite products in our State Street Global Link franchise. And so what we're seeing is that clients are shifting gently their deposits between different categories. But they also need an outlet for that cash. They need an outlook for that cash at a reasonable price, at a reasonable ability to move it and use it as necessary. So with that as a context, I think we continue to see some expected rotation out of noninterest-bearing into interest-bearing, that's been happening at a reasonable pace and kind of in line more or less with what we've seen before, and we expect that to continue for the next few quarters. At the same time, clients do have cash, especially given the risk-off environment but in general, they all sit on cash as part of their investment planning. And we found that they're engaged with us to leave cash in our balance sheet. They like the flexibility. They like some of the pricing. And obviously, some cash comes in at noninterest-bearing, some at lower rates when it's very transactional, some at rates that are closer to market levels. And so it's an ongoing engagement with them and the visibility we have is reasonably good. It can always change. But deposits as a result, seem to be in the zone now after a couple of quarters in the first half of the year of coming down a bit, seem to be flattening out. I won't say that we won't see a little bit of seasonality occasionally in January into February, we see a downtick. And then March folks prepare for tax payments which is up and then April is down. So we'll see some of that kind of movement. But on average, we expect deposits to be flattish going forward into next year and through the bulk of the year.

I appreciate that color. That's good. You mentioned repo, so maybe I'll just have my follow-up question. In the slides, I noticed you created this inventory platform for peer-to-peer repo, I would love a minute to go on what it is for, who is it for, and how you get paid for that? Thanks.

Sure. This is part of the innovation heritage that we have here at State Street across the franchise, but inclusive of the global markets area. Our sponsored repo program, which is now $100 billion in size, was started in 2005, if I go back to the history books. And there's now a $100 billion franchise. And we do this in FX, we do this in securities lending. Venturi is a repo offering that instead of working through our balance sheet or one of the clearing corporations, which is how we do repo today actually directly connects lenders and borrowers of securities and cash. And so it's just another platform, so to speak, another venue that clients seem to want to engage with. A big part of it early on is working with the asset owners, those who hold long positions in securities and cash. And what we find is sometimes when they may want to make margin calls or have margin calls, they want to raise cash without selling securities. And so a natural question is, where do I repo, do I repo through a bank structure, or do I repo with someone who's on the other side of that trade who actually wants to lend against securities. And so we find that there are counterparties on the other side of that trade who would be interested in doing that. What Venturi does is it actually connects borrowers and lenders with direct access to one another. So they have both the underlying collateral as the stabilizing force and then they have the counterparty rating. And with different counterparties, you get slightly different pricing and sometimes that flow-through is positive and quite appealing both to the lenders and borrowers. So that's a little bit of it in a nutshell. We like to grow it to some amount during the course of the year, early returns are positive. But it's in a bucket of innovation and how to connect folks in the capital markets, connecting our core clients and providing additional services for them.

Great tutorial, thanks.

Thank you. Your next question comes from the line of Betsy Graseck from Morgan Stanley. Please go ahead.

Hi, good morning.

Hi, Betsy.

Okay, one follow-up question on NII and then a question on expenses. Just a follow-up question on NII Eric, I just wanted to make sure I understood the cadence, the pace that you are suggesting NII should follow. I know you used the word attenuate, but we had a debate over here as to which way attenuate was going to trajectory, so sorry to ask the ticky-tacky, but appreciate it?

That's all right. We want to be transparent and sometimes language always matters, as you say. Our perspective is we've got a very nice step-off point from fourth quarter NII. We said we'd be roughly flattish into the first quarter. And then we expect it to trend downwards, so attenuate downward, let's say, 1% to 2% for the next few quarters. Just as you see a tailwind of interest rates creating a positive but you see that continued rotation out of noninterest-bearing deposits being a headwind. And the net of that is down NII we think 1% to 2% for a couple of quarters. And then towards the end of the year and into 2024, we see rough stabilization probably because we've kind of burned out on the noninterest-bearing rotation, and then we get to a more stabilized area. But all in, we expect full year NII to be up about 20% year-over-year, and we'll take it from there.

