State Street Corporation

Good morning and welcome to State Street Corporation's fourth quarter 2020 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 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 Eileen Faisal-Buehler, 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 Abloff, our CFO, will take you through our fourth quarter 2020 earnings slide presentation, which is available for download in the investor relations section of our website, investors.statestreet.com. Afterwards, we'll be happy to take questions. 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 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, Eileen, and good morning, everyone. Earlier this morning, we released our fourth quarter and full year 2020 financial results. Before I review our results, I would like to reflect on how State Street successfully adapted to the unique operating environment of 2020 and supporting our clients, communities, and the financial system, all while advancing and positioning the business for future success. 2020 was a year like no other in recent memory. As we entered the year, few could have predicted how volatile the operating environment would be as the health crisis precipitated by the COVID-19 pandemic resulted in a global economic recession, which the world is still dealing with. Against that backdrop, governments, central banks, and financial institutions like State Street needed to act quickly to assist in limiting the impact of this crisis on the financial markets and the global economy. 2020 also highlighted a number of racial and social injustices that we must act to address. When faced with these economic and social challenges, I'm proud of how State Street team members around the world lived our values of being stronger together and a trusted and essential partner to our clients and communities, all while generating solid earnings growth for our shareholders in 2020. As the pandemic worsened last year, Our global operating capabilities allowed us to adapt quickly and deliver products, services, and results for our clients when they needed us most. In addition to the client-focused product and service enhancements we made in 2020, we continue to transform our operating model by simplifying our operations, increasing automation, and driving productivity and efficiencies while continuing to invest in our business. State Street has been on a journey to transform its operating model for the last two years, and we expect that we'll be able to deliver further improvements during 2021 to drive costs lower, self-fund investments for the future, and transform how we compete and operate in the years ahead. At the same time, the volatility in markets demonstrated the strength of our global FX franchise, where we retained the number one market share position with asset managers and achieved an approximately 30% uptick in revenue. We continued our intense efforts to innovate throughout 2020 with the further development and delivery of the State Street Alpha front-to-back platform, which has gained traction with clients. Through the open architecture nature of the platform, we have been able to rapidly increase functionality through a number of partnerships with leading data and analytics providers, unlocking new sources of revenue. We signed six Alpha clients in 2020, where early adoption has helped us accelerate our development. the alpha pipeline remains strong. While the alpha platform remains an integral part of our future strategy, We also remained laser-focused on improving the financial performance within investment servicing, which is the core engine of our business. We recently enhanced our institutional services client-facing strategy, and during 2021, we will leverage improvements in client coverage, segments, and regions to broaden and drive investment servicing revenue growth over time. As a result, our strategic moves, the strength of our capabilities and operating model, and the commitment of our team members enabled successful navigation of 2020 and improved year-over-year financial performance, which I will now discuss further. Turning to slide three, fourth quarter EPS was 139 or 169, excluding notable items. Relative to the year-ago period, fourth quarter total revenue declined 4%, largely driven by the impact of interest rate headwinds on our NII results. However, fee revenue increased 2%. reversing recent trends and demonstrating an improved servicing and management fee performance, as well as strong FX trading results. Despite an increase in transaction processing, total expenses were flat year over year, excluding notable items. At the end of the fourth quarter, AUCA and AUM both increased to record levels, supported by higher period end markets. At Global Advisors, we had another strong performance in ETFs and cash. These results in both businesses provide good step-off points for 2021. Turning to our full-year 2020 results, we made solid financial progress relative to 2019 as we worked to drive fee revenue growth higher and total expenses lower. Full-year EPS was 632. or 670 excluding notable items. EPS results were up 17% and 9% excluding notable items, despite the dramatic lower rate environment. Supported by year-over-year improvements in servicing and management fees, very strong FX trading results, and a higher revenue contribution from CRD, which continues to perform well, total fee revenue increased 4%. However, total revenue is roughly flat year-over-year as a result of the impact of interest rate headwinds on NII. Our team drove total expenses down 1.5% year-over-year, excluding notable items. We continued to build on the strong culture of expense reduction that we successfully established in 2019. Operating leverage was positive, and margin was up in one of the most challenging years in history. To conclude my opening remarks, State Street faced a number of unprecedented challenges during 2020. As a result of our operational capabilities and innovation, we were able to successfully navigate those challenges all the while acting as a trusted and essential partner to our clients and communities and generating solid year-over-year earnings growth for our shareholders. As we look ahead for the first quarter of 2021, our board has authorized up to $475 million of common stock repurchases, which is, in effect, the limit set by the Fed. We are well positioned for and looking forward to returning significantly more capital to shareholders in the future. In addition, the Board has also authorized the partial redemption of our Series F preferred stock, which will further benefit our common shareholders following its partial redemption in the first quarter. And with that, let me turn it over to Eric to take you through the quarter in more detail, and then I will return to update you on our medium-term targets.

