Q1 2022 State Street Corp Earnings Call
Good morning, Andrew Welcome to State Street Corporation's first quarter 2022 earnings conference call and webcast.
Today's discussion is being broadcasted live on state streets website at investors thought states treat dotcom.
This conference call is also being recorded for replay state.
State Street's conference call is copyrighted and all rights are we served 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 Eileen Fisher <unk> Bieler global head of Investor Relations at State Street.
Good morning, and thank you all for joining us.
On our call today, our CEO , Ron <unk> will speak first then Eric <unk>, our CFO will take you through our first quarter 2022 earnings slide presentation, which is available for download in the Investor Relations section of our web site investors that state Street Dot com.
Afterwards, we'll be happy to take questions. During the Q&A. Please limit yourself to two questions and then re queue.
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.
Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation. In addition, today's presentation will contain forward looking statements actual results may differ materially from those statements due to a variety of important factors such as those factors referenced in our discussion today and in our SEC.
Filings, including the risk factors in our Form 10-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 Eileen and good afternoon, everyone earlier today, we released our first quarter financial results before I review our results I would like to briefly reflect on the operating environment in the first quarter, which included both significant geopolitical events as well as notable macroeconomic developments and market movements.
Turning to slide three of our presentation first I would like to acknowledge the ongoing events in Europe following Russia's invasion of Ukraine.
In March I traveled to crack out to visit some of state Street's approximately 6400 employees in Poland.
During my visit I was moved by the selflessness of our colleagues in Poland.
Continue to support displace Ukrainian people in a number of important ways from opening their own homes and providing shelter to offering professional support such as interpretation services.
While state Street's direct exposure to Russia, and Ukraine is very small are our teams.
We're responding fluidly to the situation and delivering for our effected clients and other stakeholders with dedication and professionalism in what continues to be a stressful time.
Well established and regularly tested business continuity plans designed to continued critical service services for our clients and support for our people.
The first quarter also saw dramatic market movements, driven partially by the conflict in Ukraine, plus a broader set of macroeconomic forces are.
A tight labor market rising energy prices continued supply chain disruptions and the ongoing effects of significant COVID-19 related fiscal stimulus has contributed to inflation, reaching multi decade highs.
As a result in March we saw the first interest rate hike from the Federal reserve since late 2018, a substantial upward move in long end interest rates as well as volatile currency and equity markets and a stronger U S. Dollar.
Each of these factors and part shaped state Street's financial results in the first quarter, which I will now discuss before Eric takes you through the quarter in more detail.
Starting with our financial performance.
First quarter 'twenty, two EPS increased 15% year over year and was up 8%. Excluding notable items with earnings growth supported by both higher total fee revenue and stronger net interest income leading to an improved year over year total revenue performance in the first quarter.
Within fee revenue, our global markets franchise performed particularly well driven by higher FX market volatility.
And while state Street's revenue performance.
Improved we also remain highly focused on controlling the expense space now.
Notwithstanding continued new investments in our business and operational capabilities first quarter total expenses were flat year over year.
<unk> increased just 1% excluding notable items supported by ongoing productivity efforts and the stronger U S dollar.
Taken together, we delivered both positive fee and total operating leverage as well as pre tax margin expansion good earnings growth and higher return on equity relative to the year ago period.
Turning to our business momentum, which you can see across the middle of the slide we recorded another quarter of solid new AUC asset servicing wins, which amounted to 302 billion in the first quarter, while AUC a won but not yet installed amounted to two nine trillion at quarter end.
Front office software and data also experienced good business momentum with annual recurring revenue for the first quarter, increasing 15% year over year to $235 million.
Yes.
At Global Advisors assets under management totaled 4.0 trillion at quarter end importantly, we saw another quarter of solid net inflows of 51 billion. Despite the volatile market environment in the first quarter.
Our ETF business continued to perform well as we further focused on innovation and enhancing our ETF product offerings.
For example in January Global Advisors launched three new ESG oriented Spider Etfs across small cap international and emerging market equities aimed at helping investors incorporate ESG considerations into their portfolios.
In February global advisors expanded its fixed income offering what they do with the debut of the actively managed Spider Blackstone High income ETF as we continue to innovate in the active ETF category, which accounted for 13% of U S. Net industry flows in the first quarter.
At Phase III digital we announced a number of exciting developments in March we entered into a licensing agreement with copper co.
<unk> provider of institutional digital asset custody and trading infrastructure, we intend to leverage copper core technology to develop an institutional grade digital custody offering where clients can store and settle their digital assets within a secure environment operated by state Street.
Turning to capital our ratios remained healthy although CET, one declined quarter over quarter, largely due to lower OCI driven by the significant moves in interest rates in the coming quarters, we remain focused on maintaining strong capital ratios.
Regarding BPH the regulatory review process for the proposed acquisition of the BPH Investor services business has progressed more slowly than we anticipated.
While many required approvals have been obtained some required regulatory approvals, most notably approvals of the relevant federal banking agencies remain outstanding.
We're evaluating potential modifications to the transaction that are intended to facilitate resolution of the bank regulatory review.
We are working towards concluding regulatory reviews during the third quarter. While we are engaged in an ongoing dialogue with the relevant federal banking agencies, there can be no assurance of the timing or outcome of their regulatory review.
Both parties State Street in BPH continued to be excited about the overall financial and strategic opportunities of combining BPH investor services with our business we.
We are continuing to work closely with the <unk> team on pre integration planning. This includes all the preparatory work in product operations technology as well as employee communication and client planning, we still expect the transaction to be accretive to earnings per share in the first quarter post first year post closing.
To conclude my opening remarks, the first quarter was defined by both unexpected significant geopolitical events and notable macroeconomic and market developments in the face of which state Street delivered an improved year over year financial performance and solid business momentum metrics, while supporting our clients and colleagues.
As we look ahead in this environment of heightened geopolitical uncertainty and market volatility we remain laser focused on delivering on delivering what is within our control, including excellent strategic execution across the front middle and back office, maintaining the recent improvement in our sales effectiveness.
