State Street Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
January 19, 2024

Key Takeaways

  • In 2023, State Street executed its strategic agenda—driving strong sales wins, implementing productivity actions, and managing costs—to deliver full-year EPS growth of $0.76 (ex-notables) despite market headwinds.
  • The Investment Services business achieved a record $103M in Q4 new annualized servicing fee wins—the highest quarterly level in recent years—contributing to $301M of full-year wins and momentum toward $350–$400M in 2024.
  • Front office software & data, including State Street Alpha, reached a record quarter with $32M of new bookings, seven Alpha mandate wins in 2023, and a 16% ARR increase YoY, bolstering fee revenue diversification.
  • Q4 net interest income rose 14% YoY to $678M, aided by higher rates and a surprising deposit surge linked to reduced Fed reverse repos, though deposit levels and mix remain unpredictable.
  • With a standardized CET1 ratio of 11.6%, the firm returned $6.4B to shareholders over the last five quarters and authorized a new unlimited $5B buyback program, targeting ~100% of 2024 earnings in dividends and repurchases.
AI Generated. May Contain Errors.
Earnings Conference Call
State Street Q4 2023
00:00 / 00:00

There are 15 speakers on the call.

Operator

Good morning, and welcome to State Street Corporation's 4th Quarter and Full Year 2023 Earnings Conference Call 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.

Operator

The only authorized broadcast of this call will be held on the State Street website. Now I would like to introduce Eileen Fizel Deeler, Global Head of Investor Relations at State Street.

Speaker 1

Good morning, and thank you all for joining us. On our call today, our CEO, Ron O'Hanley will speak first Then Eric Abloff, our CFO will take you through our Q4

Speaker 2

and full

Speaker 1

year 2023 earnings slide presentation, which is available for download in the Investor Relations section of our Web investors. Statestreet.com. Afterwards, we'll be happy to take questions. During the Q and A, please limit yourself to 2 questions and then re queue. Before we get started, I would like to remind you that today's presentation will include results presented on a basis that excludes or adjusts 1 or more items from GAAP.

Speaker 1

Reconciliations of these non GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation, also available in the IR section of our website. In addition, today's presentation will contain forward looking statements. Actual results may differ materially from those statements due to a variety of important factors such as those factors referenced in our discussion today and in our SEC filings, including the risk factors in our Form 10 ks. 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.

Speaker 3

Thank you, Eileen, and good morning, everyone. Earlier today, we released our Q4 and full year 2023 financial results. As I reflect on 2023, the operating environment was dynamic with a complex set of challenges for the world's investors and for our industry. And I am proud of how we carefully navigated State Street through various headwinds while continuing to execute against our strategic agenda. We focused and delivered on that agenda in 3 key areas: achieve strong sales wins across our businesses, drive strategic change in our Investment Services business and remain disciplined on productivity and broader cost management.

Speaker 3

Further on that last point, during 2023, we implemented key productivity actions and announced additional efficiency measures that will enable us enhance the productivity of our operating model in 2024 in the years ahead. We took these many actions all while investing in our business and returning capital to our shareholders, which helped to drive full year earnings growth excluding notable items. The world's investors, State Street and our industry faced a host of significant market events and macroeconomic forces in 2023. In the Q1, turmoil in the banking sector ultimately led to the resolution of several banks, which was a catalyst for some of the largest fixed income market move seen in decades. In the Q2, anticipation grew about the potential economic benefit from artificial intelligence, helping to drive equity markets higher.

Speaker 3

However, as we progress into the Q3 and as the Federal Reserve raised interest rates to the highest level in 2020 2 years in July, the prospect of higher for longer rates led to a substantial sell off in bond markets With the U. S. 10 year treasury yield exceeding 5% in October for the first time since the global financial crisis, Rate uncertainty and an increasing number of geopolitical concerns caused equities to struggle. Then during the Q4, The equity market rallied vigorously as inflation receded and investors grew increasingly optimistic about a soft landing with positive sentiment gaining further momentum in the last month as the Federal Reserve signaled a pivot to lower interest rates this year. In sum, while our full year overall financial results benefited from higher interest rates globally last year and despite the strong market appreciation in the 4th quarter, Daily average global equity markets only increased by low single digits in 2023, providing just a modest tailwind to our fee revenue, While client activity was muted as investors stayed on the sidelines for much of the year and even in such an eventful year, Equity and FX market volatility continued to contract creating revenue headwinds for our trading businesses.

Speaker 3

Slide 3 of our investor presentation provides some of our highlights for the year. Beginning with our financial performance, Full year earnings per share was $0.58 or 0 point 0 $0.76 excluding notable items. Year over year, Excluding notable items, EPS growth was supported by $3,800,000,000 of common share repurchases, a record level of NII, Continued growth of our front office software and data business and higher securities finance revenues, the combination of which more than offset the impact of lower servicing and management fees and underlying expense growth, which was still well controlled. We continued to build business momentum and position States for longer term success. To that end, we achieved a number of important accomplishments 2023, as you can see on Slide 3.

Speaker 3

A key highlight of today's results is the clear progress we're making on innovation and advancing product capabilities, which in turn contributes to stronger sales momentum across our broad franchise aimed at generating better fee revenue growth in the year ahead. Within the Investment Services business, we are intensely focused on ensuring better execution against our strategy and revenue goals. We unveiled the sharpened execution plan last year underpinned by a number of measurable actions aimed at driving servicing opportunities across key regions and product areas, realizing the full potential of our alpha value proposition and accelerating sales and revenue growth, particularly in our core back office custody. Encouragingly, as I just noted, today's results demonstrate our proven ability deliver the level of sales required for attractive organic servicing fee revenue growth in the future as we built upon the $91,000,000 of new servicing fee sales in 3rd quarter by recording $103,000,000 of new servicing fee wins in 4Q, which is the highest level of quarterly new servicing fees in recent years. From its inception, we have noted that Alpha will further establish, broaden and deepen client relationships, Positioning State Street as our client's essential partner, Alpha distinctively enables us to grow and tie together the full breadth and depth of State Street's capability As a true one State Street solution for our clients from front to back, 2023 was an important year for Alpha Software Delivery.

Speaker 3

Last two quarters of the year included the significant development of the fixed income portfolio management module, which PROPEL CRD and alpha capabilities and competitiveness forward. In 3Q, we recorded our first alpha for private markets client. And in the Q4, we continued Alpha's momentum by deepening relationships with a number of key existing mandates and recording 4 new Alpha wins, While our front office software and data business had a record quarter of new bookings in 4Q, both demonstrating our ability to drive stronger sales. Within our global markets business, even as low volatility created a headwind, we continue to see proof points of our very strong market position. For example, in its 2023 FX Awards, Euromoney Magazine named State Street as the winner across 4 important categories, including the best FX bank for real money clients.

Speaker 3

We also continued to innovate and strategically expand our product capabilities and geographic reach, including the planned acquisition of outsourced trading firm CF Global Trading. At Global Advisors, We undertook targeted strategic actions aimed at gaining market share and driving the SME growth in the coming years. As a result, We saw encouraging business momentum with GA setting a number of growth records in 2023. A number of key performance indicators make us optimistic as we look ahead. For example, in Q4, GA recorded the best ever quarter of aggregate total flows, including record quarterly flows within our Spider ETF franchise amounting to a capture of 21% of total global ETF flows in Q4 and ending 2023 with a record level of total ETF assets under management.

Speaker 3

Our cash business had an exceptional year delivering record annual flows in 2023 with institutional money market fund AUM also reaching a record. Overall, we gained market share in a number of key areas including institutional money market funds and U. S. Low cost equity and fixed income ETFs. Turning to our efficiency and productivity efforts, underlying expense growth was well controlled in 2023 with full year expenses increasing 3% excluding notable items.

