State Street Corp (XLF) Q3 2023 Earnings Call Transcript

Good morning and welcome to State Street Corporation's Third Quarter 2023 Earnings Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website 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 website. Now, I would like to introduce, Ilene Fiszel Bieler, Global Head of Investors Relation at State Street. Please go ahead.

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 third quarter 2023 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com. Afterwards we'll 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 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 on 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. Earlier today we released our third quarter financial results. As we issued these results, the world has witnessed a surprise and unconscionable terrorist attack on innocent Israeli citizens and the resulting enormous human toll in Israel and Gaza. These terrible events have shocked the world and created further global geopolitical uncertainty. State Street stands with the people of Israel and we are united with all those impacted. Now turning to the third quarter, global financial market performance was mixed as a positive start for equity markets in July turned decisively negative as the quarter progressed. Against the backdrop of softening economic data, market sentiment was negatively impacted by continued global central bank rate hikes and investor concerns of a higher-for-longer interest rate environment in an economic hard landing. As a result, equities fell, while global bond yields continued climbing around the world, reaching levels not seen for many years with the US 10-year yield reaching its highest level since 2007. Despite these factors, the third quarter continued to be characterized by relatively low currency market volatility. Turning to Slide 3 of our investor presentation, I will review our third quarter highlights before Eric takes you through the quarter in more detail. Beginning with our financial performance, third quarter earnings per share was $1.25 or $1.93, excluding a loss on sale from an investment portfolio repositioning, which was a notable item in 3Q. EPS growth year-over-year, excluding notable items was driven by our significant common share repurchases during the period, coupled with a 3% increase in total fee revenue. This fee revenue growth reflects higher servicing and management fees, better front office software and data fees, and an increase in other fee revenue. Taken together, the benefit of share repurchases and the improvement in fee revenue more than offset lower NII, market headwinds within trading businesses, as well as the impact of year-over-year expense growth. That said, we are pleased with our ongoing transformation and productivity initiatives, which help us to contain that expense growth, while allowing us to continue to invest in our businesses. Turning to our business momentum, within Investment Services, total AUC/A increased to $40 trillion at quarter end and we recorded $149 billion of new asset servicing wins during the third quarter, largely driven by wins in Official Institutions and Private Markets. The estimated annual new servicing fee revenue to be recognized in future periods associated with 3Q asset servicing wins amounted to $91 million, which is the highest level of quarterly new servicing fees in over two years, demonstrating our ability to achieve our ambition of driving stronger sales performance. Encouragingly, Alpha's momentum continued in 3Q. We deepened relationships with existing mandates and recorded two new Alpha mandate wins, including our first Alpha for Private Markets mandate for one of the world's most influential investors. During the third quarter, we outlined a number of strategic focus areas for our Investment Services franchise, as we aim to drive opportunities across key regions and product areas and realize the full potential of our State Street Alpha value proposition. Importantly, we are taking actions aimed at gaining market share in reinvigorating revenue growth. We are executing against our plan to improve core back-office custody sales performance as it is our largest revenue pool installed quickly has significant scale and drives high-margin ancillary revenues. As an illustration of our custody sales momentum and the power of Alpha. In the third quarter, State Street in Vontobel, a premier global asset manager headquartered in Switzerland, entered into an agreement to expand our existing front and middle office relationship, by providing back-office services, subject to necessary approvals. State Street had no relationship with Vontobel until discussions began in 2020 around Alpha, resulting in the adoption of our front, middle and now back office services. Key client wins such as Vontobel, demonstrate how Alpha can establish, broaden, and deepen client relationships, further positioning State Street as our client's essential partner. It illustrates the value of the Alpha proposition and confirms our strategic rationale of how Alpha can grow and tie together the full breadth and depth of State Street's capabilities in a true one State Street solution for our clients, from front to back. Accelerating the sales cycle and implementation timeline, particularly back-office services remains an important strategic priority to drive even more fee revenue growth. Turning to our front office software and data businesses. CRD continues to perform well and has a strong pipeline. By the end of the third quarter, annual recurring revenue for our front office software and data business increased by 12% year-over-year to $299 million. At Global Advisors, assets under management reached $3.7 trillion at quarter end, supported by a record $41 billion of net cash inflows in 3Q. Importantly, our cash business gained market share in an expanding market, driven by strong investment performance coupled with a higher yield environment. In aggregate, Global Advisors gathered $10 billion of total net inflows in 3Q. Record quarterly flow performance in cash was partially offset by outflows in the institutional business, coupled with the impact of risk-off market sentiment in our ETF business in 3Q. While our ETF franchise saw modest net outflows in aggregate in 3Q, our US low-cost SPDR ETF franchise continues to be a bright spot, generating $7 billion of net inflows, gaining further market share. To drive continued growth, in 3Q we reduced the price on 10 low-cost SPDR portfolio ETFs, demonstrating our commitment to delivering institutional quality investment solutions at competitive price points. Lastly, on business momentum. I am proud to highlight that State Street's foreign exchange business has once again been recognized as the industry leader. After being ranked number one FX provider to asset managers by Euromoney Magazine in 2022, this year Euromoney Magazine’s 2023 FX Awards named State Street as the winner across four categories, including Best FX Bank for Real Money Clients, Best FX Bank for Research, Best FX Venue for Real Money Clients, and Best FX Bank Sales. Turning to our financial condition, State Street's balance sheet, liquidity and capital positions remain strong. Our CET1 ratio was a strong 11% at quarter end, well above our regulatory minimum. This strength has enabled us to deliver against our goal of capital return to our shareholders. In 3Q, we returned $1.2 billion of capital, buying back $1 billion of our common shares and declaring over $200 million of common stock dividends. This means that cumulatively over the last four quarters to the end of September, we have returned approximately $5.6 billion of capital to our shareholders, through a combination of share repurchases and common stock dividends. As we look ahead in the fourth quarter, it remains our intention to continue common share repurchases, under our existing authorization of up to $4.5 billion for 2023, subject to market conditions and other factors. To conclude, amidst the challenges of the market environment in 3Q, we remain dedicated to driving stronger business momentum and improving fee growth. To that end, in the third quarter, we outlined our sharpened execution plan to the Investment Services business, underpinned by a number of actions aimed at accelerating sales and revenue growth, while simultaneously improving the discipline in accountability for this execution. Our laser-focused on expense discipline also remains high. We have a well-established track record of re-engineering our processes and transforming our operations to improve our efficiency and realize productivity growth. In the third quarter, we reduced expenses quarter-over-quarter, and announced another step in our multi-year productivity efforts aimed at improving our operating model, while enabling even greater investment in our business. As part of our ongoing transformation and productivity initiatives, we are streamlining our operations in India, we have now assumed full ownership of one of our joint ventures in the country. This consolidation will continue the transformation of State Street's global operations and enable us to achieve productivity savings as part of our plans to deliver positive fee operating leverage in 2024. Now, let me hand the call over to Eric, who will take you through the quarter in more detail.