And expense discipline, all while continuing to provide valuable insights and promote better outcomes for the owners and managers of the world's capital.
And with that let me turn it over to Eric to take you through the quarter in more detail.
Thank you Ron and good afternoon, everyone.
Again, My review of our first quarter results on slide four.
We reported EPS of $1 57, or $1 59, excluding acquisition and restructuring costs.
On the left panel of this slide you can see we had yet another solid quarter of total fee revenue growth with strength in many of our businesses notwithstanding the macroeconomic environment.
At the same time, we held total expenses roughly flat year on year as we continue to both invest in the franchise and control expenses.
As a result, we generated positive operating leverage of about five percentage points in the quarter and continued to improve our pre tax margin year over year.
All things considered this was another strong quarterly performance demonstrating the progress we are making as we continue to improve our operating model and drive growth.
Turning to slide five we saw period end <unk> increased by 4% year on year and decreased 4% quarter on quarter.
The year on year change was largely driven by higher period end equity market levels client flows and net new business growth.
The quarter on quarter decline was largely the result of lower period end market levels in both equity and bond markets.
Similarly at global Advisors, AUM increased 12% year on year, but declined 3% sequentially.
Relative to the period a year ago. The increase was also driven by higher period end market levels, coupled with strong net inflows across all three of our franchises, our ETF institutional and cash businesses.
The sequential decline was primarily driven by lower market levels, which was partially offset by strong net inflows of 51 billion in the quarter.
Turning to slide six.
Before I start I would like to remind you that we are expanding our servicing fee revenue disclosures by dis aggregating the line into back office servicing fees and Middle Office services.
With that on the left side of the page Youll see first quarter total servicing fees were flat year on year as higher client activity and flows.
<unk> equity market levels, and net new business were offset by normal pricing headwinds and a 2% currency translation headwind.
We continue to see good growth in both our insurance and official institutions client segments.
Sequentially total servicing fees were down 1%, primarily as a result of the seasonal pricing headwinds and lower average equity market levels, partially offset by strong client activity.
Within servicing fees back office fees were flat both year on year and quarter on quarter, largely driven by the factors I just described.
Middle office servicing was down 3% year on year, and 5% quarter on quarter, primarily due to a partial transition from our legacy climb and lower professional services fees in the quarter.
Notwithstanding the decline in the quarter Middle office is an important component of our alpha proposition when it comes to both the front office when it connects to both the front and back office and we expect to see good growth over the medium term as evidenced by our uninstall revenue backlog, which I'll talk more about in a moment.
In terms of business momentum I am pleased with how 2022 has started as we report another quarter of solid new AUC wins of 302 billion.
While AUC, a one but yet to be installed amounted $2 nine trillion at quarter end.
We continue to be happy with our pipeline and I'm also particularly pleased to report that our first quarter wins spanned a good mix of strategically important premium and preferred clients.
Turning to slide seven.
First quarter management fees were $520 million up 5% year on year, primarily reflecting higher average equity market levels and strong ETF inflows management fees were down 2% quarter on quarter, largely due to equity market headwinds, partially offset by the tailwind of lower fee waivers and net inflows.
Of note our management fee performance for the quarter was supported by strong net inflows of 51 billion with positive inflows across our entire business franchise institutional cash and ETF.
With respect to money market fee waivers the fee waiver impact to management fees for the quarter was roughly $10 million down from about $20 million in the fourth quarter.
I would note that following the 25 basis point fed rate at.
Hike, we saw in March of this year, we no longer expect money market fee waivers to be a headwind to management fees starting in April .
As you can see on the bottom of this slide our franchise remains well positioned for growth I'm, particularly pleased that the strategic actions that we've previously taken in in our long term institutional ETF franchises are now helping to draw inflows even in the current volatile market environment.
On slide eight you can see that FX trading services had yet another strong quarter relative to the period a year ago FX trading services revenue was up 4% year on year and 20% quarter on quarter.
Both the year on year and quarter on quarter performance benefited from high FX market volatility, while higher client FX volumes also contributed sequentially.
Part of the revenue uptake has come from about $5 billion and higher risk weighted assets, we put to work this quarter, which demonstrates our balance sheet flexibility and which I'll come back to in a moment.
Our securities Finance revenues decreased 3% year on year permanently driven by lower average agency assets alone, partially offset by solid new business wins in enhanced custody.
Sequentially revenues were down, 6%, mainly reflecting lower average agency and enhanced custody balances due to the declining market levels and fewer specials.
First quarter software and processing fees were up 26% year on year, and 7% quarter on quarter, largely driven by higher front office software and data revenue associated with the CRD, which I'll turn to shortly.
Finally, other fee revenue of 29 million almost doubled year on year and quarter on quarter, mainly reflecting fair value adjustments on equity investments.
Moving to slide nine we have provided a breakdown of our consolidated front office software and data revenue on the lat.
Broken down the revenue into software categories, you've seen us use before on premise professional services and software enabled revenue.
While CRD represents a large majority of this line Alpha data services Alpha data platform and <unk> revenues are also included here as well.
As we've highlighted earlier foreign office software revenue growth was particularly strong up 44% year on year, primarily driven by on premise renewals as well as the continued strong growth in software enabled and professional services revenues.
On the right of the slide we have provided some key growth metrics enabled by CRD and alpha.
As I mentioned earlier during today's presentation, you'll notice that we've broken out both the front office and Middle office on installed revenue backlog, both of which are key components of our alpha proposition going forward.
The front office backlog of 93 million is up 43% and the middle office backlog has more than tripled year on year to $63 million.
The backlog reflects expected annualized revenue, which can be compared to the $900 million of annual revenue base in 2020 across both the front and middle office businesses.
And as an indicator of future revenue growth once fully installed.
The alpha pipeline remains promising despite the current geopolitical.
<unk> environment as clients realize the transformational benefits to their technology and operations infrastructure.
Yes.
Okay.