Speaker 3

Q4 expenses excluding notable items rose just 1% quarter on quarter reflecting the impact of our ongoing expense actions. Transforming our operations to improve effectiveness and realized productivity growth remains a key priority for us. To that end, we announced important steps in our multiyear efforts aimed at improving our operating model. As we previously announced, we are streamlining our operations in India. We have now assumed control of 1 of our joint ventures in that country with a second joint venture consolidation expected to close in the spring.

Speaker 3

We expect these actions will accelerate the transformation of State Street's global operations, improve service quality and client experience, and enable us to achieve productivity savings as part of our plans to deliver positive fee operating leverage in 2024. Turning to slide 4 of our presentation, you can see our Q4 financial highlights and business momentum indicators, which Eric will shortly take you through in more detail. Before I conclude my opening remarks, I would like to touch on our continuing balance sheet strength, which has enabled us to return a substantial amount of excess capital in recent quarters. For example, over the last 5 quarters to the end of December, We have returned $6,400,000,000 of capital to our shareholders. As we pivot to a more normalized level of capital return, In 2024, it is currently our intention to return approximately 100% of earnings in the form of common share dividends and share repurchases subject to market conditions.

Speaker 3

Accordingly, as we announced this morning, our Board of Directors has authorized a new common share program of up to $5,000,000,000 with no set expiration date. To conclude, while 2023 was an eventful year, we finished strongly in 4Q, which creates an encouraging starting point for our businesses into 2024. This year, we remain highly focused on both the execution of our strategy and the accountability for results. Our goals are clear. We must continue the improvement in our sales performance that we demonstrated in the second half of twenty twenty three, continue to implement a set of productivity initiatives and product enhancements that will drive longer term improvements in our operating model efficiency and effectiveness and deliver positive fee operating leverage in 2024, all while returning capital to our shareholders.

Speaker 3

We are laser focused on these goals. Now, let me hand the call over to Eric who will take you through the quarter in more detail.

Speaker 4

Thank you, Ron, and good morning, everyone. Before I begin my review of our Q4 and full year 2023 results, let me briefly discuss the notable items we recognized in the quarter on Slide 5, which collectively totaled $620,000,000 pre tax or $1.49 of EPS. First, We recognized an FDIC special assessment of $387,000,000 which is reflected in other expenses. 2nd, we recognized $203,000,000 of net repositioning charges enable the next phase of our productivity program. As we had indicated in December, the bulk of this action primarily relates to severance of around 1500 employees.

Speaker 4

Our initiative to streamline and de layer our operations, technology and staff functions and improve efficiency will allow us to sustainably reduce expenses. We expect these actions collectively to have a payback of roughly 6 quarters and begin this quarter with roughly 2 thirds of the benefit occurring in 2024. These actions and the related will contribute to our fee operating leverage goal for 2024 and in subsequent years. Turning to Slide 6. I will begin my review of both our Q4 and full year 2023 financial results.

Speaker 4

As you can see on the table, total fee revenue was flattish for all periods of comparison quarter on quarter, the year on year quarter and for the full year. The slight market appreciation notwithstanding, the combination of muted volatility, central bank pivot and geopolitical concerns push investors to the sidelines for much of the year. In terms of our more durable revenues, we continue to benefit from strong momentum in our front office software and data business, which was up 5% on a full year basis and 13% on the year on year quarter. In terms of areas that have begun to rebound, Management fee performance was down for the full year at minus 3%, but has begun to rebound with an up 5% result year on year quarter as flows picked up and we gained share. Back office servicing fees was challenged for much of the year as the client's transactional activity was muted, but has started to turn positive and is up 1% this quarter as we've seen a recent lift in equity markets.

Speaker 4

And of course, we continue to be affected by industry wide headwinds in our global markets businesses given the low levels of volatility in the FX markets specials activity in agency lending throughout the year. NII has been tough to predict and surprise to the positive this quarter compared to Q3. I'll turn to that in a few minutes. Expenses were well controlled in the quarter as we continue to thoughtfully allocate resources across the franchise and to areas where we see the greatest opportunities for top line growth. Relative to the year ago, total expenses ex notables were up 2% year on year and reflect intensifying cost management in a tough environment as the year progressed.

Speaker 4

This expense control coupled with the repositioning actions I just mentioned prepare us to deliver productivity savings and positive operating leverage in 2024. Finally, despite a dynamic and challenging operating environment, We delivered full year 2023 EPS growth of 3% excluding notable items. This was supported by share repurchases, a record level of NII and the growth of our front office software and data business which is less exposed to macroeconomic conditions. Turning now to Slide 7. We saw period end AUCA increase by 14% on a year on year basis and 4% sequentially.

Speaker 4

Year on year, the increase in AUCA was largely driven by higher period end market levels and net new business. Quarter on quarter, AUCA increased primarily due to higher period end market levels. At Global Advisors, period end AUM increased 19% year on year and was up 12% sequentially, largely reflecting higher period end market levels and strong net inflows. Notably, as Ron mentioned earlier and I'll describe momentarily, in Q4 GA recorded the best ever quarter of aggregate net flows of $103,000,000,000 which sets us up well for 2024. At the center right, we've also added a table with market volatility indices, which we believe can be useful indicators of client transactional activity that drives servicing fees, specials activity in agency lending and flows and margins in FX trading.

Speaker 4

On Slide 8 now. On the left side of the page, you'll see 4th quarter total servicing fees up 1% year on year, primarily from higher average equity markets, partially offset by pricing headwinds, lower client activity and adjustments and a previously disclosed client transition. Sequentially, total servicing fees were down 2%, primarily as a result of the pricing headwinds and a previously disclosed net client transition, partially offset by higher client activity and adjustments, which was nice to see as clients started to come off the sidelines. On the bottom left of the slide, we summarize some of the key performance indicators of our servicing business. We were quite pleased see new servicing fee revenue wins of $103,000,000 this quarter, the highest in many recent years, primarily reflecting the enhancements of our sales processes and product offerings, including in North America where we saw strong outcomes after a period of underperformance.

Speaker 4

These servicing wins to the total full year fee revenue wins of $301,000,000 and underscores the progress we're making towards stronger sales performance. Recall, our goal for 2024 is even higher at $350,000,000 to $400,000,000 in servicing fee sales for the year. Finally, we had $270,000,000 of servicing fee revenue to be installed at quarter end, up $57,000,000 year on year $15,000,000 quarter on quarter. We expect about half of this to install in 2024. We also had $2,300,000,000,000 of UCA to be installed at period end.

Speaker 4

Turning to Slide 9. 4th quarter management fees were $479,000,000 up 5% year on year, primarily reflecting higher average equity market levels and some performance fees, partially offset by a previously described shift of certain management fees into NII and the impact of a strategic product suite repricing initiative that has aided ETF flows. Relative to the Q3, management fees were flat, mainly driven by higher performance fees offset by a previously described shift of certain management fees into NII and the impacts of the strategic ETF product suite repricing initiative. As you can see on the bottom right of the slide, our Investment Management franchise remains well positioned with very strong and broad based business momentum across each of its businesses. In ETFs, we had record quarterly net inflows of $68,000,000,000 driven by record net inflows into SPY as as the Spider portfolio U.

Speaker 4

S. Low cost suite experiencing consistent market share gains. In our institutional business, we saw quarterly net flows of $6,000,000,000 primarily driven by defined contribution products. And lastly, across our cash franchise, we saw quarterly cash net inflows of $29,000,000,000 primarily into money funds which contributed to the record total full year 2023 cash net inflows of $76,000,000,000 and institutional money Turning now to Slide 10. 4th quarter FX Trading Services revenue was down 11% year on year ex notables and 2% sequentially.

Speaker 4

Relative to the period a year ago, the decrease was mainly due to lower FX spreads from muted market volatility offset by slightly higher volumes. Quarter on quarter, the decrease primarily reflects lower direct FX revenues from muted volatility. 4th quarter securities finance revenues were down 6% year on year due to lower agency balances partially offset by higher agency spreads, higher specials activity and prime services revenue. Moving on to software and processing revenues. 4th quarter fees were up 10% year on year and 26% sequentially, largely driven by CRD, which I'll turn to shortly.

