State Street Corp (XLF) Q1 2024 Earnings Call Transcript

Good morning, and welcome to State Street Corporation's First Quarter 2024 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 Investor Relations at State Street. Please go ahead.

Thank you. Good morning, and thank you all for joining us. On our call today, our CEO, Ron O'Hanley will speak first; then, Eric Aboaf, our CFO, will take you through our first quarter 2024 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 first quarter financial results. We had a strong start to the year with our results demonstrating the breadth of our client franchise, the efficacy of our strategy, and our focus on execution. We reported both fee and total revenue growth, all while continuing to invest meaningfully in our business and controlling underlying expenses. Excluding notable items, we delivered both positive fee and total operating leverage, as well as solid EPS growth in Q1 relative to the year-ago period. The first quarter was an important milestone. We have detailed our strategic priorities for 2024, including the growth initiatives we are undertaking across each of our business areas, as we continue to both invest in our capabilities and also target further productivity gains. Guided by our purpose to help create better outcomes for the world's investors and the people they serve, our four strategic priorities are aimed at continuing to extend our competitive advantage, while delivering positive fee operating leverage excluding notable items in 2024. These 2024 priorities are: growing fee revenue; extending our leadership in our markets and financing and global advisors franchises; enhancing and optimizing our operating model; and continuing to differentiate our business through innovative client solutions and technology-led capabilities to support business growth. We remain intensely focused on executing against these strategic priorities, particularly in a dynamic operating environment in which financial market expectations continue to change significantly. For example, as inflation remains elevated and economic data continued to be robust, investors pushed back their expectation for the timing of Central Bank rate cuts and treasury yields increased during the first quarter. Despite this, global equity markets performed strongly and volatility remained muted, with many indices setting records as fears of a hard economic landing receded and optimism surrounding the potential economic benefit from artificial intelligence continued in Q1. Turning to slide three of our investor presentation, I will review our first quarter highlights before Eric takes you through the quarter in more detail. Beginning with our financial performance, 2024 started strongly. Year-over-year, we produced both positive fee and total operating leverage, as well as good EPS growth, excluding notable items. First quarter EPS was $1.37 or $1.69, excluding a notable item related to the increase to the FDIC special assessments. Underlying year-over-year EPS growth was supported by total fee revenue growth and continued common share repurchases, which more than offset the impact of lower NII on total revenue. Underlying expenses continued to be well controlled, supported by our ongoing productivity efforts, with first quarter expenses increasing just 1% year-over-year, excluding notable items, even as we have increased the level of investments in our business. Turning to our business momentum, which you can see on the middle of the slide, we continue to make progress across our client franchise in generating better fee revenue growth. Within asset services, AUC/A increased to a record $43.9 trillion. We generated asset servicing AUC/A wins of $474 billion in Q1, supported by key wins in both North America and Europe. Servicing fee revenue wins totaled $67 million. After hitting our full-year sales target of $300 million in 2023, we remain confident in our ability to achieve our increased servicing fee revenue sales goal of $350 million to $400 million in 2024. Our priority to grow fee revenue this year is underpinned by a strategy of leading with service excellence and driving stronger back office sales, differentiating with our State Street Alpha and private markets platforms. Our two new Alpha mandate wins this quarter demonstrate our ability to execute on the strategy, while also showcasing the clear competitive advantage and differentiation that Alpha creates for our business. For example, both Alpha mandate wins this quarter include back office services, which can install quickly, allowing us to realize revenue faster. Further, one mandate is our second Alpha for private markets win, a key growth area for us. Encouragingly, both of these Alpha wins were takeaways from a key competitor, with one of the wins having no existing services with State Street prior to becoming an Alpha client, and the other a shared client that will now consolidate back office with State Street. Within markets and financing, even as low FX volatility created a headwind for the industry in the first quarter, we attracted higher FX client volumes, both sequentially and year-over-year, supported by our market-leading and wide-ranging FX trading solutions. In FX, we were pleased to see higher client volumes in the 8% Q-over-Q fee revenue growth. We also expanded our markets franchise. Within outsourced trading, we continue to expand our product capabilities in geographical reach completing the acquisition of CF Global Trading in Q1. Global Advisors performed well, buoyed by higher equity markets, the strategic actions we have taken to position our asset management business for growth, and the benefits of the strong finish in step-off point at year-end 2023. First quarter 