Got it. Yes. No, that's helpful. And then on the expense side, I know you mentioned that the benefit of the actions you've taken is about a $100 million run rate. I just wanted to understand when that comes into the 2023, is that immediate in 1Q, or is that something that comes in over time, that would be helpful? Thanks.

Yes. Roughly about half of that comes in in 2023. The payback on most of these actions is about five quarters so roughly half comes in on a fiscal 2023 basis. And then we'll hit the run rate, I think, within quarters, whatever, six-ish after these actions, most of these actions are in the next few quarters. The run rate then builds to $100 million. So good payback and the kind of actions we want to keep taking in this kind of environment.

Yes. So your point, that was my final follow-up, which was, do you feel this is the extent or if for whatever reason, top line disappoints based on macro not working out or what have you, is there more that you would consider doing going forward?

Betsy, it's Ron. Maybe I'll take that. We've obviously got a pattern of investments that we're intending to execute. We've also got an ongoing program in place that we've really had running now since 2019. So we certainly — if the environment were to change materially, we would think about those investments. We would also think about being more aggressive. I mean, we have more or less in the background, continued to take a lot of gross expense out of the system every year. We see an ongoing ability to do that, but we also want to keep investing in the business. So there is a balance there. But to the extent to which things started to go south in an unanticipated way, we do have levers.

Thank you.

Thank you. Your next question comes from the line of Ken Usdin from Jefferies. Please go ahead.

Thanks, good morning. I was wondering if you had any kind of just post the BBH decision and within that, just you acknowledged and put forth this $4.5 billion capital plan. Just how will we think about your commitment to that now as opposed to whatever thoughts you might have about acquisitions going forward? Thank you.

Ken, as we've always said, we've got a very clear strategy and M&A is not a strategy. M&A is a way to help execute a strategy, to move it faster, to enable it to get further than was anticipated. But it's not a strategy by itself. We are very comfortable with our organic strategy. BBH was a scale enhancing acquisition that we would have liked to have done, but it doesn't materially change. In fact, it doesn't change at all our strategy. So at this point, where we sit, we have a strategy that we like. We have a strategy that we're executing against. There are some big milestones that we're confident we're going to be delivering on in 2023. And therefore, we are committed to that share buyback.

Okay, great. And then on servicing fees, can you help us understand in your flat to plus one, what's the impact of the BlackRock ETF deconversion, where are we in that process, and how much, if any, has already been recognized of that expected revenue attrition at this point? Thank you.

Yes, I think maybe just to answer that in the various components. I think you saw the BlackRock transition begin at the end of last year was $10 million in the quarter, sort of call it, a $40 million run rate. That continues to transition out in 2023 and in 2024, there's obviously just a natural schedule that you expect that we've worked closely with them on. And so it'll impact our servicing fees during 2023, during 2024, and into 2025, just when you think about the year-on-year comparison basis. I think if you want to model it out broadly, we've said in our last regulatory filing, we said it was worth about two percent of fees as of the December 31 pointer we just crossed. It's now about 1.7% of fees. And I'll let you sort of build it from there. But it's included in our forecast. It will continue to be included in our forecast. We think about net new business, we've got to sell. We always have a bit of attrition, and we'll want to continue to be net ahead. And as you've seen us in the last couple of years, we've been net positive with net organic growth broadly. And then with BlackRock specifically, they continue to be a very important client of ours. We have continued and kept a good amount of business that we do with them. We're strong providers for them in alternatives, which is growing quickly. And we've also been awarded new business over the last year. And so that will just be part of the outlook that I give you as we go forward.

Okay, great, thanks a lot.

Thank you. Your next question comes from the line of Alex Blostein from Goldman Sachs. Please go ahead.

