道富銀行 (STT) 2018 Q3 法說會逐字稿

Good morning, and welcome to State Street Corporation's Third 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 recorded for rebroadcast or distribution in whole or in part without the expressed written authorization from State Street Corporation.

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

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

Ma'am, please go ahead.

Thank you, Laura.

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 third quarter 2018 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com.

Afterwards, Ron O'Hanley, our President and COO, will join Jay and Eric, and we'll be happy to take questions.

During the Q&A, please limit yourself to 2 questions and then requeue.

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 2Q '18 -- 3Q '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, we announced our third quarter financial results this morning.

Our third quarter and year-to-date results reflect solid performance across our businesses as we continue to win new business and invest in the future while reducing legacy cost as we advanced our digital transformation.

Despite a higher-than-average share count, third quarter earnings included substantial EPS growth and increased return on equity compared to 3Q '17.

Assets under custody and administration rose to record levels of $34 trillion, a 6% increase year-on-year, driven by strength in equity markets and new business wins.

We achieved new asset servicing mandates of approximately $300 billion during the quarter, driven by 2 substantial wins of approximately $90 billion each from a large European client and a top insurance and investment management company.

Importantly, year-to-date, we've now seen a number of sizable new client business wins, totaling $1.8 trillion and our new business pipeline opportunities remain robust across the franchise, giving us continued confidence about the differentiation in the marketplace from the services solution standpoint.

Assets under management at State Street Global Advisors were at record levels of $2.8 trillion at the end of the third quarter, up 5% year-on-year and 3% sequentially, reflecting strength in equity markets and ETF inflows, driven by the continued success of our low-cost product launch late last year, and institutional inflows.

These positive growth trends within our core franchise were partially offset by market and industry headwinds, leading to overall fee revenue increasing only 2% year-over-year.

I'm particularly pleased with our ability to drive cost out of our core business and adapt quickly to the revenue environment we experienced this quarter.

We actively brought down expenses for 2 successive quarters.

Beacon continues to deliver significant savings, and we've embarked our new productivity initiatives to achieve greater standardization and globalization of our operations and services.

These levers equip us to achieve strong expense control as evidenced by the year-to-date increase in our pretax margin, while continuing to invest for the future.

More importantly, these initiatives enable us to create new data-oriented services and will provide the foundation for the integration of Charles River into the industry's first ever front to back office asset servicing platform from a single provider.

Let me take a moment to update you on Charles River Development.

As you know, the acquisition closed October 1, integration is well underway and initial client reaction has been overwhelmingly positive.

Charles River is already creating opportunities among new and existing clients.

We have our management team in place and are establishing a client-advisory board anchored by OMERS, the Ontario pension fund, which is a broad-based user of Charles River dating back 11 years.

We're encouraged by the early reaction to the acquisition and are confident that will enable us to deepen and grow our client base while delivering positive results for our shareholders.

With that, let me turn the call over to Eric to take you through the quarter in more detail.

Thank you, Jay, and good morning, everyone.

Please turn to Slide 4 where you'll find our quarterly results as well as few a notable items from prior quarters.

As a reminder, 2Q '18 included a repositioning charge of $77 million and 3Q '17 included a $26 million gain related to the sale of an equity-trading platform as well as $33 million in restructuring cost.

I'll also remind you that 3Q '18 results include the impact of the new revenue recognition accounting standard.

This increased both fee and total expense by $70 million year-over-year but is EBIT neutral.

Now let me move to Slide 5 where I will review the quarterly results as well as year-to-date highlights.

Third quarter 2018 EPS increased to $1.87, up 13% relative to a year ago.

ROE was 14%, up a full percentage point and pretax margin increased 0.5 point as compared to prior year.

3Q '18 results reflected disappointing fee revenue environment, largely offset by strength in net interest income and tighter expense control.

We achieved positive operating leverage of 80 basis points compared to 3Q '17.

Fee operating leverage, however, was negatively impacted by lower-than-expected fee revenue which I will touch on shortly.

Given the soft fee revenue environment, we intervened on expenses, excluding the impact from revenue recognition and the prior year restructuring charge, we held expense growth to just 1% as compared to last year.

Sequentially, we actively flexed expenses downward.

Last quarter, I told you we would keep second half expenses flat to first half.

In 3Q, we did just that.

Expense control is a key management priority as we navigate the quarterly revenue environment.

We're carefully investing in product differentiation that continues to drive new business wins, while reducing legacy cost.

On a year-to-date basis, we delivered solid results.

EPS increased 24%, and ROE increased approximately 2 percentage points.

We achieved positive operating leverage of 2.3 percentage points supported by positive momentum in NII and 4% year-to-date servicing fee growth.

Pretax margin increased approximately 1.5 percentage points, further demonstrating our focus on managing expenses.

Now let me turn to Slide 6 to review AUCA and AUM performance, which increased on both the sequential and year-over-year basis.

AUCA increased 6% from 3Q '17 to $34 trillion.

Growth was primarily driven by U.S. market appreciation in several large client installations, partially offset by the previously announced BlackRock transition.

In Global Advisors, our asset management business, AUM increased 5% from 3Q '17, driven by strength in U.S. equity market and new business from ETF mandate only partially offset by lower net flows within the institutional and cash segment.

Please turn to Slide 7, where I will review 3Q '18 fee revenue as compared to 3Q '17.

Total fee revenue increased 2%, reflecting higher equity markets and trading activity as well as the benefit related to revenue recognition.

Servicing fee revenue was lower compared to 3Q '17 as well as compared to 2Q '18 although, it was up 4% on a year-to-date basis.

3Q results reflect the previously announced BlackRock transition which was worth an additional $20 million this quarter as well as challenging industry conditions.

Most important, global economic uncertainty has driven investors to the sidelines, causing significant outflows and lower activity across the bulk of the asset management industry.

We have also seen some fee pressure and 2 to 3 quarters of fund outflows in both the U.S. and Europe, which together creates a downdraft on industry servicing fees.

And emerging markets, which typically represent higher per dollar servicing fees, were negative both year-over-year and quarter-over-quarter.

That said, net new business was strong again this quarter, and year-to-date servicing fees are up 4%, as I mentioned.

Now let me briefly touch on the other fee revenue lines related to 3Q '17.

Management fees increased 13%, benefiting from global equity markets as well as $50 million related to the new revenue recognition standard.

Trading services revenues increased to 11%, primarily due to higher FX client volumes.

Securities finance fees decreased, driven by some balance sheet optimization that is now complete.

This provides a base off of which to grow these revenues in line with our balance sheet expansion as I've previously mentioned.

Processing fees decreased from 3Q '17, reflecting a prior year gain, partially offset by higher software fees.

Moving to Slide 8, NII was up 11% and NIM increased 13 basis points on a fully tax equivalent basis relative to 3Q '17.

NII benefited from higher U.S. interest rates and continued disciplined liability pricing, partially offset by continuing mix shift towards HQLA securities in the investment portfolio.

NIM increased due to higher NII and a smaller interest earning base due to deposit volume volatility.

Deposit betas for the U.S. interest-bearing account were relatively unchanged from last quarter, though we expect betas to continue to edge higher in future quarters in line with industry trend.

Now I will turn to Slide 9 to highlight our intense focus on expense discipline which continued into the third quarter.

3Q '18 expenses were well controlled relative to 3Q '17, increasing 3%.

Excluding approximately $70 million associated with revenue recognition and a prior year restructuring cost, expenses were up less than 1% from a year ago quarter, as we continue to actively manage the cost base.

The 1% increase in expenses was due to investments and costs of -- for new business as well as higher trading volumes, partially offset by Beacon saves.

Sequentially, expenses decreased 4% from 2Q, which included the second quarter $77 million repositioning charge, excluding the charge, expenses were flat further demonstrating our ability to flex the cost base to the current revenue environment.

As I mentioned, this is a second quarter in a row of sequential underlying expense reduction.

During 2Q '18, we reduced incentive compensation.

This quarter we reduced vendor and discretionary spend.

Quickly, from a line item perspective and relative to 3Q '17, compensation and employee benefits increased just 1%, reflecting costs for new business and annual merit increases, partially offset by Beacon savings and new contractor vendor initiatives.

Information systems increased, reflecting Beacon-related investments as well as additional investments to support new business growth.

