道富銀行 (STT) 2019 Q2 法說會逐字稿

Good morning, and welcome to State Street Corporation's Second Quarter 2019 Earnings Conference Call and Webcast.

Today's discussion is being broadcasted 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.

Thank you, operator.

Good morning.

Thank you all for joining us.

On our call today, our CEO, Ron O'Hanley, will speak first; then Eric Aboaf, our CFO, will take you through our second quarter 2019 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com.

Afterward, 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 results presented on a basis that excludes or adjusts one or more items from GAAP.

Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation.

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

Actual results may differ materially from those statements due to a variety of important factors such as those factors referenced in our discussion today and in our SEC filings, including the risk factors in our Form 10-K.

Our forward-looking statements speak only as of today, and we disclaim any obligation to update them, even if our views change.

Now let me turn it over to Ron.

Thanks, Ilene, and good morning, everyone.

Turning to Slide 3, you will have seen, we announced our second quarter financial results this morning, reporting second quarter EPS and ROE of $1.42 and 10.1%, respectively.

Relative to the year ago period, Our results reflect challenging industry conditions, including client pricing, global industry outflows and volatile interest rates as well as weaker international average market levels.

When compared to the first quarter, our results stabilized somewhat and were supported by market tailwinds within our asset servicing and investment management businesses as well as a slight seasonal uptick within our markets business.

Assets under custody and administration reached $32.8 trillion, and we are encouraged by strong new wins in the quarter of $390 billion with assets yet to be installed at $575 billion.

At Global Advisors, assets under management increased by 4% quarter-on-quarter to $2.9 trillion, supported by higher period-end equity market values as well as institutional client wins and cash inflows.

At CRD, we are encouraged by our first front-to-back investment service client agreement and 6 additional exclusive discussions that are in advanced negotiations.

At the same time, the pipeline continues to grow as evidenced by another quarter of increasing client engagements.

Following our strong performance under the 2019 CCAR stress test, we anticipate increasing our common dividend by 11% in the third quarter, while conducting $2 billion of share repurchases through the second quarter of 2020, as our proactive balance sheet actions in 2018 contributed to our ability to return an increased level of capital to shareholders.

We continue to believe our front-to-back strategy positions us well for success in the medium and long term.

And while we may currently be seeing some stabilization in servicing fees, we have not yet returned to growth.

As such, we will be updating and sharpening our core business strategy as well as conducting a fundamental reassessment of our technology ecosystem.

We have established teams to focus on reinvigorating revenue growth, accelerating the simplification of our operations model and reducing non-personnel expenses.

At the same time, we continue to act with urgency on the things we can control, while fostering a culture of execution and productivity, with reinvigorated attention to delivering industry-leading client service.

I believe we are making progress in these areas.

For example, disciplined expense management continues to be one of my top priorities, the firm-wide hiring freeze for all noncritical roles outside of CRD has been very effective.

Year-to-date, we have already reduced high-cost location headcount by more than 1,800 staff and expect that as a result of our actions we can increase that number to 2,300 by year-end.

Process automation efforts are in full gear, allowing us to decrease headcount while delivering even better service and outcomes for our clients.

Furthermore, year-to-date, the $350 million expense savings program we announced in January 2019 has already achieved just over $175 million in total year-over-year savings, and we are now increasing our targeted expense saves under the program by an additional $50 million to $400 million for 2019.

Our focus right now is finding better ways to reignite revenue growth and generate additional expense reductions, while driving sustainable improvements in our operating model.

This means addressing and surmounting the wave of asset manager pricing pressure, completing our executive client coverage rollout, using the increased capacity we have achieved for balance sheet optimization to restart growth in securities lending and trading and leading in alternatives and ETF servicing where we are second to none.

Our vision remains becoming the leading asset servicer, asset manager and data insight provider to the owners and managers of the world capital.

I am confident we are strategically aligning the organization with the fastest-growing and most attractive client segments, but we must continue to find ways to better serve these and all of our clients in a more holistic and scalable way.

We have to continue to innovate and by doing so, grow more diversified revenue streams.

We must continue to reduce complexity across our operating model through increased automation and by simplifying our technology stack, while reengineering our client and organizational processes, in order to drive efficiencies, while delivering industry-leading client service.

There are a number of areas we are examining such as leveraging our IT partners to create better technology outcomes at lower cost.

We also have an opportunity to leverage process improvements and expertise within our global hubs to drive further efficiencies, while being constantly focused on resource discipline.

As we drive these initiatives forward, I and my team will provide strategy and progress updates in the fall including a reassessment of our technology plans.

And with that, let me turn it over to Eric to take you through the quarter in more detail.

Thank you, Ron, and good morning, everyone.

Let me start on Page 4. On the top-left panel, we show our GAAP results as well as certain results ex notable items and seasonal expenses, for those of you who want to see some of the underlying trends.

On the right panel, we summarize notable items, including $12 million pretax or $0.03 per share in 2Q 2019 of acquisition and restructuring cost, primarily related to Charles River.

Turning to Slide 5. We saw period-end AUC/A levels decline 3% year-on-year and remain flat quarter-on-quarter.

The quarter-on-quarter move in AUC/A was driven by the impact of the previously announced BlackRock transition, partially offset by higher spot market levels.

In regards to the BlackRock transition, please note that the 2Q '19 saw the departure of approximately $450 billion of fund-of-fund AUC/A, which was part of the previously announced deconversion and had no material revenue impact this quarter.

AUM levels increased 7% year-on-year and 4% quarter-on-quarter to a record $2.9 trillion, driven largely by higher equity market levels and institutional wins.

2Q '19 saw inflows of approximately $20 billion, the second sequential quarter of positive flows and were driven by institutional wins and cash.

Moving to Slide 6. Servicing fees were down 9% year-on-year, but flat quarter-on-quarter.

While challenging industry conditions persist, the pace of the quarter-over-quarter servicing fee pressure moderated somewhat during 2Q '19.

Unpacking the drivers of 2Q's flat sequential quarter results, we estimate that market levels were a 1% tailwind, flows and client activity taken together with net new business were a slight positive, while client pricing was less than a 1% headwind.

We are pleased that the actions we have taken since late last year are having some impact.

These include the rollout of our new client coverage model, which has opened up more share of wallet opportunities.

And our newly formed pricing review committee has strengthened discipline, leading to some moderation this quarter, which we expect to continue for a couple quarters.

Nevertheless, as Ron mentioned, we are not satisfied with the servicing fee results and recognize that we need to do more to restart fee growth.

On the bottom left panel of this page, we added some AUC/A sales performance indicators to provide a little more texture to our servicing fee dynamics.

As you can see, AUC/A wins totaled $390 billion in 2Q '19, up significantly on a quarter-on-quarter and year-on-year basis.

While at the same time, our AUC/A-to-be-installed this past quarter was also up to $575 billion.

While we are encouraged by these sales performance indicators, we also know that we need to maintain similar such momentum going forward.

I would add that Charles River continues to help drive our investment servicing client dialogues and we are excited about our first agreement to provide front-to-back investment servicing for Lazard Asset Management, more on that in a few minutes.

Turning to Slide 7. Let me discuss the rest of our fee revenues, beginning with management fees.

2Q revenue was down 5% year-over-year, driven by the ongoing impact to the late 2018 outflows and mix changes away from higher-fee products, partially offset by higher equity market levels.

