Good morning and welcome to State Street Corporation Second Quarter 2023 Earnings Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website at investors.statestreet.com. This conference call is also being recorded for replay. State Street's conference call is copyrighted and all rights are reserved. This call may not be recorded for rebroadcast or distribution in whole or in part without the expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on State Street's website. Now I would like to introduce Ilene Fiszel Bieler, Global Head of Investor Relations at State Street. Please proceed.

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 second quarter 2023 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 two questions and then re-queue. 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 measures are available in the appendix to our slide presentation, also available in the IR section of our website. In addition, today's presentation will contain forward-looking statements. Actual results may differ materially from those statements due to a variety of important factors such as those factors referenced in our discussion today and in our SEC filings, including the risk factors in our Form 10-K. Our forward-looking statements speak only as of today and we disclaim any obligation to update them even if our views change. Now let me turn it over to Ron.

Thank you, Ilene, and good morning, everyone. Earlier today, we released our second quarter financial results. Relative to the significant volatility experienced by investors in the first quarter, market conditions in 2Q were more subdued and global financial market performance is varied. Global equities generated positive returns for the third consecutive quarter as investors saw continued strength in developed equity markets, but weakness in emerging markets. Fixed income market sell as investors had to contend was still elevated levels of inflation and further central bank rate hikes, including the Federal Reserve raising interest rates above 5% for the first time since 2007. The second quarter was also characterized by falling currency market volatility, which created headwinds for our foreign exchange business. Turning to slide three of our investor presentation, I will review our second quarter highlights before Eric takes you through the quarter in more detail. Beginning with our financial performance, second quarter ROE was 13% and pre-tax margin expanded by 1.2 percentage points year-over-year to 29.5%. Relative to the year-ago period, 2Q EPS increased by 14% to $2.17 supported by our common share repurchases, significantly higher NII, strong front office software and data revenue growth and an increase in securities finance revenue. Our results also benefited from the release of an allowance related to the support of a financial -- US financial institution as well as an accounting adoption. Taken together, these factors more than offset headwinds in some of our other fee-based businesses and the impact of higher-than-desired year-over-year expense growth. Turning to our business momentum, in Q1, I highlighted that by strengthening our implementation capabilities, we have a line of sight into a meaningful amount of client onboarding this year. We began to realize the benefits of this plan and onboarded $1.2 trillion of AUC/A during the…

Thank you, Ron, and good morning, everyone. I'll begin my review of our second quarter results on slide four. We reported EPS of $2.17 for the quarter, an increase of 14% relative to the second quarter a year ago. As you can see on the left panel of this slide, revenue grew by 5% year-on-year, driven by the expansion in our front-office solutions area, where we are an industry leader, continued momentum in securities finance business as well as strong growth in net interest income. This growth enabled us to offset some of the headwinds we saw in other fee areas given the relatively mixed macroeconomic backdrop. We also had the benefit of an accounting change for tax credit investments, which simplifies our reporting going forward. While our overall year-on-year fee growth was less than we would have liked to deliver, we did see sequential quarter revenue momentum and a step up in the sales pipeline, which we expect to build upon in the coming quarters and which I'll discuss later in today's presentation. As we drive growth, we continue to prudently invest in the business while remaining focused on managing costs given the current operating environment, and we stand ready to further intervene on expenses should the softness in the global environment persists. Turning now to slide five. We saw period-end AUC/A increased by 4% on a year-on-year basis and 5% sequentially. Year-on-year, the increase in AUC/A was largely driven by higher period-end equity market levels and client net inflows. Quarter-on-quarter, AUC/A increased as a result of the significant trillion-dollar Alpha installation and higher period-end market levels. At Global Advisors, we saw similar positive dynamics play out in the quarter. Period-end AUM increased 9% year-on-year and 5% sequentially. The year-on-year increase in AUM was largely driven by higher period-end…

Thanks, Eric. Operator, we can now open the call for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions) And our first question comes from Brennan Hawken from UBS. Your line is now open.

