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spk13: Good morning and welcome to State Street Corporation's third quarter 2021 earnings conference call and webcast. Today's discussion is being broadcasted live on State Street's website and 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 authorized broadcast of this call will be housed on the State Street website. Now I would like to introduce Eileen Feazell-Buehler, Global Head of Investor Relations at State Street.
spk12: Eileen Feazell- Good morning, and thank you all for joining us. On our call today, our CEO, Ron O'Hanley, will speak first. Then Eric Alboff, our CFO, will take you through our third quarter 2021 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'd 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.
spk07: Thank you, Eileen, and good morning, everyone. Earlier this morning, we released our Q3 results. which reflect continued strong performance across our enterprise. Before I discuss our third quarter financial results, I want to acknowledge our employees for their ongoing achievements in supporting our clients and generating the performance and momentum we are now seeing across the franchise. Thanks to their hard work and execution, we are now seeing measurable progress in our financial results, even as we invest in our business for the future. We continue to successfully execute against our strategic objective of being an enterprise outsource solutions provider across the front, middle, and back office and a leading asset manager. This is just the beginning. We are encouraged by the opportunities we see within our industry, our sales wins, the momentum in our pipeline, and what this means for our ability to drive future growth in 2022 and achieve our recently enhanced medium-term financial targets. We are encouraged by the trajectory of our organic profile is demonstrated by our year-to-date business wins. For example, on a year-to-date basis, we have delivered the strongest AUCA wins in the company's history, while AUCA won but not yet installed stood at $2.7 trillion at quarter end. At Global Advisors, our ETF franchise crossed $1 trillion of AUM this year, with year-to-date SPDR flows on track for a record year and already surpassing the full year 2020 flows. Global Advisor's financial performance continues to strengthen, with pre-tax margin expanding to 36% in Q3. I also want to take a moment to note the intended acquisition of Brown Brothers Harriman Investor Services, which we announced in the third quarter. We are excited by the opportunities this transaction presents. It is a strong demonstration of our confidence in the industry, our investment servicing business, and our overall strategy. The transaction is also financially compelling, as it will enhance State Street's financial profile, and importantly, it will create long-term value for our shareholders. From a strategic perspective, this combination will strengthen our competitive positioning and market leadership and deepen geographic coverage, with State Street becoming the number one provider of asset servicing globally by assets under custody. Further, the accompanying talent will build on State Street's already strong expertise and better position us for growth. The compelling nature of the deal has enabled us to raise our medium-term pre-tax margin target. Turning to slide three, I will review our third quarter highlights. Third quarter EPS was 196, up 35 percent year over year. We delivered about seven percentage points of positive operating leverage this quarter and generated a strong improvement in State Street's third quarter pre-tax margin, which increased by about five percentage points year over year to over 29%. This year-over-year improvement was driven by solid fee revenue growth, good organic results, and higher NII supported by robust loan growth, leading to a strong total revenue performance. Meanwhile, our focus on expense discipline continued to drive earnings growth as expenses remained well-contained. Relative to the year-ago period, quarterly total fee revenue increased 9% as we delivered broad-based improvement across all fee revenue lines. Servicing and management fees increased 7 percent and 10 percent year-over-year respectively, and we delivered solid results within our markets businesses despite a continued moderation of FX market volatility. Even with 9 percent year-over-year total fee revenue growth, expenses were well controlled, increasing just 1 percent over the same period. Though expenses were flat year over year, excluding notable items, as our productivity improvements continued to yield results. AUCA increased to a record $43.3 trillion a quarter end, with new asset servicing wins increasing to $1.7 trillion for the quarter, including a large alpha mandate with legal in general, which was announced in July. As a result, AUCA won, but not yet installed increased to $2.7 trillion at quarter end, as I noted a moment ago. Including the legal and general mandate, we reported three new alpha client wins in the third quarter, taking the total number of alpha clients to 18 at quarter end. At Charles River, annual recurring revenue increased 12% year over year to $239 million. And I am pleased with its business performance and how it continues to propel our alpha strategy. At Global Advisors, assets under management total $3.9 trillion a quarter end, and management fees increased to a record $526 million in the third quarter, benefiting from higher average equity market levels and continued inflows to our ETF franchise, where we continue to innovate. For example, in recent years, we have been expanding our actively managed ETF capabilities. And through three quarters this year, we have the most successful active ETF in the U.S. in terms of asset growth, which is SPDR Blackstone Senior Loan ETF. By quarter end, this fund had gathered $5.5 billion in flows in 2021 and had AUM of $7.7 billion. We also made an addition to our actively managed fixed income ETF range in the third quarter, as a launch of the SPDR Loomis Sales Opportunistic Bond ETF. Turning to our balance sheet and capital, we completed a $1.9 billion common stock offering related to the proposed acquisition of BBH Investor Services in the third quarter. Also related to the transaction, we suspended common share repurchases in the third quarter and currently expect to reinstate common share repurchases during the second quarter of next year. We increased our quarterly common stock dividend by 10% in the third quarter. Capital return remains a key part of our medium-term targets, and we recognize its importance to our shareholders. We believe that the BBH Investor Services acquisition is a financially compelling use of our capital and that it will deliver earnings accretion and value creation for our shareholders over time. And with that, let me turn it over to Eric to take you through the quarter in more detail.
