State Street Corporation (STT) Q1 2013 Earnings Report, Transcript and Summary

Valerie C. Haertel - Senior Vice President of Investor Relations Joseph L. Hooley - Chairman, Chief Executive Officer, President, Chairman of Executive Committee and Member of Risk & Capital Committee Edward J. Resch - Chief Financial Officer and Executive Vice President

Howard Chen - Crédit Suisse AG, Research Division Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division Kenneth M. Usdin - Jefferies & Company, Inc., Research Division Glenn Schorr - Nomura Securities Co. Ltd., Research Division Brian Bedell - ISI Group Inc., Research Division Alexander Blostein - Goldman Sachs Group Inc., Research Division Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division Cynthia Mayer - BofA Merrill Lynch, Research Division Brian Foran - Autonomous Research LLP Betsy Graseck - Morgan Stanley, Research Division Josh Levin - Citigroup Inc, Research Division James F. Mitchell - The Buckingham Research Group Incorporated

Good morning, and welcome to State Street Corporation's First Quarter 2013 Earnings Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website at www.statestreet.com/stockholder. 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. [Operator Instructions] Now, I would like to introduce Valerie Haertel, Senior Vice President of Investor Relations at State Street.

Thank you, Lisa, and good morning, everyone, and welcome to our First Quarter 2013 Earnings Conference Call. Our first quarter earnings materials include a presentation that Jay Hooley, our Chairman, President and Chief Executive Officer; and Ed Resch, our Chief Financial Officer, will refer to in their remarks. Reconciliations of our non-GAAP or operating basis measures to GAAP measures referenced on this webcast, as well as other materials can be found in the Investor Relations section of our website. Before Jay and Ed begin their discussion of our results, I would like to remind you that during this call, we will be making forward-looking statements. Actual results may differ materially from those indicated by these forward-looking statements as a result of various important factors, including those discussed in State Street's 2012 annual report on Form 10-K and its subsequent filings with the SEC. We encourage you to review those filings, including the section on risk factors, concerning any forward-looking statements we make today. Any such forward-looking statements speak only as of today, April 19, 2013. The corporation does not undertake to revise such forward-looking statements to reflect events or changes after today. Now I would like to turn the call over to our Chairman, President and CEO, Jay Hooley.

Thanks, Valerie. Good morning, everyone. Before I get started, I just want to acknowledge the horrific tragedy that's beset our great city this week, and just say that our thoughts and prayers go out to everyone that's been impacted through this event. As Valerie noted, our remarks will follow the financial highlights slide presentation that we issued with our earnings press release this morning. And I'll focus my comments on our operating basis results and primarily on the sequential quarter comparisons since those seem to be of most interest you. I'm pleased with our first quarter financial results. State Street benefited from stronger-than-expected equity market performance and increase in foreign exchange market volumes and continued strong expense controls across the organization. We continue to bring on new business and our pipelines remain strong. If I take you to Page 3, on an operating basis, first quarter 2013 earnings per share was $0.96, which is a decrease of 14% from the fourth quarter of 2012 and an increase of 14% from the first quarter of 2012. It's important to note that the first quarter of 2013 included the effect of $118 million pretax or approximately $0.19 per share after tax of equity incentive compensation expense for retirement-eligible employees and payroll taxes. Our revenue was slightly higher than the fourth quarter and was 2% greater than the first quarter of 2012, driven mainly by improved equity markets, higher trading services and new business, including the Goldman Sachs acquisition, offset by lower net interest revenue. Our core fee revenue comprised of asset servicing and asset management fees increased about 2% to $1.4 billion from the fourth quarter of 2012 and more than 9% from the first quarter of 2012. Importantly, we produced positive operating leverage of 130 basis points compared to the same…