Good morning. Thanks for taking my questions. Eric, I'd like to sort of double-click on some of the comments that you made about deposits. So you talked about back-book pricing in the US dollar book. Does that mean that we should be thinking about the potential for betas to exceed 100% here when that starts to work through? And what kind of magnitude do you think that could reach? And could you also help me understand the euro because when I look in the financial supplement in the breakout by currency, it looks like the euro deposit costs were up about low 40s bps quarter-over-quarter which seems like a beta that's a good deal, higher than the 50% you referenced. I know there's some swap noise so maybe that's what it is, but could you maybe flesh that out a bit for me?

Brennan, sure. Let me start on the on the betas that we saw in particularly on the US book because we are at a period in the interest-rate cycle where we've now had multiple 50 basis points moved. It's been a very strong signal to our clients that rates are much, much higher and much more quickly and much more visibly. And at the same time, they now have because of that highly inverted yield curve, they have real substitute alternatives that they used to not have in the past, whether it's treasuries, whether it's money market, whether it's repo. There's a range of what they can invest in. And what we found is that our larger clients and you know we primarily have large sophisticated clients are quite active and thinking about their alternatives and then that has been accelerated by the swiftness of this cycle and the place that we've come to and the speed. If we think about the US deposit betas, they were in the 80% to 90% range last couple of quarters. This quarter we saw 100% and, yes, we expect next quarter we'll be well over 100% and what's driving that is really a catch-up in the back-book. We have clients coming to us as you'd expect, just like it happens with retail deposits for retail banks, but we have sophisticated large clients coming back and saying, look, some of our lower transactional rate levels or mid-tier rate levels are something that they like us to adjust. And in a way, what I think we -- has played out is that while spreads widened for us on the deposit, but for some period of time, we're now seeing a convergence back to where they would have been. And that's coming through and so what…

Okay, no problem. And then another question just quickly on fee revenue. You flagged that the large client migration is going to be part of the outlook. How much of that will be impacting the third quarter delta? And then how much will be -- how should we be thinking about the timeframe for whatever is left and when that would end up playing out?

Yeah, I think the broader context, as you recall, Brennan, is that we disclosed that large client deconversion was going to happen over multiple years. We announced it well over a year ago and we described it in our K at about 1.7% of fee revenue. So you can calculate that through. I think in our fourth quarter earnings call in January, I described that we had seen about $20 million on a run-rate come out, but I can reconfirm that. In the next quarter third -- this coming third quarter we'll see about $20 million come out sequentially. And then in the fourth quarter, there's another piece of about another $15 million that will come out as well. And then after that, it's several more quarters before we see the later and final installments. But that's incorporated into our guide.

Okay. Thanks for taking my questions.

Your next question comes from Alex Blostein from Goldman Sachs. Please go ahead.

Hey, good morning, guys. So just maybe staying on the deposit question for another minute. Why do you guys think this catch-up happening now sort of late in the cycle? We've obviously been in a higher rate environment for well over a year. So curious if you can provide more color on particular customer segments in the US that's driving that and sort of the discussions around that? And then maybe as you sort of think about the end state for US interest-bearing deposits, I think, you're at 3.5 or so today. The cumulative beta on that is, I think, is around 70% relative to the Fed funds rate. Should we think of that approaching, I don't know, 85%, 90% kind of how do you think about where that deposit price in the US will stabilize?

