道富銀行 (STT) 2020 Q3 法說會逐字稿

Good morning, and welcome to State Street Corporation Third Quarter 2020 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.

Good morning, and 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 third quarter 2020 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com. Afterwards, we'll be happy to take questions. (Operator Instructions)

Before we get started, I would like to remind you that today's presentation will include results presented on a basis that excludes or adjusts 1 or more items from GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measures 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.

Thank you, Ilene, and good morning, everyone. Earlier today, we released our third quarter and year-to-date financial results. Let me start by saying how proud I am of our team members worldwide who continue to put our clients first and deliver strong results for our shareholders in these extraordinary times.

Turning to Page 3. Our vision is clear and remains that of becoming the leading services and data insight provider to the owners and managers of the world's capital. Despite the challenges of the current operating environment, we continue our strategic pivot in investment services from being primarily a fund servicer to being an enterprise outsource provider, further enabled by our differentiated State Street Alpha platform. We are forging ahead with the implementation of our strategy, developing new business opportunities and continuing to drive productivity improvements.

As we successfully navigate the COVID-19 environment, we are operating against 4 priorities: one, delivering growth through deeper client engagement; two, improving our product performance and innovating; three, driving efficiencies through improved productivity and optimization; and four, supporting the financial system and planning ahead for our team members. I will provide you a short update on each of these areas before moving on to our results.

First, our clients are at the center of everything we do. This year, we have proven that as a result of our strong operational capabilities, we are able to effectively and efficiently onboard new clients and install new assets in even the most volatile of market environments, and we continue to see proof points of our operational excellence. For example, this quarter, we successfully installed approximately $800 billion of investment servicing assets. This was accomplished while also driving sales and expanding the pipeline as demonstrated by the strong level of new investment servicing wins this quarter, which amounted to $249 billion. Our front-to-back Alpha platform drove approximately 1/3 of these wins. Of note, included in these wins was a front-to-back CRD, middle office and core custody mandate with a large European asset manager that was not a pre-existing client relationship.

Also, despite the challenges, we continue to expand in critical growth markets with the opening of a new office in Saudi Arabia to support our growing opportunities in the Middle East. Lastly, we continue to win new business and maintain a strong pipeline at CRD. For this quarter, we more than doubled new bookings, both year-over-year and quarter-over-quarter.

The institutional investor market is experiencing significant disruption. Our clients are facing increased pressures to effectively employ data to achieve better investment outcomes and drive efficiencies within their operating models. We are positioning ourselves strategically to meet our clients' needs and help them with their own strategic pivot.

Second, product differentiation and innovation are critical elements of how we are driving revenue growth across the franchise. Clients continue to turn to State Street for our comprehensive and differentiated servicing capabilities. For example, we recently launched our new NAV insights product for our hedge fund clients. Elsewhere, the open architecture and interoperability of our platform will enable us to expand our capabilities and attract new clients by partnering with other service providers, such as our recently announced partnership with SimCorp for the insurance segment in EMEA. At Global Advisors, where assets under management reached a record level of $3.1 trillion this quarter, we continue to expand our product offering, including expanding our range of fixed income ETFs.

Third, we remain highly focused on driving productivity improvements and automation benefits as we strengthen our operating model and achieve cost efficiencies even during this challenging period. Company-wide productivity and efficiency efforts in just the first 9 months of 2020 have so far achieved gross savings of 5% of our 2019 year-to-date total expense base, excluding notable items as we continue to gain efficiencies through IT optimization as well as other measures. The efficiencies we gain from the optimization of our business model to date are enabling both margin expansion and further investments to support our operations, client needs and technology innovation, including our ongoing investments in CRD and our Alpha platform.

Last, throughout this crisis, State Street has supported the financial markets and our employees. Our human capital is critically important to our success. We have safely reopened most of our office locations across the world and have brought back critical functions that operate more effectively, full or part-time in office, though most of our workforce remains work from home. At the same time, we are planning for the postpandemic workplace of the future. We believe that enabling better productivity, innovation and fostering cultural attributes that set us apart are critical to our success.

As many of you know, Global Advisors has long been a leader in its stewardship efforts and its focus on diversity and good governance with portfolio companies. We are also addressing racial and social injustice by improving the diversity and inclusion within our own organization and advocating for the same in our industry. This is critically important to our leadership team, and we are taking a number of concrete actions aimed at reducing these injustices, including 10 specific actions we have committed to executing, which I encourage you to review on our website.

Turning to Slide 4. We present our third quarter and year-to-date financial performance highlights. You will see that as we continue to implement our strategy and improve our productivity, these actions are bearing fruit. First, looking at our third quarter results relative to the prior year period. Total revenue decreased 4%, largely driven by the impact of interest rate headwinds on our NII results. However, fee revenue increased 2%, demonstrating the progress we are making as we work to reignite fee revenue growth as well as the year-over-year contribution from CRD.

Turning to expenses. Here, again, I am pleased to report that as a result of our continued productivity improvements, we have reduced both third quarter and year-to-date expenses by 2%, excluding notable items. Productivity management is now a way of life for us, and we will continue to build on this strong culture of expense management we have successfully established.

On a year-to-date basis, and excluding notable items, we have driven 3 percentage points of positive operating leverage, improved our pretax margin by 1.3 percentage points and generated 19% of EPS growth relative to the year ago period. We have achieved these improved results in a very challenging operating environment, particularly the low interest rate environment that I just mentioned.

Lastly, reflective of our business model, our balance sheet and capital position are strong, and we continue to operate with capital levels well in excess of our regulatory requirements. As we await the outcome of the latest Federal Reserve stress test in the fourth quarter, given our strong capital levels and unique business model, we are considering a full range of capital return actions in line with Federal Reserve constructions and market conditions.

To conclude, despite the challenges of the current operating environment, we are navigating it well. We are implementing our differentiated front-to-back Alpha strategy, developing new business opportunities and continuing to improve our operating model, thereby driving productivity improvements. I am pleased that our third quarter and year-to-date performance demonstrate this and how we are making measurable progress in improving State Street's financial performance.

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. To begin my review of our 3Q '20 results, I'll start on Slide 5. As you can see on the top left panel, during the third quarter, we recorded good growth in both servicing and management fees. Our expense discipline continues to bear fruit too, with total expenses down 4% year-on-year and 2% ex notables. On the right-hand side of the slide, you can see 2 notable items, including a small legal release this quarter. Separately and for comparison purposes only, we have also called out some of the noteworthy impacts within NII, which I will discuss more -- in more detail shortly.

Turning to Slide 6. Period end AUC/A increased 11% year-on-year and 9% quarter-on-quarter to a record $36.6 trillion. The year-on-year change was driven by higher period end market levels, client inflows and net new business. Quarter-on-quarter, AUC/A also increased the result of higher equity market levels and net new business installations. AUM increased 7% year-on-year and 3% quarter-on-quarter to $3.1 trillion, also a record. Relative to the year ago period, the increase was primarily driven by higher period end market levels, coupled with net ETF inflows, offset by some institutional net outflows. Our SPDR Gold ETF continued to perform strongly, generating $6 billion in net inflows this quarter and taking in a record $23 billion year-to-date. Quarter-on-quarter, AUM increased mainly due to higher period end market levels, partially offset by cash net outflows as very strong inflows during the first half of the year reversed with a recent risk on sentiment.