Turning to slide 10.
As we see the start of another rate tightening cycle first quarter NII increased 9% year on year, primarily driven by growth in our investment portfolio, coupled with higher loan balances, which will also benefit us in future quarters.
Relative to the fourth quarter NII was up 5%, which came in better than expected due to higher long end rates.
The sequential increase was largely driven by the improvement in both short and long end rates, which benefited our yields together with higher investment portfolio balances.
On the right of the slide we show our average balance sheet during the first quarter, which has been relatively steady.
Average assets were down 3% quarter on quarter, largely driven by seasonally lower <unk> deposit balances, which are down slightly from the seasonally high fourth quarter, but up year on year.
Turning to slide 11 first quarter expenses, excluding notable items increased 1% year on year or 2% adjusted for currency translation.
Productivity savings and targeted investments remain on track for the first quarter as we generated approximately $90 million in year on year gross savings and self funded most of the strategic investments, we've been making in the businesses, including technology infrastructure broader automation Alpha and state III digital.
Compared to third quarter on a line item basis, excluding notable items compensation employee benefits was down 1% as lower head count in high cost locations and the tailwind of currency translation was partially offset by higher seasonal expenses.
Information systems and communication expenses were up 5% due to continued investment in our technology infrastructure and resiliency.
Occupancy was down 13% due to footprint optimization and lower maintenance costs and other expenses were up 9%, primarily reflecting higher professional fees.
Relative to the fourth quarter expenses were primarily impacted by higher seasonal expenses, partially offset by productivity and footprint optimization savings.
Head count increased slightly quarter on quarter as we began to in source some technology functions from vendors and growth in alpha.
Overall, we remain focused on delivering positive total and fee operating leverage and have demonstrated that this quarter amidst the current macroeconomic environment.
Moving to slide 12.
We show the evolution of our CET, one and tier one leverage ratios as.
As of quarter end, our standardized CET one ratio decreased by two four percentage points quarter on quarter to 11, 9% due to both numerator and denominator effects.
<unk> increased by roughly 15 billion or 160 basis points of set one during the first quarter of 2022 compared to year end driven by three factors.
A modest rebound from an unusually low fourth quarter.
Our strategic contemporary allocation of additional <unk> capital to our markets businesses to generate the higher than expected first quarter revenues that we just discussed.
And lastly, the <unk> impact from the SA CCR implementation that started on January one this year, which we had planned for.
At the same time, our capital base was also impacted by a substantial reduction in OCI of about $1 3 billion worth of 110 basis points of set one relative to the fourth quarter.
As we saw a significant an historic quarter on quarter movement in long end rates, particularly in the belly of the curve.
For instance, the rise in the five year U S. Treasury of roughly 120 basis points was the largest in the last 30 years.
Taken together the increase in <unk>, coupled with a meaningful reduction in OCI, partially offset by about 35 basis points of earnings accretion net of dividends drove the decrease in our set one ratio this quarter.
In contrast, first quarter tier one leverage was down only slightly to five 9%, mainly driven by the substantial decrease in OCI, reflecting a significant change in the interest rate environment and a stable balance sheet.
While capital return remains an explicit priority for us and we recognize its importance to our shareholders. Given this $1 $3 billion move in OCI related to higher interest rates, we no longer expect to resume our share repurchase program in the second or third quarter as we operate with a conservative balance sheet philosophy.
A fee.
Given the volatility in rates and the possibility of further significant increases we are in the process of taking several actions to reduce the OCI risk by about half.
This primarily includes shifting additional iff's securities to HTM as well as shortening the portfolios duration through swaps lowering extension risks and consciously, allowing some portfolio runoff.
Yes.
Some of these latter actions can be reversed in the future when we choose to reinvest at higher rates.
Turning to slide 13.
We provide a summary of our first quarter results. Despite the continued volatile market environment I am pleased with our financial performance, which demonstrated solid underlying trends within our businesses.
Total fee revenue was up 4% year on year, primarily driven by higher management fees, FX trading software and processing fees and other fee revenues.
Expenses were well controlled and were held roughly flat year on year, demonstrating the progress we are making in improving our operating model.
Next I would like to provide our current thinking regarding the second quarter outlook and some of our economic assumptions as we look out over the year.
At a macro level, while we know that rate assumptions have been moving our rate outlook is broadly in line with the current forwards, which suggests a yearend fed funds rate of two 5%.
In terms of second quarter of 2022.
We expect overall fee revenue to be down about 2% on a sequential basis with servicing fees up about 1% and management fees up 2% to 3% assuming equity markets remain flat to March 31st levels for <unk> and some downward normalization in FX trading revenues.
In terms of some of our newer fee revenue line items that we started to disclose this quarter, we would not expect to see a repeat of the size of on premise renewals in our front office software line, nor the positive equity investment markups in the other revenue line into Q.
Regarding NII, we now expect <unk> NII to increase 7% to 9% sequentially, which will be driven by the expected fed rate hikes, partially offset by the OCI mitigating portfolio actions that I outlined earlier.
For full year 2022, we now expect to see year on year NII growth of around 18% to 20%, depending on fed actions and rate moves as well as the shape of our portfolio.
Turning to expenses, we remain laser focused on driving sustainable productivity improvements and controlling costs.
We expect that second quarter expenses ex notable items will be up around 2% to 3% on a sequential quarter basis, excluding notable items and seasonal compensation expenses of $208 million.
On taxes, we expect that the <unk> 22 tax rate will be around 20%.
We continue to expect to deliver on our goals of margin expansion and positive total and fee operating leverage for the year.
And with that let me hand, the call back to Ron.
Thank you Eric.
Operator, we can now open it up to questions.
Thank you.
To get into queue, you May press Star and then the number one on your Touchtone telephone. If your question has been answered or you wish to remove yourself from the queue. Please press the pound key.
As a reminder, please limit yourself to two questions and then requeue.
We have our first question from Ken Houston with Jefferies.
Okay.
Thanks.