Thank you, Ron, and good morning, everyone. Turning to slide four, and before I begin my review of our fourth quarter and full year 2020 results, Let me briefly outline 145 million of notable items we recognized in the fourth quarter, which total 30 cents of EPS, that will collectively help us deliver another year of declining expenses in 2021. First, we took an employee severance charge of 82 million to eliminate approximately 1,200 positions, mostly in middle management, which will be partially offset by insourcing and critical hires during the year. This complements the senior management reductions we made two years ago, and the ongoing reduction of junior roles through automation that were deferred during the COVID-19 pandemic. We expect this to generate savings of approximately $120 million in 2021 and about twice that in the following year. Second, we took a $51 million occupancy charge for real estate to reduce our total office space across 20 sites by about a million square feet, or approximately 13% of our total square footage. This is the start of our process of reconfiguring our office space for a post-COVID environment. We expect this action to generate savings of roughly $30 million in 2021. We try to minimize repositioning charges, but we have delivered two years in a row of underlying expense reduction while investing in our business and want to do so again in 2021. Turning to slide five, I will begin my review of both our 4Q20 and full-year 2020 results. As you can see on the top left of the table, we finished fourth quarter with strong revenues. Total fee revenue increased 2% year-on-year and was up 5% quarter-on-quarter. And while interest rate environment continues to be a headwind, the absence of the $20 million third quarter true-up, combined with a stronger-than-expected balance sheet growth, led to a 4% quarter-on-quarter improvement in NII. Total expenses ex-notables were flat year-on-year, but increased 2 percent quarter-on-quarter, including currency translation and higher variable costs. On the right side of the slide, we show our full-year 2020 performance. And despite the challenging operating environment, dramatically lower interest rates, and a suspension of buybacks, we delivered full-year positive operating leverage of 1.4 percentage points, a 50 basis point improvement in pre-tax margin, and EPS growth rate of 9 percent, excluding notable items. our gap results were even better across the board. Turning to slide six, period-end AUCA increased 13 percent year-on-year and 6 percent quarter-on-quarter to a record $38.8 trillion. The year-on-year change was driven by higher period-end market levels, client flows, and net new business installations. Quarter-on-quarter AUCA increased as a result of higher period-end market levels and better client flows. At Global Advisors, AUM increased 11% year-on-year and 10% quarter-on-quarter to $3.5 trillion. The year-on-year and sequential quarter increases were both primarily driven by higher period and market levels, coupled with net ETF and cash inflows, but offset by continued institutional outflows in the equity index product line. Our SPDR ETF business recorded its second highest quarter of net inflows, driven by strong U.S. and European flows, taking total net ETF inflows to over $43 billion for the full year, almost 30% higher than last year. Now on to slide 7. Fourth quarter servicing fees increased 1% year-on-year, including currency translation. The increase reflects higher average market levels, softer than expected sales in 2020, as well as lower levels of client activity and normal pricing headwinds. Servicing fees were flat quarter-on-quarter, including currency translation, as higher average market levels were partially offset by a continued normalization of client activity. On the bottom left of the slide, we summarize some of the key performance indicators of our servicing business. AUCA wins totaled $205 billion, while AUCA yet to be installed amounted to $436 billion in the fourth quarter. As we look ahead, we are focused on generating the level of gross sales volume needed to offset the typical client attrition and normal pricing headwinds, which we think is about $1.5 trillion or more of net AUCA each year. The amount of gross wins needed to offset these factors will vary year to year and be impacted by a number of factors, including product mix. This would include alpha mandates, which were over 25% of our second half AUCA wins, Though, as I have mentioned before, the sales cycle and installation of these more complex solution-focused services take some time. In 2020, we've had some strong success and growth across our top 50 asset manager clients, as well as within our insurance and asset owner client segments. We have been disappointed, however, with our sales to our midsize asset managers in North America and EMEA and are implementing a plan to address these areas of opportunity. On the bottom right panel, we highlight some of these tactical enhancements to our institutional services strategy, which involves expanding coverage to a total of our top 350 clients and diversifying our pipeline across segments and geographies. Turning to slide eight, let me discuss the other important fee revenue lines in more detail. Before I begin, you will notice that for the current and prior periods, we have reclassified the AUM-based fees that Global Advisors receives for acting as the marketing agent for the SPDR Gold ETF from FX Trading Services into the management fee line. Going forward, we think this reclass better reflects the management fee performance at Global Advisors. Inclusive of this reclass, fourth quarter management fees reached $493 million, up 3% both year-on-year and quarter-on-quarter, including the impact of currency translation. Year-on-year management fees benefited from higher average market rates and the strong ETF inflows I mentioned earlier, partially offset by money market fee waivers of about $3 million, net institutional outflows, and the timing of cash outflows. Our fourth quarter investment management pre-tax margin reached 32%, which you can see in our segment reporting in our financial addendum, and we generated significant positive operating leverage. Regarding money market fee waivers, we currently expect they will continue at the current rate of $5 to $10 million per quarter company-wide in 2021, which is included in our outlook that I will discuss further shortly. FX Trading Services had another strong quarter. Fourth quarter FX revenue increased 25% year-on-year and was up 20% quarter-on-quarter, demonstrating the strength of our top-ranked FX franchise for asset managers. Year-on-year and sequentially, FX revenue benefited from substantially higher indirect FX volumes, as well as stronger market-making revenue on elevated volatility, as we helped clients rebalance their global portfolios in the light of ever-changing economic and political conditions. The full-year 2020 FX revenue surge of approximately 30% will obviously make the 2021 year-on-year comparisons more difficult. Fourth quarter securities finance revenue fell 21% year-on-year, primarily driven by lower enhanced custody balances and agency spreads. Securities finance revenue increased 5% quarter-on-quarter, however, mainly as a result of both higher agency lending assets and higher enhanced custody balances, as we saw demand for some leverage reemerge. Finally, fourth quarter software and processing fees were down 7% year-on-year due to lower on-prem CRD revenue. Software and processing fees increased 19 percent quarter-on-quarter as a result of sequentially stronger CRD revenue and positive market-related adjustments. Moving to slide nine, we show CRD revenue growth and business performance metrics. We have again separated CRD revenues into its three categories, given the lumpy revenue pattern inherent in the ASC 606 Revenue Recognition Accounting Standard for on-prem revenues, in particular, Fourth quarter, CRD revenues fell 9% year-on-year, largely as a result of the timing of revenue recognition in the fourth quarter of 2019, but was up strongly at 16% quarter-on-quarter on higher renewals. CRD demonstrated very strong revenue growth for the full year, driven in part by the success of the CRD wealth strategy earlier in the year, with total standalone CRD revenues up 14% year-on-year and with the more durable SAS and professional services revenues growing 18% relative to full year 