道富銀行 (STT) 2017 Q4 法說會逐字稿

Good morning, and welcome to State Street Corporation's Fourth Quarter of 2017 Earnings Conference Call and Webcast.

Today's discussion is being broadcast live on State Street's website at investors.statestreet.com.

This conference call is also being recorded for replay.

State Street's conference call is copyrighted and all rights are reserved.

This call may not be recorded for rebroadcast or distribution in whole or in part without the expressed written authorization from State Street Corporation.

The only authorized broadcast of this call will be housed on the State Street website.

Now I'd like to introduce Ilene Fiszel Bieler, Senior Vice President of Investor Relations at State Street.

Please go ahead.

Thank you, Nora.

Good morning, and thank you all for joining us.

On our call today are Chairman and CEO, Jay Hooley, will speak first; then Eric Aboaf, our CFO, will take you through our fourth quarter and full year 2017 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com.

Afterwards, we'll be happy to take questions.

(Operator Instructions)

Before we get started, I would like to remind you that today's presentation will include operating basis and other measures presented on a non-GAAP basis.

Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our 4Q '17 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 in our 4Q '17 slide presentation under the heading Forward-Looking Statements and in our SEC filings, including the Risk Factors section of our 2016 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 Jay.

Thanks, Ilene, and good morning, everyone.

As you've seen today, we ended 2017, which is our 225th year, with strong operating results reflecting momentum across our asset servicing and asset management businesses and continued strength in equity markets as we advance our digital leadership.

As you're also aware, although we think tax reform will have a significant positive for us going forward, it did result in a onetime net impact in the quarter related mostly to deemed repatriation of foreign earnings, partially offset by the revaluation of our deferred tax liabilities, which we'll go into shortly in the presentation.

Right now, we will be discussing our business performance on an operating basis, which excludes the onetime tax impacts.

Fourth quarter and full year results included strong EPS growth and improved return on equity.

We continue to see momentum across our core franchise.

Strength in equity markets and new business lifted our assets under custody and administration to record levels at year-end with growth of 15% from the end of 2016 to $33.1 trillion.

We achieved new servicing commitments of $445 billion in the fourth quarter 2017 and $800 billion for the year.

Our total new business yet to be installed at quarter end was $350 billion, which was roughly the same as last quarter.

And importantly, new business opportunities remain robust across the franchise.

State Street Global Advisors finished the year with record assets under management of $2.8 trillion, up 13% from 2016 year-end, driven by strength in equity markets, follow-on wins from the acquired GE Asset Management business and higher-yielding ETF inflows of $28 billion.

Furthermore, 2017 results reflect success in realizing the benefits from State Street Beacon, our multiyear program to digitize our business, enhance our client experiences and gain efficiencies.

Importantly, as a result of the efforts we have made to expand and accelerate Beacon, we now expect to complete the Beacon program and realize the related financial objectives by mid-2019, 18 months ahead of schedule.

Now turning to Slide #5, I'd like to review some of our key achievements for the year.

I'm very pleased with our performance this year as we achieved or exceeded all of our 2017 financial objectives.

Fee revenue growth of 8% was driven by continued market appreciation and new client business, enabling us to exceed our fee revenue target for 2017 by a healthy margin.

We remain committed to expense control as evidenced by full year positive fee operating leverage of 2.1% and Beacon expense savings of approximately $150 million.

Net interest income growth of 14% exceeded our financial goal for the year by 8 percentage points as we actively managed our balance sheet.

We also achieved a pretax operating margin of 31.4%, surpassing our 2018 Beacon target 1 year ahead of schedule.

These results demonstrate our commitment to achieving our financial goals, advancing our digital leadership through Beacon and continuing to drive growth in our business by creating new product solutions to support our clients.

We delivered full year EPS growth of 25% and improved return on equity by 210 basis points to 12.9%.

And during 2017, through share repurchase and common share dividends, we returned $2 billion of capital to shareholders.

Beyond the achievement of our financial goals in 2017, we marked our 225th anniversary with employees and clients around the world, celebrated the 40th anniversary of our foundation, and with Fearless Girl, State Street Global Advisors advanced an important agenda to achieve greater stewardship and diversity in our industry and beyond.

Before I turn the call over to Eric to review our financial performance for the fourth quarter and our outlook for 2018, let me take a moment to talk through the recent tax reform change and how we will deploy some of the benefits.

The majority of the benefits will flow through our financials and result in higher earnings.

We are targeting a small percentage of the gain toward 3 specific initiatives that will benefit our employees and the communities where we live and work.

First, we'll invest in an employee retirement plan by enhancing the matching contributions from our defined contribution plans.

Second, we will introduce new technology and content to provide employees a customized learning experience to build the skills they need for future success.

And third, we will increase our State Street foundation matching gift benefit for employees and increase our global grantmaking to support the communities in which we live and work.

And with that, Eric, over to you.

Thank you, Jay, and good morning, everyone.

Before I begin my review of our 2017 results, I'd like to take a moment on Page 6 to discuss notable items in 4Q '17 and 4Q '16 and the related impact on our financials.

In 4Q '17, we recognized $270 million of onetime tax cost and revenue adjustments based on estimates associated with tax reform.

The primary impact from our GAAP basis results include a repatriation tax expense of $454 million, which was partially offset by a tax benefit of $197 million associated with the revaluation of our net deferred tax liability due to lower future tax rates.

We also had a revenue reduction of approximately $20 million associated with a onetime accelerated amortization of tax-advantaged investments.

Together, this resulted in a 30 basis point impact to CET1 and a 15 basis point reduction on Tier 1 leverage.

Just to remind you, a year ago, our 4Q '16 results included a tax benefit of $211 million and the acceleration of incentive compensation expense of $161 million.

The net effect of these 2 items was a benefit of $50 million in the year-ago quarter.

Now please turn to Slide 7, where I'll start my review of our operating basis results for 2017.

Overall, full year 2017 results were driven by client fee revenue momentum and increase in net interest income supported by higher U.S. interest rates coupled with disciplined pricing as well as a continued focus on prudently managing expenses while reinvesting in the business.

Key performance metrics for full year 2017, excluding the impact of tax legislation and last year's items that I just mentioned, are as follows: EPS increased 25% to $6.41 a share, supported by fee revenue growth of 8% and NII growth of 14%.

ROE increased 2.1 percentage points to 12.9%, now nicely in our targeted range.

Positive fee operating leverage came in at 2.1 percentage points.

Pretax operating basis margin reached 31.4%, which is now ahead of our 2018 Beacon target of 31%.

Turning to 4Q '17.

EPS of $1.83 increased 36% from a year-ago quarter, driven by strength in servicing and management fees and higher net interest income.

Return on equity for the quarter measurably improved to 14.1%, up 2.7 percentage points.

Just like last quarter, 4Q '17 results also benefit from a lower-than-expected tax rate of 27%, primarily due to the higher share of lower tax foreign earnings and benefits related to stock-based compensation, which was worth approximately $0.07 per share.

Now let me turn to Slide 8 to briefly review growth of 2 key drivers.

Business momentum continued in 4Q '17 in both AUCA and AUM.

Record AUCA of $33.1 trillion at year-end increased 15% from 4Q '16.

Growth was primarily driven by a combination of market appreciation and client activity.

Flows were particularly strong in EMEA and middle-office outsourcing.

At State Street Global Advisors, AUM increased 13% from 4Q '16, driven by market appreciation and higher-yielding ETF inflows, partially offset from lower-yielding institutional mandates during the year.