Turning to Slide 7. Third quarter servicing fees increased 2% year-on-year, including FX, reflecting higher average market levels, increased amounts of client activity and net new business, only partially offset by pricing headwinds, which continue to moderate. Servicing fees were also up 2% relative to the second quarter, including the effects of FX, driven by higher average market levels, partially offset by a sequential normalization of previously elevated client activity.

As a result of our commitment to clients and our strong operational capabilities, we have continued to close deals and successfully onboard new client business throughout this pandemic. On the bottom line of the slide, we summarize the statistics. On the bottom right panel, we summarize the actions we're taking to further ignite growth. In 2019, you may recall that we saw servicing fees decline 6% year-over-year, partly as a result of elevated pricing pressure, which is now moderating. We quickly intervened by rolling out a client coverage model to our top 50 clients, instilling pricing governance, launching the new Alpha front-to-back offering and working more closely with our clients. The result was to not only stabilize servicing fees, but also begin to drive growth in servicing fee revenues, which are now up 2% year-on-year and year-to-date. The next phase is to extend our enhanced sales coverage model to another 150 clients, leveraging both country and regionally focused segment teams to further develop our pipeline. We think this is worth another couple of percentage points of servicing fee growth over time as we saw across our top 50 clients.

Turning to Slide 8. Let me discuss the other important fee revenue lines in more detail. Beginning with Global Advisors, third quarter management fees increased 2% year-on-year and 7% quarter-on-quarter, with the year-on-year performance largely driven by higher average market levels as well as net ETF and cash inflows, partially offset by institutional outflows. For a complete view of our investment management segment revenues, we've included a page in the addendum, which also includes fees we earn as a marketing agent as we do for our SPDR Gold ETF, which are booked in other GAAP lines. All in, total investment management segment fee revenues increased 5% year-on-year and 7% quarter-on-quarter, and the business segment margin reached 29% this quarter. With the third quarter complete, we anticipate that the likely impact of money market fee waivers, net of distribution expense, will be within the previously announced $10 million to $15 million range for full year 2020.

Turning to FX trading services. Third quarter results were up 4% year-on-year, but were down 15% quarter-on-quarter as we saw the second quarter bump proceed. Securities finance revenue decreased 28% year-on-year, primarily driven by lower client balances and lower agency reinvestment yields affecting the industry. Securities finance revenue was down 9% quarter-on-quarter, mainly as a result of those lower yields. Finally, third quarter software and processing fees increased 21% year-on-year but were 30% lower quarter-on-quarter largely driven by CRD, which I'll turn to next, as well as market-related adjustments.

Moving to Slide 9. We show a view of CRD's business performance and revenue growth. As you can see, we have separated CRD revenues into 3 categories: on-premise, professional services and software-enabled revenues. The slide illustrates a lumpy revenue pattern inherent in the 606 revenue recognition accounting standards for on-prem, and more importantly, demonstrates the consistent growth in the more predictable streams of Software-as-a-Service and professional services revenues. As a reminder, second quarter CRD stand-alone revenue of $145 million was primarily driven by a large well on-prem implementation and several large asset manager renewals. This quarter, CRD stand-alone revenue was a more normalized $99 million.

Looking over a broader time horizon, you can see that total revenue as well as the SaaS and professional fee revenue growth are strong, up 16% and 20%, respectively. As we continue to invest in and expand the CRD platform, we are seeing good momentum in the business, and we now expect full year CRD stand-alone revenue growth to be in the low double digits.

Turning to Slide 10. Third quarter NII declined 26% year-on-year and 14% quarter-on-quarter. Excluding the impact of episodic and true-ups, NII was down 20% year-on-year and 11% quarter-on-quarter. As a reminder, the year ago period included approximately $20 million of episodic market-related benefits related to the FX swap mark-to-market and hedge effectiveness. This quarter's NII included a negative true-up as we recognized approximately $20 million from OCI to net interest expense related to the prior period transfers of securities from AFS to HTM. Year-on-year, the change in NII was primarily driven by the impact of lower market rates, the impact of these 2 items, partially offset by larger investment portfolio and loan balances. Relative to the second quarter, the decline in NII was primarily driven by the impact of lower market rates, the roll-off of MMLF balances and this quarter's true-up, partially offset by a $5 billion expansion of the core investment portfolio, which was worth about $10 million of additional revenues.

On the right-hand side of the slide, we show our end-of-period and average balance sheet trends. We currently expect to operate at around $190 billion of average deposits, so that may actually increase given the Fed's continued expansion of the money supply. As a result, this puts us in a position to continue to consciously expand the investment portfolio in the coming quarters to mitigate the effect of the low rate environment.

On Slide 11, we've again provided a view of the expense base this quarter ex notable so that the underlying trends are readily visible. 3Q '20 expenses were down 2% year-on-year, but up 1% quarter-on-quarter, excluding notable items, but including the impact of FX. As we continue to concentrate on driving productivity improvements and cost management in a challenging environment, we reduced expenses across 4 of 5 GAAP lines: comp and benefits, transaction processing, occupancy and other, relative to the year ago period. Info sys costs remain lumpy, but we continue to focus on technology optimization and are making good progress. On a year-to-date basis, total expenses are down 2% ex notables relative to the year ago period, demonstrating the solid progress we are making in improving our operating model as we reduce gross expenses by about 5 percentage points, which is partially offset by natural growth and reinvestment of approximately 3 points.

Moving to Slide 12. In the left panel, we show the growth and evolution of our investment portfolio. The investment portfolio increased to $112 billion as we thoughtfully put more client deposits to work even as MMLF securities continue to run off as anticipated. You will see that we continue to maintain a high percentage of HQLA assets. And as the short-dated MMLF securities matured, the average duration of the portfolio extended to almost 3 years at period end.

In the right panel, we show the evolution of our CET1 and Tier 1 leverage ratios. As you can see, we continue to navigate this challenging operating environment with strong and elevated capital levels. As of quarter end, our standardized CET1 ratio increased by 10 basis points quarter-on-quarter to 12.4%, driven by solid retained earnings, only partially offset by modestly higher risk-weighted assets. Tier 1 leverage ratio has improved by 50 basis points to 6.6% as a result of our higher retained earnings and lower average assets, consistent with the restrictions imposed on large banks by the Federal Reserve, who made no common share repurchases in the third quarter and cannot do any in the fourth. As Ron noted, we are confident in our strong and elevated capital position, and we will consider a full range of capital actions, including the resumption of share repurchases in upcoming quarters when regulatory and market conditions allow.

Turning to Slide 13. We've again provided a summary of our 3Q '20 and year-to-date performance. Our third quarter results reflect our focus on not only stabilizing but also reigniting fee growth as well as the obvious headwinds from the low interest rate environment. Both our third quarter and our year-to-date results show clear evidence of how we are successfully executing on our strategy to improve State Street's financial performance and create shareholder value, all the while temporarily holding elevated capital well above our regulatory requirements.