Quarter-on-quarter, management fees were up 5%, driven by higher equity market levels, day count and $20 billion of net inflows.

FX trading was down 13% year-on-year and 3% quarter-on-quarter, mainly due to lower market volatility.

Securities finance revenues were down 18% year-on-year, largely reflecting the CCAR-related balance sheet optimizations made in the second half of '18, but up 7% quarter-on-quarter due mainly to seasonal activity.

In regards to the CCAR-related business actions taken last year, we've now made some trade structure changes to mitigate the CCAR counterparty limitations and are confident that we are creating room for incremental capacity for growth going forward.

Finally, processing fees were up year-on-year, reflecting approximately $86 million in revenue contribution from CRD.

Quarter-on-quarter, processing fees were down 12%, driven by the absence of prior quarter onetime items and lower revenue recognition in CRD.

Moving to Slide 8. You'll see in the top left panel, a summary of CRD's operating performance in 2Q '19, generating $91 million of revenues and $46 million of operating expenses, resulting in $45 million of pretax income.

The business also saw $31 million in new client bookings during the quarter, including significant bookings from our asset management and asset servicing units, which will drive important deal synergies.

While CRD continues to perform well, I would remind you that the lumpiness inherited in the 606 revenue reporting standard and to not read across any one quarter's results.

Turning to the upper-right panel on this page, we wanted to again provide you an update on our active client discussions.

As you can see here, our client discussions continue to advance.

We're now actively engaged with approximately 140 clients representing approximately $40 trillion in assets.

As anticipated, these dialogues are resulting in a variety of revenue opportunities and we remain confident in the revenue and cost synergy goals announced at the time of the acquisition.

On the bottom 2 panels of the page, we've also listed some of the growth and synergy milestones achieved this quarter.

As I mentioned earlier in the call, our new front-to-back agreement with Lazard Asset Management is an important milestone and reflects as a sort of new growth opportunities envisioned when we acquired CRD.

We currently have a strong front-to-back pipeline and are currently in exclusive negotiations with several clients and expect more announcements to come.

Turning to Slide 9, NII was down 7% year-on-year and 9% quarter-on-quarter, with our NIM declining 8 and 16 basis points, respectively.

In regards to NII, the decline on a sequential basis was primarily driven by the level of mix for deposit balances as well as our lower long-end rates have resulted in higher-than-usual MBS premium amortization and lower reinvestment yields.

In terms of client deposit behavior this quarter, as expected, we continue to see a mix shift out of noninterest-bearing deposits in an amount similar to what we saw the last quarter and much of the quarterly rate in 2018.

At the same time, we'd note that our average total deposits were up slightly quarter-on-quarter, as we saw some lift from our deposit initiatives, though some came at higher rates.

In terms of our balance sheet priorities going forward, we have a series of additional deposit initiatives underway, including efforts to drive diversity of our deposit base and ongoing client share of wallet discussions to drive deposit balance growth.

These initiatives supported our average total deposit balances this quarter, and we're confident that there are incremental opportunities available going forward.

And on the other -- on the earning asset side, we continue to target careful growth in client lending, while modestly increasing the size of our investment portfolio.

Now turning to expenses.

As Ron emphasized in his remarks, we continue to be laser-focused on expense management in this challenging revenue environment.

And we're executing on a number of expense initiatives designed to generate durable efficiency and productivity gains every year.

On Slide 10, we've again provided a view of expenses this quarter, ex notable and seasonal items, so that the underlying trends are readily visible.

Year-on-year, our underlying expenses, excluding notable items and seasonally deferred compensation, were up 2%, but down 1% excluding CRD and flat quarter-on-quarter.

As you can see, this result was again achieved across almost every major line of the expense base with information systems and communications where we continue to make technology infrastructure investments, effectively the only expense line that saw a material growth ex CRD.

The hiring freeze implemented earlier this year, combined with the ongoing reduction in our senior ranks has also resulted in 2 consecutive quarters of total headcount declines, with our total headcount down 1% quarter-on-quarter and 2% year-to-date.

We are now harnessing the benefits of previous automation initiatives across more and more operational processes, while we deliver higher and higher service quality.

Moving to Slide 11.

We are pleased with how we turned the corner on expenses over the last year.

And to provide more color on where we've realized expense reductions to date and where we see incremental opportunities going forward.

Starting with the stacked bar chart on the left, we've provided a few of our underlying expenses, categorized by IT, operations as well as business segments and corporate functions.

As you can see, due to our cost management efforts, for 2019, we expect to achieve year-on-year expense declines in 2 of these 3 segments, with significant efficiencies realized in operations as well as reductions in our business and corporate functions.

That said, the growth in our IT cost is currently too high.

And as Ron mentioned, we have embarked on a top-to-bottom review of our technology cost structure.

We see an opportunity to intervene on our technology infrastructure costs while investing in core business functionality and continuing to invest in resiliency.

Turning to the right-hand side of the page, with the various resource discipline and process reengineering initiatives we have underway, we expect to continue to see headcount come down over the coming quarters and believe that we can further reduce our high-cost location headcount by an additional 800 beyond our target to a total of approximately 2,300 in 2019, albeit while delivering quality service as we automate processes.

We are committed to simplifying our operations and technology model.

We currently support an application-intense IT architecture, which we need to consolidate with a goal of driving cost reduction, including an initial rationalization of 10% of our applications globally by the end of this year.

But we believe there is more that we can do.

We are now ruthlessly assessing every development program against strict payback criteria while investing in client functionality.

Taken together, we now see our 2019 expense plan yielding an additional $50 million savings by the end of 2019, totaling $400 million for the year and resulting in a 1.5% reduction in our underlying expense base year-on-year, excluding notable items and CRD as compared to the 1% target identified earlier this year.

Moving to Slide 12.

Our capital ratios were again largely consistent quarter-on-quarter, with our standardized CET1 sitting at 11.4% and our Tier 1 leverage at 7.6%.

We returned a total of approximately $475 million of capital to shareholders during the quarter, $300 million of which were share buybacks under our remaining authorization from the last CCAR cycle.

On the left side of the page, you can see that we consciously rebalanced our investment portfolio in 4Q '18, and we're now holding a relatively higher percentage of HQLA, which has created significant CCAR-stressed capital capacity.

As you are aware, we are pleased with our 2019 CCAR results released last month and expect to increase our dividend to $0.52 per share beginning third quarter and to repurchase an incremental $2 billion of common stock through 2Q '20, thus delivering on our priority to significantly increase capital return to our shareholders.

I would note that we are confident in our capital position.

And as proposed changes, the leverage ratio rules are finalized, we anticipate sharing a more fulsome perspective on our capital position and any associated optimizations opportunities going forward.

Before turning to Slide 13, I would like to cover our third quarter outlook.

On a sequential quarter basis, we expect servicing fees will be flattish and management fees will be up low single digit.

This assumes current equity index levels.

While market revenues are always difficult to forecast, we currently expect them to take a seasonal step-down quarter-over-quarter given the summer months, similar to what we experienced last year.

Processing fees and other is expected to be down sequentially, but still within our quarterly guidance of $70 million to $80 million ex CRD, with CRD expected to be in the low 80s.

In regards to NII, given the expectation of lower long rates, continued rotation of deposits into interest-bearing and 2 rate cuts, we currently expect sequential quarter NII to be down 1% to 3%.