Speaker 4

Finally, other fee revenue for the quarter increased $15,000,000 year on year, primarily due to a mid year tax credit investment accounting change, partially offset by the impact associated with the devaluation of the Argentinian peso. Moving to slide 11. You'll see on the left panel that 4th quarter front office software and data revenue increased 13% year on year, primarily as a result of the continued SaaS implementations and conversions driving software enabled and professional services revenue growth. Sequentially, Front office software and data revenue was up 38%, primarily driven by higher on premise renewals and go live implementations. Turning to some of the Alpha business metrics on the right panel, we are pleased to report 4 more Alpha mandate wins in the quarter, which means 7 wins for the full year 2023.

Speaker 4

State Street Alpha continues to be an important differentiator of our business and creates an attractive value proposition for our clients with contractual terms usually covering 5 to 7 to 10 years. We've also gone live with 3 more Alpha clients, which brings us to 6 for the year, which sets us up well for 2024 and added significant new functionality for fixed income portfolio managers. 4th quarter ARR increased 16% year over year driven by 20 plus SaaS client implementations and conversions and we had a record quarter for front office new bookings at 32,000,000 Turning to slide 12, 4th quarter NII increased 14% year on year, but increased 9% sequentially to 678,000,000 The year on year decrease was largely due to lower average deposit balances and deposit mix shift, partially offset by the impact of higher interest rates. Sequentially, the increase in NII performance was primarily driven by the impact of interest rates and the full quarter impact of the 3rd quarter investment portfolio repositioning as well as higher deposits and loan balances. The NII results on a sequential quarter basis were better than we had previously expected as both interest bearing and non interest bearing deposits increased and certain client repricings were further delayed.

Speaker 4

Some of the higher deposit balances may have been seasonal, but the Fed's quantitative tightening appears to have been offset by the reduction of the Fed's reverse repo operation, which seems to have resulted in clients leaving higher bank deposit balances. It's hard to know how deposits will trend, but we're pleased with this higher step off going into the Q1 of 2024. On the right side of the slide, we show our average balance sheet during the Q4. Average deposits increased 4% quarter on quarter with non interest bearing deposits up 3% for the quarter. Turning to slide 13.

Speaker 4

4th quarter expenses excluding notable items increased 2% year on year or 1% ex FX. Sequentially, 4th quarter expenses were up only 1% as we actively managed expenses and continued our productivity and optimization savings efforts, all while carefully investing in strategic elements of the company, including Alpha, Private Markets, Core Custody and Tech and Ops Process Improvements and Automation. On a line by line basis and year over year ex notables, compensation and employee benefits increased 1%, primarily driven by higher salaries and employee benefits, partially offset by lower contractor spend and performance based incentive comp. Information systems and communications expenses increased 4%, mainly due to higher technology and infrastructure investments, partially offset by the benefits from ongoing optimization efforts in sourcing and vendor credits. Transaction processing increased 1% mainly reflecting higher brokerage costs.

Speaker 4

Occupancy increased 24% of an episodic sale leaseback transaction in the prior period. And other expenses were up 3% sequentially, Flat year on year, mainly reflecting higher marketing expense and professional fees. Lastly, let me spend a moment on headcount. As we discussed in the Q3, as part of our ongoing transformation and productivity initiatives, we've streamlined our operating model in India and have now assumed full ownership of one of our operations joint ventures and we recently announced that we intend a similar undertaking with a second consolidation in the country this spring. This consolidation continues the transformation of State Street's global operations and will enable us to unlock productivity savings, which we expect to start this quarter through a reduction in contractor services and in the years ahead as we simplify our fragmented operating model.

Speaker 4

As you would expect, consolidating 1st joint venture increased our FTE headcount roughly 4,400 in the quarter as we in sourced global capabilities. However, these costs were already in our expense base and reported historically under the comp and benefits line. These actions are contributing to our higher productivity savings targets for 2024. Moving to Slide 14. On the left side of the slide, we show the evolution of our CET1 and Tier 1 leverage ratios followed by our capital trends on the right of the slide.

Speaker 4

As you can see, we continue to navigate the operating environment with very strong capital levels, which came in above both our internal targets and the regulatory minimums. As of quarter end, our standardized CET1 ratio of 11.6% was 60 basis points quarter on quarter, largely driven by episodically lower RWA and improvement in AOCI, partially offset by the continuation of common share repurchases. The decrease in interest rates during December The completion of our buyback contributed about 20 basis points to our CET1 ratios and some market factors over the last week of December conveniently contributed roughly another 50 basis points to the RWA end of period print. Going forward, I would expect RWA to run at higher levels to support our various businesses. Our LCR for State Street Corporation was a healthy 106% 122% for State Street Bank and Trust.

Speaker 4

In the quarter, we're quite pleased to return over $700,000,000 to shareholders, consisting of $500,000,000 of common share repurchases and over $200,000,000 in common stock dividends. Lastly, as we announced earlier today, our Board authorized a new multiyear common equity repurchase program of up to $5,000,000,000 with no expiration date. Turning to Slide 15. Before I start, let me first share some of the assumptions and underlying Our current views for the full year. Let me cover our full year 2024 outlook as well as provide some thoughts on the first quarter, both of which have more potential for variability than usual given the macroeconomic environment we're operating in.

Speaker 4

In terms of our current macro expectations, as we stand here today, we expect global equity markets to be flat point to point in 2024, which equates to the daily average being up about 10% year over year. Our interest rate outlook for 2024 largely aligns with the forward curve as of year end 2023, which I would note continues to move. We expect to see modest increase in FX and equity volatility, which should slightly higher FX trading services fees this year, but we are still seeing muted volatility in the Q1. And we currency translation to have less than 0.5 percentage point impact on revenues and expenses due to dollar depreciation, and I would remind you that a weaker U. S.

Speaker 4

Dollar has impact on revenues and an unfavorable impact on expenses. So we currently expect that full year total fee revenue will be up approximately 3% to 4% ex notable items with servicing fee and management growth driven by higher market levels and continued business momentum and continued strong growth in front office software and data. This includes a headwind of a little less than 1 percentage point to fee growth from the expected previously disclosed client transition. Regarding the Q1 of 2024, we currently expect fee revenue to be up 2% on a year over year basis with servicing fees expected to be up 1%, management fees up 7% to 8% and front office software and data expected to be up over 20%, largely due to increased SaaS, new business and conversions and on premise renewals. We expect full year 2024 NII to be down about 10% on a year over year basis compared to a record 2023.

Speaker 4

This is dependent on the outcome of global rate cuts and deposit mix and levels, which are obviously difficult to predict. Regarding the Q1 of 2024, After a significant step up in 4Q 2023, we expect 1Q 2024 NII to be flat to down 3% on a sequential quarter basis given current deposit mix expectations. Turning to expenses. As you can see on the walk on Page 16, we expect full year expenses ex notables will be up about 2.5% on a nominal basis in 2023, driven largely by our continued investment in the business, which we expect to largely offset through greater productivity savings worth $500,000,000 which is approximately 1.7 times last year's gross savings level. Regarding the Q1 of 2024, we expect expenses ex notable items to be up 1% to 1.5% on a year over year basis, keeping in mind that seasonal expenses usually occur in the Q1.

Speaker 4

As a reminder, we expect to achieve positive fee operating leverage, excluding notable items for full year 2024 given the projected growth in fee revenue and well controlled expenses. Finally, we expect taxes should be in the 21% to 22% range for 2024. And with that, let me hand the call back to Ron.

Speaker 3

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

Operator

Thank you. Ladies and gentlemen, we will now begin the Your first question comes from Alex Blostein with Goldman Sachs. Please go ahead.