Our new low-cost ETF offering added $5 billion of inflows in just 3 months.

These 4Q '17 levels in both AUCA and AUM position us well for 2018.

Please turn to Slide 9, where I will cover 4Q '17 fee revenue results on a year-over-year basis.

You'll also find additional detail in the appendix with the sequential quarter comparison to 3Q '17.

Total fee revenue increased 6% from 4Q '16, driven by strength in asset servicing, asset management and securities finance fees.

Servicing fees increased 7% from 4Q '16, reflecting higher global equity markets, broad-based new business wins and the benefit of a declining dollar, partially offset by modest hedge fund outflows.

Management fees again demonstrated strong growth in 4Q '17, increasing 16% relative to the year-ago quarter.

The increase was driven by higher global equity markets and higher revenue-yielding ETF inflows, including $28 billion in 4Q '17 alone.

Compared to 4Q '16, both servicing and management fees benefited from the weaker U.S. dollar, as we outlined in the table below.

Trading services revenue decreased from 4Q '16, primarily due to lower volatility as well as a modest impact from the businesses we exited in 2017, partially offset by higher client FX volumes.

Securities finance fees increased from 4Q '16, primarily due to higher client volumes in both our agency and enhanced custody businesses, partially offset by lower spreads.

Moving to Slide 10.

NII was up 20% and NIM increased 31 basis points from 4Q '16.

NII benefited from higher U.S. interest rates, disciplined liability pricing and loan growth, partially offset by a smaller balance sheet.

U.S. dollar interest-bearing client deposit betas remained relatively low around 25% when compared to 4Q '16.

As I've previously commented, we expect deposit betas to increase over time as they have in past cycles.

Relative to 3Q '17, noninterest-bearing deposit balances declined only slightly, while interest-bearing deposit balances remained relatively flat.

U.S. dollar interest-bearing client deposit costs increased by only 2 basis points sequentially.

Notable in our financial supplement, you'll see a decrease in our non-U.

S. domiciled interest-bearing deposits and a corresponding increase to the U.S. domiciled interest-bearing deposits.

This was the result of a transfer of approximately $14 billion of foreign-denominated Cayman branch deposits.

The transfer had no impact to our deposit rate paid.

Overall, we continue to price deposits carefully in order to manage the size of our balance sheet while providing the necessary value to our servicing clients.

Now I will turn to Slide 11 to review 4Q '17 expenses.

Expenses increased 4% on an ex-FX basis from 4Q '16, excluding the acceleration of compensation expense a year ago, which I mentioned earlier in my remarks.

The increase was driven by new business activity, merited incentive and additional investments in technology, partially offset by Beacon-related savings and lower professional services costs.

Compensation and employee benefits increased from a year-ago quarter, primarily due to increased costs to support new business, annual merited incentive comp and the impact of the weaker U.S. dollar, partially offset by Beacon savings.

Information systems, transaction processing and occupancy costs increased as a result of new business activity and technology-related investments.

Other expenses decreased from 4Q '16, primarily reflecting lower professional services costs.

4Q '17 GAAP results also included a pretax $133 million Beacon restructuring charge, which will provide payback on average within the next 7 quarters.

Program to-date, Beacon-related restructuring charges now total about $385 million at December 31, 2017.

Let me now move to Slide 12 to review our progress on State Street Beacon.

Starting on the right side of the slide, we achieved $150 million in Beacon savings in 2017, including $50 million in 4Q.

This exceeded our 2017 target by $10 million.

We now expect an additional $150 million in savings in 2018, and we now expect our previously targeted $550 million in aggregate savings to be realized 18 months ahead of schedule by the middle of 2019.

Shifting over to the left side of the slide, I will briefly touch upon notable achievements we have realized since the inception of Beacon.

We continue to digitize how we receive and process data from clients and use speed as a way to differentiate our service.

Key accomplishments include improving efficiencies from advancing our global accounting platform and creating a global workforce to service clients 24 hours a day.

We've also expanded Beacon to our asset management and corporate divisions, including procurement and real estate, and we expect to build further traction on these areas as we move forward.

Now let's turn to Slide 13 to review our balance sheet and capital position.

We continue to maintain a high-quality balance sheet.

Our capital ratios remain healthy, which enabled us to return capital to shareholders through dividends and common stock repurchases, including buying back $350 million of common stock and declaring a common share dividend of $0.42 in 4Q.

We ended the year strong, with our common equity Tier 1 ratio up 30 basis points from last quarter and last year, even with the impact related to the recently enacted tax law.

Notably, you can see that our Tier 1 leverage ratio increased 80 basis points from last December to 7.3%, which positions us well for this year's CCAR.

Turning to Slide 14.

Let me touch upon notable items that will impact our financials going forward.

First, let me start with the impact of the tax law change.

We expect, based on our current guidance, our 2018 GAAP basis effective tax rate to be approximately 16%.

This reflects a 4% to 5% benefit to our core tax rate, which I would define primarily as federal, state and foreign tax rates combined, resulting in a 2018 benefit of approximately $150 million.

As Jay commented in his remarks, while the large majority of the benefits from the enacted tax law will be realized by our shareholders, we are putting key initiatives in place to share some of the benefits with employees and the communities in which we operate.

Next, starting in 2018, on a prospective basis, the new FASB revenue recognition standard takes effect, in which certain costs previously presented on a net basis will now be presented on a gross basis.

We expect the revenue recognition standard to impact both revenue and expenses by about $225 million.

Lastly, moving to the bottom of the slide, we will now be presenting our financials on an operating basis in 2018.

We will provide a primarily GAAP basis presentation.

We will continue, however, to present certain non-GAAP measures such as pretax margin as well as call out additional notable items such as acquisition and restructuring costs in line with industry practice.

This should offer investors a more streamlined presentation with enhanced clarity.

Now please turn to Slide 15, where I will discuss our 2018 financial outlook.

In 2018, we remain focused on continuing our revenue momentum, investing in our business to drive growth in our core franchise and deliver additional capabilities to our clients while at the same time prudently managing expenses, including executing on Beacon.

On this page, you can see on the left an illustrative 2018 operating basis outlook on a like-for-like basis for 2017, which excludes the impact of the revenue recognition standard I just mentioned as well as the impact from the changes in the tax law.

We're providing this view because we believe we continue to have strong momentum in the business and expect to deliver on our Beacon pretax margin goal that was made on this basis.

In the right column, you can see our 2018 outlook as we intend to present it going forward on a GAAP basis, which factors in the new revenue recognition standard, the new tax law and addresses the 2017 gains on sale.

On a GAAP basis, considering the gains on sale, we expect 2018 fee revenue to increase 7% to 8%.

We are assuming good equity market growth as well as continued low volatility trading commissions.

The primary difference between the historical operating basis fee growth outlook of 4% to 5% and our 2018 outlook is the impact from revenue recognition standard plus a small impact from the changing tax equivalent gross-up.

We expect positive fee operating leverage of 75 to 150 basis points considering the gains on sale in 2017 that I mentioned.

I would also note that fee operating leverage will vary by quarter.

We are committed to calibrating expenses against the revenue backdrop over the course of the year.

Turning to NII.

We expect NII to grow within a range of 10% to 13%, reflecting higher expected interest rates in the U.S. Balance sheet growth in 2018 will largely depend on new business and related client deposit activity.

Lastly, we expect the GAAP basis tax rate to be approximately 16% in 2018, which, as I mentioned, reflects a 4 to 5 point improvement over our core GAAP tax rate, which is the $150 million benefit I referenced.