Turning to the rest of the year outlook. Throughout the pandemic, I've discussed our outlook under a certain set of assumptions. Now with 3 quarters of the year behind us, let me share with you our current thinking, but with the caveat that the macroeconomic could continue -- environment could continue to change. We expect global central banks will keep short rates at current levels and long end rates will stay at current spot rates through year-end. We also assume that average global equity market levels for the remainder of 2020 will be flat to current levels. With that backdrop, we now expect that full year 2020 fee revenue will be up approximately 2.5% to 3%, with servicing fees expected to be up approximately 2% for full year, both of which are up from our previous guide. Regarding NII, given the impact of continued lower long end rates, we still expect full year NII to be down approximately 15%, in line with our previous guidance.

Turning to expenses. We have successfully transformed the expense base and remain laser-focused on driving sustainable productivity improvements and operational efficiencies. We, therefore, still expect that full year expenses will be down 2% year-on-year excluding notable items, as we continue to find ways to reduce expenses.

In regards to our provision for credit losses, we continue to see a range of outcomes based on evolving economic conditions and any credit quality changes. On taxes, we continue to expect our tax rate for the full year to be at the low end of our 11% to 19% range.

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

Thank you, Eric. Operator, let's open it up to questions.

(Operator Instructions) Your first question comes from the line of Glenn Schorr from Evercore ISI.

So it's good to see the consistent and good new business growth. And I know that we get that on a gross basis all the time, but it looks good enough to be very positive on a net basis. I don't know if I can get you to comment on that. But the follow-on question that I have is, it's also good to see the pricing moderation over the last couple of quarters in your conversation. The question I have is, how do you know how durable that is? Meaning, how much of the book has gone through it? The confidence in what the pricing committee is doing, the next 150 clients? And then, can clients just sticky up next year or 2? I just -- I'd love to get your -- just the overall feeling of confidence that we can keep this trend going in the right direction.

Glenn, it's Eric. Let me start on pricing, and then we can cover the broader topics of pipeline and momentum. I think on pricing, we continue to feel that the actions we took, right, literally, centralizing and turning pricing into a very senior conversation internally here and management process for one, have made a real difference in a practical way. And so while you turn back the clock and you see that historically, this industry has always had some pricing compression, literally because there's always appreciation in our fees due to markets, right? So there's always a natural balance that we play out with our clients. That history was in the range of 2% per year. We saw that expand to a 3% and 4% headwind last year, which obviously was not something that we want to or expect to repeat. This year, we thought it would be down to 3%, and we updated our view that it will be down at around 2.5% for the year.

And I think the perspective that we have is that, that is largely due to a more heightened set of actions, governance, education, to be honest, both of our team and clients. I think what happens next, we'll -- time will tell. But I think there is not only the continuation of our intensity and actions here, but I think the other feature is that as our value proposition offering that kind of front-to-back offering, which connects the Charles River, the middle office, the custody and accounting becomes a bigger part of what we offer. Those contracts tend to be longer. They tend to be more integrated. They tend to be stickier. And we think that's going to continue to provide some support to the pricing benefits that we've accrued and at least keep us at this level. If we can do better, let me tell you, we'll lean hard into that. But we're -- I think we're confident in where we've gotten to and operating in this area.

Okay. So I couldn't get you on the net new business. That's cool. Maybe, Ron, last one for me is you mentioned considering the full range of capital return options, which is cool. You got a lot of capital to consider options on. You particularly have had a good long history in consolidation on the asset management side. I'm just curious your take of or observation of what's going on in the industry. And if there's room for State Street to participate, not that you're not already a huge player.

Yes. I mean your observation is accurate. There's a heightened amount of consolidation going on. We think about it from 2 dimensions, not just as an asset manager, but also as a servicer to asset managers. So it's something that we're looking at carefully. We're always looking at our 2 businesses, investment services and investment management. And trying to determine how we best optimize them. And we like what we have. But to the extent to which we could add to it through some kind of a tuck-in, we'll consider that also.

Your next question comes from the line of Alex Blostein from Goldman Sachs.

Great. So Ron, just maybe building on that last point around a pickup in asset management industry M&A. Obviously, with Eaton Vance and Morgan Stanley, and there's been speculations that there could be others, how do you think about that from a service provider perspective? Obviously, on the one hand, I could see how that could be a net positive, given you guys are kind of in the sweet spot with sort of large global kind of giants as you described them in the past. So perhaps maybe more volume, but pricing could come under pressure given kind of the benefits of a larger platforms. So how we think about that? Is that a net positive or a net negative for State Street that we see more consolidation in the asset management space? And then specifically with respect to Eaton Vance and Morgan Stanley, any risk or opportunities from a revenue side you guys see for yourself? I don't know to what extent you provide services to either.

Yes. So we're not going to -- I'm not going to comment on any specific client situations. It's public that we serve both of them, but I'm not going to comment on that, Alex. But in terms of the impact on us, there's some negatives, but there's also a fair number of positives. The negatives, obviously, would be if we lost a client or if we consolidate it, but ended up at a different spot on the aggregate fee schedule. The positives are that in most of these situations, we often are involved in some way, right from the beginning. Because of our knowledge of asset managers, our ability to help with operating models, the fact that we now have this front-to-back Alpha platform. So there's -- we're often there at the table or certainly brought to the table quickly thereafter. The other thing that we believe we can stimulate with all this is, if you're going to go through all the integration, you might as well go through a platform upgrade.

And so we think that in some ways, this is actually going to spur activity because oftentimes, the synergies that are being promised or looked for have to do with the back office and operations, and you're going to get even more synergies if you actually take the opportunity to overhaul the operation and have a true front-to-back kind of implementation done. So positives and negatives, but we think, over time, probably more positives for us.

Great. And the follow-up question for Eric, Ron, NIR. So just to clarify, the down 15% NIR for the full year, again, in line with prior. Does that include the $20 million true-up in the quarter? So sort of you're talking about this on a reported basis, which I think implies about $480 million for NIR for Q4, so just double checking that. And then more importantly, how do you guys think about that run rate developing into '21?

Alex, it's Eric. Yes, we did do it on a reported basis at the 15%. So I think your estimate of what we're looking at for fourth quarter is in the right area. I think the way I describe this is, first, to describe this year and then maybe talk a little bit about next year. We've clearly been in this interest rate environment that fell sharply. And what we're finding is that at this point, we're starting to really slow the decline or the pace of decline of NII quarter on quarter on quarter. And so you saw in our results this quarter, adjusted for the true-up, we'll come back to that if necessary, down 11% sequentially.

If you actually just open up the lens and say, how much was NII down first quarter to second quarter, it was down 16%, right? So we started at 16% 1Q to 2Q. This quarter, we're at down 11% on a kind of underlying basis from 2Q to 3Q. And to your point, if you take our full year guidance and you've done the math like many others, we're looking down at around 4, maybe 5 percentage points from 3Q to 4Q. So you can see that pattern consistently slowing. And that's really the effect of the kind of grind through the portfolio coming through, which slows over time, offset by our actions to expand the asset side, whether it's loans, the investment portfolio, which I said was up $5 billion on average for the quarter. It's actually up $9 billion on an end-of-period basis. And then some expansion of what we're doing in that sponsored repo program. So those are the puts and the takes.

As we look at next year, it's a little early, but our view is that, that pace of reduction continues to slow. And so we're probably looking at a couple of percentage points from 4Q into 1Q or 2Q. And then we see some stabilization at that level. And so I think you've seen us now really intervene and slow the decline. We'll see stabilization in 1Q or 2Q. And then I think at that point, we can offset the grind down from the portfolio.

