道富銀行 (STT) 2018 Q1 法說會逐字稿

Good morning, and welcome to State Street Corporation's First Quarter of 2018 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 rerecorded or rebroadcast or redistribution in whole or in part without the expressed written authorization from State Street Corporation.

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

Now, I would like to introduce Ilene Fiszel Bieler, Global Head of Investor Relations at State Street.

Thank you, Sam.

Good morning and thank you all for joining us.

On our call today, our Chairman and CEO, Jay Hooley, will speak first; then Eric Aboaf, our CFO, will take you through our first quarter 2018 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 adjusted 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 1Q '18 slide presentation.

In addition, today's presentation will contain forward-looking statements.

Actual results may vary materially from those statements due to a variety of important factors such as those factors referenced in our discussion today.

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 in our announcement today, we started the year with strong business momentum across our asset servicing and asset management business, as we continue to deepen client relationships, win new business and advance our digital leadership.

First quarter results included strong EPS growth and improved return on equity.

Importantly, we continue to see momentum across our core franchise.

Strength in equity markets and new business lifted our assets under custody and administration with growth of approximately 11% from first quarter 2017 to more than $33 trillion.

We announced record new servicing commitments of $1.3 trillion in the first quarter with total new business yet to be installed of $1.6 trillion.

We're seeing strength across our pipeline, both geographically and by capability.

State Street Global Advisors finished first quarter 2018 with asset under management levels of $2.7 trillion up approximately 7% from first quarter 2017, driven by strength in equity markets and ETF flows, with continued traction in our low cost ETF products launched last year.

Furthermore, we continue to realize benefits from State Street Beacon our multiyear program to digitize our business and drive new solutions and innovations for our clients as evidenced by this quarter's announced wins.

Beacon investments are enabling us to go beyond traditional custody services and provide greater speed, scale and quality to clients globally.

Additionally, our ability to deliver new tools and functionality is proving to be a meaningful factor and a differentiation in client decisions to expand their relationship with us across asset classes and funds.

To conclude, I'm very pleased with our financial performance to date.

Revenue growth was strong driven by both fee revenue and net interest income, reflecting higher U.S. market interest rate, continued market appreciation, new client business wins and higher trading activity.

We remain focused on expense management, while calibrating investment in our business with the revenue environment and prudently investing in new products and solutions.

We also purchased $350 million of our common stock and declared a quarterly common stock dividend of $0.42 per share in the first quarter '18.

And importantly, we continue to be well positioned to achieve our financial objectives in 2018, including delivering full year positive fee operating leverage.

Now over to Eric.

Thank you, Jay and good morning, everyone.

Please turn to Slide 4, where I would like to remind you of a few items.

Beginning this quarter, we are reporting primarily on a GAAP basis.

We will continue to call out notable items such as restructuring cost to better provide investors insights on an underlying business trends.

As you can see on the right side of Slide 4, we did do not have any notable items in 1Q, '18.

We have, though, listed the notable items for 4Q, '17 and 1Q, '17.

As a reminder, 1Q, '18 results reflect the impact of the new revenue recognition accounting standard, resulting in an increase in both fee revenue and total expense by $65 million, which is EBIT-neutral.

Now let me move to Slide 5.

Most of my comments will focus on 1Q '18 results compared to 1Q '17, the year-ago period.

1Q '18 EPS increased to $1.62, up 41%, reflecting strength in servicing and management fees from higher equity markets and new business, continued momentum in net interest income supported by the higher interest rate environment and the lower share count.

We continue to prudently manage expenses relative to the revenue environment, as demonstrated by an increase of 3.4 percentage points in 1Q '18 pretax margin.

We, thus, achieved positive operating leverage of 5 full percentage points.

Fee operating leverage was negative 6/10 of 1 point.

The elevated impact of higher FX swap cost, which we would have preferred to book in net interest income, amounted to a 1% headwind to fee operating leverage this quarter.

Notably, return on equity increased approximately 3 percentage points relative to 1Q '17.

1Q '18 results reflected a 14% tax rate, albeit lower than our full year expectation, primarily due to a seasonal benefit of approximately $0.02 a share attributed to equity compensation.

Now let me turn to Slide 6 to briefly review AUCA and AUM performance.

AUCA and AUM increased from 1Q '17, benefiting both our asset servicing and our asset management businesses.

1Q '18 AUCA of $33.3 trillion increased 12%.

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

Strong inflows continued in ETFs around the world in both on and offshore funds in EMEA and within our middle office outsourcing business.

Hedge fund outflows continued in 1Q '18, albeit at more modest levels.

Notably, as Jay referenced, we announced a record $1.3 trillion in new mandates for 1Q '18.

In our asset management business, AUM increased 7% driven by market appreciation and higher-yielding ETF inflows, partially offset by outflows from lower fee institutional index mandate.

Our new low-cost ETF offering continues to gain momentum and added $7 billion inflows this quarter, bringing us to $12 billion cumulatively over just 6 months.

Please turn to Slide 7, where I will review 1Q '18 revenue compared to 1Q '17.

You will also find additional detail in the appendix with the sequential quarter comparison.

Total fee revenue increased approximately 8%, reflecting strong performance across our businesses.

Let me take you through some of the details.

Servicing fees increased 10%, reflecting higher global equity markets and new business, partially offset by some continued modest hedge fund outflows.

Adjusting for currency translation, which you can see at the table at the bottom, servicing fees were up 6%, which shows strong business momentum.

Management fees increased 24%, benefiting from higher global equity markets, as well as approximately $45 million related to the new revenue recognition standard.

Trading revenue increased 11%, primarily due to strong FX client volumes and higher electronic trading activity as well as approximately $15 million in related to the new revenue recognition standard.

The breadth and depth of our FX capabilities and platforms continues to differentiate our offerings.

Securities finance fees increased from 1Q '17, driven by higher lending activity in the agency business.