Hey, Eric just a follow up on all things related to the rates environment. Just wondering first of all on the commentary about considering.
Some alternatives with regards to the Brown brothers deal can you elaborate what that might mean is that potentially some type of debt.
You might have to fix on the capital side or is that related to just timing and deal structure any help there would be appreciated.
Ken It's Eric No capital from a capital perspective, we're quite comfortable.
With.
With with closing, we've got almost 12% capital ratios today.
We've got a very I think smooth path too.
To being prepared for <unk>.
Lows.
From a capital perspective, the modifications we're talking about are just around the underlying structure.
Of all the transaction and you've seen this done from time to time before but.
We're working through legal entity and subsidiary structure, the exact transfer of systems and 33rd party contracts.
Some of the trends in servicing agreements those kind of structure and modifications that.
We think will.
We will make this a.
Cleaner.
A cleaner process and.
The favorable on.
On several fronts.
And then is there any any updated thoughts about general zone of what you might think about for potential closing.
As Ron had said.
The.
Regulatory review process has taken taken a bit longer.
We've obviously been heavily engaged in that process.
Because of some of the modifications that were working through jointly with Brown brothers leadership team.
We're deeply in the process of.
<unk>.
Getting additional and refine submissions in those will take several months for review in further dialogue I think you have a sense for how this plays out and Thats why.
In the prepared remarks, I think Ron described that we expect those reviews too.
Two.
Two.
To come through during the third quarter I think at that point, we obviously then.
Sprint to a close and depending on exactly what month and what week those come through.
We look for you.
You take out the calendar you look at the weekends and do the usual.
How do we know.
Just.
Close, but we've got to always closed carefully just given the.
The usual.
Financials and controls that you want to be mindful of.
Okay and just.
<unk> started one on NII and then leave it to others, but just can you do you know just the impact.
Related to the restructuring type of actions versus what you might have thought for NII.
There is.
There is a range.
That.
<unk> seen us guide to NII up for the quarter of up 7% to 9%.
And.
That on a year on year basis is actually going to be quite nice I think.
Is it worth a percentage 0.2 or three it's those kinds of.
I think adjustments that we're willing to make so that we.
Both.
Ron <unk>.
Appropriate portfolio in what could be a highly volatile.
Rate environment, including another possibility of rates could move another 50, or 100 basis points and we want to have a portfolio that can withstand that and to be honest, we're willing to take a few percentage points of.
NII growth off the table on a sequential basis to do that so I think it's a balance but that's the range and.
Even with some of those adjustments.
A lot of what we'll be doing is in is in the move from NFS HTM, which is not NII.
NII impacting there are others on the margin that are but that's kind of the range.
All right.
Share with you.
Thanks, Eric.
Your next question is from Glenn Schorr with Evercore ISI.
Hello there.
Bob.
So the SEC wants.
<unk> T plus one by the end of next year I saw the comment letters, including Yours Mike.
Personal opinion is nobody's ready for it.
And the industry.
I'm curious why the move from T plus two to C plus I am sorry, <unk> T plus two was kind of easy and people as to the T plus one that everybody seems to be pushing back is it.
Is it the complexity in shorter time horizon has the money to spend on the technology.
Just a little weird to me.
It's Ron why don't I take that.
I think that.
If you look back in history, everybody has resisted these moves to some degree because it does involve some spending money and changing it systems of all that.
And we've spent a fair amount of time on this and thought about the sort of burden.
In conversations with regulators.
It will be an added burden, but we don't think it's something the industry can't get done in a reasonable amount of time.
So.
<unk>.
I haven't read other People's comment letters I know, how we've thought about it.
So we think it will.
It will be one of these things likes.
A LIBOR, if you will or recent history.
It will take a lot of time take a lot of effort.
It's certainly not something that's going to in our mind.
Sideline officer sidelined other major players.
Okay I appreciate that I'm good thanks.
Our next question is from Brennan Hawken with UBS.
Good afternoon. Thanks for taking my questions just to sort of a clarification here the expense guide.
Eric that was plus two 3% quarter over quarter, and but we're supposed to ex out the seasonality right. So do we back out.
What exactly is the rate base that we're supposed to do we did take the $23 18, and then back out the 208 and then grow that.
Let me just open up the slide so I think here I think youre doing at the front end.
In line with how we've described it.
Yes, you can take the.
First on slide 11 of the of the.
The slide deck that too yes.
$3 18 of expenses that includes the seasonal expenses, which are in the footnote right of two away.
You can pull that out and then you can add 2% to 3% sequentially and get our estimate for second quarter Thats correct.
Okay. Okay. Thank you for clarifying that and then.
About the.
The.
<unk>.
Yeah.
What you when you were talking about the decline in deposits you've flagged you know normal seasonality, which would suggest that there wasn't anything unusual that you've been seeing but we started to see rates back up in the market.
The policy.
We've already seen one policy hike likely to see.
Quite a pace here in the next few meetings.
How is dialogue with your customers what are your expectations to updated expectations around deposit action and.
Do you have any kind of estimate about where you might think you could see.
Positive growth or runoff end up shaking out here at least.
Next quarter or two.
Sure Brennan.
For the time being we have seen.
Little movement in deposits other than a little bit of the seasonality a little bit of currency translation.
It's also played through.
This is all within the bounds of what wed expect and we've obviously been watching deposits carefully across currency pools and across client segments and.
For the time being it's been it's just been flattish.
Regardless of which way we look at it.
As we go forward.
We like many others have.
Tried to guesstimate and I use the word guesstimate not estimate.
The level of.
Shift in deposits movement of deposits that we will see.
With the amount of quantitative tightening that the fed has has announced and I guess the best context I have for you and others is if we go back to the pre Covid era.
We've grown our deposit base since then by $60 billion to $70 billion.
We've also increased our AUC as by about 25% during that time period.
And because of those correlate.
We estimate that about half of the increase of $30 billion to $35 billion has come from the quantitative easing as the fed expanded the fed and the other central banks were primarily the fed expanded to its balance sheet by.