Thank you, Jay, and good morning, everyone. I'll begin my comments on Slide 7 of the earnings presentation, which shows a summary of operating basis results for the first quarter and unless noted separately, I'll be referencing only operating basis results. Revenue was up slightly in the first quarter of 2013 compared to the fourth quarter of 2012 and up 2% from the first quarter of 2012. The first quarter demonstrated our commitment to controlling expenses. Expenses increased 5.7% from the fourth quarter of 2012. However, excluding $118 million of equity incentive compensation expense for retirement-eligible employees and payroll taxes, expenses were actually down 1.2%, and we achieved 145 basis points of positive operating leverage in the sequential quarter comparison. Compared to the first quarter of 2012, we achieved 130 basis points of positive operating leverage. Earnings per share of $0.96 decreased 13.5% from $1.11 in the fourth quarter of 2012 and increased 14.3% from $0.84 in the first quarter of 2012. As you may recall, there were several items totaling approximately $36 million on a pretax basis or $0.06 per share that favorably affected our results in the fourth quarter of 2012. The first quarter of 2013 included a negative impact of $118 million on a pretax basis or approximately $0.19 per share of equity incentive compensation expense for retirement-eligible employees and payroll taxes. Return on equity of 8.9% decreased from 10.3% in the fourth quarter of 2012 and increased from 8.6% in the first quarter of 2012. We purchased approximately $360 million of our common stock during the first quarter at an average price of $54.95 per share, resulting in approximately 463 million average fully diluted common shares outstanding during the first quarter, a reduction of 4.7 million average shares in the sequential quarter comparison. Now let's turn…

Thanks, Ed. Let me briefly close our call with 3 points. First, in the first quarter, we delivered good results amid rising equity markets in a persistently low interest rate environment; we continued to aggressively manage our expenses while maintaining a high quality of service to our clients; and we remain confident in the secular trends that underpin the prospects for growth in our business, and I believe that we're focused on the right value drivers. With that, Lisa, we'll open the call to questions.

[Operator Instructions] And your first question comes from the line of Howard Chen with Crédit Suisse. Howard Chen - Crédit Suisse AG, Research Division: Thanks for hosting the call, I know it's a challenging week up in Boston, Jay. My first question is a question of balance sheet size, Ed. Just given all the puts and takes to begin the year that you and Jay walk through, I was hoping you could comment from where you are now, what would you characterize is seasonal and frictional rather than the impact of new core business installation?

Well, that's a little hard to say. I think it's a combination of clearly some new business, but it's also, I think, a combination of the world being fairly awash in liquidity. I think we're seeing some of the customer deposit flows because of that, because of both factors really. I mean, we saw average deposits up about $6 million over Q4 and TAG had the effect of bringing deposits down about $7 billion, which was in line with what we expected. So we're seeing, I'd say, more liquidity, a greater increase in Europe. The non-U.S. deposits are, we think, awaiting reinvestment. And I would say that that's probably in the temporary category, to your question. But in the U.S. we're seeing deposits up around $1 billion, but that's net of the TAG outflows, so we've seen about $8 billion of USD inflows. We're also seeing another trend, a little bit of a trend, I guess, where the U.S. deposits, half of them are coming into interest-bearing accounts which we think, again, is a reflection of excess liquidity being available in the marketplace, hopefully awaiting reinvestment, but looking for some investment that is obviously safe and relatively market yielding. Howard Chen - Crédit Suisse AG, Research Division: Great. And then shifting over to securities lending. I realize the business isn't is as large as it used to be. But we saw a seasonal lift but maybe not as much as we see in the past. Could you just talk through your current outlook for that business and maybe latest thoughts on some of the rule proposals we're hearing out of Europe?

The seasonal lift, Howard, you mean the dividend season? Is that what you... Howard Chen - Crédit Suisse AG, Research Division: No, I just meant 4Q to 1Q. I know that we usually see a bump up, Jay, just with the new year.

Yes. Yes, I think there is some bump up although, as you know, the dividend season, which is the real cyclical high quarter is about to come on us in the second quarter. But I would say generally, securities lending, balances have stabilized in the low-300. I think if you look at quarter-to-quarter, year-over-year, the effect of the downward pressure on revenue has been largely the Fed fund to 3-month LIBOR rate. So I would suggest that the business is kind of in a stable state, I think, waiting for a pickup in merger and acquisition activity which will have a positive effect on that and further leverage in the general financial services system would be catalyst for growth, in addition to any widening of spreads. Howard Chen - Crédit Suisse AG, Research Division: Okay. And then the second part of the question, Jay. Just thoughts on the rule proposals coming out of Europe, any latest views.

I think it's too early to tell. I think that there's a number of things that are circling around securities finance. But our outlook is really unchanged as far as the business continuing to be a good business for us over time. As the rules firm up, that may change, but no view as of today.