spk14: Thank you, Ron, and good morning, everyone. I'll begin my review of our third quarter results on slide four. We reported gap EPS of $1.96, or $2, excluding the impact of notable items. On the left panel of the slide, you can see that we delivered strong revenue growth year-over-year across every line item, controlled expenses. We delivered significant pre-tax margin expansion, all of which drove strong earnings growth. In fact, expenses were down year-on-year, excluding notable items in the headwinds from currency translation, which you can see at the bottom of the slide. This was another strong quarter where we were able to demonstrate the progress we were making in delivering on both our strategic priorities and our medium-term targets. Turning to slide five, you'll see our business volume growth. Period end AUCA increased 18% year-on-year to a record $43.3 trillion. The year-on-year increase was largely driven by higher market levels, net new business growth, and client flows. At Global Advisors, AUM increased 23% year-on-year to $3.9 trillion. The year-on-year increase was primarily driven by higher market levels coupled with net inflows. Quarter-on-quarter, both AUCA and AUM were relatively flat, given relatively stable domestic market levels. Turning to slide six, you can see another quarter of strong business momentum. Third quarter servicing fees increased 7% year on year. The increase reflects higher average equity market levels, good client activity and flows, and positive net new business. These items were only partially offset by normal pricing headwinds and about a percentage point of impact from some divestiture activity. On a sequential basis, servicing fees were flat as favorable equity markets and client activity were offset by about a percentage point of currency translation from the U.S. dollar appreciation. AUCA wins totaled roughly 1.7 trillion in the third quarter, which gets us to a record of over 3 trillion of new AUCA wins year-to-date. We continue to estimate that we need at least 1.5 trillion in gross AUCA wins annually in order to offset typical client attrition and normal pricing headwinds. And given the strong wins we've garnered year to date, we have already more than doubled that this year. At quarter end, a UCA 1 but not yet installed amounted to $2.7 trillion. And I would also note that the unique alpha value proposition represents a large proportion, which reflects our competitive strength as the only front-to-back office offering from a single provider. I will remind you that installations typically incur in phases and over time. and deals will vary by fee and product mix. And as we've discussed previously, we would expect current one but yet to be installed AUCA to be converted over the coming 12 to 24 month time period with about half of the annualized revenue benefit through 2022 and about half in 2023. We continue to be pleased with our pipeline and our robust wins this quarter further showcases the broad-based geographic and multi-segment momentum of our business and will help drive net new business revenue growth in 2022. Turning to slide seven, third quarter management fees reached a record $526 million, up 10% year-on-year, and were up 4% quarter-on-quarter, resulting in a record investment management pre-tax margin of about 36%. Both the year-on-year and quarter-on-quarter management fee results primarily benefited from higher average equity market levels and strong ETF flows. These year-on-year benefits were only partially offset by the impact of the previously reported idiosyncratic institutional client asset reallocation and money market fee waivers. Notably, we previously estimated that gross money market fee waivers on our management fees could be approximately $20 to $25 million per quarter. As a result of the recent improvement in short-end rates, we now expect they will be modestly lower at around $20 million in the fourth quarter, assuming current forward rates. Lastly, as you will recall, we have taken a number of actions to deliver growth in our long-term institutional and ETF franchises, and we continue to have strong momentum and year-to-date results, as you can see on the bottom right of the slide. Turning to slide eight, let me discuss the other important revenue, fee revenue lines in more detail. Within FX Trading Services, we are pleased that we continue to generate strong client volumes, which remained above pre-pandemic levels in the third quarter. Related to the third quarter of 2020, FX revenue increased 3% year-on-year, reflecting higher direct sales and trading revenue and indirect volumes, partially offset by lower FX volatility. FX revenue was down 2% quarter-on-quarter, largely driven by seasonally lower client volumes and spreads. Moving to securities finance, third quarter fees increased 26% year-on-year, mainly reflecting higher client securities loan balances and spreads, as well as business wins and enhanced custody. On a sequential basis, fees were down 3% quarter-on-quarter, mainly as a result of lower agency