道富銀行 (STT) 2022 Q1 法說會逐字稿

Good morning, and welcome to State Street Corporation's First Quarter 2022 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 express 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 first quarter 2022 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.

During the Q&A, please limit yourself to 2 questions and then requeue. Before we get started, I would like to remind you that today's presentation will include 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.

Thank you, Ilene, and good afternoon, everyone.

Earlier today, we released our first quarter financial results. Before I review our results, I would like to briefly reflect on the operating environment in the first quarter which included both significant geopolitical events as well as notable macroeconomic developments and market movements.

Turning to Slide 3 of our presentation. First, I would like to acknowledge the ongoing events in Europe following Russia's invasion of Ukraine. In March, I traveled to Krakow to visit some of State Street's approximately 6,400 employees in Poland. During my visit, I was moved by the selflessness of our colleagues in Poland, who continue to support displaced Ukrainian people in a number of important ways from opening their own homes to providing shelter to offering professional support, such as interpretation services. While State Street's direct exposure to Russia and Ukraine is very small, our teams are responding fluidly to the situation and delivering for our affected clients and other stakeholders with dedication and professionalism in what continues to be a stressful time. We have well-established and regularly tested business continuity plans designed to continue critical services for our clients and support for our people.

The first quarter also saw dramatic market movements, driven partially by the conflict in Ukraine, plus a broader set of macroeconomic forces. A tight labor market, rising energy prices, continued supply chain disruptions and the ongoing effects of significant COVID-related fiscal stimulus has contributed to inflation reaching multi-decade highs. As a result, in March, we saw the first interest rate hike from the Federal Reserve since late 2018, a substantial upward move in long-end interest rates as well as volatile currency and equity markets and a stronger U.S. dollar. Each of these factors in part shaped State Street's financial results in the first quarter, which I will now discuss before Eric takes you through the quarter in more detail.

Starting with our financial performance. First quarter '22 EPS increased 15% year-over-year and was up 8%, excluding notable items, with earnings growth supported by both higher total fee revenue and stronger net interest income, leading to an improved year-over-year total revenue performance in the first quarter. Within fee revenue, our global markets franchise performed particularly well, driven by higher FX market volatility. And while State Street's revenue performance improved, we also remain highly focused on controlling the expense base. Notwithstanding continued new investments in our business and operational capabilities, first quarter total expenses were flat year-over-year and increased just 1%, excluding notable items, supported by ongoing productivity efforts and the stronger U.S. dollar.

Taken together, we delivered both positive fee and total operating leverage as well as pretax margin expansion, good earnings growth and higher return on equity relative to the year ago period.

Turning to our business momentum, which you can see across the middle of the slide, we recorded another quarter of solid new AUC/A asset servicing wins, which amounted to $302 billion in the first quarter, while AUC/A won but not yet installed amounted to $2.9 trillion at quarter end. Front office software and data also experienced good business momentum with annual recurring revenue for the first quarter, increasing 15% year-over-year to $235 million.

At Global Advisors, assets under management totaled $4.0 trillion at quarter end. Importantly, we saw another quarter of solid net inflows of $51 billion despite the volatile market environment in the first quarter. Our ETF business continued to perform well as we further focused on innovation and enhancing our ETF product offering.

For example, in January, Global Advisors launched 3 new ESG-oriented SPDR ETFs across small-cap international and emerging market equities, aimed at helping investors incorporate ESG considerations into their portfolios. In February, Global Advisors expanded its fixed income offering with the debut of the actively managed SPDR Blackstone high income ETF as we continue to innovate in the active ETF category, which accounted for 13% of U.S. net industry flows in the first quarter.

At State Street Digital, we announced a number of exciting developments. In March, we entered into a licensing agreement with Copper co, a provider of institutional digital asset custody and trading infrastructure. We intend to leverage Copper.co's technology to develop an institutional-grade digital custody offering where clients can store and settle their digital assets within a secure environment operated by State Street.

Turning to capital. Our ratios remained healthy, although CET1 declined quarter-over-quarter, largely due to lower AOCI driven by the significant moves in interest rates. In the coming quarters, we remain focused on maintaining strong capital ratios.

Regarding BBH, the regulatory review process for the proposed acquisition of the BBH Investor Services business has progressed more slowly than we anticipated. While many required approvals have been obtained, some required regulatory approvals, most notably approvals of the relevant federal banking agencies, remain outstanding. We are evaluating potential modifications of the transaction that are intended to facilitate resolution of the bank regulatory review. We are working towards concluding regulatory reviews during the third quarter.

While we are engaged in an ongoing dialogue with the relevant federal banking agencies, there can be no assurance of the timing or outcome of their regulatory review. Both parties, State Street and BBH, continue to be excited about the overall financial and strategic opportunities of combining BBH Investor Services with our business. We are continuing to work closely with the BBH team on pre-integration planning. This includes all the preparatory work in product, operations, technology as well as employee communication and client planning. We still expect the transaction to be accretive to earnings per share in the first year post closing.

To conclude my opening remarks, the first quarter was defined by both unexpected significant geopolitical events and notable macroeconomic and market developments, in the face of which State Street delivered an improved year-over-year financial performance and solid business momentum metrics while supporting our clients and colleagues. As we look ahead in this environment of heightened geopolitical uncertainty and market volatility, we remain laser-focused on delivering what is within our control, including excellence of strategic execution across the front, middle and back office, maintaining the recent improvement in our sales effectiveness and expense discipline all while continuing to provide valuable insights and promote better outcomes for the owners and managers of the world's capital.

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

Thank you, Ron. I'll begin my review of our first quarter results on Slide 4.