And your next question comes from the line of Robert Lee with KBW. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: First question I have is I'm just curious, if I look at the assets under custody and administration and clearly you've had some tailwind of favorable markets in new business. But I mean, the pension assets, the pension products there have been relatively flat for several quarters. And I'm just curious, I mean, could you address maybe what kind of mix you're seeing? New business wins coming mainly in kind of fund products and maybe it's the pension clients, where you're seeing some runoff of the clients or business?

Yes, it is a real mix. This quarter, which was -- I think, last year, we had total assets, new asset service of $1.2 billion, this quarter was $230 billion, so kind of an in-line quarter from a longer-term trend standpoint. 2/3 U.S., 1/3 non-U.S., that's a little bit different than what we've seen in the past. But I guess, more to your sector question, pension's kind of stable. We've had some good new business wins there, no losses that I'm aware of, so kind of a net positive. But as you know, in the pension segment, it's a pretty stable segment. Most of these are DB-oriented funds that aren't getting new flows. So on the other side broadly, the funds business, U.S. and non-U.S., obviously benefits from flows and all those things that happen when clients rerisk. And that pipeline and the successes have been very good and as you know in many markets, including the U.S. where a little bit of significant market share leader, and I think we continue to gain on that leadership. I just draw a little bit of a line under Dimensional Fund Advisors, which is a very significant U.S.-based, but with global products in the asset management space, and converting that business this quarter was a big win for us. And we would hope that they will continue to succeed. And with the success, we'll benefit from it as well. So again, we pretty diversified. The only other segment that I would call out would be the alternative segment, which -- and you see this in broad-based flows or asset growth. The alternatives continue to grow. And for us, the growth is twofold. It's -- we grow as the funds grow, we grow as we competitive -- we're successful in competitive new business wins, but also a good deal of that particularly private equity and real estate segment is yet well [ph] source. So that's why I continue to call it out because that should continue to be a ripe area for growth for us. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. And maybe just my follow-up. It's for Ed, this is a question in -- possibly it's that not big a deal and may be hard to quantify. But I'm just curious, I mean, I know in the -- probably in the ETF business and some of the funds business and maybe even net interest revenue, there is a little bit of an impact from day count just there being a few -- a couple fewer days in the first quarter. Is there any way of quantifying what that impact is on revenue at all?

Yes, there is. I mean, we think about that frankly more from the perspective of net interest revenue. I don't have that number at my fingertips, Rob, but absolutely, there's an impact in terms of day count. We're looking for the number now. I don't know if we have it immediately available. I could certainly follow up with you after the call.

And your next question comes from the line of Ken Usdin with Jefferies. Kenneth M. Usdin - Jefferies & Company, Inc., Research Division: Ed, I wonder if you could just talk a little bit about just on the servicing line side, did you have any negative impact from FX translation this quarter? And can you -- Jay, I heard your comments about starting rerisking in the beginning quarter and then a little bit of tailing at the end. But just kind of what were the core drivers of the servicing line? It certainly was up nicely, but not as much as it seemed like people were looking for, so what are the key drivers?

Yes, let me start that, Ken. Well, I was looking for a number here. So servicing is up, I think, 2.2% sequentially, 9% year-over-year. So a good year-over-year growth, decent sequential growth. You'll also note that the first quarter is a pretty big installation quarter for us when you think about what was left from last year and what we installed that we committed in the first quarter. So I think on the rerisking, Ken, if I were to walk you through kind of a monthly scenario, which largely mirrors what you see in the U.S. mutual fund industry. We exited last year, December was kind of a peak quarter that traveled through January, February and March, tailed off a little bit, but still running stronger than we've seen in prior years. So I guess the other little nuance would be that as opposed to a rotation, which is flows out of fixed income and into equities, it's been more coming out of cash products. And I suspect not just money funds but other bank cash products has been fueling the little equity run that we've had here. So it's been kind of a tumultuous couple weeks here in the global environment. We'll see what -- how the rest of the quarter plays out, but it does feel a little bit different than years past with regards to some level of resiliency in investor behavior even though we've come off of the peak of the December, January months.