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

I just wanted to follow up on that actually, Eric. The couple of percentage points from 4Q levels, does that utilize the same underlying assumptions that you laid out initially, basically keeping spot rates unchanged? And then also, given the level of importance mortgage-backed securities have on your portfolio, what assumptions are you making for prepayment rates? Are you just holding those steady? Are you assuming that they ease a little bit? What's embedded there, just so we can calibrate as we move forward.

Yes, Brennan, thanks for the question because each of those assumptions are very important, right? We're looking for this working -- looking for and driving towards an inflection here. So first on rates, I think we're looking at current short rates, which have become a little more normalized. Remember, we had an inversion between repo and treasuries, which now is normalized. So that's slightly beneficial. We're hoping that continues. That stays that way. And long end rates in the 70 to 80 basis point range. They've been bouncing good bit over the last week or so. So that's the broad assumption.

I think as you think about the assumption on MBS premium amortization, prepayment speeds, we are assuming that third quarter and fourth quarter are at a more elevated level of prepayments. And then we do expect some amount of burn out into first quarter, second quarter and going forward. And so that is an underlying assumption. We think that's a fair assumption given a look at the models, and we obviously get models from the -- 3 or 4 providers and have our own assessment as well. But it is driven by that.

And then finally, it will be -- our performance will be dependent on the pieces that we can control. You've seen us expand our loan book. Our loan book, which is exceedingly high-quality for our clients is up about 10% year-on-year. You see our investment portfolio is also up about 10% year-on-year. And our sponsored repo program, we've started to see a build of balances now that we've had a little more of a normalization.

And what you're seeing us do there is effectively put more deposits to work. Deposits are up, call it, 20% from the kind of pre-COVID era. The Fed balance sheet is -- continues to expand. And so our view is that we have more of those deposits can be put to work, whether it's in the loan book and the investment portfolio over the course of a couple of quarters. And you could see, even this quarter, I gave you a sense for the difference. It makes a real difference, and it lets us kind of lean in and drive this stabilization.

Excellent. Eric, that's great. And then when we -- shifting gears to the servicing revenue. You referenced some new business installations. We know -- we saw -- all saw the sort of rapidity of the equity market rally. And in the past, sometimes that has resulted in some -- the way The Street calculates your servicing fee rate to compress just because of the mix, not all of your servicing mandates and contracts are purely based on asset levels. And so could you maybe help us unpack a little bit how much of the lag, how much of the servicing fee not going up as much as the AUC/A was lags from new business installations where the revenue has not yet come on? And how much of it might be from the market rally, which naturally would only be partially captured due to some of those contract dynamics?

Yes. Let me, Brennan, take that from a couple of different angles, right? Equity markets are clearly a tailwind for our business. And there's always a little bit of timing, but let's -- that's kind of -- the timing is really rounding. What's important really here is the average equity markets and the average equity markets across the globe, right? So if you step back, S&P is up 12%, 13% year-on-year. But the emerging markets are up. The international EMEA markets are actually down a smitch year-over-year. So it's the mix of those that matters.

And then not only the EOP matters, but the average matters. And so on average, year-to-date, we've got equity markets at up around 6%, which is beneficial, right? We've always talked about equity markets up 10%, fees up 3%, fixed income markets up 10%, fees up 2%. And so we do have a tailwind of 1 point, maybe 1.5 points of fees that are coming through on a quarterly basis or a year-to-date basis, and we'll take that.

Over and above that, I think we've also got some net new business. And so to the question that came earlier and that folks are always asking about, our business wins are outpacing some of the bit of turn that you always get in the portfolio. And then we've been able to charge more on a, whether it's client activities or flows have been a little more positive this year, and those are coming through and offsetting some of the fee headwinds. So I think there's a good mix in general. If equity markets stay at this level, that will help us with the compares on a year-on-year basis. But remember, third quarter to fourth quarter of '19, equity markets were up as well, right? And so that will help us on a sequential basis from 3Q to 4Q. But year-on-year, we're also going to have a tougher comparison there as well, 4Q to 4Q. Anyway, there's a lot there, which is probably why I gave the overall fee guide for the year on servicing fees, up 2% because we think that's a good indication of a bit of tailwind in equity markets around the globe, but also driven by our ability to drive new business growth, manage pricing and then take advantage of some of the flows and activities that we're seeing.

Yes. I appreciate that, Eric. But just the lag in new business billing versus the AUC coming on. I just -- is there a lag with some of that? Sometimes there is. And so I just wanted to confirm. I appreciate all that. That's a great color on the market dynamics and the beta.

There is a bit of a lag, but I think the EOP and the averages were relatively consistent for the quarter. And so we're not expecting a large lag adjustment into the fourth quarter at this point. There'll be a little bit. But because of the end-of-period and the quarterly average was pretty consistent, I think it will just play through more naturally.

Your next question comes from the line of Ken Usdin from Jefferies.

Eric, why don't I just come back to the capital return question? You have an 8% CET1 minimum. Just wondering if you can just level set us again now that SCB is totally done, we have the stress test ahead of us and the limitation through 4Q. What do you guys see as your limiting capital ratio? And when you are able to get back into buybacks? Do you go back to 100% capital return? And how do you think about like what the actual excess is over just getting back to a more normal buyback plan?

Yes. Ken, it's obviously an important topic we've been working through in a way we've gotten -- been forced to defer any of those decisions. But I'd tell you, it's one that we're anticipating and eager to act upon, given how strongly capitalized we are, I use the word, elevated capital purposely in my prepared remarks just because that's what we're running at, right? We've got significant headroom. I think there's a couple kind of parts to the question you asked. I think first, in terms of our capital ratio, the binding constraint, it is now CET1. So core risk-weighted assets divided by common equity Tier 1 capital. At this point, the leverage ratio is not really anymore the binding constraint. And you've seen us take advantage of that as we've reduced some of the stack of preferreds on our book.

And then as you think about the CET1 ratio, we'd like to get that down. I mean, there's very little reason that we should run above 12%. There's little reason we should run above 11%. And so there's at least a point and a half, if not more, we're working through what's appropriate, right, because we've gotten a lot of data over the last couple of quarters that we want to factor in, but there's a solid $1.5 billion of capital there that needs to go back to shareholders over and above what would go back to shareholders just from the earnings that we create each quarter, right?

And so we obviously want to see the results. I think as the Fed and market participants do of the new CCAR test, we went through all the assumptions, as I think you guys did, too. And we think we'll show well. We're very comfortable with our SCB. And I think what we'll do is kind of market dependent and also based on any Fed guidance for the industry. We'd like to restart capital return, and if we can, do that in the first quarter. Now the pace of that, it needs to be a little bit paced. It got to be careful in this environment, and we're careful bankers after all. But our view is that we need to start, and then we need to accelerate that pace of return so that we return more than what we earn each quarter and start putting that back into our shareholders' hands.

Great. Yes. Great color. And just a follow-up on an expense question. You've been talking for a good while now that you think that the company should be able to take expenses down annually. And I know we'll hear more about this when you get to your formal outlook for the year. You did a very good job this year, still being at about down 2%. With the NII still being a headwind but fees looking better, how do you start to just think about that calibration? And where are you in terms of just the ability to continue to net down the expense base?