Transaction processing costs increased due to the impact of the new revenue recognition standard, offset by sub-custodian savings this quarter.

Occupancy costs were down as a result of the continued progress in optimizing our global footprint.

And excluding the $38 million impact of revenue recognition, other expenses decreased 3%, reflecting lower discretionary spend such as travel expenses and Beacon-related savings.

Turning to Slide 10, let me briefly highlight what actions we have successfully taken to manage expenses relative to the revenue landscape over the last several quarters.

On the top of the slide, you can see that we achieved $65 million in net Beacon saves this quarter through our efforts to optimize the core servicing business, transform our IT infrastructure and gain efficiencies within the corporate functions and SSgA.

Notably, we are on track to complete Beacon by early 2019, significantly ahead of our original year-end 2020 target.

We continue to invest towards a highly digitized environment, including robotics and machine learning, which are driving innovation and cost savings for us and our clients.

In addition, as you can see in the bottom panel, we just rolled out a series of new expense initiatives in light of current industry conditions that are affecting quarterly revenue.

These total $40 million just this quarter.

And additional actions are planned in the fourth quarter.

Moving to Slide 11, let me touch on our balance sheet.

The size of our investment portfolio remained flat sequentially and well positioned, given the rate environment.

Our capital ratios increased measurably from 2Q '18, as a result of our prefunding related to the Charles River acquisition, which we completed on October 1 as well as earnings retention.

As a reminder, in late July, we issued approximately $1.1 billion of common stock, and in September, successfully issued $500 million of preferred stock while temporarily suspending buyback.

We fully intend to resume our common stock repurchases in 1Q '19, and expect to return $600 million to shareholders through 2Q '19.

We also completed the necessary adjustments for our management processes and believe that we are well prepared for CCAR 2019.

Moving to Slide 12, let me summarize.

Our 3Q '18 results reflect a continued strong focus on managing expenses in response to the current quarterly revenue environment.

The 11% increase in net interest income compared to 3Q '17, offsetting part the softness in servicing fee revenue as I described.

Notably, 3Q '18 pretax margin increased to 29.4% supported by the strength in NII and disciplined expense management.

Year-to-date result also reflect solid progress from the 2017 period.

We announced new business wins of $1.8 trillion of custodian assets.

EPS increased 24%, and ROE improved by almost 2 percentage points or 13.8%.

NII increased 17%, reflecting higher U.S. interest rates and our success in managing liability pricing.

Calibrating expenses, the revenue generated positive operating leverage of 2.3 percentage points.

Let me briefly touch on our 4Q '18 outlook, which currently excludes the recently completed Charles River acquisition.

We expect 4Q '18 servicing fee revenue to be flattish to 3Q, assuming continuing industry conditions and stable market levels.

We expect continued sequential NII growth, though this always depends on market rates and betas.

We expect total expenses only slightly above 3Q levels but consistent with our expectations to keep second half of 2018 expenses flat to the first half, excluding the seasonal deferred incentive comp and repositioning, as we actively manage expenses relative to the revenue landscape.

As I said, these estimates do not yet include acquisition of Charles River that we completed earlier this month.

So let me give you some color on that before I turn the call back to Jay.

Although it is early days, we're excited about the opportunities to deliver to our -- for our clients, the first ever front to back office asset servicing solutions from a single provider.

During fourth quarter, we'll be giving guidance on the revenues and expenses from the Charles River acquisition at an upcoming conference.

In 2019, we look forward to providing regular updates to investors and how we are progressing against the revenue and expense synergies that we communicated on the July earnings call.

Now, let me hand the call back to Jay.

Thanks, Eric.

And Laura, we're now -- if you would open up the call to questions, we're available.

(Operator Instructions) And our first question comes from Glenn Schorr of Evercore ISI.

A couple of quick ones on the securities portfolio, I see: a, the duration extends a little bit, I think; b, the yield on the securities book was flat; and c, it now has $1 billion unrealized loss position, which I think is just expansion of the mortgage book, but could you mind commenting on those 3 things?

Sure, Glenn.

It's Eric.

Maybe in reverse order, the OCI position is just one that moves in firstly with rates, and so as we have seen the upward rate environment that comes through as a mark on the balance sheet.

I think, it's within good set of bounds of that's -- that was to be expected.

In terms of the investment portfolio, I think as we described in first quarter and second quarter, we continue to remix that portfolio.

We've been gently shifting out of credit and into sort of more classic HQLA securities.

There were some movements of that this quarter between ABS and munies and so forth, which resulted in relatively flat yields.

The big piece that you have to remember is that we've added and continue to add international foreign debt securities, right?

German bunds and British gilts and that kind of high-grade sovereign.

As we do that, we do less of the FX swaps back to the U.S. And so our FX swap cost actually came down by nearly $35 million this quarter.

And so what you actually see is you see relatively stable yields in the portfolio, in aggregate.

But if you look down on the interest-bearing liability line for non-U.

S. domicile deposits, you see reduced interest expense because we have less of that FX swap.

So just keep in mind that the FX play through both on the investment portfolios, on the assets side and the liability side as you read through.

I definitely get that.

I appreciate it.

And then, there's a further migration out of non-U.

S. deposits, and it looks like U.S. deposits were up.

It also is a big drop in the yield paid in the non-U.

S. deposit.

So is that you purposely migrating those deposits via pricing?

No.

This has less to do with rates than just the movement of the domiciles and deposits.

If you remember, we like many banks, had deposits in the Cayman branches and other, what I'll call, offshore but U.S.-related areas.

Those were all those -- those were typically U.S. dollar deposits but were classified by the regulatory reporting standards as non-U.

S. domicile.

So we effectively did is, we closed down that program.

It's no longer necessary.

It's one of those legacy programs that we and other banks have had.

So what's happened is, the U.S. deposits, which are paid U.S. interest rates, which tend to be higher than foreign deposits interest rates have actually moved out of the non-U.

S. line into the U.S. line, which is what brings the non-U.

S. line down sequentially and then, it just blends into the U.S. line.

At this point, we've made I think 2 steps of a change of about, I want to say, almost $20 billion that we've moved.

It's now -- those moves are completed.

And so on a go-forward basis, the account should be a little cleaner for you to read through.

Our next question is from Brennan Hawken of UBS.

First question just wanted to follow up, Eric, on the fourth quarter indication on servicing fees.

You had indicated that you expected them to be flat with this third quarter.

So I guess, the question is, is that based upon the current quarter-to-date action that we see in some of the markets because there is some -- been some continued EM weakness, and I know that's a headwind for you.

So does it consider those dynamics?

And do you just think that it'll be offset by improved volume trends?

Or can you give us a little bit more there, please?

Yes.

I think when you look quarter-to-quarter, it's always -- it's a set of small moves and rounding.

So we continue to see negative flows in all the public data whether it's EM but also in the other international markets, which will be a bit of a headwind.

We've got nearly all of the BlackRock transition out, we've got, I said, 10 in the 1Q to 2Q, 20 from 2Q to 3Q.

We got $5 more, so that will get to a $35 million run rate, so that's nearly finished up.

And then, there's some installations coming through as the pipeline plays out.

And then, the open question will be, what happens to market levels because you know how that plays through our fee structure.

So we think it's going to be flattish.

I think there is -- it's rough estimate for now and kind of an assemblage of those -- the composite of those moves.

Okay.

So it does consider some of that weakness, thank you for clarifying that.

Second question being, you previously had indicated an expectation of fee operating leverage, I want to say that the bottom end of the range was positive 75 bps for the full year.

I don't think you included those comments in your prepared remarks.

Is there an update to that outlook?

How should we think about that?

I'm guessing, it'd be pretty hard to reach that kind of fee operating leverage for the full year given the first 9 months trend?

Yes, Brennan, it's Eric.

And I think you've called it right.

I gave outlook here.

I needed to give outlook either on the 4th quarter basis or on a full year basis.

And obviously, you guys can model out the other piece either way.

But I just do it for, for fourth quarter just to give you the direct information.

I think, if you put together the composites of 1Q plus 2Q plus 3Q, you add my fourth quarter, you'll see that we have good line of sight to many of the targets that we gave in January but I think, fee operating leverage, as you described, will -- it's not going to be one of them on a full year basis.