Yes, and Ken, the answer to your question in terms of currency effect on total revenue, it's fairly immaterial. It's about $10 million down sequential quarter and $14 million down year-over-year first quarter to first quarter. So not much. Kenneth M. Usdin - Jefferies & Company, Inc., Research Division: Got it. And then my second question, just kind of a similar question on the asset management fees -- on the fee -- on the asset management fee side because there you did the -- also positive flows, positive AUM growth. I was just wondering, was there any delta in either performance fees, or why did that line not grow more sequentially given the better backdrop than the AUM growth?

Yes. So that was -- sequentially, it was fairly muted year-over-year, up 11%. The flows within the story would be positive on the security finance-led cash collateral pools. The FX -- the ETFs was a little bit of a mixed story, so we had -- as we've been telling you, we're creating and innovating new products in Europe and the U.S. We saw some good growth in Europe. But the offset was you've seen gold prices and therefore, we've seen some outflows into gold, so that was a little bit of a negative on the ETF side. And you also -- we typically see year end a little bit of a run-up in the S&P 500 ETF, which came off in the first quarter. So those are kind of the quarter-to-quarter trends that occurred. I point you a little bit to the 11% year-over-year and say that we feel pretty good about how that business is progressing. We think we're in some of the sweet spots of the market, passive and ETFs, in particular, albeit, there was a little bit of a muted quarter-over-quarter growth in management fees.

And your next question comes from the line of Glenn Schorr with Nomura.

First one is just a quickie on the average balance sheet. The biggest driver, I think, on the NIM decline is the decline in the other investment line. Just curious, down, what, 16 basis points quarter-on-quarter. Just curious what is producing the biggest drop there.

Those are loans we have out to custody clients, collateralized loans that are driving that, as well as our Boeing [ph] investment, nonportfolio assets.

And what's -- is it just utilization that's the biggest driver of the movement because...

Yes, it's episodic.

It's episodic. But it's episodic in size, but also you're saying the runoff and that just pushes the yield down.

Yes.

Okay. Other one was, just curious if you can frame even in round numbers what the Goldman acquisition added to revenues, expenses and thoughts -- early thoughts on client and revenue retentions thus far.

Yes. I mean, Goldman is -- the acquisition is progressing right on track. We announced that and said it was about $120 million annual revenue business with a margin in the range of 30% to 35%, and it's right on track. And in terms of client revenue retention, we're exceeding the 90% target that we put out for every acquisition that we do. So nothing but good news on the Goldman Sachs Administration Services acquisition.

Okay, that's good. And it sounds like it might have been a modest contributor to the positive operating leverage, but the core is still there and good.

Absolutely. Right on both counts, Glenn.

And your next question comes from the line of Brian Bedell with ISI Group.

Just to go back to the core servicing line. Ed, you mentioned $10 million revenue impact from foreign currency translation. Is that mostly in the servicing line? And then, if you could talk a little bit about the pace of installations. You've installed the large DFA business during the quarter. And inclusive of the other installments from the very strong fourth quarter, should we expect a lagging benefit as we move into the second quarter on the servicing line?

Yes. The -- it was, as I mentioned earlier, a pretty strong installation quarter given the tail of what was left from 2012 and implementing a good deal of what we committed in the first quarter. In the case of DFA, not completely installed but a good chunk of it installed and should layer in, I think, through the course of the second quarter. So kind of all else equal, yes, we should see the benefits of that roll forward as we move through the year.

Okay, great, that's helpful. And then my follow-up would be just on the balance sheet investment strategy. I know that you highlighted a 1.05% reinvestment yield. It's a lot lower than the fourth quarter. I guess, is there any change in strategy in terms of trying to shorten the duration or improve the credit quality that's driving that compression? I know the yields are down in general, but that seemed like a larger drop than I was expecting for the reinvestment.

Yes, no change in strategy, Brian. We're of the same mind that we've always been, which is investing through the cycle and keeping the portfolio in the range roughly 50-50 fixed-rate and floating-rate. And it's just a question of the market opportunities that we saw in the quarter, so no change there. Back to your earlier question, about 1/3 of that $10 million effect is in the servicing fee line for the quarter.

And your next question comes from line of Alex Blostein with Goldman Sachs.