Thank you, Ron, and good morning everyone. I'll begin my review of our third quarter results on Slide 4. We reported EPS of $1.25, which was down year-on-year due to the impact of the $294 million loss on sale in connection with the repositioning of our investment portfolio, which will benefit NII in the future periods. EPS was up year-on-year at $1.93, excluding the repositioning, which you can see on the right-hand side of the page. Turning to the core business, as you can see on the left panel of the slide, total fee revenue grew by 3% year-on-year, driven by growth in our front, middle and back office investment services business, as well as solid management fee performance at Global Advisors. This performance enabled us to offset some of the industry-wide headwinds we saw in our Global Markets business as well as lower NII, given the mixed macroeconomic backdrop in the quarter. Lastly, we remain focused on managing costs in the current operating environment, limiting expense growth to just 3% this quarter and achieving productivity savings as part of our plan to deliver positive fee operating leverage in 2024. Turning now to Slide 5. We saw a period-end AUC/A increase by 12% on a year-on-year basis and 1% sequentially. Year-on-year, the increase in AUC/A was largely driven by higher period-end equity market levels and net new business. Quarter-on-quarter AUC/A increased primarily due to client flows and net new business. While net new business was positive, long-term flows in the asset management industry have been muted, as you can see on the bottom right of the slide. This risk-off sentiment leads to the current headwind across the servicing industry. At Global Advisors, period-end AUM increased 13% year-on-year and was down 3% sequentially. Relative to the period a year ago, the increase was primarily driven by higher quarter-end market levels and inflows of $10 billion. Notably in the quarter, our cash franchise continued to perform strongly, generating a record $41 billion of net inflows, as our competitive performance contributed to market share gains. Quarter-on-quarter AUM increased mainly due to lower quarter-end market level. Turning to Slide 6. On the left side of the page, you'll see third-quarter servicing fees up 1% year-on-year, primarily from higher average equity markets, net new business and the impact of currency translation, partially offset by lower client activity and adjustments, normal pricing headwinds and a previously disclosed client transition. Sequentially, total servicing fees were down 2% primarily as a result of lower client activity and adjustments in a previously disclosed client transition, partially offset by higher average equity markets. As I've mentioned over the past year, we continue to see lower levels of client activity inflows, all of which impact transactional volumes, leading to a 2 percentage point to 3 percentage point headwind on servicing fees year-to-date. Part of this is the cyclical nature of the servicing business. The full-year effect has ranged from minus 2% to plus 1 percentage point impact over the last five years. Within servicing fees, back office services were generally consistent in total servicing fees. Middle office services, which is part of the Alpha proposition had another quarter of good growth. On a year-over-year basis, middle office fees were up 3% and up 1% sequentially, largely driven by net new business. On the bottom panel of this page, we highlight the business momentum we saw in the quarter. We won $149 billion of new AUC/A. We onboarded roughly $250 billion of AUC/A in the quarter, primarily in the asset management client segment. And importantly, as Ron mentioned, we achieved new annual servicing fee revenue wins of $91 million this quarter, which will be recognized in future periods. These servicing wins underscore the progress we're making towards stronger sales performance. While we've historically only described wins in AUC/A terms, we recently expanded our disclosure to indicate that a healthy level of annual servicing sales is in the $300 million range this year. You can measure us against this benchmark. We now have about $2.3 trillion of assets to be installed and about $255 million of servicing fee revenue to be installed as well. Turning to Slide 7, third-quarter management fees were $479 million, up 1% year-on-year, primarily reflecting higher average equity market levels, partially offset by a previously described shift of certain management fees into NII. Quarter-on-quarter, management fees were up 4% as a result of higher equity market levels and record quarterly cash net inflows. As you can see on the bottom-right of the slide, our investment management franchise remains well-positioned with very strong and broad-based business momentum across each of its businesses. In ETFs, we had neutral overall flows, but saw positive net inflows and consistent market share gains in the SPDR portfolio low-cost suite. As you know, we strategically dropped the fees on about a third of our low-cost suite of products and expect more growth in the coming quarters from this action. In our institutional business, notwithstanding net outflows of $30 billion in the quarter, which were primarily driven by client in-sourcing, both our Defined Contribution and Index Fixed Income products continue to drive strategic momentum. Lastly, across our client franchise, we saw record quarterly cash net inflows of $41 billion as we captured some of the cyclical movement of cash in the financial system. I'll just remind you that cash flows can be volatile quarter-to-quarter. Turning now to Slide 8. Third quarter FX trading services revenue was down 2% year-on-year, while up 3% sequentially. Relative to the period a year ago, the decrease was mainly due to lower direct FX spreads and lower FX volatility, partially offset by higher volumes. Quarter-on-quarter, the growth primarily reflects higher volumes. Industry volatility is down 25% to 40% across developed markets and emerging markets relative to the period a year ago, and down 5% to 10% sequentially, which is presenting fewer trading opportunities and lower spreads. Securities finance revenues were down 6% year-on-year due to lower specials activity and lower agency balances. Sequentially, revenues were down 12%, primarily as a result of seasonally lower activity and the recent industry drop-off of US Equity shorting activity and specials. Third quarter software and processing fees were up 2% year-on-year, but down 15% sequentially, largely driven by CRD, which I'll turn to shortly. Other fee revenue increased $49 million year-on-year, primarily due to the tax credit investment accounting change and the absence of negative market-related adjustments. Moving to Slide 9, you'll see on the left panel that front office software and data revenue increased 2% year-on-year, primarily as a result