2019. On the bottom right of the slide, we show some of the highlights of the State Street Alpha front-to-back platform sales during 2020. In total, we signed six Alpha clients during the year, including three in 4Q, which included one new client and two clients converted from existing relationships. The alpha pipeline remains promising as clients begin to realize the transformational potential of the platform for their technology and portfolio management needs. Turning to slide 10, fourth quarter NII declined 22% year-on-year, but was up 4% quarter-on-quarter. The quarter-on-quarter increase in NII was driven by the absence of the 20 million true-up in the third quarter. not including that true of the significant investment portfolio balance growth and higher average loans, coupled with a $17 billion of higher average deposits, which were worth about $10 million, and approximately $5 million of episodic FX marked market swap benefits over quarter end, were enough to offset the ongoing headwinds of the low interest rate environment on investment portfolio yields. Each quarter, we try to offset the persistent effect of low rates on the portfolio by taking these sorts of tactical actions. In some quarters, we'll be able to fully offset the headwind like we did here as we put the $17 billion of the deposit surge to work, but that won't be the case every time. On the right side of the slide, we show our end of period and average balance sheet highlights. Last quarter, I noted how we expect to operate at around $190 billion of average deposits, but that our deposit levels might increase given the Fed's continued expansion of the money supply. As it turns out, we've begun to see the tailwind and now expect to operate at even higher levels of client deposit and more in line with our fourth quarter average or even higher. We will be opportunistic from here regarding the deployment of cash and the expansion of our investment portfolio, but we also need to be mindful of currently tight credit spreads and the potential for OCI risk from interest rate changes. On slide 11, we've again provided a view of the expense base this quarter, X notables, so that the underlying trends are readily visible. Four Q20 expenses were held flat year on year, but increased 2% quarter on quarter, excluding notable items and including the impact of currency translation, which was worth about a point in the fourth quarter. Relative to the third quarter and X notables, we achieved a decline in the largest expense segment of comp and benefits, while occupancy and information systems costs were held flat. However, this was more than offset by higher transactional processing and other expenses in the fourth quarter. Transaction processing increased 10% quarter-on-quarter as a result of variable costs tied to higher market data volumes, subcustody balances, and brokerage volumes. Other expenses rose 8% quarter-on-quarter as a result of higher marketing and professional fees. For the full year, total expenses were down approximately 1.5 percent ex-notables relative to 2019, demonstrating the solid progress we are making in improving our operating model as we continue to reduce expenses, self-fund investments in our business, and more than offset natural expense growth. We want to be down again in 2021, which I will detail shortly. Moving to slide 12, on the left of the slide, We show the growth and evolution of our investment portfolio in 2020 as we supported clients with the MMLF and we thoughtfully put higher levels of client deposits to work to support NII. On the right of the slide, we show the evolution of our Set 1 and Tier 1 leverage ratios. As you can see, we continue to navigate this challenging operating environment with extremely strong and elevated capital levels relative to our regulatory requirements. As Ron noted, we are excited that our board authorized a new common share repurchase program for the first quarter, up to $475 million, and which is in line with the new Fed limits. We're also optimizing the capital stack by redeeming $500 million of PREF stock, which will have a benefit to our common stockholders starting in Q2. Turning to slide 13. you could see a summary of our 4Q20 and full year 2020 results. I've already covered fourth quarter in detail, so let me say a few words about our full year results, given that we've been on a journey to turn around growth and improve margins and returns. Following a 3% decline in total fee revenues in full year 2019, we successfully drove a 4% increase in total fee revenue growth in full year 2020. Many initiatives came together to successfully make this happen. Following a 6% decline in servicing fees in full year 2019, we intervened to moderate pricing pressure, we revamped our coverage of our top 50 clients, and we executed on our alpha strategy, leading to an increase in servicing fees by 2% year-on-year, which made for a real turnaround. At Global Advisors, despite a challenging year on our long-term institutional index product line, Our ETF business had a very strong year, with total flows up 30% year-on-year, and our cash business performing quite well. Our FX trading services business had a remarkable year in 2020 as a result of higher market volatility and record client volumes, and we reaped the benefit of our prior investments in our number one position with asset managers. On expenses for the full year, we continue to demonstrate our ability to drive costs out of the business, recording a second consecutive year of total net expense reduction, excluding notable items and adjusting for the acquisition of CRD, all the while investing in our products and capabilities. All told, excluding notable items, State Street delivered full-year operating leverage of 1.4 percentage points, a 50 basis point improvement in pre-tax margin, and EPS growth of 9%, notwithstanding some of the interest rate headwinds. and GAAP results were even stronger across the board. All that said, we have more to do in 2021, so let me get into it. Turning to slide 14, let me cover our full-year 2020 outlook, as well as provide some thoughts on the first quarter of 2021. As I usually do, let me first share some of the assumptions underlying our current views for the full year. At a macro level, our rate outlook assumes that short-end rates remain relatively flat and there is some modest deepening to the yield curve in line with the current forwards and anticipates modestly slowing prepayment speeds. We're also assuming around seven to eight percentage point-to-point growth from equity markets in 2021, as well as normalized market volatility, which impacts our trading businesses. So, beginning with revenue, we currently expect that feed revenue will be flat to up 2% for 2021. and fee revenue X trading will be up 3 to 5 percent. This includes servicing fees growing towards the top end of the 3 to 5 percent range. Regarding the first quarter of 2021, we expect fee revenue to be down year-over-year by low single digits, perhaps down 2 to 4 percent given headwinds such as the outsized FX trading revenues we saw last year due to volatility in the early days of the pandemic in March. Regarding NII, we expect full-year 2021 NII to be down 14% to 17% on a year-over-year basis, as investment portfolio yields continue to grind lower from prepayments and reinvestments. Regarding first quarter of 2021, we expect NII to be down about 68% sequentially, driven by the continued impact of lower rates and day counts, and should stabilize there and be somewhat range-bound. assuming that our rate assumptions do not change significantly. Turning to expenses, as you can see in the walk, we expect expenses X notables will be flat to down 1% on a nominal basis in 2021 due to our continued focus on resource and infrastructure optimization and currently assume that currency translation will be a 1% headwind in this estimate. This net expense reduction includes approximately 4 to 5 percent of variable costs and ongoing business investments in areas like CRD, alpha and tech infrastructure and automation. Regarding the first quarter of 2021, we expect expenses to be largely in line with this guide year over year and consistent with the seasonal expenses usually occurring in the first quarter. We also expect releases of provisions for credit losses during 2021 of at least a third of what was built in 2020. Taxes should be in the 17 to 19% range for 2021. And with that, let me hand the call back to Ron.