To help clarify the differences between the historical operating basis outlook and GAAP basis outlook, we have also included Page 19 in the appendix, which has a reconciliation between the old operating basis and GAAP basis outlook for your reference.

Now a word on first quarter.

We expect first quarter 2018 to be broadly in line with this full year guidance.

But let me remind you that as in previous years, 1Q '18 compensation and benefits expense will be seasonally higher due to the effects of the accounting treatment of equity compensation from retirement-eligible employees as well as payroll taxes.

Finally, to Page 16.

In summary, we are very pleased with our 2017 results.

Strong 2017 results including -- included operating basis EPS growth of 25% as well as returning $2 billion to shareholders through common stock dividends and share repurchases.

Strength in our asset servicing and asset management businesses and a focus on calibrating expenses against the revenue backdrop enabled us to achieve our 2017 financial objectives, including generating approximately 200 basis points in positive fee operating leverage.

Importantly, we continue to invest in our businesses to enhance client experience.

We also achieved our 2017 Beacon-related savings target and now expect to realize the full program benefits 18 months ahead of schedule.

As we look forward to this year, we are well positioned to achieve our 2018 financial objectives and key strategic priorities, including advancing our digital leadership while controlling expenses and delivering on behalf of clients.

And with that, let me turn it back over to Jay.

Thanks, Eric.

And Nora, I think we can now open the call to questions.

Our first question comes from the line of Alex Blostein from Goldman Sachs.

Thanks for all the additional color, obviously, and the -- and trying to streamline the reporting.

I think it's definitely very helpful as we kind of try to compare you guys against the industry, so appreciate that.

I guess, along those lines, Eric, a question for you around the margins.

I guess if we look at the new reporting, some more kind of under GAAP basis, excluding any significant charges, State Street's pretax margin is in the high 20s, kind of 28%, 29%, obviously, with some room for improvement given Beacon initiatives still.

But when we look at the peers, the margins there, again, on a similar basis, look to be in the low to mid-30s, and I just wanted to get your take on, a, either do you see anything structural about State Street's business that prevents you guys from getting closer to those kind of industry averages.

And if not, where do you see the margins going over time once kind of all the Beacon savings are in the run rate?

Alex, appreciate the question.

It's Eric.

On margins, I think a couple different parts to the answer to your question.

I think, first, we're pleased with where we came in on margins for the quarter and the year.

Those are ahead of our Beacon expectations by a full year.

And I think we're confident that as part of the outlook we gave, margins should continue to trend up in a positive direction, and that's certainly part of the business model that we've designed when it comes to top line revenue, fee operating leverage and benefits in NII.

In terms of comparisons, the comparisons are kind of -- have a good-sized range.

And part of that is, as you probably know well, the tax-advantaged investments which go through the GAAP line have varying effects on margins for different companies, partly based on how much they do in the tax-advantaged investments and partly because there are a couple of different ways to account for them.

And I just encourage you to factor that in into the comparisons.

I think if you do -- we show that we're within the range.

I think from a perspective of should we be at the high, middle or lower end of the range, business mix matters, U.S., international, more middle office versus the Class A custody operations, having asset management or not.

So I'm not overly fussed with where we are in the range.

I think with the view that we are -- we're within it and our perspective is margin is one of the key indicators of our business and our expectation is that it should continue to widen over time.

Got it.

And then second question around NII, just some clarification, I guess.

Your comment around deposit betas in the U.S., I think you said about 20%, still seems pretty low, again, relative to what we heard from some of the others so far.

Is there something, again, structural about State Street's business that's keeping it that way?

Is there something that you guys doing proactively to keep it this low?

And as we think about your commentary on the forward, should it be more over-ramped or could we see a bit more of a catch-up on the deposit costs because you guys have done absolutely quite a good job maintaining that at a fairly low level?

Yes, let me first reemphasize, what we've said over the last couple of quarters and what I just said in the call summary is that our deposit betas have ranged about 25% over the last year, right?

So that's kind of the current state.

And a couple of quarters back, it was at the -- a bit lower than that, and that's where we're at today.

I think what we factored into our outlook is a continued uptick in deposit betas.

I think we've seen that around the industry.

We've seen that in corporate deposits quite a bit.

We've seen that in wealth management deposits.

We've seen some of that in custody deposits.

While we think custody deposit betas will tend to be somewhat less than some of the other price-oriented deposit categories that I just mentioned, deposit betas have to rise over time.

They have to rise into next year.

We don't think they rise -- well, I guess, we say they just are going to rise, and the question is a little bit of how much and how fast.

And part of the reason we put an NII range in place in the outlook is to accommodate that uptick that we expect.

Your next question comes from the line of Brennan Hawken of UBS.

For my first one, just to follow up on Alex's question there on NII from a different direction.

So we saw the balance sheet decline again this quarter, although slower pace than last quarter.

Could you maybe let us know how much of a balance sheet growth or decline you have reflected in your outlook for NII growth and whether or not the rate rises are only in the U.S. or whether or not you might have some tailwinds from that in Europe, U.K. as well?

Glenn (sic) [Bren], it's Eric.

Let me start with the back end of the question.

I think the rate rises that we've expected in the outlook are primarily in the U.S. I think we're clear that -- about 3 are expected.

There was a rate rise in sterling in the fourth quarter, which has already started to factor into the 4Q results that we just released and obviously will help next year in 2018.

But for the time being, we haven't expected much more in sterling or euros, and I think that's consistent with the forwards.

In terms of balance sheet size, we made a conscious effort several years back and then reemphasized that over the last year to just run a -- what I'll describe as a compact and efficient balance sheet.

I think you saw us deliver on our objectives for this past year.

I think at this point, we feel confident in the size of our balance sheet.

You could see the capital ratios and leverage ratio, in particular, are at a nice place, which gives us the room we'd like.

I think our pricing is fair, and we'll continue to share some of the benefits of rate rises with clients as they'd expect.

And so there's a range in the NII guidance, and part of that range accommodates some of the range that we might have in deposit betas, some amount of range in balance sheet growth.

I think the balance sheet at one end could be roughly around where we are today.

It could grow modestly.

I don't think there's anything -- there's going to be any dramatic shifts, but there's a range of outcomes, and we're just preparing for that range.

That's fair, that's fair.

And then second question, you made reference to capital and how you feel quite good about things, Eric.

How should we think about potential for capital relief?

We've heard in the press that regulators are preparing to moderate leverage ratio calculations and requirements.

Is there a way in which you could help investors frame that potential relief and how that would translate into capital return policies at State Street?

Yes, Glenn (sic) [Bren].

We're clearly optimistic like others around regulatory reform and refinements here with the current administration.

And we're pleased to see both movement in the agencies, the Treasury Department, in Congress around leverage ratios and some of the other constraints that are important to us, including some of the most recent announcements of -- and intentions.

I don't think we can translate that, though, into direct action that quickly until we see what might come out.

I mean, part of the question will be, is it supplementary leverage ratio?

Is it leverage ratio?

Is it CCAR that changes?

Which part?

Which one?

I think the -- we recently saw that there are 22 capital rules out there and ratios.

And I think you all can feel that just like we can.

So I think hard to translate it directly.

I think we're optimistic that we'll see some changes.

What we'll need to work through is if we have changes in one ratio, the question is, is that ratio a binding constraint?

Or can we find a way to expand in a certain manner that is -- that's offered to us in that way.