of higher growth in our more durable software-enabled and professional services revenue, as we continue to convert and implement more clients to the SaaS environment, which now accounts for about 60% of our clients, partially offset by fewer on-premise renewals. Sequentially, front office software and data revenue was down 20%, primarily driven by lower on-premise renewals, partially offset by higher software-enabled revenues. Our sales pipeline continues to grow and remain strong for our Charles River Development front office solutions products. Turning to some of the other Alpha business metrics in the right panel, we are pleased that we had two more mandate wins in the quarter for Alpha. Most notably, we also had our first Alpha for Private Markets win. We also meaningfully advanced CRD's institutional fixed income capabilities. Turning to Slide 10, third quarter NII decreased 5% year-on-year and 10% sequentially to $624 million. The year-on-year decrease was largely due to the continued mix-shift from non-interest-bearing deposits to interest-bearing, and lower average deposit balances, partially offset by higher interest rates. Sequentially, the decline in NII performance was primarily driven by lower average deposit balances and the deposit mix-shift, partially offset by the benefit of higher interest rates, including international central bank hikes and our investment portfolio repositioning. The NII results were somewhat better-than-expected due to non-interest-bearing deposit levels coming down slightly less-than-expected, and the portfolio repositioning, partially offset by client repricing, some of which will be delayed and will impact the fourth quarter instead. On the right of the slide, we showed our average balance sheet during the third quarter, with average deposits declining 4% quarter-on-quarter. Cumulative US dollar client deposit betas were 73% since the start of this recent cycle, while cumulative foreign currency deposit betas for the same period continued to be much lower in the 25% to 50% range. Finally, as I mentioned earlier, last month, we executed an NII accretive and capital accretive investment portfolio repositioning exercise to take advantage of both higher yields and spreads, which all else equal, should drive NII towards the higher end of the previously disclosed range of $550 million to $600 million per quarter next year. Turning to Slide 11. Third-quarter expenses excluding notable items increased 4% year-on-year. Sequentially, third-quarter expenses were down 1% as we actively managed expenses and continued our productivity and optimization savings efforts, all while carefully investing in the strategic elements of the company including Alpha, Private Markets and Technology, and Operations Automation. On a line-by-line basis, year-on-year compensation and employee benefits increased 4% primarily driven by salary increases associated with wage inflation, higher headcount, and the impact of currency translation. Sequentially, however, we brought headcount down and we also reduced incentive compensation this quarter, in line with our year-to-date performance. Information systems and communications expenses increased 3%, mainly due to higher technology and infrastructure investments, partially offset by the benefits from ongoing optimization efforts, insourcing, and vendor savings initiatives. Transaction processing increased 6%, mainly reflecting higher sub-custody vendor costs. Occupancy increased 4% as we relocated our headquarters building, and other expenses were up 4%, mainly reflecting higher marketing spend and professional fees. Moving to Slide 12. 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 side of the slide. As you can see, we continue to navigate the operating environment with very strong capital levels, which remain above both our internal targets and the regulatory minimum. As of quarter end, our standardized CET1 ratio of 11% was down 80 basis points quarter-on-quarter, largely driven by the continuation of our share repurchases and modestly higher RWA, partially offset by retained earnings. Our LCR for State Street Corporation was a healthy 109% and 120% for the State Street Bank and Trust. In the quarter, we were quite pleased to return roughly $1.2 billion to shareholders, consisting of just over $1 billion of common share repurchases and over $200 million in common stock dividends. Over the last year ending September 30th, we repurchased approximately 12% of shares outstanding. Finally, a few brief closing thoughts before turning to outlook. Our third-quarter performance was solid with fee revenue growth of 3% year-on-year. We executed on our plan to improve sales capacity and reported $91 million in new servicing fee wins in the quarter, as we look towards our goal of $350 million to $400 million in servicing fee wins in 2024. And as you've seen us do for the last four years, we again demonstrate expense discipline while continuing to invest in the business. Next, I'd like to provide our current thinking regarding the fourth quarter. At a macro level, our interest rate outlook is broadly in line with the current forwards. We currently assume global equity markets will remain flat from now to quarter end, which implies the daily averages down about 3% quarter-on-quarter, bond markets are also expected to be down about 3% on average quarter-on-quarter. Regarding fee revenue in 4Q on a year-over-year basis, we expect overall fee revenue to be flat to up 1% year-over-year, with servicing fees approximately flat, and management fees to also be flattish. As we expect the year-on-year business drivers, similar to what we saw this quarter. We do expect fourth quarter sales momentum to be similar to the strong sales performance we saw in the third quarter. We also expect that our market businesses will be down modestly year-over-year, given lower volatility. We expect software and processing fees to be up 10% to 12%, largely due to the timing of on-prem renewals and the expected new SaaS installations, and we expect the other revenue line to come in at around $30 million to $40 million in the fourth quarter. Regarding NII, we now expect 4Q NII to be towards the middle of the $550 million to $600 million range we previously mentioned. This includes continued expected rotation of about $3 billion to $4 billion out of non-interest-bearing deposits and the impact of deposit pricing, which we previously noted, but with more stability in the total deposit averages. Turning to expenses, we remain focused on controlling costs in this environment and expect to maintain relatively flat expenses in 4Q quarter-over-quarter. As always, this is on an ex-notables basis, and in this regard, we are keeping an eye on the likely FDIC assessment. And we expect our adjusted effective tax rate for 4Q will be around 22%. And with that, let me hand the call back to Ron.