Effectively three trillion dollars.
And so we see that.
Reversing over time with the rough math being.
For every trillion dollars of fed balance sheet wed expect a $6 billion to $10 billion.
Run off in our deposits and if they start and then they started in may.
May or June we will see exactly when they get going at.
At their announced pace.
Yes, you could see a little trickle down and we think in the fourth quarter.
And then the kind of the $6 billion to $10 billion per year. After that so that's our that's our guesstimate.
We're obviously flushed with deposits and we're happy to be flushed with deposits as rates rise so well.
We'll monetize them for the time being.
But thats our guests, but right now the other factors are how the interest rate hikes play out.
We expect betas to be similar but theyre never exactly the same as they are before and so will be will be sharply focused there. So those are some of the moving parts in some of our thinking at this point.
Okay. Thanks for that color.
Sure.
Our next question is from Betsy <unk> with Morgan Stanley .
Hi, good afternoon.
Hi, Betsy.
Last year, you announced state Street digital and I wanted to get a sense as to how thats going relative to expectations.
Yes.
Been able to execute on there and what your clients are asking you to do more of.
Yes.
<unk>.
They've had a lot going on.
Maybe I'll focus on that last question first.
Because this is a very client intensity.
<unk>.
Division and spending a lot of time response I think the single.
Biggest thing clients are asking for help with a R.
Kind of.
Comprehensive regulatory framework.
This was particularly acute in the U S.
The lack of guidance and the like.
<unk>.
Really an agreed upon framework.
As.
Left a lot of uncertainty.
And to what institutions can do particularly banks.
No.
That's out there I think most of it though beyond that Betsy would be around and where we're spending a lot of time is.
Firstly around.
Enabling clients to.
Invest in digital efforts.
And.
That's not just the trading of them, but it's the movement of them, it's the control of them.
It's the custody of them that.
Portfolio accounting of them. So it's really if you think about what we do know for digital assets tokens coins et cetera.
I think the other.
Very large thing that the group is focused on which is.
It's less about external products and much more about.
How do how does state street itself moved into a digitalized world more than it is already and what does it mean for the core.
Core operations, such as Trust Securities movement in control.
Which is really about.
Lack of a better term the next stage of digitalization.
We are working a lot with the major players.
In the industry because these ecosystems reforming.
And in some cases, we actually want to be a very integral part of the ecosystem and other.
Our cases, we actually want to access that so.
There is quite a bit going on there.
Is the way I would summarize my answer to you.
Would you say that yes go ahead.
It's Eric I was just going to add the other thing we're doing is obviously.
Where clients, especially institutional clients.
Have added crypto holdings within their fund right we're effectively.
Providing some of the services you would expect and so we've gone through there is across our client base.
They have about.
73 funds I think at last count with half a billion dollars of crypto exposure, we're effectively record keeping those assets as part of their underlying.
Funds, and then I think more broadly where clients are developing.
Sure.
Specific Etfs and exchange traded products right, that's where we are.
And an industrious way signing them up for you.
Administration recordkeeping.
Does that in a way as is our view is the one of the next land grabs because as ETF and ETP.
Product set comes of age that's what we will see some significant inflows.
Okay and would you say you're at scale for these offerings are there's more investment to do to get to scale.
Yes.
I think where we are now as of adequate scale, but one would expect that more scale will be required.
I mean.
As as much excitement as there is around this.
Still a relatively small proportion of total investment asset. So I think we're at adequate scale I think the focus now is more on <unk>.
How do we think about additional capabilities when.
Yes, no I totally get that but as CBD cease come through it's going to be critical to have this infrastructure.
Great. Thanks, Joe Bank digital.
Central Bank digital currencies.
Alright, thank you.
Thanks.
Our next question is from Brian Bedell with Deutsche Bank.
Great good afternoon folks.
Back to BPH, just on the on that timing of closing one more time.
Yes, I guess.
Potentially could move into the fourth quarter.
Just.
Is it safe to say that you think this would certainly close before year end and is there any risk to it not closing under.
Without changing the terms dramatically and is it mostly the U S regulatory side.
As opposed to non U S.
Yeah, I mean, Brian .
<unk>.
The regulatory environment is uncertain, probably gotten more so over the last couple of years than LIFO.
But we are making progress it is taking longer than we are.
Than we anticipated.
The dialogue.
So it's not like there is.
<unk>.
We're not doing anything or there is violence funnel. This.
We're in a fair amount of dialogue and working.
Kind of the restructuring that we referred to earlier.
Explicitly aimed at trying to accelerate this.
But we view speed is of the essence here, but there's a fair amount of uncertainty.
I said in my prepared remarks, and Eric just reiterate it.
What we are.
Sure.
Targeting at this point.
And assuming that there'll be a.
<unk> get done in the third quarter and then as Eric noted the actual once refused on the close itself is going to take a lot of time I mean everything is ready the.
The monies in place there's been a fair amount of.
Of integration planning, but it really is around the uncertainty of both the timing and the outcome of.
These regulatory reviews and yes, it's mostly.
Right now the open ones are mostly in the U S banking regulators we've received.
Lots of approvals from around the world both from finesse.
Financial services regulators and the antitrust regulators globally. So I.
I don't want to minimize what has been done but this is one of those things was basically not done until last one Stan.
Yes that makes sense, that's great color and then just on the maybe on the deposit side again, so obviously brown b BPH.
Give you pretty good capability to bring on incremental deposits and I know, it's getting pushed out a little bit, but maybe Eric if you want to just.
If you can sort of update us on your thoughts or just reconfirm. Your original thoughts about the level of PVH deposits that would be coming on.
If it were to close today for example, and then your appetite for bringing.
More deposits on I think it was up to $20 billion of additional deposits at some point, maybe just to talk about how youre thinking about that if there is any change in that thought process other than it's been the delay and.
Is the core BPH.
Fundamentals right now I assume at least on the interest side those are probably tracking better given the additional fed hikes since the last guide.