Speaker 5

Hey, good morning, everybody. Thanks for all the details. I was hoping we could start with unpacking some

Speaker 6

of the NII dynamics and

Speaker 5

I guess appreciate the uncertainty when it comes to deposits. But Eric, maybe talk a little bit about What drove the upside in the Q4 in deposit levels? And if you have a view on what sort of seasonal versus more kind of core client franchise driven? And maybe give us some insight on where you expect balances to ultimately stabilize in the back half of 'twenty four?

Speaker 4

Sure, Alex. It's Eric. Let me share with you the texture we have, but I'll just say deposits and deposit levels continue to be volatile, they surprised to the upside. And in particular, we saw a nice uptick in deposits into September, October. We actually saw on the NIB side a downtick in November And then a large uptick again in December.

Speaker 4

So the averages came in up for the quarter, which made a big difference. Dollars 1,000,000,000 of NIB for a month is worth $5,000,000 and you kind of multiply through and That quickly adds up as we had a spread in December of $5,000,000,000 $6,000,000,000 relative to our expectations. And at the same time, we also saw interest bearing deposits up. Now some of that is just our regular way engagement with clients from that is they're leaving more deposits with us. And I think you did see in the Fed reports, The banking system deposits are up 1%, 2% quarter on quarter from Q3 to Q4.

Speaker 4

So it does seem like there's something happening in the market that's creating a little more stability, a little bit of buoyancy. There's some amount of seasonality that we always tend to see in at the end of the year as folks accumulate cash sometimes to pay dividends and ETFs in the next year. So it's just hard to read. But that's what played out and it played out better through the quarter and through the end. If I then Try to look forward.

Speaker 4

It's very hard to look forward for the year. We'd like to operate and to operate in a deposit range of $200,000,000,000 to $210,000,000,000 That's our kind of goal. A lot of that is just client engagement and helping put They're cash to work and sometimes they put cash to work in deposits and repo and money market sweep. But there's a category, each one of those is an important category and outlet for clients. And what we're seeing is clients using all the I'll call it all the above, right, including just holding treasury securities.

Speaker 4

So that we expect to continue and we think deposits will be roughly in this zone in the Q1. What's a little harder to read is just how non interest bearing deposits play out. We do expect those to continue to flow downward. They tend to flow downward for our clients with the largest funds. Those are the ones that have been floating down over the last 2 years.

Speaker 4

So we continue to see that expectation. There continues to be a little bit of repricing that plays out into the Q1 or 2 as well. And that's why I guided on an NII basis Flat to down 3% for the Q1, just to give you a little bit of an indication. But we expect that to be roughly on flattish deposits.

Speaker 5

I got it. It's very helpful. My follow-up sticking with deposits is around just deposit beta as we start to sort of end of the rate cutting cycle. So hoping you could articulate maybe what you're assuming for deposit beta on the way down in your 2024 NII guidance. And then broadly, how we should think about sort of the cadence of deposit betas as we progress through the rate cutting cycle into the back half 'twenty four, 'twenty five maybe.

Speaker 5

But just curious to know kind of high of the upper at the beginning, lower towards the end or the opposite?

Speaker 4

Alex, It's an important topic because it's how we interact with our clients. It's how we price our products. It's how the industry has operated in for many years. I think you know that our deposit betas on a cumulative basis have climbed quite a bit in the U. S.

Speaker 4

There are 75% or so cumulatively since the start of the cycle. In euros, it's around 60% cumulatively in pounds sterling closer to 30% to 35%. So they're clearly moved up. What certainly happens as and I'll say when, if and when rates fall is the deposit data is reverse. There is some amount of symmetry.

Speaker 4

Now does it reverse instantaneously? We want to be Careful with our clients. We want to be fair. But we do think that over multiple quarters and certainly over any realistic timeframe, the Fed cuts and there's got to be an adjustment. Now Part of that happens because we have a good bit of our deposits that are indexed to markets, right?

Speaker 4

They're indexed to market indicators. There are quite a few that are indexed with a spread and then there are a small amount now that has a transactional Kind of, I'll call it administered feature, but you'll generally see a broad amount of symmetry in deposits down versus up. I think what you do need to keep in mind is that our asset sensitivity and liability sensitivity though are Somewhat different between international markets and in the U. S, right? In international markets because those cumulative betas are still In the 30% to 60% range, we're still asset sensitive.

Speaker 4

So we make more money with increases in rates and we actually NII will trim down with decreases in rates. And that's where we're most That's our interest rate sensitivity today. On the U. S, we have a slight positive bias towards being liability sensitive, but it's still relatively slide, I'd almost call it neutral. So part of what we're doing is just navigating this interest rate environment.

Speaker 4

It's not exactly clear when the rates come, Not clear whether the U. S. Cuts before Europe or vice versa. And part of what we'll do is actively manage our portfolio to try to take advantage of what's common. At the same time, we'll price our deposits fairly and prudently.

Speaker 5

Great. Very helpful. Thanks very much.

Operator

Your next question comes from Brennan Hawken with UBS. Please go ahead.

Speaker 6

Good morning. Thanks for taking my questions. I think maybe some Of what you just said on the non U. S. Side might explain this.

Speaker 6

But when we think about triangulating the minus 10% to The fact that 1Q is either going to be flat, totally down a little on NII, it sort of suggests that your exit rate By the time you get to 4Q 'twenty four, based on what you can see today, it's probably going to be rather Am I reading correctly in thinking that it's that non U. S. Piece and that's going to drive some of that weakness? And am I extrapolating the comments correctly to think that we could see a little bit more back end weighted decline for NII?

Speaker 4

Brennan, it's Eric. I think you've got the right general pattern frame in the area of NII. Clearly, we have very strong step off in particular in December, but in the Q4, which will flow into Q1. And then we expect a trending down. We had Couple well, probably earlier this earlier last year, so a couple of quarters ago, described an NII range of 5 to $600,000,000 And we think we'll get into that range, the top end of that range by around the 3rd quarter, but it's a little bit hard to know the exact shape.

Speaker 4

We just but you've got the right direction of travel. And then we expect some stabilization In the second half of next year, maybe around the top half, the middle half of that range, just really hard to tell exactly where and when. If you step back and ask, what are the underlying drivers? There are really Three drivers that continue to be important. In terms of tailwinds, we continue to have long rates playing through When the investment portfolio balances as they recoupon at higher rates, that's particularly important in the first half of the year, A little less so in the second half of the year, but that continues through as a positive.

Speaker 4

You then have, as you mentioned, short rates starting to come down. And because of our sensitivity position across the global markets, that does start to have a headwind impact on NII as those cuts continue to come through. Now we'll see what's the pattern and pace of U. S. Versus international cuts.

Speaker 4

And I think Right now, we've pegged to the forward, which shows a lot of consistency and symmetry, but we'll see if that really happens because You can see inflation expectations keep moving around literally daily, weekly. And then the third feature is just client deposits and mix. And while we expect client deposits to be in that zone of $200,000,000 $210,000,000 they might bump up above that, a little below that, but they'll be in that broad zone. The mix will continue to shave down out of non interest bearing over the next quarter or 2, we think it's hard to again to predict. And then there's the we're working through the final stages of some of our interest bearing deposit repricing, those seem to have taken a little longer in some cases than we expected.

Speaker 4

That's okay. That means we accrete income. But those continue to come through and they'll play through in the Q1 or 2 as well. And then that's what kind of brings us to some level of reasonable stability in the back half of the year.

Speaker 6

Thanks for all that texture, Eric. It's very, very helpful. And by the way, I apologize about any background noise there. Second question, a bit more strategic. So we saw a flurry of Bitcoin ETF Launches firm whether my early read on that is right.

Speaker 6

And given the magnitude of the investment and the focus you've made on digital assets, What did you learn if you guys missed on that? And is that what led to the restructuring of the digital asset group? And what should we see as a change from that restructuring?

Speaker 3

So, Brennan, there were 11 launched on the day that the or day after the SEC gave approval and we actually serviced 3 of them. And I think we're the only ones that servicing across 3 different digital custodians. So we helped 3 of the major players make this happen. So we're quite active in the space. And As you'd expect, we do everything for each of those 3 except for the actual custody the reasons that I think you know.