We reported EPS of $1.57 or $1.59 excluding acquisition and restructuring costs. On the left panel of this slide, you can see we had yet another solid quarter of total fee revenue growth with strength in many of our businesses, notwithstanding the macroeconomic environment. At the same time, we held total expenses roughly flat year-on-year as we continue to both invest in the franchise and control expenses. As a result, we generated positive operating leverage of about 5 percentage points in the quarter and continue to improve our pretax margin year-over-year. All things considered, this was another strong quarterly performance, demonstrating the progress we are making as we continue to improve our operating model and drive growth.

Turning to Slide 5. We saw period-end AUC/A increased by 4% year-on-year and decreased 4% quarter-on-quarter. The year-on-year change was largely driven by higher period end equity market levels, client flows and net new business growth. The quarter-on-quarter decline was largely the result of lower period end market levels in both equity and bond markets. Similarly, at Global Advisors, AUM increased 12% year-on-year, but declined 3% sequentially. Relative to the period a year ago, the increase was also driven by higher period end market levels coupled with strong net inflows across all 3 of our franchises, our ETF, institutional and Cash businesses.

The sequential decline was primarily driven by lower market levels, which was partially offset by strong net inflows of $51 billion in the quarter.

Turning to Slide 6. Before I start, I would like to remind you that we are expanding our servicing fee revenue disclosures by disaggregating the line into back-office servicing fees and middle office services. With that, on the left side of the page, you'll see first quarter total servicing fees were flat year-on-year as higher client activity and flows average equity market levels and net new business were offset by normal pricing headwinds and a 2% currency translation headwind.

We continue to see good growth in both our insurance and official institutions client segments. Sequentially, total servicing fees were down 1%, primarily as a result of the seasonal pricing headwinds and lower average equity market levels partially offset by strong client activity. Within servicing fees, back office fees were flat both year-on-year and quarter-on-quarter, largely driven by the factors I just described.

Middle office servicing was down 3% year-on-year and 5% quarter-on-quarter, primarily due to a partial transition from a legacy client and lower professional services fees in the quarter. Notwithstanding the decline in the quarter, middle office is an important component of our Alpha proposition when it comes to both the front office when it connects to both the front and back office, and we expect to see good growth over the medium term. As evidenced by our uninstalled revenue backlog, which I'll talk more about in a moment.

In terms of business momentum, I'm pleased with how 2022 has started. As we report another quarter of solid new AUC/A wins of $302 billion, while AUC/A won but yet to be installed, amounted to $2.9 trillion at quarter end. We continue to be happy with our pipeline, and I'm also particularly pleased to report that our first quarter wins spanned a good mix of strategically important premium and preferred clients.

Turning to Slide 7. First quarter management fees were $520 million, up 5% year-on-year, primarily reflecting higher average equity market levels and strong ETF inflows. Management fees were down 2% quarter-on-quarter, largely due to equity market headwinds, partially offset by the tailwind of lower fee waivers and net inflows. Of note, our management fee performance for the quarter was supported by strong net inflows of $51 billion with positive inflows across our entire business franchise, Institutional, Cash and ETF.

With respect to money market fee waivers, the fee waiver impact to management fees for the quarter was roughly $10 million, down from about $20 million in the fourth quarter. I would note that following the 25 basis point Fed hike we saw in March of this year, we no longer expect money market fee waivers to be a headwind to management fees starting in April. As you can see on the bottom of the slide, our franchise remains well-positioned for growth. I'm particularly pleased that the strategic actions that we've previously taken in our long-term Institutional and ETF franchises are now helping to draw inflows even in the current volatile market environment.

On Slide 8, you can see that FX trading services had yet another strong quarter. Relative to the period a year ago, FX trading services revenue was up 4% year-on-year and 20% quarter-on-quarter. Both the year-on-year and quarter-on-quarter performance benefited from high FX market volatility while higher client FX volumes also contributed sequentially. Part of the revenue uptick has come from about $5 billion in higher risk-weighted assets we put to work this quarter, which demonstrates our balance sheet flexibility and which I'll come back to in a moment.

Our securities finance revenues decreased 3% year-on-year, primarily driven by lower average agency assets alone, partially offset by solid new business wins in enhanced custody. Sequentially, revenues were down 6%, mainly reflecting lower average agency and enhanced custody balances due to the declining market levels and fewer specials. First quarter software and processing fees were up 26% year-on-year and 7% quarter-on-quarter, largely driven by higher front office software and data revenue associated with CRD, which I'll turn to shortly.

Finally, other fee revenue of $29 million almost doubled year-on-year and quarter-on-quarter, mainly reflecting fair value adjustments on equity investments.

Moving to Slide 9. We've provided a breakdown of our consolidated front office software and data revenue on the left. We've broken down the revenue into software categories you have seen us use before, on-premise, professional services and software-enabled revenue. While CRD represents a large majority of this line, Alpha Data Services, Alpha Data Platform and Mercatus revenues are also included here as well. As we've highlighted earlier, front office software revenue growth was particularly strong, up 44% year-on-year, primarily driven by on-premise renewals as well as the continued strong growth in software-enabled and professional services revenues.

On the right of the slide, we've provided some key growth metrics enabled by CRD and Alpha. As I mentioned earlier during today's presentation, you'll notice that we've broken out both the front office and middle office uninstalled revenue backlog, both of which are key components of our alpha proposition going forward. The front office backlog of $93 million is up 43% and the middle office backlog has more than tripled year-on-year to $63 million. The backlogs reflect expected annualized revenue, which can be compared to the $900 million of annual revenue base in 2020 across both the front and middle office businesses and is an indicator of future revenue growth once fully installed.