balances. Finally, third-quarter software and processing fees increased 15% year-on-year, but were 8% lower quarter-on-quarter, largely driven by CRD, which I'll turn to next. Moving to slide 9, I'd like to highlight our CRD and alpha performance. We delivered strong standalone CRD results in the quarter, with a year-on-year revenue growth of 22%. We saw growth across all three categories of CRD revenues, on-premise, professional services, and software-enabled. The more durable SaaS and professional services revenues continued to grow nicely and were up 18% year-on-year. Record new quarterly bookings of $28 million and a healthy revenue backlog of $105 million also demonstrate the continued business momentum that we're seeing in CRD supported by the alpha value proposition. On the bottom right of the slide, we show some of the third quarter highlights from our State Street alpha mandates. We reported three new alpha mandates during the third quarter as the value proposition continues to resonate well with clients. Notably, since inception through third quarter, we now have seven of 18 total alpha client mandates that are live. As a testament to our ongoing commitment and investment to further building out our alpha value proposition, we've also acquired Markatus, a premier front and middle office solutions and data management provider for private market managers. In connection with the acquisition, we launched Alpha for Private Markets, which will extend our end-to-end data platform offering for alternatives. Turning to slide 10, third quarter NII increased 2% year on year, mainly driven by higher loan balances, growth in the investment portfolio and more deposits, as well as the absence of the previously disclosed third quarter 20 true-up, partially offset by lower investment portfolio yields due to the low rate environment. Relative to the second quarter, NII came in 4% higher, primarily as a result of higher loan balances and a larger investment portfolio, as well as higher short-term rates, all of which was partially offset by ongoing compression of yields. I would also note that we saw a larger-than-usual slowdown in premium amortization in the quarter due to some tactical rotation in the MBS portfolio, which accounted for about a third of the sequential quarter improvement, and something we wouldn't expect to repeat in the fourth quarter. On the right of the slide, we show our average balance sheet during the third quarter. Notably, total average deposits decreased by $9 billion in the third quarter, or a decrease of roughly 4% quarter-on-quarter, reflecting the active management of non-operational deposits. We also put more of our surplus balance sheet cash to work. We added approximately $3 billion quarter-on-quarter to our investment portfolio. We also increased our average loan balances quarter-on-quarter to $32 billion in response to good client demand. Turning to slide 11, third quarter expenses excluding notable items were flat year-over-year. as productivity savings for the quarter continue to more than offset targeted business investments, typical expense headwinds, and $10 to $20 million of higher-than-expected revenue-related quarterly costs. Compared to the third quarter of last year, on a line-item basis, excluding notables, compensation employee benefits was down 1%, driven by higher salary deferrals and lower headcount, partially offset by higher medical benefit costs as claims begin to normalize. Information systems and communications were up 3% due to continued investment in infrastructure in our technology estate, partially offset by our savings programs. Transaction processing was up 8%, primarily driven by higher revenue-related expenses associated with subcustody volumes and market data costs. Occupancy was down 6%, reflecting benefits from our footprint optimization efforts. And other expenses were down 5%, primarily driven by lower asset management sub-advisory fees and the timing of some marketing costs. Relative to the second quarter, expenses excluding notable items were down primarily driven by the currency translation of the strong dollar and lower headcount. Overall, we are pleased with our continued ability to demonstrate productivity and expense discipline while driving high single-digit fee revenue growth year over year. When combined together, we delivered a solid pre-tax margin of nearly 30 percent and generated a robust operating leverage of about seven percentage points year over year. Moving to slide 12, on the right of the slide, we show our capital highlights. As Ron mentioned earlier, to finance the proposed acquisition of Brown Brothers Investment Services Business, we completed a $1.9 billion common offering this quarter. Also in conjunction with the transaction, we did not repurchase any stock during the third quarter and intend to temporarily suspend repurchases before resuming them during the second quarter of 2022. Lastly, we still increased our quarterly dividend by 10% and return a total of $179 million to shareholders in the third