That said, we are very focused on controlling what we can control and you've seen us, I think, intervene pretty significantly on expenses and we'll continue to do that, as we navigate through the quarterly revenue environment.

And that's probably an area, expenses in particular, where I think we've well outperformed our intentions for the year.

Our next question is from Ken Usdin of Jefferies.

Eric, you talked a little bit about -- you mentioned that in second quarter you had trimmed back on the incentive comp and then, this quarter, you made the additional changes to $40 million.

I guess, how do we -- can you help us understand given the third quarter results in the fourth quarter outlook, how do we understand where you are in terms of incentive comp overall?

Like is it truing-up relative to where the revenues have come from through part of your fourth quarter outlook for flat expenses?

How do you just generally think about -- State Street's done that in the past or it's trued-up at the end of the year for disappointing revenue trajectory.

So just maybe you can hover through some of the moving pieces of how you expect that flat expense in the fourth to be coming from?

Sure.

So Ken, let me first describe how we and, I think, other banks address incentive compensation, right?

At the beginning of the year, we have estimates of where we're going to deliver in terms of revenues and expenses and other NII and total earnings and EPS.

As we move through the year, right?

We check to see how we're trending against those expectations.

First quarter was a good quarter generally, and there was no need to make any adjustments.

In second quarter, right?

As we saw that step down around flows and those industry conditions that have started to permeate through the P&L, we came to clear realization that we weren't going to deliver at least for the first half year and as a result, we did a year-to-date catch up on incentive compensation.

And that was worth $40 million, $45 million in terms of reduction in that quarter.

This quarter, we've kind of kept that at the adjusted pace.

So but for obviously, without the catch up, so the quarters are lumpy.

And then, in fourth quarter we'll assess again where we are.

But as I said, I think we have delivered on a number of our objectives and targets that we set out for ourselves and made public, but not all of them, and every one of those targets count.

In terms of line of sight into fourth quarter, we -- there is kind of a comp and benefits and a non-comp and benefits of part to that.

Merits already played through on comp and benefits.

I think, incentive compensation, we kind of have some line of sight to between this quarter, but we need to kind of see how the fourth quarter plays out.

As you described, headcount is important in particular.

You remember in second quarter, we took some decisive actions and drove some management delayering, right?

That was a result of the organizational globalization and streamlining, that we took upon ourselves to do.

And so some of that will start to play out as a benefit into the fourth quarter.

So there's kind of a number of puts and takes for fourth quarter, as we think about the comp and benefits line.

And then, the non-comp and benefits is every vendor and third-party spend and discretionary line.

We know how we've done this quarter, we have -- we reforecast and think about the actions we have taken or intend to take and that gives us some line of sight, which is why we said fourth quarter would be up slightly from third quarter.

But we think well controlled and deliver nicely on a year-on-year basis.

Okay, got it, Eric.

And then, second one, just you mentioned in the slides, sec lending business has been changed a little bit due to some of your balance sheet optimization.

Can you just talk us through, are you through with that balance sheet optimization?

And would you expect sec lending to kind of have formed a base from here?

Sure.

Yes, we are through with the adjustments we needed to make in the sec lending business.

That one includes the classic agency lending and enhanced custody.

There has been a number of regulatory rules, including CCAR that affect those businesses.

We had a condition upon our -- of our that we had the conditional approval under CCAR.

We did I think some very good work around the analysis and the reporting and the management of counterparties, which did include the securities lending area.

We now feel like we're complete on those.

We have confidence.

We're, as a result, well prepared for CCAR.

And when we think about the work we've done, we actually feel like we have also begun to deploy the kinds of future actions or actions today and actions that we can continue in the future that can give us lift and headroom.

And so we have implemented a set of additional diversification from the very largest counterparties, the next group, sometimes it's U.S., international, sometimes international to U.S. We've done netting and novations that help compress the book in some ways, so you don't have the large puts and takes but you've got netted down exposure.

And then, what we've done is effectively systematize many of those tools because those are kind of action tools and we've systemized those in many cases on a day-by-day and even intraday basis.

And that gives us confidence that we've been able to now create headroom off of which we can grow sec lending on a go-forward basis.

Certainly, in line with the balance sheet, but our intention is that, that is a continued growth area.

Our next question is from Betsy Graseck of Morgan Stanley.

Maybe you could talk a little bit about some of the expense opportunities that you see -- maybe not next quarter, if you can't do it specifically, but over the next year or so?

And not only your own benefits from Beacon that you've been generating, but what you'd expect to get from CRD?

Betsy, this is Jay.

Let me start that, then Eric will pick up.

The -- you mentioned Beacon and I think that's a good place to start because a lot of that expense actions, that Eric just referenced a few minutes ago, are kind of tactical expense actions.

I think, that more strategically, as we have gone through Beacon and its predecessor ITOT, the deeper we go the better the opportunity looks.

We are standardizing activity, connecting processes together, eliminating human touch.

Reducing reconciliations, all of which have multiple benefits.

The one you're asking about is the cost benefit.

And we'll expire Beacon formerly next year, but those opportunities will, by no means, expire.

I mean, there are multiyear opportunities to continue to drive greater efficiencies in this core operations around custody accounting globally and you'll recall it.

At the back end of 2017, we reorganized the business so that we're in a better position to take advantage of systematically going at, we call it, straight-through processing, really to reduce the human labor content and the core activities that we conduct.

And we've got a long way to go before we get that to a place where we're straight through.

And it'll have huge benefits to clients, it'll have huge benefits to the cost line.

So it's plenty to do.

Betsy, this is Ron.

Let me just add a little bit to what Jay said.

Because I think that for all the things that we've accomplished to date, I would say that there is a second order that we can get out of it, and let me be specific here.

So we've been on this big push to put in place end-to-end processing and that's been enabled by a lot of the automation and changes we've done in Beacon.

But there is more that can be done there.

I mean, as we do some, we find more.

As we've stood up the -- and strengthened our global hubs in India, Hangzhou and Poland, they've matured.

And they've gotten to the point where it's less about just taking in bits of work and more about taking in whole processes.

So that would be one.

The second order and third order out of this is we've talked earlier about the delayering.

I would say that we're going -- that we're moving into the point where we can do major flattening of the organization as you actually move these processes together.

And then lastly, much of the Beacon journey and the technology journey has been about standardizing when we can.

Our -- the historic core of our client base has been large asset managers.

And in many cases, in the past, that had driven us to customization.

We've now learned and we continue to learn how to standardize as much as possible and move less to customize and more to configure and that in itself will provide more opportunities.

So we see ongoing opportunities to reduce expenses without actually in fact, impairing client service but at the same time improving client service.

Okay.

And how far away do you think you are from fully digital asset capability?

Let me take that, Betsy, because this is a journey and you can think of the glass as half full, because there continues to be opportunities literally in every area.

As we've globalize the business and think about somewhat, Jay described as, straight-through processing.

Those kinds of opportunities exist that are level of, say, accounting or custody, but they also exist deep down -- custody, for example, you can break down into bank loan processing, securities processing, derivatives processing.

And every one of those in our minds we have -- we continue to find more areas as we fully globalize the organization.

And so it's hard to say whether we're in the third inning or at the seventh inning.

We're Red Sox fans up here, so it's a -- there's always the temptation to do that.

But the truth is, there continues to be real substantial opportunities and as we go deeper and deeper and more and more globally through the organization.

Our next question is from Alex Blostein of Goldman Sachs.

So I was hoping we could peel back the onion a little bit on what's going on in servicing fees and understanding the quarter-to-quarter dynamic is -- could be pretty lumpy.

But Eric, you mentioned fee pressure a bit more specifically, I guess, in your prepared remarks.

So I was just wondering, whether or not you guys are seeing acceleration in fee pressure within servicing from some of the asset management clients?

If so kind of what's changed in the last kind of 6 months?

And then, because the active management you should see outflows for a long time, so kind of what's driving the incremental fee pressure?

And more importantly, I guess, as you think about State Street servicing fee organic growth, over the next kind of 12 to 24 months, what should we be thinking about taking to -- into account the fee dynamics as well as your comments about the pipeline?

Alex, this is Jay.

Let me start and Eric and probably Ron will want to weigh in on this, this is an important question.