And turning to expenses, we expect expenses ex notable items to be flat on a sequential quarter basis, including the CRD build.

Finally, we expect to see the tax rate between 19% to 20%, similar to our year-to-date tax rate.

Moving to our summary on Page 13.

While we remain unsatisfied with our revenue performance, we did see some moderation in servicing fee headwinds that helped result in flat total fee revenues quarter-on-quarter.

Moreover, the underlying expense reduction we've achieved to date demonstrates our ability to further bend the cost curve as we've now reduced headcount 2% year-to-date, while also raising this year's expense savings target to $400 million.

And we achieved a non-objection to our 2019 CCAR submission, and we'll be able to deliver on our priority of increasing capital return to shareholders.

Finally, as Ron noted in his opening remarks, we'll be providing updates on our current business strategy and the results of our technology reassessment.

We look forward to coming back to you in the fall with our progress.

And with that, let me hand the call back to Ron.

Thanks, Eric.

Operator, we can now open the call to questions.

(Operator Instructions) Our first question comes from the line of Brennan Hawken with UBS.

Just wanted to start out with the NII guide.

Eric, thanks for providing that.

Just curious about what beta is embedded, I believe you referenced that did reflect 2 Fed fund cuts in the back half of the year.

And so how should we think about your expectations for beta that's embedded in there?

And how should we think about what you are assuming for overall balance sheet growth and -- I know you referenced continued -- I think you referenced continued non-interest-bearing rotation, but about just overall deposit balance growth?

Thanks, Brennan.

Let me give you the kind of the components and maybe some direction on each one of them.

Because you know, the NII -- the direction of NII is dependent on several different features that we've been working through both as an industry and as a bank.

So first, we do expect continued rotation of net interest -- non-interest-bearing into interest-bearing deposits, that is expected to continue and will weigh to some extent on NII.

We're seeing long rates down relative to where they were this past quarter, where they've been over the last couple of years and so is the reinvestment cycles from the investment portfolio, you see some downward progression.

And in contrast, you also see, I think some modest expansion in the asset earning side of the book, right, investment -- the investment securities balances are up modestly, we're continuing to grow lending in a disciplined manner.

And those will provide some uptick.

When it comes specifically to deposit betas, we're almost at an equilibrium point.

If you think about it early in the rate cycle, the deposit betas were quite low and so as the Fed raised rates, there was a significant tailwind of NII for us and other banks and the betas were in the 10%, 20% range.

They floated up right to the 40% to 50% range and now 60% to 70% range.

And so in effect, as the Fed moves 25 basis points up, if it were to do that, had it originally anticipated right, there wouldn't have been much uptick in NII.

And similarly, as it now anticipates and is within our expectations that it actually moves down, the betas are similarly at that higher level.

And so deposits rates will naturally come down reasonably quickly for the first move or so.

I think what -- and that's I kind of say we're at an equilibrium point with betas, effectively covering or being neutral with respect to the Fed rate change.

I think what's uncertain is what happens after the first rate change, for the second, third or other movements and that we've got to see.

But anyway hopefully, that's enough to give you some color on a second quarter, the third quarter basis.

And obviously, we'll continue to provide some texture as rates evolve.

Okay.

That's really helpful.

And then thanks for the update on the expense outlook.

It's really encouraging to see some more assertive movements there.

When we think about the $8.43 billion that you've provided for operating expenses, is that comparable to the $8.27 billion, which you previously provided which I believe excluded the CRD expenses?

And how much of that lower expectation is in the first half '19 results, as in already reported?

And how much is still on to come?

Let me do that in -- kind of in a fulsome way.

So the progress on the expense program has been I think quite good.

We've logged $175 million year-to-date.

We are -- and that was out of $350 million that we additionally anticipated, and that's why we have a lot of confidence in being able to hit not only that initial target by taking it up, but taking it up.

And I think what we've seen is, we've seen a real progress in addressing some of our prior year growth in headcount.

And that's effectively what we're reversing, right, because we're growing headcount at 4% to 5% a year for several years.

And as a result, while we were automating and I think you've finally seen us begin to do in an industrious way is actually now ensure that the automation is actually used, it's used consistently in a widespread way.

And that is part of what our COO described at one of the recent conferences on how we're scaling the use of the automation tools.

And once you do that, you actually need fewer people in the mix, and you actually deliver even better and higher levels of service and quality because the processes effectively are straight through.

On the overall expense guide here for the year, we've done it apples-to-apples relative to '18.

I think, Brennan, we're quite clear in the footnote that it's -- you see that the underlying expenses are ex notable items and CRD-related expenses.

And so if there's some specific question you have versus some other numbers that you've seen, just we can follow up offline and kind of do this, we can effectively help you all model this with and without CRD if that's helpful for you.

But this is on a, what I'll describe as a -- what I think is really an apples-to-apples way to think about the expense base.

And then just, sorry, the last point about how much of that lower expectation is already reported.

Is the difference -- is the right way to think about the difference just be $175 million that you've already done versus now the $400 million is the new target, therefore you've got $225 million left to go versus your prior expectations?

Is it that simple?

Yes.

Yes, that's exactly it.

Yes, and because of the run rate at which we're operating in the second quarter, the amount of the -- I think we're ahead of plan, as I've said on some of our headcount changes.

For example, we had described that we had targeted 1,500 reduction in high-cost location headcount for the year.

We've already gotten to 1,800 in -- just in the first 6 months, so we're ahead of the plan there.

And that kind of run rate benefit is what is -- we feel confident will give us the full year savings of the $400 million.

Our next question comes from Alex Blostein with Goldman Sachs.

So was hoping to start with a question around the servicing business.

Eric, obviously, you mentioned that the pricing pressure you've seen over the last couple of quarters is starting to moderate.

Obviously, it's a pretty important sign for investors given the pressures we've seen in that line item.

Can we expand on that a little bit?

I guess, historically, you talked about sort of 2-ish percent annual sort of pricing decline for servicing.

Sounds like recently, it's been running closer to 1% this quarter, you expect that to persist for the next couple of quarters.

But are we through the worst of it?

How should we think about pricing pressure sort of beyond 2019?

In other words, like, given the changes that you guys might have made, is 1% pricing compression kind of the run rate?

Or should we think about that normalizing back to 2% or so that we've seen historically?

Alex, this is Ron.

Why don't I start and Eric can pick up.

I think what we're seeing is as we'd said now for a couple of quarters, we've been in this period of almost extraordinary price pressure.

This is a business that's always had a price downturn kind of built into it, and we would expect that kind of secular element to remain.

But there's been unusual price pressure, really driven by primarily the pressure on the actual asset managers and asset owners themselves and them looking for some relief through their -- a large provider such as ourselves.

Secondarily, I think it was somewhat driven by when you had the big run-up in the markets in '16 and '17 and clients would look and say, gee, I just wrote a check to you guys, it was 20% more than the check last year, it seems like we have to get some of this back.

So what we're saying -- what we're seeing is the moderation of that, what I call, that extraordinary price pressure.

Part of it is we've worked our way through many of the clients.

We've also gotten some term out of it.

But also, we've gone about it, we said we were changing the way we are going about repricing, and we've done that.

That used to be a relatively routine decentralized kind of decision here.

And for any individual RM, it might be something that he or she experiences 1 or 2 times every couple years.

So we kind of brought that expertise in centrally.