quarter in the form of dividends paid. To the left of the slide, we show the evolution of our CET1 and Tier 1 leverage ratios. As you can see, we continue to navigate the operating environment with strong capital levels, with or without the recent equity raise relative to our requirements. As of the third quarter, our standardized CET1 ratio improved by roughly 230 basis points quarter-on-quarter to 13.5%. The improvement was primarily driven by the issuance of $1.9 billion of common stock related to the proposed acquisition of Brown Brothers Investment Services and higher retained earnings. We also managed down our RWAs. Our Tier 1 leverage ratio also improved quarter-on-quarter by a little over 100 basis points to 6.3%, primarily driven by the issuance of the common stock, a decrease in the balance sheet size as we actively reduced some excess deposits, and higher retained earnings. Post-closing of the Brown Brothers Investment Services acquisition, we expect both capital ratios to be at the lower end of our target ranges. Turning to slide 13, in summary, I'm pleased with our quarterly performance. which demonstrates continued business momentum on our top line and productivity in engineering across our operating model. Total fee revenue was up 9% year-over-year, continuing the momentum we saw last quarter, reflecting growth in all businesses, with management fees reaching a record level this quarter. Our expenses remained effectively flat, excluding the impact of notable items as a result of our productivity efforts, notwithstanding higher revenue-related costs mentioned earlier. As a result, we delivered about seven percentage points of operating leverage year-on-year and were able to drive pre-tax margin and ROE closer to our recently enhanced medium-term targets, even in this low-rate environment. Next, I'd like to update our outlook. With just one quarter left in the year, I would like to provide our current thinking regarding the full-year outlook. At a macro level, our rate outlook broadly aligns to the current forward rate curve. We're also assuming global equity markets levels will be flat to the third quarter average for the rest of the year, as well as continued normalization of FX market volatility. In terms of the full year outlook, we expect overall fee revenue to be up 5% year-over-year, with servicing fees expected to be up 7.5% to 8.5% year-over-year. You will recall that at the beginning of the year, our guide was for total fee revenue to be flat to up 2%. So this continues to be a meaningful increase over our earlier expectations. We increased this due to both higher equity markets and our net new business performance. Regarding NII, we had a small rebound in the short-end market rates and some movement in the longer end of the curve as well. We now expect NII in the range of $475 million to $490 million next quarter, which is a meaningful improvement from the range we provided last quarter. This assumes rates do not deteriorate and premium amortization continues to trend favorably, though as I mentioned earlier, we would not expect the same episodic slowdown in amortization that we saw in the third quarter to repeat in 4Q. Turning to expenses, we remain confident in our ability to effectively manage core operating costs while onboarding new clients and investing in the business. Given the strong revenue performance this year and the healthy pipeline in front of us, we now see the need to both invest in our staff and in our business, as well as covering some revenue-related costs. We thus expect full-year expenses, ex-notables, to be up 1 to 1.25% year-over-year, which means a sequential quarter increase into the fourth quarter. This is the equivalent of full-year expenses being flat, adjusted for the currency translation headwind, and this would put us in a position to drive solid full-year margin expansion and operating leverage in spite of the double-digit year-on-year decline in NII. On taxes, we now expect that full-year 2021 tax rate will be towards the lower end of our range of 17 to 19 percent. And with that, let me hand the call back to Ron
spk07: Thanks, Eric. To conclude our prepared remarks, we had a strong third quarter and continue to demonstrate measurable progress towards achieving our medium-term financial targets, including our recently increased pre-tax margin target. As we look ahead, we need to both appropriately recognize staff for a strong year and proactively invest in our business as we see growth accelerate. These strategic investments will include the alpha platform and private markets expansion in particular, as well as State Street Digital to drive future growth. As we stand here today and make these business investments for the next stage of growth, we have confidence that we will be able to do so while also delivering positive operating leverage and expanding our pre-tax margin each year through our medium-term horizon, aided by the strong momentum we are seeing across our businesses. With that, operator, we can now open the call for questions.