2024 management fees of $510 million are the highest since the first quarter of 2022. While GA experienced total aggregate outflows in Q1, this was driven by the impact of a large, but expected single client redemption within the institutional business. We saw continued momentum in the defined contribution business driven by our target day franchise. Encouragingly, we saw cash net inflows of $9 billion in the quarter, the fourth consecutive quarter of positive net inflows of our cash business. ETF AUM reached a record $1.4 trillion at quarter end with GA continuing to gather net inflows and expand market share within U.S. low-cost ETFs. Now let me spend a moment on our continuing productivity efforts. We have a detailed set of initiatives across our business aimed at creating cost efficiencies and lasting productivity improvements. Regarding our ongoing operating model transformation, which forms an important part of these productivity initiatives. As you know, we are streamlining our operating model in India, and last quarter we consolidated our first operations joint venture in the country. I am pleased to note that the consolidation of our second operations joint venture in India closed on April 1. Combined, these two consolidations will propel the continued end-to-end transformation of our global operations and enable State Street to unlock productivity savings in the years ahead as we simplify our operating model. Before I conclude my opening remarks, I would like to touch on our continuing balance sheet strength. Total capital return amounted to $308 million in the first quarter, consisting of common share dividends and share repurchases. I would highlight that we have returned a substantial amount of capital to our shareholders in recent quarters, with total capital return over the last six quarters equivalent to almost 30% of State Street's total market cap at quarter end. As we pivot to a more normalized level of capital return this year, as we have outlined previously, it remains our intention to return approximately 100% of earnings in 2024 in the form of common share dividends and share repurchases subject to market conditions and other factors. To conclude, we have delivered a strong start to the year as demonstrated by both sequential and year-over-year total fee revenue growth, encouraging business wins, strong underlying expense discipline, and continued capital return. As we look ahead, we remain highly focused on the execution of a set of clear strategic priorities for 2024. These strategic priorities are backed by detailed action plans aimed at driving growth across each of our business areas. Underpinning this execution is a set of business investments paired with a comprehensive set of productivity initiatives aimed at driving longer-term improvements in our operating model efficiency and effectiveness and generating 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. Turning to slide four, I'll begin my review of our first quarter financial results, which included a $0.32 EPS impact from an additional FDIC special assessment, as described within the notable items table on the right of the slide. As Ron noted, we produced a strong start to the year. On the left panel, you can see that total fee revenue was up both sequentially and year-on-year. Relative to the year-ago period, we delivered robust management fee growth, higher front office software and data revenue, and servicing fee growth, while underlying expenses were well controlled. As I mentioned during the first quarter, we recorded a provision for credit losses of $27 million, largely due to two CRE names. All told, we generated both positive total and fee operating leverage relative to the year ago, excluding notable items. We also delivered solid year-on-year EPS growth of 11%, excluding notable items, which was supported by the continuation of our share buybacks in the first quarter. Turning now to slide five. We saw period end AUC/A increase by 17% on a year-on-year basis and 5% sequentially to a record level. Year-on-year, the increase in AUC/A was largely driven by higher period end market levels, net new business and client flows. I would note that we have seen a mixed shift into cash and cash equivalents with an estimated 1 to 2 percentage points of total AUC/A versus a year ago. Quarter-on-quarter, AUC/A increased primarily due to higher period end market levels and client flows. As global advisors, period and AUM also increased to a record level, up 20% year-on-year, largely reflecting higher period end market levels and net inflows, and up 5% sequentially, primarily due to higher period end market levels. At the right center of the slide, the market volatility indices provide a useful indicator of client transactional activity that drives servicing fees, spreads in FX trading, and specials activity in agency lending. Turning to slide six, on the left side of the page, you'll see first quarter total servicing fees up 1% year-on-year, primarily from higher average market levels, partially offset by pricing headwinds, a previously disclosed client transition, and lower client activity and adjustments, including changes in certain client asset mix into lower earning cash and cash equivalents. In addition, the pace of installation started slower than we expected in the first quarter. Let me dimension some of these items for you. As I've told you before, the impact of the previously disclosed client transition was a headwind of approximately 2 percentage points to year-on-year growth. In addition, lower client activity and adjustments, including the client asset mix shift to cash, was also a headwind of approximately 2 percentage points to year-on-year growth this quarter, some of which