So hard to tell.

Apologies, I can't answer that until we see more.

But I think when we see more, we'll be able to give you more background, Bren.

And Bren, this is Jay.

Just as we saw the regulatory rules come in on kind of a slow basis, I think they're going to go out on a slow basis.

I think what is overwhelmingly clear, though, is that the trend is positive.

The leverage ratio, which is front and center for the trust banks, has gotten special attention, I think, from our good efforts.

And as you probably know, there's a bill working its way through the Senate, which is a broader banking bill which has in it some relief for the trust banks around leverage ratio.

So I think the trend is quite clear, but it's going to take longer than any of us would hope to get some of this regulatory -- the regulatory adjustments implemented.

Another question from the line of Ken Usdin of Jefferies.

I just wanted to ask you just on the spending side.

It's great to see you guys accelerating the recognition of the Beacon saves.

And embedded within, I guess, the operating leverage is still a pretty healthy rate of cost growth.

And I'm just wondering, can you help us understand how much of that -- is any of that a pull forward layered against the pull forward on the Beacon saves?

And how much of it is putting a little bit of the tax benefits back into the business?

And just where do you think you are on just kind of tax spend needs versus your prior thoughts and any changes because of the tax changes?

Ken, let me start that, this is Jay, and then I'll turn it over to Eric.

I've always believed -- we've always believed that you need to spend in this business to continue to drive the revenue line.

And in addition to Beacon, we're still making some pretty steady investments.

They tend to be technology-oriented.

I'll just give you some flavor for that.

We've talked before about the investments we've made in our ETF platform, which are paying great benefits as we compete in the servicing of the ETF world.

Most recently, we just finished off a Japanese accounting system and we just brought our first Japanese mutual fund account onto the system in the fourth quarter.

We think that's a robust future opportunity.

I guess the last one I might spike -- the last couple I might spike out would be, Eric referenced the European offshore markets, which continue to run at great speed, and we're the recipient of that.

We're the largest provider of services in places like Luxembourg and Dublin.

And we have embarked recently on an investment in our transfer agent platform, which was a differentiated -- we continue to differentiate ourselves when we compete for new business and serve existing customers.

On the regulatory front, the MiFID rules recently and even more recently, SEC modernization have caused us to spend money to put in place administrative platforms.

So there's a fair amount of spending that goes on, and we think that's a good thing.

That's going to serve our clients well, get in front of opportunities in the market, which, to us, look like growth opportunities.

So that's where the spend comes.

I'll let Eric pick up on the Beacon saves and some of the other offsets.

Yes, it's Eric.

I'll just add that we've been careful and I think considerate in how we operate the business.

So within the revenue growth envelope that we had this year, which had revenues in the 7%, 8%, a little higher than we would typically had expected, we had expense growth of about 4%, adjusted for FX.

And if you think about what drives that, there's a couple of percent, call it, 2% for net new business, there's -- as we onboard clients.

There's a couple percent, call it, 2% for merited incentive that we have.

There's a couple percent, again, call it 2%, just to keep it simple, but it's literally how the map works for technology and some of those business investments that Jay described.

And then there's a couple points that go the other way, right, in Beacon savings.

And you add that together -- and it's actually a good business system and it lets us both do the right thing by our business and our clients and also work within the operating leverage that we'd like to deliver.

Got it.

Okay.

And then just one quick one, just on core business flows and transaction activity.

I think you mentioned that hedge fund outflows continue to be slightly negative.

Can you just give us a flavor for that activity in flows component of hedge fund emerging market and how that trended sequentially and if you've seen any stabilization ahead?

Yes, let me -- I'll take it more broadly, Ken, and then I'll get into hedge funds.

The flow -- the direction of flows may remain pretty constant in the fourth quarter.

So you've got the rapid ETF inflows.

You've got the U.S. mutual fund outflows.

We're in the middle of both of those.

I mentioned the -- in Europe, the European -- particular focus on the offshore markets, and you can see the numbers if you look them up, they're quite robust.

In the alternative world, you ask about hedge, and you've seen throughout 2017, the hedge outflows have moderated.

In fact, there were some quarters where there was even a hint of inflows.

And we're largely seeing that.

We've seen still a little bit on the outflow side but considerably diminished from '16 to '17.

And we're hopeful with the outflows that have occurred that we've reached the trough.

We even see some -- more recently, some new fund introductions on the hedge fund world, which is a positive sign.

So I'm not declaring a turn yet, but the trend is pretty positive.

I'd just add, over the past year, we've seen the servicing fee line on hedge fund outflows cost us more than a percentage point of growth.

We're still seeing some of that in the fourth quarter.

We expect to see some of that into next year.

And the question is when does it balance out, stabilize fully in turn, but -- though we've seen some improvements.

But it's still there, and we're just obviously navigating through it, and you see some positives from some of the other parts of the franchise, which Jay described, as offsetting that, which I think gave us some good overall results on the servicing fee line this quarter.

Another question from the line of Glenn Schorr of Evercore.

Maybe a first question in enhanced custody prime brokerage lends.

Curious how you would define where enhanced custody begins and ends versus prime brokerage, and then as I've seen some competitors dabble in certain asset classes like doing FX prime brokerage, how you think about the different asset classes and where State Street's aspirations might go there.

Glenn, it's Eric.

I think it's a good question because it's an area that clearly we've expanded into in the last couple of years.

We think as a custody provider where we have -- where hedge funds have their assets with us, it actually provides a platform by which we can provide a portion of the classic prime brokerage services directly for them.

I don't think there are any bright lines as to where we play versus where some of the traditional broker-dealers play.

I mean, they start from a position oftentimes of having to borrow collateral to lend it, right?

So in a way, they start with a 2-sided model.

We have the collateral -- or we have our client's collateral sitting right there, which helps facilitate that and it gives us some advantages.

It gives us some advantages with some of the '40 Act or some of the clients we already serve.

But it's a good-sized market.

I think we are -- we continue to explore how to both strategically and tactically compete.

In our perspective, it's been attractive, and we just need to make sure we balance some of the capital rules, some of which may change over time, which could be beneficial with how we go to market.

So no need for further technology bill that's more of the -- is it an ROE accretive event?

Well, it's -- actually, it's an area where we've invested in the technology years ago.

I think that's what, in a way, got our business off the ground is we were able to access from -- directly from the custody system and what our clients already had with us.

So we created that access.

Over time, it's been -- and I think we've described it as 9 or 10 systems that you have to actually pull together and we've actually integrated a good part of that.

It's one of the areas where we've actually developed some blockchain technology to actually connect the lenders and the lending pools that are either in our asset management or away from us in the market to our custody system.

And so it's an area which I think continues to have developments technologically, and we're finding that clients are quite pleased and respond so accordingly with the business that they've brought our way.

Okay.

I appreciate that.

Just a follow-up on the fee operating leverage conversation.

I think the year-on-year numbers impacted just because of tough comps in the fourth quarter last year but for the full year is really good.

But I did notice that your target went from, I think, 100 to 200 of fee operating leverage to 75 to 150.

Is that just it's harder to do as margins have moved up?

Or maybe that leads into Ken's past question on are you accelerating some of the investments?

I wouldn't read anything in particular into that, to be honest.

I think, this past year, we had both a strong view as to what we could do on the expense side, and I think we saw early on that markets were going to be quite favorable.

If we have that kind of favorability again, I mean, that'd be great to have, and if you can assure us, we'd take it.