Thank you, Eric. Turning to slide 15, I would like to update you on the current thinking on our medium-term targets. which we now aim to achieve by the end of 2023 or on a run rate basis for 2024. At this time, we still consider these target levels to be the right ones for our business and our shareholders. As a result, they remain unchanged, as you can see from the slide. However, we now expect that these targets may take longer to achieve than we had initially anticipated, largely as a result of exogenous factors. We set these medium-term targets in early December 2018. Soon thereafter, interest rates fell as the Fed tried to stimulate a slowing economy in 2019, and then again as COVID hit in 2020. The market went from expecting in 2018 the Fed to approach 3% by late 2019 to ending 2020 at 25 basis points with no rate hikes expected until at least 2023. Meanwhile, long-end rates also fell from about the 2.90% level at the time we gave the target to average just 90 basis points during 2020. All told, we estimate that the sharply lower rate environment since 4Q18 has impacted our 4Q20 pre-tax margin by about 5 percentage points and ROE by around 2.5 percentage points. We also witnessed a large downdraft in global equity markets in late 2018, followed by a steady rebound in US equity markets. But international equity market averages over the last two years were down. While we are clearly operating in a dramatically different environment relative to when we set our targets, we have made real progress. We went from a 3% decline in fee revenue in 2019 to a 4% growth in fee revenue by reversing the trajectory of our servicing fees and delivering in our global markets business. We are evolving our business model to become an enterprise outsource provider while at the same time enhancing our investment servicing capabilities and client coverage, distinguishing us from our competitors. We've also systematically reduced net expenses ex notable items, which has helped us begin to close the margin gap to our peers by about two percentage points. We remain confident in our ability to deliver ongoing strong expense results. In summary, though interest rates have impacted the timing of our medium-term targets, I am confident in the direction of our business, and we will continue to innovate to meet our clients' needs and drive business growth, while also focusing on improving productivity to achieve our goals. And with that, operator, we can now open the call for questions.