we believe is cyclical. Sequentially, total servicing fees were up 1%, primarily as a result of higher average market levels, partially offset by lower client activity and adjustments, including the changes to certain asset mix and pricing headwinds. On the bottom of the slide, we summarize some of the key performance indicators of our servicing business. In the first quarter, we generated $67 million of servicing fee wins, nicely spread across both North America and Europe. As you recall, solid sales in North America like this was one of the goals that we had described at a conference last fall. In addition, we had $291 million of servicing fee revenue to be installed at quarter end, up $71 million year-on-year, and $21 million quarter-on-quarter. We also had $2.6 trillion of AUC/A to be installed at period end. Turning now to slide seven, first quarter management fees were up 12% year-on-year, primarily reflecting higher average market levels and net inflows from the prior periods, partially offset by the impacts of the strategic ETF product suite repricing initiative. Related to the prior quarter, management fees were up 6%, due to similar reasons, partially offset by lower performance fees. As you can see on the bottom right of the slide, following record inflows in 4Q ‘23, our investment management franchise remains well positioned with momentum across each of its businesses. In ETFs, the overall flows were relatively flat in first quarter. Our spider portfolio, U.S., low-cost suite achieved continued market share gains driven by net inflows of $13 billion. In our institutional business, we saw first quarter net outflows of $19 billion, primarily driven by a single client. That said, we saw continued momentum in the U.S.-defined contribution area with record AUM of approximately $730 billion. Lastly, in our cash franchise, we saw first quarter net inflows of $9 billion, the fourth consecutive quarter of positive net flows into cash. Turning now to slide eight, first quarter FX trading services revenue was down 3% year-on-year, but up 8% sequentially. Relative to the year-ago period, the decrease was mainly due to lower spreads associated with subdued FX volatility, partially offset by higher volumes as client engagement increased across nearly all of our FX venues. Quarter-on-quarter, the 8% revenue increase primarily reflects higher volumes with particular strength in our EM business, as well as higher direct FX spreads. First quarter securities finance revenues were down 12% year-on-year, mainly due to lower agency balances and lower spreads, primarily associated with significantly lower industry specials activity. On a quarter-on-quarter basis, we have seen agency lending balances up as demand is rising. Software and processing fees were up 25% year-on-year in Q1, largely driven by higher revenues associated with CRD, which I'll discuss in more detail shortly. Quarter-on-quarter, software and processing fees declined 13%, primarily due to our lower on-premise renewals, partially offset by higher lending-related fees. Finally, other fee revenue for the quarter increased $5 million year-on-year. Sequentially, other fee revenue increased $17 million, largely driven by an episodic currency devaluation in the prior quarter, which did not occur. Moving to slide nine, you'll see on the left panel that first quarter, front office software and data revenue increased 32% year-on-year, primarily as a result of continued SAS implementations and conversions, driving higher professional services and software enabled revenue growth. Sequentially, front office software and data revenue was down 20%, primarily driven by lower on-premise renewals and installations. Turning to some of the Alpha business metrics on the right panel, we were pleased to report two additional Alpha wins, including our second Alpha for Private Markets mandate. In addition, three mandates went live in the first quarter, bringing the total number of live mandates to 21. First quarter ARR increased 19% year-on-year, driven by over 20 SAS client implementations and conversions over the last year. Turning to slide 10, first quarter NII decreased 7% year-on-year, but increased 6% sequentially to $716 million. The year-on-year decrease was largely due to deposit mix shift and lower average non-interest bearing deposit balances, partially offset by the impact of higher average interest rates, client lending growth, and investment portfolio positions. We were pleased to report a sequential increase in NII, which was primarily driven by higher investment securities yields, an increase in average interest-bearing deposits, and loan growth, partially offset by the decline in average non-interest-bearing deposits. The NII results on a sequential quarter basis were better than we had previously expected, primarily driven by strength in both interest-bearing and non-interest-bearing deposit balances towards the end of the quarter. While it is difficult to forecast the path of deposits in the current environment, we're pleased with the success that we are having in engaging our clients. On the right of this slide, we provide highlights from our average balance sheet during the first quarter. Average deposits increased 4% year-on-year and 6% quarter-on-quarter, mainly driven by client-balanced growth across the interest-bearing deposit stack, partially offset by a reduction in non-interest-bearing deposits. Average non-interest-bearing deposits decreased by less than $3 billion quarter-on-quarter. Cumulative U.S. dollar client deposit betas were 80% since the start of the current rate cycle with cumulative foreign currency betas for the same period continuing to be lower in the 30% to 60% range depending on currency. Turning