Processing fees and other revenue decreased from 1Q '17, largely reflecting the absence of a onetime gain in 1Q '17 from the sale of the business and the impact of elevated FX swap costs, which I mentioned earlier.

We would expect lower FX swap cost going forward here, as more swaps qualify for hedge accounting and as we ship the currency mix of our balance sheet.

Moving to Slide 8.

NII was up 23% and NIM increased 26 basis points on a fully tax equivalent basis from 1Q '17.

NII and NIM benefited from higher U.S. interest rates, disciplined liability pricing and higher client balances.

U.S. dollar, interest-bearing, client deposit betas floated up during 1Q '18, in line with our expectations.

Relative to 4Q '17, average noninterest-bearing deposits declined only slightly, while interest-bearing deposits increased $5 billion on average, which demonstrated good client engagement.

Relative to 4Q '17, NIM improved 5 basis points driven by higher market rates and disciplined deposit pricing, partially offset by a smaller tax equivalent adjustment for our municipal bond portfolio and a modestly larger balance sheet.

As we said previously, we are comfortable -- we are comfortable with modestly growing the balance sheet to accommodate client demand, and have even created more room to do so by adjusting our investment portfolio this quarter, which I will cover in a few minutes.

Now I will turn to Slide 9 to review 1Q '18 expenses.

Expenses were up 6% adjusted for currency translation, though this included $65 million in higher expenses related to the new accounting standards for revenue recognition, partially offset by the absence of restructuring cost this quarter.

When considering these 2 effects, underlying expenses increase only 4% for the year-ago quarter.

The components of the 4% underlying growth in expenses include, 3 percentage points of new business and volumes, 2 percentage points of merit and incentive compensation and 2 percentage points in technology spent, partially offset by a net 3 percentage points in Beacon savings.

From a GAAP line item perspective, compensation and employee benefits increased primarily due to increased costs to support new business as well as annual merit and incentive compensation, partially offset by Beacon savings.

Transaction processing increased relative to 1Q '17, driven by higher sub-custody fees.

Information systems cost increased relative to 1Q '17 as a result of additional technologies spent.

Occupancy costs were up compared to 1Q '17, but have been relatively flat for several quarters.

Finally, as compared to 4Q '17, expenses were up primarily due to the seasonal deferred incentive compensation cost, which I described in the footnotes.

Let me now move to Slide 10 to review our progress on State Street Beacon.

On the left side of the slide, you see some of the achievements which are enabling us to win with clients.

We continue to digitize how we receive and process data from clients, using speed and scale as a way to differentiate service.

Key accomplishments include improving efficiencies from enhancing our global accounting platform and upgrading the functionality of our information delivery platform to better meet client needs.

We're also continuing to realize enterprise-wide efficiencies as we automate internal processes through Beacon initiatives.

On the right side of the page, you can see that we achieved $58 million in net Beacon saves this quarter, through optimizing our core servicing business, transforming our IT infrastructure and by gaining efficiencies within the corporate functions and SSGA.

We continue to expect $150 million in Beacon savings in 2018, including the $58 million achieved this quarter.

Now let's turn to Slide 11 to review our quarter end balance sheet and capital position.

On the left of the slide, you will notice that we reduced the size for our investment portfolio from year-end 2017.

We sold approximately $12 billion of non-HQLA securities during the quarter.

Those portfolio sales reflect our strategy to prioritize capital efficient client lending, while prudently managing OCI sensitivity.

We chose to rotate out of thin spread credit securities and we will reinvest into interest earning assets over time.

Trimming the portfolio, especially the dollar portions, will also have the benefit of reducing the size of our FX swap balances and the associated cost, which I mentioned earlier.

Moving to the right of the slide, our capital ratios remained healthy and all of our ratios are flat to up, year-on-year.

As compared to 4Q '17, the only significant change was a decrease of 80 basis points in the standardized version of a common equity Tier 1 ratio due to an increase in client overdraft balances, which have since been recovered by our clients and the impact has reversed.

While we are mindful of our leverage ratios, recent regulatory developments make us even more confident we can put our balance sheet to work for our clients.

To recap, moving to Slide 12, we saw strong business momentum, resulting in headline total revenue growth of 13% and servicing fee revenue growth of 10%.

Our pretax margin increased by 3.4 percentage points from 1Q '17, and we delivered EPS growth of 41%.

Before turning the call back to Jay, let me take a moment to provide you with some additional color relative to our quarterly outlook.

We expect business momentum within an asset servicing to continue.

Although, there may be some variability within quarters as new business is installed.

We expect securities finance, which includes the agency and enhanced custody businesses, to experience some 2Q seasonal uptick in relation to 1Q, albeit at muted levels relative to last year.

As I mentioned earlier, we expect swap cost to moderate as we adjust the currency mix of our balance sheet.

As such, a typical quarterly range for processing fees and other revenue should be around $35 million to $45 million in 2018.

We expect momentum in NII to continue in 2Q, consistent with our full year target range.

In summary, we believe that our strong first quarter business momentum positions us well to execute against both our financial and strategic priorities, including positive fee operating leverage, in keeping with our full year 2018 outlook range that we provided in January.

Now let me turn the call back to Jay.

Thanks, Eric.

And Sam, we should now -- I'd ask you to open the call to questions.

(Operator Instructions) Your first question comes from Brennan Hawken with UBS.

Eric, interested to hear a little bit more about the plan to shift up the investment and the earning asset portfolio.

What types of loans are you looking to grow?

And how should we think about that as far as a change, proportionally?

I think it might be helpful to sort of base a little bit of that.

Hey, Brennan.

It's Eric.

Let me describe a little bit of our intentions here.

Clearly, as we enter this market with rising rates, right?

It's a natural time for us to consider how much to keep a non-HQLA assets versus other interests earning assets.

We've made a choice to continue to optimize that part of the balance sheet.