Ladies and gentlemen, to ask a question, please press star, then the number one on your telephone keypad. To withdraw your question, press the pound key. Your first question comes from Alex, hosting with Goldman Sachs. Your line is open.

Great. Thank you. Good morning, everybody. So first, Eric, for you, maybe just to clarify some of the comments you made around service and fees. So you talked about $1.5 trillion in sort of annual client attrition. Is that a That's about 4%, I think, of your AUC. Is that sort of what we should be thinking about as kind of like a gross impact on revenues as well? And, you know, qualitatively, how does that compare to prior periods? Has anything changed that sort of drives this turn higher?

Alex, it's Eric. Thanks for the question. We're trying to be real clear about our sales expectations for our business because at the end of the day, you know, that is part of what we do, you know, every day, and we do it across segments, across regions, across client groups. And I think to kind of give you some perspective on that, we wanted to be clear that to actually have to demonstrate net new business, right, so to be able to offset, you know, the nominal amount of attrition that we always get, which is a few percentage points, and actually overcome that, plus deliver some amount of net new business growth, we need about 1.5 trillion of gross new sales a year to accomplish that. And we think that's what would really contribute to the rebound of growth that we'd like to see. Now, in truth, we've not gotten there this year. this year net new business was flat and you saw our AUCA wins at about 800 billion. And so it's, it's just, uh, you know, obviously an area of, uh, um, of, uh, of pretty intense focus, but I think it's the kind of area that we feel like we can make a dent on. You know, if you step back, we've made really good progress on our top 50 clients where our, uh, where we rolled out a coverage, uh, process and, uh, a set of executives about two years ago, and we've seen the growth there. We've seen it in a couple of segments, and now we need to broaden that and deepen that kind of coverage intensity across the rest of the franchise.

Alex, I'd like to just add to that. I would not want to leave you with the impression that there's a client retention problem here. If anything, client retention has gone up. If you think about things like what the market is facing in terms of reduction in funds, for example, or if you think about M&A, oftentimes that presents an opportunity for us. So there's a small amount of attrition broadly defined. It's as much asset attrition as it is client attrition. And what we're trying to be here is very clear on how we think about what we need to do from a sales perspective and what we're doing about it.

Great. Thank you. That clears it up a bit. Speaking of M&A, Ron, I wanted to ask you a question around SSGA. Obviously, there's been several headlines around potential strategic actions State Street could make around a test management business. And in the past, you also talked about, you know, the drive for scale in that business, just like what you're trying to provide to your clients. So maybe you can update us in your latest kind of strategic thinking for SSGA when it comes to either acquisitions or divestitures. Obviously, there was a JV headline out there as well. And as you think about sort of these various avenues, what is the ultimate kind of financial and strategic goal you're trying to achieve for StateShared as a whole when it comes to SSGA? Thank you.

Yeah, Alex, I'm not going to comment on market rumors, but what I'm going to say is what I've said before. We have a very strong franchise in SSGA. It's particularly strong in the ETF space, the cash space, the indexing space. It's got an increasingly strong position in the ESG space. Having said that, as we've said before, we see the world evolving, and therefore we need to think about how to add capabilities, both product and distribution capabilities, or distribution access to this. So we are – it's not new. Anytime you ask us about this, I think I answer it more or less the same way, that we're constantly thinking about this. We've made some steps over the past several years in terms of organically adding really important product capability, for example, fixed income ETFs, ESG capabilities. We launched the low-cost range of funds. We created the distribution arrangement to help propel those low-cost funds. So we will continue to look at those things, and we'll continue to look at inorganic activities, if we think it's the best outcome. And to answer the last part of your question, what we're looking to do is to best position SSGA for growth. It's a remarkable asset. It's got a lot of potential, and we'll do what we need to do to best position it for growth.

Yep, for sure. Great. Thank you very much.

Your next question comes from Ken Asden with Jefferies. Your line is open.

Thanks. Good morning, everyone. Hey, Eric, just a follow-on on the NII side. I'm just wondering if you can help us understand. You talk about some type of step-off from fourth to first in terms of NII and then stabilization. And I'm just wondering if you can walk us through the pieces of what are still moving through other than day count in the first quarter and how much premium AM was in the quarter, and is that part of a rate of change that you can see any type of help that stabilization or benefit thereafter? Thanks.