spk13: As a reminder, to ask a question, simply press star, then the number one on your telephone keypad. Again, that is star one to ask a question. Our first question is from Alex Bloestein with Goldman Sachs. Please go ahead.
spk01: Hey, guys. Good morning. Thanks for taking the question. So maybe we can start with a question around asset management. I'm not sure if you can answer, but I'll give it a shot. So we obviously continue to see market speculation surrounding strategic alternatives to SSGA. We've seen that in the past as well. You know, Ron, you've been very vocal about sort of the secular changes in the asset management industry that are sort of supporting your growth strategy on the servicing fee side, and a lot of that just emphasizes scale. So I guess with that in mind, do you think SSGA has enough scale to succeed in the marketplace today? And if they are sort of strategic alternatives that you're considering, do you need to remain a majority shareholder of any asset management kind of entity, or if minority or a GV structure would make more sense? Are the capital rules just too onerous and the obstacles too high to ultimately get anything done here?
spk07: Well, Alex, thanks, and you've said a mouthful there. I mean, I'll begin this by saying that we like the business, and we particularly like our business. It is continued, its performance has continued to improve, and it's now at least at average, if not above average, in terms of the market, and continues to grow in what are sectorally growing areas, if you think about the ETF business, particularly fixed income ETFs, et cetera. So, we think the business is, it's an attractive business, it's a business that helps us strategically from a portfolio perspective. And for many years now, it's been a bit of a laboratory for us to test out different things. It gives us an insight into the rest of the marketplace. So our overriding goal would be to continue to participate in the business, you know, assuming that we continue to believe that we can improve performance. I'm not going to comment on speculation other than to say that it's speculation. And, you know, if we have something to talk about, we'll certainly come to you.
spk01: Got it. Fair enough. Eric, maybe one follow-up for you just on the servicing fee side. You know, obviously really nice momentum in terms of wins, but servicing fees are flattish quarter-over-quarter and even taken into account something cursing into it. So it sounds like a lot of it is just timing with next kind of 12 to 24 months. Hopefully we'll see the benefit of the revenues on the yet-to-be-installed business. Can you help us frame and sort of size the revenue pool attached to the $2.7 trillion on yet-to-be-installed? And then within that, maybe hit on the pricing dynamics as well. I think in your comment set, you continue to see kind of normal pricing headwinds in the business. I think it's been kind of in a 2% to 3% range long-term. Is that sort of the headwind we're still talking about, or has that changed? Thanks.
spk14: Alex, thanks for the question. Let me answer them maybe in reverse order. I think we continue to see the normalized pricing headwinds in the marketplace. We feel they're well controlled. We feel like they're understandable. They're logical. And that headwind is back down to about 2%, which is the historical norm. And a lot of that is how we go to market, how we engage with clients, how we now have added more feature functionality to our offering. Alpha is a big part of that, of course. And the duration of some of these deals will, I think, help reinforce that over time. We are very pleased, I think, as you could expect, with the wins this quarter, last quarter, the first quarter, for that matter. And they're certainly in the range of the fee rates that we have for the company. We don't feel comfortable going into individual deals or individual quarters on that, but they are in that range that you broadly see on average, and that gives us confidence that as this business gets installed, it's going to have a meaningful impact to revenues. We've been clear we need about a trillion and a half plus of AUCA wins. You know, that at the current or, you know, around the fee rates that we have, you know, creates the right amount of gross revenue wins as well, which then get implemented over time. So that's, you know, that's why we put that benchmark out there. And what I would say is, well, I think we've had until this year a couple of lighter years in terms of sales. You know, we need to continue the momentum we've been building, and part of the reason we referenced the pipeline is we feel comfortable with the pipeline, and we see, you know, maybe not another $3.2 trillion of AUCA wins, but at least, you know, substantial wins embedded in the pipeline for us to continue this momentum, you know, into next year. Great. I appreciate all that. Thanks.
spk13: Our next question is from Brendan Hawkin with UBS. Please go ahead. Mr. Hawkin, your line is open.
spk16: Sorry, was on mute. Thanks for taking my question. I'd like to start maybe with BBH. Could you talk about what you would expect the impact of that acquisition could do to your asset sensitivity? and how the inclusion or pro forma balance sheet would be sensitive to 100 basis point shift in rates, and then also to help contextualize investors. Eric, you had discussed on the M&A call that the cost savings assumption is conservative. What's a historical range for the right way to think about expenses for these types of deals? Thanks.