Speaker 3

So no, we're very active in the space. It was What did we learn? I mean, it's early. What I think everybody's watching out for is there's a lot of players that went into the market. Some of them with some existing high levels of assets.

Speaker 3

What will be interesting to see over time is Does it actually consolidate? How does it work in terms of Who the buyers are institutional versus retail versus intermediary, but these are early days and It was good to get the uncertainty cleared up and for all this to get launched and we're keen to be part of it.

Speaker 6

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

Speaker 3

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

Operator

Your next question comes from Glenn Schorr with Evercore. Please go ahead.

Speaker 6

Thanks very much. So big flows in SSCA, which is great, good See, these things aren't predictable, but I am curious on if you had any thoughts towards sustainability. And maybe it would be the color What clients are buying? What clients are I mean, I'm sorry, what flavors of ETF are they? The average And what you're specifically doing differently on the distribution front and education front to get at those flows?

Speaker 6

Thanks.

Speaker 3

Yes. So there are a number of things going on there in the Q4, Glenn, and throughout 2023. I think as we've noted and certainly you all would have observed, there was it was most of the year With some episodic exceptions, it was a risk off environment. That changed in Q4 somewhat as predicted Once investors got a sense of where interest rates were going As they did when the Fed communicated in the 3rd quarter more or less a pause, I think that started activity going. So much of the activity late in the year would have been the Kind of classic risk on, let's put positions on quickly, benefiting the highly liquid SpiderCore, Spy in the sector ETFs.

Speaker 3

But Underlying it and throughout the year, the low cost ETFs, which represent different investors, these would be the ultimate holders here tend to be individuals. They're often advised by an intermediary like an RIA. So they're, it's very sticky and we have continued to build share there, both in equity and fixed income low cost. Across the board, fixed income is seeing dramatic growth. I think there's increasing acceptance both by retail investors and institutional investors that the ETF is a good vehicle to hold fixed income and you're just seeing that asset allocation Moving that way.

Speaker 3

And then finally, active ETFs of all sort you're seeing growth in and It's been a long time coming. As you know, it's been over a decade on how was this actually going to play out. It's ironic how it's playing out and that Everybody's just taking their standard investment strategy and putting it in active ETF. We benefit from some of that on the GA side in terms of what they're doing in fixed income, but we benefit from it greatly on the servicing side because We're very, very not to overuse the word active in the active ETF servicing space and We believe you'll see a lot more growth there as core funds and core offerings of well known asset managers either get converted to ETFs or launch ETFs. So we're really pleased on the GA side.

Speaker 3

In terms of what drove it, I think was the Next part of your question. I mean part of it was much more focus and resources dedicated to the various intermediary channels. I mean, our roots are in the institutional channels, but the lots of the growth is in the intermediary channels. So That's part of it. And then as we talked about, I believe last quarter, we took a hard look at pricing, particularly in the so called low cost ETFs and recognizing their durability, felt that it was worth the investment to reprice them to continue to gain market share because they tend to be Very, very sticky.

Speaker 6

There's a lot of detail. It's perfect. I'll go quickly on the follow-up. It's the same question, just different on the servicing front. Happy with the wins you noted.

Speaker 6

Maybe we could just drill down. I know it's not huge yet, but the private markets piece of the servicing wins, I'm curious if you want to tell us how much it was, but More importantly, what it is and how is it one client or is it multiple clients? I'm curious on how that the product market servicing space is developing. Thanks.

Speaker 3

No, no, it's well to answer the last part of it first, Glenn, it's certainly not one client. I mean, this is a space that we've invested in and we're well known and we see a secular trend here where It's so many of these operations are held inside firms are highly bespoke, often sitting in very expensive locations. And as the product sets have become more complicated, I mean, it's following a path that the active long only industry followed 10, 15 years ago. It was fine to do all this stuff inside when it was just a couple of products that were fairly straightforward. That's not what's happening now.

Speaker 3

Products are more complicated. As you start to think about structures that enable high net worth individuals to participate in it, you've got that added complexity. And then oftentimes There's side investments that are permitted, etcetera. So it's very complicated, lends itself to Outsourcing, it's still very much an in source business. So we see lots of potential growth in it.

Speaker 3

Its fee characteristics are different, positive in the sense that the fees are higher, but also The fees get fully recognized when the fund is fully invested. So the part that we pay a lot of attention to is what's the expected actual money raise and then drawdown. And

Speaker 7

How do

Speaker 3

we do our best to match our expenses to that? But we're very excited about the business. Much of the investment, product investments that Eric talked about in the 2024 guide includes further strengthening of our position there. There's innovation in there and our goal is to continue to set moats around us so we can continue to excel at it.

Speaker 4

And Glyn, it's Eric. I'd just add, privates has been a real strong area of growth for us. We've described it as up 10%, 15% in different quarters. So it's a big part of our growth agenda. As we this past year and then this coming year as we take our sales goals up $350,000,000 to $400,000,000 at least a quarter of that plus is going to be around privates and that's what's going to help us continue to drive privates growth, we think in the 15% plus range in terms of year on year revenue.

Speaker 4

So it's It's an area that I think we've actually broadly with both large and small and midsize. It's actually well And it's got a good mix of U. S, Europe and Asia Sales coming through as well.

Speaker 3

Yes. As well as, Glenn, it's not just Private Equity, it's Private Equity Venture. Private Credit is booming and for every bank that Complaints about what's going to happen with regulation and the fact that it's pushing activity out of the banking system that's going right into the private credit area and We should be the beneficiary of that growth.

Speaker 6

We appreciate all that. Thank you.

Operator

Your next question comes from Gerard Cassidy with RBC. Please go ahead.

Speaker 7

Hey, Eric. Hey, Ron.

Operator

Eric, can you share

Speaker 7

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

Speaker 4

Gerard, it's Eric. I take a sigh when I think about this question. I think the Predictability is partly around Fed actions, right? This is the highest rate level that we've seen in 22 years. And also the if I

Speaker 8

go back a couple of

Speaker 4

years, the lowest rate level we've probably seen in 2 decades as well, right? So we've kind of we're at these wide bookends relative to Really the since the I want to say that the turn of the century, right? Right. And that's really created this volatility. Can we manage that and mitigate?

Speaker 4

Well, we do try to on a regular basis match off deposit, deposit tenor, rate characteristics with The asset side of the portfolio and we do that with duration. The challenge is if you take too little duration, you have even more volatility. If you have to take too much duration on the asset side of the portfolio, you've got more AOCI risk. And so our tools to stabilize work up to a point and then have some negative implications. So I don't really see a way to turn What we'd like to have, I don't see a way to turn this into just a flywheel, a metronome that moves at a certain pace.

Speaker 4

And it's just a feature of what we do. And part of it is our Institutional deposits have somewhat more asset sensitivity or liability sensitivity to rates relative to a very simple regional bank. So we'll tend to have a little more, but that's part of the industry. That's I think we're in line with peers.

Speaker 7

Very good. Ron, in your prepared remarks, you talked about the success And the momentum you're having with the Alpha product in the servicing business in the Investment Services business, I should say, Is there any capacity constraints that you've got to be careful about if the momentum continues? Or is it almost Now you got plenty of bandwidth to handle future growth.

Speaker 3

I would say that the capacity constraint has been particularly with these large complicated clients, the really large ones, Some of which are well, most of which are still being onboarded. The capacity strength has been around onboarding.

Speaker 9

Over

Speaker 3

the past year in particular, we've gotten better at that. You can if you just look at that number, We were roughly at about as I recall $3,600,000,000,000 in assets to be onboarded and we're now down to $2,300,000,000,000 So you can see we're getting better at that. The real constraint To be specific about it tends to be and how quickly do you onboard the middle office element to that because that often requires Engineering and by that I mean engineering with the client because ultimately that's A client and it's like any other kind of industrial outsourcing. A client has an operation, does things in a particular way, wants to outsource that element of it to us. We're not interested in taking somebody's mess for less.