Now I think the -- at the very broadest level, there's derisking, which really begin in the second quarter.

Broad-based derisking has only continued.

And the way that it affects us is we've -- we talk about outflows, but out -- mutual funds have been outflow -- outflowing in the U.S. for a long time, I'd say the step down we saw was in Europe, where we have a large business, mostly in the offshore centers.

Last year in first quarter, we had very robust inflows that went to neutral and I think that's probably a factor of Brexit in Italy and all the commotion that's going on in Europe.

So that was kind of a new factor and we're -- because of our success over there probably, disproportionately affected, I'd say, broadly the EM pressure is kind of the second thing that has really put pressure on us.

And that -- all that combined created lower transaction fees.

So it's mostly around the broad-based derisking that has those 2 or 3 tributary factors that go with it.

And I'd say Europe with the a little bit of emphasis.

I think, the -- so that's -- none of that's particularly good news.

I'd say, if there was a silver lining at all is that, at least we all see this.

Our clients are under considerable pressure.

And that can play out in a couple of ways with us.

It puts pressure on our fees that we charge to our clients.

But in the overall scheme of things, our fees aren't going to solve our client issues, so relatively de minimis.

So it really opens up the opportunity which is why we continue to stress the new business pipeline, the differentiation, middle-office data GX, more recently Charles River.

Because our clients are continuing to come to us on an accelerated way to say help us out, take over the middle office, help us solve the data problem.

The response to Charles River was over-the-top.

I mean, our clients get what's going on and the need to consolidate front-to-back processing to extract data.

So I would say, I'll let these guys weigh in, but in the broadest context, it's the derisking and all of the things that flow from that.

And the reaction from our clients is some pressure but also help us out.

Yes, what I would add to that, this is Ron.

Just to maybe a little bit more specificity on the flows in Europe.

Mutual funds are still quite popular relative to ETFs.

And Jay noted the net flows went from positive to basically neutral, but it's worth looking at the underlying component for kind of what was the in versus what was the out.

With that derisking, the big help out was in emerging markets, as Jay noted, and that's just a higher fee per asset for us.

So that just hurts disproportionately.

At some point, these things reverse.

We're not here to predict when but when that does reverse obviously, we should benefit from the opposite.

In terms of the client discussions that Jay talked about, client discussions for several years now have moved much away from conversations between us and the head of ops to heavily strategic conversations between us and the CEO and the CIO.

And those have just accelerated for all the reasons that Jay said.

And I think it's at the point now where virtually every asset management firm that hasn't done something, and by the way, most haven't, right?

Most haven't outsourced their middle-office, most haven't moved to a platform like Charles River or Aladdin are talking about doing that.

What Charles River has enabled to do is just to broaden that conversation, but we're already having it.

And I -- we are very optimistic that this will turn into more and stronger new business as we go forward simply because our clients' challenges, while imposing certainly some fee pressure on us, are also our future opportunities.

And I guess my second question, Eric, maybe around NIR.

So heard you guys still expect growth sequential in the fourth quarter, maybe talk a little bit about what you're seeing in balance sheet trends so far in Q4?

I know the ending deposits were lower and then, could move around of course.

So what are you seeing with respect to deposits so far in the fourth quarter?

And then, I guess longer term, as we think about the trajectory for State Street deposits in the mix interest, noninterest bearing, how should we think about that for next kind of 12 to 24 months?

Sure, it's Eric.

The deposits have been -- they've just been bouncing around at about this level here and we show around $160 billion.

You get -- it's hard to predict the month-by-month or even the first 2 weeks of a quarter, because we do get these very large spikes.

Remember, as a one of the top custodians, just think about the amount of transactions that flow through our pipes.

And you do see that in the end of period balance sheet relative to the average.

We did have the seasonal lightness in deposits in that August time period.

We heard that in the some -- at some of the conferences that didn't put us off.

It kind of came back as expected in September.

So we have these ebbs and flows, and so it's hard to divine kind of a coming quarter or a coming year based on those.

What I would tell you is part of the reason that we felt good about our deposits, and obviously, we've got to see what happens with quantitative easing and fed balancing trends and so forth is, we've been very engaged with our clients on deposits over the better part of the year, if not 1.5 years.

And part of that is it's a natural way for them to pay us, right?

Or for us to serve them.

And if you remember, deposits is just one of the offerings we make, right?

We think of it as a set of liquidity solutions we offer our clients.

Sometimes deposit, sometimes repos, sometimes money market sweeps.

And each one of those has a value to our deposits and offering that cascade, is actually one of the more sophisticated discussions that we've been having with our clients over the past year or so.

Anyway, that's a little bit color more than anything else, Alex, but we feel like we've got healthy amounts of deposits.

We feel like there is relative stability there.

We feel like we're sharing in the economics appropriately with clients earn more, we earn more as the fed rates float upwards.

And to be honest, we're continuing to turn our attention to Britain to Europe to Asia because there are big pools of deposits there and we'd like to see prevailing interest rates rise in some of those geographies.

And if they can't, that could be another opportunity for us in the coming quarter or coming quarters, I should say, or coming years.

Our next question is from Brian Bedell of Deutsche Bank.

Maybe just to go back on to the, on the servicing side, maybe I just want a different angle on that.

Obviously, we see the fee rate coming down, sounds -- it sounds like it's -- as you're saying, it's due to that mix away from EM and European mutual funds.

I know, to the extent that assets do shift towards passive and ETF, it's a lower -- it's a much lower fee.

But I think, Jay, you've also said in the past, the profitability of those assets is comparable to mutual funds.

So can you just maybe talk a little bit about if we can just continue to see pressure on the asset mix there.

And we see those fee rates come down, where do we see the offset on the expense line?

Does that come through sort of right away?

Or does that take some time to work its way through?

Brian, it's Eric.

let me start on that.

I think you've got the right couple buckets of drivers on fee rates, right.

The first is the mix, in particular, EM and even Europe is at a higher rate than the U.S. And then, active funds are at a higher rate than passive.

So both of those play through.

I think the other thing that is playing through in the fee rate is literally our, the 2 of the largest transitions ever here.

With BlackRock floating out, that was on an old fee rate contract and had a stack of different products and services in their collective funds and that's obviously transitioning out.

As we bring on Vanguard, we've been quite clear that we've started with the most core of the core products, which is custody, right?

And obviously, we always have discussions with large clients about bringing on other parts of the stack but custody is 1 piece of that stack.

And so we're kind of, you're seeing the offset of a stack of services versus a 1 service star on a trillion plus in assets.

So that's the other piece that's just coming through in the quarter-on-quarter.

But I think in general, you have the right view.

It's around mix of assets, it's around mix of underlying fund and fund types and that's playing out.

And in terms of the expenses, our perspective is the reason why we're focused on margin, it's the reason why we're focused on operating leverage and we can -- you know operating leverage fully or fees or there are different ways to and all the ways matter, right?

We're focused on driving down our cost and the increasing efficiency every year because we know that's what this business requires.

And our view is, if we can do that smartly and with the -- in ways that help our clients, right, that can be good for them and good for us.

And can you just remind of the servicing wins to be installed in the fourth quarter, and you're not including any wins that you'll be getting in the fourth quarter?

What would that -- what would the servicing installation pipeline look like coming into 2019?

Yeah, the -- we've got that in the press release.

Servicing business to be installed with that $465 billion.

You'll see that's been -- that's, I think a -- it's quite a nice level if I go back over the last 8 or 9 quarters, it tends to be above the level which we run, which is part of the reason why we have some confidence, not only in the pipeline but some of what we see in terms of revenues in the, in the coming quarters.

But the $465 is for the fourth quarter, or is it into next year?

That's into next year right, so sometimes clients come on quite quickly.

If you remember the Vanguard, kind of custodial client played through quickly and that was because it was simpler to put on the $465 will come through over several quarters.

And obviously, what we're working on now is the pipeline and pushing through closing that pipeline so we add more as we install more and that's just the natural cadence of the sales and then installation activity.

Got it.

And I just missed the last part of your fee operating leverage comment to your prior question.

Can you just repeat thatwhat your expectation for fee operating leverage for the full year is now, with the weaker fees?

Yeah, I said I didn't go through it in detail, right?