spk14: Sure. Let me start on the deposit side, and then we'll leg into the other part of the P&L. And obviously, it's early with Brown Brothers Investment Services. We've now gotten our regulatory filings in. We're obviously working through the closing process and would continue to target a year-end close. You know, in terms of asset sensitivity, I think it's a little early to model it too finely, but I think I would say is that the asset sensitivity of the book is probably in the range of what we have at State Street, just because it's, you know, similar asset management-oriented clients. They have, you know, similar expectations of deposits and deposit pricing, and I think you'd get similar betas. well, similar betas and adjustments overall. I think what's different, Brennan, and constructive here is because of the Brown Brothers Bank sweep program, you know, we have more flexibility than usual to either bring in deposits at, you know, attractive rates, and so that could, in a way, enhance our asset sensitivity, though you have to be careful by the, you know, you have to have to model that in, or it could let us, you know, protect the size of the balance sheet and the, you know, and the leverage constraint, leverage ratio constraints that we have, which also let us, you know, adjust the amount of preferred securities that we need to run the business. So I'd say overall, it's probably in the same, you know, ballpark, but with an ability through the rate cycle to either, you know, add deposits in NII or to manage leverage. And I think that's a constructive program and a new functionality that they bring to us and one that will continue. In terms of the expense guide, I did say I was hopeful it'd be a bit on the conservative side. I think the expense guide was for a reduction of about you know, 25%, so kind of I think on the lower end of what we've achieved before. I think, you know, but it's hard to compare, you know, to past deals too, I guess, too forcefully because every deal is different. We need to bring this business on, and I've said in the past, we've not always, you know, finished what we started and made sure that all the integration happens and all the functionality that we bring in from an acquisition gets fully integrated and created in our own offering. And I think that's why it's been at the lower end of our expense savings targets. But I think we'll see. I think it's early. I think we'll certainly give guidance as to some of those cost estimates in January, and we'll certainly, you know, keep you posted. But we stand by the guidance, and, you know, as the CFO, I'm hopeful we can, we certainly want to meet those. And, you know, I always like to exceed where I can, but I think it's a little early to lean too far.
spk07: Hey, Brennan, it's Ron. What I would just add to that is we've emphasized about this acquisition, it is about capabilities and geographic reach and talent. So as we think about the synergies here, we're thinking about them as combined synergies, if you will. I mean, there's instances where there's just some better capabilities that exist over at Brown Brothers.
spk16: Great. Thanks for all that color. And then for my second question, Ron, actually, Eric, when you provided the color on the fourth quarter expense expectation, you made reference to some needs to invest and whatnot. I know it's probably early. You're probably just starting to work on the budget for 2022. But cost inflation is very much on the minds of investors. We hear about it broadly. One of your competitors at a recent conference raised the point that there would probably be some upward expense pressure in 2022. Should we begin to prepare for a bit of a lift? Is it appropriate maybe to use the fourth quarter as the jumping off point and then adjust for seasonality and then think about that into next year? Is there just some general guiding principles you could provide to help people level set on 22?
spk07: Yeah, Brendan, let me start on that, okay? Because we are definitely seeing instances where there is some cost pressure, but it'd be untrue to say that it's across the board. Certain types of employees, for example, in the technology area, as you'd expect, because there we're not just competing with other custody banks, we're competing with technology firms. So we are definitely seeing that. But we also continue to see productivity improvements in our business. We're engineering them in. So we do see an ability to offset some, if not all, that. And we're just going to be careful about how we proceed forward. We don't want to under-invest in key staff. But we also think that, as we see performance, we can pay performance and do it through the incentive line. So it's something we're watching out for. And there are particular areas where we are seeing the need to raise the fixed costs of talent, but not at an overwhelming, we're not seeing an overwhelming kind of thing yet. Eric, you probably want to add something.
spk14: Yeah, Brennan, I'd add to that. You go through the line items of expenses. Ron covered salary comp incentives, and obviously we have a little pressure there, but we also have a little more attrition. I think everyone's seeing that as they, so we're trying to We need to net that out as we go into next year. I think you see a little bit of a creep on the tech side, obviously some of those costs and transactional costs. But again, we have our engineering programs to offset some of that. And while it means there's more work to do, there's always more work to do. That's just how it plays out. If you step back and you say, what are the guiding principles that we use as we go into our budget process, which has just really started and, you know, full swing in November and then comes through in December, it's really about how do we continue to make healthy or solid progress in expanding margin each year? How do we do that with positive operating leverage? And you've heard me say before, we don't like to live on the edge and be too hopeful of an equity market tailwind or something of that sort. And so I think you've got to think of it as a commitment to progressing towards our medium-term targets and progressing at pace where we can make a progress each year. You've seen us notwithstanding the interest rate headwinds this year. We're making progress this year towards those targets. We're proud of that and we feel like we need to continue that.
