State Street Corp (XLF) Q4 2023 Earnings Call Transcript

Good morning. And welcome to State Street Corporation's Fourth Quarter and Full Year 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.

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 2023 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com. Afterwards, we will be happy to take questions. During the Q&A, please limit yourself to two questions and then 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 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 fourth quarter and full year 2023 financial results. As I reflect on 2023, the operating environment was dynamic, presenting a complex set of challenges for the world's investors and for our industry, and I am proud of how we carefully navigated State Street through various headwinds while continuing to execute against our strategic agenda. We focused and delivered on that agenda in three key areas; achieving strong sales wins across our businesses, driving strategic change in our investment services business, and remaining disciplined on productivity and broader cost management. Further on that last point, during 2023, we implemented key productivity actions and announced additional efficiency measures that will enable us to enhance the productivity of our operating model in 2024 and the years ahead. We took these many actions while investing in our business and returning substantial capital to our shareholders, which helped to drive full year earnings growth excluding notable items. The world's investors, State Street, and our industry faced a host of significant market events and macroeconomic forces in 2023. In the first quarter, turmoil in the banking sector ultimately led to the resolution from several banks, which was a catalyst for some of the largest fixed-income market moves seen in decades. In the second quarter, anticipation grew about the potential economic benefit from artificial intelligence, helping to drive equity markets higher. However, as we progressed into the third quarter and as the Federal Reserve raised interest rates to the highest level in 22 years in July, the prospect of higher for longer rates led to a substantial sell-off in bond markets with the US 10-year treasury yield exceeding 5% in October, for the first time since the global financial crisis. Rate uncertainty and an increasing number of geopolitical concerns caused equities to struggle. Then during the fourth quarter, the equity market rallied vigorously as inflation receded and investors grew increasingly optimistic about a soft landing with positive sentiment gaining further momentum in the last month as the Federal Reserve signaled a pivot to lower interest rates this year. In sum, while our full year overall financial results benefited from higher interest rates globally last year and despite the strong market appreciation in the fourth quarter, daily average global equity markets only increased by low single digits in 2023, providing just a modest tailwind to our fee revenue, while client activity was muted as investors stayed on the sidelines for much of the year. Even in such an eventful year, equity and FX market volatility continued to contract, creating revenue headwinds for our trading businesses. Slide 3 of our investor presentation provides some of our highlights for the year. Beginning with our financial performance, full year earnings per share was 5.58 or 7.66 excluding notable items. Year-over-year, excluding notable items, EPS growth was supported by $3.8 billion of common share repurchases, a record level of net interest income (NII), continued growth of our front office software and data business, and higher securities finance revenues. The combination of which more than offset the impact of lower servicing and management fees and underlying expense growth, which was still well-controlled. We continued to build business momentum and position State Street for longer-term success. To that end, we achieved a number of important accomplishments in 2023, as you can see on Slide 3. A key highlight of today's results is the clear progress we're making on innovation and advancing product capabilities, which in turn contributes to stronger sales momentum across our broad franchise aimed at generating better fee revenue growth in the year ahead. Within the Investment Services business, we are intensely focused on ensuring better execution against our strategy and revenue goals. We unveiled the sharpened execution plan last year, underpinned by a number of measurable actions aimed at driving servicing opportunities across key regions and product areas, realizing the full potential of our Alpha value proposition and accelerating sales and revenue growth, particularly in our core back office custody. Encouragingly, as I just noted, today's results demonstrate our proven ability to deliver the level of sales required for attractive organic servicing fee revenue growth for the future as we built upon the $91 million of new servicing fee sales in the third quarter by recording $103 million of new servicing fee wins in the fourth quarter, which is the highest level of quarterly new servicing fees in recent years. From its inception, we have noted that Alpha will further establish, broaden, and deepen client relationships, positioning State Street as our clients' essential partner. Alpha distinctively enables us to grow and tie together the full breadth and depth of State Street's capability as a true one State Street solution for our clients from front to back. 2023 was an important year for Alpha software delivery. The last two quarters of the year included the significant development of the fixed income portfolio management module, which propelled CRD and Alpha capabilities and competitiveness forward. In the third quarter, we recorded our first Alpha for private markets client. In the fourth quarter, we continued Alpha's momentum by deepening relationships with a number of key existing mandates and recording four new Alpha wins, while our front office software and data business had a record quarter of new bookings in the fourth quarter, both demonstrating our ability to drive stronger sales. Within our Global Markets business, even as low volatility created a headwind, we continued to see proof points of our very strong market position. For example, in its 2023 FX awards, Euromoney Magazine named State Street as the winner across four important categories, including the best FX bank for real money clients. We also continued to innovate and strategically expand our product capabilities and geographic reach, including the planned acquisition of outsourced trading firm CF Global Trading. At Global Advisors, we undertook targeted strategic actions aimed at gaining market share and driving occupancy growth in the