Ken, it's Eric. Sure. Let me describe first maybe third quarter to fourth quarter to give you some context, and then fourth quarter to first quarter, and then kind of what we see from there. Going into the fourth quarter, we have the usual headwinds from the investment portfolio and actually higher premium amortization than we've had previously, and that would cost us sequentially about $35 million. That's kind of the headwind. We'll come back to it because that headwind is attenuating each quarter, but that was the headwind. Against that headwind in the fourth quarter, we had some unusual benefits. We had the FX swap mark-to-market, which was about $5.00. We had a surge in deposits both in developed markets and in emerging markets. Remember, they're valuable in emerging markets, worth about $10 as a tailwind. And then we built our investment portfolio and added quite a bit of loans to the tune of about $20 million. Now, that was a larger build than usual, but a remunerative one. And so those are the kind of features that held us flat in effect from 3Q to 4Q. I think if we go into first quarter, you kind of take each of those in pieces. The investment portfolio headwind is probably going to be about 25 million instead of 35 million. So you see it attenuate. And part of that is that the prepayment speeds are neutral, we think, from 4Q to 1Q. We have some tailwinds of deposits and loans and investments, but that's probably worth about 10 bucks. And then we still have a couple headwinds. We have the unwind of that swap mark to market, which sequentially is worth 10 because you've got to double up. The positive turns negative. And then you have day count worth another 10 as a headwind. So that's kind of what gets us to the guide that we gave. Once we get through the first quarter, I think what we expect to see is that stabilization and what we're What we're effectively expecting is that the investment portfolio headwind, which was $35 million, becoming $25 million, is going to start to trend down to $10 million a quarter. And why is that? Partly rates have been kind of working through on the yield side, and partly because prepayment speeds we expect to start to attenuate as we see higher rates. And so we do expect some lesser headwinds. And against that, we think that the actions that we take on a more traditional basis will be worth about plus 10. And so we'll be roughly neutral and stable from 1Q to 2Q and 2Q to 3Q and so forth. Obviously, it'll be range bound. And obviously, there's always a little bit of lumpiness that we get into. But that's our best estimate of what we're seeing today based on the curves, the expectations of rates, and so forth.

So, Eric, sorry if I can speak that back at you. Does that mean kind of a $50-something million decline for the first, if I got all your add-ups there, $10, $25, and $10, and $10, and $10? I'm just trying to understand what that all gets to.

Yeah, I think I said 6% to 8%, so I think we're looking at a $35 million decline in the first quarter and then stable from there.

OK, sorry. Got it. Understood. All right. Great. Thank you. And then just one follow up on a big picture. Unfortunately, another news item to ask you about. Yeah, we're going on now, I guess, nine months since the BlackRock ETF headline news was out there as well. And I know it's a specific client, but there's a way of just helping us understand just what needs to happen for that to either be codified as you're keeping it or going away. Just any commentary would be would be helpful. Thank you.

Yeah, that process is still underway. We're working very closely with them. They have not made any decisions at this, but we are feeling reasonably positive about that.

And, Ken, it's Eric. I'd also just remind you, though, that is a growing, you know, it's a growing business, a growing asset at quite a high pace, right? And so... I think the last time we had one of these, it took three years, you know, from start to finish to kind of work out from, you know, discussion to RFP to response and so forth. And so I think there's, you just have to factor that into the, you know, any scenarios that you run.

Yep, understood. Thank you.

Our next question comes from Brennan Hawken with UBS. Your line is open.

Thank you, and good morning. This is Adam Beattie in for Brennan. Just wanted to focus in a little bit on some of the softness you mentioned in the U.S. and EMEA mid-market space, and wondering if you could help us maybe size that a little bit, recognizing your efforts to broaden and diversify the business, just in terms of the core of what you've got right now, either maybe size it or talk about the impact that had on your 21 guide, and also interested in any interaction with with the activities of the pricing committee there in terms of, you know, either structuring, pricing, or what have you, you know, in order to better retain or win business. Thank you.

Sure, Adam. It's Eric. Let me start. I think the way we think about our business on the servicing side is across segments, right? We have asset managers, we have asset owners, we have insurers, and, you know, our business is more geared to to asset managers in the other segments. And so we've historically built our franchise there, but we've actually found quite a bit of success in those other segments as well. Within asset managers, what we're starting to find is over the last year, last two years, the last year in particular, we've actually secured more growth in the largest of the asset managers. They're obviously winning when you look at the external data. and either less growth or in some cases decline in the midsize and smaller asset managers. And so what, and that gap can be, you know, that gap in a particular quarter or a year could be a two percentage point growth gap. It could be a three or four percentage point growth gap. It bounces around. And so what we're finding is that we really feel like we have the right coverage and intensity and kind of seniority focused on the largest of our clients. But our mid-sized clients are really an important part of our franchise. We built our franchise on them. We provide really, I think, authentic products and capabilities. And we're finding we need to spend both senior time on the mid-sized clients as well as the time of our relationship managers and client executives. And so this is really about intensifying our coverage of those groups and, um, uh, you know, helping them see the, the, the strength and the opportunities and the products and services that we can offer and make sure we're, uh, we're top of mind that we're building on share of wallet. You know, I've got share of wallet statistics for a top 250 clients, and that includes the midsize players and really executing, uh, in that area. you know, day in, day out, product one, product two, product 30, product 50. It's literally down at that level of granularity where we're focused now.