Hi, good morning. Thanks for the question. Maybe just to follow-up on Ken's last point around servicing fees. I guess if you take your run rate servicing fees at the end of the year, it still implies a pretty wide gap versus where you guys expect to end for 2023. So maybe just provide a little bit more granularity where the ramp is going to come from. So I know equity market is one thing, and you guys are assuming, I think, 10-ish-percent growth in global equity, so that certainly helps. But off of the kind of $4.8-ish billion run rate that you exited that to get to, I don't know, $5.1 billion, that's a 6% growth that's still wider than we've seen in the past. So I'm just curious whether it's new business or something else that you see on the horizon that will help you bridge that gap?

Yes. Alex, if you tend to spend a little more time on the full year to full year kind of servicing fees, it sounds like you're modeling the last four quarters and then the next four quarters, which obviously we model as well, and we have in our budget. It's really a combination of factors. So there is on a full year basis some appreciation in equity markets. We'll see if that plays out, and we'll obviously stay in touch with you all. We think that will be a tailwind. We think client flows and activity, in particular, should not be a headwind like it was in 2022, maybe neutral, maybe a positive just as clients have adapted to this new environment. And so we see the new year as a time when they're going to be trading, investing, building positions. So we'll see if that plays out, that will be part of it. Then we have net new business. And so we do have a good pipeline both in the traditional servicing and Alpha area. And I think as part of that, we continue to mine our existing client base because the share of wallet growth can be positive there. And then finally, there's always some amount of normal pricing headwinds, but that's factored in. But you kind of have to go through those areas. And remember, we're assuming some growth in equity markets on a point-to-point basis but we'll see if that plays out.

I got you. Alright, that's helpful. Maybe just a follow-up around the balance sheet strategy. I heard the NII guidance, the deposit commentary all makes sense. When it comes to the tailwinds from sort of repricing the fixed portfolio, the fixed securities portfolio, can you help us frame what the roll-on, roll-off dynamic looks like today? And also whether or not there are some more opportunistic actions you guys might take, perhaps liquidate with both RFBK and Northern over the last month or so, with respect to just maybe reaccelerate some of the lower-yielding securities roll off into something that might be a little more attractive here.

Let me describe it as follows. The investment portfolio has an average duration of a bit over two and a half years, so call it an average maturity of five years. And so you go through the math, and that means about 20% of it rolls on, rolls off in a typical year. It will move around a bit. I think what we found, and that's invested across the curve, it's invested in various currencies, so there's a mix. So you tend to get as you have rolled-off, rolled-on somewhere between 1%, 1.5% to sometimes 2.5% tailwind for that particular quarter of the amounts that are rolling off and rolling on. And so that's what's actually been one of the factors that's in driving the yields and the yield improvement on the profile and both how it was designed and what we're pleased to see. So that will be a gentle tailwind assuming five-year rates stay more or less where they are and European rates continue to float up. And so we'll just have to — that will be one of the tailwinds that we see. In terms of more dramatic action, we obviously always think about what we might do. What we've noticed is that if you have high risk-weighted asset positions in your risk-weighted asset-intensive positions in your portfolio, then what happens you could take the loss, you reinvest, and it helps accelerate a buyback, right. That's why I think a number of players are doing that. Doing that for vanilla instruments, treasuries, agencies, government-guaranteed securities, I think the benefits are a little closer to a push. We could take some losses through the P&L. They're already in the equity accounts through AOCI, you put on NII in the future. I think that's just moving around of the financials, and we just don't find that that's a particularly compelling trade to do. We'll always evaluate well. So we see if we have specific positions that might need some adjustment. But we don't see that as particularly compelling. It's not really compelling economically. And the financial benefits you guys can kind of model out either way. And so we're pleased with the ability to continue to manage the portfolio in line with our current processes, and they've been numerous. The NII is up significantly this past year and up another 20% next year, and we've got a tailwind and it bodes well for where we are and where we're going.