coming years. As a result, we saw encouraging business momentum with GA setting a number of growth records in 2023. A number of key performance indicators make us optimistic as we look ahead. For example, in the fourth quarter, GA recorded the best ever quarter of aggregate total flows, including record quarterly flows within our SPDR ETF franchise, amounting to a capture of 21% of total global ETF flows in the fourth quarter and ending 2023 with a record level of total ETF assets under management. Our cash business had an exceptional year delivering record annual flows in 2023 with institutional money market fund AUM also reaching a record. Overall, we gained market share in a number of key areas, including institutional money market funds and US low-cost equity and fixed income ETFs. Turning to our efficiency and productivity efforts. Underlying expense growth was well controlled in 2023 with full year expenses increasing 3%, excluding notable items. Fourth quarter expenses, excluding notable items, rose just 1% quarter-on-quarter, reflecting the impact of our ongoing expense actions. Transforming our operations to improve effectiveness and efficiency and realize productivity growth remains a key priority for us. To that end, we announced important steps in our multiyear productivity efforts aimed at improving our operating model. As we previously announced, we are streamlining our operations in India. We have now assumed control of one of our joint ventures in that country with a second joint venture consolidation expected to close in the spring. We expect these actions will accelerate the transformation of State Street's global operations, improve service quality and client experience, and enable us to achieve productivity savings as part of our plans to deliver positive free operating leverage in 2024. Turning to Slide 4 of our presentation. You can see our fourth quarter financial highlights and business trends and indicators, which Eric will shortly take you through in more detail. Before I conclude my opening remarks, I would like to touch on our continuing balance sheet strength, which has enabled us to return a substantial amount of excess capital in recent quarters. For example, over the last five quarters to the end of December, we have returned $6.4 billion of capital to our shareholders. As we pivot to a more normalized level of capital return in 2024, it is currently our intention to return approximately 100% of earnings in the form of common share dividends and share repurchases, subject to market conditions. Accordingly, as we announced this morning, our Board of Directors has authorized a new common share purchase program of up to $5 billion with no set expiration date. To conclude, while 2023 was an eventful year, we finished strongly in the fourth quarter, which creates an encouraging starting point for our businesses into 2024. This year, we remain highly focused on both the execution of our strategy and the accountability for results. Our goals are clear. We must continue the improvement in our sales performance that we demonstrated in the second half of 2023, continue to implement a set of productivity initiatives and product enhancements that will drive longer term improvements in our operating model efficiency and effectiveness, and deliver positive fee operating leverage in 2024, all while returning capital to our shareholders. We are laser focused on these goals. 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. Before I begin my review of our fourth quarter and full year 2023 results, let me briefly discuss the notable items we recognized in the quarter on Slide 5, which collectively totaled $620 million pretax or $1.49 of EPS. First, we recognized an FDIC special assessment of $387 million, which is reflected in other expenses. Second, we recognized $203 million of net repositioning charges to enable the next phase of our productivity program. As we had indicated in December, the bulk of this action primarily relates to severance of around 1,500 employees. Our initiative to streamline and delayer our operations, technology, and staff functions and improve efficiency will allow us to sustainably reduce expenses. We expect these actions collectively to have a payback of roughly six quarters and begin this quarter with roughly two-thirds of the benefit occurring in 2024. These actions and the related savings will contribute to our fee operating leverage goal for 2024 and in subsequent years. Turning to Slide 6. I will begin my review of both our fourth quarter and full year 2023 financial results. As you can see on the table, total fee revenue was flattish for all periods of comparison quarter-on-quarter, the year-on-year quarter and for the full year. The slight market appreciation, notwithstanding the combination of muted volatility, central bank pivot, and geopolitical concerns, pushed investors to the sidelines for much of the year. In terms of our more durable revenues, we continue to benefit from strong momentum in our front office software and data business, which was up 5% on a full year basis and 13% on the year-on-year quarter. In terms of areas that have begun to rebound, management fee performance was down for the full year at minus 3%, but has begun to rebound with an up 5% result for the year-on-year quarter as flows picked up and we gained share. Back office servicing fees were challenged for much of the year as the client's transactional activity was muted but has started to turn positive and is up 1% this quarter as we've seen a recent lift in equity markets. And of course, we continue to be affected by industry-wide headwinds in our global markets businesses, given the low levels of volatility in the FX markets and specials activity in agency lending throughout the year. NII has been tough to predict and surprised to the part of this quarter compared to the third quarter. I'll turn to that in a few minutes. Expenses were well controlled in the quarter as we continue to thoughtfully allocate resources across the franchise and to areas where we see the greatest opportunities for top-line growth. Relative to the year ago, total expenses ex-notables were up 2% year-on-year and reflect intensifying cost management in a tough environment as the year progressed. This expense control, coupled with the repositioning actions I just mentioned, prepare us to deliver productivity savings and positive fee operating leverage in 2024. Finally, despite a dynamic and challenging operating environment, we delivered full year 2023 EPS growth of 3% excluding notable items. This was supported by share repurchases, a record level of NII, and the growth of our front office software and data business, which is less exposed to macroeconomic conditions. Turning now to Slide 7. We saw period end AUC/A