Excellent. That's helpful on the dynamics. Thank you. And then just a quick follow-up on MBS prepays. You know, and I appreciate the detail from before on that. Recognize, of course, that interest rates will be the main driver there. Do you feel as though this past year, 2020, there was any type of pull forward in prepayments or refinancing such that a reversal and downward tick in rates might not generate the same level of prepays as previously, or is it very much still linked to rates? Thank you.

Adam, it's Eric. I always like to hope that prepayments are you know, burning through, that there's been a, you know, one-time pop, and then they're going to attenuate. But I've learned that hoping isn't a strategy, right? We just have to operate through the environment. I think what we've seen is certainly a surge of prepayments, you know, starting in the end of 2Q, right, once people figure out how to do the paperwork during COVID in 3Q and 4Q. And our best estimate, you know, is informed by the, you know, the various, you know, modeling programs You know, we subscribe to three or four of them because we need that diversity of opinion. You know, suggest that, you know, prepayment speeds should probably continue into the first quarter, and then I'll begin to edge down from there in the second quarter and the third quarter, you know, with some stepwise improvement. That said, you know, I think we've got to live through time here and just see how it plays out. and we'll know more. What we're trying to do, though, is make sure that we're always taking the actions that we can on investment portfolio, on deposit reinvestment, on loans, you know, because that's something we can control, and we need to stay focused on those actions.

Fair enough. Thank you, Eric.

Your next question comes from Betsy Gracek with Morgan Stanley. Your line is open.

Hi, this is Ryan Kenny on behalf of Betsy. Good morning. So we saw the OCC stable coin approval come through earlier this month. Just wondering if that has any impact on State Street and how you're thinking about your blockchain strategy going forward.

Yeah. Brian, this is Ron. In terms of direct impact, first, the OCC doesn't regulate us, and secondly, it directly impacts or, if you will, poses the most challenge to the payments banks. For us, in general, it's probably neutral to positive because anything that stimulates more interest in blockchain and particularly more interest in digital currency is going to create a custody opportunity for us. And we have been investing fairly significantly in that space. As we've said in the past, blockchain itself is actually quite an important part of lots of things that we're doing. in custody and asset servicing, and increasingly we see digital coins, cryptocurrency, as part of the holdings within our client base, and we'll continue to invest in that. But the OCC's work itself is, I would say, not directly relevant to us at this time.

Thanks. And then one quick other question, wondering how we should think about the impact from money market fee waivers in 2021. Is it in the run rate now, or should we expect any uptick from here? Thanks.

Brian, it's Eric. A good part of it is in the run rate. I think we said about $3 million in 4Q. We do expect it to take up one more step, and we're now expecting about $5 to $10 million a quarter in the coming years. I think we're We're much less exposed than others. We don't have retail money market funds. We don't have high net worth funds with higher fees. But those are the figures.

Thank you.

Your next question comes from Brian Bedell with Deutsche Bank. Your line is open.

Great. Good morning, folks. Eric, maybe just to continue along the net interest income guide for 21, if you can just talk about your earning asset assumptions for the year and deposit growth strategy, realizing obviously they spiked up in 4Q, but as you're building your servicing business and you're trying to enhance some of the deposit strategies, maybe if you can talk about that and your assumptions for 21. And then, Bec, Also on the premium amortization, I think to 35 million from 3Q to 4Q. So is that about a $170 million level? Just wanted to fact check that.

Brian, it's Eric. Let me do those in reverse order. I think the 35 million was the headwind we're seeing on a quarterly basis from 3Q to 4Q in the investment portfolio. And that was a combination of the investment yield grind down and actually higher premium amortization because we're still living through that wave. What I then said is that 4Q to 1Q, we thought the combination of the investment portfolio headwind, including premium amortization, would be about a $25 million headwind. And then I said starting in second quarter, we thought it would trend down even further to closer to $10 million, $15 million headwind. and 10 million in those out quarters each quarter. So I think what we're starting to see is an attenuation or have that expectation, which partly is the kind of tractor of the investment portfolio playing through, and partly, you know, lower levels of premium amortization expected as speeds begin to edge downwards. In terms of the the deposit forecast and the earning asset strategy. On deposits, you know, it's really hard to gauge. You know, the Fed continues to expand the, you know, the money supply by, what, about $120 billion, you know, a month. You know, we're 1% or 2% of the deposits, so we pick up, you know, deposits just by being here, you know, every month. So there's some amount of tailwind. It's just really hard to read given, you know, lots of talk about stimulus bills, you know, asset allocation and reallocation from risk to risk on to risk off to barbelling. So I think right now we're assuming that we're going to at least stay at these fourth quarter level of average deposits with probably a little bit of edging up. And so we're not yet, we're not at this point expecting a, you know, yet another surge, but you just don't know. And I think we'll, we'll obviously respond as it happens. In terms of asset strategy, that's a tough one. I think it's tough for us and for every other bank because we can certainly take some risk on the curve, but you don't get paid very much for it. And so I think there's a balance that we're making, which is how much dry powder do you want to keep? And so then when you do see a spike of interest rates, you can add your leg into that at a higher and better return. versus forsaking some income in the short term. And we're, you know, our investors are always kind of carefully thinking about that, trying to be opportunistic, and we'll come and go. You know, and we'll do that in treasuries around the curve. MBS, you've seen us build up our MBS book over the last year, you know, by a solid $10 billion. I think we want to just be careful there. We prefer some of the prepayment-protected subsegments. We've done a little bit of credit. We want to be careful there, too, because credit is impacted during the CCAR and SCB process. So it's a pretty diversified approach, I think, is the core of our strategy, looking for opportunities. And I think as we see some of those, we'll act and we'll certainly report on them to all of you.