Yes, Ken, and I appreciate you letting us answer that now. And then as you say, in January, we'll give our annual guidance. I think I've been clear. I think we've all been clear here from the management team that down in expenses is the right direction of travel. And the direction and the volatility we've seen in market interest rates just reaffirm that, that down is the new up. And that that's the kind of way we should operate in this environment.

And I think what you've seen is us being able to do that now for effectively 2 years in a row, right? We did that last year, if you adjust for the acquisition cost of CRD. We're doing that again this year. And I tell you, we have a lot of confidence in that momentum, partly because that frame of mind, I think, has really kind of organically expanded through not only our management team but our one-downs and two-down. So we've got hundreds of people. Hundreds of senior folks working on productivity and expenses, all the while driving revenue growth and fees and so forth as you noted. But we're finding ways to do that across the line items, right? You saw 4 out of 5 of our expense line items down year-over-year, and many of them were down quarter-on-quarter as well.

And I'd tell you, in our core operations area, we continue to find ways to automate and reduce manual touches, and we think that has years of opportunity for us in technology. We're driving a transformation, and we've been clear there. And I think more broadly, across our corporate functions, our businesses, the notion of productivity, kind of more outcomes per person is something we're actually adding measurement tools on so that we can, in a more incisive way, find opportunities. And I think that's why you've seen, even with the pandemic, our comp and benefit costs are down 2% year-on-year, even more, if you adjust for the currency swing. Our occupancy costs are down. And every one of those is a result of those pretty broad-based and deep actions.

Your next question comes from the line of Betsy Graseck from Morgan Stanley.

I wanted to just dig in a little bit on the wins that you've been announcing recently. There's been several press releases on servicing wins for semitransparent ETFs. And I just wanted to understand how you think about the market opportunity there. And how we should be expecting that's going to be impacting fee rates as they come in? And what kind of time frame it takes from announcement to fully loaded and in the plant?

Yes. So I think it's fair to say, Betsy, that virtually every active manager is thinking about these. And there's a lot of work underway at many asset management firms. There's basically 5 firms have come out and actually launched them. And I'm not sure what the total is. Most firms have launched multiple funds. But of the 5 firms that have come out, we're servicing 4 of them. And I think that you'll find that many others, as I said, are looking at this. And also, many are looking at what's the experience of those that have gone first. So I think many firms view this as a potential new revenue opportunity.

In that case, and to the extent it cross, it will be an opportunity for us. We have -- from a servicing innovation perspective, we've been on this now for a while. We're familiar with all the different ways of doing it and, in effect, are servicing most of the ways, if not all the ways, of doing it. But I think it's too early to tell whether or not this would be a game changer, but it's certainly something that we felt like was important enough that we needed to put some innovation against it. We have. We've got great market share at this point, but on a market that's small and growing.

And then just thinking about how you -- the fee rates associated with it, is it something that's going to impact the overall fee rates? Is it like lower than traditional fee rate type of product or not? I'm not sure how it's priced. And then the other question is just how long does it take from an announcement to be loading up into the plant? Is it like a 2, 3 quarter load or it's just growing with the product itself, which is nascent?

Yes. So I mean, the fee rate is higher, but it's rate times volume. And I would say, so far, the volumes are -- they're growing, but off a very low base. So I think it's just too early to tell whether or not this will be a game changer for us. But again, our view was that it wasn't something we should ignore. We really -- we -- because we'd spent time on it right from the beginning. We'd actually worked on some of the rule-making around it with the SEC. We felt like it was something we should step into. And we'll just see where it develops. Not being evasive, we just don't know.

All right. Okay. And since the investment has been made, it would be a relatively high-margin as these wins coming on to your platform?

Yes. I mean, certainly, to the extent to which any of the existing funds grow, yes, high margin. We understand all the different models. So our -- what it takes for us to install them, I mean, we understand it now. So it's not like a lot of new incremental costs.

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

Just 1 clarification before I ask the question. The tax rate, Eric, that you mentioned, that should be 17% to 19% for 2020 at the low end. Do I have those numbers right?

Yes, that's correct. 17% to 19% was the guidance, and we've reaffirmed that we're coming in at the low end of that rate.

Yes. I think I understood the number. Okay. Good. And then first question is on CRD. The low double-digit revenue guidance for 2020, I think, implies a little over $100 million for 4Q. I just wanted to make sure that I was thinking about that correctly. And then as we move into '21, given the new wins that you're seeing and the momentum you're seeing on the Alpha platform, I guess, maybe an early look of what you're thinking for core CRD in '21 in terms of that growth rate potentially even accelerating from that low double-digit or around the same or lower?

Yes. Brian, on CRD, I don't want to get out ahead of myself for 2021. We're still doing the pipeline assessment growth and so forth. I think what I'd tell you is that we're quite pleased with the growth that we've seen here. And we bought a business that had top line growth of 7% a year. Last year, we nudged that up to 8%. That was our first year of ownership. And this year, we're looking at low double digits with some upside relative to where we were a couple of months back. And you saw some -- I think some impressive wins in the second quarter with -- in the wealth space and some major renewals that kind of give you a sense for the kind of the effect of the State Street backing a software offering has on the market and our ability to convert that into some significant adds to revenue.

Now we'll have to lap ourselves next year. So that's obviously going to be the hard part, quarter by quarter by quarter. And so we're doing all the things you'd expect us to do. We're expanding the sales force. We're expanding the technical base. We're expanding the implementation engineers. But I think we're real pleased with the trajectory and just a double-digit revenue performance, 2 years into an acquisition, I think, gives us the confidence that not only did we buy the premier property in this space, but under our ownership it's very strong and -- on a top line basis. And that's just CRD itself, right? CRD is really part of that front-to-back Alpha offering. And you've seen us expand that with partnerships, win business in custody and accounting and middle office with Charles River. And so I think that broader effect on our offering and our client discussions is shaping up nicely as well.

Brian, I want to underscore that last point that Eric just made because we've been talking to you all right from when we acquired Charles or when we closed it in, in October of 2018, and we started talking about how the pipeline was developing for not just what we -- Charles River, but also for broader front-to-back kinds of offerings. You'll note that in our new business wins this year -- this quarter, 1/3 of those wins were Alpha related. So remember, that means that it's not just a CRD win but we're getting out of that some form of the middle office and the back office.

And we'd said that we were seeing it develop. We said that not only would we drive CRD wins off of our existing custody platform, but we saw CRD and the Alpha platform as potentially driving back office wins. And we're starting to see that. I noted the -- one of the Alpha wins was a large European asset manager that we had no existing relationship with before. So we've gone -- we'll go from 0 to having CRD, the middle office and fund services. So that's how you -- you should think about CRD both in and of itself as a software provider, but also as part of this Alpha platform and our pivot to being an enterprise outsourcer.

That's great color. And maybe just, Ron, while I have you on some growth initiatives. ESG, obviously, you guys are very strong [bank for ESG] with I think you have [$50 billion] of ESG dedicated AUM. Maybe if you can talk about what the plan might be to launch more products that's sustainably focused product, maybe especially on the ETF side. Obviously, we've seen BlackRock really advance in the space. And then also on the servicing side, to what extent within your data analytic offerings, are you able to integrate ESG data and analytics services for your clients?