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

Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. Your first question comes from Mr. Alex Blostein from Goldman Sachs. Your line is open.

Hey, good morning. Thanks. Thanks, everybody. Hey, Ron and Eric, I was hoping maybe you can touch on your comments earlier around positive fee operating leverage into 2024, which is definitely very encouraging to hear after a couple of years of very good cost management already. So, as you think about the revenue uncertainty between the markets and customer flows, I guess, what is the range of outcomes you're assuming for fees as you look out into 2024? And if revenues prove to be more challenging than the base case, is there enough room to still deliver that positive fee-operating leverage? Thanks.

Yeah, Alex, it's Ron. I mean we're basing that comment largely on two things. One is, we feel like we've got quite good visibility around what we're doing from a cost perspective. So we feel like we've got a series of initiatives underway that will continue into 2024 on managing our costs, while also continuing the investment program that we've got in place. That investment program includes some investments that will drive revenues in 2024 and beyond. But also the second thing it's based on is some of the actions we've taken around strengthening our sales and sales effectiveness and just pointing to the results we had in Q3, the note that Eric just made to you in terms of the visibility we have on 2024. So those two things, our confidence in expenses and what we believe is a nicely developing pipeline, and it's a set of sales capabilities and processes. I mean, obviously, markets could turn everything upside down, but based on a reasonable market forecast and not necessarily one that's going to be necessarily a tailwind, we do believe we can achieve positive fee operating leverage.

That's great. And I appreciate the new disclosure on the backlog and the revenue backlog, definitely helpful. So maybe within that, can you help us maybe understand the cadence of how quickly some of that $255 million of backlog will get converted into service and fee revenues? Is that expected largely over the course of 2024 or some of that is going to spill into 2025? And then ultimately, do you think that's going to be enough to offset some of the BlackRock related outflows and revenues that you still expect? Thanks.

Alex, it's Eric. Let me address that from a few angles to provide some clarity. When we consider future fee revenues, several factors are important: executing the backlog, generating new sales, and maintaining the momentum from the third quarter into the fourth quarter and next year, as some of these sales will materialize over the following quarters. Additionally, as we discussed in September, it's crucial to be effective in our retention efforts. Each of these aspects is significant. Regarding the backlog, we indicated there’s approximately $255 million in service fee revenues and over $2 trillion in assets under custody or administration. The implementation varies in each respect. In terms of revenues, we anticipate that 5% to 10% will be realized in the fourth quarter, which is factored into our guidance. We expect 50% to 60% of the $255 million to be recognized next year, with the remainder in 2025. This distribution aligns well with our goals. The implementation for assets under custody or administration tends to be a bit faster, with about 30% expected in the fourth quarter and around 60% next year; however, these figures may fluctuate as we progress. We're currently seeing good visibility. Particularly noteworthy from our third-quarter sales was the strong performance in back office services, which are among the quickest to onboard and implement, providing us with momentum heading into the first half of 2024.