We've been reasonably successful in things like extending term, at getting more business and most importantly matching the price -- any price decrease -- any inordinate price decrease we're giving to incremental business coming in as opposed to the price decrease first and the business later.

So what I would say kind of from a qualitative basis is you can expect this business to continue to be price competitive and that there will be ongoing price pressure.

But that we are seeing moderation in that extraordinary element of repricing, driven both by the fact that we've accomplished a lot of it already; and secondly, our own actions in mitigating the effects of it.

And Alex, it's Eric.

Let me just add some of the quantitative kind of beacons to that, right.

So the history here is that this business operated over the last, I'll say, decade with normal fee headwinds of about 1.5% to 2%, so call it 2% to keep things straightforward.

During 2018, that ticked up to about 4% for the full year, and we saw about -- we expect about 4% this year as well to play through the revenue line.

What we're starting to see is that -- and that 4% is effectively 1 percentage point each quarter, right.

Now it comes a little -- it tends to come a little sharper in the first quarter and then a little lighter in the second, third and fourth quarter.

And as we've, you can imagine, devoured our own data, client-by-client and area-by-area what we're starting to see is that sequential amounts of pricing that are hitting us are starting to moderate.

And as Ron describes, we're through not only a majority of the discussions, but closer to 3/4 of this, kind of what I'll describe as an unusual or larger than usual wave.

As that -- those hit the revenue accruals, it feels like the peak quarter was in the -- or the peak time period was towards the end of the first quarter.

And we -- our expectation is that this is beginning to normalize back to some level.

So we're trying to be quite transparent with you about what we're seeing.

We've got some amount of visibility into what will likely happen with the pressure in the third quarter and fourth quarter, right.

Because those are all our large clients, we know where we may have open negotiations and so forth, and we can tabulate those.

And so that's what gives us some confidence that we're seeing some signs of moderation here.

I think what we all want to be careful of is the 4% year-on-year that we saw last year that we expect this year, the pace of that coming down, we're seeing it start to moderate.

Does it come down to 3% year-on-year after being at 4% year-on-year?

That's what we'd like to see, and we expect to have more visibility into that as we move further in the year.

And then ideally, it comes back down to some normalized level.

And that's what we're -- we need to -- we'd like to see, but we also need to work forward in finding ways, as Ron described, to balance some of our actions.

And I think we'll learn more in the coming quarters.

Got it.

That's pretty clear.

Secondly, wanted to follow up on CRD.

Looks like the order intake or sort of the new bookings you guys described in the quarter was around $31 million.

And I'm just trying to think about how should we think about that flowing through into the model.

Does that kind of hit you all in the subsequent quarter or over some period of time?

And then the pipeline around the front-to-back initiatives that you highlighted, obviously, one would be Lazard, but also the ones that haven't hit yet.

How should we be thinking about the economics of that pipeline growing?

And not sure if you guys could describe it in terms of like AUM times the fee rate or some sort of frame of reference on how we should think about the revenues of that opportunity?

Let me describe it from 2 different angles, Alex.

We -- when we did our diligence on CRD, and then decided to pursue the deal and shared that with you, we described that this business was growing at about 7% top line over the last few years.

And our expectation is that we should be on the CRD-specific revenue lines, be able to double that.

And we're quite confident that we're -- we've started to get that level of growth in that business.

And that's kind of one way to think about what we're beginning to deliver.

And part of that literally comes from it being owned by a large parent who's been in business for a couple centuries as opposed to a couple years and the willingness of clients to sign on.

So that's one way to think of it, and we've got quite a bit of confidence that we're seeing that kind of lift.

I think on a tactical basis, what you saw this quarter and what you'll see in various quarters is the bookings.

The bookings are, we describe on a run rate revenue basis, just to give you a sense for a size.

Those bookings tend to begin to get implemented and roll through an implementation timeframe of 6, 9, 12 months.

So it takes some amount of time.

And then I just remind you that we were clear that the bookings this quarter did have a larger, obviously, spike.

And 2 of those bookings -- so and we I think were actually pleased it was 2, are actually internal bookings with -- one with our asset management business, right, where they're now rolling out CRD in substantial portions in operations.

And the other one, which is our servicing business where the CRD systems are effectively replacing an old compliance engine that we used to offer through our custody servicing business.

And if you think about it, on one hand, those revenues will be eliminated in consolidation.

On the other hand, those revenues actually lead to direct expense synergies because had we not implemented CRD in such a I think fulsome way, we would have been on those legacy platforms, on those -- on that patchwork of the 25 systems that we've described for the typical large asset manager.

And so we're actually quite pleased that we can effectively lead with our own implementations, which becomes a model, right, for what Charles River can do.

Because if you can implement Charles River on an asset manager of a couple trillion dollars of assets over time, right, then it proves its power and effectiveness in a broad range of different scenarios.

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

Question on securities portfolio.

I know I'm overgeneralizing it.

But when credit risk assets were super tight, low rates and tight spreads, you made the switch over to some mortgages, got unlucky, and who know rates fell 50 basis points and they prepaid on you.

So my question is now what do we do?

You expect some balance growth, you expect some loan growth.

What do you do on the asset side as the balance sheet grows?

Because the rate and spread picture hasn't changed all that much.

Glenn, it's Eric.

The bankers have always had these challenges.

As rate cycle is going up, there are opportunities.

As rates come down, the opportunities tend to be fewer and as rates invert, there's an even different way to operate.

So I don't think there are any silver bullets that I would put out there, any other CFO or treasurer would share with you.

I think what we technically do in this environment is where we have excess liquidity, and we are a liquidity-rich bank, we continue to add to the securities portfolio.

We do that and effectively on balances.

And you've seen our securities portfolio inch up a couple billion dollars this quarter and we've got capacity to continue to do that in the coming quarters.

And that provides some yields and effectively puts some cash to work.

We do that selectively in the agency MBS space or in the very high-grade credit space or some of the foreign jurisdictions, each of those are tactical choices that we'll make depending on the relative value opportunities.

And then I think coincident with that, the other part of the asset yield part of the book is that we continue to grow our lending franchise.

We don't have a large lending franchise by typical bank standards.

And we think that's not inappropriate for a custody bank.

On the other hand, our capital call financing business, which is a real area of growth and connectivity with our clients, continues to grow at a very attractive pace as the alternative lenders are all out there, building bigger and bigger funds and it's one which operated quite well during the crisis.

And so that kind of capital call financing, the 40 Act leverage fund financing all has very good risk-return dynamics and I think we see some opportunities there.

But like anyone, we want to stick to what we're good at and what our clients do given where we are in the cycle.

So anyway, hopefully, that's a little bit of a texture at this point on the price.

Yes.

One last one.

The $575 billion of won but not yet funded, can you give any color in terms of what we should think about in terms of timing, working its way into the pipeline and impact on fees?

Yes.

Each one of those is different, it's literally a composite.

The largest, the wins in there were in the insurance sector.

And I think we've talked to you about our becoming more industrious in some of the subsegments outside of asset managers where we're already strong, but I don't think we've emphasized our expansion as much as we did in the asset manager segment, which has historically been our kind of core.

So there's some insurance wins, there's some asset management wins, there's a pool.

It's hard to directly anticipate the exact on-boarding.

But it tends to be 6 months, 12 months, sometimes 15 months, it just takes time.

And the way it works is the simpler stuff can get done, custodies sometimes get done in 6 months.

But more complex accounting or middle office is 12 to 18 months.