I wanted be helpful at the end of my prepared remarks, and I gave you my fourth quarter outlook by area, including fees.

I think you can easily now calculate an estimate of all of our metrics, including fee operating leverage if you just add up the first 3 quarters on a parachute in an estimate of fourth quarter, and I think what you'll see is, I think we had 5 main targets out there, as part of our January guidance.

I think we've hit many of those, but not all of them, and I think fee operating leverage is one that where we won't achieve what we intended.

But on others, like expenses with Beacon, we started off with an intention to save $150 million this year.

We're at -- we've said we're confident we can do $200.

We've actually already done $180 after 3 quarters, so we have some -- we have quite a bit of confidence there.

And then you saw, we deployed another $40 million of more tactical expense reductions just this quarter, right, to add to the expense management effort.

So I'd say, it's -- there are a number of these that we're going to hit on.

Some we'll also deliver on and others that we may not, but we're focused on navigating through this environment.

Thanks for all the additional color.

Thanks.

Our next question is from Mike Carrier of Bank of America.

Thanks guys.

First one, just one more on the servicing side and more on the outlook.

When you look at the pipeline, like any context or color on the mix of that?

Meaning is it on the passive side, the traditional, you know, alternatives, just to get some sense?

And then Eric, maybe just -- when we think about fee rates on products, whether we're in a derisking or if we eventually get to a rerisking environment, what's the, maybe the divergence on fee rates across the products?

Do that, can shift things around, both on the positive and negative side.

Mike, it's Ron here.

Let me talk about the outlook.

I think the outlook is quite strong as we've said for the reasons that we talked about.

It's as much because of the pain that our clients are suffering.

So the nature of the outlook is less about active versus passive, because typically, it's what we get reflects what the underlying asset manager itself is managing.

But what I would say is that the outlook more often than not, or the discussions more often than not include, as you'd expect, custody and fund accounting, but quite frequently, the middle office.

And as we look back on many of the large deals we've done, roughly half of them have been middle office plus custody and accounting.

And I think that reflects just the nature of these large and medium sized asset management firms saying, this isn't just about, am I going to shave a little bit of fee and move it over to another custodian, but more, who is able to help me improve my operating model.

And so that set of discussions is rich, the pipeline is strong.

Are all the discussions going to result in a pipeline?

Probably not.

But I -- think just on the sheer amount of activity we're encouraged by the outlook for the pipeline.

And Mike, let me just give you some of the, kind of ranges on the fee rate.

Our overall fee rate, if you take servicing fees divided by AUCAs, is about 1.6 basis points.

But the range is actually quite large within that if you think about alts, or because of their complexity and the bespoke nature, you now, can be 5, 6, 7, 8 bps and that's the industry standard.

ETFs are at the other edge of that, and can be well below a bp or half of it.

It's just -- there's a wide range of mutual funds, collected funds, institutional, retail, are all quite different.

And then the European offshore centers versus onshore centers, because of the tax and the accounting complexity, have, offshore tends to be at a higher rate than onshore.

And offshore's been where we've had much of the flows in Europe right through the Luxembourg vehicles and the Irish vehicles, which is what actually went negative in the second quarter, was dead flat in the third quarter.

So those are some of the, maybe the ranges and the drivers and it's, even when I work through and try to give guidance on something like servicing fees the fourth quarter, I mean there's a number of different considerations and which is why the results can move, even over the course of a couple of months.

Got it, that's helpful.

And then, Eric, just real quick.

It's actually a little lower.

I don't know if you mentioned that, but just on the outlook, and then on the expenses, you guys mentioned where you are on Beacon, and then you mentioned the $40 million.

And just wanted to get some clarity on, is that an addition?

And when you see these, like revenue pressures, like where are you guys, in terms of the expense base, being maybe more a variable, universally in the past?

Yes, let me do those in order.

First on taxes, then on expenses.

On taxes, we had some discrete items, but the largest one was a true-up on the year-end 2017 tax package.

If you remember, we had a charge in the fourth quarter of $250 million.

There's a lot of information that's come through, some puts and takes, but we had more benefits than otherwise, as we trued up on depreciation R&D and some of the many nuances so you remember we're not finalized or hadn't come through on the rule-making and so, that true-up was worth about 3.5 points on the tax rate, roughly, and I think was obviously a positive this quarter.

On expenses, I think the, we think about the expense opportunities as we covered earlier at a number of different levels, right?

There was an enormous amount of continued opportunity as we continued through Beacon and standardized and simplified, and we do that at multiple levels and sometimes it's in the processing shop, sometimes it's in the IT shop so there is a whole set of, I'll call it more process engineering that we continue to do there as we continue from the learnings from Beacon into the next phase.

I think the management delayering and simplification, as Ron described, is an area of continued opportunity and that gets us a fixed cost, and we got to take out fixed cost, not just variable cost as we drive down the productivity curve.

And then I think the areas of the third party or non-compensation spend, if our clients, the asset managers are under pressure and they're asking us to see how we can do a bit better for them and giving us more business as an offset, we're going back to our vendors and say, look, you've got to look upstream as well and help us deliver better for our clients and so, we're working actively, whether it's market data vendors, sub-custodial vendors, contractor vendors, IT vendors, I mean, it just goes to the long list and I'd say, every one of those are our vendors, but they're partners to us and they need to help us deliver what we need to on our productivity journey.

Okay, thanks.

Our next question is from Mike Mayo of Wells Fargo.

Hi, if you could help me with the disconnect that I have.

The first part of the decade, State Street claimed victory for business op and IT transformation.

The second part of the decade, you're claiming success, the Project Beacon, which is about done.

Today's press release says "solid performance" but the year-to-date pretax margin, it looks like it's worst in classthe same as it was in 2011.

You highlight some recent derisking and certainly, EM hurts, but for most the decade, you had a lot of risk going, a lot of higher stock market.

So 3 questions, number one, you alluded to new expense efforts.

Will there be a new expense program in 2019 or in the next few years ahead?

And again, it's getting all the same for Project Beacon, but not showing the positive ops and levers, not showing the improvement in pretax margin, so I guess the hope or expectation will be a new expense program would lead what to for the pretax margin?

Number 2, how do you guys think about governance?

Because we hear Jay saying things are good, solid performance, and he's the outgoing CEO.

And then, Ron, you're the new CEO, taking over next year and there seems to be a little gap, and this is one of the longest CEO transitions in a while, so if you can comment on governance; and three, in terms of a strategic pivot, you highlighted Charles River partly to pivot strategically to State Street.

Think about a larger strategic pivot, perhaps even a combination with say a brokerage firm, you might consider a bank or asset manager, you had a deal yesterday.

So what are your thoughts about expenses, governance and acquisitions?

Thanks.

Mike, why don't I start that, on expenses.

So your specific question is, are we planning to employ a new expense program either by the end of this year, in 2019?

And the answer is, at this point, I don't think we need to because there is intense focus on expenses now and much of the programs you cited in the past, have provided -- one, they provided savings; two, they provided foundations for the next one.

And I look forward and the rest of us look forward and see lots of opportunity to continue to manage our expenses, and to do that, in concert with improving our product and improving outcomes for clients.

So I just don't see that we actually have to announce a separate program because I would argue that, that's what we're doing.

The other thing Mike said, we want to be clear on here, and I think we've said this in our materials is, we do continue to invest, and we're investing, one, to continue to get more of that expense out and to make share it's enduring expense reduction, so that it's not just belt-tightening, but that, in fact, we're actually getting end-to-end processing in place, that we're actually getting real automation, that we're getting kind of full usage out of the global hubs, so.

And to continue to improve our offering to clients, so.

I mean, the easy way out of this would be, I suppose to just stop investing, but we don't see that as an option, given what we're trying to do to maintain competitive superiority.

Mike, it's Eric.

I'd just also emphasize that we did ITOT as a multi-year program over 3 or 4 years.

We've done Beacon over 3 or 4 years and have completed it sooner.

I think we -- we're quite comfortable now that we have the tools.

I described the levels of different expense levers.

And that's naturally can be folded into an annual program and we have every intention as we've discussed this to here among the 3 of us that in, January's a natural time to tell you here is how much we plan on taking out of the expense base, here are the areas in which we'll be doing that and here's what to expect in the coming year.