And what you'll see us doing over time is shifting some of that into interest earning assets for clients, right?

And I'll -- some of that will be lending, as you've asked about, I'll come back to that in a moment.

Some of that will support the Enhanced Custody business, some of that will support our other activities.

And then another portional just we reinvested in interest earning assets that are HQLA qualifying, and thereby, balance of the balance sheet.

So I think you'll see us continue to design the balance sheet in a way that supports multiple objectives.

In terms of lending, our lending growth, and you see mid-teen lending growth over the last year.

It's been consistent over the last couple of years.

We lend to 40 Act Funds, we lend to the parent companies of some of our large clients, we do capital call financing for some of our private equity clients.

And so, that's the kind of, I'll call it near-end lending that will be -- that'll continue to be the core of what we do.

And our perspective is that some of that lending is renumerative on it's own.

Some of that lending is actually positive, because it gives us an extra way to interact and to connect with our clients.

And that's something that they value.

And sometimes actually ask for as part of the servicing mandates or others that we participate in.

That makes a lot of sense actually.

And it seems like a good way to expand out the relationship.

So another question on the balance sheet.

And it seemed like you implied it in your prepared remarks, Eric, but please correct me if I'm wrong.

It seems like the balance sheet and the average deposit balances grew here similar to the peers.

But seems as though there is sustained appetite there.

And so am I correct in implying that we shouldn't necessarily think about that reverting from what was a pretty strong growth rate here this quarter?

And you think that, that could sustain, or at least the indication so far looks like it's pretty durable here?

Brennan, yes, I think the way to think about our balance sheet growth is that you dial back 3 years, we needed to compress the size of our balance sheet and kind of focus of the most valuable part of the funding of the deposits that we had.

And we did that like many others.

I think last year, we felt like we had also seen another tick up in balances, in some currencies and some overall balances.

And we felt like we had to continue to trim and make it more compact and kind of more higher NIM generating.

I think we've gotten to a point over the last couple of quarters where we're comfortable with the size of our balance sheet and we've signaled, as part of the January outlook, that we're comfortable with modest growth.

And so you saw a little bit of that, quarter-on-quarter.

The trimming of the investment portfolio gives us an ability to do that.

Deposits now in dollars, in particular, come in at healthy margins.

And it's just another way to engage with all of our clients, whether it's the asset managers, whether it's the alternative providers, whether it's some of the FX kind of parties.

They all value the ability to leave their cash with such a highly rated counterparty.

And our perspective is, that's part of what we can do and should do.

And if you come full circle, that's a good service for them and provides good earnings and earnings growth for us.

Your next question comes from the line of Glenn Schorr with Evercore.

If we could talk about the new business wins.

So talk about what they're engaging you on?

Is it new versus existing clients, fee rate relative to overall maybe you could go through a little bit of that?

Sure, Glenn.

This is Jay.

I'll start and Eric can jump in.

Obviously, an outsized quarter, this quarter for new business commitments, that the $1.3 trillion.

And not surprisingly, there's a couple of big deals embedded within that.

I would say, general themes, our clients consolidating with fewer providers.

So if the two big deals, one represented that, a global player that operates in many different geographies and chose to consolidate with State Street, which is terrific.

The other big deal represented a large client that decided for the first time to outsource fund accounting and administration.

Which I think just speaks to the ongoing challenge that the asset management industry is having and looking for ways to get more efficient, outsource more activities.

So that represent a little bit of the outlier growth in the quarter.

I would say, maybe more generally, Glenn, that the pipelines and the new business that we committed is pretty diverse.

Little concentration in Europe, which continues to be a -- an outperformer in the offshore marketplace.

ETFs, as a service provider to ETFs, we think we have a very differentiated proposition.

So ETFs continue to be a theme.

But across the geographies, well balanced.

Final point I'd make before I give Eric a shot is that in the 2 big deals that we -- that were embedded in the quarter.

They both went very deep in their diligence looking at, as you'd expect, State Street's capabilities.

And Beacon featured very positively.

As people get in and peel back the covers and understand the investments that we're making and how we view the future around consolidating back, middle, front office, it's really a differentiator.

So in one of those in particular, I don't remember being examined the way we were examined by that respective client.

And the deeper they got, the better we looked.

So I'd say that it's reinforcing to me, the efforts of Beacon, not just to create more efficiencies, but when clients take a look at us, they merely understand that we are investing for the future.

And we do have a vision about how this business is going to look over time.

Eric, would you add anything?

Yes, Glenn, I'd just add that, it showed some real positive momentum of the business.

I'd just be careful.

It's hard to model how and when that hits.

Some new business comes in right away.

Some of the simpler activity.

Some of the more complex stuff takes time.

We're not going to, in any particular quarter, give guidance as to when this stuff is going to get installed or not.

I think we're just going to overdo it then.

But there is a range, right?

Sometimes you bring on an alternative mandate and you get 5 or 6 bps because of the fee structure.

Sometimes it comes on as custody accounting administration, so you get what might be typical in terms of fee yield.

And sometimes, you might just get custody because there may be other activities in discussion or possible down the road.

And so you start with your foot in the door, so to speak.

And that comes at a fraction of the typical or the average fee rate.

So there is a mix there.

I think it's nice positive momentum from a business standpoint, which makes us feel good about the progress and successes today.

Okay.

One tiny follow up.

Eric, on the balance sheet.

It seems like you got more fixed rate versus floating.

As rates are rising, just not as intuitive as I would've thought.

Just -- I'm sure it's much more involved than that.

Yes, Glenn.

Good observation, what the -- the immediate change that you noticed, which is really just a quarter-on-quarter change on the asset side of the balance sheet.

So we'll come back on the liabilities on the asset side as we sell down the non-HQLA securities.

You know the bulk of those were credit instruments.

Credit instruments tend to be floating rate.

So the mix changed, just in kind of a percentage nature, not in a dollar amount.