increase by 14% on a year-on-year basis and 4% sequentially. Year-on-year, the increase in AUC/A was largely driven by higher period end market levels and net new business. Quarter-on-quarter, AUC/A increased primarily due to higher period end market levels. At Global Advisors, period end AUM increased 19% year-on-year and was up 12% sequentially, largely reflecting higher period end market levels and strong net inflows. Notably, as Ron mentioned earlier and I'll describe momentarily, in the fourth quarter, GA recorded the best ever quarter of aggregate net flows of $103 billion, which sets us up well for 2024. At the center right, we've also added a table of market volatility indices, which we believe can be useful indicators of client transactional activity that drives servicing fees, specials activity in agency lending, and flows in margins and FX trading. On Slide 8 now. On the left side of the page, you'll see fourth quarter total servicing fees up 1% year-on-year, primarily from higher average equity markets, partially offset by pricing headwinds, lower client activity, and adjustments, and a previously disclosed client transition. Sequentially, total servicing fees were down 2%, primarily as a result of the pricing headwinds and a previously disclosed net client transition, partially offset by higher client activity and adjustments, which was nice to see as clients started to come off the sidelines. On the bottom left of the slide, we summarize some of the key performance indicators of our servicing business. We were quite pleased to see new servicing fee revenue wins of $103 million this quarter, the highest in recent years, primarily reflecting the enhancements to our sales processes and product offerings, including in North America where we saw strong outcomes after a period of underperformance. These servicing wins contributed to the total full year fee revenue wins of $301 million and underscored the progress we're making towards stronger sales performance. Recall, our goal for 2024 is even higher at $350 million to $400 million in servicing fee sales for the year. Finally, we had $270 million of servicing fee revenue to be installed at quarter end, up $57 million year-on-year and $15 million quarter-on-quarter. We expect about half of this to install in 2024. We also had $2.3 trillion of AUC/A to be installed at period end. Turning to Slide 9. Fourth quarter management fees were $479 million, up 5% year-on-year, primarily reflecting higher average equity market levels and some performance fees, partially offset by a previously described shift of certain management fees into NII and the impact of a strategic product suite repricing initiative that has aided ETF flows. Relative to the third quarter, management fees were flat, mainly driven by higher performance fees, offset by a previously described shift of certain management fees into NII and the impacts of the strategic ETF product suite repricing initiatives. 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 ETF, we had record quarterly net inflows of $68 billion, driven by record net inflows into SPY as well as the SPDR portfolio US low cost suite experiencing consistent market share gains. In our institutional business, we saw quarterly net flows of $6 billion, primarily driven by defined contribution products. And lastly, across our cash franchise, we saw quarterly cash net inflows of $29 billion, primarily into money market funds, which contributed to the record total full year 2023 cash net inflows of $76 billion and institutional money market fund market share gains. Turning now to Slide 10. Fourth quarter FX trading services revenue was down 11% year-on-year ex-notables and 2% sequentially. Relative to the period a year ago, the decrease was mainly due to lower FX spreads from muted market volatility, offset by slightly higher volumes. Quarter-on-quarter, the decrease primarily reflects lower direct FX revenues from muted volatility. Fourth quarter securities finance revenues were down 6% year-on-year due to lower agency balances, partially offset by higher agency spreads, higher specials activity, and prime services revenue. Moving on to software and processing revenues. Fourth quarter fees were up 10% year-on-year and 26% sequentially, largely driven by CRD, which I'll turn to shortly. Finally, other fee revenue for the quarter increased $15 million year-on-year, primarily due to a midyear tax credit investment accounting change, partially offset by the impact associated with the devaluation of the Argentinian peso. Moving to Slide 11. You'll see on the left panel that fourth quarter front office software and data revenue increased 13% year-on-year, primarily as a result of the continued SaaS implementations and conversion, driving software-enabled and professional services revenue growth. Sequentially, front office software and data revenue was up 38%, primarily driven by higher on-premise renewals and go-live implementations. Turning to some of the Alpha business metrics on the right panel. We’re pleased to report four more Alpha mandate wins in the quarter, which means seven wins for the full year 2023. State Street Alpha continues to be an important differentiator of our business and creates an attractive value proposition for our clients with contractual terms usually covering five to seven to ten years. We’ve also gone live with three more Alpha clients, which brings us to six for the year, which sets us up well for 2024 and added significant new functionality for fixed income portfolio managers. Fourth quarter ARR increased 16% year-over-year, driven by 20 plus SaaS client implementations and conversions, and we had a record quarter for front office new bookings at $32 million. Turning to Slide 12. Fourth quarter NII increased 14% year-on-year but increased 9% sequentially to $678 million. The year-on-year decrease was largely due to lower average deposit balances and deposit mix shift, partially offset by the impact of higher interest rates. Sequentially, the increase in NII performance was primarily driven by the impact of interest rates and the full quarter impact of the third quarter investment portfolio repositioning, as well as higher deposits and loan balances. The NII results on a sequential quarter basis were better than we had previously expected, as both interest-bearing and non-interest-bearing deposits increased and certain client repricings were further delayed. Some of the higher deposit balances may have been seasonal, but the Fed's quantitative tightening appears to have been offset by the reduction of the Fed's reverse repo operation, which seems to have resulted in clients leaving higher bank deposit balances. It's hard to know how deposits will trend, but we are pleased with this higher step-off going into the first quarter