I got you. Great, thanks so much.

Thank you. Your next question comes from the line of Brian Bedell from Deutsche Bank. Please go ahead.

Great, thanks, good morning folks. Actually on net interest revenue outlook for 2023, Eric, can you talk a little bit about what you view as sensitivity to say if we had rate cuts in the back half of the year, I don't think that's assumed in your outlook, but just if you can talk about that dynamic and whether you think that would just be offset by reducing the deposit beta? And then also on the foreign deposit beta that you talked about, which is much better than U.S., do you expect that to continue or do you see incremental foreign deposit betas moving higher from here?

Let me do it in reverse order. The U.S. versus foreign currency betas in our experience, this cycle, prior cycles, do tend to run at different levels, partly because the U.S. has the structure of noninterest-bearing versus interest-bearing deposits. So the client deposit betas are a subset of the total and partly because the international markets just operate a bit differently, how we're paid and how that operates have been set over decades for the industry. So I think for the next few quarters, we think the U.S. client deposit betas ex any new money that we bring in on an initiative basis is going to be in that 65% to 70% and the international betas, we think will continue in the 20% to 50% range when you look at euros, pound sterling, Canadian dollars, Aussie dollars and some of the other currencies. So we think they're kind of in this zone and that gives us some ability to continue to take advantage of the interest rate increases. If I then work through the other part of your question, what happens with rate cuts, that's in our expectations, that's in the forward curves, especially for the U.S., that there could be a December cut. There's some probability there could be a cut before that. I think it doesn't dramatically affect because they are late in the year. The rate cuts don't dramatically affect the NII forecast, so we'll kind of take it as it goes. I do think there's a bit of this offset, which is if the Fed's cutting rates, there's probably going to be even more cash that clients keep on hand and deposits in the system, there'll probably be some offsetting impact. And obviously, with the U.S. betas higher, conveniently rate cuts actually at some point help with the NII as well. So I think there's a range of scenarios in the second half of next year. We'll be having this conversation often with you. And we'll certainly keep you posted as we see some of those scenarios develop or there's more variability.

That's super helpful. And then just maybe on asset servicing, just maybe an update on how you're seeing the pricing headwinds fold out for this year and also obviously, you typically do get a pricing headwind just from a mix shift towards ETFs, but maybe if you could talk about whether you think that might be set off by some of the growth in alternatives? And then I know I think there is an expense offset too or I should say, I believe the margin is the same on ETFs versus say mutual funds, so you again an expense offset, so maybe if you just want to confirm that?

I think that the pricing experience that we're seeing in the industry has been stable and consistent over the last few years, and we expect it to be consistent into next year and beyond. Because our contracts are tied to market cycles, when they roll over every four, five, six years, typically, folks are thinking whether they expect equity markets to be higher. They know we're going to get paid, they're going to pay us more in the coming years, and they want to share some of that. And so there's a partial pricing offset. But it's in the roughly 2% headwind per year on servicing fees and has been relatively consistent.

Brian, the mutual fund to ETF shift — there have been some high-profile conversions of mutual funds to ETFs. But that's not a large-scale wave. More typically, what you're seeing is ETFs being added to lines. And yes, the economics are different, the revenue fees are lower, but particularly when you're at scale like us, the expenses are much lower. So it's not meaningful in this overall revenue guide that we're giving you.

Yeah, perfect, great. Thank you so much.

Thank you. Your next question comes from the line of Brennan Hawken from UBS. Please go ahead.

Good morning, thanks for taking my questions. So I'd like to start on capital. So the buyback sends a strong message. Ron, very encouraging to hear about your comments on M&A. But I wanted to clarify that the buyback is up to $4.5 billion. So does the upper end of the range there assume that you're going to see some AOCI accretion and is the quarterly range of $120 million to $200 million still the right way to think about it, if rates are stable?