But it's -- we're trying to be, I think, careful and vigilant that in a way, we don't want to overestimate what the market will do and sort of say, look, then the top range should be higher and higher and higher.

I think we actually want to run a conservative business model as we have been over the last couple of years and have realistic expectations of revenues and then make sure that we both invest and save at the same time.

So I wouldn't read anything into it.

I think where we are at the 75 to 150 is kind of where we're comfortable.

I think it's where -- it's a good range for the last few years.

And I think it's at least an indication of where we're going to be running the business this year and likely going forward.

Another question from the line of Betsy Graseck of Morgan Stanley.

A couple of questions.

One, on the NIM side, I know we discussed the deposit angle.

I'm just wondering, Eric, as you're thinking about reinvesting, is there any interest in maybe going a little bit longer duration and picking up some yield that way?

Betsy, it's Eric.

We're always reassessing our positioning against rates and -- in the market.

We certainly do that across the curve as you're suggesting.

We do that in dollars, sterling, euro, yen and so forth.

I think if you look carefully, our duration expanded a little bit this quarter as an example.

I don't think it's a trend, but it's an example.

We've seen some steeper curves in euro and sterling and given that we have good-sized deposit basis there, it's natural for us to take advantage of that.

And so we've done that a bit.

But I think we also want to be careful and keep the front end of the curve position open so that as rates rise, they come up.

So I don't think you should expect some large changes in positioning.

But that's an example of the, I think, the tactical adjustments that we make and we'll continue to make and look for opportunities accordingly.

And as we're thinking -- and we' just had a little bit of discussion on Europe as well, I realize that you're baking in the forward curve.

Just wondering, given some investor in kind of discussion around inflation and global inflation, will that pick up.

What -- can you just remind us if the European rate structure were to move up 25 bps, let's say, beyond what the forwards are currently estimating, what that impact is on your financials?

Yes, I think the best way to describe it is, and we've tried to share the basis of the balance sheet, but we described in the -- in our Qs and Ks that we're open to interest rates, right, on a -- and we say about half of that's in the U.S., half of that is non-U.

S. The value of a 25-point move in the U.S. has been in the $20 million to $25 million range, kind of the last -- over the last year, I think.

More currently, it's going to be in the $10 million to $15 million range.

But it's -- these are ranges, right?

And given that, that is half of our exposure, if there's a 25 basis-point move instantly in euros, you'd expect something in that order of magnitude, well it have to be euros and sterling because I'd say half our balance sheet is U.S., half non-U.

S. But I think you could probably build off of that, would be an indication.

Okay.

And then just lastly on the tax guidance that you've got on the forward look.

Nice decline there, when we penciled it out, I think we had a slightly larger decline and obviously, you have more information than I do.

I'm just wondering if this tax rate outlook for 2018 is similar to what you're thinking 2019, 2020 is?

Or is there any migration in your structure that would drive different tax rate outlook for 2019?

And could you also discuss a little bit about the BEAT and whether there or not there is any impacts on you?

Betsy, you've asked a sort of tough question.

We'll give you the award of the call for that.

Here's how I'd say it.

The tax law is new.

I think we've had every tax expert here and around the world trying to work through it, understand the implications for us.

We've made -- we're confident in our good estimates at this point for 2018.

And we don't see large movements going forward from then, but I think it's just too early to tell.

And as we learn more, we'll certainly share that with you.

But I think we're confident that there's a nice $150 million benefit in '18.

That's going to fall primarily to the bottom line and shareholders.

And as we learn more, we'll certainly share that.

Okay.

So is this tax outlook for '18 more -- like your other guidance conservative?

Would that be a fair statement or...

Our guidance is our guidance.

We're trying to be appropriate in how we characterize our expectations.

And hopefully, that's a good bit for you to work off of.

Another question comes from the line of Jim Mitchell of Buckingham Research.

Maybe, I don't think you've mentioned it, but can you discuss what your equity market assumption is on the fee income line?

And if that also includes BlackRock in that equation?

Jim, it's Eric.

Are you asking about the outlook?

Or are you asking about the '17 results?

No, I'm sorry.

I'm looking in your 4% to 5% guidance range for the fee income.

Just wanting to see what your equity assumption is?

And what your assumption is around the loss of the BlackRock contract?

Yes, see, here's how I'd -- what we've incorporated.

We've incorporated basically all the known market expectations and client activity.

So we have market expectations of where we have market knowledge where we are today on equity markets and fixed income markets and both are important to our book of business.

And there is some consensus there will be some continued growth, we've factored that in.

We factored in new business that we've already sold but has to be installed.

We've factored in business that is migrating away from us as you'd expect.

And then we've factored in some mix of flows, some good continued positive flows, for example, in EMEA, strength in the ETF activity.

Little bit of headwind in hedge fund.

So I'd characterize it as an outlook that factors in all the various parts that you'd expect.

Okay.

That's helpful.

And then maybe you did have very nice improvement on the standardized ratios and leverage ratios sequentially on year-over-year.

Does that -- I think last CCAR, you guys were flat with your buyback.

Does that give you some wiggle room, particularly with the tax cut to up the buyback this year?

Is that a fair way to think about it?

Jim, it's a little early to say.

What I'd tell you is that we're quite conscious about our capital position under CCAR.

I think we made a decision early in the year that, that would be just like revenue growth and operating leverage in Beacon.

Managing a compact balance sheet would be a priority for this year.

We've done that, I think, with pretty good results.

So it certainly positions us well, and I'd say we did that purposely.

I think a little soon to jump to what you're going to ask for in CCAR.

We actually have to -- we're waiting.

Maybe even this week, if not next week, we'll see the CCAR instructions and see if they are very similar to past years or if there's anything new.

So a lot of moving parts.

And obviously, as we know more, we'll let you know more.

Another question comes from the line of Mike Mayo of Wells Fargo.

This is the first conference call since the CEO change has been announced and I was just hoping to get some kind of discussion on that.

And I guess, Jay, you have 343 more days to go before you step down as CEO, but who's counting?

I guess the question is -- Ron O'Hanley, I'm not sure if Ron's there on the line, but certainly Ron, you've run 3 of the largest asset managers globally.

Certainly, the GE acquisition has gone better than you guys expected.

You have record AUM.

So no issues with that, but some questions that would come up.

The first one is for you, Jay, you'll be leaving before Beacon is done and granted you've accelerated the targets, but you still have $75 million left in 2019, and your pretax margin target of 33% is not targeted, I guess, until the end of 2020.

So you're leaving before you've actually gotten everything done.

And then for Ron, I mean, it's 3 years at State Street for a 225-year-old company, that's not as long a tenure as you've seen in the past at State Street.

And the third thing for Ron also, you've overseen asset management, but you haven't overseen the rest of the company.

So what was the discussion of the board?

And your thoughts, Jay, and Ron, your thoughts on accepting the job.

Yes, Mike, thanks for the question.

And you're right, this is the first call since we announced our transition.

And just to be clear, the transition, which I instigated is that I will leave at the -- before the end of 2018 and likely chair the board through '19.

When we began that discussion a year ago with the board, they went through a pretty extensive evaluation looking at internal talent, looking at external talent.

As you pointed out, Ron has been with us for 3 years.

He's done a terrific job with SSgA, but he casted even broader shadow over the bigger State Street.

And so the board in their evaluation concluded that Ron is the right person to take over the CEO-ship of State Street at the end of 2018.

We decided, Mike, to announce it early.