of 2024. On the right side of the slide, we show our average balance sheet during the fourth quarter. Average deposits increased 4% quarter-on-quarter, with non-interest-bearing deposits up 3% for the quarter. Turning to Slide 13. Fourth quarter expenses, excluding notable items, increased 2% year-on-year or 1% ex-FX. Sequentially, fourth quarter expenses were up only 1% as we actively managed expenses and continued our productivity and optimization savings efforts, all while carefully investing in strategic elements of the company, including Alpha, Private Markets, Core Custody, and tech and ops process improvements and automation. On a line-by-line basis and year-over-year, ex-notables, compensation employee benefits increased 1%, primarily driven by higher salaries and employee benefits, partially offset by lower contractor spend and performance-based incentive compensation. Information systems and communications expenses increased 4%, mainly due to higher technology and infrastructure investments, partially offset by the benefits from ongoing optimization efforts in sourcing and vendor credits. Transaction processing increased 1%, mainly reflecting higher brokerage costs. Occupancy increased 24%, largely due to the absence of an episodic sale leaseback transaction in the prior period. And other expenses were up 3% sequentially, flat year-on-year, mainly reflecting higher marketing spend and professional fees. Lastly, let me spend a moment on headcount. As we discussed in the third quarter, as part of our ongoing transformation and productivity initiatives, we have streamlined our operating model in India and have now assumed full ownership of one of our operations joint ventures, and we recently announced that we intend a similar undertaking with a second consolidation in the country this spring. This consolidation continues the transformation of State Street's global operations and will enable us to unlock productivity savings, which we expect to start this quarter through a reduction in contractor services and in the years ahead as we simplify our fragmented operating model. As you would expect, consolidating the first joint venture increased our FTE headcount roughly 4,400 in the quarter as we insourced global capabilities. However, these costs were already in our expense base and reported historically under the compensation and benefits line. These actions are contributing to our higher productivity savings targets for 2024. 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 very strong capital levels, which came in above both our internal targets and our regulatory minimums. As of quarter end, our standardized CET1 ratio of 11.6% was up 60 basis points quarter-on-quarter, largely driven by episodically lower RWA and improvement in AOCI, partially offset by the continuation of common share repurchases. The decrease in interest rates during December after the completion of our buyback contributed about 20 basis points to our CET1 ratios. Some market factors over the last week of December conveniently contributed roughly another 50 basis points to the RWA end of period print. Going forward, I would expect RWA to run at higher levels to support our various businesses. Our LCR for State Street Corporation was a healthy 106% and 122% for State Street Bank & Trust. In the quarter, we were quite pleased to return over $700 million to shareholders, consisting of $500 million of common share repurchases and over $200 million in common stock dividends. Lastly, as we announced earlier today, our Board authorized a new multiyear common equity repurchase program of up to $5 billion with no expiration date. Turning to Slide 15. Before I start, let me first share some of the assumptions and underlying our current views for the full year. Let me cover our full year 2024 outlook, as well as provide some thoughts on the first quarter, both of which have more potential for variability than usual given the macroeconomic environment we're operating in. In terms of our current macro expectations, as we stand here today, we expect global equity markets to be flat point to point in 2024, which equates to the daily average being up about 10% year-over-year. Our interest rate outlook for 2024 largely aligns with the forward curve as of year-end 2023, which I would note continues to move. We expect to see modest increases in FX and equity volatility, which should support slightly higher FX trading services fees this year, but we are still seeing muted volatility in the first quarter. We expect currency translation to have less than 0.5 percentage point impact on revenues and expenses due to dollar depreciation. And I would remind you that a weaker US dollar has a favorable impact on revenues and an unfavorable impact on expenses. So we currently expect that full year total fee revenue will be up approximately 3% to 4% ex-notable items, with servicing fee and management fee growth driven by higher market levels and continued business momentum and continued strong growth in front office software and data. This includes a headwind of a little less than 1 percentage point to fee growth from the expected previously disclosed client transition. Regarding the first quarter of 2024, we currently expect fee revenue to be up 2% on a year-over-year basis, with servicing fees expected to be up 1%, management fees up 7% to 8%, and front office software and data expected to be up over 20%, largely due to increased SaaS new business and conversions and on-premise renewals. We expect full year 2024 NII to be down about 10% on a year-over-year basis compared to a record 2023. This is dependent on the outcome of global rate cuts and deposit mix and levels, which are obviously difficult to predict. Regarding the first quarter of 2024, after a significant step up in fourth quarter of 2023, we expect first quarter 2024 NII to be flat to down 3% on a sequential quarter basis given current deposit mix expectations. Turning to expenses. As you can see on the walk on Page 16, we expect full year expenses ex-notables will be up about 2.5% on a nominal basis in 2023, driven largely by our continued investment in the business, which we expect to largely offset through greater productivity savings worth $0.5 billion, which is approximately 1.7 times last year's gross savings level. Regarding the first quarter of 2024, we expect expenses ex-notable items to be up 1% to 1.5% on a year-over-year basis, keeping in mind that seasonal expenses usually occur in the first quarter. As a reminder, we expect to achieve positive fee operating leverage, excluding notable items for full year 2024, given the projected growth in fee revenue and well-controlled expenses. Finally, we expect taxes should be in the 21% to 22% range for 2024. And with that, let me hand the call back to Ron.