Brennan, the answer is yes and yes. If you think about it, we forecasted just as you have seen in earnings and coming through the P&L, AOCI in that range, $120 million to $200 million a quarter, it bounces around a little bit and it may with movements in rates. But the pull apart has been good to us and will be a nice tailwind. There's some normalization of RWAs, which I mentioned into the first quarter, then there is some RWA growth in our plans because we want to continue to lend more to clients and support their foreign exchange or hedging activity so we'll continue to do that. And then there's the buyback. Our plan is just to, at pace, get back into our range and that authorization comfortably gets us there.

Okay, excellent. And then a couple folks have touched on it before, but maybe if we think about the fee revenue, can you please update us on the impact of market moves to fee revenues and whether or not there also a corresponding impact on the expense side — I'd assume there's at least some degree of impact there? Thanks.

Let me do it this way. If you look at the gearing, a 10% average change in equity markets will typically lead to about a 3% increase in servicing fees. It's higher on management fees — 10% higher equity markets tend to be closer to a 5% increase in management fees. On the expense side, it moves around a bit, but a 10% average increase in equity markets could be around half a percentage point to a percentage point increase in expenses, depending on market data and subcustodian costs. That particular expense increase generally comes with real revenue growth and that delivers EBIT and earnings growth when you bring it all together.

Excellent, thank you for that color.

Thank you. Next question comes from the line of Steven Chubak from Wolfe Research. Please go ahead.

Hi, good morning. So Eric, I actually have a two part if you'll indulge me just on some of the NII guidance. First, I was hoping you could provide just some guardrails on your assumptions for noninterest-bearing outflow given you're relatively close to the trough that we saw last cycle? And for the second part, since you alluded to NII stabilizing beyond 2023, even as noninterest-bearing remixing pressures abate and reinvestment tailwinds start to work through the balance sheet, I was curious why NII isn't actually growing beyond 2023 — is that a function of rate cuts, international mix, any perspective would be really helpful?

Crystal balling into 2024 is challenging given variability in economics and central bank policy. I know there's a lot of talk about where NII goes after a peak. I was trying to level set that we see stability in 2024. There's a scenario where you see growth and scenarios where you may not. In terms of noninterest-bearing deposits, you saw noninterest-bearing on average was about $44 billion this quarter. This quarter it was down 5% sequentially. It's bounced around quarterly but we see it could be between $2 billion to $4 billion of rotation out per quarter, and we think we'll continue to see some of it in the first half of the year, then it slows down into the second half. We've used that base case in our modeling and it's factored into the 20% increase in NII that we expect for next year.

That's great. And my defense, Eric, since you did talk about stabilization, I felt like I had to take advantage of that window of opportunity to look forward to talking about it a little bit more in the middle of the year. Just one more for me on capital management, I was hoping you could give us some insight into the cadence. Should we expect that buyback to be executed ratably or be a little bit more front-loaded here? And given the commitment to optimize capital levels, how are you scenario planning for the Basel changes that we should be getting from the Fed early in 2023?

We want to front-load the buyback to some degree. You saw us start particularly strong this past quarter. We want some amount of front loading, but it's stabilizing to the stock to have buybacks on a consistent basis. So we don't want to front-load at an extreme, and we don't want to be ratably flat through the year at the extreme either. The goal is to get into our target range at pace and operate in the middle of our range over time. We'll learn more about Basel III and any changes in capital rules later this year and we'll evaluate and that will also inform how we manage the pace.

That's great, thanks so much for taking my questions.

Thank you. Your next question comes from the line of Gerard Cassidy from RBC. Please go ahead.

Good afternoon guys. Eric, as a follow-up on the stock repurchase commentary, did you guys — and especially in the sense you referenced it would be more front-end loaded — did you guys consider an accelerated share repurchase program?