to slide 11, first quarter expenses excluding notable items increased barely 1% year-on-year as we both invested more to fuel fee growth and increased the size for our productivity and optimization savings efforts by more than 50%. On a line-by-line basis, excluding notable items, on a year-on-year basis, compensation employee benefits decreased 3%, primarily driven by lower incentive compensation and salaries, as well as a decline in contractor spend that was partially driven by the consolidation of one of our operations joint ventures in India. Information systems and communications expenses increased 4%, mainly due to higher technology and infrastructure investments, partially offset by the optimization savings and vendor savings initiatives. Transaction processing increased 4%, mainly reflecting higher broker fees due to increased global market volumes. Occupancy increased 10%, partially due to the real estate costs associated with the consolidation of the joint venture in India, which used to form part of the contractor cost within compensation and benefits, partially offset by footprint optimization. Other expenses increased 5% largely due to the timing of foundation funding. Lastly, I'll spend a moment on our transformation efforts. If you recall, consolidating the first operations joint venture last October increased our FTE headcount as we insourced those capabilities. However, it also came with an expected financial benefit excluding integration costs of $20 million over the course of the year. As Ron mentioned, the consolidation of our second operations joint venture in India closed on April 1. This will also come with an increase in additional headcount from 2Q, as well as expected financial benefits. The consolidation of these two joint ventures will be a catalyst for the next phase of State Street's global operations transformation and enable us to create a second wave of service improvements and productivity savings next year. Moving to slide 12. On the left side of the slide, we detail 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, our capital levels remain well above the regulatory minimums. While we continue to focus on optimizing our capital stack, the strength of our capital position enables us to extend our balance sheet to support our clients. As of quarter end, our standardized CET1 ratio of 11.1% was down approximately 50 basis points quarter-on-quarter, largely driven by the expected normalization of RWA. The LCR for State Street Corporation was a healthy 107% and 130% of State Street Bank and Trust. Our exceptionally strong liquidity metrics benefit from the deep and diversified nature of our funding base and active balance sheet management. In the quarter, we were pleased to return $308 million to shareholders, consisting of $100 million of common share repurchases and $208 million in declared common stock dividends. As Ron noted, we continue to expect to return around 100% of earnings to shareholders this year. In summary, we're quite pleased with the quarter. We have a clear strategy for growth, a detailed set of priorities that we are executing against in order to drive continued positive business momentum and expect to deliver increased fee operating leverage this year, excluding notable items. Finally, let me cover our full-year and second-quarter outlook, which I would highlight continues to have the potential for variability given the macro environment we're operating in. In terms of our current assumptions, as we stand here today, we're assuming global equity markets flat to first quarter end for the remainder of the year, which implies daily averages up 5% quarter-on-quarter in 2Q and up around 17% for the full-year. Our rate outlook broadly aligns with the current forward curve, which I would note continues to move while we expect FX market volatility will remain muted. Given our strong start to the year and higher average market levels, we think total fee revenue for the full-year will now be at the higher end of our prior guide of up 3% to 4% year-on-year, so up a solid 4%, which is better than our previous outlook. There are, however, episodic and industry headwinds impacting our servicing business this year, including a previously disclosed client transition and the impact of client activity and adjustments, which includes the client asset mix shift into lower earning cash and cash equivalents. We believe some of these factors are cyclical in nature, and we expect to offset a portion with higher sales and additional management actions this year. Turning to NII as a result of our first quarter outperformance, strong deposit growth and the improved interest rate outlook, we now expect full-year NII will be down approximately 5% year-on-year, which is better than our previous guide of down approximately 11%. On expenses, we expect full-year expenses, excluding notable items, will be roughly in line with our prior guide of up about 2.5%, but with the potential for some additional revenue-related costs this year. Given our improved outlook, we now expect to deliver additional positive fee operating leverage for the full-year, excluding notable items. Finally, turning to 2Q on a quarter-on-quarter basis and excluding notable items, we would expect total fee revenue to be up 1.5% to 2%, NII to be down 2% to down 5% and expenses up about 2% to 2.5%, excluding the seasonal compensation expenses in 1Q and notable items. We think the provisions for credit losses could be in the $15 million to $25 million range in 2Q, and we would expect to have a better view on that later in the quarter as we continue to monitor our portfolio. Lastly, we expect 2Q tax rate to be approximately 22%. And with that, let me hand the call back to Ron.