We've continued to maintain, though, the asset-sensitive balance sheet that we've had.

And we feel good about that.

That's paid out nicely over the last 2 years and -- so our asset sensitivity still remains in the range where we'll -- where we're positioned for a rising rates, in particular, at the short end of the curve.

Your next question comes from Ken Usdin with Jefferies.

Your next question comes from Alex Blostein with Goldman Sachs.

I want to start off with, just talking about the operating leverage dynamic in the quarter.

So I, understand the FX swap dynamic.

Obviously, Eric, your point attracted about 1 percentage point from operating leverage on the fee side.

So adjusted modestly positive, but again albeit, very modest especially in the light of pretty strong equity markets and improving volumes.

So maybe go through a little more what's going on there?

Anything that drove, in particular, sort of muted operating leverage on the fee side this quarter.

I don't know if it's just the sizable wins that might've suppressed some of that a little bit.

So just help us understand how to think through the fee operating leverage through the rest of the year.

Yes, Alex.

Fair question.

There's always variability quarter-on-quarter on both the revenue side and the expense side.

You saw that on the revenue side with the FX swaps.

And in that processing other line that we have, it's really the kind of all other line.

Every bank has that somewhere in their books.

And so you have the swaps.

And then we had slightly better results from that line a year ago.

Slightly below average this year.

And so the year-on-year actually got accentuated.

You have other stuff in there.

Small stuff.

You have the mark-to-mark on the seed capital for a new asset management fund, which was positive a year ago.

You've got the tax advantage investments and how much they run through revenue.

On the negative side, that was less negative a year ago.

So you kind of have those puts and takes.

And that's why in addition to the FX swap, we saw lower than typical processing in other line and that impacted the top line part of operating leverage by 1 point for FX swaps.

And then there is another point but it's small stuff, which we don't like to get into, but just tends to play through.

On the expense side, if you think through expenses, you keep an eye on currency translation, keep an eye on the accounting, the revenue recognition accounting standard and then the absence of restructuring, underlying expenses were up 4%.

That's the normalized fine given the revenue momentum in the business, but came in just a little more than it may in a typical quarter.

So we had some of the ramp-up cost, as you mentioned, of new business, right?

And that kind of have some ebbs and flows.

But if you could imagine, as you bring on new business, before you bring it on, you've got to run in parallel.

Before you run in parallel, you've got to set up.

Some of that is technology cost, which is typically expense.

Some of that is people, some of that is underlying processing.

And so there are periods where 1 quarter or even 2 quarters ahead, we can pick up some expenses in advance of the revenues.

And then we also had, I noted, some higher sub-custody fees, if you have noticed, emerging markets were up almost 30%.

That's where sub-custodians are.

And so that ends up being a little higher than this particular quarter.

So anyway, there is some variability, I think, in the -- on the revenue -- on the fee revenue line.

There is a little bit of variability in the expense line.

We're pleased with the overall momentum.

And as I said at the end of my prepared remarks, we're committed to our full year fee operating leverage within that range that we have provided at this point.

Got it.

Okay.

So no real change there.

And then the second question for me, I guess, just around some of the NIR dynamics.

I guess one, maybe we could hit on the deposit beta.

Obviously, cost seem to be pretty well controlled on the U.S. side.

For quite some times frankly as well.

So Maybe talk a little bit about what were the deposit betas on the U.S. side and why they're so much lower than for your peers?

And then maybe just to kind of round up the whole conversation around processing fee versus NIR.

Do I hear you correctly that, I guess, if the FX cost go away, roughly $10-ish million drag this quarter, so processing fees steps up about $10 million but then NIR goes down $10 million?

Let me take those questions in the order that you asked.

So betas came in reasonably well relative to expectations.

So we've been signaling that they've been floating up.

We had betas in the U.S. in the low 40% range, which is kind of right where we had, thought they would come.

That's up from last, I guess, the last rates hike we had.

We had it about 25%.

So we're kind of in -- we've been moving up in line with our expectations.

The part of the balance sheet that performs better than expectation was actually that transition from noninterest-bearing to interest-bearing, was actually slower than we've continued to model.

And so if you think about interest-bearing betas are at expectations or even though a bit better.

But total deposit betas, right?

Because that's what really matters if that's come in better than expected.

And I think if I step back, I think that's in the range of what we've seen in peers.

I think you see some types of deposits are -- that corporate deposit money, very high beta.

Or the wealth management money, very high beta.

The retail is very low beta and we tend to be in the middle as a custody bank.

And so we've been pleased with those results.

And finally, just on the FX swaps, that's -- you've got it right.

They -- instead of being in NIR, that FX swap cost, that ended up in processing fees.

If they had qualified for hedge accounting, they would've been in the other line.

I think going forward, we -- our intention is certainly to put as much as possible into the NII line by making sure they qualify for hedge accounting.

But even more importantly, our perspective is, we should bring down the volumes of FX swaps.

They were up at the -- the kind of $15 billion to $20 billion level.

They're now in the $10 billion to $15 billion level.

And actually trending at the lower end of that range.

Our intention in the coming quarter is to bring down even further.

And as we've trimmed the investment portfolio by trimming the dollar portion of the investment portfolio on the non-HQLA side, that actually, on a dollar-for-dollar basis, can actually bring down the swaps further.

So our perspective is to align the balance sheet over time, so that it's as currency matched as possible.

That'll bring the swap cost down.

And in fact, it will give us over time, the ability to take advantage of swap dislocations and actually do a little bit better depend -- one way or the other.

Your next question comes from Brian Bedell with Deutsche Bank.

Maybe just to go back on the -- one more on the balance sheet.

The end of period balance sheet, obviously, was a lot higher.

As a big step up -- I mean a big difference from the average balance sheet.

I know there's always a lot of quarter-end noise.

But maybe, Eric, if you can, sort of, comment on what do you think that reverts and we should be looking at the sort of the trend line on the average balance sheet.