Alex, it's a good question. I mean, we're clearly navigating and living through an interesting environment that we've not seen in two decades, right? You've got to go back pre-crisis before you see 5% prevailing rates. I think if you -- if you also think about how swiftly we've gotten to where we are, that's why we created -- we put some of this information back on page 16 in our materials. You see this cycle has moved twice as far in terms of the uptick in rates in half the time of the last cycle. And so what plays out as that happens is that we always have clients that, as rates move up, they begin discussing with us and engaging with us on what would be appropriate maybe putting in place multiple balance tiers, having discussions about their expectations, we negotiate and so forth. And you can imagine large client discussions occur over three, six, sometimes even nine-month periods. And so if you kind of turn back the clock and say, when did some of those discussions occur, some of them early ones may have started second quarter of last year, third quarter of last year, fourth quarter of last year because there was also a perspective among our clients and us for that matter, that rates might continue to 5%, but they might have gone to 4% or 3%, which would have put us and our clients in a different position from a NIM and NII and rate-setting perspective. So I think it's really the speed of this that has played out and on one hand. And on the other, the inverted yield curve gives clients and the prevalence of the money funds and treasuries and so forth, give clients an alternative, right, that's more vivid, I'd…

Got it. And then like just the end game in terms of what you ultimately think US deposit cost is going to look like relative to kind of the 3.5 and the Fed funds at 5?

I think it's -- I've not calculated directly on a cost versus rate basis, on a NIM basis, but I guess we could back into it if it'd be helpful to you. As we think about the long range view of NII on our book, I've given some guidance for 3Q NII, for 4Q NII. I think our instinct is that NII will settle in this $550 million to $600 million range per quarter. And if it's helpful, we can try to calculate that back into spread on assets or a spread or a cost of funds on deposits and follow up with you.

I got you. That's helpful. Thanks. And my bigger picture question for you guys and to Ron as well as I think you mentioned productivity efforts in light of the fact that NII has clearly become a bigger headwind over the next several quarters and you guided servicing fees down in the third quarter. So as you think about measuring those productivities, are you solving for overall pre-tax margin stability? Are you solving for kind of fee margin stability sort of like ex-NII? How should we think about sort of measuring the productivity efforts in light of a more challenging revenue backdrop?

Yes. Alex, I mean, where we start with is, I mean, because what you're describing is outcomes of the productivity efforts where we've -- and these are not new, these are ongoing. We really start with how do we create more scale in our business. How do we increase speed, lower error rates, increase client satisfaction, take out manual interventions. So the measures that we're using would be the traditional productivity measures and this has been underway now for several years. You've been seeing the results in our -- and we've been able to manage costs certainly relative to others. But in terms of how we think about the business going forward, particularly given that NII is no longer a tailwind in terms of an outcome basis, we really think about the operating leverage, I think, is the key outcome we're managing to, if that's the question you're asking.

Yeah, the operating leverage. Got it. All right. Thank you very much.

Thanks.

Your next question comes from Rob Wildhack from Autonomous Research. Your line is now open.

Good morning, guys. Just trying to ask about the asset side and the securities book quickly. Decent uplift in yield again plus 21 basis points. Can you give some color, some numbers around the front book, back-book difference there? And how much repricing can sort of assist NII going forward?

Rob, it's Eric. There is a good bit of tailwind that comes from the front book, back-book. I think this on a kind of year-on-year basis, long rates were quite constructive from a year-on-year NII standpoint, the long rate tailwind year-on-year was in the $100 million basis. So it's quite substantial. On a quarter-on-quarter, the long rate tailwind is closer to $15 million, $20 million. So it's not insubstantial. And I think as we see some steepness in the curve come back or I guess I'll describe less inversion, we've got some, we've got abilities to leg into duration or curve position or, in some cases, some amount of convexity where we'd find it helpful. From a rate standpoint, like you said, average rates on the investment portfolio in aggregate was 270 basis points or so. The runoff is a good bit below that kind of in the 180 basis point range, so 90 basis points, 100 basis points south of that. And the roll-on that occurs is well above that 270 basis point average is closer to 410 basis points or more. So you've got a nice tailwind there that's playing through. We also have a tailwind on short rates for international currencies. So that's helpful. And then we are -- we continue to invest and think about opportunities across currency from a basis standpoint and so forth and we've got some latitude to do that as well given our global balance sheet.