Yes. I mean, you've outlined it well in terms of how we think about it. Most of the -- much of the visible ESG activity to date has been in SSGA. And in addition to all the stewardship work that they do, there's been much new product and more new product on the drawing board. What's as exciting for us, though, is that as these managers are now integrating ESG into their overall investment risk framework and overall portfolio construction, that's driving more and more needs for measurement, data analysis, et cetera. So we've got a series of products that we're working on now that will help support that. So stay tuned on this. It's something that's very important to us. We're actually -- we're even thinking about it in terms of how we put our resources together across the firm on this and go out on a united front. So you'll see more of this in the next few quarters.

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

Just a quick one. Eric, on the 150 clients that you mentioned reviewing and working on, is there any difference with this group versus the prior 50 that could create a different outcome?

No. I think what -- the way we think about it, Mike, is that we've rolled out a more sophisticated and engaged and kind of action-oriented coverage structure on the top 50, starting at the end of 2018, and that really took effect this year. And that's about folks with a kind of a sales orientation, with a deep relationship, kind of, building orientation, a sophistication to leverage the whole organization and bring it to bear to our clients. And what I'd tell you is that, that actually has created at least several points of additional fee growth for that group over and above what we're seeing for the rest of our client base, right? And so as we step back, we're saying, wow, given that, that has created differential amounts of revenue growth -- and we track it, right? We track the top 50. We track the rest of the client base. And then we further subsegment below.

What we've decided to do is take the learnings. Now you don't take them kind of pound for pound because there's a cost to a coverage organization. There is productivity and loading that you want to think about with a coverage organization with different sized clients. But the client base, the next 150 clients are not dissimilar from the largest, or just tend to be maybe in 1 or 2 investment areas if they're servicing clients as opposed to 3, 4 or 5. They may be $50 billion or $100 billion clients instead of $1 trillion or $2 trillion clients. But these are -- our clients in the next 150 are large. They're scaled. They can take advantage of our custody, accounting, middle office, front office services. And so I think they're similar in a lot of ways, and that's why we think that in a more intense and orchestrated coverage organization, which really then has the ability to unleash another several points of revenue growth there can then help lift the overall revenue growth of the franchise in a way that we've already seen for the top 50.

Your next question comes from the line of Steven Chubak from Wolfe Research.

So Eric, I wanted to start with the question on the securities portfolio. The duration increased sequentially, announcement said about 2.9 years. And maybe a little bit of a surprising development, just given the accelerating prepayment activity. Some investors, admittedly, not all, but some are speculating we could see some steepening in the curve in the event of a blue wave and various inflationary programs are launched. And I know that outcome is not contemplated in the NII guide. I was hoping you could just speak to how you're handicapping extension and AOCI risk. Maybe you could just frame the capital and duration sensitivity if we do see 50 or 100 bps of steepening.

Yes. Steve, it's Eric. Those are exactly the kind of the balancing drivers that we're quite careful of. To your point, we model out all the up rate scenarios, 50, 100, 150, 200. And what you've seen us do is both be, I think, considered in how much maturity and duration we've put on. We've historically run at this 2.5 to 3-year range of duration. So I think we're within that band. We added a little more to offset some of the shortening that came on the MBS prepayment. So we did that consciously. But you also didn't see us take that up to 4-, 5-year duration and run long on 10-year and 30-year bonds. So I think it's calibrated.

One of the tools we use here, though, is not only to think about where we play on the curve, right, where this is really the middle part of the curve. This is 5 and 6 year maturity paper on average with some a little longer, but we're careful. But we also use the HTM accounting designation because a lot of what we hold, we'd like to hold for to maturity. And you've seen us put $40 billion, $45 billion of securities in held-to-maturity, which insulates it from the OCI pressure. And we do that very, very consciously. And we also are quite purposeful in what we put in held-to-maturity because we think that's got to be pristine. It's government paper. It's government-guaranteed paper.

And so that's how we balance the up rate scenarios, is through a mix of kind of just carefulness on duration and then the HTM accounting. And I think in a lot of ways, that lets us feel comfortable that we always need a volatility buffer in capital, but we don't want to have 1 that's inordinately large because then we couldn't return capital to shareholders. And that's why earlier in some of my remarks, I described that there's a solid amount of capital to give back. We need to keep some for the OCI volatility. But we think we can manage that to reasonable levels given the portfolio design and some of the accounting designation.

Great. And maybe just as my follow-up, just wanted to ask on the investment management strategy. The segment did see a nice lift in pretax margin this quarter. But the profitability has consistently lagged some of the traditional asset management peers. And just with the latest wave of consolidation, how are you thinking about scale adequacy of the platform, especially on the active side? And just given more subdued profitability as well as a significant capital cushion, Eric, that you cited, just how might you look to repositioning the segment to compete more effectively? And I guess, more specifically, how does inorganic growth fit into that strategy?

Yes. So it's Ron. I mean these are exactly the questions that are very much on our mind and that we're working through quite actively. We like the franchise. It's got some terrific assets to it, particularly the ETF franchise. And we're seeing more and more that that's an area where the big are getting bigger. And it's just hard if you're not in a top 3 or 4 position there. But it also has its challenges, right? It's a fairly narrow platform from a product perspective. So it operates really at the beta, the active beta and quant beta and is relatively small in things like alternatives. So we're thinking about it from a product perspective, both organic and inorganic. And then, obviously, from a distribution perspective, it's -- the only distribution we have is our institutional distribution. So we'll probably talk more about this at some of the upcoming conferences as we finish through our work, but it's something that we're actively considering and evaluating.

Your next question comes from the line of Jeff Harte from Piper Sandler.

Can you talk about the value of kind of deposits to State Street? I guess I'm thinking about it from the angle of with deposits up a lot, 20% some year-over-year, NIM as low as I can ever having remember seen it. And you're holding a bunch of capital events, the balance sheet's just kind of swollen with these deposits. At some point in time, does it become economically advantageous to kind of turn deposits away, say, through pricing, and delever the balance sheet and return more capital to shareholders, assuming the Fed let you buy stuff back?

Jeff, it's Eric. Those are all the right questions that we -- that I think we, as bankers, have to navigate through. I think what's changed and is particularly important for us as a bank is that the binding constraint for us has actually shifted. 2, 3, 4 years ago, it was around leverage, and partly around Tier 1 leverage, partly around supplementary leverage ratios, right, which have an expanded kind of view of the balance sheet. And those rules, though, were effectively adjusted over the last year, I think in such a way that they became more rational and didn't put us in this position where we needed to any longer push away client deposits, which is something we did do. I remember in 2017, that was 1 of the actions that we took. And it wasn't very pleasing to us, nor to our clients, but we're no longer in that position.

What's really changed now is that it's the common equity Tier 1, the risk-weighted asset ratios, that really matter, both the spot ratios, then under CCAR and the SCB. And because of that shift, we're effectively in this position where we're open for business on deposits. And while in a kind of a -- in a way, it's a larger balance sheet, it's 20% larger. That's not constraining for us. And what that does put us in a position to do is to carefully expand the investment portfolio. You've seen us do that this year. Continue to lend more to our clients, and you've seen us do that as well. And so that's the path we're taking, which I think actually supports our -- the financial system in the right way. As we lend and expand the investment portfolio, it supports our clients. And to be honest, that will come back as earnings and returns to our shareholders.