I was hoping you could help us reconcile, I guess, what you're seeing as far as the environment and what's going on with the servicing business, I guess, versus what we're seeing which is the revenues. So, Jay, I guess on the one hand, you described a little bit of a better risk appetite environment and clearly better markets, and it seems like the middle office in the alternative solutions continue to win a largest share of total business which again, feels like all should result in higher fee rate. Yet we haven't seen that, and it doesn't sound like in the near term that's going to improve. So I was hoping you could help us reconcile that and maybe it's the other part of the business that is maybe seeing more pricing pressure, or the business that you guys are winning doesn't seem to be all that different from a pricing perspective relative to kind of like the a core custody business.

Yes, So I think that's a multi-headed question, although I do -- I continue to remind you of the sequential quarter versus year-over-year, where there was good service fee growth. So I think some of this can't be read into a specific quarter-to-quarter comparison. But generally speaking, the environment, I think the pipelines are good and I think that's a reflection of -- in the asset management world and the alternative world and then the pension world, the asset-owner world, clients are continuing to outsource more work to us. We continue to do better than hold our own with regard to -- on the competitive front. We're continuing to introduce new products to differentiate our service offering. And in concert with that, the pricing environment, I don't think it's changed much, but we've become more disciplined with regard to bidding for new business, with regard to making sure that we're extracting a fair economics from our customers for the value that we're providing. So I think that begins to frame it. I think the risking behavior, as I said, has been episodic but better than last year. And I think if you look at the year-over-year 9% increase in servicing fee, some of that is reflective of a better risk environment. I think that the thing that we're all waiting for and hoping for is that this follow through not only on the move to equities, which we've seen some evidence to, but at some point, you're going to see flows come out of fixed income into equities. And I think that given our position particularly in the asset servicing for asset manager space, we have expectations that that's going to be a good thing once that starts to happen, hasn't happened yet.

Got it. And then on -- just wanted to go back for a second on the ETF activity we're recently seeing with your business. It seems like first -- second quarter to date, total AUM is down in the $14 billion-ish range and a lot of is yield-driven. I was hoping you can maybe give us a sense of on a net basis, what does that to do to your earnings? I know it's not big numbers, but I think the fee rate that you guys collect on the actual management is a little bit higher relative to what the net impact is because I guess of some of the expenses. But just kind of help us understand that $14 billion of outflows you show in the ETF business, what the net impact of that could be.

Yes. So to begin with, not really material, but if you look at that GLD product, we share management fees with the Gold Council, and I think we're in a 14 basis point-ish range for what we -- the revenues that we derived from that, so that gives you a little bit of sense of the dimension of the effect.

And your next question comes from the line of Mike Mayo with CLSA. Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division: I see on Slide 7 of the presentation, you're now including the pretax operating margin, so I see that increased -- I know it's your focus. But I'd like the extra presentation, and that's my question. So if you back out the accelerated options expense for the quarter, that pretax operating margin on the Page 7 goes from 26% to what? I guess it goes to 31%, is that correct?

About right, yes. Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division: And then your goal, as pointed out, I think, in Slide 36 from your Investor Day presentation, you talked about the core margin in 2010 of 27.5%, your goal is to improve that by 400 basis point. So your goal is 31.5%. So it's 31% core this quarter, and your goal is 31.5%. And then if you have about $400 million of additional savings from the IT project, all-in, if it drops -- just reduce expenses and that's it, I get a number of 35% pretax operating margin. So if you can correct my math or if you can caution us about potential headwinds you're concerned about as for the reason not increasing that target.

Well, I mean, we put the 400 basis point margin target out there, Mike, predicated on 2010's results and as caveated by saying all else equal and obviously, all things are not equal. It's always a little bit dangerous to take a quarter and project it out over a multi-year program. I can't disagree with the math you ran through in terms of -- if you excluded $118 million of expense from the quarter, the margin would be higher. But however, that expense would have to be recognized over the succeeding quarters and years. I mean, our normal amortization period is the vesting period for those awards. So the expense would be over the next 16 quarters, okay? So you have to recognize there are some moving pieces here and to look at the first quarter and say, we're already at or close to our program target is, I think, a bit of a leap. Now we're not signaling by that answer that we think the target is not achievable. We believe we're going to get the $575 million to $625 million out of the expense base, but that's going to occur over time, and we would expect the margin to improve over that period of time in line with what we originally said, not looking at just the first quarter. Michael Mayo - Credit Agricole Securities (USA) Inc., Research Division: Okay. Well, just making that 1 adjustment if we spread that over quarters you said, 31%, I guess, should be 30% this quarter and 34% once you have all the savings just by the math. So my follow-up question is, your goal is to become the low-cost producer. What would you perceive as a pretax operating margin for the low-cost producer in the processing business?