And then, use that as the cadence by which as we give guidance, we give guidance on revenues, on operating leverage, on NII, to cover what our intentions are in a very practical and specific way on expenses, so I think you can plan on that in our January call.

In terms of the metrics, I think the -- I do think it's worth stepping back to the metrics.

And I like how you do it over half a decade, a decade, and I know you're a student of this industry for even longer.

But ROE, right, hit 14% this quarter, up almost 2 points on a year-to-date basis, right?

And that's ROE, that's not return on tangible common equity ex the goodwill that gets reported by many of our peers, which, in our case was 19%.

But like classic ROE, 14% for the quarter for year-to-date.

Margin, which I think you've got to look at both the GAAP margin because we do more tax advantage investing than other peers, but if you want to do it on a normalized basis, it's in the 31% range, is, I think pretty healthy.

And clearly, we don't have an enormous lending book like others do, which tends to make margins even wider, but I think we're quite comfortable with the margins that we have in the 30% range, on a 31% range on an operating basis, and you see our GAAP margins continue to build.

So I think we're very focused on driving expenses that are calibrated to revenues and we have a good strong way to continue to do that.

So Mike, let me -- this is Jay, I think that was the first question.

Let me pick up the second and then, bridge to the third.

The, that Ron and my transition is going quite well.

At the end of the year, I will phase out and become Chairman and Ron will take over the CEO role.

And he's, I know he's well-equipped, but I think this year has given us both good transition time with clients, employees and more recently, shareholders.

Let me go to your CRD question.

I think that we still like this space, this space being the trust and custody business because we think it has global expansion possibilities.

We think that it will still grow as assets still grow, as they move from government to retirement, so the secular macro picture, I think still looks pretty good to us.

Having said that, this business, over many decades, has been a business of evolution and custodians, if you call us custodians, continuing to evolve, to find points of differentiation.

And so -- and I think we have been leaders in that, whether it's been finding the international opportunity, whether it was finding the ETF opportunity, whether it was being first to the hedge fund opportunity.

More recently, moving into the middle office where we now have a $10 trillion plus scale business that's bridging into that DataGX angle, and the next big frontier is the front office.

Not just the front office but connecting the front office to back office.

And you'd only have to be in some of these conversations to realize that when you have CEOs across the table and we're, we now acknowledge this that this business has been built up over time with huge inefficiencies in multiple systems.

And they now view State Street as not only having the foresight to be there first, but having the fortitude to build this front, middle, back office business that will help them compete in the next decade.

So I think that, to your point of, is there more to do?

Is there more dramatics due?

I think the big dramatic, we just did, which was to lurch into the front office.

I think the to-do is to knit all these things together, and I think that will define how this business looks into the future.

Yes, what I would add to that, Mike, is that in terms of, does that necessarily mean that we are gonna be forced to do more acquisitions, or to do kind of dramatic types of actions, like you saw yesterday with Invesco and Oppenheimer.

We don't see that need right now, the -- with Charles River, and the platform that we're building, and our organic activities, we feel like we've got what we need.

We can build out organically to the extent to which there's something that makes sense to augment our capabilities and is -- has the financial criteria that we would like to see.

We'll do that, but we don't -- we're not here to say, well, with us, we need an acquisition.

Alright, thank you.

Our next question is from Jim Mitchell of Buckingham Research.

Good morning.

Maybe, just asking it this way on the expense question, do you think that going forward, you can generate positive fee operating leverage, relative to organic growth?

Jim, it's Eric, I think we'd have to, positive fee operating leverage, you know it's certainly a good objective to have organic growth is hard to, I think, analytically, like we have to clarify the terms because remember how this business model works that we built up over years on servicing fees, right?

There is a piece of servicing fee revenue that comes from market appreciation.

There's a piece that comes typically from flows, and client activity, and that actually has gone negative this quarter.

There's a piece from net new business and share shift as we continue to consolidate or we move up the value chain, and there's always a little bit of pricing that we work through, so there's a set of 4 elements.

And I think our view is, and I, there's 4 elements on the fee side and then there are deposits now.

And I think the deposit conversation continues to become more important because of the position our clients are in, and in ways to even renumerate us for some of the services that we provide.

So I think over time, as we -- you know, we want to drive expenses down and expenses cannot grow faster than total revenues.

I think that's just a fact, right?

Our margins need to continue to float upward and that's our, we have -- we're all -- that's got to be a very clear bar.

I think there will be, time to time, where we focus more on fee operating leverage when we might be getting an unusual benefit from NII because of the rates tailwind, or when we have a downdraft in rates, because you want to kind of peel that apart.

But I think in more normalized times, we probably do want to focus on total operating leverage, but you know there's, I'm one of those folks who believe that every measure has a purpose and a place, and we should keep an eye on all of them.

Jim, I would just add to Eric's point on your organic growth question is, that the other factor is consolidation amongst custodians and that continues to happen, and for the most part, we tend to -- have tended to be the beneficiary in that as clients move from multiple custodians to, either to one or towards one.

Right, okay, that's fair.

And maybe a follow-up, Eric, on just the other expense line.

It dropped, I think $45 million sequentially.

Is there anything unusual in there?

Or is that just Beacon savings that might be somewhat sustainable going forward?

I know you highlighted the expenses in the fourth quarter only up slightly.

So is that a reason, is that a new kind of run rate to think about in other, or how -- anything unusual in there?

Yeah, that one bounces around a little bit.

It bounced around quite a bit, and there's a series of different elements there, so I'd just be careful about that one, and I try to use kind of a multi-quarter view of that.

There are big, lumpy items like professional fees, which move around by $10 million because those spend both IT and non-IT.

And some of our regulatory initiatives, there are large items like insurance and that -- including the FDIC insurance with a substance coming in and out and so forth.

There are T&E flows through that line and as I mentioned, that one was particularly well-controlled this quarter There is litigation that kind of -- that bumps through that line and that can make it move that actually wasn't significant this quarter, but can make it move.

So there's a, I think it's a, it's one that's always going to be lumpy, but our view is, there are 15 kind of sublines in there at the first quarter, and we've got initiatives on each of those 15.

And one where there's a significant amount of, I'll call it, non-comp and benefit spend that we can and will control.

All right, thanks.

Our next question is from Geoffrey Elliott of Autonomous.

Good morning, thanks for taking the question.

You mentioned EM quite a few times as one of the drivers of pressure on servicing fees.

I wonder if you could do anything to help quantify that, help us in future, have a better feeling for how weakness in EM or strength in EM is going to feed through into that line?

Geoff, it's Eric.

I've been wrestling with your question, because in -- I think just like, you'd like see it better, I'd like to find ways to disclose it better.

I think the, if you think about our disclosures, we have good disclosures on what happens when markets appreciate or depreciate and how that affects servicing fees.

And part of your question makes me think, can I turn that into a disclosure on emerging markets versus developed markets?

So I'm just kind of thinking it through and -- as you ask the question.

I think there's a related set of disclosures that we make verbally and on our slide decks, but maybe, you're encouraging us to see if we can quantify, but if flows are negative in U.S. active funds or flows are negative in emerging markets by x or sufficiently different from the average, right, how much could that mean in terms of impact on service fee growth or decline?

I mean, I think that's the kind of question you're asking, so I don't have a prospectus answer for you, we have that deep in our analytics.

And let me just take it on as an option, you see if we can add more over time.

So I think what you're looking for is the, kind of the first order approximation of how these different trends impact us.

And we'll do some work to see if we can get some more out there and some rules of thumb, knowing that mix, as we've talked about today, creates an enormous kind of fuzziness over those rules of thumb.

But let's -- we'll -- anyway, a little bit of context and thought there for you.

I think that just kind of helps get away from the mechanical S&P up and the CI world up.

Asset servicing fees must be up as well.

And then, second one on Charles River, you mentioned you're going to give some more color around expectations for that at a conference later in the quarter.

What are you kind of waiting for?

What are you still putting together before you can come out with those numbers on how CRD is going to impact Q4?

Yes, Geoff, so the biggest change that we have to do, besides just integrating Charles River into our systems and our closed process and so forth, and we've owned it now for 18 days, is we have to complete the work on the accounting 606 implementation of revenue recognition.

If you recall, we, as a bank, did that January 1 of this year, as did most of the other banks and asset managers, and it was quite significant to them.