The Alpha pipeline remains promising despite the current geopolitical environment as clients realize the transformational benefits to their technology and operations infrastructure.

Turning to Slide 10. As we see the start of another rate tightening cycle, first quarter NII increased 9% year-on-year, primarily driven by growth in our investment portfolio coupled with higher loan balances, which will also benefit us in future quarters. Relative to the fourth quarter, NII was up 5%, which came in better than expected due to higher long end rates. The sequential increase was largely driven by the improvement in both short and long end rates, which benefited our yields together with higher investment portfolio balances.

On the right of this slide, we show our average balance sheet during the first quarter, which has been relatively steady. Average assets were down 3% quarter-on-quarter, largely driven by seasonally lower 1Q deposit balances, which are down slightly from the seasonally high fourth quarter, but up year-on-year.

Turning to Slide 11. First quarter expenses, excluding notable items, increased 1% year-on-year or 2% adjusted for currency translation. Productivity savings and targeted investments remained on track for the first quarter as we generated approximately $90 million in year-on-year growth savings and self-funded most of the strategic investments we've been making in the businesses, including technology infrastructure, broader automation, Alpha and State Street Digital. Compared to first quarter on a line item basis, excluding notable items, compensation and employee benefits was down 1% as lower head count in high-cost locations and the tailwind of currency translation was partially offset by higher seasonal expenses.

Information systems and communication expenses were up 5% due to continued investment in our technology infrastructure and resiliency. Occupancy was down 13% due to footprint optimization and lower maintenance costs and other expenses were up 9%, primarily reflecting higher professional fees.

Relative to the fourth quarter, expenses were primarily impacted by higher seasonal expenses partially offset by productivity and footprint optimization savings. Headcount increased slightly quarter-on-quarter as we began to in-source some technology functions from vendors and growth in Alpha. Overall, we remain focused on delivering positive total and fee operating leverage and have demonstrated that this quarter amidst the current macroeconomic environment.

Moving to Slide 12. We show the evolution of our CET1 and Tier 1 leverage ratios. As of quarter end, our standardized CET1 ratio decreased by 2.4 percentage points quarter-on-quarter to 11.9% due to both numerator and denominator effects. RWA increased by roughly $15 billion or 160 basis points of CET1 during the first quarter of 2022 compared to year-end, driven by 3 factors: a modest rebound from an unusually low fourth quarter; a strategic and temporary allocation of additional RWA capital to our markets businesses to generate the higher-than-expected first quarter revenues that we just discussed; and lastly, the RWA impact from the SA-CCR implementation that started on January 1 of this year, which we had planned for. At the same time, our capital base was also impacted by the substantial reduction in AOCI of about $1.3 billion, worth 110 basis points of CET1 relative to the fourth quarter as we saw a significant and historic quarter-on-quarter movement in long-end rates, particularly in the belly of the curve.

For instance, the rise in the 5-year U.S. treasury of roughly 120 basis points was the largest in the last 30 years. Taken together, the increase in RWA, coupled with a meaningful reduction in AOCI, partially offset by about 35 basis points of earnings accretion, net of dividends, drove the decrease in our CET1 ratio this quarter.

In contrast, first quarter Tier 1 leverage was down only slightly to 5.9%, mainly driven by the substantial decrease in AOCI, reflecting a significant change in the interest rate environment and a stable balance sheet.

While capital return remains an explicit priority for us, and we recognize its importance to our shareholders, given this $1.3 billion move in AOCI related to higher interest rates, we no longer expect to resume our share repurchase program in the second or third quarter as we operate with a conservative balance sheet philosophy.

Given the volatility in rates and the possibility of further significant increases, we are in the process of taking several actions to reduce AOCI risk by about half. This primarily includes shifting additional AFS securities to HTM as well as shortening the portfolio duration through swaps lowering extension risk and consciously allowing some portfolio runoff. Some of these latter actions can be reversed in the future when we choose to reinvest at higher rates.

Turning to Slide 13. We provide a summary of our first quarter results. Despite the continued volatile market environment, I'm pleased with our financial performance, which demonstrates solid underlying trends within our businesses. Total fee revenue was up 4% year-on-year, primarily driven by higher management fees, FX trading, software and processing fees and other fee revenues. Expenses were well-controlled and were held roughly flat year-on-year, demonstrating the progress we are making in improving our operating model.

Next, I would like to provide our current thinking regarding the second quarter outlook and some of our economic assumptions as we look out over the year. At a macro level, while we know that rate assumptions have been moving, our rate outlook is broadly in line with the current forwards, which suggests a year-end Fed funds rate of 2.5%. In terms of second quarter of 2022, we expect overall fee revenue to be down about 2% on a sequential basis, with servicing fees up about 1% and management fees up 2% to 3%, assuming equity markets remain flat to March 31 levels for 2Q and some downward normalization in FX trading revenues.

In terms of some of our newer fee revenue line items that we started to disclose this quarter, we would not expect to see a repeat of the size of on-premise renewals in the front office software line nor the positive equity investment markups in the other revenue line in 2Q.

Regarding NIIs, we now expect 2Q NII to increase 7% to 9% sequentially, which will be driven by the expected Fed rate hikes, partially offset by the AOCI mitigating portfolio actions that I outlined earlier. For full year 2022, we now expect to see year-on-year NII growth of around 18% to 20% and depending on Fed actions and rate moves as well as the shape of our portfolio.

Turning to expenses. We remain laser-focused on driving sustainable productivity improvements and controlling costs. We expect that second quarter expenses ex-notable items will be up around 2% to 3% on a sequential quarter basis, excluding notable items and seasonal compensation of expenses of $208 million.