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

Your first question comes from Alex Blostein with Goldman Sachs.

I was hoping we could start with unpacking some of the NII dynamics, and I guess appreciate the uncertainty when it comes to deposits. But Eric, maybe talk a little bit about what drove the upside in the fourth quarter in deposit levels, and if you have a view on what sort of seasonal versus more kind of core client franchise driven? And maybe give us some insight on where you expect balances to ultimately stabilize in the back half of 2024?

Let me share the details we have. Deposits and their levels remain volatile, surprising us positively. Specifically, we noticed a significant increase in deposits during September and October, followed by a decrease in November and another large increase in December. This led to higher average balances for the quarter, which was impactful. For instance, $1 billion in noninterest-bearing deposits for a month translates to $5 million, and that adds up quickly, especially with a spread in December of $5 billion to $6 billion compared to our expectations. We also experienced an increase in interest-bearing deposits, partly due to our ongoing engagement with clients who are leaving more funds with us. The Federal Reserve's reports indicate a 1% to 2% quarter-on-quarter rise in banking system deposits from the third quarter to the fourth quarter, suggesting some stability and a bit of buoyancy in the market. There is also a seasonal trend at the end of the year where clients accumulate cash, sometimes in anticipation of paying dividends and ETFs in the coming year. While it's challenging to interpret, that's how things unfolded, and it improved as the quarter progressed. Looking ahead, it's tough to make projections for the year. We aim to maintain deposits in the range of $200 billion to $210 billion, which largely depends on client engagement and assisting them in utilizing their funds effectively. Some may choose to keep cash in deposits, repos, or money market sweeps, and each of these pathways is significant for clients. We observe clients employing various strategies, including holding treasury securities. We anticipate this trend will continue, with deposits remaining in this range for the first quarter. However, predicting the behavior of noninterest-bearing deposits is trickier. We expect these to decline, especially among clients with larger funds, who have experienced this downward trend over the past two years. Our expectations continue in that direction, and some repricing will also occur in the first quarter. Consequently, I indicated that net interest income could remain flat or decrease by 3% in the first quarter, providing some guidance. We anticipate deposits to remain roughly stable.

My follow-up question is about deposit beta as we enter the rate-cutting cycle. Could you clarify what you expect for deposit beta as it decreases in your '24 NII guidance? Additionally, how should we understand the trend of deposit betas as we move through the rate-cutting cycle into the latter part of '24 and '25? I'm interested to know if you anticipate higher beta at the beginning and lower towards the end, or the reverse.

Alex, it's an important topic because it's how we interact with our clients, it's how we price our products, it's how the industry has operated for many years. I think you know that our deposit betas on a cumulative basis have climbed quite a bit in the US. They're 75% or so cumulatively since the start of the cycle. In euros, it's around 60% cumulatively; in pound sterling, closer to 30% to 35%. So they've clearly moved up. What certainly happens is when — and I'll say when, if and when rates fall, the deposits' beta will reverse; there's some amount of symmetry. Now they won't reverse instantaneously; we want to be careful with our clients; we want to be fair. But we do think that over multiple quarters, and certainly over any realistic time frame, the Fed cuts, there has to be an adjustment. Part of that happens because we have a good bit of our deposits that are indexed to market — they're indexed to market indicators. There are quite a few that are indexed with a spread, and then there are a small amount now that have a transactional kind of, I'll call it, administered feature. But you’ll generally see a broad amount of symmetry in deposits down versus up. What you need to keep in mind is that our asset sensitivity and liability sensitivity, though, are somewhat different between international markets and in the US. In international markets, because those cumulative betas are still in the 30% to 60% range, we're still asset-sensitive. So we make more money with increases in rates. In fact, NII will trim down with decreases in rates. That's our interest rate sensitivity today. In the US, we have a slight positive bias towards being liability sensitive, but it's still relatively slight; I'd almost call it neutral. Part of what we're doing is just navigating this interest rate environment. It's not exactly clear when the rates will come; it's not clear whether the US cuts before Europe or vice versa. Part of what we'll do is actively manage our portfolios to try to take advantage of what's coming. At the same time, we'll price our deposits fairly and prudently.