And also on the noninterest-bearing side, that spiked up.

It looks like about -- by about $10 billion.

So I just want to make sure we're normalizing that.

And then on the swap, I think that's out of the non-U.

S. deposit side, it's $22 million if I'm not mistaken.

And would that make it more like an 18 basis point core rate instead of a 7 basis point core rate on that?

Let me start on the balance sheet.

And then I'd just -- I'll actually to clarify the swap question a little bit more.

On the balance sheet, we do get, on a daily basis and then at end of quarter basis, we do get higher deposit balances.

And if you think about the very largest of our asset manager and pension clients, that is quite typical.

I don't think this quarter was any different than the other quarter ends other than it ended on a Good Friday.

And that, in some cases, creates a little more cash on our balance sheet.

But there's nothing -- there was nothing unique about the quarter end which signals any changes really on the average balance sheet.

The average balance sheet, as I described, I think is moving in the right direction.

I think we've got good client engagement.

We've got a good sharing of the benefits of the rate rises with our clients and we continue to engage them in making sure that, that's fair on both sides.

And as I said earlier, our perspective is our balance sheet.

It's something we can put to work on the -- for the benefit of our clients, and we're going to keep doing that.

That's a nice way to supplement the fee revenue that we have in this business.

Do you want to just clarify a little more on your second question?

Yes, all I did was added the $22 million of the swap cost to the non interest, I'm sorry, to the non-U.

S deposit line.

And that would take that rate from 7 basis points that you published in your average balance sheet to that 18 basis points to sort of establish a core rate.

Is that accurate?

Is that -- am I -- is the geography correct in where I'm putting now?

Let me -- why don't we have the IR team follow up off-line.

I think you're -- there is a 2 parts of the answer to that question.

First, the FX swap costs were $15 million this quarter and there was a $7 million benefit a year ago.

So the $22 million I called out, the delta year-on-year.

So you've got to adjust for the absolutes.

So then we can work with you on the line item part of the balance sheet.

I think directionally, it should go against the non-U.

S. domicile deposits.

I'll remind you, this is a domiciled view of deposits, not the currency view.

Sometimes, those are similar.

Sometimes, those are not.

So it's -- you've got to be careful there.

And we do have some extra footnotes at the bottom of that average balance sheet page of the supplement to try to help.

But why don't we just do that offline with you and help with the modeling.

Yes, sure.

Perfect.

And then the follow up would be on backup to the wins, the $1.3 trillion, sounds like the bulk of that is in 2 clients, Jay.

Sometimes I know you -- I don't know if you've announced the actual clients.

It'd be great if you could say those.

If not, the -- just understanding, once again, the nature of that business.

I think you mentioned one is a mutual funds accounting administration.

And I forget, did you say the other was a mid-office?

And effectively, from an AUC level or AUA level, it looks like it offsets the BlackRock loss, and should we be thinking of this coming in, overall, as a higher yield than the BlackRock loss?

Yes, let me take that, Brian.

We -- we're not in a position to name names.

But you have it, right, that there are a couple of meaty transactions which make up the bulk of that $1.3 trillion.

And they're both kind of multidimensional.

I described one as multi-geographic of full custody, admin, middle-office.

Both existing clients that we had a small piece of.

And then the other really represents more of a custody fund accounting fund admin, mostly U.S. And these will feather in over the course of the next year with component parts along the way till we get it fully implemented.

But I think I'd go back to my point, they do represent what I've been saying all along, which is the -- we're getting more clients that are consolidating with fewer providers.

And increasingly the pressure felt by the asset management industry on multiple dimensions, the active to passive, the regulatory pressure they're feeling.

Both of these clients, by the way, took advantage of our new capabilities and liquidity, monthly liquidity reporting, which is a new SEC requirement.

So I think it's more outsourcing.

It's more consolidation.

All good news.

And we also had our typical range of new business, as I mentioned, across hedge, across ETF, offshore domicile.

So a really good momentum.

You mentioned the BlackRock offset, I mean, they -- all of this kind of offsets, generally, the BlackRock outflow, which I think we said will kind of commence somewhere mid-year and that'll take one year to roll out as well.

So it all -- collectively, it gives us greater confidence in our ability to meet the guidance that we provided on service fee growth rates for 2018.

And is it fair to say it's a richer revenue yield than the BlackRock loss?

It's a real mix, Brian.

It wouldn't be sensible for me to try to break that down.

Your next question is from Jim Mitchell with Buckingham Research.

Maybe just following up on that.

I guess, Jay, what's your sense of sort of your active discussions or pipeline right now?

Do you feel like it's stronger than it has been?

Just kind of get a sense of the environment.

Obviously, you had a very good quarter today on a couple of big wins.

So how do we think about your pipeline and thoughts on it going forward?

I would say, Jim, it's been steady and quite positive.

So I don't -- these 2 transactions maybe a little bit of an outlier.

But we continue to see opportunities across the spectrum.

And we'll continue to be positioned, and whether it's the alternative world, the ETF world or traditional fund world.

Folks consolidating, doing more.

The more outsourcing piece, which Brian's question got into a little bit.

There's more middle office activity.

There is increasing interest in having us wire together the back office and the middle office.

Through DataGX, we're offering new data-based analytics services.

I mentioned the liquidity stress testing.

So the environment is such that not only asset managers but also asset owners and big pension funds are craving more outsourcing, more analytics, more ability to respond to regulatory requirements.

So it's -- you might say at, one level, it's mixed, and that there is a lot of pressure in our client set.

And that comes with normal pressures back to us.

But it's also -- it also comes with pretty steady opportunity to do more for them.

And some of the -- the reference to spend on technology is designed to stay ahead of the new product opportunities, which are pretty vast as well.

So strong, broad environment for new business.

No real change.

I don't see it letting up either.

Okay, that's really helpful.