On taxes, we expect that the 2Q '22 tax rate will be around 20%. We continue to expect to deliver on our goals of margin expansion and positive total and fee operating leverage for the year.

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

Thank you, Eric. And operator, we can now open it up to questions.

(Operator Instructions) We have our first question from Ken Usdin with Jefferies.

Eric, just a follow-up on all things related to the rate environment. Just wondering, first of all, on the commentary about considering some alternatives with regards to the Brown Brothers deal. Can you elaborate what that might mean? Is that potentially some type of -- that thing you might have to fix on the capital side? Or is that related to just timing and deal structure? Any help there would be appreciated.

Ken, it's Eric. No, capital from a capital perspective, we're quite comfortable with closing. We've got almost 12% capital ratios today. We've got a very, I think, smooth path to being prepared for a close from a capital perspective. The modifications we're talking about are just around the underlying structure of the transaction. And you've seen this done from time to time before. But we're working through legal entity and subsidiary structure, the exact transfer of systems and third-party contracts. Some of the transition servicing agreements, those kind of structure and modifications that we think will make this a cleaner process and be favorable on several fronts.

And then is there any updated thoughts about general zone of what you might think about for potential closing?

As Ron had said, the regulatory review process has taken a bit longer. We've obviously been heavily engaged in that process because of some of the modifications that we're working through jointly with Brown Brothers leadership team. We're deeply in the process of getting additional and refined submissions in. Those will take several months for review and further dialogue. I think you have a sense for how this plays out. And that's why in the prepared remarks, I think Ron described that we expect those reviews to come through during the third quarter. I think at that point, we obviously then sprint to a close. And depending on exactly what month and what week those come through, then we look for -- you take out the calendar, you look at the weekends and do the usual, how do we now just close, but we've got to always close carefully, just given the usual financials and controls that you want to be mindful of.

Okay. And just -- I guess I'll ask a starter one on NII and then leave it to others. But just can you -- do you know just the impact related to the restructuring type of actions versus what you might have thought for NII?

There's a range of that. I think you've seen us guide to NII up for the quarter of up 7% to 9%. And that on a year-on-year basis is actually going to be quite nice. I think it's -- is it worth a percentage to 2% or 3%. It's those kinds of I think, adjustments that we're willing to make so that we both run an appropriate portfolio in what could be a highly volatile rate environment, including another possibility of rates could move another 50, 100 basis points, and we want to have a portfolio that can withstand that. And to be honest, we're willing to take a few percentage points of NII growth off the table on a sequential basis to do that. So I think it's a balance, but that's the range. And even with some of those adjustments, a lot of what we'll be doing is in the move from AFS to HTM, which is not NII impacting. There are others on the margin that are, but that's kind of the range that I'd share with you.

Your next question is from Glenn Schorr with Evercore ISI.

So the SEC wants to implement T+1 by the end of next year. I saw the comment letters, including yours. My personal opinion is nobody is ready for it in the industry. So I'm curious why the move from T+2 to T+ -- I'm sorry, T+3 to T+2 was kind of easy and T+2 to T+1 everybody seems to be pushing back. Is it the complexity and shorter time horizon. Is the money to spend on the technology? It's just a little weird to me.

Yes, Glenn, it's Ron. Why don't I take that. I mean I think that if you look back in history, everybody has resisted these moves to some degree because it does involve some spending of money and changing in systems and all that. We've spent a fair amount of time on this and thought about this and have been in conversations with regulators and it will be an added burden, but we don't think it's something the industry can't get done in a reasonable amount of time. So I'm not -- I haven't read other people's comment letters. I know how we've thought about it. So we think it will be one of these things like a LIBOR, if you will, more recent history, that will take a lot of time, take a lot of effort, but it's certainly not something that's going to, in our mind, sideline us or sideline other major players.

Our next question is from Brennan Hawken with UBS.

Just a sort of a clarification here. The expense guide, Eric, that was plus 2% to 3% quarter-over-quarter and -- but we're supposed to x out the seasonality, right? So do we back out -- what exactly is the right base that we're supposed to -- do we take the $2,318 million and then back out the $208 million and then grow that?

Let me just open up the slide. So I think you're doing it, Brennan, in line with how we've described it. Yes, you can take the first on Slide 11 of the slide deck that $2.318 billion of expenses. That includes the seasonal expenses, which are on the footnote, right, of $208 million, you can pull that out and then you can add 2% to 3% sequentially and get an estimate for second quarter. That's correct.

Okay. Okay. And then thinking about the deposits. What -- when you were talking about the decline in deposits, you flagged a normal seasonality, which would suggest that there wasn't anything that's unusual that you've been seeing, but we've started to see rates back up in the market. The policy hikes -- we already see 1 policy hike, likely to see quite a pace here in the next few meetings, how is dialogue with your customers? What are your expectations, updated expectations around deposit action? And do you have any kind of estimate about where you might think you could see deposit growth or runoff end up shaking out here in the -- at least next quarter or two.

Sure, Brennan. For the time being, we've seen little movement in deposits other than a little bit of seasonality, a little bit of currency translation has also played through. But this is all within the bounds of what we'd expect. And we've obviously been watching deposits carefully across currency pools and across client segments. And for the time being, it's been flattish, regardless of which way we look at it. As we go forward, we like many others have tried to guesstimate, and I use the word guesstimate not estimate, the level of shift in deposits, movement of deposits that we'll see with the amount of quantitative tightening that the Fed has announced. And I guess the best context I have for you and others is if we go back to the kind of pre-COVID era, we've grown our deposit base since then by $60 billion to $70 billion. We've also increased our AUC/As by about 25% during that time period. And because of those quarterly, we estimate that about half of the increase of $30 billion to $35 billion has come from the quantitative easing as the Fed and the other central banks primarily that expanded its balance sheet by effectively $3 trillion.