You next question comes from Brennan Hawken with UBS.

I think maybe some of what you just said on the non-US side might explain this. But when we think about triangulating the minus 10% to the fact that 1Q is either going to be flat or it's only down a little on NII, it sort of suggests that your exit rate by the time you get to the 4Q '24 based on what you can see today is probably going to be rather low. Am I reading correctly in thinking that it's that non-US piece that's going to drive some of that weakness? Am I extrapolating the comments correctly to think that we could see a little bit more back-end weighted decline for NII?

I think you've got the right general pattern framed in the area of NII. Clearly, we had a very strong step off, particularly in December, but in the fourth quarter, which will flow into the first quarter, and then we expect a trending down. We had a couple of — well, probably earlier last year, so a couple of quarters ago, I described an NII range of $550 million to $600 million. We think we’ll get into that range, the top end of that range by around the third quarter. But it's a little bit hard to know the exact shape. You've got the right direction of travel. We expect some stabilization in the second half of next year, maybe around the top half, the middle half of that range; just really hard to tell exactly where and when. If you step back and ask, what are the underlying drivers? There are really three drivers that continue to be important. In terms of tailwinds, we have long rates playing through the portfolio and the investment portfolio balances as they recoupon at higher rates; that's particularly important in the first half of the year, a little less so in the second half of the year, but that continues through as a positive. You then have, as you mentioned, short rates starting to come down, and because of our sensitivity position across the global markets, that does start to have a headwind impact on NII as those cuts continue to come through. Now we'll see what's the pattern and pace of US versus international cuts. Right now, we've pegged to the forward, which shows a lot of consistency in symmetry, but we'll see if that really happens, because you can see inflation expectations keep moving around literally daily, weekly. The third feature is just client deposits and mix. While we expect client deposits to be in that zone of $200 million, $210 million, they might bump up above that, a little below that, but they'll be in that broad zone. The mix will continue to shave down out of noninterest-bearing over the next quarter or two, we think, it's hard to again to predict, and then there's — we’re working through the final stages of some of our interest-bearing deposit repricing; those seem to have taken a little longer in some cases than we expected. That's okay; that means we accrete income. Those will continue to come through and they'll still play through in the first quarter or two as well. That brings us to some level of reasonable stability in the back half of the year.

And by the way, I apologize for background noise that is here. Second question, a bit more strategic. So we saw a flurry of Bitcoin ETF launches here recently. It didn't seem like you all actually landed any of those servicing opportunities. So I want to confirm whether my early read on that is right. Given the magnitude of the investment and the focus you've made on digital assets, what did you learn if you guys missed on that? Is that what led to the restructuring of the digital asset group, and what should we see as a change from that restructuring?

Brennan, there were 11 launched on the day that the — or day after the SEC gave approval, and we actually serviced three of them. I think we're the only ones that are servicing across three different digital custodians. So we helped three of the major players make this happen. So we're quite active in the space. As you'd expect, we do everything for each of those three except for the actual custody for the reasons that I think you know. So no, we're very active in the space. What did we learn? I mean it's early. What I think everybody is watching out for is, there's a lot of players that went into the market, some of them with some existing high levels of assets. What will be interesting to see over time is does it actually consolidate and how does it work in terms of who the buyers are; institutional versus retail versus intermediary, but these are early days. It was good to get the uncertainty cleared up and for all this to get launched, and we're keen to be part of it.

Ron, thanks for clarifying pure custody versus the servicing. Very, very helpful.

And just to clarify, I mean, I think everybody knows this. But I mean, right now, it's extremely difficult for a bank to do pure custody because of the capital requirements that are imposed on a bank. It's basically 100% capital. Therefore, virtually everybody is working with some kind of digital custodian, a non-bank digital custodian, but all of the other parts of the ecosystem, which we're quite familiar with, we are participating in.

Your next question comes from Glenn Schorr with Evercore.

So big flows in SSGA, which is great. Good to see. These things are unpredictable. But I am curious if you had any thoughts towards sustainability? And maybe it would be the color of what clients are buying, what clients are — I mean, what flavors of ETF are they, the average fee? And what you're specifically doing differently on the distribution front and education front to get at those flows?