Speaker 3

I mean, we need to actually work with them to engineer it in a way where as much of it as possible is standardized and that the customization is limited to the kinds of user interfaces or how things are actually applied. And we've just gotten better at that over time. So I would say Looking forward, we don't see that as being a meaningful constraint.

Speaker 7

Very good. Thank you.

Operator

Your next question comes from Jim Mitchell with Seaport Global. Please go ahead.

Speaker 8

Good afternoon. Just maybe a follow-up on the outside of sort of the private markets you've had, You've ramped up pretty quickly in terms of getting to your $400,000,000 of net of new servicing fee wins. And maybe if private markets are a quarter, we talk a little bit about the other three quarters where you've seen success? What's worked? What hasn't worked?

Speaker 8

And what kind of opportunity set do you see maybe even get above the $100,000,000

Speaker 3

Yes. Jim, it's Ron. I mean, It's no one thing, but a lot of really important things across the board to ramp up our execution. Where we're seeing it to answer the first part of your question is The core Investment Manager segment still remains strong and active for us. And as some of those Firms are facing the same kind of market that everybody else is.

Speaker 3

They're more interested in actually trying to do more with us and do different things with us. A little bit of a resurgence in the asset owner marketplace. And in particular amongst asset owners that aren't just pure asset allocators meaning managing some assets themselves or truly actively asset allocating doing not just listening to a consultant tell them what to do, but either managing money or at a strategic and tactical level, allocating assets, which again requires support. But in all cases, what we're doing is, we're really focused on ensuring that the back office part of all this comes with it and comes with

Speaker 6

it

Speaker 3

in a timely fashion, right? Because as I was saying earlier when I was talking to Gerard, The thing that takes a long time or a longer time to onboard would be the middle office, the outsourcing element of it. Onboarding back office is pretty easy, pretty straightforward. And it's in almost all instances comes on in a pretty healthy incremental margin given the scale activities to it. And then finally, I should just talk about regions.

Speaker 3

We have invested heavily in the capabilities in all of our regions, where you'd see probably the most impact from that over the last couple of years has been Just the very good growth that we're seeing in Asia Pacific and really all parts of Asia Pacific from Australia, North to Japan and everything in between. The U. S. We've talked about in the past, We were not pleased with where we were in this past year, particularly the second half of the year. We're actually reasonably pleased with how we've done.

Speaker 3

Europe has always been strong to us. It was a little softer in 2023, but again, a very strong pipeline. So but that regional focus where we're actually pushing accountability down into the country and regional level and making sure It's very clear who's responsible for what, sharing obviously not just the technology and the product, but the best practices and how you move these things forward, but very much decentralized in the accountability.

Speaker 8

Okay. That's all really helpful. And maybe Eric, just a quick one on the held to maturity book, still yielding just a little over 2%. Can you kind of walk us through the maturity profile of that? How long we start to see some pickup in or turnover and reinvestment benefits from that portfolio?

Speaker 4

Yes, it's Eric. The way I describe it is we've got a natural roll off in that portfolio. It's about $5,000,000,000 a year. So it sort of plays out and that's related to the maturity in the latter. So that'll come down over the next couple of years.

Speaker 4

As that happens, because as you say, it's At a lower coupon relative to our average, right, our average portfolio yields are 3, 3.5 range. There's real pickup that comes through that line At least for the next couple of quarters, I guess it is probably for the next couple of years even because Once rates stabilize, we do think that we'll also get some steepness in the yield curve and that'll help So there's some benefits coming that way. It's also a portfolio that obviously will be They'll insulate us from rate moves. I don't think in the next few years, this is the last Down cycle versus upcycle and that we'll see. And so it'll serve its purpose then as well.

Speaker 8

All right. Helpful color. Thanks.

Operator

Your next question comes from Steven Chubak with Wolfe Research. Please go ahead.

Speaker 10

Hi, good afternoon. So, Eric, I wanted to start off with a question just On the fee guidance and benchmarking your historical fee performance versus the guidance, You've struggled to at least meet or exceed the guide in the absence of significant equity market gains. So can you guys hear me okay?

Speaker 6

Yes.

Speaker 10

And I'm sorry about that. So you have a conservative market assumption embedded in the fee guide for the coming year. And just given that historical experience, I was hoping you could just provide additional granularity in terms of growth across the different fee lines that's underpinning that 3% to 4% growth assumption for this year?

Speaker 4

Sure. Let me maybe describe it in a couple of ways because 3% to 4% is for the overall franchise. We think that there are some areas of the franchise that will be higher and in some cases a good bit higher than that. Asset Management very geared towards the equity markets and the 10% tailwind in equity markets comes through on literally half of that tends to go right through the asset management fee line. And then the flows that we talked about earlier in the call provide a nice tailwind.

Speaker 4

We need to see how markets play through, but the combination of those 2, which is exactly how the business is designed, it's It's market based and it's flow based, we'll be healthy. I think software and data processing, We've historically said high single digits, sometimes low double digits. If you look at the last couple of years, you're at the 9%, 10% average full year growth and we've got good visibility there. Part of that is alpha and part of that is outright software and data sales. And so that's strong.

Speaker 4

I think at the other bookend, servicing fees will come in, it will be A bit below the 3% to 4%. Now some of that is core organic net new business that we need to drive, which is why we've reshaped and tuned that area in on the sales and how we go to market, you're seeing some of the benefits there and how we measure ourselves. We're being very conscious there. But one of the reasons that one will be lower this coming year is that we had that previously announced transition coming through, which will mute some of what we'd like to see. And then the markets activities, we're hoping it will be somewhere in the middle of the range, whether FX trading and sec finance.

Speaker 4

I think what plays out behind the market dependent areas and sometimes why we don't meet is around client we describe as client activity, how much transactional activity, whether our clients are on the sidelines or whether they're all in. That this past year on the servicing fees, which are half of our fees, that was worth 2 to 3 percentage points of servicing fee headwind. I mean that literally, so you do the math that's worth $100,000,000 $150,000,000 of headwind because We don't have those that activity, the transactional activity in derivatives, in international custody, which is very valuable to us. Part of what plays through is these macroeconomic features, equity bond markets on one hand, You've got a client, the kind of risk on risk off sentiment, I think is important. You've got volatility levels in FX and agency lending.

Speaker 4

And so those we have to live through and navigate through and sometimes those will come in more strongly and sometimes less. And then I think finally the piece that we do need to Deliver on, Steve, is the part that we can control, which is sales, it's retention. And we've been very clear about Our goals and our targets very purposely because that's where we think we need to hold ourselves particularly accountable and where you can hold us accountable. And there's a version of goals and targets in servicing. We spent a little extra time there.

Speaker 4

But if you go through Our line of businesses, we've got similar kinds of goals area by area and that's on us to deliver, which will help power us through, but the 6 elements will still come and go.

Speaker 10

Thanks, Eric. That's really helpful color. Just one quick follow-up for me. What's the assumed timing for the large client transition? Just wanted to get just whether that's reflected in the 1Q servicing fee guide or you're expecting that later in the year?

Speaker 4

Let me see how let me try to describe this to you in a couple of ways and to be helpful. At this point, on a quarterly run rate basis, and I say that very specifically, we're about halfway through the transition, including a piece that came out in the Q4. So we're halfway through on a quarterly run rate basis. You also though have to think about it on a fiscal year on year basis. And the way I would describe it on a fiscal year on year basis, Remember, we said this was worth about 2 percentage points of total fees.

Speaker 4

That's what we've disclosed in our Qs and Ks. About a quarter of that fiscally has come out through the end of 2023, about half of it will come out through 20 24 and about another quarter in 2025. So it just takes time to play through. And so we did include that headwind in the Q1 2024 versus 1st quarter 2023 guide and it is important to that guidance. Our guide includes that and you've got the net guide as a result.

Speaker 10

Very helpful. Thanks for taking my questions.