And then maybe for Eric, to be a dead horse on the balance sheet.

But you guys were the only one of your peers to see deposits grow and grow pretty significantly quarter-over-quarter at period end.

You're sort of signaling maybe continued growth in average assets when others are signaling declines.

So is it -- are you competing on price?

I mean how do we think about what you're seeing and how you're attracting those deposits versus what your peers are seeing?

Yes, Jim, there's, I think, part of the -- there are a couple of things going on.

There is the quarter end spikes versus the averages.

There is a natural seasonality in the deposits as well that I think some of the others have referenced.

January, February, tends to be higher.

And then March a little lighter.

So there is that trend, which I've heard, mentioned outside and we obviously see some version of that are custody books are similar enough.

So I wouldn't read too much into the end of period or the month.

I mean deposits tend to ebb and flow.

The discussions we've had with clients are not strictly on price.

I mean they shouldn't be and we don't want them to be and that in fact clients -- if that's not the client that we are looking for and vice versa.

Because then it ends up being hot money.

I mean we do tier pricing, right?

Appropriately for larger clients versus smaller ones, we differentiate dollars and other currencies.

There are relationships there that we engage in, but it's part of the relationship.

It's part of the -- all clients have immediate cash that move around all the time.

They have cash that's somewhat stable.

There is some cash they sweep in institutional money market funds that we support through our asset management arm, right?

They all have a waterfall of cash and cash availability and our perspective is we should engage with them on that, but prices are result of a lot of other things.

It tends to not be something we lead it with and we won't lead with.

It's -- and in fact, I think if you look at the underlying pricing and betas and so forth that we described in the U.S. market, which is the easiest for all of you to take a look at, we've actually been disciplined on deposit pricing and our view is we'll -- we should continue to do that.

Okay, so you're saying it's really just incremental demand for you guys.

No change in how you're pricing the business?

So that's great.

Correct.

Yes.

This question is from Mike Mayo with Wells Fargo Securities.

I think I'm in a state of cognitive dissonance over your results.

If you can help me out.

On the negative side, I mean, you had tried the Beacon for few years.

And Jay, you've had restructuring all decade.

And it's great to hear Beacon savings.

But then you have all these expenses for the new business wins and compensation and tax spend.

And I thought one purpose would be you can raise -- more business on more efficiently.

my purpose of Beacon was to able to put more business on more efficiently.

And headcount is up 7% year-over-year.

That way surpasses peers.

Expense growth, certainly at more than I think some had expected this quarter.

So that's the negative feeling I have.

I guess on the other hand, the positive feeling is double-digit organic client growth in the first quarter, which was great.

So I'm trying to reconcile those two thoughts, and I think the answer comes in what you've said about the lag between adding new business and getting all the revenues from that.

I can't remember when that's had this much of an impact before.

So if you can at least quantify the extra expenses this quarter, what kind of revenues you expect or give a little bit of color on that, that would be helpful.

Sure.

Happy to do that, Mike.

This is Jay.

And I'll quickly wrap latter of this to Eric.

But we don't measure life by a quarter.

We're confidently investing.

We're bringing on new clients.

Beacon is a multiyear journey.

We're tracking against our operating leverage goal as we said a few times, we are determined to achieve our fee operating goal in 2018.

So things can come and go in a quarter.

But we're investing in this business.

And we're investing to bring on new clients.

We're investing to make sure that we have those products that ultimately will differentiate and allow us to continue to grow.

And that's not just an asset servicing, that's an asset management.

So as Eric referenced and he'll go over again, today he gave some episodic revenue and expense situations in a quarter.

But we're thrilled with 5% operating leverage.

We're thrilled with our top line.

Our -- we're pretty happy about our market-based activity and the revenues that's driving.

And we're going to make sure that we spend what we need to spend in order to bring those clients in successfully and stay ahead of the fact with regard to competing in these businesses.

But, Eric, you might want to?

Yes, Mike, I'll might just add to that, as I mentioned earlier in the prepared remarks but also in some of the Q&A, right?

The expenses do have a little bit of variability to them, we talk about the ramp-up cost and those come and go and that's kind of the installation, right?

And some of that can be quite Beaconized away, because it takes custom effort to plugs client in, especially some of our largest clients, remember are quite bespoke and unique and so connecting them take some effort.

I mentioned the sub-custody fees, which were higher this quarter as emerging markets, as we saw more flows in emerging markets, we ended up with more volumes there.

And the market levels take through them in.

As you saw we continue to invest carefully in the tax spend law and you see us float up purposely because we see headroom on the revenues.

We want to spend some on the -- we want to spend some on for client functionality and product development and so forth.

I will remind you and the others, that first quarter expenses typically are up relative to fourth quarter by about $150 million because of that seasonal effect, the differed incentive comp which comes through, in one way, once a year.

So just keep an eye on that as you think about the modeling, right?

This is not the new run rate, this is -- exactly not know what it is.

And then finally, you mentioned headcount.

It's something we actively manage.

Overall headcount is up, as you pointed out, 6% to 7% range.

High cost location headcount is actually down 3%, which is a purposeful movement from the -- some of our geographies to others.

We found the -- really strong capabilities in our global hubs, which we have around the world in China, India, Poland.

And so that's another part of the Beacon efforts.

But you won't see that in the nominal numbers because of the transition in kind of bubble headcount that you create floats up.

So one more attempt.

Can you size at all, the disconnect between the extra expenses in the new business?

Is it bigger than a bread box?

Is it material?

And also, did any asset management business come along with some of the custody wins?

I think there's always going to be some expense and revenue variability.

I think one way to think about it, Mike, is we gave an operating leverage range for the full year, right?

That we committed to 75 basis points to 150 basis points on a fee operating leverage basis.

So on a full year basis, you can imagine there is 75 basis points of variability.

On a particular quarter, right?

There can easily be a variability of 1 percentage point on expenses, right?