So to us, it's a sign that we're out there selling and driving client activity.

And part of what we know we need to do is we know we need to continue to drive that client activity as a way to restart the revenue growth that we need to deliver to all of you.

So we're trying to also be I think more transparent of some of the indicators.

And that's one of several indicators but one -- that we've held for this quarter.

Our next question comes from the line of Ken Usdin with Jefferies.

Eric, just one follow-up on the -- on balance sheet.

Can you just remind us just how fast does the securities portfolio reprice?

And within -- and where does the duration stand today after some of the recent changes in investments?

Yes.

Ken, the duration is at about just over 2.5 years, it's been in the 2.5 to 3 years, I think for the last few quarters, if not the last couple years.

The -- and so it kind of tractors in concert with that average duration.

I think the other way to think about it and we've tried to be helpful in our disclosures in the Qs and Ks that as you have movements in long rates, say the 10-year treasury, that comes back and impacts our NII.

And I think the rough -- maybe a rough rule of thumb might be for every basis point change in the 10-year rate, that's worth about $1 million a year.

So you can multiply that out for 25 basis points, what it would be worth or 50, and that's part of the down drift that we've started to see through first and second quarter and we just need to be sensitive to.

So if Fed cuts rates, that's we think -- that will have one impact.

If the curve picks up maybe a little steepness as it does that, we'll see.

That would be constructive if the curve stays flat or inverts that could -- that can move around the yield for us and other banks.

Got it.

And then my second question, Eric, you guys had the very successful CCAR result, you burned meaningfully less bad than last year, 280 basis points better.

So that didn't obviously affect this year's CCAR, but you did a -- do a good job in boosting, as expected, buyback.

Can you talk about your views on where the plan proposals are on SLR, [SCB], et cetera?

And if the results of this year's CCAR might let you be more aggressive looking ahead or -- on capital returns?

Sure, Ken.

It's Eric.

And let me do this one in stages.

Because I think as the Fed governors have said, there's about 24 different capital metrics that banks operate under.

And so it has a series of different steps.

I think first as you described, we're very pleased with our CCAR results this year.

And a lot of that was some of the actions that we took in the investment portfolio.

We literally created several billion dollars of room under CCAR, and ended up with, as we shifted that investment portfolio out of credit.

So that was the first stage.

And I think what that effectively demonstrate is under a CCAR-type stress, we have room for -- we have room in the capital account.

So that's certainly a first step.

The second step is then what are the next most important binding capital constraints and what happens if the CCAR downdraft isn't -- the stress isn't the constraint.

Then you go back to what are our spot levels of capital ratio.

And those spot levels are on that Page 12 of our deck.

And if you go through the different spot levels, what you'll find is that as a custody bank, the leverage ratio and especially the supplementary leverage ratio under the spot rules of 5% for the Holdco, 6% for the bank are what becomes the next most binding capital constraints.

And so the assessment then is how much space do we have there?

And I think what happens -- what we're now looking at is what happens with some of the Fed changes in the -- and the SLR that have come out of the Congressional bill that's out for comment, those comments I think concluded just a few weeks ago.

And now the Feds got to turn that into a rule and based on that and the timing of that rule is certainly that frees up and could free up some capital capacity under SLR.

And then after that, we go to the next most important binding constraint, is it CET1?

What happens with the SCB?

What happens with Basel IV and so on and so forth?

So think of it as a waterfall.

I think why we're optimistic, and I described a little bit of that in my prepared remarks is, we've very effectively created room under stress, we think there is a path, some more room under the supplementary leverage ratio.

And we'll all learn more about that in the coming months or quarter or 2.

And then what we can do is we'll go back and think about our capital stack, right?

Because we're looking at CET1 opportunities, that's one potential pool you all know that we have about 3 points of alternative Tier 1 in the form of preferreds, that's another larger-than-usual pool for banks.

But as a custody bank that has been bound by the leverage ratios, that was important to have at the time.

And obviously, there is the Tier 2. And so what it effectively does is, I'm trying to give you a bit of a roadmap so to speak, how we think about the opportunities, but that's the process and then it's around the whole capital stack.

And where there are opportunities and -- that we can -- that we could appropriately share back with you and our investors.

Our next question comes from Betsy Graseck with Morgan Stanley.

You dug a lot into the expenses in the trajectory.

And I just wanted to understand when I'm thinking about the pretax margin improvement of 200 basis points that you're looking for.

How you're thinking about the drivers of that in terms of a little bit bigger picture in the sense of how much of that 200 basis points you're expecting is going to be coming from expenses versus revenues, just given the inputs that you have right now today?

Betsy, why don't I start that.

I mean, ideally, what you would like to see is a little bit of both.

But we are cautious enough about the revenue environment that we feel we need to keep doubling down on expenses.

We want to do that wisely because we have to do that while continuing to ensure that our client service remains at high levels and that we are investing in the business.

But the way we think about it now particularly given the downdraft that we experienced at the end of last year and the ongoing pressure that we've had is that expenses will be the first move in terms of improving that margin, and that the revenue actions that we're taking as well as the longer-term revenue that's going to flow and as a result of this front-to-back work will then provide some of that margin uplift later.

So conceptually, that's where we think about it.

In terms of timing, we're standing by our goals there.

But obviously, the world changed a lot from when we put those goals out late last year.

So that's why we've been very cautious with you in terms of really going quarter-to-quarter, as we can -- so we can try and get a picture of what's going on, on the revenue side.

And so we can focus on what we know we can control, which is expenses.

And Betsy, it's Eric.

I would just add that a part of what we're doing is to continue to work through more and more of the expense base.

One of the reasons we shared with you the page on full year expenses in the earnings deck is to actually show you where we are in that process and where we've made more progress and where we feel like there's a lot more opportunity.

And I think you see in particular as we've automated a lot of more and more of our work and of course, utilization of some of our automation tools, you see that year-on-year 8% anticipated reduction in operations.

And that's exactly what should do as we automate a factory, it -- the costs go down, and you'd expect that we want to continue that process year after year after year.

I think to some extent, we've made some good headway in our businesses and functions, and there's always more we want to do there.

But I think we're on a good path relative to the past.

And more to come and in those, it's really -- it's personal expense and it's nonpersonal expense, and each one of those has opportunities.

And then finally, I think technology cost is the area where we've made a decision more recently and part of it comes as merge operations and technology together under a COO, and part of it comes with the realization and a decision here at the top that we can't live given the revenue environment with the kind of technology cost structure and growth that we've been operating under.

And so that's why we've said, top to bottom we're going to address opportunities, find opportunities and more to come as that review proceeds.

Okay.

And then just, Eric, I know we had a conversation earlier about the securities.

But we just wanted to round that out with, at this stage, do you see any opportunities for restructuring securities book positioning or you feel like where it is right now is optimized for your current rate outlook?

Betsy, I think the securities book is in a pretty good position overall.

I think we'll always do some adjustments around the margin, rates are lower, we can always, if we wanted, get out of some securities and buy back others.

So I think we have some latitude, which is convenient.

But I think generally, we like the mix now of the securities portfolio I think selectively and tactically we'll want to maintain duration, we've lost a little bit of duration as we've had rates come down and you have the natural prepayments work their way through.

So we tactically add that back.

And then as I said, I think we want to find ways selectively to expand the securities portfolio because it provides good yields for us at least as a custody bank.