Operator

Your next question comes from Ebrahim Poonawala with Bank of America. Please go ahead.

Speaker 2

Hey, good afternoon. Just a very quick follow-up. I know the call has gone on for long, Eric. I heard you talk about just the Right level of deposits between $200,000,000 $210,000,000 Did you say that you expect the growth we saw in 4th Q2 reverse in 1Q as we think about where deposits shake out?

Speaker 4

Ebrahim, it's Eric. No, what I said is that We think we'll operate in the $200,000,000,000 to $210,000,000,000 range in the Q1, second through the year. We expect that to be where we land. I think in Q4 on average, right, remember we also I think talked a little bit about the month. We talked There's in the period data, which is very volatile.

Speaker 4

But on average, we ended up at, I think, around $207,000,000,000 for the quarter in 4Q. And so we think roughly flattish deposits into 1Q. It's just hard to tell. There's seasonality at year end. There is there tends to be a low point in February and then you've got cash building for tax purposes into March.

Speaker 4

But I'd call it flattish in the scheme of things, but with a range around that.

Speaker 2

And just a bigger picture question around NIB mix and NII. Do we need to get to a point where QT is shut, The Fed is done with cutting rates before we see NII stabilize and maybe the deposit mix shift will stabilize as well. Like do we need to get to that point or Can it happen sooner than that?

Speaker 4

It's a fair question. My instinct on this is NIB will begin to stabilize sometime in 2024 by we think sometime in the by the middle of the year Q3, you've kind of at that point, we've I'll call it burn through the largest accounts. Those are the ones that kind of on us since its Peak are down 75% in NIB. The smallest accounts are down by about 25 percent since the peak and those we're seeing stabilize more and more. So, I think we'll see some stability in NIB because Clients and funds and fund boards have made their decisions, especially the ones that have $1,000,000 or $2,000,000 in an account.

Speaker 4

Some of them just don't want to deal with the tax reporting. And so you'll get to some stabilization. So we think That'll kind of stabilize. I think the broader question on NII will then come with How what well and at that point, I think deposit beta is kind of tend to stabilize as well. So think at that point in the second half of next year, the real question is what is the direction of interest rates on the front end.

Speaker 4

It's a very important question, which is What's going to where's the long end going to go? And where's the long end going to go in the U. S. Versus in the international markets? And that is particularly important to the banking sector because with some amount of steepness in the yield curve and it's hard to remember when we've had steepness, It's been a while.

Speaker 4

Some amount of steepness in the yield curve is quite accretive to NII and you expect a good economy to have some. And so that'll be a feature. So there's a series of elements that'll come through and it's hard to, I think to as a result predict too precisely.

Speaker 2

That's helpful color. Thanks, Eric.

Operator

Your next question comes from Ryan Kenny with Morgan Stanley. Please go ahead.

Speaker 11

Hi, thanks for taking my question. Just a follow-up on the capital side. So you've had an 11.6 percent CET1 ratio. That was a nice improvement sequentially. It looks like that was driven mostly by $6,000,000,000 of lower RWA.

Speaker 11

Can you just help us impact the RWA dynamics a bit? What drove the optimization? And then you also mentioned RWA could be higher this year to support various businesses. Does that mean that the optimization was just temporary?

Speaker 4

Sure. It's Eric. Let me describe it in a couple of different ways. We're all every bank tries to manage RWA, just because it's part of our capital requirements and returns. And we try to report it carefully and we take advantage we do it fully to the rules as you'd expect.

Speaker 4

What tends to create the volatility because it's a spot measure, it's a one day of the quarter, 1 out of 90 day measure is the market factors, right? So if you've got an FX or in any of the trading businesses, if you've got A forward book or even a vanilla derivative book, you've got counterparty exposures, you've got that are affected in particular by the currency pairs. And as those move around in the last week of the quarter, you might be in the money or out of the money in those positions and than those directly because of how the standardized RWA mathematics work just goes right through RWA. And so that could create a swing of $4,000,000,000 $5,000,000,000 on the size of our RWAs. Our is about 100 and we printed around $112,000,000,000 About half of that is in the markets area.

Speaker 4

And so there's a good bit of variability and that's literally what happens. And so sometimes we'll end up low, sometimes we'll end up high. If you look At Page 14 of the presentation materials, you'll see low point of $107,000,000,000 A year ago in RWA, you'll see a higher point of $118,000,000,000 last quarter and quite a bit of that is driven by just the those market factors playing through into the calculations that we have. And then in addition to that, if you run a loan book Like we do, you'll have overdrafts, overdrafts take RWA as well. And so we also saw some amount of benefit there this quarter.

Speaker 4

I think the way I would describe the go forward view is that We ended up particularly low this quarter. We said by it could be $6,000,000,000 $7,000,000,000 lower than expected. What would par be? Maybe I'll describe it that way. Going forward, it might be $118,000,000,000 It might be $120,000,000,000 but you've got to put up plus 5,000,000,000 minus 5,000,000,000 band around that.

Speaker 4

And so we'll what we want to do is we want to take we want to gently continue to reinvest Capital into our businesses because these FX businesses now that we have, have good returns. We've managed them well. They've got 10%, 12% returns in many cases. The securities finance businesses typically are high single digit return businesses, but that's healthy and it's very connected to the servicing and the administrative fee business that we have and important to our clients. And so our view is that These are ways for us to solidify and expand and deepen our relationship with clients.

Speaker 4

And so we'll gently add RWA Each year, how much do we add? We add a few $1,000,000,000 $3,000,000,000 to $5,000,000,000 more RWA each year perhaps. But there'll be some volatility around that. And that'll be a part of the way we drive our organic growth. We're a high return bank, that's for sure.

Speaker 4

But we will we do want to put some of our capital to work for core organic growth reasons.

Speaker 11

Okay, great. Appreciate all those details. Thanks.

Operator

Your next question comes from Mike Brown with KBW. Please go ahead.

Speaker 9

Great. Thank you for taking my questions. I guess, I noticed that you saw record cash net inflows in 2023 and you mentioned that you actually took share in the institutional money market space. As we head into a declining rate environment here, I guess what's your expectation about how these cash and money fund assets Good trend from here. I guess, historically, institutional money markets, they can act quite differently than retail.

Speaker 9

So I guess once the Fed begins to reduce rates here, what are you thinking about in terms of the path of the flows out of money funds? Could you actually still see some money fund inflows from institutional investors?

Speaker 3

Yes, Mike, it's a good question and one we think about all the time. So part of the way we've attracted More money market funds going back to one of my prior answers is we just have a broader client base. So and that helps. We've gained market share not just in terms of assets, but we've just attracted more clients. And once you have them, whether the balances go up or down, you typically have them.

Speaker 3

I think historically what's happened in terms and you've got to look back in history now because we haven't had this kind of a marketplace. But the really sophisticated holders of institutional money market funds tend to hang on, Right. Because the fund itself, depending on its duration, and there is a little bit of duration in it, actually lags. So it's usually the opposite when rates are rising, the very sophisticated holders or toggling in and out depending on whether they see opportunities to go direct. Just given the nature of our client base.

Speaker 3

We don't see a lot of that activity. So we expect to keep them and it really will be around Where do their balances go in? Do they need it for some other reason or do they see more attractive investment opportunities? I would expect that we would see if indeed we see a continued risk on environment that itself will cause a little bit of reallocation of institutional money market funds because the saying that everybody What everybody's talking about that there's so much parked on the sidelines. Well, a lot of it is parked here.

Speaker 3

But I would go back where I began the answer, which is it really is about establishing more client relationships, servicing them very well and then continue to grow the number of clients based on that track record.

Speaker 9

Okay, great. Thanks, Ron. The $5,000,000,000 share buyback authorization, that certainly was a big number. Eric, as you just alluded to in the last question, just a lot of puts and takes to consider on the capital front in 2024 and into 2025. I guess my question is really just why come with such a large authorization?