So there are a number of things going on there in the fourth quarter, Glenn, and throughout 2023. I think as we've noted and certainly, you all would have observed, there was — it was most of the year with some episodic exceptions. It was a risk-off environment that changed in the fourth quarter somewhat as predicted once investors got a sense of where interest rates were going, as they did when the Fed communicated in the third quarter more or less a pause. I think that started activity going. So much of the activity late in the year would have been the kind of classic risk-on, let's put positions on quickly, benefiting the highly liquid SPDR Core SPY in the sector ETFs. Underlying it and throughout the year, the low-cost ETFs, which represent different investors, these would be — the ultimate holders here tend to be individuals. They’re often advised by an intermediary like an RIA, so they’re — it's very sticky. We've continued to build share there, both in equity and fixed income, low-cost. Across the board, fixed income is seeing dramatic growth. I think there's increasing acceptance, both by retail investors and institutional investors that the ETF is a good vehicle to hold fixed income, and you're just seeing that asset allocation moving that way. Lastly, active ETFs of all sorts are seeing growth, and it's been a long time coming. It’s ironic how it's playing out and that everybody is just taking their standard investment strategy and putting it in active ETFs. We benefit from some of that on the GA side in terms of what they're doing in fixed income but we benefit from it greatly on the servicing side because we're very, very — not to overuse the word, active in the active ETF servicing space. We believe you'll see a lot more growth there as core funds and core offerings of well-known asset managers either get converted to ETFs or launched as ETFs. We’re really pleased on the GA side. In terms of what drove it, I think it was the next part of your question. Part of it was much more focus and resources dedicated to the various intermediary channels. Our roots are in the institutional channels, but the lots of the growth is in the intermediary channel. That’s part of it. Then as we talked about, I believe, last quarter, we took a hard look at pricing, particularly in the so-called low-cost ETFs and recognizing their durability, felt that it was worth the investment to reprice them to continue to gain market share because they tend to be very, very sticky.

I'll go quickly on the follow-up. It's the same question just different on the servicing front, happy with the wins you noted. Maybe we could just drill down. I know it's not huge yet, but the private markets piece of the servicing wins. I'm curious if you want to tell us how much it was, but more importantly, what it is and how — is it one client or is it multiple clients? I’m curious about how that private market servicing space is developing?

No, no, it's both. To answer the last part of it first, Glenn, it's certainly not one client. This is a space that we've invested in and we're well known in. We see a secular trend here where it's — so many of these operations are held inside firms that are highly bespoke, often sitting in very expensive locations. As the product sets have become more complicated, I mean, it's following a path that the active long-only industry followed 10, 15 years ago. It was fine to do all this stuff inside when it was just a couple of products that are fairly straightforward; that's not what's happening now. Products are more complicated. As you start to think about the structures that enable high net worth individuals to participate in it, you've got that added complexity. Oftentimes there are side investments that are permitted, etc. So it's very complicated; it lends itself to outsourcing. It's still very much an in-sourced business. We see lots of potential growth in it. Its fee characteristics are different, positive in the sense that the fees are higher, but also the fees get fully recognized when the fund is fully invested. So part that we pay a lot of attention to is what's the expected actual — one, money raised and then draw down, and how do we do our best to match our expenses to that. But we're very excited about the business. Much of the new investment, product investments that Eric talked about in the 2024 guide includes further strengthening of our position there. There's innovation in there and our goal is to continue to set moats around us so we can continue to excel at it.

I'd just add that privates have been a real strong area of growth for us. We've described it as up 10%, 15% in different quarters. So it's a big part of our growth agenda as we — this past year. This coming year, as we take our sales goals up, the $350 million to $400 million, at least a quarter of that plus is going to be around private, and that's what's going to help us continue to drive privates growth. We think in the 15% plus range in terms of year-on-year revenues. So it's an area that I think we've actually broadly with both large and small and midsize, it's actually well-distributed and it's got a good mix of US, Europe, and Asia sales coming through as well.

Yes, as well as, Glenn, it's not just private equity; private credit is booming. For every bank that complains about what's going to happen with regulation and the fact that it's pushing activity out of the banking system, that's going right into the private credit area, and we should be the beneficiary of that growth.

Your next question comes from Gerard Cassidy with RBC.

Eric, can you share with us — I know you and Ron were in State Street 10 years ago, but your comments about the net interest income outlook and just how volatile it is due to what's going on in the bond market with the Federal Reserve and their balance sheet. Are there any indicators you're monitoring that we could look at that might be able to give us a better insight into when net interest income for State Street might be more predictable on a go-forward basis?

I take a sigh when I think about this question. I think the predictability is partly around Fed actions. This is the highest rate level that we've seen in 22 years. If I go back a couple of years, it's been the lowest rate level we've probably seen in two decades. So we've kind of — we're at these wide bookends relative to really since the — I want to say, the turn of the century, and that's really created this volatility. Can we manage that and mitigate? Well, we do try to sustain on a regular basis, match off deposit tenor, rate characteristics with the asset side of the portfolio and we do that with duration. The challenge is if you take too little duration, you have even more volatility. If you take too much duration on the asset side of the portfolio, you’ve got more AOCI risk, so our tools to stabilize work up to a point and then have some negative implications. I don't really see a way to turn what we'd like to have — I don't see a way to turn this into just a flywheel of metronome that moves at a certain pace, and it's just a feature of what we do. Part of it is our institutional deposits have somewhat more asset sensitivity or liability sensitivity to rates relative to a very simple regional bank. We'll tend to have a little more, but that's part of the industry; I think we're in line with peers.