that's great color thank you and then on the just um back to the 1.5 trillion uh that you mentioned of growth servicing winds to offset some of the headwinds um just talk about the cross sell portion of that so this would be you know um adding different you know new services to existing clients um maybe how that sort of tracking within that that outlook and then also the the importance of SSGAs indexing business as a cross-sell to asset servicing clients.

Yeah, Brian, it's Ron. Cross-sell is a is a very big piece of this. I mean, if you think about what Eric said earlier, you know, look at 2020 performance. It was largely the same in 2019. The fastest growing segment or the segment that accounted for the most growth was, in fact, our global client. division, which is our largest client. So, by definition, we weren't adding many to that, if any, but what we were doing was growing substantially in there. And that will be a key part of our growth going forward for both traditional asset servicing products, as some of these institutions continue to consolidate providers, but also for front-to-back alpha activities as we install, either fully install alpha or even put Charles River in a situation where we have the middle and the back office but not the front. So that's a key part of it. As we think about the numbers, certainly the ability to have common clients where we're both the asset servicer and the indexer is attractive. We always look for those opportunities. That's not in the assumption that Eric's describing there. So, what we really were trying to do here in response to many questions we've gotten is more or less dimension what we need to do to grow the revenue. Obviously, that number, it's based on averages. So, to the extent to which in a given year or a given quarter, we're bringing in higher fee kinds of assets, then obviously the 1.5 goes down. So that's the way to think about it. You know, you could never at the end of any particular quarter say, well, if you're not a quarter of the way there, are you making it or not making it? You've got to go one click down and see what was the nature of the kind of underlying business. which you'll be able to understand from us.

Great. That's helpful. Thank you.

Thanks, Brian.

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

Good morning, guys. Hi, Rob. You called out some reduced client activity as pressuring servicing fees in the fourth quarter. Just wondering how that played out with respect to expectations and then more qualitatively the level of client activity you're thinking about into the outlook for next year or, well, this year, 2021?

Yeah, Rob, it's Eric. You know, there are a number of features in, you know, how we quantify, you know, the, you know, the growth kind of headwinds, tailwinds of our servicing business. Client activity is one of those that fluctuates. and really represents some of the trading volumes of our clients because there's some tolling that we do for that. In particular, cash and derivative trades tend to more likely have tolls than others just because they're a little more complicated. You know, ETF creation, redeem, that kind of stuff. So it's a part of our fee schedules that we try to quantify, but it has a long list of kind of volumetric elements I think on a year-on-year basis, 4Q20 versus a year ago, some of the client activity volumes actually trended down. So on servicing fees, it was worth about a percentage point of servicing fee headwinds. That's an example of a time it hits against us. For full year 2020, it was actually a positive of almost two percentage points. So, you know, we saw that as a tailwind. And obviously, you know, all the activity in first quarter, second quarter in particular, was helpful. Next year, we're going to have to lap ourselves on that. So it'll probably be a, you know, 1% headwind. So it's got that kind of effect. And, you know, what it does is it reminds us that, you know, everything matters in our business to drive growth, right? If there's an equity market, you know, tailwind or headwind, that matters. This client activity matters as well. Net new business, right? And I referenced kind of the importance of gross new sales matters. And then there's always the the normalized fee headwinds. And the good news on that last one is that those have normalized back to something pretty close to historical levels.

Okay, thanks. And I wanted to also ask about the business that you're forming with Microsoft, IHS, Simcoe, and others. Can you give us some more detail on the structure there, what products and services you'll be contributing, and how You know, the potential offering there will compare to your standalone offering today.

Yeah, Rob, it's early days. You're referring to Hub. And it's early days there in terms of what's going to happen. And our view was that given the role that we play as a custodian, as well as our own alpha custodian, product that this was a good initiative to hang around, if you will. We also have clients that are part of it, but it's just very early days in terms of how that's going to develop. Its initial focus is on is on data and data usage and helping firms kind of manage and employ data in a more efficient way. But again, it's so early on, there's really not much to report.

Okay, no problem. Thank you.

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

It's Ron. I'll take it. Thank you everybody for your time and attention and we look forward to following up with you.

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