And that's part of the -- of some of our anticipated actions.

Our next question comes from the line of Mike Carrier with Bank of America.

Eric, maybe first one, I think you mentioned, there's some more balancing capacity for CET1, and I think maybe FX, do you see the demand by clients, given some of the repositioning that you did last year.

Just are you seeing that demand?

And how soon could we see some growth in those areas?

Mike, the answer is that there is demand out there, there are opportunities for us, and I think we have found ways to create capacity.

I think the question that comes around the pace of that growth and that takes some time.

And I think part of the reason is as we implemented some of our constraints and caps that came out of the CCAR counterparty task, in some cases, we actually had to reduce activity with some clients or put some constraints on.

And as you do that, right, clients appropriately say, all right, fine, I understand, but when you then go back to them after having created room and doing some of the diversification of counterparty optimizations and the innovations, and I've described some trade structure refinements, those clients are delighted that you're back open for business.

But they also come back over time, right, because it's about then serving them even better than their current providers about, shifting where they place their wallet.

And so I think it takes quarters to -- for it to build, and part of what we'd like to see is that and we'll report on is that build as it comes.

It's also a little lumpy because you got the seasonal effects of 2Q and agency lending and enhanced custody and then the seasonal summer months that work the other way in third quarter.

But we'll try to provide as much of a window into that evolution.

But I think the point we did want to make is that we found ways to create capacity here and so it's a matter of time now for us and for our business teams to execute.

Okay.

That's helpful.

And then just quickly on the strategy in tech just the reassessment ahead and the update in the fall.

Just as that expectation, it sounds like it's focused on cost.

But I just want to make sure, there is that -- anything on like the innovative or growth with partners, just want to make sure you've got any set expectations in terms of what initiatives you guys are thinking and what we'll get an update on?

Yes, Mike, it's Ron.

Maybe we are thinking comprehensively about this, clearly, cost is on our minds.

But it's also about how do we get to market as rapidly as possible.

How do we innovate as rapidly as possible.

As tech changes, how do we substitute as rapidly as possible.

So we're thinking about this comprehensively.

And I don't have to tell you that world has changed in tech.

And as we have moved our applications to be much more comprehensive and covering the full range of activities from front to back.

If you think about a front-office system it's highly -- you're highly focused on the user interface.

You think about the back-office system, you're talking about transaction speed and basically invulnerability, if you will, and high amounts of resiliency.

So we haven't really done that kind of broad-based reassessment.

It's already started.

It's not going to take months, I mean it will take a few months, but it's not going to take many months.

And we'll come back to you and keep you updated on what we're thinking about.

Our next question comes from the line of Jim Mitchell with Buckingham Research.

Maybe just now that you're close to reality with a front-to-back contract with a client, how do we think about the pricing, because I think there was concerns initially that the sum of the parts would be less than the separate parts.

So are you seeing, is pricing holding up and/or is it -- so is it revenue-accretive margin in terms of the fee rate?

Is it -- or is it more margin-accretive because it's more efficient?

How do we think about as you build this business, the impact on revenue and margin?

Yes, Jim.

The way I would think about it is that our intention had always been and so far, we've been succeeding on this to not let this become just a throw away or an add-on for custody business.

And that -- those have actually been pretty easy conversations.

I mean that's actually not what the client is focused on.

What the client is focused on here is how do I simplify my own operations?

How do I actually reduce my own cost?

And how do I get access to data more quickly and be able to rely on that data?

So those have been the key buying factors.

I mean certainly, there is a cost element to this, but we're not seeing it kind of come back into the, gee, CRDs to be priced at x and we want to price at some fraction of x. The second thing I would point out is, as we had said from the earliest days on CRD and when we rolled out the front-to-back strategy, these clients that we're talking to and there's several that are in advanced negotiations, exclusive negotiations, they're all sorts of flavors.

Some of them are already CRD and State Street clients, so if you will, we're putting together the final mile.

At the other extreme, there is an -- there is a perspective client in there.

We had no relationship with them.

I mean we knew who they were, they knew who we were.

But we did not have an existing relationship, but they had this need that we've described.

So the nature of that will be, if it comes to fruition, is that we'd expect to see new custody, new accounting and new CRD as a result of that.

So there's 2 elements to your question.

One is kind of pricing, but the second element is, what's the content and nature the business?

And in some cases, we're filling out the wallet, if you will.

In other cases, the wallet is opening up to us for the first time, and we're taking the whole thing.

Right.

Okay.

That's helpful.

And then, maybe, Eric, just pivoting on to deposits.

If I look at your Q, 100 basis point short end shock.

It's actually pretty neutral based on disclosures.

Is that still the best way to think about it?

If you have the long end staying where it is and we get some cuts, is it pretty neutral to NII?

Is that still fair?

Jim, it's Eric.

I think the way we would describe it is that the short-end change of rates in the U.S. in particular is roughly neutral for the first 25 basis points.

I think after that, it starts to have a negative impact, right.

And why would that be?

It's because, if the rate -- if rates were to come down, 75, 100 basis points, you start to get compressed against the lower bound on the deposit cost.

And so there's a -- the convexity, the stair-step actually matters here.

And so that's important to factor in.

And then I think the other one is the currency dynamic, and we'll continue to add more currency information in some of those disclosures so you could see what happens if the U.S. moves down.

I think there's a big question mark in my mind is that what's going to happen in Europe.

And that environment, given the change in central bank leadership and some of the other economic growth changes that we're seeing.

So anyway, hopefully, that gives you some color.

I think the first one should be neutral.

After that there's -- you get back to that more expanded situation that we need to work through.

Our next question comes from the line of Brian Bedell with Deutsche Bank.

A lot of my questions are answered.

I just have 1 2-part question on the cost side.

Just looking at Slide 11 and Slide 17 to the cost guidance for '18 and '19 on an underlying basis and then looking at that versus the appendix.

I see the $8.57 billion for 2018, but if I add up 1Q '19 and 2Q '19 on the same basis, your $8.43 billion would imply a 3% increase in the second half on that basis versus the first half.

So I just wanted to verify if I am doing the right apples-to-apples there?

And then the second part of the question is as we get through the cost saves, shouldn't we be coming into -- in 4Q at a lower endpoint?

And as we move into 2020, especially with some of the reengineering ideas you talked about, Ron, should we be looking at a lower expense trajectory on a year-over-year basis in 2020 versus '19?

Brian, let me start.

I think on the specifics that you just went through, we probably hopefully just cover that as a follow-up.

I think that was quite clear that third quarter expenses ex notable and lumpy items will be well-controlled.

And I think you can expect that we like expenses to be either flat or trending down, and that'll be the case on a quarterly basis.

I do think, and it's a little early for us to do our planning for next year, but given the revenue environment, as Ron and I have described, we need to double down on expenses, given the -- given our commitments and our intentions to find ways to widen margin and improve ROE.

And we do the same kind of things that you're thinking through, which is what's our run rate at the -- in the third quarter versus the first, what's our run rate in the fourth quarter versus the first.

And that's exactly what we should be doing.

And why we've been, I think pleased that we've gotten our headcount now under much better control.

We've gotten some of our offshoring activities to -- at pace because the second half of the year run rate as a fourth quarter run rate will be more indicative of what we can deliver in next year.

And then there's obviously the hard work we need to do as to what we can we do over and above that, and we always want to find more we can do.