Well, I mean, we've been reluctant to put a number out there for what the low-cost producer is or on our operating margin target other than to quantify what we think the effect of the program will be on the margin, again, all else equal, predicated on 2010. I mean, clearly we think we're making good progress on the project. Clearly, we think we're improving the margin. I think you can see that through the first 9 quarters of the program and its implementation. But to date, we have not put an operating margin target out other than what we've said about its effect on the -- the program's effect on the margin.

Mike, the other thing I might add to that is the -- we do aspire to be the low-cost producer in those activities that have become more standardized and commoditized in the business. And we think that our IT and ops transformation program is aimed right at that. Additionally, by layering in the cloud environment, we also think we're able -- be able to be a lead producer of new products and new capabilities in this business. So the goal is really to make sure on those core activities that we do have the lowest unit cost in the marketplace, but we're continuing to invest through the cloud environment to make sure that we're differentiating our products so that we can have pricing power on the other end. I mean that's the magic combination is to be the -- you have the lowest unit cost but also be the most effective innovator on the product side. We think that's the best combination for us going forward.

And your next question comes from the line of Luke Montgomery with Sanford Bernstein. Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division: You were targeting NIM of 1.3% to 1.4%. Now you're kind of pointing to the low-end of that range. It's only Q1, you're already at 131. So I'm trying to gauge your confidence that you can maintain that guidance going forward.

We're pretty confident, Luke, that if, in fact, the assumptions that I articulated relative to portfolio size and balance sheet size and customer deposit levels, prepayment speeds, et cetera, play out, that we'll be able to hit within that guidance. And remember, we're talking about our expectation for the year being a net interest revenue decline in the range of $150 million versus 2012. So we're confident that will be able to do that given those assumptions. Luke Montgomery - Sanford C. Bernstein & Co., LLC., Research Division: Okay. And then I want to return to Alex's question on middle office. Given your commanding market share there, it doesn't seem to be a commodity service at this point. So it's sometimes confusing that you've communicated that the fees you charge for that don't look much different from the back-office outsourcing. You said you're getting paid fairly for their value you provide, but can you just remind us why you can't charge more for this suite of services.

Yes. Luke, we don't, in any single instance, offer middle-office servicing as a standalone. So it's -- I view it as it's an enhancement to our overall bundle of services. And you're right to point out that we have a significant market leadership in that, which translates into when we're competing for new business, we do well. We compete very effectively because we have the best capabilities. And the more differentiated you are at the point of sale, the more you can hold price. So I think that that's how that translates. I think in very complex opportunities that have a middle-office component, we're highly successful where we attract -- where we really want to win the business and pricing is pretty good because we're differentiated.

And your next question comes from the line of Cynthia Mayer with Bank of America Merrill Lynch.

Maybe one micro question, one big picture question. The micro question is just on expenses. The drop in other category was really noticeable even apart from the unusual expense in 4Q. So you guys mentioned professional fees is the main factor in that. Is that a sustainable level, or would that bounce back seasonally or with some projects that you plan?

Well, our focus has been very significantly on that line among others. But in the fourth quarter to first quarter decline, we did have a lower level of professional services. We're not expecting the professional services spend the bounce back to what was in prior quarters, but it may increase somewhat depending on the situation, okay? There are consulting costs in there, for example, for evaluation of regulatory initiatives, things like that. So there may be some increase in the future, maybe it's more of a timing question to some of these expenses from -- that went down in the first quarter, but it's absolutely a line that we're looking at very hard and are trying to make sure that we do not see a rebound in that expense line above what we think is absolutely necessary to comply with the regulatory initiatives, for example.

Okay. And then bigger picture, you mentioned you're focused on growing your ETF business in Europe. And I'm just wondering if you could give some color on that, talk about -- are you targeting certain market shares, certain parts of that market, certain products? What is your strategy over the next few years to be bigger in Europe?