And so we see that reversing over time with the rough math being for every $1 trillion of balance sheet, we'd expect a $6 billion to $10 billion runoff in our deposits. And if they start in May or June, we'll see exactly when they get going at their announced pace. Yes, you could see a little trickle down, we think, in the fourth quarter and then the kind of the $6 billion to $10 billion per year after that.

So that's our guesstimate. We're obviously flush with deposits, and we're happy to be flush with deposits as rates rise. So we'll monetize them for the time being. But that's our guesstimate right now. The other factors are how the interest rate hikes play out. We expect betas to be similar, but they're never exactly the same as they are before. And so we'll be sharply focused there. So those are some of the moving parts in some of our thinking at this point.

Our next question is from Betsy Graseck with Morgan Stanley.

Last year, you announced State Street Digital. And I wanted to get a sense as to how that's going relative to expectations. What you've been able to execute on there? And what your clients are asking you to do more of?

Yes. They've had a lot going on, Betsy. Maybe I'll focus on that last question first because this is a very client-intensive decision and spending a lot of time on it. I think the single biggest thing clients are asking for is help with the kind of a comprehensive regulatory framework. This is particularly acute in the U.S., the lack of guidance and the lack of -- really an agreed upon framework is has left a lot of uncertainty and see what institutions can do, particularly banks. So that's out there.

I think most of it, though, beyond that, Betsy, would be around and where we're spending a lot of time is, firstly, around enabling clients to invest in digital assets. And that's not just the trading of them, but it's the movement of them. It's the control of them. It's the custody of them, that's a portfolio accounting of them. So it's really, if you think about what we do now for digital assets, tokens, coins, et cetera. I think the other very large thing that the group is focused on, which it's less about external products and much more about how does State Street itself move into a digitalized world more than it is already? And what does it mean for the core operations such as custody, securities movement and control, which is really about, for lack of a better term, the next stage of digitalization. We are working a lot with the major players in the industry because these ecosystems are forming. And in some cases, we actually want to be a very integral part of the ecosystem and in other cases, we actually want to access that. So there's quite a bit going on there. is where I would summarize my answer to you.

And would you say that -- yes, go ahead.

And Betsy -- it's Eric. I was just going to add. The other thing we're doing is, obviously, where clients, especially institutional clients have added crypto holdings within their fund, right? We're effectively providing some of the services you'd expect. And so we've gone through the -- across our client base. They have about 73 funds, I think, at that count with $0.5 billion of crypto exposure, we're effectively record keeping, right, those assets as part of their underlying funds. And then I think more broadly, where clients are developing specific ETFs and exchange-traded products, that's where we are in an industrious way signing them up for the administration and recordkeeping because that, in a way, is our view as one of the next land grabs because as the ETF and ETP products that comes of age, that's where we'll see some significant inflows.

Okay. And would you say you're at scale for these offerings? Or there's more investment to do to get to scale?

Yes. I mean, I think where we are now is of adequate scale, but one would expect that more scale will be required. But as much excitement as there is around this, it's still a relatively small proportion of total investment assets. So I think we're at adequate scale. I think the focus now is more on how do we think about additional capabilities growing.

Yes. No, I totally get that. But as CBDCs come through, it's going to be critical to have this infrastructure -- central bank digital currencies.

Next question is from Brian Bedell with Deutsche Bank.

Just back to BBH, just on that timing of closing one more time. I guess potentially could move into the fourth quarter. Just -- is it safe to say that you think this would certainly close before year-end? And is there any risk to it not closing under without changing the terms dramatically. And is it mostly the U.S. regulatory side as opposed to non-U.S?

Yes. I mean, Brian, the regulatory environment is uncertain, probably gotten more so over the last couple of years been less so, but we are making progress. It is taking longer than we anticipated. We're in dialogue. So it's not like there's -- we're not doing anything or there's silence on all this. We're in a fair amount of dialogue and working the kind of the restructuring that we referred to earlier is explicitly aimed at trying to accelerate this that we view speed is of the essence here. But there's a fair amount of uncertainty. So as I said in my prepared remarks, and Eric just reiterated, what we're targeting at this point and assuming that there'll be a -- this review will get done in the third quarter. And then as Eric noted, the actual -- once the review is done, the close itself isn't going to take a lot of time. I mean everything is ready. The money is in place. There's been a fair amount of integration planning, but it really is around the uncertainty of both the timing and the outcome of these regulatory reviews. And yes, it's mostly -- right now, the open ones are mostly the U.S. banking regulators.

We've received lots of approvals from around the world, both from financial services regulators and the antitrust regulators globally. So I don't want to minimize what has been done. But this is one of those things that may be not done until the last one is done.

Yes. That makes sense. That's great color. And then just on the -- maybe on the deposit side again. So obviously, Ron, BBH gave you pretty good capability to bring on incremental deposits, and I know it's getting pushed out a little bit. But maybe, Eric, if you want to just -- if you can sort of update us on your thoughts or just reconfirm your original thoughts about the level of BBH deposits that would be coming on if it were to close today, for example, and then your appetite for bringing more deposits on, I think it was up to $20 billion of additional deposits at some point. Maybe just to talk about how you're thinking about that, if there's any change in that thought process other than the delay? And is the core BBH fundamentals right now, I assume, at least on the interest side, those are probably tracking better given the additional Fed hikes since the last guide.