And we were industrious this year, we need to be industrious next year.

We also need to offset whatever the natural headwinds of merit and so forth.

So there's a lot lots going in that, but we're certainly of the same mind that I think you're intimating, which is how do you take advantage of the benefits and do that -- and how do you tackle expenses year after year after year because it's an industry in which we need to do that.

That's got to be the operating mode that we use.

Our next question comes from the line of Marty Mosby with Vining Sparks.

I had 2 kind of specific questions.

One is, when we talk about the net interest income impact this particular quarter, [we're excited at the] accelerated premium amortization.

When I look at the actual sequential decline of $60 million, there's just not a way for the long-term portfolio to reprice in a normal way to generate that much pressure.

So it seems like to me that this premium amortization was a pretty big deal this particular quarter.

And sometimes that could be a catch-up.

So I'm just curious how much of the $60 million sequential decline was related to that premium amortization.

And then if rate stay flat, long-term rates, not short-term rates, obviously, they would be headed nowhere.

But if long-term rates kind of stabilized at their relative position today, what does that mean for that particular amortization number going into the next couple of quarters?

Marty, it's Eric.

Let me first give a little decomposition, then we'll talk about the coming quarters.

So the decomposition on a quarter-on-quarter basis was that a little less than half of the $60 million reduction in NII came from the premium amortization, a little less than half came from the rotation noninterest-bearing deposits and interest-bearing deposits.

And then there was another little stuff from just general reduction in rates and some other more minor impacts.

So that gives you a little bit of color.

I think what has happened here, and the reason why there was an acceleration is that part of what we did as we rotated out of credit last fall when prevailing long rates were at 3%, 3.10%, 3.15%, is we were in some higher coupon bonds.

And some of those pay very good rates, and as you have the fall in rates, you have the acceleration.

So that's what played through.

I think some of that is burning out.

And so then you get a residual set of bonds at good rates.

And so its amount is about working through that.

As we look into third quarter, there's a couple different features happening.

There is still some amount of premium amortization that will come through.

And so we -- there'll be a bit more in the third quarter and then it begins to tell from there assuming long rates stay where they are.

And then what we also have in the third quarter is just the general level of rates and the reinvestment yields and that kind of tractor that I described earlier come through.

And so that's playing out as well.

The offset to some of that is the some modest growth in the size of the portfolio, some modest growth in loans.

And that should help and then obviously, the deposit dynamic will probably be the larger of the pieces going into the third quarter.

What we try to do is kind of knit that together and give you some range of guidance to be able to estimate the -- a bit of the third quarter.

So what I did hear you say is the $30 million, there'll be some of that left to come into the third quarter, but by the time we get to the fourth quarter or the first quarter of next year, at least, if rates don't decline further, that $30 million negative goes away and NII would get the benefit from that?

Yes.

It gets a -- it starts to -- exactly, it starts to attenuate, right, it gets -- you have less of it towards the fourth quarter and the first quarter.

But remember, you always have a certain amount of prepayments floating through a mortgage book, that's always been in our numbers.

We've always operated with a certain amount.

And it could be helpful.

There's some good disclosure in the 10-Q on the amount of premium, the premium amortization, and we can take you through some of the kind of the waves that you should expect for us or for any bank.

Okay.

And then the other very particular thing I wanted to hone in on was, in the back end of the fee income, you talked about CRD revenue due to revenue recognition standards.

Just was curious what you meant by revenue recognition standards?

What is that is that?

Is that a seasonal thing?

Is that a shift that you had a business and now you're understanding it better so you changed the standards, I just was curious what that meant?

No, that's just a -- there was industry-wide change to the accounting.

It's I think ASC 605 going to ASC 606, I've got to make sure I double check my acronyms.

So I'll do that as a follow-up with our controller.

That went into effect I guess about 1.5 years ago.

And it affects the software-oriented businesses that also affected our management -- our asset management business.

And it's quite prescriptive on how revenue is recognized.

And so for fast implementations, the revenue is recognized in quite a, I'll call it, a natural way.

But from on-premise installations at the contract renewal point, you literally have to -- that particular quarter of a contract renewal, you have to record x percent and we can, again, get you some of the details of the entire contract.

And it ends up with lumpy revenues even though you're effectively providing the service over a period of time.

I mean we agree with the accounting literature, and it's probably more consistent way to do the revenue recognition accounting for the industry, but it just ends up with lumpiness because of the way contracts are structured.

And that's not seasonal or anything, there's no rhyme or reason to it, it's just going to be how you're onboarding new relationships or different things that are happening within the, I guess the actual recognition of that revenue is the activities?

Correct.

It's the onboarding of new, but it's also the -- as existing contract cycle through when they -- when the contract renewal date is, ends up lumpy and they're not all stacked up in that kind of perfectly even way during the year.

So it will just go up and down.

We're just going to -- we -- what we want to do is be clear that we -- the underlying revenues, I think we're trying to be clear about, the GAAP revenues are the most appropriate way to measure.

They'll be lumpy and you just wanted to take over the course of several quarters or over a year to actually see the numbers in a way that are more intuitive.

And lastly, a bigger picture question.

When you all mentioned earlier that the pricing pressure accelerated, which started to make sense, it started to really become much more crystal-clear.

In other words, market valuations are gone up so much over the last decade that as you price to those market valuations that are really not increasing the activities or work that you're doing for a customer.

And your customers are getting under pressure, so their revenues per assets under management are going down.

They're going to kind of turn to you and say, well, look, you're not really doing that much more work for us but, yes, we've paying you that much more.

I think you mentioned the 20% price increase, the kind -- just as a -- just kind of an example.

So is there any thought or process where you could get away from being per assets where market valuation would kind of roll around versus being tied more to transactions and activities and more like a cash management type of a relationship where you pay for processing versus paying for the amount that you have, which is dictated by market valuations.

In the past it made a lot of sense because they got revenue on their assets so they could pay you on their asset, but that relationship is kind of busting up.

So I just didn't know historically versus going forward, is there a way to disconnect from the market valuation and the AUM and get to transaction processing.

Yes.

Marty, it's Eric.

You're -- either all the -- you're absolutely spot on in describing how this pricing has evolved in this industry.

And I think we're having -- we've got as a result broader and broader fee structures with our clients to make sure that there is a mix of flows and client activity and transactions, which directly represent the kind of work we do.

I think what keeps some of the history going is that our large clients or the large asset managers and those large asset managers often get paid on a management fee basis, right, if you think about a mutual fund, which is market dependent.

So there's a bit of an interest in our clients tying their expenses to market level, just like their fees are.

We'd ideally like to, obviously, charge for the service itself as you described.

And so I think over time, there will be an evolution, but there is a range of interests here.

And I think our view is we just need to make sure we're appropriately creating value for our clients.

So that they -- so that we can remunerated appropriately.

We find ways to do it in a way that -- the more stable the better.

And so those are the kinds of some of those areas that you described are the areas that we've been engaging on.

Our next question comes from the line of Rob Wildhack with Autonomous Research.

Just one from me.

Looking at the management fee line you mentioned again the shift towards the lower fee products.

I was wondering -- hoping to get some color on the velocity of that shift.

Is that a trend that's been accelerating or decelerating in any discernable way?

And then how do you think about that velocity going forward?

Yes.

Rob, this is Ron.

I think that it's certainly something we're trying to manage, and we're having some return on that effort here.