Yes. So I would add to that, Cindy, Asia, as well, but a little bit more focus on Europe. So the strategy is to participate in an evolving market opportunity. And I do think, when you look at the ETF business globally, the world is -- Europe is underweight in ETFs, and so we're starting to see those opportunities unfold. And I would say that the way we get at that is really twofold. One is through introducing differentiated product to the market. So we've introduced, I think, it's 40 products over the last 18 months. I'd say creative and innovative products, which are commanding higher fees. So part of our strategy is to not be as much in the commoditized end of ETFs, but be in a differentiated end. A large part of which revolves around the portfolio strategy. But equally important and sometimes not understood, there's a distribution into that. So the distribution in Europe is largely through private banks and other intermediaries. And as a result, we've added wholesalers and distributors in Europe, so that's part of the buildup. I think that's largely in place, so it comes to continuing to introduce new product and distributing it through those wholesalers. So we think the opportunity is emerging, and we think we're well positioned for it. And I would say Asia is a story that's a few innings behind that whole story, but the same thing should unfold.

And your next question comes from the line of Bryan Foran with Autonomous Research.

I guess, I hope this doesn't come across as like too simplistic a question. But if I just think about 30 years of trust bank data, not just you but the whole industry, I mean, it just seems like the operating margins have always been about the same level. And I guess, if you step back and think about these as scale businesses and all the investments in technology, why isn't there at some point in the future kind of a step-change up in operating margin? It just seems like for a lot of investors maybe part of the frustration with the whole industry, certainly not you alone, is the benefits of scale never seem to have accrued?

Yes, so let me take a swing at that, Brian. I think for a long period of time, decades, these were growth businesses where markets were growing, new products were being introduced, and there was plenty of opportunity to grow top line and there was enormous need to invest infrastructure domestically, globally, product-wise. I think part of that run-up on the revenue side introduced market-driven revenues to that mix. And then if I just pick a point in time, the last 5 or 6 years, postcrisis, market-driven revenues have declined for all the reasons that we all know. We've all been working on, I'd say, as an industry adjusting to a lower growth environment, which means -- my interpretation of it means we need to get more efficient. We need to be that low-cost producer in that core activity, yet there's still an enormous need to invest in the business. So I think we're -- for State Street, I'd say we're working through a period, where we're adjusting to a lower growth rate, which we think is more temporary than permanent. And there's a lot of things that we spoke about change in environment, whether it's rerisking or some of the market-driven revenues improving. A point to NIR is just a specific and important one. As we get our infrastructure more designed for lower growth environment and the environment changes and we stay disciplined on the cost side, then we think we can change the mix going forward. So I think that's a little bit of where we've been, and I think the transition of what we're doing in this period is trying to become -- is becoming more efficient, more effective. While still investing in the business, we think that, at some point, it will cycle out, and we'll see improved environment, and we'll be in that improved environment with an improved infrastructure. So that should give us the opportunity to generate more returns, which will bring to the bottom line and invest to further distance ourselves from competition would be kind of my streaming thought on that.

And one follow-up on OCI. Do you think, as we move forward with Basel III ratios and maybe with a rate backup scenario and future stress test, OCI will kind of change in any way, be potential for buybacks in the future? And within that, did regulators think about OCI on short-duration securities books the same way they do on longer-duration securities books? It just seems like even in the severe interest rate stress scenario, a lot of the OCI risk in your portfolio would fix itself in 1 year or 1.5 years.

Yes. I don't know exactly what the regulators think. I tend to have a view that OCI is OCI at this point. It doesn't really get differentiated between longer-term and shorter-term securities. At least, we haven't really heard anything to that effect. The issue of OCI on a go-forward basis and its potential effect on buybacks, I mean, there is information submitted as part of the CCAR, which does include Basel III-related information. I mean, the official test and the statistics published are Basel I, but the regulators do view our balance sheet under a Basel III regime. So the mark obviously in the Basel III capital ratios is included. I think too, from our perspective, the potential for its inclusion on a go-forward basis with the rules not yet being final, Brian, is one of the main reasons why we put a 200 basis point cushion on top of our 8% requirement, which includes our SIFI buffer. It's because of that uncertainty in part that we've done that. So I guess the punchline is that we need to see what the final rules ultimately are, and we'll look at those and formulate a view on what our Basel III Tier 1 common target going forward should be.

And your next question comes from the line of Betsy Graseck with Morgan Stanley.

Just a quick question on the cost saves from the cloud investment. You're expected to have a $220 million benefit to earnings this year, and I'm just wondering how much of that was used up this quarter.