It's kind of unusual that we would announce early because we wanted to get Ron situated in the core businesses of both the asset servicing, trading and the Global Exchange business.

And in this transition period, I'll oversee the asset management business just so he can come fully up to speed, but as you pointed out, running 3 of the largest asset managers over the last 20 years and having been the first McKinsey consultant that started their asset management business, he's deeply knowledgeable in the trends of asset management and has overseen a great deal of front office, middle office, back office transformation.

So he certainly understands the business from our client perspective and understands the core components.

I think this transition is designed to give him even more time to focus on, as you point out, the key for back office, middle office business.

So we are working together throughout 2018, with a plan to turn over the baton in beginning of '19.

To your comment, Mike, about Beacon, I think Beacon will never end, in my opinion.

I mean, we've declared a premature completion of Beacon mid-'19, but Beacon represents the digitization of State Street.

And I would say, Beacon, as we know it, in my view is simply a down payment.

We have a long way to go to fully digitize the $33 trillion in assets that we oversee for our clients.

And the ability to mine that information, and this is not something that just State Street is looking at.

Everybody's looking to take that critical information, incorporate it with other data sets in order to provide insights that our clients can benefit from.

So that journey is underway, but it's far from complete.

And I'm not sure I'd be -- I'd live long enough to see the end of Beacon, as I know it.

So I think we're on the right track.

I think Ron, and more importantly, the board thought that Ron was the right guy to carry the ball for the next period.

And I'm excited to work together with him to make sure the hand off is smooth and that Ron takes over the execution of Beacon and driving growth in the core business.

And a follow-up then.

I mean, if you leave with a pretax margin of 31%, I can't imagine that's what you want to leave at the end of 2018, so can you give any guidance for that other than 33% by year-end 2000 (sic) [2020]?

Or that's where it comes out and you'll leave on that note?

I think, Mike, where -- I would say that it'll end up where it ends up based on the guidance that we gave you and based on factors that are outside of our control, market factors.

I would also say that margin is important to keep focus on, but to me, it's as important that we continue to invest in this business.

And so I would think it would be bad advice to just push margin at the expense of not investing in the business.

I think State Street has been around for 225 years because we've kept some amount of balance between understanding clients' needs, investing in those things that represent future growth opportunities.

So we're focused on margin improvement, but we're also focused on creating the right balance between investing in areas that will provide long-term payback.

Mike, it's Eric.

I'll just add if you go through the outlook, you'll build up the model with the revenue growth we've given and the operating leverage guidance, right, that adds to the margin in '18.

Does it get -- and in a nice way, does it pull forward the 2000 -- the 2020?

33% by a full 1 year, 2 years, I think we'll see as we get to the end of this year, but there's -- I think there's a nice -- there's another more than a down payment, a recurring payment that we're going to make on margin improvement this year in '18.

Another question comes from the line of Mike Carrier of Bank of America.

Just a question on the management fees.

The year-over-year, the growth was impressive.

Just sequentially, it was flattish given the markets.

And I didn't know if there was anything that was unusual in quarter-over-quarter numbers because it seemed a little odd.

It's Eric.

Let me just start and I think -- and Jay may participate on this one as well.

There's -- just to remind you, there's always a little bit of lumpiness in management fees, whether it's performance-based fees, whether it's accruals and so on and so forth.

And between 2 quarters, sometimes you have a little bit of positive in one and a little bit of negative in the other.

So I wouldn't read too much into the quarterly performance.

If you look at the fee rate on management fees, which I think is a good indicator, it was, I think, 6.1 basis points, that's nicely in line with the first half of this year.

I think third quarter was a little bit of -- was a little lumpy and nicely above where we were last year.

So we're feeling -- I think we've got good results in management fees in asset management on the revenue line.

Yes, Mike, let me just unpack a little bit the quarter, which I think was quite a strong quarter, the -- we noted net flows of $6 billion in the quarter in assets under management.

But importantly, we had ETF flows of $29 billion, which is -- I don't know if we've had that ever, but it's been a long time.

The institutional business had $2 billion in negative flows and then cash was $21 billion in negative flows.

And importantly, the cash, 2/3 of that cash outflow was -- came from our securities lending collateral.

And it's clients increasingly using noncash collateral, which we don't view as a negative thing, it's really neutral to us.

So I think that your question was about sequential quarter.

I would say the quarter itself from a standpoint of flows was quite strong.

Okay.

That makes sense.

Then as a follow-up, in terms of the outlook on some of the investments that you guys are making, I think throughout the industry there is a lot of commentary on fee pressure, whether it's on the asset management or servicing business.

But I guess, on the flip side, when you look at some of the areas that you're investing, where do you see some of those opportunities for the best growth and maybe not pricing power, but pricing stabilization, where you can still grow the business?

There's demand for the products given that there are some areas in the industry that everyone is seeing some pressure.

Let me start that one, Mike.

I've mentioned a few of them earlier.

But the ETF industry is obviously growing and is likely to continue to grow.

And so the investment we're making in our platforms to provide -- enhance really their data and analytics services, to authorize participants and plan sponsors, I think, is a differentiator.

I referenced the offshore markets, which are markets that were quite prominent and are making investments in the areas that are differentiating, transfer agent being a specific.

Japanese fund market, which has historically internalized servicing, we're starting to punch through the outsourcing there.

And then the last one I would kind of spike out for you is the whole data and analytics world.

So we have -- Beacon and digitization represents us getting the information we hold on behalf of clients in a more real-time basis.

We established GX, Global Exchange, probably 3 years ago now.

And one of the products, one of the seminal products was something called DataGX, which is an aggregation platform, which we can't keep up with the demand.

It represents the capability to aggregate data across not only State Street but other custodians.

And so I point that out because that's -- if we secure that position, which we're in a position to do, the ability to get into the front office with data and analytics services, which not only provides some revenue uplift, but importantly, protects the core franchise that provides differentiation.

So those are the 3 or 4 things that I would just highlight are things that we are investing in, which we think have revenue attendant to them.

But also importantly, differentiate the core product.

We have another question comes from the line of Brian Bedell from Deutsche Bank.

Just to clarify a couple of things in the guidance for the expense guidance given the fee operating leverage.

I assume that includes the charges for Beacon.

And Eric, if you just want to outline what you think those might be?

And then, also I think a prior question asked about market return assumptions within the guidance.

And I didn't get exactly what that was, if you could reiterate that.

Sure.

On the expense side on Beacon, the fee operating leverage guidance is, I think, pretty straight down the middle of the fairway, right?

We know what we expect on revenues and we -- and is -- and against that, our expectations of quarterly expenses.

I think you saw that this quarter, we had a good-sized restructuring charge that's partly because we tend to look forward, right?

The accounting guidance that encourages us to do that.

And also we were laying out our plans for 2018.

And so we thought through what are the -- what is the range of areas in which we're restructuring.

And we followed the guidance to take that on.

The guidance here on operating leverage is actually future restructuring.

And I think what we tell you is we don't want to restructure every quarter, that's a little clunky.

We do want to be mindful though as new opportunities come up, what are they and take action on those.

And I think our perspective is, if there are new opportunities that come up from time to time, we'd expect additional benefits to come and add to the $550 million of Beacon benefits accordingly.

So anyway, hopefully that clarifies the -- on the expense side.

On the fee side, we're expecting market growth, I think, in line with consensus.

There's a -- I think there is a general point of view that markets will continue to tick up this year.

There's a range of economists out there.

We've looked at that range and said let's think about the midpoint of that range.