spk16: Thanks for all that, Culler.
spk13: Your next question is from Betsy Grist with Morgan Stanley.
spk11: Hi, good morning.
spk07: Hi, Betsy.
spk11: Okay, so two questions. One, I think on the expense side, one of the reasons why there's so many questions here is that there had been a period where State Street had a tougher time delivering positive operating leverage. And then more recently, you've had very good success. So when I hear the point about, hey, we're going to be reinvesting a bit for future growth, I'm just wondering, is this a message we should take that, you know, the investment spend was a bit under, you know, you underinvested over the past year and a half, and now we're going to ramp back up to quote unquote normal? Or is this more of a temporary, we've got some things, specific opportunities that that we need to invest in. We can't tell you how many quarters it's going to take, but it's more of a specific opportunity. And the positive operating leverage we've been used to seeing recently will persist once we get through this period. I guess that's part of the reason why there's so many questions on expenses. And if we could frame it like that, would there be any more color you could share with us? Thanks.
spk07: Betsy, it's Ron. So we've been... We certainly have not been under-investing in our business. And whether it's inorganic or organic, I mean, obviously it was Charles River more recently, Brown Brothers on an inorganic basis. But as we've tried to emphasize quarter over quarter every time we've talked about us keeping expenses flat or even down, that's been done by a fairly aggressive engineering effort to bring down BAU expenses while also continuing to invest in the business, particularly in the technology area. In terms of future investments, you know, we just see the momentum building in areas where we've already started to invest, and there's opportunity to invest more and accelerate growth. And the three areas that we highlighted were, one, just continuing to invest in alpha and kind of bring more and more of that to market quicker. Second is private markets. And then third is the whole digital space, where you're seeing a lot of activity there, and that's a combination of both supporting our clients in their digital kinds of ventures, and also continuing to go to the next stage of digitization of our own business. So that's what we're talking about there. And again, I would underscore what I said at the end of my prepared remarks, that we will do so with a commitment to positive operating leverage and continued margin expansion over the short to medium term. That's great color.
spk11: And those three threads, those are top of our list too in terms of revenue generating growth potential over the next three to five years. So that seems like it makes a lot of sense to be investing for that. Maybe a little bit more quarterly oriented kind of question, but just on the loan growth that you saw in the quarter, just want to get a sense as to key drivers of that growth and should we think that it was a – you know, specific to this quarter, or there's a demand there that we'll likely see that kind of growth continue as we look into next year? Thanks.
spk14: Betsy, it's Eric. It's a little bit of both, actually. We saw, you know, higher than usual opportunities this quarter. I think, you know, sequentially our loan balances were up, you know, we're talking about $3 billion. That's quite a bit on a $30 billion base of loans. A little bit of that was some discretionary lending we do, and then some of it was literally higher demand from private equity capital call financing. Obviously, as the alternatives market continues to boom, some of our classic fund finance clients were looking for some support and so forth. I think it was a higher than usual quarterly print. I think year on year what we're seeing is some confidence that we can grow this loan book in the low double digits, which is nice. The one thing we are conscious of though is with loans comes RWA, and so what we're always doing in background is optimizing the risk-weighted asset and the returns mix of those loans to make sure that In some cases, we add. In other cases, we self-fund by optimizing other positions. And that'll be part of how we think about it going forward. But we do think of lending as an opportunity for us to drive an I.I. in the coming quarters and years.
spk11: Thanks, Eric.
spk14: Sure.
spk13: Your next question is from Glenn Schuer with Evercore ISI.
spk15: Hello there. I wonder if you could expand on the NII discussion. Just talk about what you think are non-operating excess deposits right now and how you think they behave. Have you had a model of them behaving in a modestly rising world as we go into next year? Thanks.