That's great. Thank you very much, both.

Thank you. And your next question comes from Mr. Ken Usdin from Jefferies. Your line is open.

Good morning, Eric. I wanted to follow up on the fourth quarter net interest income you expect to be in the middle of that range, and you mentioned the upper end for next year. Could you explain the factors contributing to a potential positive shift as we transition from this year to next? Specifically, I'd like to understand more about whether it's related to left side repricing or if deposits are moving into more favorable areas. Thanks.

Yes, Ken, it's Eric. There are several important factors to consider, particularly at this stage of the cycle. As we shift from a decline in net interest income to a level of stabilization, we foresee a potential increase from the fourth quarter into the first quarter of next year. Let me outline these factors. There continues to be a rotation of non-interest-bearing deposits, which we still anticipate in the fourth quarter, but we expect that to begin stabilizing at the start of next year. The timing and extent of this is uncertain. We also have good visibility into our repricing efforts, particularly for our largest, most sophisticated clients, as I mentioned last year. We made progress on this in the third quarter and expect similar visibility in the fourth quarter. The repricing effects are essentially a bubble we’re managing through. Additionally, we have our investment portfolio maturing, which brings in $4 billion to $5 billion in bonds each quarter that are typically reissued at rates 200 to 300 basis points higher than those maturing. This is contributing to a positive trajectory. Overall, these three factors, along with some lending growth and other controllable actions, suggest that we are moving toward stabilizing net interest income as we transition from the fourth quarter to the first quarter. However, this will depend on various movements, and we will keep you updated regularly as we have in the past. These are the trends and expectations we have at this time.

Understood. Thanks. And my second one is just the costs were, I think, a little better than you had thought and your flat to 4Q also probably little better than the market thought and a slower implied year-over-year rate of growth. Just wondering, have you done anything incremental to slow the organic growth rate of expenses? And is that something we should think about as we go forward as well?

Yes, Ken, it's Ron. There are a number of initiatives currently in progress, as we have always discussed. We have a productivity initiative that is thoroughly examining the organization. One of the current efforts involves our joint venture in India, which dates back to our early days there, before we established our Center of Excellence. This initiative will help us reduce redundancy and minimize oversight activities, allowing us to cut costs and eliminate repetitive expenses. We are also undertaking a thorough review of our operating model, which should start to deliver results in the next year. We are assessing how work is done globally to identify opportunities for consolidation and to create a more streamlined approach. Some of these initiatives have been in progress for some time, and we expect to see the benefits soon. We have enough visibility to make these assertions while continuing to invest significantly in the business, ensuring we can keep costs under reasonable control.

And Ken, I'll just add that another topic we've been discussing over the past quarter is our hiring freeze. What we've discovered is that we have excellent individuals on our team. Part of our focus is to reinvest in various features of the business or different areas. We actually need to reallocate some of that talent to those areas, while also finding efficiencies in others. Although it's challenging work, it's been an effective way to manage our team and human resources actively. We still need to invest in everything required for new products, functionality, regulatory requirements, and so on. However, the reallocation resulting from this freeze has proven to be a very effective strategy for us at this point in the cycle.

Yes. Ken, what I would add to this, I think what we're talking about now is a continuation of what we started going back to 2019, that was rudely interrupted by COVID and everything that occurred coming out of COVID, the disruption, the great resignation, the issues that arose out of that with service quality and where we needed to overinvest to make up for some of the turnover that we were seeing that led to the kind of cost increase that you saw. That's all been normalized. Service quality has stabilized. And so, I would say that we're back on the path that we started back in 2019, and overcome what we saw in the kind of 2021-2022 period.

Thank you.

Thank you. And your next question comes from Brennan Hawken from UBS. Please go ahead.

Good morning, Ron and Eric, and thanks for taking my questions. One question on your expectations for 4Q, Eric. Encouraging to hear that you still are expecting non-interest-bearing to find a stable point here in the beginning of next year. But when you think about your fourth quarter expectations, are you thinking that the typical seasonality that we see in deposits will come through? And is that embedded within the middle of that range of $550 million to $600 million for NII?

Yes, generally, but there are seasonal variations that we've observed, leading to fluctuations that are occasionally stronger or weaker than usual. We do notice a slight increase and normalization in total deposits. We anticipate stabilization, and perhaps a slight uptick, though we need to monitor it closely. This outlook is rooted in a thorough analysis of our client deposit base. It's important to remember that we manage deposits both in US dollars and various foreign currencies. For instance, with non-interest-bearing deposits, we have around 30,000 accounts, each averaging $1 million. We've observed significant declines in the largest, most sophisticated client accounts, while smaller accounts have remained more stable. Our guidance incorporates these trends alongside seasonal factors, and we'll provide updates as necessary. We seem to be witnessing some positive changes, but we must remain cautious given ongoing shifts and the dynamics of balances and pricing. We have good visibility on many of these factors, but it will take some time to fully understand how they will unfold in the coming months and quarters.

Thanks for the insights. As you begin the budgeting process for 2024, do you have any early projections for what your operating expense growth might look like for the upcoming year?