Jeff, what I'd add to that is many of these deposits, to the extent to which we push them away, we create operational complexity for our clients because most of these deposits that we get are associated with our custody activities. So when you start to separate those, you're creating some operational complexity. And Eric noted that we did some of this, mostly in Europe, in 2016, 2017. And it would be hard for us to get those deposits back if we did that, too. So if you believe that these are going to be useless forever, it might be something that you'd be willing to do. But given the lack of constraint, given the fact that it creates operational complexity for our clients and given -- and to retain that optionality if and when, in fact, you do see a steepening of the curve or even increase in rates. We like our approach right now.

Yes. The current approach drives 85 basis point of spread income effectively on those deposits because many of those are actually priced at 0 or 1 basis point. Not as much as we'd like, but to be honest, that's remunerating to the income line and to our shareholders. And over time, there will be some normalization of rates, we could see that expand again.

Okay. And just a quick kind of bigger picture follow-up. It's probably too soon to tell, but have you seen or do you expect to see any impact kind of versus the pre-COVID environment in servicing and as far as kind of the trend of industry consolidation and maybe even pricing pressure? Do you see anything changing because of -- with the whole work at home and just everything we're kind of facing now versus a year ago?

I think the trend that's most visible to us at this point is that investment managers, even asset owners, sovereign wealth funds, plan sponsors are really taking a hard look at their operating model. They were before. If anything, this has put more spotlight on those operating models. I mean, we had instances where we had clients, the example I'm thinking of was an asset owner, had roughly 1,700 employees and had the ability to have 70 of them working from home from a technology perspective. So there's broad-based look at operating models, which we think will be beneficial to us. Ultimately, as long as you believe that investment markets are going to continue to function and grow, what we do will still be there. What we're positioning ourselves strategically for is that as these operating models need to be overhauled, we want to be the enterprise outsourcer there that's doing it for them, taking on as much as we can of the front, middle and back office.

Your next question comes from the line of Vivek Juneja from JPMorgan.

Eric, Ron, a couple of questions for you folks. Firstly, can you give an update on -- you had a good run with CRD in terms of the revenue growth, as you mentioned. Can you give an update on where you stand on the synergies that you've achieved and accretion dilution?

Yes. Vivek, we continue to run well along those lines. I think we had said that accretion would turn positive by the end of the second year. We effectively gotten to that point, given that the synergies have come in and -- both on the revenue and the expense side. I think the expense synergies came in actually a little faster than expected. I think we've always historically been good at expenses as a company. And the revenue synergies have come in quite nicely. They've moved around a little bit. We had some synergies from some of our sponsored repo activities sold into the CRD base, which came in a little lighter because of the compression in rates, but some of the fee activity that we have and the sales activity that came from the State Street franchise have come in stronger. You saw the very significant wealth win and some of the other activities. So I think we're really pleased with where we are and have hit our milestones.

Okay. A couple of different ones, Eric, for you. The reverse repo business, it's been shrinking. You've shrunk quite a bit the last couple of quarters as spreads have diminished. Do you see it shrinking further? Or is it stabilizing? What are you seeing in spreads? Any color on that.

Yes. The sponsored repo business is something that we've done. It started small. It got to $50 billion, $75 billion, $100 billion of assets that got north of that. Sometimes it's spiky. We had months or -- where we were at $150 billion. We're back now in the kind of $80 billion to $90 billion range. And the biggest driver has been the changes in front-end rates, right? Repo rates and kind of 1 month T bills tend to create movements in positions of asset managers who are very focused on overnight out through 1 month of paper. And because T bills were suddenly more attractive during really the spring and part of the early summer, we saw that sponsored repo balances come back down.

We've now seen some, I think, normalization in those rates. I think they're back to being 5, 10 basis points apart. We think that gives us some opportunity. And we've seen a bit of growth here over the last month or 2. And I think we're -- notwithstanding the flood of cash from the central banks see some amount of upside there, and that's what we're working towards. That comes through our NII line, and that could be a -- that is factored into some of our forecast, but that's the kind of area that we're pushing on.

If I may sneak in one more, Eric. What types of securities are you adding, the most recent purchases that you've done?

Vivek, I think you mean on the investment portfolio?

Sorry, yes, investment portfolio. I shifted gears on you. I know, right. Sorry.

I'm okay with the off-balance sheet client sponsor program questions or the on-balance sheet investment portfolio questions. They're both good ones. On the investment portfolio itself, what we've done is we've continued to a couple of things. I think, first, we've generally expanded our MBS portfolio. So we were up $9 billion in securities end-of-period to end-of-period this quarter. I'd say $5 billion, $6 billion of that would be in the MBS space. But we have rotated the types of mortgage-backed securities. You'll see eventually in the regulatory filings that we expanded a little more in CMOs, in commercial MBS, all government-guaranteed because part of what we're doing is trying to put on some cleaner duration paper as opposed to take up premium at risk. And we've also continued to hunt in the specified pools and not just the current coupon. So that's been some of the rotations there. And then we've supplemented that with a little bit of expansion in the international areas around some foreign sovereigns and then some of the AAA agencies have also been an area of expansion.

Your next question comes from the line of Mike Mayo from Wells Fargo Securities.

I guess one kind of easy question, one tougher question. But first, so end-of-period loans were up, is that right? And why is that looking to be a little different?

Mike, end-of-period loans were up. Well, they were up slightly. We like lending to be up in this environment, given that we're there for our clients. You had 2 offsetting factors. You had, number one, the continued growth in our client lending. Capital call financing, in particular, continues to be a real important part of our growth to the alt managers. And that was just offset by some amount of reduction in the overdraft balances on an end-of-period basis, but the net was up slightly. And I think more indicative is total loans were up about 9% or 10% year-over-year.

Okay. And have you said anything about cutting costs in 2021? How should we think about costs next year?

I guess you continue to ask the easy question. So we've not given outright guidance for next year, Mike, yet. We'll do that in January. But we've been clear that we reduced cost this year, 2%. Last year, adjusted for the acquisition, we were down 2%, and we continue to like the approach given the economic environment to drive costs down. And we think that's appropriate. So those are in our plans. And what we're working through is what's the magnitude of that next year because what we do need to do is continue to drive for gross cost savings, but we also need to reinvest in our business. And especially as we add new business, and you saw some of the wins this year, we're going to have to implement that. Some of that takes some funding. And then we want to continue to invest and expand into products, features and so forth of the platform and that front-to-back platform, in particular, which is going to take some resources. But net-net, we expect cost to continue to be down, not only this year, but also next year.

Yes. Mike, what I would add to that is we've been very clear that this is not a one-and-done kind of thing. I mean, sure, there's some tactical things that we -- that if they're there in low-hanging fruit, you grab at it. You realize that. But we've been -- we're on a sustained program to transform our business. Much of it is around productivity improvement. And much of that is driven by the ongoing automating of processes, reduction in manual processes, et cetera. So this is -- I mean, this -- you should expect us to be thinking about this and implementing this on an ongoing basis.

Okay. And that's a good segue to my harder question, which is -- maybe it'd be phrased like a jeopardy question. So the answer, I think, and correct me if I'm wrong, is what you're doing is you're improving efficiency, productivity, automation. You're expanding your revenue streams, as you said at the start, Ron. And now you're expanding the total addressable market with more focus, not just on the top 50, but the next 150. And I guess the question is why? And is part of the why because assets under custody were up 11% year-over-year, and the servicing fees were only up 2%. In other words, I don't see the revenues keeping up with the business volume, and therefore, you have to go to these alternative streams. And I guess, really the question is, what are you seeing on pricing pressure? You said it was easing. You said some business has been coming on at a higher margin, but we're not seeing it in the final results that are released to us.