Ryan, it's Eric. We've been pleased as we've been monitoring and working closely with Brown Brothers on the business performance. It's -- it had a good finish last year. It's had a performance in the first quarter that's within the bands that we had expected. And obviously, there's a little bit of NII tailwind in there, offset by a little bit of equity market, a downtick. But it's a -- business is performing well. We're -- we continue to be excited about it. And the partners, the 9 partners that have been operating that business that are coming over to us are doing a fine job as we'd expect, which is really, really nice to see.

In terms of the deposits and the close and the assets and the modifications and the broader questions. You're asking about the underlying economics of the transaction. I'm not going to go into detail on that at this point. I think Ron in his prepared remarks affirmed that the economics are sound that they'll be accretive within the first year. And what I'd tell you is, as we work through the modifications, which is oftentimes a legal entity kind of structure where we in the finance and treasury side are working very closely with our legal colleagues to navigate those modifications and make sure that they preserve the economic and the accretion that we're looking for. And so we continue to be positive, and we think it will be positive for shareholders.

Our next question is from Gerard Cassidy with RBC.

Eric, can you share with us -- I think you -- in your comments when you were talking about the CET1 ratio that you used the temporary allocation of additional RWA to capture some market business that generated some better revenues for you in the quarter. Can you elaborate on that? And if you pull back, does that mean in the second quarter, the RWA capital that was allocated would decline, meaning the -- all other things being equal, your CET1 ratio could bump up a little bit.

Gerard, it's Eric. That's the -- those are the kinds of scenarios and I'll say, navigation that we do for our capital ratios, and they are sometimes dependent on market opportunities, whether it's the FX trading desk here in the U.S. or abroad, whether it's the sec finance unit or sometimes even the lending unit, there -- we're in close partnership with them around on one hand, they are a sophisticated operating within their limits and sometimes they come by, and we have real I think, constructive commercial discussions about, hey, if there's a little more capacity at the top of the house, can that be put to use? And that's where we were this quarter. And you saw we had quite a nice uptick in FX trading revenues up 20% quarter-on-quarter, which I think had not been anticipated was facilitated as we gave them larger limits, partly because we're sitting on an abundance of capital right now.

I think what you will see is that we'll do that selectively. We'll probably do that for another couple of months. We'll see how we're feeling towards June. We would like to keep our RWA asset levels at or below where we are today. So we do expect them to be within those boundaries. And so we'll selectively work through it. But part of the discipline here is we also want to make sure that there's real incremental revenues that we can bring to bear if we're going to deploy the incremental capital and that was the scenario this quarter.

Very good. Very helpful. And then, Eric, I know it's not a giant number, but you touched on it in the outlook regarding the adjustments and the fair value adjustments to equity investments were up so strong in Q1 -- in Q1 versus both the fourth quarter and the year ago quarter. How big of a portfolio is that? And was it private equity investments? Can you maybe give us a little more color there?

Sure, Gerard.

These are primarily or primarily almost exclusively minority investment opportunities and investments that we've made in a series of companies over the years. There's 5 to 10 of them that are in the crypto space, sometimes providing software, sometimes providing infrastructure, sometimes providing different capabilities. There are some in the more classic technology areas where we've invested over time, again, in minority positions that help facilitate some AI capabilities and capacities that have helped us with our automation and engineering efforts, and so there's a group of them. But we're primarily -- we're not trying to build an investment portfolio. What we have is investments, typically of $5 million, $10 million, maybe $15 million in early to mid-stage companies. Oftentimes, they are companies that are providing a utility type service for multiple large banks.

So we're in there with sometimes the other G-SIBs or an international bank or what have you. And so we get -- effectively -- they get -- the entity gets a network effect for multiple banks, and we participate because we get upside in some of the services. So we're doing it to help facilitate primarily either revenue growth, automation capability or just general capabilities to build up our product set. And the -- I guess, the knock-on benefit of that is because we know this market space well. These tend to appreciate over time. And it's one of the ways we've been driving, I think, innovation would probably be the broader word to use. And we've made some -- I think this particular quarter, we saw a couple of these really appreciate, which is good to see.

And our next question is from Jim Mitchell with Seaport Global.

Just, Eric, any -- you updated the guidance on NII for the full year. Any change to the expense or fee revenue guidance that you gave in the prior quarter for the full year?

Jim, I didn't go that far, partly because the market environment has just been volatile whether it's equity markets, whether it's rate hikes. And so there's a number of drivers that are moving around. I think NII, we felt just because the Fed forecast were so explicit between the dot plot and the new consensus that we should just describe that for all of you. But the other lines, we think it's still early to go through. It's still early to really call what the equity markets will do, both in the U.S. and internationally, where they've been more depressed. We'll obviously navigate and adjust our expenses to some extent as we go through the year. I think what we did do as part of the outlook commentary after I finish the quarterly description was affirm that we're committed to both positive total operating leverage and positive fee operating leverage. And so I think that gives you some boundaries that we're working within.

Right. Maybe just one curious question on Securities Finance.

I appreciate the balances are down, specials are down, and those are important factors. But I've always thought that spreads on sec lending were kind of the spread between -- you benefited from a steepening at the short end of the curve. I didn't really seem to see any of that benefit in the spreads. Is that to come? Or we just not thinking about that right? How should I think about security lending spreads, excluding specials and volume?

Yes. I think directionally, you're right, it tends to have some correlation. And I think what we find though is that the special activity and the mix of -- the underlying mix of assets that are being borrowed or lent tend to be a little more dominant in terms of their effects on the P&L in a given quarter. So it's -- that has a piece to the rate environment, but it tends to be the volumes and the mix that dominates.