Operator, we can now open the call for questions.

Thank you. Your first question will be from Brennan Hawken at UBS. Please go ahead.

Good morning. Thanks for taking my questions. Eric, your updated guide sort of suggests that NII, you guys expect to pull back a little bit here from this strong result in the first quarter. But one of the things that I noticed was repo was particularly robust in the quarter. Could you give a little color around what drove that strength and how sustainable it is? And is some of that normalization embedded in your outlook? Thanks.

Brennan, it's Eric. You know, there are a number of factors that drove the upswing in NII into the first quarter. The bulk of that was actually deposit balances coming in stronger than we had expected, both on the interest-bearing side across the stack and non-interest-bearing as well. That made up for the $30 million uptick in terms of our results relative to our expectation. The repo balances did tick up as well. They were a small part, but worth in NII terms, about a percentage point of more NII than we had expected. And I think what we're seeing is that as the conditions in the economy continue to evolve, clients are holding more cash on their balance sheets, or then putting that into a variety of different instruments. Sometimes it's on deposits, sometimes it's on sweeps, and sometimes it's in repo. And that's also been, in particular on the repo side, aided a bit by the reduction in the Fed's overnight repo operation. So it's really a mix of factors that we're seeing, which together though are driving a better NII performance, which we're pleased with.

Yes, great. Thank you. You also quantified the impact of the BlackRock transition. So thanks for that. It does seem as though maybe that impact is a little larger than your prior expectation. Do I have the right read on that? And maybe could you give us an update on where we stand as far as the ongoing impact goes?

Sure, Brennan, it's Eric again. The previously announced client transition that we had referenced is in line in terms of amounts that we had expected. If you recall, we had said it would be worth about 2 percentage points of servicing fees this year, which is about a percentage point of total fees. And remember, if you go back to our original disclosure over the last couple of years, we had described the total amount to be worth about 2 percentage points of total fees. We're seeing about half of that come through on a year-on-year basis this quarter and for this year. And so, you know, fully in line with what we had previously described.

Okay, thanks for taking my questions.

Sure.

Thank you. Next question will be from Glenn Schorr at Evercore. Please go ahead.

Hello there. One quick follow-up on the NII stuff, and thank you for all the details. The balance is coming in, in March. I know these things are really hard to predict, but is something happening with the client discussions and the overall profitability management that might give you confidence that those balances stick? Or should we think of this as rates are higher, parking balances with a safe custodian?

Glenn, we've been deeply engaged with our clients over the past year to year and a half, as we've observed considerable changes in the industry and the trends in deposits within the banking system. To address your question from a few perspectives, we initially anticipated total client deposit balances to be between $200 billion and $210 billion for this year. Currently, we expect that range to shift to $210 billion to $220 billion for this quarter, and honestly, we expect to maintain those levels moving forward. A significant factor in this is our active engagement with clients, many of whom have cash that we encourage them to deposit with us. Additionally, our approach to client relationships, profitability, and the services we provide has contributed to the increase in deposit levels. Moreover, there has been a general uptick in deposits across the banking system, contributing to this growth. We foresee this trend continuing to be relatively stable, although future developments will depend on the Federal Reserve's actions and their impact.

Very cool. Appreciate that. One quickie, you can't comment on the specifics, but I'm more talking the big picture. You were named in some stories as a potential interest in some private credit manager. I'm more talking big picture of where theoretically that might fit in and just I like the better flows on CNS, SSGA, but strategically what are you focused on in terms of continuing growth across that franchise?

Yes, Glenn, it's Ron. So we've tried to be quite clear about what we're doing over at SSGA. I mean, first is around continuing to grow the ETF franchise. As you know, our legacy strength is in the institutional business, where we continue to be quite strong, and we've focused a lot over the last several years on growing the low-cost ETF franchise, which tends to find its way into retail portfolios through intermediaries. That led to the repricing initiative that we did last year, which in retrospect is proven to be quite a smart move because the market share has gone up and those portfolios tend not to move; these are buy and hold investors. So ETFs would be one and then we continue to grow the active space, typically with working with very close partners of ours, and we see a lot of runway in active. And then finally, fixed income, particularly out, we have a strong fixed income offering here in the U.S., and we've built it out quite a bit in the last couple of years in Europe, and you're seeing lots of strength in the ETF ecosystem in Europe. Second area of growth is really trying to leverage the institutional client base, because its legacy is the passive index business. If we have an institutional relationship, we tend to be the number one or number two manager on their platform. That leads you to a position that gives us a seat at the table and we believe it gives us an ability to potentially distribute other kinds of products and services. So that's where a lot of our focus is now on the institutional business. Finally, continuing to deepen, we have a global franchise, but there's areas that we can deepen it more. You've heard us talk about Europe, and we're focused just as much on Asia Pacific as those markets continue to grow, and we're able to leverage the positions we have, but really focusing on deepening as opposed to broadening geographic reach. So that in a nutshell is how we're thinking about it, and we're pleased with how it's playing out.

I appreciate that, Ron. Thanks.

Thank you. Next question will be from Ken Usdin at Jefferies. Please go ahead. Please go ahead, Ken, your line is open.

Could you please unmute? No response. Moving on to Alex Blostein at Goldman Sachs. Please go ahead.

Hey, good morning, everybody. Thanks. Another one for NII, I guess good quarter, good guide for the second quarter as well and that's sort of elevating your full-year NII guidance also. But similarly, I guess to kind of what we saw in your guidance last quarter, the back half of the year seems to have a pretty meaningful drop off for the tune of maybe $100 million bucks or so versus the quarterly run rate. Eric, I guess given your comments on deposits being stable and higher rates are kind of where they are, you still get in the benefit of repricing on the securities portfolio? What sort of informs this sort of decline in NII towards the back of the year?