Well, we achieved about $50 [ph] million of the $220 million in the year. I think a linear view of that achievement is what we expect and would expect to see roll through the succeeding quarters of the year, Betsy.

And your next question comes from the line of Josh Levin with Citigroup.

With all the work you've been doing on expenses, how much of your core cost structure would you say is fixed versus variable, and how would that compare to maybe 1 or 2 years ago?

Well, again, it's always a question of what time frame, Josh, right? And I think that probably the best way to think about is over a relatively short time frame, i.e., a couple of quarters, maybe a year. And we can look at a couple of different lines on the income statement and talk about them in terms of how much is fixed and how much is variable. I mean, the largest one obviously is the compensation line, and that is a function of how many people we have, and we've been taking action on that line over the last couple of years given what our view of the revenue environment is. So you could say, at least, a portion of that is variable given the assumption of a year or so time frame. I think that the other line that we've been looking at very carefully over time is the other expense line. Some of that is actually not really very variable given that there's some amortization of intangibles in that line, for example, which are based on prior acquisitions. But there are other expenses as we had in the first quarter that are in fact variable, which are the professional fees that we had a very good performance on as we've noted. And then maybe in between that is transaction processing, which can vary with market levels and transaction volumes. Usually, we have offsetting movements in revenues, so it kind of nets to a profit if the transaction servicing line goes up. There's a revenue item that's up more than that, and the converse is also true. But I'd say, overall, it's an expense base which over a short to intermediate term, while has some variability is for the most part, a fixed cost expense base. I'd be hesitant to put a percentage on it, but that's how we think about it. I mean, I would put another statement out there, which is our IT expense, which is both people and machines and licensing fees, and we can move that over time, and I'd say over -- again, the year's timeframe. Between the operating range of 20% to 25% is -- which is what we target of expenses, so that's a number that's in the range of $1.4 billion per year, that includes people. So that can be moved around, and that's a function of demand and regulatory imperative certainly lately and the need to continue to invest in the business and develop new products.

Okay. A week or 2 ago, you made an announcement you're appointing a new senior executive to work on. I think it's sort of a big data initiative. I was wondered if you could talk about the size and timing of that opportunity.

Yes, sure. It was -- we introduced a new set of services under global exchange. And you're probably right generally relate it to big data. I think the -- within our business, within our businesses, we have a number of different products and services, which are analytical in nature, data-driven analytics for risk management, for performance management compliance, and we've decided to pull those together into a separate unit so that we could focus more directly on what we think is a pretty big opportunity, which is more in the middle office space. I'd say middle-office and front-office space on the back of our middle-office position, and more and more of our clients as we listen to them are challenged by the need to rationalize their data to make it more available on a real-time basis. And in many cases, we are the ones that have that data. So we formalize the structure that we think will launch us into that space, and we're pretty excited about it, but it's going to take some time to sort out exactly how we position the strategy. But we've given it some heft with the existing structure so that we'll have some ability to invest in this new area. And it is -- it does have a big data orientation to it.

And your final question comes from the line of Jim Mitchell with Buckingham Research.

I just had a quick follow-up on the expense side. Your compensation expense, I know, Ed, you talked a lot about the other line, your compensation composition expense is down 2.7% or 2.8% year-over-year. Given your outlook on the revenue front, assuming that stays the same, I know it can be tough with -- incentive comp bounces around. But do you think that kind of year-over-year decline is sustainable for the rest of the year, or it's too early to be able to give any kind of guidance there?

I think it's really too early. I mean, obviously, we're pleased with the 2.7%, again, reflective of the achievement on the Ops and IT program, as well as the effect of the reduction that we announced in the fourth quarter. But I think it's too early to give you an answer to that question right now.

Okay. And then on -- just one last on the deposits. Have you seen further deposit outflows in the second quarter, or given your kind of discussion on average earning assets, are you seeing it kind of stabilize here, and that's part of the issue?

We're seeing it fairly stable.

This concludes today's question-and-answer session. At this time, I would like to turn the call back to Mr. Jay Hooley for closing remarks.

Yes. Thank you. Thanks all for being with us here this morning. And we look forward to talking to you at the end of the second quarter. Thank you.

This concludes today's conference. You may now disconnect.