Thanks, Eric. And then one more just on the operational deposits. If I use the numbers on page 10, operational or excuse me overall deposits are down -- operational deposits are down as a percentage of the mix. Conceptually, what would be driving that? I guess I'm confused as to why operational deposits would be down year-over-year more than non-operational deposits.

Yes. I think there's a little bit of -- I look at that data and I think you've got roughly similar movements in operational and non-operational deposits. I think what's happening in this part of the cycle is as deposits or I'll say, as cash for our clients is more valuable, right? They are selectively thinking about how much cash do I absolutely must keep in the -- in their custodial accounts. And if you think about it, they make that decision in, I think it's more than 100,000 different accounts themselves, right? It's a very large and disparate set of decisions and sub decisions by 100,000 plus fund managers and many, many fund boards. And so they're trying to see, hey, can I edge it down, and that's why at this point in the cycle, you see total deposits drift down, but also operational. What they end up needing to trade off and the reason why it will level off over time is that they need a certain amount of deposits that they don't overdraw. They -- fund managers really hate the overdraw at the end of day. And then there's also a governor where we engage with our clients on intraday and make sure that they have enough cash to cover their transactional flow and throughput, but we're just at the period where in the core custody accounts, you've got this drift downwards where they're trying to optimize without going too far and that's what you're seeing. But this is expected. We expect the operational deposits to stay comfortably in this kind of 75% range. And it's a part of the kind of custodial operations, which is what makes them so sticky, right, because they need to be there for the very significant daily, hourly and minute-by-minute transactional flows that we are processing on their behalf so that they aren't overdrawn.

Okay. Thanks, Eric.

Sure.

Your next question comes from Glenn Schorr from Evercore. Please go ahead.

Thanks, Eric. Maybe just a different attempt of the deposit discussion. So I get clients wanting more yield. I bought treasurers too, we all did. But is there any point where the client profitability discussion has teed. Like are they able to move 100% of non-operating deposits if they want, like what discussions you're having with them about doing more with State Street areas like FX like lending, alpha. But maybe you could update us on what you're doing to try to help impact what seems like you can't impact the deposit side. So is there anything else you can do?

Yes. Let me start there, Glenn, and I think Ron will weigh in as well because a number of us have these engaging conversations with clients. I think from a burn down standpoint, let me first take it from that angle is if you think about our $200 billion of deposits, we've got deposits at a number of different price tiers and we have kind of very large sophisticated clients and then kind of that large tail of small and midsized clients. Of the $200 billion, we think there's about $50 billion that we've been very focused on and continue to be focused on. So about a quarter of our total deposits are with these clients that as we've talked about the last couple of questions, there's been a real catch-up on the back book. I described that because of that $50 billion, which is either a very low price or zero price for our larger and most sophisticated clients, where we have these engaging and balance of trade discussions, right? We've around -- we've got about $25 billion that's behind us, where largely, we've repriced those deposits. We've had those discussions and some of those have come with some balance of trade improvements or some commitments on stability on fees, and those are behind us. Included in the outlook that I provide beyond the $25 billion, there's another $15 billion that's underway right now. That's included in my third quarter outlook, right? So that gets us to $35 billion, almost $40 billion of the $50 million. And then there's a trail that we'll still have. And so I think from a client discussion and negotiation standpoint, the third quarter we expect to be the peak. I think what you'll find is that each of these questions on deposits, certainly,…