Alex, it's Eric. We will continue to observe the trends we've been seeing, and it will depend on how the various elements partially or fully offset each other over time. We expect to benefit from the current rates, as indicated by the forward curve, which positively impacts the investment portfolio and contributes to growth in lending. The challenge we are facing comes in phases; sometimes it moves down or slightly back up, particularly concerning the levels of interest-bearing deposits. While deposits are at satisfactory levels, we are noticing a decline in non-interest-bearing deposits, which we anticipate will continue for another quarter before stabilizing in the latter half of the year. Therefore, you'll see these trends persist. Overall, we expect a slight decrease in the second quarter and stabilization in the third and fourth quarters for our net interest income. Historically, we've mentioned being in a range of $500 million to $600 million per quarter, but we now expect to comfortably surpass the $600 million mark. The headwinds and tailwinds we face will ultimately determine where we land. The level of client engagement, including both core transactional and discretionary deposits, has been a priority for us, and we've had good success in this area. This has led to more positive expectations than we had at the start of the year, and we believe this will provide stability and potential growth in net interest income in the coming years.

Great. All right. I think that's helpful. My second question is around expenses. You talked about how the consolidation of the GV, I guess, that took place recently in April here, will create a new wave of optimization for next year, if I got that right? Can you just outline what that could mean in terms of incremental, either rejuvenating benefits or cost benefits, however you want to frame that, and what that means for maybe the overall kind of expense growth for the franchise? I know you're holding the line this year really well, but is there an opportunity to continue that into 2025 as well? Thanks.

Yes, Alex, it's Ron here. I think it's good to focus on what we said here because we've talked to you and your colleagues just about ongoing productivity improvement. We've been at it for years. And we do believe this unlocks a potential, not a potential, but a new wave of productivity growth. And why is that? Well, firstly, almost by definition, if you're taking these ventures on, you're eliminating the margin that was in it, that was in our expenses, that now comes out, right? So you've got that as a near immediate tailwind. More importantly, and more important for the long-term, is that we can really complete and take advantage of true end-to-end process improvement and simplification. We had created through the JVs, which go back to the early days of our off-shoring journey. We created a lot of complication. Unintentionally, we created a lot of complication. This enables us to get at that. The work has already started. Our operations folks are spending a lot of time in India there. They've done some recent hiring and brought on some great leadership there. If you think about the importance of India to our operations and, you know, the amount of work that passes through there, between this end-to-end simplification, this ability to eliminate checkers of checkers of checkers and all those kinds of things, we see an enormous amount of opportunity to improve. And then finally, as we continue our technology investment, a lot of that will be directed there. It'll be directed at some of the things that, you know, in the past you would have said, well, let's take advantage of labor arbitrage. Now the technology is at a cost level where we can simply eliminate the labor and not have, particularly for some of these repetitive kinds of tasks between machine learning and other kinds of AI that you can use to replace labor. You end up then with a lower labor cost, but more importantly, you've got job content that's very attractive to people, and people want to make careers here as opposed to feeling like they're stuck in this dead-end repetitive task. So we are very optimistic about this.

Thanks so much.

Thank you. Next question will be from Brian Bedell at Deutsche Bank. Please go ahead.

Great. Thanks. Good morning. Thanks for taking my questions. First, just a confirmation on the guidance you gave, Eric, on the 2Q fee revenue up 1% to 2%, NII down 2% to 5%, expenses up 2% to 2.5%. Is that sequential for revenue and year-over-year for expenses?

No, it was sequential for every one of those as you look forward. So it was all on a 1Q to 2Q basis.

2Q basis, okay. So then going back to the NII guide, I think you also said down 2% to 5% versus the 7% to 16% in 2Q and then did you say down again in 3Q and then flattening out?

What I described is a flatter second-half of the year. And so, you know, there are different paths here, to be honest. It will just depend on the level of deposits, the level of interest rates, just how the pale of some of the climate deposit or pricings that we've described come through or the back end of those. I gave some, you know, a high level view, but Brian, I think there's a range of scenarios. But we do have some confidence in the expectation that in aggregate, NII will be down 5% from a full-year basis, and that's quite a bit better than the down 10% that we had previously guided towards.

If I assume a flat scenario, I'm thinking of a flat outcome for the year. Would that still represent a better end of the range you mentioned, or is achieving that really challenging?

No, let me try to clarify. We expect total NII to be down 5% on a year-on-year basis for the full-year. What I did say is that we expect NII to be in 3Q and 4Q to be roughly the same, to be flattish between those two quarters. And so, you know, now the question is exactly how much does it come down in the second quarter, and then from the second quarter into the combination of third and fourth quarter, how much does that come down? There is a range of different scenarios I think you could foresee. But the reason we're trying not to over-spec the exact quarter by quarter by quarter by quarter expectation is there's just underlying volatility out there in the kind of macroeconomic conditions in the risk-on risk-off sentiment in the central bank's actions right. Then in our client deposit levels. And so hopefully that gives you enough context to go on.