So this year, for example, half of the new business SSGA has brought in has been outside of the traditional passive area where we've seen the most price pressure.

And we applaud that kind of diversification.

Realities are though in terms of where the flows are going.

So if you look, for example, at ETF flows, we had a, at the top level, I would describe it as a so-so quarter.

But that was driven by continued market share gains in Europe and in low cost offset by really outflows in some of the big institutional products like SPY.

So this is -- there's clearly a market shift going on particularly in ETFs, and you would find the same, by the way, if you looked at some of our large ETF competitors and where their flows are going, the preponderance is going to these low-cost products as -- and really what's behind that is a substitute for a higher costs whether it's mutual funds, and typically, it's advisers that are employing these as building blocks.

So we have to live with that.

And that's why we have to: one, make sure we reduce our cost; and two, that we're opening up our distribution channels, so that we are continuing to gain share in those areas.

(Operator Instructions) Our next question comes from Gerard Cassidy from RBC Capital Markets.

Ron, you mentioned about the competitive forces that many of your customers are under, which has led to pricing challenges for you and your peers.

Can you share with us your insights about the competition amongst the custody banks, especially some of the New York banks seem to be stepping up their intensity in competing in this business because they've got diversified revenue source and this is an area that maybe was not as much of the focus 5 years ago, but it seems to be today.

But I'm interested in the competitive dynamics of your competitors and the pressure that puts on pricing.

Yes, Gerard.

If you look at the history of the universal banks in the space, it's been cyclical.

There've been times where they're all in and there been times when the business has languished.

And I would say, this is one of those periods in the cycle where they have been focused on it.

The -- that is one of the things that drove us to re-examine our strategy a year, 1.5 year ago and to make the move that we did.

Rather than be forced into a position where we're all combating for the same back office stuff, that we wanted to make sure that we had the full range of back, middle and front office, and to be able to offer a really integrated offering to them.

It changes the nature of the relationship, it changes the nature of the pricing discussion, it even changes what the objective function is.

I mean if a client out there is just building -- bidding out custody, it's not the custody, it's a commodity.

There certainly are service differences, but it really is more price.

If a client is having or a prospective client is having a discussion with you on front to back, it's really about the next 10 years of their firm.

And how are they going to build their firm in a way that they're going to be able to scale, that they're going to be able to manage their economics, that they're going to be able to have better access to data to be able to: one, provide better investment outcomes; but two, better services their clients.

So -- and we're the only ones that are in position to be able to do that.

We're the only custody bank that has those services front to back, so we think we're having just a very different set of conversations.

Doesn't mean we don't respect them.

Our competitors are good.

To survive this long in the asset-servicing space, it means that they you are good, but that's why it was important for us to differentiate our offering.

Very good.

And as a follow-up, for a number of years State Street and even some of your competitors have talked about an ongoing expense savings programs, improving technology, obviously, it's underway right now at State Street.

Is there any way that we as outsiders can measure how successful the integration of technology is into your day-to-day operations?

Or can you create a metric, I don't know if it's is the percentage of actions taken by humans versus robots and technology, to show us the evolution and the success you could achieve by becoming more focused on technology in the mundane day-to-day operations?

Yes.

I mean it's certainly something that we think about.

Because these operations are large, complex, far-flung.

The 2 that come to my mind that we focus on a lot is just the percentage of processes that are straight through, that are truly straight through that go from beginning to end without any kind of human intervention or some kind of manual handoff.

And then the second one, we're -- the second closely watched number for us is the number of robotic applications.

And robots in this kind of a transaction processing industry is very different than the robots you might see in a manufacturing environment.

What you're really talking about is subsegments of tasks that then get replaced by the robot, and then linking those together.

And so that scenario where we've done a lot of work on it, we've done the preparation, and now we've got to actually install the robots.

We've got hundreds of robots installed, but you should expect to see thousands if not tens of thousands of those installed from us in the fullness of time.

And we should think about, I don't know that we've talked about or even thought about what we would disclose externally, which is a good question for us to think about.

And Gerard, if I might just add that on the metrics, it's a suite of metrics that we need if you think about the straight through processing on equity trades.

Near -- basically, near a 100.

Derivative is much more complex.

And so part of what -- as this industry has had explosive growth in volumes, right, we need to always be at the forefront of what are the right metrics, what are the right suite of metrics.

And those shift because that's a way we can manage better, and I don't think we've always done that as an industry.

And let's us better communicate to all of you.

So we'll think about the right suite of metrics.

And then I'd say that the other metric that really matters at the end of the day is can we get our cost down, year after year because there is no amount of metric that substitute for total cost.

And that is -- you've seen us do that this year.

I don't think we've done that consistently in previous years, but it's where the rubber meets the road.

Certainly does on the expenses and coast, as you said.

But you will certainly differentiate yourselves from you others if you could come up with a suite of metrics, as you point out, just to show progress over the last 2 or 3 years and then as we go forward, just to show that the investing you're doing is paying real dividends.

Our next question comes from the line of Brian Kleinhanzl with KBW.

Quick question on the management fees.

I mean I know there's movement and flows going in and out of the business, but how are you thinking about the fee-rate pressure in their going forward and that there is lot of 0-fee ETFs and all that.

Are you expecting it to accelerate from here or decelerate?

It's certainly an area that we're concerned about, Brian.

At some level, 0 is the limit.

And we don't see a widespread application of a 0 fee, I mean, there's been a lot of attention paid to these 0-fee mutual funds, and I think it's mostly been mutual funds, not ETFs at this point.

So when you look at how those mutual funds are being employed, the distribution is being controlled by the sponsor.

They're typically a part of a larger offering.

So we don't see a widespread nor would be interested in participating in a widespread adoption of 0-fee vehicles.

My intuitive sense is that there's been a lot of pressure here and a lot of movement.

And that what we're probably as an industry far more likely to see is continued pressure on the higher end of the market and higher end of products.

If you think about what the pressure has been, it's somewhat ironic that the pressure has been on the lowest-fee products.

And you've seen relatively little pressure at the other end of the market on alternatives and things like that.

I think you'll start to see more attention paid there.

Okay.

And then, Eric, you did mention that you wanted to lower expense, given -- in light of the revenue environment that you're facing.

Does that mean you're looking for revenues to continue to be under pressure out in '20 versus '19?

And you need to bring down the expenses just to have the positive operating leverage?

Yes, it's Eric.

It's too early to begin to think about 2020.

We're only halfway through this year.

I think we've got some indications of where some of our servicing fee revenues are going to be in third quarter, and we need to navigate through the rest of the year.

I think the broader statement that I made that I'll stand behind, I think and Ron and I and the management team is that this is an industry that where productivity really matters.

It's not an industry where you got high single digit revenue growth rates and if you -- and given that, we always need to have expense programs, we need to have an expense program every year.

That expense program needs to -- that may have some partial offsets of reinvestments, but those need to be calibrated.

But this is one where the expense side of the question for the industry is twice as important as ever.

So we'll continue to do that.

And if we get -- as we get lifts in revenue, we want to get back to a place of margin expansion in ROE.

And the best way to do that is to grow revenues and to drive expenses down at the same time.

And there are no questions in queue at this time.

I will turn the call back over to Ron O'Hanley for closing comments.

Well, I just wanted to thank you all for joining us, and we look forward to having further conversations with you.

Thanks very much.

This concludes today's conference call.

You may now disconnect.