Eric, in your prepared remarks, you talked about the success and the momentum you're having with the Alpha product in the servicing business — in the Investment Services business, I should say. Is there any capacity constraints that you've got to be careful about if the momentum continues or is it almost now when you've got plenty of bandwidth to handle future growth? I would say that the capacity constraint has been particularly with these large complicated clients, the really large ones, some of which are well — most of which are still being onboarded. The capacity strength has been around onboarding. Over the past year, in particular, we've gotten better at that. You can — if you just look at that number, we were roughly at about, as I recall, $3.6 trillion in assets to be onboarded, and we're now down to $2.3 trillion. So you can see we're getting better at that. The real constraint to be specific about it tends to be how quickly you onboard the middle office element to that because that often requires engineering, and by that I mean engineering with the client, because ultimately, that's a client and it's like any other kind of industrial outsourcing. A client has an operation, those things in a particular way, wants to outsource that element of it to us. We're not interested in taking somebody's mess for less; we need to actually work with them to engineer it in a way where as much of it as possible is standardized and that the customization is limited to the extensive user interfaces or how things are actually applied. We've just gotten better at that over time. So I would say, looking forward, we don't see that as being a meaningful constraint.

Your next question comes from Jim Mitchell with Seaport Global.

Just maybe a follow-up on the — outside of sort of the private markets, you've ramped up pretty quickly in terms of getting to your $400 million of new servicing fee wins. Maybe if private markets are a quarter, can we talk a little bit about the other three quarters, where you've seen success, what's worked, what hasn't worked and what kind of opportunity set do you see maybe even get above the $100 million?

I mean, it's no one thing, but a lot of really important things across the board to ramp up our execution. Where we're seeing it, to answer the first part of your question, is the core Investment Managers segment still remains strong and active for us. As some of those firms are facing the same kind of market that everybody else is, they're more interested in actually trying to do more with us and do different things with us. There's a resurgence in the asset owner marketplace and in particular, amongst asset owners that aren't just pure asset allocators, meaning they're managing some assets themselves or truly actively allocating, doing not just listening to a consultant telling them what to do, but either managing money or at a strategic and tactical level, allocating assets, which again requires support. But in all cases, what we're doing is we're really focused on ensuring that the back office part of all this comes with it, and comes with it in a timely fashion, right? Because as I was saying earlier when I was talking to Gerard, the thing that takes a long time or a longer time to onboard would be the middle office, the outsourcing element of it. Onboarding back office is pretty easy, pretty straightforward, and it generally comes down to a pretty healthy incremental margin given the scale activities to it. Finally, just to talk about regions, we've invested heavily in the capabilities in all of our regions where you see probably the most impact from that over the last couple of years has been just the very good growth that we're seeing in Asia Pacific and really, all parts of Asia Pacific from Australia north to Japan and everything in between. The US, we've talked about in the past; we were not pleased with where we were in this past year, particularly the second half of the year. We're actually reasonably pleased with how we've done. Europe has always been strong for us. It was a little softer in 2023, but again, a very strong pipeline. That regional focus where we're pushing accountability down into the country and regional level and making sure that it's very clear who is responsible for what, sharing, not just the technology and the product, but the best practices in how you move these things forward, but very much decentralizing the accountability.

I would just add that we've got a pretty industrial productivity plan for this year. Part of that was the repositioning that we announced, but two thirds of the roles impacted are really around delayering and simplifying State Street. We're actually taking our spans of control in some areas like operations from 5:1 to 8:1. We're taking standard controls in the business and staff functions in some cases from 3:1 to 5:1. The benefit of that is it actually brings our teams, our client teams and operational teams even closer to our clients. Some of what we're doing with the joint venture consolidation is a catalyst for that because, in some cases, we had too many hand offs, and now we can simplify processes and again, bring them closer to our clients. There are some real structural changes there. We do want to see those through. As Ron mentioned, there’s always a little more, we'll look at on the margin but we want to be careful. We want to do this right. On the margin, you continue to work on vendors and so forth; you look at performance-based incentive compensation. There are smaller levers. But we're pretty — I think we've got a nice work set out and a lot to do. I think we've got real confidence that this is, I think, year probably five. I don't think we name our programs with annual versions, but this is probably a year five of the productivity program and should really deliver quite a bit.

And then on the regulatory front, there was some commentary last week from the FDIC around regulations for large index fund providers. I'm curious if you have any thoughts there on how that can potentially impact your business?

From the FDIC, I didn't see this, Rob. I'm curious as to the FDIC's role in index funds. I wonder what Vanguard has to say about that. I'm just not familiar with it, Rob.

Why don't we follow up offline, Rob, just send it through to Ilene and the team.

Yes, it could be, Rob, that GA is already on this. I just haven't seen that.

There are no further questions at this time. Please proceed.

Well, thank you everybody for joining the call.

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