We literally have to do that with Charles River, which means you literally have to pull every contract, and go through every contract, bucket it between on-premises versus cloud, and each of those has term or doesn't have term and how much term.

There's not upfront revenue recognition.

In some cases, there is, and over time in others.

And so it's literally a contract -- it's a manual exercise, and the team's been intensely working through that.

At that point, I'll be able to give you an estimate of fourth quarter revenues, but I'd like to do that once and well for you.

We have a rough estimate, and we've had them for, since the spring and summer.

But I'd like, to be honest, to finish that work, I'd like, to close October and maybe November results under GAAP standards as opposed to private company.

More cash accounting, that's often been done, and then share that with you, so that's the work.

We've got a couple of opportunities.

Certainly, by December we'll -- the first week or 2 in December, we'll certainly do that for you.

And our intention is to share with you here is, GAAP revenue estimates or a range for fourth quarter, here's the expenses and EBIT.

And here are probably some of the metrics that we'll be tracking for you, right?

So this is one of those where there's a pipeline, there's beyond a pipeline, there's a set of booked, contractually booked activity.

And then, there's an installation period and then it turns into revenue, and so we'll come back with some of the leading indicators as well.

So that'll be -- but we'll do that very proactively and we'll do that obviously during the latter part of the fall here, so that everyone's well prepared as we go into the end of the year.

Understood.

Thanks very much.

Our next question is from Steven Chubak of Wolfe Research.

Hi, good morning.

So wanted to start off with a question on the securities portfolio.

The duration is extended for each of the past few quarters.

The most recent one, it was at 3.3 years and if I look at the peer set, they're actually running a little bit below 2. And I'm just wondering, given the market's expectation for multiple rate hikes, a flatter yield curve, what's really driving the decision to extend the duration at this point in time?

And maybe, as just a quick follow-up, how we should think about the impact that we'll have on the pace of asset yield expansion in the context of the mix of the fixed versus floating portions of a book?

Sure, Steve, it's Eric.

So there's a lot that goes into the design of investment portfolio, and I'd share with you a bit -- a couple of bits of context.

The first is, that we've always run a very short portfolio here.

In particular, because it was a large opportunity in rising rates at the short end.

And you've seen that, that's been quite remunerative for us and continues to be quarter-after-quarter.

So what you're seeing us do is I think, effectively, just trying to balance out the portfolio as rates get higher, right, because you -- as rates went from near 0 to north of 200 basis points at the front-end and north of 300 basis points at the back-end, right?

At some point, we have to, as bankers, all begin to pivot and say, when do I want lock in some of that duration?

I don't want to do it all in 1 day or 1 month or 1 quarter, but I do want to take advantage of that curve, because that curve has some current earnings benefits on one hand and it's an anticipation of -- at some point, the Fed stops raising rates, maybe we, a couple of years from now, go through another business cycle, and rates come down, and when rates come down you do want to have that duration in place.

So a little bit of context on we are kind of -- we are still -- I think we're still relatively short from an interest rate sensitivity perspective.

And remember, we have more fixed-rate deposits than most of our peers, so we tend to need more fixed-rate assets.

So you got to keep that in mind as you benchmark us with some of the other universals or regionals in particular.

And there is a question of navigating through the cycle.

I think to summarize though, we're actually quite pleased with the performance of the portfolio, the performance of NII and NIM, and we continue to seek good upside even with this duration, at -- every rate hike is probably worth almost $10 million a quarter in the coming quarters with this level of investment positioning.

And so, both good earnings and good upside in our minds.

Thanks for that Eric.

And just one follow-up for me on some of the noninterest-bearing deposit commentary from earlier.

You alluded to stability in that deposit base of around 160, but the noninterest-bearing deposits, at least end-to-end, declined 20%.

I know there's a lot of volatility around the end-of-period balance sheet, but just given that sheer magnitude of the decline, I was hoping you could speak to what drove that acceleration at the end of the quarter?

And maybe what's a reasonable expectation for noninterest-bearing deposits in 4Q, just so we can get comfortable that pace of decline should not continue?

Sure.

So the let me kind of tackle that from a couple of different perspectives.

The first is, I think the average deposits have been in this kind of 160-ish range in aggregate.

I think what we have seen on a year-over-year basis and a quarter-over-quarter basis, we've seen it for us, and every bank has seen it, it continued I'll call it, rotation out of noninterest-bearing into interest-bearing.

And on a quarter-to-quarter basis, that's 5%, so it's literally $2 billion of $35 billion rotates out and that -- from non-interest-bearing into interest-bearing, and that -- that's just, I think what is completely to be expected, given where we are in the interest rate cycle.

And I think you've seen other banks that show that.

You've seen some show actually a faster rotation than that.

I think we're quite comfortable with the pace of this rotation.

What's hard to perfectly forecast is, what's the future pace of that gonna be, and will it level off?

I think we all believe it'll level off at some point because there are different segments who hold noninterest-bearing deposits.

In particular, a number of the hedge funds arealternativesproviders for whom we do servicing, they tend to hold noninterest-bearing deposits with us, probably because those are less valuable for us than other banks and as a regulatory rule, and probably because that's the way to pay us for our services, and some of that is probably relatively sticky for the duration and through cycles.

There are other parts of that $35 billion of noninterest-bearing deposits, that will just continue to gently rotate through.

And what I tell you is, we keep modeling it and the rotation keeps being a little less than expected.

And well, that doesn't provide certainty to the future, it gives us some indication that the pattern here is a pattern that we can just use as a way to forecast from.

So anyway, hopefully, that's enough color.

I think deposits, in particular, because we're at this higher rate of proportion in the cycle, right.

We're starting to get to higher rates, finally, which is nice to see in the U.S. and because of the Fed, the reversal of Fed easing and the reversal of the Fed balance sheet, is always hard to forecast.

And so we're just navigating through carefully and working very closely with our clients, quarter-to-quarter to serve them in this function.

Got it.

Just very quick follow-up.

I know that you mentioned that it's difficult to forecast the deposit trajectory, but since the correlation is so high between your deposits and industry-wide excess reserves, do you feel like that's a reasonable proxy that we can track, while also contemplating some organic growth?

I think you couldn't.

I think -- I have less confidence in a direct correlation between excess reserves in our deposits.

Why?

Because our deposits are those remaining, kind of frictional deposits by and large, that exist as the custodian where, you got the asset manager or the pension fund or the asset owner who's moving a lot of fund back and forth.

They need some frictional deposits with you, so that they don't draw on their overdraft lines, which they tend to be loathed to do.

So they use it as a way to -- you would balance, keep some funds in a checking account.

And I think we've pushed off most of the what I've described, excess deposits that might directly correlate to the reserve.

What I try to do from a deposit forecasting perspective, to be honest, I look at the Fed deposit reports.

There's the HA reports that come out weekly, and then the monthly version of those.

And I think that is overall deposits in the banking system that were a proxy for overall deposits in the banking system.

Those have been inching up, it was at 4%, 5% a year for a little while.

Now it's closer to 2%, 3% a year right now, sometimes, 1%, so that's a good proxy.

And I think the question is, we certainly want to grow deposits at that rate.

With assets in their custody growing and new business wins, part of the discussion that we're having now, I think more than we've ever had before is, hey, as you bring in custody assets, what deposits are you going to bring with you?

How do you make sure that you keep the right amount of deposits with us?

How do we serve you well with those deposits or with repo or some of the other?

And so I think as you see assets under custody grow, there should be deposits that come with those, and that's another part of the modeling that I do.

Got it.

I know it's been a long call, thanks for accommodating the additional questions.

Our next question is from Brian Kleinhanzl of KBW.

I just had one question.

When you look at that serving fee, and I do appreciate the additional color that you gave us this quarter, but ever since Project Beacon's been launched, you've had nothing but pretty much a linear trend down on your asset servicing fee rates.

I mean -- and I get that there are some categories that do have higher fee rates, but I mean, when you think about the legacy book of business that you have, why is -- why should we just not assume that -- that just continues to reprice lower over time?

Brian, it's Eric.

Just first order though, remember that since we launched Beacon, right, we've had a run-up in market and equity market levels, right, appreciation.

Just think of, in 2017 equity markets, spike nicely, 20%, depending on what the time period.