And there's -- I'd just say, there's some optimism in that, general optimism, and we're -- we've included that in the outlook.

I'm sorry, on the expenses, the -- you're $385 million through the Beacon charges now, what do you expect the terminal Beacon charge to be in?

And again is that actually in the 2018 expense guide?

Yes.

I think the way to think about this is, as Jay described, I mean Beacon is becoming, right, has become kind of a way of life and the way we do business.

And so we can try to keep announcing a program or adding to the program or a new program.

But what we'd like to move to is -- certainly, as we communicate with you all in the analysts and the investor community is that we want to do Beacon every year, right?

And we -- you've seen the rate of savings, $175 million 2 years ago, $150 million last year, we expect $150 million this year.

It's about 2 percentage points of improvement each year, right, on our expense base.

And obviously, that accumulates through, which is really valuable from an earnings and a shareholder perspective.

I think as we go forward, right, there will occasionally be some restructuring charges.

If I knew enough now and I had defined actions under the accounting rules, I would be taking charges now.

I will say we've tried to look forward and we've tried to look forward over the next few quarters and just it's hard for me to say that we will not come up with new initiative and new benefit.

So if we have -- if we see areas of benefit that can take us past the $550 million of benefits, at that point, we'll do the right thing.

And if necessary, not all initiatives take restructuring, but if necessary, we'll consider some out more.

We just don't want to do that every quarter, and we'll certainly call it out if we haven't.

Okay.

Fair enough.

And then on the fee revenue growth at 4% to 5%, just can you parse it out just between the recurring businesses, the asset servicing and asset management versus the volume and volatility-related businesses, whether you think you see better growth in the core asset servicing and asset management versus the volatility.

Because I think you mentioned you'd expect volatility to remain sort of tame.

And then maybe just to tack on, Jay, what you said about -- you gave a good example on DataGX as an example of digitization helping the revenue growth profile, is that -- is the incremental revenue growth opportunities from the things that you've done with Beacon also a significant part of the 4% to 5% fee growth for '18?

I think -- let me just start on the fee outlook.

I think you're looking for enormous amount of detail.

And in truth, right, we don't really know what the future will hold.

So we're trying to give you an overall fee guidance, which is why we gave a range.

I think within that, there's servicing fees, you've seen the pattern over the last year or years plowed on.

I think you can use that as some trending.

On asset management, that's done well and with markets -- with positive markets, it does positively well too.

Just as you'll think about last year versus next year, you've got the GE acquisition that helped by half a year, so you should factor that in.

And in trading, it's just could be what it could be.

And I think we'd always want to be careful there.

But we're not going to give guidance kind of line by line and -- because I think it's -- at that point, it's little too precise and inaccurate and we're just trying to give you some directional indications.

Hopefully that's enough.

Another question comes from the line of Geoffrey Elliott of Autonomous Research.

So I guess, just to clarify on the restructuring charges, it sounds, if I'm hearing what you said the right way, like there's a bit of a change in mindset.

I mean, historically, they have been almost every quarter.

It sounds like going forward, they're going to be more occasional, when there's something really specific that you want to work on.

Am I hearing that right?

Yes, I think that's a good way to summarize.

And then just on BlackRock and that business exiting.

Can you give a quick update on kind of how that flows out over the course of 2018?

And is there any lumpiness that we are going to see in the numbers as a result of that?

Yes, Geoffrey, this is Jay.

I'll make a comment on that.

As I think we said in prior quarters, we would expect the transition to commence some time mid-first half of the year and these things can take a year or longer to progress.

That's probably the best I can give you.

But importantly, it's all factored into, as Eric mentioned, our fee revenue guidance.

So it takes time for these things to happen.

Another question comes from the line of Gerard Cassidy of RBC Capital Markets.

This is Steven Duong in for Gerard.

First question, just on your dividend, your payout ratio is around 25%.

Is there a level you guys expect to bring it to in the long run, especially given your valuations?

Steven, it's Eric.

There's not a level at this point that we feel wedded to either on a percentage basis or a dollar basis.

I think we're continuing to do the financial and economic work on one hand to think through as you have a higher and higher PE, you adjust the mix of buyback and dividend.

But there is -- on one hand, that's we do, and I think all the other banks are probably going to consider doing that given market trading levels.

On the other hand, what we have also been doing is being in touch with some of our largest shareholders and certainly value your opinion about do they prefer a certain mix of dividends versus buybacks because we're certainly open to input.

I think what's important to us, if I step back is that as earnings grow and EPS grows that we share that with shareholders as much as we can and that's why you see us taking the dividend up.

Certainly, we're going to consider shareholders actively as we go into CCAR this year, for example.

Great.

And then just in your presentation, you'd mentioned that you guys had reduced manual touches on trades by 30% since 2015.

Do you -- is there a dollar amount you're aware of that that's brought to the bottom line?

And is there a further target of reducing the manual touches too?

Steve, let me -- this is Jay.

Let me comment on that.

The -- we put that out there as just more symbolic to what we're trying to achieve here, which is we get a lot of input, client trade data.

And our goal is that, that enters electronically and passes through our system electronically.

And what we referenced there is eliminating manual transactions, transactions that have to be manually fixed in order to see them (inaudible) internally.

So we have internal metrics, none of which would be particularly helpful for you, but we do measure all the stuff.

And the more important thing is this whole straight-through processing, which is to connect our systems internally, which is, in some respects, what Beacon is all about, so that as information enters us electronically, it passes all the way through and out the other side.

And it has all the obvious benefits of better service, lower cost and it enables this -- it frees up this information so that the data can be used for other purposes.

And I would just add.

There's a host of metrics, 1 and 2 levels down below that and across our accounting platform and systems across our product line and businesses around unit costs as you'd expect.

Straight-through processing is important, but can actually be measured at many, many individual points in the chain.

And our perspective is, we continue to build out Beacon on one hand, but now with our -- as you've seen, we've refined our organization structure where we've added more to the operations on a global basis, right?

We're creating a real operations and production organization, which is almost twice the size of what it was, right, relative to the client-facing business activity.

That gives us an even larger area in which we can systematically drive that straight-through processing in those kind of unit cost improvements and efficiencies.

Another question from Vivek Juneja of JPMorgan.

Jay, first question for you.

Can you talk a little bit about where you are in the whole process of digitization?

You've had a competitor who has talked about stepping things up.

Where do you stand given that you're letting a lot of the tax reform benefits drop to the bottom line?

And even sort of give us a sense of outlook where you expect to be on that?

Sure, Vivek.

Happy to do that.

I mean, as you know, I don't have perfect visibility into the competitive landscape, but I do feel pretty good about where we are relative to Beacon.

And I'd build a little bit of a story starting with for a long time, State Street has had good discipline around common systems.

We made a number of acquisitions in the last 15 years.

As we acquired, we've moved to common accounting systems, cash and security systems.

So we have a great starting point.

Beacon, as I was mentioning earlier, represents the digitization of connecting all these systems up together and taking advantage of straight-through processing.

And if your question of where are we in that journey, we're 1/3 of the way into it, just pick a number.

We've got a very high percentage of those incoming trades that I referenced earlier come through on an automated basis.

But in my perfect world, think about the fund accounting activity that we do for tens of thousands of portfolios all over the world.

A trade would come in, it would hit the accounting books, it would hit the cash books, it would hit the pricing books and you'd have a virtual system where you could price a portfolio virtually throughout the day.