Next question from Alex Blostein with Goldman Sachs.

Maybe just taking a step back for a second. And when you sort of think through the capital mitigating factors and the steps you guys have taken to sort of the capital position here ahead of BBH closing. When you think on a multiyear basis and maybe sort of lessons learned from the move in interest rates and effect that had on your guidance capital position this quarter and maybe after. What is the more appropriate mix of kind of cash, securities and loans for us to think about over time as well as just the duration of the securities portfolio? How much of that will look different perhaps as we look forward?

Eric?

Yes, Alex, it's a good question in a way we've not been in this environment for 20 or 30 years, right, where rates either are going to move quickly to the upside or maybe move quickly to the upside and stay high either. I think there are a couple of thoughts that we've developed over time. I think the first is that the more we can add lending assets, classic loans to our balance sheet, they have to be high quality, but the more we can add lending to the mix of the asset side of the balance sheet, the better off we are. And you've seen us -- you've seen us consistently grow our lending book 10%, 12%. It's just -- it's off of a small base. So that's an area we'll continue to evolve in. I think given that, that will though take some time.

The other elements here is what kind of investment portfolio do you run? We -- just because of our trust and custody heritage, believe it should be a high-quality, pristine one that is unassailable. And our perspective as we do that is I think we're more comfortable putting more of that over time into HTM just because it's an accounting convention that while you all can read through in our 10-Ks and Qs, what the underlying market doesn't immediately -- or doesn't affect the capital ratios. The one governor on that, and you'd say, well, why not put it all in HTM and put it in the drawer, is that in a down rate environment, which typically happens when the Fed moves into intervene on a recession, you tend to get an appreciation of securities, and you want to be able to monetize or take advantage of that to offset whether it's credit or reserve builds. And so that's one of the reasons why you don't want to put all of it in HTM.

And the other reason is, if you're -- if rates are flattish or moving within a band of 25 basis points here, 50 basis points there. The AFS convention allows you to rebalance, to adjust your position a little shorter, a little longer. And that's beneficial. And I think over time, we found that that's been additive to our NII and P&L. And so I think over time, you'll probably see us put more in HTM, but not -- there are some limits to that. But that's some of the ways we're thinking about it. And then I guess there's a last layer, which is what's the composition. And I think you've seen us adjust the mix of treasuries, MBS, CMOs. Because we're such a global bank, the foreign sovereigns, especially as euro and international rates rise, I think we'll over time become a bigger part of what we do to grow. So there's a bit of, I think, the mix, the composition will evolve as well over time.

Got it. All right. That's helpful. And then maybe a little bit more of a tactical near-term question. When we look through the NII guide, just extrapolating the full year from the second quarter, I guess how surprisingly the benefits of subsequent rate hikes seem to have a smaller effect on NII. But curious how you guys are thinking about deposit beta assumptions beyond sort of the first 100 basis points. Maybe looking at the U.K. market as kind of lessons learned there a little bit further ahead of us, I guess, on the hike in terms of both pricing and client behavior.

Yes. I think the first 100 basis points, I think, are a little bit easier to read to your point, like the first rate hike, the beta as we generally assume are in the 20% range. So that's the first 1 or 2. So that's comfortable and pleasing, I guess, I should say. Once you get to the third and fourth you're now floating up in betas in the 30% to 45% range, and this is where it kind of depends. And then I think once you get past the first 4 or 5 hikes, you are looking at sequential quarter betas in the 60% range. I think you're just -- that's just what happens. And to be honest, we're -- we want to go back to a position where the NII is healthy. The NII can support the preferred security stack that we should run from a capital perspective, but we also want to be fair and thoughtful with our clients in the embedded sharing that's been a partnership here for decades and decades with them. So that's what we're looking at and thinking.

You never know how the speed of rate hikes affects that. Some of that's been taken into account in some of those guesstimates that's given to you, but I use the word again, guesstimates here, not estimates because we think these cycles aren't perfectly comparable. And some amount of quantitative tightening has been factored into some of our thinking here as well. But that will have an effect.

And then I think the last one that we'll have to see is depending on how the macro economy does, whether it's if the economy -- if rates move up another 100, 200, 300 basis points and the macro economy is strong, then there's a lot of demand for lending. And so there's this big ask between deposits to fund loans. If you have a slowdown in the kind of real economy, then there's not as much lending that's going to be done and that's more beneficial to deposit rates. So that's another feature that we're keeping a close eye on.

Our next question is from Steven Chubak with Wolfe Research.

So Eric, I was hoping to ask a multipart question on the capital impact of BBH and how that maybe informs the buyback cadence from here. So as we think about the pro forma impact to your capital ratios, if we were to assume the deal closes in the next quarter or 2, and we shut off the buyback through the third quarter. Given the large pro forma capital hit, I believe it's about $3.5 billion from goodwill and deal intangibles, so about 120 bps of Tier 1 leverage. Your ratio exiting 3Q would still shake out below your lower bound of 5.25%, meaningfully below, but somewhere close to 5%. I just wanted to confirm if the $3.5 billion capital drawdown from BBH all in is the right level for us to be contemplating for modeling purposes. And as we think about the buyback cadence, if you're still running at or below that lower band. And how quickly should we be thinking about you getting -- returning to normal course payout target roughly 80%.

Yes. I think the -- it's probably a little bit easier to think about it in CET1 terms. But the translation is kind of the CET1 divided by 2 gives you the leverage. And remember, on leverage, especially in these economic times, we certainly want to stay within the target range of 5.25% to 5.75%. But I've been on record saying getting closer to -- as long as you stay in the 5%, leverage is quite comfortable given that it's not a risk-sensitive measure. If you then pivot back to CET1, we're at almost 12% relative to the target range of 10% to 11%. So there is an almost 200 basis point spread there of excess capital that we have.