During that period, remember what happens is, then we disclosed in our queue that you don't have a linear effect on servicing fees.

We described 10% up in equity markets or 10% up in fixed income markets increases servicing fee revenues between 1% and 3%.

So automatically, as markets appreciate, our fee rate, by definition will flow downward, right?

Just because we -- they aren't linear, right?

The fees are not linear with markets like they are in the more classic asset management industry.

So I think, in appreciating markets, you're always going to get some floating down.

I think the, that's kind of first order effect.

The second order effects are what are interesting, which is, what else happens, mix happens, there's a little bit of fee discussions with clients, but there's more services that we continue to add as well, whether it's middle office or alts for someone who we just do mutual funds and so on and so forth.

And so there's a series of other effects.

And then, if you recall as well, if you have ETFs, dominating flows in the U.S. in particular, right, and the outflows, right, we've had, what now, 2 or 3 years of inflows into ETFs and out of actives in the U.S., right?

That has a downward pressure on our fee rate as well.

So anyway, I think there are 2 dominant ones.

One is just market appreciation, affects the map and the kind of the swings to ETFs in the U.S. affects the map, and then, there are a number of other pieces that we, that will influence it quarter-to-quarter.

Our next question is from Vivek Juneja of JPMorgan.

Hi, thanks.

Couple of questions -- just shifting gears a little bit to asset management fees.

Seeing that, that fee growth has also been a little bit slower than AUM growth, any comments on pricing trends there?

Yes, Vivek, this is Ron.

You're seeing -- in terms of asset management fees, you're seeing, what I would describe as pressure, and in some cases accelerating pressure on asset management fees.

A lot of our business, as you know, is either index or quantitative.

Particularly on the index side, institutional index has been quite a bit of fee pressure there.

As investors are looking for everything they can to reduce their fees, so yes, the pressure remains.

We expect it to continue to be there, but at some level, it's almost got to moderate because you're approaching a point where people are going to -- institutions are going to be just start turning away from the business.

And Ron, you don't think you're going have to match your former institution's 0 fee rate or pricing on any of your ETFs?

No, the -- it's a longer question.

The -- I believe that if you look at the rationale for why the Fidelities and others are contemplating this, they're using it really more in the context of a retail environment, and using it as a way to attract customers in and also, using -- typically they're using those vehicles as building blocks for a bigger kind of retail SMA and so I think it's not quite as comparable to what our business is here, but your point, Vivek, in fact is a good one, and that drove overall kind of fee pressure, it's another factor.

And one of the things we do continue to do, right, we've got the ETF business, we also have the OCIO business.

And I think part of the trends we're seeing is there is some fee pressure on where the legacy institutional activity and then, on the other hand, if some of the barbelling and expansion of some of that OCIO business does provide some offset to that, and we're also seeing that.

I think year-to-date, our fee rate was, it was relatively flat in asset management and that's -- those are effects -- those countervailing effects are, you can see in the numbers.

Okay.

And did you -- normally in the third quarter, do you not see some seasonal benefit from performance fees?

It doesn't seem like we saw that this quarter.

Am I missing something?

I think it depends by -- you know, we're fairly global, and so it depends, kind of on quarter-on-quarter market levels and then, fund-by-fund, but remember, emerging markets were down and equity is good this quarter.

International was down as well, it was only in the U.S. it's kind of back here at home where it feels good.

So I think there was -- they averaged to be relatively neutral this quarter.

And one more, if I may, on the servicing fees side.

I'm sure you're -- it's getting -- it's a long call on that.

But just while we are all on the topic, over the -- this is going back over the years, Jay, you've always talked about middle office business, providing you stickiness which you can generally translate into also helping somewhat with pricing erosion.

We haven't seen that, obviously.

Wedon't need to go into that.

But given that trend, given everything that's going on, is there a reason why the CRD offering doesn't just become another free offering over time?

Just given what we've seen over now over a decade in this industry?

I think it's -- Vivek, this is Jay.

I think the front office in CRD is different.

It's at the central nervous system of these asset management firms.

It's a conversation with a different level of clientele than we've dealt with in a typical back-office, middle office services, so I don't think it's the same.

I think that the value that we see inherent in the front-office is the obvious piece, which is to create connectivity and efficiency through the middle and back, but the bigger value is we view this front-office initiative as not just a software platform, but rather a platform that can network other investment capabilities, whether it's liquidity or other things into it.

So I think it's a different conversation with a different clientele and has a different value proposition.

Yes, I'd add to that, Vivek.

I think that it's -- these are not commodities that we're talking about here.

What we're talking about is working with fund managers or asset owners that act like fund managers and how do we help them add value to their investment process.

How do we help them simplify their overall operation and lower their cost, so there's a real value element to this, that I think which will enable us to keep the pricing discussion quite separate.

Our final question is from Gerard Cassidy of RBC.

Thank you, good morning.

Eric, you touched on a moment ago, the revenues and the servicing fees, with markets going up or down the range, 1% to 3% of how they're impacted.

Can you exclude the net interest income revenue for a moment, and just look at your total fee revenue?

What percentage of total fee revenue is linked to the value of assets under custody or management?

Years ago, I know it was much higher.

It's lower today, but where does it sit today?

If you think about total fee revenues, right, you've got servicing fees, management fees, FX fees, securities-finance fees.

I think we start to get impacted by the large numbers on the averages.

And so, I think the disclosure we tend to do is the, 3 in 10 out of equities, the 1 in 10 for fixed income.

It's hard to, kind of, on a every-quarter basis, be precise about that, right?

So if mid-markets go up, but FX volatility goes down, I've got FX fees going in the opposite direction.

So I'm -- while the, while it's true on average, right, which is how the disclosures are clearly made, I think the market sensitivity is a tough one to pin down, to be honest.

I think what we can say constantly is that most of our fees, right, are market sensitive, but they are sometimes market sensitive to market levels, to market volatility and to market flows, right?

And so, as a result, if the first question's what percent are our fees are market sensitive?

I'd say most of them are.

If you'd say, well, what part of market sensitivity, level, flow or volatility, I'd say it's a mix of those 3 and different mix of each of those 3 for each of the different fee lines that we report.

Very good.

And then, another follow-up question.

I'm glad you've called out the ROE number that you guys reported since I think many investors point to the ROE as a good indication of valuation on a price to book basis.

So when I go back and look at State Street in the 1990s, this company almost always reported ROEs in the high teens, and then, we went into the tech boom and they actually got into the mid-20s, then following in tech before the financial crises, they dripped it down into the mid-teens.

We had to step down, we all know, following the financial crisis, with the increased levels of capital that you're all required to carry, so there was a step function down.

With your ROA now up around 120 basis points, which is one of the highest that State Street's achieved over that time period, is it really just a matter of leverage that the ROEs are just never going to be able to get back up to high teens, or is it, no it's not leverage, it's a structural pricing issue?

And if we ever get pricing back, maybe we'll see higher ROEs?

I think Gerard -- it's Eric.

Let me start on that.

I think, because I don't have the luxury that you have, of being in the business for as many decades, but the decade and half that I've been in this business, both here and then as part of the Universal Bank, I think the single biggest change, precrisis to postcrisis, is the capital requirement, and the capital requirements, cover what you'd expect, little bit of market raise, a little bit of credit risk and operational risk, right, sort of it's the core of what we do, and those capital requirements are not perfect, right, many and so they're imperfect, but they're real and they are part of running a bank.

I think we used to have processing houses that were not banks.

Most of them are banks today, and so as a result, I think we are in a somewhat different zone than where we might have been a couple of decades ago.

That said, if we're reaching to 14% now in ROE, if the following question you might ask is, well is there more upside?

Is yeses I do think there is more upside because I think there's upside in margin, there's upside in what we do for our clients, there is upside in kind of balance sheet optimization and management, and so, we have expectations.

I think that margins will float up and ROE will float up.

I think what the destination may be, it's hard to, I think that, that one is still open, believe me.

We see the upside, maybe just not what -- maybe not what you may have recalled from the '90s.

Thanks, Gerard.

Laura, does that conclude the questions?

Yes, we have no further questions, sir.

All right.

Thank you, and thank everybody else for your attention this morning.

This concludes today's conference call.

You may now disconnect.