Brennan, it's too early to provide that information. What gives us confidence in the necessity of achieving fee operating leverage is our commitment to running the business in a way that benefits our shareholders and stakeholders simultaneously. We have completed a strategic planning process over the summer months, and we have a defined path forward. While it is still early to discuss specifics regarding revenue and expenses, we are actively working on this and ensuring we have comprehensive plans for each business and function. We are exploring various scenarios and developing contingency plans. Additionally, we are being cautious with our spending for next year and will add to it only with careful consideration. We will provide a complete set of guidelines and guidance in January. However, we are confident that we have a solid path ahead, and considering fee operating leverage is a beneficial approach for us and for you as well.

Yeah. Thanks very much, Eric. Appreciate that color.

Thank you. The next question comes from Glenn Schorr from Evercore. Please go ahead.

Hello. Thank you. So we've discussed over time and today that the lower client flows from the market, the whole active to passive trend, and that how disadvantages kind of all of us. Can you talk about what you're seeing in all private markets, both from a servicing standpoint and you sprinkled in a little comment about Alpha for private markets, like bring this to life a little bit? Could this be a growth industry for the next handful of years, just curious on the side of that. Thanks.

Hey Glenn, it's Ron. The private markets have experienced significant growth, particularly in private equity and more recently in private credit infrastructure, and we don't see that trend slowing down. While private equity might be momentarily pausing, the underlying fundamentals indicate that these sectors will continue to expand. Many large multi-asset managers are seeing substantial growth from their private investments. Currently, much of this business is in-house, and there are very few industry standards, resulting in services being provided in high-cost locations, which can lead to a poor experience for the ultimate limited partner investors. This presents a fast-growing area for us. It's increasingly important for sponsors and firms to manage this effectively, especially as the average investment size decreases. In the past, typical limited partner investors were institutions like pension funds or sovereign wealth funds. Today, the average investor tends to be wealthy individuals participating in pooled funds. Therefore, getting this right is crucial, and the demand from us is quite high. We are investing heavily in this area, focusing on technology. As these firms evolve into multi-asset entities rather than concentrating solely in one domain, the concept of an Alpha front-to-back approach becomes vital, particularly in relation to data. The opportunity here extends beyond just large private providers to significant private investors such as sovereign wealth funds and asset owners. We recognize it as a major opportunity for us.

And Glenn, just to add a little bit of the kind of quantitative elements of this. Private markets, broadly defined around the world from a servicing fee standpoint are growing in the 9% to 10% a year. We described our performance, which has been quite strong in that area. And based on our client base and our pipeline, our expectation is that we should be growing in the 15% range next year. Part of that is because we serve so many large global asset managers who have a wide range, both in traditional products and in privates, right? So they're coming to us, and partly because increasingly we're serving the classic alternative and private organizations, right, who increasingly want to focus on what their core investment process is as opposed to processing. And so, we see more and more outsourcing and opportunities for us from that segment as well.

Do you believe you have a head start and a competitive advantage in the private market, similar to how you were early on with offshore outsourcing and hedge fund outsourcing, which contributed to your growth rate? We're interested in your perspective since we don't observe the same competitive landscape. Thank you.

It's a little bit hard to tell, Glenn. I think that we are certainly amongst the traditional asset servicers, we think that we were early. You've got some of the very focused fund administrators that do some narrow kinds of activities in there, and certainly in terms of offering a full front to back solution that includes data, as far as we can tell, we're the only ones out there. So yes, we think in general we're early.

Thank you. Your next question comes from Ryan Kenny from Morgan Stanley. Your line is already opened.

Hi, thanks for taking my question. So the industry has been seeing servicing fee rate pressure for a while. Can you update us on what you're currently seeing in terms of fee rate repricing? And are the newer wins coming in at a lower fee rate than your existing contracts or at a higher fee rate?

The overall pace of fee repricings has remained stable for us and the industry over the past couple of years. In 2019, we experienced a period of higher repricings, but they have generally been consistent around a 2% headwind level, which is similar to what we saw over the past five to ten years. This stability is noteworthy. We have also noted strong fee rates on new business, partly due to the nature of activities in the private sector, which tend to require more manual effort. The fee rates in this area are considerably higher than our average. In fact, in recent quarters, the fee rates on new business have been well above our historical averages. While we should be cautious about drawing comparisons for every quarter, a look at recent quarters of AUC/A wins and fee wins supports this perspective. We have highlighted this in our quarterly reports this year. We believe that with Alpha, we are able to offer more value to clients across the AUC/A spectrum. We have distinct fees on the front office side but also engage with complex clients in both the middle and back office, which has proven beneficial. Furthermore, the alternatives and private sectors generally feature much higher fee rates, contributing to the revenue momentum we have seen in the third quarter and expect to maintain into the fourth quarter.

Thanks, that's helpful. And if we look at the quarter, it looks like the servicing fee rate over average AUC/A did come down a bit. Was there anything driving that? Is that just a function of lower volatility and timing, or is there anything else in that number that we should think about?

No, if you look at the overall figures, keep in mind that when equity markets rise, there is a natural reduction in the fee rate due to the way fee schedules are structured. They differ from those in the asset management sector. So, that was expected and aligns with the ranges we've observed.