Brian It's Eric.
We.
We've been pleased as we've been monitoring and working closely with Brown brothers on the business the business performance.
It's it it had a good finish.
Last year it had its had a.
Performance in the first quarter that's within the.
The band So we had expected.
And obviously, there is a little bit of tailwind and they're offset by a little bit of equity market.
Downtick, but it's our business is performing.
Well we are.
We continue to be excited about it and.
The partners non partners that have been operating that business that are coming over to us are doing a fine job.
As as we would expect which is which is really really nice to see.
In terms of.
The deposits and the close on the assets and the.
The modifications in the.
And.
The broader question, you're asking about the underlying economics of the.
The transaction I'm not going to go into detail on that at this point I think Ron in his prepared remarks.
Firm that.
That the economics are sound that there'll be accretive within the first year.
And what I would tell you is as we've as we worked through the modifications which is oftentimes a.
Our legal legal entity kind of kind of structure.
Where are we in the finance and Treasury side are working very closely.
With our legal colleagues too to navigate those modifications that make sure that they are.
They preserve the economics and the accretion that were looking for and so we are we continue to be.
Positive and we think it will be positive for shareholders.
Great Fair enough. Thank you so much.
Our next question is from Gerard Cassidy with RBC.
Good afternoon really going after the year.
Sure Eric.
Can you share with us I think.
Your comments when you were talking about the CET one ratio that you use to temporary allocation of additional R&D of UA to capture some market business that generated some better revenues for you in the quarter can you elaborate on that.
And if you pull back does that mean in the second quarter. The <unk> capital that was allocated would decline meaning that all other things being equal your CET, one ratio could bump up a little bit.
Gerard it's Eric that's.
Those are the kinds of scenarios and I'll say navigation that we do for our capital ratios and they are they are sometimes dependent on market opportunities, whether it's the FX trading desk.
Here in the U S or abroad, whether it's the SEC finance unit or sometimes even the lending unit there we're in close partnership with them around.
On one hand they are.
Estimated operating within their limits and sometimes they come come by and we have real I think constructive commercial discussion about hey, if there is a little more capacity at the top of the house.
Be put to use so that's where we were this this quarter and you saw we had quite a nice uptick in FX trading revenues.
Up 20% quarter on quarter, which I think had not been anticipated with facilitated as we gave them.
Larger limits now partly because we are sitting on an abundance of capital right now.
I think what you will see is that.
We will do that selectively we'll probably do that for another couple of months, we will see how we're feeling towards towards June we would like to keep our <unk> way.
Asset levels.
At or below where we are today, so we do expect them to.
B to B to B within those boundaries and.
So we will selectively worked through it but.
Part of the discipline here is we also want to make sure that there's real incremental revenues that we can bring to bear if we're going to deploy the incremental capital and that was the scenario of this this quarter.
Very good very helpful. And then Eric I know, it's not a giant number but you touched on it in the outlook regarding the adjustments on the fair value adjustments to equity investments were up so strong in Q1.
Q1 versus both the fourth quarter and the year ago quarter.
How big of a portfolio is that was it.
Private equity investments.
Give us a little more color there.
Sure Gerard.
These are primarily or.
Primarily almost exclusively minority investment opportunities.
<unk>.
Investments that we've made in a series of companies over the over the years.
Or is.
There is five to 10 of them that are in the in the crypto space, sometimes providing software, sometimes providing infrastructure, sometimes providing different capabilities.
There are some in the more classic technology areas, where we've invested over time again in minority positions.
That help facilitate some AI capabilities.
Capabilities.
And.
Capacities that have helped us with our automation and engineering efforts and so there's a there's a group of them.
But we're primarily we're not trying to build an investment portfolio. What we have is.
As investments typically a five to 10, maybe $15 million in early to mid stage companies oftentimes. They are companies that are.
Providing a utility type service for multiple large bank. So we're in there with the sometimes the other G. Sibs are an international bank or what have you.
And so we get effectively they get the the entity gets a network effect for multiple banks and we participate because we get.
Upside in some of the services. So we're doing it to help facilitate primarily either.
Either.
Revenue growth automation capability, or just general capabilities to build up our.
Our.
Our product set.
And.
The I guess the knock on benefit of that is because we know this market space well these tend to.
Appreciate over time.
And.
It's one of the ways we have been.
Driving I think innovation will probably be the broader word to use.
And we've made some I think this particular quarter, we saw a couple of these.
Really really appreciate.
Good to see.
Thank you and our next Gen is from Jim Mitchell with Seaport Global.
Sorry, I was on mute there for a second.
Just Eric.
You updated the guidance on NII for the full year.
Any change to the expense or fee revenue guidance that you gave in the prior quarter for the full year.
Jim I didn't go that far partly because the market environment has just been volatile whether it's equity markets, whether its rate hikes and.
Uh huh.
And so theres a number of drivers.
That are moving around.
I think NII, we felt just because the fed forecast were so explicit between the dot plots and.
The new consensus that we should just describe that for all of you.
But the other lines.
We think it's still early to go to go through it until early to really call what the.
Equity markets will do both in the U S and internationally, where they've been more depressed.
Well, obviously navigate and adjust our expenses to some extent as Lee as we go through the year I think what we did do as part of the outlook commentary after I finish the quarterly description was affirm that we're committed to.
Both positive total operating leverage and positive fee operating leverage and so I think that gives you some.
Some some boundaries that we're working with them.
Right maybe.
Just one curious question on Securities Finance.
I appreciate the balances were down specials were down and those are important factors, but I've always thought that.
Spreads on SEC lending and where kind of the spread between you benefited from a steepening at the short end of the curve. It didn't really seem to see any of that benefit in the spreads is that to come or we just not thinking about that right. How should I think about securities lending spreads excluding specials and volume.
Yes, I think I think Directionally you are right it tends to have some correlation.
And I think what we find though is that the specials activity and the mix of the underlying mix of assets that are being borrowed or land.