Gerard, we did. Accelerated share repurchase programs typically accelerate buybacks within a quarter and there are benefits. You tend to add a small EPS benefit. It's interesting in a high interest rate environment, you also lose the NII benefit of the capital. So we've actually found that ASRs tend to be a push roughly. We often do a more typical buyback within the available trading days in the quarter in a way that's fairly market practice as a way to return the cash and the capital to shareholders.

Very good. And then I know you pointed to the RWA benefit you had this quarter for the CET1 ratio. And I think you said in your slides, you're targeted range is 10% to 11%, which of course you're above at this time. Do you have any guidance on when you think you may reach your targeted 10% to 11% CET1 range?

It will depend. We want to return the capital at pace and we've given some bookends as to what that means. We'd like to get to our target range at pace; we don't want to wait an extended period. The timing will vary depending on RWAs and business utilization of limits. We are driving toward that range and will execute the buyback at pace.

Great, appreciate it, thank you.

Thank you. Your next question comes from the line of Mike Mayo from Wells Fargo Securities. Please go ahead.

Hi, well thanks for all the answers on the cyclical factors. I wanted to ask about the structural end game, a strategic end game post Brown Brothers. And the reason I ask, I count five restructurings in the last 20 years. They seem to come around like the softness the Olympics. The fourth quarter is yet one more quarter with notable items, notable items in 18 of the last 20 quarters. And I do get some of it. Like you have incredible headwinds, mutual funds, markets, technical debt. You've been reinventing yourself front-to-back, straight reprocessing, serving clients, more agile tech. And I also recognize what you said at the start that the ROE and the margin improved for a couple of years in a row. But when I look at fee expenses, that has gone the other way and it seems like maybe one root issue is fixed cost. So really, the question is concrete, what percent of your expenses are fixed, how does that compare to the past, I'm assuming they've come down and where would you like to take that? And then more broadly, what is the end game strategy after Brown Brothers? Thanks.

Let me start on that, there's a lot in there. I'm not going to comment on past restructurings, I'll comment on this one. We've made some changes to the way we organize ourselves. We talked about that back in the middle of the year. There's some benefits we can take out of that in terms of simplifying the management structure, having a smaller number of senior managers; we're going to take advantage of that. It's consistent with simplifying our business. It creates accountability and we stand by the need to have done that restructuring. In terms of where we take this business going forward, it has a lot of benefits to it. It's very tied to investment markets over time. Investment markets grow, they don't shrink. So while unit pricing may go down, overall revenue is more often than not having a tailwind. We like that business. It's also one that is changing fundamentally from being a back office lowest-price service to much more of an enterprise outsourcing business. We are early in that transition. We think we are very well positioned to take advantage of that in terms of technical capabilities, people capabilities, and the position we have in the marketplace. We've made initial inroads and wins in that, but there's development that we talked about that will be delivered in 2023 and beyond. We see the end game for core investment servicing as being much more akin to an outsourcing services business, much less susceptible to instantaneous RFP churn, and it's just a stickier business. We believe we have an edge and lead and we're going to capitalize on it. In investment management, there's a similar change. We're seeing increased desire for the kinds of things we do. Asset allocation, which we are very good at, is an area that everybody is talking about after decades of reliance on the 60-40 model. So we like our businesses and where we are strategically. Over time, you may see competitors decide this isn't their core business and they exit, which can further consolidate opportunity for firms like us.

That was expansive, thank you. And the fixed cost part of the question, you don't report it that way, but just in rough terms. So in asset servicing, less RFPs, lowest price, enterprise outsourcing, investment management more holistic instead of the old model. But still as you transition, you have a certain degree of fixed costs that are tough to manage. I mean it's not quite like a brokerage firm where you reduced bonuses. So is there any way just to ballpark how much of your expenses are fixed costs and I think they've come down from the past, you're probably trying to floor them more?