One way or the other.

And that's just the envelope in which we operate.

And what we're trying to do is do the right thing by the business over time, by quarter and by year.

But we want to do that in a considered manner.

And, Mike, just on the -- did any asset management business come along with it?

No.

Because most of these bigger deals were asset managers themselves as suppose to asset owners.

They'd be less applicable as asset management prospect.

Your next question comes from Gerard Cassidy with RBC.

Jay, can you share with us these business wins that you had this quarter, which of course, were outsized?

And you shared already that, as the customers dug into the way you guys are operating, they like even more of what they sore.

Can you now extrapolate that the pricing.

Are you able to price these types of products better or is it still very -- I know pricing has always been competitive for as long as you've been at State Street.

Or was it just as competitive as always?

Yes, let me try to unpack that, Gerard.

The -- I think that as a general theme, it's always been true that the more complicated the transaction is, the better the pricing.

And that may sound counterintuitive.

But I think when you have commoditized activity throughout the bid, there's a lot of people that can compete.

And when there is a lot of people, pricing gets more difficult.

The -- I'll just give you a couple of win yet.

The one deal that we talked about crosses 3 different geographies and it's very complicated.

It's a very involved service model where you've got trading desk.

In a couple of different locations, you've got product servicing capability.

In other 3 locations, it's middle office, back office.

So that narrows the field as far as the number of folks that can compete.

And as a result, pricing gets better.

And I'd say that's the theme generally holds.

I think another vignette would be when somebody is doing this work on their own and they're making a decision to outsource it, which is another one of the situations that I had referenced.

And that gets a little bit more complicated because try to understanding what ones internal cost are becomes a factor.

But I would say, in that case, it was really less about cost, more about the -- they want to get out of the risky business of doing fund accounting globally at scale across a number of different products.

So I think it still holds true that the more involved the activity is by geographies and by layers of service moving back towards the front office, generally the better pricing gets.

I don't know if that's helpful.

No, no.

That's is.

And then, Eric, you gave us some good color on your capital ratios and you've mentioned about the RWA growth due to higher client overdrafts.

A couple of questions on that.

Do you know what drove the client overdrafts since they appear to be pretty material since the CET1 ratio did fall sequentially by a fair amount?

And then second, when you look at our net interest revenue numbers, the incremental growth that you saw, how much was due to those overdrafts?

Sure, Gerard.

The overdrafts, that totaled about $5 billion on our undrawn committed lines.

That's not a large number.

But it's large relative to what's typical.

We've had the spikes in overdrafts.

We've had them when there are either -- sometimes -- when you have storms and weather events, when you have holidays.

This one in particular, if you remember we had Good Friday at the end of the quarter.

The markets aren't -- half of the markets are open, half are not open.

And so what happens is you kind of have a little bit of a discontinuity for clients who end up ahead, and one part of their funds short on the other and so draw on their lines.

Which is why, to be honest, those lines exist, right?

We're there for our clients.

And are they're delighted to help them as needed.

It was literally 2, 3, 4, 5 clients.

So a handful.

We know them well.

We've supported them.

And they've been good to us.

So it's the kind of thing that will just occasionally happen.

We don't expect it every quarter end.

But occasionally, when something is in the environment, like the -- like in this case, it was a holiday and a quarter-end, you have an effect.

In terms of NII, there is not a big effect, because remember NII is driven by average balances over the course of the quarter, right?

So all 90 days.

Not one day.

So this wouldn't have had a big impact positive to NII.

This is really a client accommodation that we're doing.

And we're there for our clients.

And one of the reasons we've got such strong balance sheet is so that we can accommodate clients like that.

And that's the kind of expectation they have, for example, on some of the -- some of those larger clients that Jay described have for a custodial bank like us.

Next question comes from the line of Geoffrey Elliott with Autonomous Research.

You touched on some of the proposed regulatory changes earlier.

Can you elaborate a bit on, if we get the CCAR changes plus the SLR changes as proposed, what you think your new binding constraints on capital would be?

Geoff, it's Eric.

I mean that's been a well-studied and modeled endeavor.

And I say that in a nice way, because it's obviously important to us.

It's obviously important to many of you and I think your team and other teams have tried to take that the new CCAR, NPR are the one with the stress capital buffer.

And so if you look, if you had a reformatted State Street and all the other bank results back to the last CCAR, how would it played out.

I think as you know, our CCAR binding constraints or let me step back, our binding constraints today from a capital perspective start with Tier 1 leverage then depending on kind of where we are it could be either CET1 or SLR.

But that kind of core Tier 1 leverage is the binding constraint.

I think the early modeling that we've seen and I think the modeling that the industry has done is not particularly different than ours.

Is that with the SCB and the implementation the SCB across the various those 5 core capital ratios.

It seems like the binding constraint will move from the standard Tier 1 leverage to CET1.

That should create some amount of capacity.

It's hard to model it precisely, but it seems to create some amount of capacity.

And I think others have observed, they kind of does the right thing for banks, which is risk-weighted asset, should I actually be the dominant capital constraint for any bank, right?

That's what a bank is about.

The leverage ratio whether it's Tier 1 leverage or SLR should be the backstop.

And I think the proposal is both well-intentioned, well-designed, or obviously some refinements that I'm sure we will suggest and others will also suggest but clearly going in the right direction.

And maybe just another quick one.

No outlook slide this time.

I know you kind of touched on the outlook in the comments.

but it feels like there's always been an outlook slide in the State Street deck, so we'd love to hear why you decided not to include that this time?

Sure, there's -- there really is no messaging at all.

I think the full year outlook that we gave in January is fully operative.

It was operative in February when we went to an industry conference, it was -- it's operative now.

I think what we are going to do is keep it simple when the outlook changes, we'll do a new slide and thereby, kind of adjust our messaging.