That's super helpful. And then maybe just on the private markets wins, it sounds like momentum is improving there. Maybe if you could just talk about what your pipeline is looking like in private markets, Alpha and kind of your expectations over the next one to two years?

We've discussed that private businesses are experiencing double-digit growth, and we continue to believe that. There is significant potential for growth in private markets, and Alpha is progressing well for several of the same reasons that apply to Alpha itself. As these firms become more intricate with their operations and technology, there is an opportunity not just to reduce costs but also to enhance and future-proof operations. Overall, we are optimistic about this development.

Okay, great. Thank you.

Thank you. Next question will be from David Smith at Autonomous Research. Please go ahead.

Good morning. Could you talk a little bit more about your capital priorities today? Your payout ratio in the first quarter was somewhat below your 100% full-year target?

David, it's Eric. We provided guidance at the start of the year on a full-year basis intentionally because each quarter will have different variables as we move forward. We indicated that the total capital return would be roughly aligned with total earnings for the year and affirmed that in our prepared remarks. In terms of the specifics for the first quarter, we anticipated a return to normal levels of RWA after the fourth quarter's lower figures. This was influenced by various market factors in the FX book, an uptick in equity markets within the agency and securities financing sectors, and our ongoing engagement with clients that is driving the fee revenue growth you've observed. Our main focus remains on returning capital to our shareholders. We maintained our dividend pace as expected and executed some buybacks this quarter. If you calculate that, the buyback activity should increase in the coming quarters. Additionally, we had new information regarding the FDIC assessment, which required us to set aside that expense instead of returning capital to shareholders this quarter. Overall, we're aligned with our commitment to return capital to shareholders in relation to earnings this year. Each quarter may present variations, but you can expect to see acceleration into the second quarter.

And I think you gave the tax rate for the second quarter. Are you still expecting 21% to 22% for the full-year?

I think I need to quickly refer back to the January remarks, but we did not update those, so I believe that is a good estimate to use for the full year, the one mentioned during the January call. Yes, that's correct.

Okay. And just one last cleanup. The preferred dividend, they'll still be elevated in the $50 million to $55 million range in the second quarter, but then it will be kind of more like $40 million in the second-half of the year?

Yes. Yes, that's correct. We're just kind of moving through this past quarter 1 and quarter 2 between the redemptions, the issuance and redemptions and then literally, the tactical timing of some of the dividends, you've got it right. There's one more quarter of elevation in the $50 million to $55 million range next quarter, meaning second quarter and then it will run at about $40 million a quarter from third quarter onwards.

Thank you.

Thank you. Next question will be from Mike Mayo at Wells Fargo. Please go ahead.

Can you hear me?

We can.

Can you talk about the relationship between stock markets and revenues? You used to have for every 10% change in the S&P 500, it impacts your servicing fees by X amount. Can you remind us what that is these days and how much of a lag there is with that? Along with that, I guess your guidance for NII instead of being down 10% to down 5%. What exactly changed in the last kind of month or so?

Yes, Mike, it's Eric. Let me address your questions in reverse order. In the first quarter, we saw higher deposit balances across our interest-bearing accounts and even better-than-expected non-interest-bearing deposits in March, which positively impacted our results. The last time we provided guidance on net interest income was back in January, where we anticipated a 10% decrease for the year. We only reassessed this today, not at the beginning of March. We're considering the higher deposit levels and the expected fewer rate cuts from central banks worldwide, leading us to improve our full-year net interest income guidance. Regarding the equity market and how it affects servicing fees, we need to examine this in segments. What matters to us is not just the S&P 500 since we have a global presence, with over 40% of our revenues derived from various markets, including emerging ones. Although the S&P is up 28% year-on-year, the All-World Index has only increased by 18%, which is more relevant to our financials due to our international footprint. With that 18% increase, we expect a significant year-on-year boost in servicing fees, typically in the 4% to 5% range, though this can fluctuate. This year, we faced two headwinds impacting servicing fees: firstly, a previously announced client transition, which equated to about a 2-point headwind, and secondly, a lower level of client activity that also resulted in nearly a 2 percentage point headwind, some of which we believe is cyclical. We discuss transactional activity that influences our fee receipts. Additionally, we noted a shift towards client cash and cash equivalents within our assets under custody, which generally yields lower fees for custody and accounting services. These factors contributed to the challenges we experienced.

And just one follow-up, you mentioned more-than-expected deposits. Can you explain why that was the case?