Mike, this section in the industry used to be variable cost intensive — very manual. As we've automated, moved to cloud, and invested in developers, this business has evolved to be more fixed and semi-fixed cost oriented. For certain types of business, core custody for example, those are the most automated parts of our franchise: you plug it in and systems process it. So this has become a more fixed cost business. I'd say it's more like 80% fixed and semi-fixed than 20% variable than it used to be. Where it remains variable is in more manual and complex areas such as servicing for private markets which is still quite manual. Those are the variable areas where we need to continue to automate and streamline and that's part of what we're doing with ongoing investments.

Alright, thank you.

Thank you. Your next question comes from the line of Rob Wildhack from Autonomous Research. Please go ahead.

Hi guys. AUC/A wins in the fourth quarter were pretty good. And Eric, you called out a strong pipeline there. What level of new business wins are you expecting in 2023? And do you see those coming from any specific client category, cohort, service area, anything like that?

The pipeline remains strong. We want to win about $1.5 trillion per year of new business to drive the kind of organic growth that we'd like. We did $1.9 trillion this past year and did nearly double that in 2021. That's our expectation for 2023 as well. The wins this past year have come in at good fee rates, in line with our overall fee rate, which means when they onboard they will be neutral or accretive to the fee rate. The pipeline is broad-based across regions and segments — Asia had strong growth this past year and we have intensity in Europe and North America as well.

Got it. And then you also mentioned some higher renewals in the Alpha business. Wondering if you could talk about the retention rate there, how is the retention among front-to-back clients compared to your more traditional back or middle office only clients?

In terms of fully installed Alpha clients, the retention rate is essentially 100%. These deployments involve significant commitment on both sides, rewire the firm front-to-back, and switching costs have gone up dramatically in these front-to-back arrangements. Contracts are longer and we take the delivery responsibility very seriously. That stickiness is a key advantage.

Got it, thanks.

Thank you. Your next question comes from the line of Vivek Juneja from J.P. Morgan. Please go ahead.

Thank you. Just a couple little details for you, Eric. You mentioned RWA came down by about $10 billion and you expect to see another decline $10 billion to $15 billion. Any color on what you did there and is it sustainable post 1Q?

Let me clarify. RWA was lower than expected in the fourth quarter by about $10 billion. In first quarter, we expect some normalization, so RWA may move back up by $10 billion to $15 billion. It's driven by underlying volatility in our business — for example overdrafts were lighter than expected this quarter and FX positioning and currency moves can drive multi-billion dollar swings in RWA. We tend to be careful to stay within internal RWA limits; these are episodic moves.

Great. Second, another detail, your software processing and data, could you parse that into data versus CRD since that's not combined. So you got this big growth rate there — what's going on underneath? How much is data? How much is CRD?

It's a combination. The bulk of the growth is really around Charles River and the franchise we purchased in 2018, which has delivered the growth we expected. Data is also a very appealing offering that supplements Charles River — sometimes sold with Charles River, sometimes with Alpha and middle office, sometimes supplemental to custody and accounting. Data is one of the faster-growing areas and it's often sold as a software-like product. The majority of the growth in software and processing is Charles River related, with data an important and growing component.

We've done a lot of innovation in this area of new product development and we expect that to continue. Clients are increasingly interested in simplifying operations and getting control of tech debt and data location; large asset owners in particular are very focused on these capabilities. This is a growth area and a way to extend our offerings in Alpha.

And just to clarify on CRD, Eric, when you previously talked about it growing in the low double-digit range, is that still the pace or is it slowing as it matures or accelerating?

It continues at a similar pace; it moves around depending on on-premise renewals. I'd say high single digits to low double-digits. The core CRD offering has broadened from equity to equity and fixed income and we've supplemented with additions like the Markidis acquisition for front-end capabilities. It's an important product and remains high-growth, low double-digit through thick and thin.

Great, thank you.

That will be our last question. I'll turn the call back over to Mr. Ron O'Hanley for closing remarks.

Thank you, operator and thanks to all for joining us.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.