Yeah, Glenn, what I would add to what Eric said is that the -- if you think about over the last four, five years, our focus on pricing has been -- initially was on fee pricing and kind of addressing, if not combating the fee compression and really working that in an institutional way and in a very high skilled way and escalating those -- or elevating those decisions way above where they used to be. Deposits for -- up until this rate cycle really weren't part of that because, I mean, there were times that we would just assume not have had the deposits. We've now integrated that as Eric has implied into that discussion, but also included a full share of wallet analysis. And the part of this is recognizing that these institutions are very large. And when you have a pricing discussion and putting that in air quotes, it really depends on what it is. And what we have worked to avoid is to not have a series of unilateral discussions without understanding and making sure that at the highest levels of our clients, they understand the impact of this. And just reminding them that you have the fee you have because of this assumption on other services that we're going to provide you or some assumption on deposits. And those conversations are actually starting to work well. It's caused a change of process for us, another change of process for us. But more importantly, it's changed in the way how we're engaging and at what level we're engaging with these clients. And so more to go there, but we also think it's a skill, but now developed, will help us through various kinds of cycles going forward.

Thanks for all that color.

Your next question comes from Steven Chubak from Wolfe Research. Please proceed.

Hi. Good morning. This is actually Sharon Leung filling in for Steven. Just on the deposits, outside of the rotation out of NIB, can you talk about the overall trajectory of total deposits, particularly because it looks like more recent liquidity drawdown has come out of RRP instead of deposits. So just wanted to get your thoughts on the expectations for the trajectory on deposits from here in the context of QT treasury issuance, et cetera?

Yeah, it's Eric. It's hard to really gauge the deposit changes outright. I think we're a little more focused on the net interest, I'm sorry, the non-interest-bearing deposits where we've signaled another $5 billion likely outflow this coming quarter. That's less of an outflow than in the second quarter. So you're starting to see some of the burn down that I've described. In the external environment, I think, from the H8 reports those banks, we've seen about a 2% sequential fall in deposits. For the trust banks, we tend to have more deposits coming in when deposits in the bank system increase and we have somewhat more coming out when deposit the bank system come out and probably just the absolute sophistication of our clients. So we're -- we expect a downtick in deposits again next quarter, but just been a little more focused on the non-interest-bearing because that's where it makes a big difference. I think there is always some movement in interest-bearing deposits, especially at the higher rate tier because what we're finding increasingly as we get to a little more of this as we expect to get to a time stabilization or at least a little more of a balance with our clients. Now what they're going to do is it's hard for them to move an underlying operating deposit that actually has to cover the hundreds, thousands, in some cases, tens of thousands of transactions that are flowing through their particular account, but sometimes they'll move the thin margin deposits to a treasury. And so we might lose 10 basis points on something and they'll pick up 10 basis points on treasury. So there's some of that that's going on. And I think in truth that's not as dominant as a driver of our NII at this point.

Thanks for that. And as a follow-up, just on some of the updated capital rules that are coming. I understand you probably won't be able to give much color because we haven't seen a proposal yet. But just in terms of like expected ways you might be able to mitigate some of that impact and which businesses might be more impacted for you guys?

Yeah, I mean, there's -- obviously, we're like many waiting to see more from the rules. We've -- the last time we saw Basel III and game draft from either the US or international regulators was several years back. So I think we've -- we expect some higher capital requirements, just hard to tell how much. We do think there'll be effects on different parts of our businesses. So the new rules will come with an operational deposit operational capital charge. That probably will be relatively hard to influence because we actually want to build our fee-driven businesses. And so those, I think, will just come with a capital requirement that's -- that will be an add. There'll be some reduction on the lending book, so that will be helpful. And then I think in particular, while the fundamental review of the trading book will affect the universal banks potentially in a negative way. For us, the sec finance business will tend to be a positive, will be in a positive territory where capital requirements will be less. We'll no longer need to hold capital to indemnify treasury. So they'll finally become economically more rational in the safer areas, right, as they should be. They should obviously -- capital needs to be held for the riskier activities. But we don't traffic in the riskier areas. And I think that, in some ways, that will give us an opportunity to grow those areas that are quite aligned with our client base like sec finance and actually deploy capital more actively. And so I think there'll be a mix of impacts, we're going to see as it comes through, but I like many were -- we're considering what's to come and we'll react accordingly as it does.

Great. Thank you.