I believe the higher-than-expected deposits can be attributed to two main reasons. Firstly, there is currently more cash in the banking system, which we think is influenced by actions from the central bank, particularly the Fed's reduction in the overnight repo operation. This has improved liquidity conditions and made them even more favorable. Secondly, over the past 1.5 to 2 years, we have been increasingly engaging with clients regarding their cash management. Clients have chosen to place their cash with us in various forms such as deposits, repo, and money market accounts, thanks to the services we provide in these areas. Our enhanced engagement with clients has led to an increase in cash and deposits with us, which is beneficial for our balance sheet and contributes positively to our earnings and margins.

Thank you.

Thank you. Next question will be from Rajiv Bhatia at Morningstar. Please go ahead.

Great. Good morning. Can you comment on how the pricing environment is for your servicing business? If inflation remains higher for longer, should we expect lower pricing headwinds? And then as I understand it, about 60% of your service fees is asset-based. How do pricing headwinds compare in the asset-based bucket versus the non-asset-based bucket? Thanks.

It's a broad question. We've been in an environment, I think, the last four years or so where we've seen pricing headwinds in the servicing business to be roughly in the 2% headwind level. That will float around a bit by quarter. It will float around on the margin a little by year, but it's substantially below what we had seen way back in 2019, which was, I'll describe, a bubble of repricing. I described it that way because during this time, we've seen, to your point, a very accentuated rise in inflation. We've now seen a partial reduction in inflation. That hasn't really had a large or substantial effect on our general fee rates or our servicing fees. I think it's not particularly determinative of that. In terms of our fee schedules, you're right, the fee schedules have several components. They have asset-based. There's an asset under custody basis for some of the fees, which is about half. There are some transactional fees. There are some flat fees. There are some per account fees. Those usually end up being negotiated as a package. It's not that when we have negotiations, one particular part of that package is treated very differently. We have large, sophisticated clients. They think of it as a package. They are looking for a fair set of fees so that as a partnership, which lasts often 10, 15, 20 years, in some cases, 30, 40 years, they feel they're getting value and that they feel that we, as a custodian, can deliver on what their expectations are. So it comes to be a reasonable accommodation, I think, in our minds, in their minds.

Got it, thanks.

Thank you. Next question will be from Ken Usdin at Jefferies. Please go ahead, Ken.

Thanks, Ron, Eric, sorry for that earlier. Just one follow-up on the servicing fee algorithm. So with all the commentary you've made. You show us the good detail about the business wins and the fees to come on, and we know about the headwinds, some cyclical, some due to deconsolidation. Do you have a line of sight when we can really start to see that back office line start to move up in a positive way? I know we have to consider the middle office and the whole front office kit as a together thing. But that's still the biggest line, and that's still kind of flattish on a year-over-year basis with all the things we talked about. But is there any path forward where you can kind of see some of those headwinds abating and some of the growth starting to come on and transitions that we can see a better growth rate overall? Thanks.

Yes, Ken, let me begin by saying that while the transition may seem prolonged, it will gradually diminish next year, assuming no additional changes on the client side. This means that the current headwind will essentially disappear. Additionally, you've observed the sales performance from last year, and this year's sales performance is contributing to our upcoming installations, which remains very strong. A part of this involves some complex Alpha clients who typically install in waves and increments, so we expect progress in that area. However, I want to highlight that there was a significant amount of back office activity in some of the recent sales, which tends to install more quickly. We are quite optimistic about the prospects for fee revenue growth, especially in servicing fees, as we move past these headwinds and begin to realize the benefits of what we have sold in Alpha and in the back office installations.

And Ken, it's Eric. I would just add that we've experienced client activity challenges, which are a combination of risk-averse sentiment that has resulted in lower transactions through the custodial accounts. Additionally, we've noted a shift towards holding more cash. We don't expect this trend to persist at the current rate, viewing it as somewhat cyclical. Generally, we don’t anticipate much additional cash to remain with clients. However, there's a possibility that clients might begin to deploy their cash levels over the next year, potentially providing a neutral or positive impact. Therefore, we are currently going through a cyclical phase concerning these environmental and activity-related challenges. Without these factors, we could start to see the positive outcomes that Ron detailed regarding sales, installations, and the fundamental growth of the franchise.

Okay. And one follow-up then is also we can see the wins and what you put on and the yet-to-be-installed to Ron's point. Can you just talk about just the pipeline, is the pipeline continuing to strengthen? Is it consistent? Have you now put more of that pipeline through? Where do we stand on that?

Yes, Ken, I mean, I think what you should have heard from us today is that we have a sales target that we talked about in January, we're standing by that sales target. That's significantly up from last year, which was significantly up from the year before. So I mean, you get there because of the pipeline. So we're encouraged by our pipeline.

Okay, great. Thank you.

Thank you. And at this time, I would like to turn the call back over to Ron for closing remarks.

Well, thanks to all of you on the call for joining us.

Thank you. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. At this time, we do ask that you please disconnect your lines.