Speaker 9

You're targeting 100% payout ratio. So this would seem to me that you certainly would not need all of that in 2024. Is this just a desire to have kind of a big authorization in place for a multiyear horizon or just to have more flexibility over time? Just look to hear a little bit more about that. Thank you.

Speaker 4

Mike, it's Eric. The background here is that the industry has evolved. I would say pre CCAR,

Speaker 6

which is

Speaker 4

a long time ago. There used to be open ended authorizations in the banking sector. Once we got into CCAR, remember, It was a very defined annual amount of buybacks that you had to submit. In fact, you had to submit the 1st year and the 2nd year and there was a lot of making sure that what you submitted within the Fed CCAR process was actually what you did because I wanted to keep consistency with that. And so the industry moved towards Quite a bit of disclosure on a 1 year basis as a result.

Speaker 4

And if you recall, a lot of those 1 year closures happened right after CCAR was announced at the either at the end of June or in the Q2 earnings in July. What we've seen as we've scanned at least the banking, our peer banks, the GSIBs, the large U. S. Regionals is now that CCAR is it's still an annual process, but it's really With the SCB and some of the refinements to it, it's really an ongoing process. And what we've realized is that, I'd say more than 3 quarters of our peers, you probably know, have actually moved to open ended programs over the last year, year and a half.

Speaker 4

And so we just wanted to conform to that. As a result, this one's multi year, it's open ended and we'll take it from there.

Speaker 9

Okay, that's great. Thanks for all the color there, Eric. Thank you.

Operator

Your next question comes from Mike Mayo with Wells Fargo Well,

Speaker 12

no good deed goes unpunished $5,000,000,000 buyback to that last question. But Are you assuming that Basel III gets modified? And if Basel III didn't exist, how much higher would that $5,000,000,000 number be? And at what price do you say buybacks don't make so much sense anymore?

Speaker 3

Mike, maybe I'll start On the Basel III, I think it's where Basel III comes out is very uncertain at this point. The comment period ended January 16th, I don't know how many millions of pages were submitted, but there's a lot to be evaluated there. And you all know the various pressure and response that the regulators are getting on this. So it's very hard to tell. I don't know that we would have changed the authorization if we had perfect clarity on Where it was coming out, it was a factor.

Speaker 3

But it's not like we have a We think it's absolutely going to be this and therefore. So I hope that helps. Yes.

Speaker 4

And Mike, it's Tara. Go ahead, Mike. Go ahead.

Speaker 12

No. Just so where your base case, what is the RWA inflation? The most recent updates, we've gotten a few changes here during earnings season due to Basel III.

Speaker 4

Yes. Mike, let me describe it this way. The headline that we've previously disclosed for the ANPR as it's written is Basel RWA increased for us at about 15%. So that's what we've shared. I think what we said at the time and we actually believe even more so now is that it will come in At a portion of that, there's been lots of discussion around, for example, energy tax credits, some of the arcane parts of Basel and how that impacts public policy mortgages, which we're not really affected on.

Speaker 4

There's much more discussion about operational risk literally over the last few months. And that would make us quite optimistic that the increases would be relatively small. So We've not updated it because it's just you got a there's a menu out there, but we're encouraged. We think the regulators are trying to navigate public

Speaker 13

policy and on one hand and

Speaker 4

the right level of And on one hand and the right level of capital in the banking system, but we think that the direction of the discussions in particular over the last few months are constructive.

Speaker 12

Okay. Thank you.

Operator

Your next question comes from Brian Bedell with Deutsche Bank. Please go ahead.

Speaker 13

Great. Thanks Most of my questions have been asked and answered. Can you hear me?

Speaker 3

Yes.

Speaker 13

Okay, great. Most of my questions have been answered. Just one quick one on securities portfolio repositioning. I guess, Eric, what's the Desire to potentially do more of those, potentially take losses and look at the sort of the capital usage for doing that and enhancing NII and NIM more versus share buybacks?

Speaker 4

Brian, it's Eric. It's something that we continue to think about. I think every bank continues to think about we included. We're just continuing to just work through how do we feel about The rate levels that we're at, in particular on the up on the curve, We are conscious of that both in the U. S.

Speaker 4

And in the international areas. We've got positions in pounds, sterling and euros and so forth. So We'll just continue to evaluate it. I think as you indicated from your question, part of the reason we repositioned Last year in Q3 was around rate position. We thought it was a very good entry point.

Speaker 4

In retrospect, we timed that quite well. So We were quite pleased and I think we felt like we came out ahead economically with the trade. We took out some bonds, but also reinvested both in the belly of the curve and overnight. So That was constructive. And we'll also keep an eye on we don't have a lot Capital intensive securities, we've always had a very vanilla book.

Speaker 4

So there's not an enormous capital motivation, but we'll selectively look at it and See if it might make sense. But I think we're like many others. It's one of the things we keep an eye on.

Speaker 13

Okay, great. Thanks very much.

Operator

Your next question comes from Rob

Speaker 14

target for this year. Hypothetically, let's say fees come in better than you expect. Would you anticipate dropping that down to the bottom line or reinvesting it? And maybe the same question in reverse, fees come in lower than expected. What kind of room is there on the expense side to preserve your fee operating leverage target?

Speaker 3

Rob, why don't I start on that? We feel like we've done a very good job this year in terms of I'm sorry, in 2023 focusing on BAU cost reduction to help finance and create a very sizable investment pool. Eric walked you through that. So obviously if fees are up dramatically more than expected, there are some revenue related expenses, but I wouldn't foresee. I think we've got a lot to invest and execute against and I really want to get through that.

Speaker 3

On the margin, there might be a few things that we would do, but the vast majority of it go to the bottom line. In the case If the opposite occurs, whatever a terrible market, geopolitical issues flare and you've just got a very different environment than any one of us anticipate. Again, we'd probably You'd see some revenue related expenses come down naturally, which would help. I think at least my initial instinct would be to try and preserve the investments and look at, is there any more to do on BAU, but then, obviously some of these, yes, we would We've got a pecking order for our investments in terms of priorities. And if it came to that, we'd defer them.

Speaker 3

And Rob,

Speaker 4

it's Eric. I would just add that we've got a

Speaker 11

pretty industrious

Speaker 4

productivity plan for this year. Part of that was the repositioning that we announced. But 2 thirds of the roles impacted are really around delayering and simplifying State Street. We're actually taking our spans of control in some areas like operations from 5 to 1 to 8 to 1. We're taking span the controls in the business and staff functions in some cases from 3 to 1 to 5 to 1, right.

Speaker 4

And the benefit of that is it actually brings Our teams, our client teams and operational teams even closer to our clients, Right. And some of what we're doing with the joint venture consolidation is a catalyst for that because some cases we had too many handoffs and now we can Simplify processes and again bring them closer to our clients. So there's some real structural changes there. And what we do want to do is make sure We see those through. As Ron mentioned, there's always a little more we'll look at on the margin and it But we want to be careful.

Speaker 4

We want to do this right. But on the margin, you continue to work vendors and so forth, you look at performance based incentive compensation. There are always other smaller levers. But we're pretty, I think we've got a nice work step out and a lot to do. And I think we've got real confidence that this is I think year probably 5.

Speaker 4

I don't think we name our programs with annual versions, but this is probably year 5 of productivity program and should really deliver quite a bit.

Speaker 14

Okay, thanks. And then on the Regulatory front, there was some commentary last week from the FDIC around regulations for large index fund providers. I'm curious if you have any thoughts there on how that can

Speaker 3

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

Speaker 14

Okay. I can send it over to you later.

Speaker 4

Yes. Why don't we follow-up offline, Rob? Just send it through to Eileen and the team. Yes.

Speaker 3

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

Speaker 6

Okay. Thanks.

Operator

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

Speaker 3

Well, thank you everybody for joining the call.

Operator

Ladies and gentlemen, This concludes your conference call for today. We thank you for participating in that. Please disconnect your lines.

Powered by Quartr