Thank you for taking my question. To follow up on the previous point, I want to confirm if my calculations are correct: the $91 million in relation to the $149 billion means 6 basis points, while the $255 million of servicing revenue corresponds to over $2.3 trillion, yielding just about a basis point. Am I interpreting this correctly? Is everything categorized as servicing fee revenue, and is this difference a sustainable new revenue run rate for the Private Markets sector?

Brian, it's Eric. I'm really glad you asked that question because new disclosures sometimes lead to straightforward answers and occasionally more complex ones. What you've conducted is an analysis. If you examine our fee wins divided by our new AUC/A wins, which, over time, will roughly align with the winning rates. The difficulty is that in any given quarter, part of what we win comes from existing AUC/A business. For instance, Ron mentioned a global asset manager where we added back office services to an existing relationship. Those AUC/As were already in our portfolio because we had been providing both front and middle office services for them. Consequently, the fee wins in the quarter are not directly comparable to any new AUC/A, as it's like comparing apples to oranges. Conversely, there are times when we might add an AUC/A with a high fee alongside another with a lower fee, simply because we've introduced a small service, and we've experienced some of this in recent quarters. Therefore, I would advise caution with quarter-to-quarter comparisons. Instead, over time, we should analyze this. I suggest looking at the revenue wins in relation to the servicing fees, where $91 million in the quarter against $5 billion of servicing fees represents a significant revenue amount. Our ability to sustain that momentum indicates the effectiveness of our sales and the growth potential we can achieve, taking into account the retention rates we also need to manage. So, I recommend focusing your analysis there. Analyzing AUC/A wins in relation to the AUC/A base can also provide insights, but I believe pursuing the revenue perspective will give you a clearer sense of our momentum.

Hey, great. Thank you for squeezing me in. So, multi-part question on the asset management business. So, first, it was just great to see the money fund flows come in this quarter and you mentioned that you believe there were some market share gains there. Can you just touch on what contributed to those gains and maybe some thoughts on the coming quarters? And then I look at the equity side, and consistent with the industry, there was pressure there on the flows. What's your thoughts on maybe when investor sentiment could improve and flex there? And then just last part here, when you take a step back and you look at SSGA today, is there anything strategically that could be interesting to you from an M&A perspective to help bolster the asset mix or accelerate some of the future growth potential in the business? Thank you.

Yes, Mike, it's Ron. Your question raises a lot of important points. Regarding the cash business, this has been a core strength for us for quite some time, and we've developed our capabilities on both the investment front and in terms of distribution channels. We have connections across various sectors, including significant integration with our core custody operations. For example, we've taken advantage of the rotation from deposits to money market investments, but most of the influx has come from outside sources, primarily driven by investment performance and where capital is flowing. We're also seeing growth in the defined contribution space, which has been ongoing. Our market share in DC investment-only products has been increasing, largely due to our focus on product innovation. SSGA was a pioneer in incorporating annuity products into target date funds, doing so ahead of regulatory approval, which has now turned into a notable growth driver. As defined benefit plans decline, we believe that combining target date funds with insurance products for longevity protection will become increasingly vital, and we possess the expertise to excel in this area. In terms of growth opportunities, our primary focus has been on institutional business, but we've expanded our product offerings in the retail and intermediary sectors. Yie-Hsin Hung, who began her role as CEO late last year, brings significant experience in this area. We aim to increase our market share within retail intermediaries. Additionally, we're interested in merging public and private markets, as we feel the traditional boundaries between them are outdated. Blended products that provide adequate liquidity can allow investors who can forgo liquidity to benefit from the illiquidity premium. We see potential for growth in product design, whether through organic development or acquisitions. Our team is actively engaged in product development, and we are fully committed to this business, seeing a lot of opportunities for growth and an exciting outlook moving forward.

Okay. Great. Thank you. I'll leave it there.

Thank you. Your next question comes from Mike Mayo of Wells Fargo Securities. Your line is already open.

Hi. Well, it's been a long journey for you guys to get the Front to Back solutions and Alpha. And I'm just trying to figure out how much traction that has and where we're seeing that in the financial results. I hear your excitement, and you have alternatives now as part of that program, and you're guiding for positive 2024 fee operating leverage, and you have all these new mandates. On the other hand, I look at the fee growth this quarter and it wasn't that great, right? And so, are we seeing evidence of the Front to Back momentum in the results? Is it something that you expect to see, or is it simply such a long sales cycle that we should be thinking two, three, four years out? Thanks.

Mike, I want to begin by discussing our journey, which has involved significant development and innovation, as this was not a standard acquisition. We invested heavily in this area, especially with the Charles River acquisition, which required additional focus on fixed-income capabilities. Over the years, we have not just been selling but also developing, working with key partners who have been instrumental in shaping our offerings. This year has been particularly notable as we've made strides in our fixed-income functionality, moving to a leading market position. We are pleased with the progress we've made, especially considering we didn't anticipate having this many clients when we started in 2018 and 2019. Additionally, we have validated our belief that this tool can attract new clients and enhance our market share, which is beginning to manifest. We see growth potential, and we anticipate revenue acceleration moving forward. I'll stop here.