Tend to be a little more dominant in terms of their their effects on the.
The P&L in a given quarter so.
It fits that has a piece to it the rate environment, but tends to be the volumes and the mix that dominates.
Okay, great. Thanks.
Sure.
Our next question is from Alex Blaustein with Goldman Sachs.
Hey, good afternoon. Thanks for thanks for the question.
Maybe just taking a step back for a second and when you sort of think through the capital mitigating factors that.
That you guys have taken to show up the capital for this year out of the branch closing.
When you think on a multiyear basis, and maybe sort of lessons learned from the move in interest rates in effect that had on your guys as capital position this quarter and maybe out there what is the more appropriate mix of kind of cash securities and loans for about over time as well as just the duration of the securities portfolio, how much of that will look different perhaps.
Florida.
Alright.
Yes, Alex it's a good question and in a way we've not.
Not been in this environment for 20, or 30 years, right where rates either are going to move.
To move quickly to the upside or maybe move closer to the upside and stay high.
Neither.
I think there are a couple thoughts.
That we've developed over time I think the first is that the more we can add lending assets classic loans to our balance sheet.
To be high quality, but the more we can add the lending to the mix of the asset side of the balance sheet. The better off we are and you've seen us you've seen us consistently grow our lending book.
10, 12%, it's just it's off of a small base so that that scenario will continue to evolve.
I think given that that will though take some time.
We the other elements.
Elements here is what kind of investment portfolio to Iran.
We just because of our trust and custody heritage believe it should be.
High quality pristine one that is unassailable.
And our perspective as we do that is I think we're more comfortable putting more of that over time into HTM just because it's a it's a it's an accounting convention that while you all can read through in our 10, Ks and Qs what the underlying market doesn't immediately.
Or it doesn't affect.
The capital ratios, the one governor on that and you'd say well why not put it all in HTM and put it in a drawer is that in a down rate environment, which.
Typically happens when the fed moves into intervene on a recession you tend to get an appreciation of securities and you wanted to be able to monetize or take advantage of that to offset whether it's credit or reserve builds and so that's one of the reasons why you don't want to put all of it in HTM and the other reason is.
If you're.
If if.
Rates are flattish for moving within a band of 25 basis points here 50 basis points. There DAA fast convention allows you to rebalance to adjust.
Adjust your position, a little short or a little longer.
And.
That's that's beneficial and I think over time, we found that that's been additive to our NII and P&L and so I think over time, you'll probably see us put more more in HTM, but.
Not.
There are some some limits to that but.
So that's some of the ways, we're thinking about it and then I guess, there's a last layer, which is whats the composition and I think you've seen us adjust the mix of treasuries MBS Cmos.
Because we're such a global bank, the foreign sovereigns, especially as.
Euro and international rates rise I think will over time become a bigger part of what we do to pros. So there is there is there is a bit of I think the.
Mix, the composition will will evolve as well over time.
Got it alright, that's helpful. Thanks, and then maybe a little bit more of a tactical near term question.
When we look through the NII guide just extrapolating the full year from the second quarter.
Not surprisingly the benefits of subsequent rate hikes seem to have a smaller effect on NII, but curious how you guys thinking about deposit beta assumptions beyond sort of the first 100 basis points maybe.
Maybe looking at the UK market is kind of lessons learned there are little bit broker ahead of us I guess hiking cycle in terms of both pricing and client behavior. Thanks.
Yes, I think the.
The first 100 basis points, I think are a little bit easier to read to your point.
The first rate hike.
Betas, we generally assume are in the 20% range. So that's the first one or two so that's comfortable.
And pleasing I guess I should should say.
Once you get to the third and fourth.
<unk> you are now.
Floating up and betas and the 32.
45% range and this is where kind of depend and then I think once you get past the first four or five hikes you are.
Looking at.
Sequential.
Quarter betas.
The 60% range I think Youre, just that's just what happens.
To be honest, where we want to go back to a position where the NII is healthy the NII can support the preferred security stack that we should run from a capital perspective, but we also want to be fair and thoughtful with our clients and the embedded sharing that's been.
Partnership here for decades, and decades and decades with them. So that's what we're looking at and thinking.
You never know how the speed of rate hikes effects that some of that's been taken into account in some of those.
<unk> estimates I have given you, but I use the word again guesstimate tier not estimates because we think the cycles are arent perfectly comparable.
And some amount of quantitative tightening has been factored into some of some of our thinking here as well.
That will have an effect.
And then I think the last one that we'll have to see is depending on how the macroeconomic economy does whether it's.
If the economy if rates move up another one to 300 basis points in the macro economy is strong and Theres a lot of demand for lending and so there is this bid ask between deposits to fund loans. If you have a slowdown in the.
And the real economy than theirs.
Theres not as much lending that's going to be done and that's that's more beneficial to deposit rates. So that's another feature that we're keeping a close eye on.
Okay. Thanks very much.
Yes.
Our next question is from Steven <unk> of Wolfe Research.
Hi, good afternoon.
So Eric I was hoping to ask just a multipart question on the capital impact of BPH and how that maybe informs the buyback cadence from here. So as we think about the pro forma impact to your capital ratios. If we were to assume the deal closes in the next quarter or two.
And we shut off the buyback through the third quarter, given the large pro forma capital head I believe its about $3 5 billion from goodwill and deal intangibles. So about 120 bps of tier one leverage.
Your ratio exiting <unk>, which still shake out below your lower bound of five in a quarter not meaningfully below but somewhere close to 5% I just wanted to confirm if the $3 5 billion capital drawdown from BPH.
All in is the right level for us to be contemplating for modeling purposes, as we think about the buyback cadence if youre still running at or below that lower bound now how quickly should we think about you getting returning to normal course payout target roughly 80%.
Yes, I think.
It's probably a little bit easier to think about it in CET, one terms, but the translation is kind of the CET. One divided by two gives you the leverage I remember him leverage, especially in these economic times, we certainly want to stay within the.
Target range of five and a quarter to 575, but I've been I've been on record saying.