Your next question comes from Brian Bedell from Deutsche Bank. Please proceed.

Great. Thanks for taking my question. Amidst Ron, I guess I wanted to come back to your comments on the, basically, the overall revenue per client, if I can sort of summarize it that way. Obviously, there are different components of how clients, the asset servicing clients pay for the business, and there are many different ways aside from the core fees that they can do that. So as you think about that across the client base, I know you have looked at this more holistically across clients over many, many years. But with the deposit beta going up, is that sort of revenue per client going down? Or do you think you're able to actually be able to improve the fee rate given that they aren't paying as much on the compensating balances?

Brian, it's a good question. And what I was referring to and what you're referring to is what I would call how we think about this tactically client by client, but I also want to come back to the strategic elements of this also. In terms of -- there's no one answer for any particular client because if you think about it, in the core back office business, you've got custody fund accounting and there's a pricing element to that along typically with associated deposits. In more and more instances, obviously, we've -- a client might have a middle office assignment with us where we're doing -- we are their back office and obviously going all the way to Alpha. And then there's the question of are we doing FX and securities finance with them? Obviously, FX is a function of are they -- do they have occasion to use FX? And increasingly, most managers do, securities finance manager, line managers. So the reason why I'm saying it's tactical, it's -- there's a holistic conversation that needs to occur here. And it's important on both sides, ours included, to lay out for the client that remember all we did for you over the past few years to get you through whatever fee challenges they were having, that was predicated on X. And X might be an assumed deposit level, it might be on an assumed FX level, X isn't playing out. We need to have a conversation on this. And that could, in cases, lead to more fees or it could and the more typical outcome is that, well, hey, we're not doing this with you, let's try and do that or even there's a set of funds over here that we've never talked about, whatever Cayman Islands or something,…

That's great color. And then maybe just on the expense side, Eric, you mentioned the expense levers. Are they more tactical in nature? Or do you see sort of an ability to reengineer -- continue to reengineer the cost base. You've already done a great job in reducing costs structurally over the last several years. I don't know if we're like mostly through that and when you do have the cost saves you reinvest them in growth initiatives? Or is there an ability to sort of reduce the overall cost structure?

Brian, let me address that first, and then Eric will comment. The -- we are definitely not through this. And by that, I mean, when we started down this journey a couple of years ago, we obviously addressed call it, which you want the lower-hanging fruit, the kinds of things that we could get at without a lot of technology investment, without a lot of reengineering, but there is more to do, and we're making a lot of progress on it. We've got people in place now on both the operations reengineering side and on the technology side that are working this through. The way this has played through in our results, you've seen what our expenses have been, but we've also been able to invest more in the businesses than we otherwise would. And we think that, that journey has more to go, and you'll see that and we'll report on that quarter after quarter. What we also talked about, though, is that there's some tactical things that we can do and should do just given the kind of outlook that we've described to you. And those would be less about reengineering and more about how do we think about short-term things like consensus and those things.

And just to round that out, we've got to pay for performance. So when we have larger -- we deliver larger sales, we'll pay for that when it's a little lighter. As you saw, we'll reign that in, and that's part of the execution mines that we have. We've also just given some of the evolution on salary increases and that we've all worked through over the last couple of quarters over the last year. We also feel like it's time where we have enough staff and so we've put in place a hiring freeze because we need to contain our staffing costs. So we need to make sure as we reengineer, we actually redeploy our folks to, say, new business areas or to growth areas and actually pair down others. And the way to do that in a more emphatic way tactically, right, is to be particularly disciplined on hiring, and freeze that or just limit it. And so given the short-term performance, we're doing that as well, which gives you a sense for our willingness to bend the cost curve.

That's great color. Thanks very much, Ron and Eric.

There are no further questions at this time. I would like to turn the call back over to Ron O'Hanley for closing remarks.

Well, thanks, operator, and thanks to all in the call for joining us.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation. You may now disconnect at this time.