And Mike, it's Eric. Regarding the financials, this is an important question. I want to provide some context for the current year, as there have been significant fluctuations in servicing fees. We saw a 1% growth in overall servicing fees, but there were both advantages and disadvantages affecting organic new business creation, which we need to show consistently each year. The market advantage for this quarter was about 4 percentage points in servicing fees. However, approximately 3 percentage points of that was offset by lower client volumes and activity, which we have noticed has decreased, and this tends to vary cyclically. Additionally, a previously announced client exit contributed almost 2 percentage points as well. Therefore, there are substantial headwinds and tailwinds impacting the financials and net new business. If we look at net new business, it showed a positive 2 percentage points year-on-year this quarter, and that's where we want to highlight the value of Alpha, traditional servicing fee sales, and private servicing fee sales. We are also enhancing our disclosures to make this clearer over time.

And then just one follow-up, Eric, and then Ron, just the exit of that large client, what inning are you in as far as that's concerned? And then Ron, as relates to accelerating revenue growth from the long journey of Alpha timing, are we thinking quarter here or several years?

We are approximately 30% through the previously disclosed client project. Most of the revenue from that will be recognized next year, and due to the nature of year-on-year comparisons, there will be some continuation into 2025.

And Mike, can you clarify your question? I just want to make sure.

Yeah, my initial question was fees aren't growing that much and Eric identified some headwinds to that. But you talked about the financial benefits from Alpha, the increased activity to result in accelerating revenue growth. I was just wondering a timeframe around that statement that revenue growth should accelerate due to the benefits of Alpha?

As we indicated earlier, we believe we will achieve positive fee operating leverage. There are revenues and expenses involved. On the revenue side, we have a program in place, including Alpha, that will help us achieve this. Some of it is driven by Alpha, while other parts are influenced by actions we are currently taking, some of which have already been implemented, with more to come this quarter and into next, aimed at enhancing our sales and revenue capabilities. You should be hearing confidence from us regarding our ability to grow revenue.

Thank you.

Thank you. Your next question comes from Gerard Cassidy of RBC. Your line is already open.

Thank you. Hi, Eric. Hi, Ron. Eric, can you share with us, I'm not asking for specifics on your budget for the upcoming year, but could you outline the external factors that impact the budgeting process regarding expenses like wage inflation or other types of inflation? Do you feel there is less pressure heading into 2024 compared to this time last year when you were preparing your 2023 budget?

Yes, the pressure has lessened, though it's still present. When we were drafting the budget for 2023 in the fall of 2022, we had already implemented two formal merit increases that year, which would impact the following year. Additionally, we had a larger merit increase in the spring of 2023 than usual. We're not in that situation anymore. We aim to provide annual merit increases in line with our typical practices over the last 5 or 10 years rather than at the elevated levels we experienced recently. On the benefit side, we're still seeing some inflation in medical and dental claims, which is consistent with prior years. A significant focus for us is managing non-personnel expenses. We're evaluating costs with our partners, vendors, software licenses, and cloud computing, seeking to determine what is appropriate. While inflationary increases in these areas are a bit less than a year ago, they still exceed our preferences. We're exploring ways to mitigate these costs, such as leveraging technology for better process efficiency and automation, and considering strategic partnerships with fewer suppliers to gain advantages from our scale. We are actively working on these initiatives as part of our budget planning process.

Very good. As a follow-up, our industry has faced significant challenges over the past few years due to the pandemic and now we're dealing with an interest rate environment we haven't encountered since before the financial crisis. If we assume that the Federal Reserve maintains higher rates, say between 4% to 5% for a while, as opposed to the 0 to 25 basis points that were in place post-financial crisis, how is this affecting your strategies? Is the current rate environment prompting you to alter how you approach your business or engage with customers in ways that were not possible three or four years ago?

Gerard, it's Eric. I think it has several impacts on us, which actually in aggregate tend to be positive for how we manage and engage on our business. Very tactically, higher rates and especially some steepness in the yield curve we talked about earlier give us some ability to add duration and feel like that's valuable. So there's some tactical effects there. I think more broadly with higher rates, the value of cash in our ecosystem, we described trillion dollars of cash in our ecosystem across deposits, money market and cash sweeps in our asset management business, our repo activity, our platform sweep activities a trillion dollars. To us, cash is valuable for our clients to keep, especially in risk-on versus or especially in risk-off versus risk-on environments. And they want to be rewarded for it, but it also means there's a whole cash wallet out there that for us is a way to engage with clients, right? We as a bank who've got not only the banking offering of deposits but the capital markets offering of repo, the money management offering of money markets and cash management. To us, it's a way to deepen our relationships with clients. And I think over time, you'll see us add to our product offering, some of that's quite broad today, but we'll think about how else do we integrate cash into, say, the Alpha proposition is a way to consider it. How do we think about it in terms of our platforms and our market activities? A number of those are important cash generators. And then, I think, at the most senior levels with our clients, the C-suite actually cares about cash today. They care about who they keep it with, how it's managed, how they are renumerated, how it's safe, but also how it can be redeployed. And so it's become a real C-suite discussion in a way that we think can strengthen both our relationships, given our broad offering, but also one that becomes more and more of a business activity and a business growth activity over time.

Great. Appreciate the color. Thank you.

Thank you. There are no further questions at this time. I will hand over the conference to Ron O'Hanley. Please proceed.

Well, thank you, operator. And thanks to all on the call for joining us.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation and you may now disconnect.