Closer to as long as you stay in the fives leverages quite comfortable given that it's not a risk sensitive measure.
If you then pivot back to CET one.
We're at almost 12% relative to the target range of 10 to 11. So there is almost 200 basis point spread there of excess capital that we have if you then fast forward and let's say, it's it's you know we've had discussions on this call is exactly.
What we should assume but if we were to assume a third quarter close for example.
The way to think about is the goodwill and intangibles.
Four.
The Brown brothers transaction is about.
$3 3 billion I think if you translate that into CET, one it's just below.
Just below the 300 basis point Mark. So the comparison is we would prefer it's not absolutely required but we'd prefer.
To have about 300 basis points of capital.
To close we've got about 200 basis points today, and then the logical way you think about how do you get from here or there over the next two quarters is actually pretty straightforward right on one hand, we accrete capital net of the dividends that's worth about 35 basis points a quarter. So you've got 70, there and on the other hand is.
We talked about earlier we've been.
Deploying our excess capital through the <unk> lines right through the risk weighted assets and we know we can easily rain in risk weighted assets by $5 billion or more which creates another 30, 40 50 basis points of capital.
As part of our closing process. So there is there's good levers here and that's why I said earlier from a.
Capital perspective, it's a comfortable closing process and plan.
Very helpful color. Thanks for taking my questions sure.
Our next question is from Mike Mayo with Wells Fargo.
Okay.
Make sure I understood. What you said on the call. So on the one hand, you're still guiding for positive operating leverage for 2022, you still expect a higher pretax margin. Your backlogs are up so that's all good.
I guess.
Just to clarify your answer just now the Brown brothers acquisition.
Sequel reduces your CET, one ratio by how much in basis points.
Just shy of just around 300 basis points Mike.
Okay and so.
You're at 11 nine now.
So if you close the deal now.
Below the low end of your target so are you <unk>.
Laying the deal because of lack of capital or I didn't understand why the delay in the deal.
No. It has nothing to do with the with capital.
If we had been in a position to close and now we would have rained. We would not have deployed five maybe even $10 billion of RW way and we would have we would've had a comfortable close of the deal.
It's not about capital it's about as we described earlier.
The underlying regulatory process is taking taking more time.
Okay.
And then as it relates to the.
The lack of resumption of buybacks.
That solely due to the timing of the closing of the deal.
It's it's.
I guess, we're just factoring it in right.
Because of where we are in the regulatory process.
We're estimating.
Potential third quarter close.
And.
To just navigate comfortably with capital.
Because we had that.
A large a OCI head of $1 billion three.
I usually buy back.
For almost $500 million of.
Shares per quarter, right that would be my usual cadence.
A OCI head has effectively put us in a position where it's best not to do those.
Two two quarters worth of buybacks during the second and third quarter.
Alright, that's clear and then lastly, your guidance for positive operating leverage.
How much do fee waivers contribute to that is that like all of it or 10% or 50% or just roughly.
Well the guidance is to positive.
Total operating leverage and fee operating leverage I think the if I just try to do the math quickly, but the IR team can probably help you offline Mike.
This quarter, we had.
Fee.
Fee waiver impacts of 10, and then we won't have any fee waivers for the rest of the year last year, we had fee waivers I can only remember the second half of the year, because I'm trying to remember when it started in the $20 million per quarter range. So.
R R.
Total fees of $10 billion I don't know rough estimate may be about half a point of fee operating leverages caused by the tailwind.
Absence of money market fee waivers, but that's.
Doing mental math.
Ill.
Without even a pencil and paper in front of me. So maybe we could follow up with you offline, but maybe in that order of magnitude at least.
I think I have I mean, Joe in terms of ZIP code. It most of it does not relate to the fee waivers the lion's share of it. So I think I got it that's correct, it's real underlying momentum.
Okay alright, thank you.
And our next question is from Rob <unk> with autonomous.
Hi, guys. Thanks for taking the question.
Just on.
Fee revenue in the quarter, how would you describe about organic growth.
Yes.
Rob why don't I start Ron.
Right.
<unk>.
Several now good organic growth quarters, both on the servicing line.
And the management fee line.
I think that.
If you think about last year there was in the servicing line.
Fair amount of that would've been an alpha front to back a lot of that now is being installed and a big chunk of that is what you see in the $2 nine trillion.
The <unk>.
Growth that or at least the sales that we reported on the servicing fee line.
Kind of disproportionately in the in the traditional back office business, which is highly scaled relatively quick to install.
So we like that mix and then management fees have been.
As Eric noted it's.
Across the board.
In the core businesses.
TFS institutional and even a little bit of cash.
So we like both the level of it.
These like more but we like the level of it but.
But.
As importantly, we like the diversity of it.
Yes.
Okay. Thanks, and then on the $2 nine trillion to be installed can you just remind us of the timeline for when that gets installed and when it starts to hit revenue.
Sure Robert It's Eric we've said that that begins to get it installed the remember the the.
Bulk of that there were two very large deals.
That were announced in second and third quarter last year those were a trillion dollar plus deals and then there is obviously.
Net of.
Kind of smaller and mid size activities.
For those two large deals they are they are complex and they are transformational for those for those clients and what we're delivering.
And so those we've said take tend to take a little longer.
Closer to the I think we've said for installations installations range from kind of six months to 36 months, but for those where the.
The middle ground is probably 24 to 30, so right now our estimate is that.
Yes.
A good piece, but probably not the majority begins to get installed by late this year.
And then this is really at 2023 lift.
Of revenues.
Yes.
Got it thank you.
Sure.
There are no further questions at this time I will now turn it back to our CEO , Ron <unk> Li for closing remarks.
Well, thanks very much. Thank you all for joining us I know it was a busy day for you. So we appreciate your time and questions. Thank you.
Ladies and gentlemen, this concludes today's conference call and webcast. Thank you for participating and have a wonderful day you may now disconnect.
Sure.
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Yes.
Yes.
Okay.
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