What I will do and I did verbally this quarter is if quarter-on-quarter there always some seasonality or other swings, I'll signal those verbally.

But no message at all.

We're just trying to keep the slide deck compact to save an extra tree in the process.

And -- but the full year outlook commitment that we made in January, our minds is a commitment.

And our intention is and -- and we have confidence that we'll deliver that.

Your next question is from Betsy Graseck with Morgan Stanley.

Just 2 questions.

One is on the proposed changes that you just discussed.

And it seems like you have 2 potential options.

Obviously, you can do a mix of each.

But 2 basic options.

One is, you have more capacity to take in deposits, grow the balance sheet even further or the other one is reduce the prefs outstanding.

And you've got some of the callable prefs that are out there today.

Do you have a preference for either one or could you give us a sense of percentage that you'd want to do with either one?

Betsy, it's Eric.

I think at this point it's little premature to make a choice there.

I think -- the rules as they stand are obviously, constraining in a certain way.

I think the SCB, the CCAR SCB proposal and SLR proposals moved in the right direction.

There's also the TLAC proposal, which we think is -- it's constructive.

I mean not huge amounts, but at least constructive directionally.

I think what we'll have to see is how they all come together and remember, they may come together little differently in each CCAR period, right?

Because the notion of the stress and how the stress impacts us will be different.

And also, we don't know if the Fed models are still fairly opaque, right?

We don't know how they really model the balance sheet, how they'll really model the PPNR given that they've signaled -- they're going to change and not grow the balance sheets as much.

And so everyone of those -- so I don't mean to avoid the question but I think you've got the right levers, which is we could add to the deposit base or other balance sheet, kind of leverage balance sheet, intensive activities like some sec landing or enhanced custody qualified.

We could reduce the prefs and some of them are callable today, some of them will be callable next year and the year after and so forth.

If that's one is the binding constraint, right?

Will be disciplined around RWA's right?

And depending on how much capacity you want to create there with, as we did this quarter with changes in non-HQLA in the investment portfolio, which have RWA will be under consideration.

So in a way, I think there's a lot of optionality that this would create and confirm use of this point.

But in my mind, it's the kind of thing, we'll optimize again, it's a better set of -- I think it's a better designed set of rules.

And we'll have the view of how to do that from -- I think from a shareholder perspective, which is how do we turned that optimization to higher earnings and earnings growth, how do we turn that into capital and capital return, that'll be the lense that we'll use.

And so, your point you just made, okay, actions taken in the quarter are shifting some of the mix in earning assets from securities to loans, for example.

That's CET1 positive, Is that your point?

It's not dollar-for-dollar, right?

Because some of those securities are 50% risk-weighted.

Some closer to 100%.

But I'm saying that, that is another lever that we have, and in fact if we have the opportunity to trade off client lending, right?

For nonclients securities, right?

There's clearly a prioritization.

We have to make sure it comes with good returns or good wallet, share of wallet from the client.

But those are absolutely opportunities that we see and I think what were -- because we have -- we still have non-HQLA in the investment portfolio that always be up to grabs for -- as we optimize for our clients.

How much left is that?

Non-HQLA in the investment portfolio.

We sold down about $12 billion on a base of $35 billion.

So there is still $20 [billion-plus]there.

Our next question comes from Mike Carrier.

Our last question indeed, from Mike Carrier with Bank of America.

Eric, just one quick one.

When I look at the fee revenue growth year-over-year, you guys had the 8%, like 5% ex FX.

And then I think ex the revenue the recognition accounting that's 3%.

Somewhere around 2%.

And I know the processing and other -- that can add like 3 -- like that can take that 2% to 3% or 4%.

It just -- it seems like that's still may be on the lighter side, just given the markets strength that we saw over the last 12 months.

And then also the volatility that we saw in the quarter that helped the trading side.

So I guess I'm just trying to figure out, is there anything else you know that may be we're missing, that may be muted growth or is it really just all the processing and other, because it still seems maybe a little bit lighter than you would've expected?

Yes, Mike, it's Eric.

Let me -- I mean I think Page 7 of the earnings deck that you all have is probably a good one to take a quick look at.

I think the -- we're quite circumspect and how we show fee revenues.

We show with and without currency translation, we actually do it on the slide so you can find them and I just encourage you to make sure all of the comparisons are apples-to-apples and you've got enough footnotes here to adjust for revenue recognition.

I think the single biggest driver of our revenues is the servicing fees, right?

That's half of our total revenues, $5 billion a year, and the $11 billion, $10 billion to $11 billion of revenues.

And so I think we're quite pleased with a 10% nominal growth there, and the 6% adjusted for currency translation.

And there is no meaningful revenue recognition in there.

So that's quite solid.

And that -- last year -- right now, it's half of our revenue, last year it was up 4% adjusted for currency on a full year basis.

Something in about that range.

So we're pleased with that.

Every quarter will be a little different variable.

But that's a good performance.

I think some of the other roads, management fees, trading, securities finance came in more or less in line with expectations, and I do think processing other is the biggest disconnect, remember a year ago we had a gain on sales 30 [bucks] so that costs up 0.5%.

You had the FX swaps delta, which was $22 million.

And then if you still do the comparison between the year-on-year, there is another, 20-25 of just small ins and outs that tended to add a positive last year and negative this year.

So I don't think you're missing anything.

I think there's just some variability here on that line.

And it went against this quarter, all tend to be neutral in other quarters and positive in still others.

so overall, I think we feel like there's good momentum in the business.

We're pleased with the result, line item geography was a little bit unfortunate on the FX swaps, but nice way in our minds to start the year, good step off and we're obviously working on the second quarter, third quarter and fourth quarter.

Sam, that's it?

There are no further questions.

Okay, great.

Thanks, everyone for joining us this morning.

We look forward to getting together at the end of the second quarter.

Thanks.

Ladies and gentlemen, this does conclude today's conference call.

You may now disconnect your phone lines.