If you then fast forward and let's say it's -- we've had a discussion on this call is exactly what we should assume. But if we were to assume a third quarter close, for example, the way to think about it is the goodwill and intangibles for the Brown Brothers transaction is about $3.3 billion. I think if you translate that into CET1, it's just below the 300 basis point mark. So the comparison is, we would prefer, it's not absolutely required, but we prefer to have about 300 basis points of capital to close it. We've got about 200 basis points today. And then the logical way you think about how do you get from here or there over the next 2 quarters, is actually pretty straightforward, right? On one hand, we accrete capital net of the dividend. That's worth about 35 basis points a quarter, so you got 70 there. And on the other hand, as we talked about earlier, we've been deploying our excess capital through the RWA lines, right, through the risk-weighted assets. And we can easily rein in risk-weighted assets by $5 billion or more which creates another 30, 40, 50 basis points of capital as part of a closing process. So there's good levers here, and that's why I said earlier from a capital perspective, it's a comfortable closing process and plan.

Our next question is from Mike Mayo with Wells Fargo.

I just want to make sure I understood what you said on the call. So on the one hand, you're still guiding for positive operating leverage for 2022. You still expect a higher pretax margin. Your backlogs are up. So that's all good. I guess just to clarify your answer just now, the Brown Brothers acquisition all else equal, reduces your CET1 ratio by how much in basis points?

Just shy of just around 300 basis points, Mike.

Okay. And so you're at 11.9% now. So if you close the deal now, you'd be below the low end of your target. So are you delaying the deal because of lack of capital? Or I didn't understand why the delay in the deal.

No, it has nothing to do with capital. If we had been in a position to close it now, we would have arranged -- we would not have deployed $5 billion, maybe even $10 billion of RWA, and we would have had a comfortable close of the deal. It's not about capital. It's about as we described earlier, the underlying regulatory process just taking more time.

Okay. And then as it relates to the lack of resumption of buybacks, is that solely due to the timing of the closing of the deal?

It's -- I guess, it's -- we're just factoring it in, right? We're -- because of where we are on the regulatory process, it's -- we're estimating a potential third quarter close and to just navigate comfortably with capital. Because we had that large AOCI hit of $1.3 billion and I usually buy back almost $500 million of shares per quarter, right? That would be my usual cadence that AOCI hit has effectively put us in a position where it's best not to do those 2 quarters worth of buybacks during the second and third quarter.

All right. That's clear. And then lastly, your guidance for positive operating leverage, how much do fee waivers contribute to that? Is that like all of it or 10% or 50% or -- just roughly.

It's -- well, the guidance is to positive total operating leverage and fee operating leverage. I think the -- if I just try to do the math quickly, but the IR team can probably help you offline, Mike. This quarter, we had fee waiver impacts of 10%, and then we won't have any fee waivers for the rest of the year. Last year, we had fee waivers, I can only remember the second half of the year because I'm trying to remember when it started in the $20 million per quarter range. So -- on our total fees of $10 billion, I don't know, rough estimate, maybe about 0.5 point of fee operating leverage is caused by the tailwind absence of money market fee waivers. But that's -- I'm doing mental math without even a pencil and paper in front of me. So maybe we could follow up with you offline, but maybe in that order of magnitude at least.

I think I have. I mean so in terms of ZIP code, most of it does not relate to the fee waivers. There's the lion's share of it. So I think I got it.

That's correct. It's real underlying momentum.

And our next question is from Rob Wildhack with Autonomous.

Just on fee revenue in the quarter, how would you describe about organic growth there?

Yes. I mean, Rob, why don't I start, it's Ron. I mean now we have had several good organic growth quarters, both on the servicing line and the management fee line. I think that if you think about last year, there was -- in the servicing line, a fair amount of that would have been in Alpha front to back. A lot of that now is being installed, and a big chunk of that is what you see in the $2.9 trillion. The growth that, or at least the sales that we reported on the servicing fee line were kind of disproportionately in the traditional back office business, which is highly scaled and relatively quick to install. So we like that mix. And then management fees have been, as Eric noted, it's been across the board in the core businesses. It's ETFs, Institutional and even a little bit of Cash. So we like both the level of it. I mean you always like more, but we like the level of it. But as importantly, we like the diversity of it.

Okay. And then on the $2.9 trillion to be installed, can you just remind us of the timeline for when that gets installed and when it starts to hit revenue?

Sure, Rob. It's Eric. We've said that that begins to get installed this -- remember, the bulk of that, there were 2 very large deals that were announced in second and third quarter last year. Those were $1 trillion-plus deals. And then there's obviously a set of kind of smaller and midsized activities. For those 2 large deals, they are complex and they're transformational, right, for those clients and what we're delivering. And so those we've said take tend to take a little longer. They're closer to the -- I think we've said for installation to installations range from kind of 6 months to 36 months. But for those were the middle ground is probably 24 to 30. So right now, our estimate is that a good piece, but probably not the majority begins to get installed by late this year. And then this is really a 2023 lift of revenue.

There are no further questions at this time. I will now turn it back to our CEO, Ron O'Hanley for closing remarks.

Well, thanks very much. Thank you all for joining us. I know it was a busy day for you, so we appreciate your time and questions. Thank you.

Ladies and gentlemen, this concludes today's conference call and webcast. Thank you for participating and have a wonderful day. You may now disconnect.