Mike, let me start here. The -- I would add a fourth element to what we're doing, which is also basically expanding our addressable market, meaning that moving from the typical traditional custodian role of being a fund servicer to also being an enterprise outsourcer and to work with the actual management companies or the plan sponsors on their own operating model. And that's just an -- that's an incremental revenue stream that isn't available to us. Why are we doing it? The -- I mean it's no secret that the traditional fund services business has its series of challenges, not just price compression, although not with the same extent that we've done a good job at it. I mean, just think about it. Go back 10, 15 years ago. It was all about new funds being created. Somebody would have a line of domestic funds. Then they create -- they might go move into other asset classes. They might move into new jurisdictions, new countries.

Now it's -- if anything, you're seeing the number of funds go down as distribution platforms are saying, one, we don't want as many funds; and two, we're more interested in SMAs anyway. So this -- it ease trends that are underlying our strategic pivot here. Now as we've also said, it takes a while for this revenue to be realized, and you're kind of seeing that even in the way we started talking to you about this expanded pipeline at the beginning of '19. Now we're talking to you about front-to-back Alpha wins. And so you should expect to see that some of the things that we talked about in the past in '19 and early '20 will start to be showing up in future quarters as Alpha wins. It just -- these things take longer because going back to what I said earlier, you're actually working with the management company on overhauling the way they work, the way they invest, the way they employ data, the actual tools that they're going to be using, the actual tools they are not going to be using. So I hope that's the why in terms of what we're doing here.

And then last follow-up, just to size that. So going from -- sorry, custodian to an enterprise outsourcer, at what point -- like what percentage of the firm or revenues would be enterprise outsourcing today? Where was it a few years ago? Where do you hope that to get to? And when do I transfer my coverage to our firm's fintech analyst? That's enough because that's the direction I think you're going.

Yes. I mean it's a little early to talk about that. And we will talk about our strategy more at some of the upcoming conferences. And maybe we'll get into that. We haven't really thought about that. But I think your point -- I would agree with your points that you should expect it to see it be a higher and higher percentage of what we do. And you're also accurate about the technology content in here. And this is very much a technology and a software-driven strategy.

Your next question comes from the line of Gerard Cassidy from RBC.

Eric, can you share with us -- you mentioned about the CET1 ratio as your binding constraint. And I think you said that it's obviously too high at 12.4%, even too high above 11%. How low do you think you could comfortably bring that down to? And then, simultaneously, what's your thoughts about redeeming more preferred stock in '21 or '22?

Yes. Gerard, it's Eric. Maybe to tackle those in reverse order. It's a little early to think through the preferred question because we really want to see what happens with this next round of kind of intermediate CCAR tests and just see if there's anything different or not there. So we're keeping an eye on it. We like the fact that we've already called a couple of preps. We'd certainly be happy to do more if we can. So I think that one is certainly always in mind, and we'll give that some more thought. I think on the broader topic of capital ratios, we're doing a lot of work here. And maybe just to frame out, the -- clearly, we have too much capital given the limitations. And that's fine. We'll get it back to shareholders as soon as we can.

The ratios that we need to do is we clearly need to run above the 8%, the SCB requirement, let's assume -- and we have confidence that, that will stay at that 8% SCB, obviously, subject to the Fed indications. But the work we're doing is how much CET1 capital volatility do you have for OCI, and that's where we're kind of working through, well, how much can we -- should we put in held-to-maturity versus available for sale. So we have some ability to influence that. And then we have some amount of volatility to be honest in RWAs, right, in the risk-weighted asset denominator just because you get volatility, you get some -- a little bit of RWA expansion in the FX book. So is that -- that is -- you need volatility cushion of at least 100, 200 basis points probably. We, as bankers want to run conservatively.

So I think what we're wrestling through is where in the range of 11% is too high, I've said. 10% is kind of 1 of those kind of areas that you want to think really seriously about crossing below because there is some volatility in our business. And so somewhere in that 10%, 11% range, there's got to be somewhere that we'd like to run. And we're doing a little work to fine tune that. But I think if you do the math that way, you get to a view that there's really a substantial amount of capital to release from -- based on where we're running because we're running at 12.5%, and 12.5% down to somewhere in the 10%, 11% range is a real return, a sizable return for our shareholders.

No. Absolutely. That would be very positive. Looking over back into the investment securities portfolio, clearly, we're all focused on the rate environment. I think everybody is on 1 side of the boat, so to speak, in that the rate environment is going to stay low for an extended period of time. But it also brings out the interest rate risk for a securities portfolio, should rates go up surprisingly for '21 and '22. What indicators do you guys keep an eye on? And you can name 2 or 3 that really would make you change the way you look at your investment securities duration or where there could be a risk of a mark-to-market situation if these things got out of line and rates started to go up, which nobody is really planning for. The forward curve certainly doesn't call for that at the long end. So I'm just curious. How do you guys manage and keep an eye on this so that you don't get caught offside should something change unexpectedly 6 to 12 months from now?

Gerard, I think there are a number of indicators, but part of what we do is we manage for the concerning outcomes, the downsides, right? So what we are careful in the portfolio is you don't want a barbell between 1-month paper and 30-year paper because you get a big move in rates, the 30-year hurts. Same thing with 3-month paper and 10-year paper. So we're quite careful about where we operate on the curve, and it's not just an average duration that we run at, but we have a series of limits across the curve. And we'll position, to your point, to be quite careful and circumspect. So that's one. There's kind of an outright management process instead of places that we'll operate. I think in terms of indications, there's clearly a set of Fed indications and then market indications. The Fed has been quite clear about their policy around lifting rates.

They've been quite clear about how long. They've been quite clear about inflation targets and kind of general monetary policy planning. And I think that's actually -- you've got to ascribe a fair amount of reliability to that. And then they're all the market indicators, whether it's the front end of the curve, the steepening, the volatility inherent in some of the curve structure is another indicator that we're very conscious of. And then I've got to say there's no substitute for doing -- running a battery of test, a battery of stress test because you're always worried about what you don't know and what you're not seeing in the marketplaces. And the good thing about rates markets is we've got 50 years plus of solid history, and we'll do all those tests, and then we'll do the theoretical ones. So anyway, it's something we're very careful on, I think, is the bottom line.

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

Great. Yes. Mine is just a real quick question -- clarification question. So Eric, when you were talking about the NII of kind of the go-forward past the fourth quarter, I think you said a couple of percentage points down first quarter, second quarter. But did you mean a couple of percentage points down in the first quarter and then another couple of percentage points down in the second quarter and then stabilize from there?

Good question, Brian. I said a couple of percentage points down either in first quarter or second quarter. We think there's a small step down from 4Q to one or the other. It's just really hard because you're always working through what are the headwinds and tailwinds at an inflection point to call the trough. But we think it's sometime in the first half. And we think it's -- we think -- given what we know today and kind of the market indicators and the assumptions we've shared, we think it's 1 of those 2 quarters.

That was our last question. I will now turn it over to Ron O'Hanley.

Well, thanks to you all on the call for joining us.