So that's my -- and once you get there, you essentially have a hands-free fund accounting operation, where everything is virtual and automated, which would take all of the manual cost out.

It would, as I say, allow one to calculate a net asset value throughout the day and most importantly, and the real prize here, I've said this consistently over the years, is freeing up that data.

If you have that data available on a real-time basis, what you can do through DataGX and other sources is where the future is in this business.

So that's -- I think, on a relative basis, that we seem to be ahead of the pack.

From my standpoint, we had a better starting point.

I think we got at this earlier.

The other thing to your question, Vivek, I would say is we're going as fast as we can go.

We don't feel constrained by investment.

But when you're changing systems the way we are or operating day in and day out, there's a certain pacing, there's only so much -- as you can only go so fast without creating damage.

So we're investing at the optimum or maximum pace that we can given the change that we are invoking.

Great.

Eric, a question for you on the tax front.

I hear you're getting some of the benefits from the tax reforms, but just trying to triangulate all the operating and GAAP and future one metric.

As I step back and think about it, are you changing the amount of tax-advantaged investments?

Are you reducing it?

Are you increasing it?

Trying to get a sense of what's going on underneath?

And -- because you are going down 4% to 5%, but yet, the GAAP rate isn't going up quite as much.

So if you can just help with that.

Yes, Vivek.

Let me try to describe how you get to the GAAP, right?

I think tax-advantaged investments, for us, will be roughly comparable in '18 versus '17.

And if you put that in with the new stated rates on federal, state and then foreign together, that's what gives us the about 16% rate that we expect in '18 and the roughly $150 million of benefit.

I think there's complexity in tax rates.

We -- the headline rates, as I said, go down by about that 5 points.

Because the tax-advantaged investments tend to be dollar-based credits, those don't flow to the effective tax rate in the same way as net income continues to grow and munis have a version of that, but they are also affected by the tax rate.

So there's a couple of different moving parts.

I think as we step back, we are pleased with landing at what we expect to be a 16% tax rate in '18.

We think that's going to be -- that's better than many other banks.

And I think that's driven by the tax planning we've done over the years.

And that rate, and we've given a bit of a range, right, 15% to 17%, I'm just using the midpoint, we'll see where that goes going forward.

I think specifically as regards to tax-advantaged investments, we have -- we intend to continue, right, that activity.

Clearly, we're going to -- clearly, there are benefits of that activity under the old rates, but there's certainly still benefits under the new rate.

On a Basel III returns basis, it's still attractive.

I think there is going to be a question of do you get the same amount of tax-advantaged deals out there that are available in the marketplace, do you get more wind, less solar, vice versa, LIHTC.

We think there's going to be some amount of market adjustments.

And I think if that ends up -- those market adjustments end up changing the amount that we'll do, we'll certainly signal that.

But for the time being, in at least dollar terms, it will be roughly consistent last year versus expectations for '18.

Another question comes from the line of Brian Kleinhanzl of KBW.

Just had one clarification question on your outlook on Slide 19.

The way we're looking at it, when you give the 7% to 8% for your revenue growth, a 10% to 13% NII growth, is the base that you're using just simply those for your numbers on Slide 18?

It's Eric.

For the left column, right, on Page 19, which is the historical operating basis outlook, it's the like-for-like outlook, then you would use the figures from Slide 18 because that's the historical basis that we just reported in '17.

When you move to the right side of 19, which is a GAAP-based outlook, you actually have to go back into our financial supplement.

And we could -- the IR team could certainly help you do that and use those amount as the basis, so that you have an apple-to-apples portrayal.

I think on an EPS basis, the net income basis, you're close, but the line items are sometimes a bit different.

And we can -- I think those are well described in the supplement because we show both operating and GAAP, and we can certainly help you walk through -- help walk you through it if you have any questions.

And then on the tax reform, I know you've outlined 3 different ways that you're investing the savings from the tax reform, but is there a way to think about that as kind of a year 1 investment?

Are you expecting some acceleration in year 2, especially in light of what some of the competitors may be doing with greater investment than what you're doing in year 1?

I think you have to probably unpack the 3 different line items.

The -- adding to the matches and defined contribution would be a recurring kind of a cost of the investing and training.

Some of that's technology, so that's front ended.

It trails off a little bit.

And then the third, which is just to increase the match, we would make that determination each year into the future.

So it's a little bit of a mix, Brian.

But are you expecting more wage inflation, I guess, in the second year above and beyond what you'd normally expect for merit increase?

No.

I think from an outlook standpoint, I think we've got wage inflation from a merit standpoint in '16 to '17, we had it in '14 to '15 to '16, we have some into '18.

And I think there's a tradition of some amount of merit increase, and we are supportive of that tradition.

I don't think we see an acceleration or deceleration at this point.

We have a last question from the line of Steven Wharton of JPMorgan.

Actually, Vivek asked my question, but I'm just want to ask one little additional add-on for that.

If you did decide in the future to reduce the amount of tax-advantaged investments because basically the tax rate is now lower, so arguably the value of those is less.

Would you then see an offset on the revenue side?

Because the way I have been thinking about it is that -- I mean, you guys have been a very aggressive user of tax-advantaged securities, which is why you have such a low tax rate, and I just wonder if the appetite in '19 and '20 is there for those type of securities?

Or would you rather let the tax rate drift up and instead invest in securities at a higher yield?

And would that be a net neutral?

It's Eric, Steven.

Let me answer this in 2 ways.

I think if you do less tax-advantaged investments, then you're right, you have less revenue amortization, less of a contra revenue and then less tax benefits.

So you've the right way around there.

I think if you step back, there's, I think, a number of different tax-advantaged investment areas.

There's munis, there's LIHTC, there's wind and solar as the major categories.

In each of those, we think may or may not adjust to some extent and each of those we run through a kind of return screening process.

Now munis, some would say won't adjust very much because it's primarily a consumer-based market.

We'll need to see if that's the case or does it adjust.

LIHTC, there's a long tradition.

And I think wind and solar, many would say there would be some realignment because of expectations from investors of what they need to earn.

So I think it's early to tell.

I think we'd say though that the returns have always been quite attractive in tax-advantaged investments.

And if you adjust the rates by the amount we have, there's still healthy returns.

And so we don't feel a need to quickly change our tactics and strategy, and our perspective is that they are still valuable to do at these tax rates and in this form.

But obviously, as the market evolves, we'll always be -- we're always reassessing and we'll do accordingly.

So is it safe to say that if you continued to invest at the same level, then there would be no upward creep, all else being equal in the 15% to 17% in the tax rate?

No, you actually have to be careful there, right?

If you invest at the same dollar amount each year as you have higher net income, your effective tax rate starts to creep up.

Alternatively, if you invest the same amount of growth in tax-advantaged income, if that growth in dollar terms and percentage terms is similar to the growth in EBIT, then the effective tax rate stays relatively constant.

And I think that's a bridge for us to cross in '19 and '20 as we learn about how the market evolves and it goes back to Betsy's question about where we think tax rates will go.

And I think as we learn more this year, there will be a lot -- there are a number of interpretations we need to see from the Treasury Department, right, with regard to this tax law change.

We need to see if there are market adjustments and all these on some of these tax-advantaged investments.

And once we do that, I think late this year, we should have a better bead on '19 and we'll share that with you and all the others.

There are no further questions at this time.

Please continue presenters.

Thanks, Nora, and thanks, everybody, for spending time with us this morning.

We look forward to talking to you after the first quarter.

Thanks.

Thank you all for participating.

You may now all disconnect.