spk14: Yeah, Glenn, it's a really good and hard question because there's not an easy answer to them. I think we clearly have, like others have had, some amount of excess deposits flow in. You know, what I would say, though, is if you go back, call it two years, you know, you can ask the question, is that, you know, the typical deposits and is all the increased excess? And I'd say that's not true. What we've had over the last two years is very significant growth in our AUCAs. And with AUCAs, right, clients need to leave a certain amount of cash with us to handle the, you know, transaction volumes. And so a good bit of the increase that we've seen over the last couple of years is on the core deposit side. There is, though, some, as you've seen, that, you know, is excess. And, you know, we've pulled off, I think, a, you know, a reasonable amount this quarter. We don't necessarily want to, you know, push down deposits too far because we do want to be there for our clients. If you go from with that context to the, I think, the next part of your question, which is what happens in either tighter monetary policy with, you know, a slower expansion of the Fed balance sheet or rising rates, you know, does that, you know, reverse the course of deposits? I think it will eventually, but I think it'll be a while. It'll be a two- to three-year process for that to happen. And part of the reason I say that is the Fed continues, even under a tapering, to expand its balance sheet. They're just expanding it less is what the talk is all about. It's not about actually stopping the expansion of its balance sheet. And so as the Fed continues to expand its balance sheet and then signal rising rates, I think we're probably going to be in an environment of having healthy deposit levels, which effectively mean their core, partly driven by the AUCA need and partly driven by just the surplus of cash in the system, and rising rates, which I think would be positive to certainly our balance sheet and NII and to other banks as well.
spk15: I appreciate that. I wonder if you could just expand a little bit more on your thoughts. You mentioned private markets as one of the key growth areas. You're one of the pioneers on the custody side of that. What does Mercatus do for you, and what can and can't you do right now for the expanding world of private markets? Thanks.
spk14: Yeah, and private markets is a broad area, which is why I think we see some opportunities. If you recall, there's hedge fund activity in private markets. There is classic private equity. There's more fixed income kind of loan-oriented private markets. There's real estate. And so it's in each of those areas where There's not one investment we need to make, but a series as we pick our spots and pick our spots not only across each of those products, but make some choices geographically as well. What Mercatus brings is a set of front-end functionality that we can use to support our are private equity and other private market clients. So functionality around reporting to LPs, reporting to their own partnership. And that's the front end that I think we value. And with that comes a set of data feeds and communication that's quite valuable. And if you think about that, that is directly plugged into the historical custodial operation that we provide and why we're so excited about it.
spk07: Yeah, Glenn, what I would add to this, that market is still largely an insourced market. So this isn't about slugging it out with competitors and a race to the bottom on fees. It's to be able to demonstrate a better offering than what these institutions are doing for The stakes are going up for them in terms of data reporting, particularly in ESG reporting. It's not just that investors are demanding it, but in some cases, particularly outside the U.S. and Europe, you're seeing reporting requirements being imposed not just on public companies, but on private companies. And investors want to know what's in their portfolio, including their private portfolios. So we think this is all going to be And Mercatus helps us do that, and this will all be further impetus to drive this to a more outsourced model.
spk15: Thank you for all that. Appreciate it.
spk13: Your next question is from Ken Usden with Jefferies.
spk03: Thanks. Good morning. Eric, I just want a couple of cleanups here. So you said that the premium M was improved, but you called it episodic. But I just want to understand, like, what was that premium M number in the third quarter so we can understand? I think you said it would continue to improve. So I just want to understand what the delta was this quarter.
spk14: Yeah, I think the best way to describe it, Ken, is remember every quarter we get some a headwind from the compression in underlying yields in the portfolio. And what offsets that is less and less premium amortization, which comes through as a negative, but it's a smaller negative each quarter. And this past quarter, I said about a third of the $20 million improvement was from, I'll describe as an excess reduction in premium amortization. And that's the piece we don't expect to repeat. We do, as I said, continue to expect some marginal headwinds in the underlying portfolio yields. We do expect some ongoing reduction in premium amortization, not just at that same level. And then we've also been pleased with some of what we've been able to do on the balance sheet asset size around lending the investment portfolio. And that's why we took our range up. But we're a little conscious that the fourth quarter print, we gave a range purposely. We don't think the third quarter print's necessarily a perfect indicator of that. But all that said, I think we're pleased with the direction that NII has taken over the last couple quarters. And we think that sets us up for the future as well.
spk03: So you have a number to give us versus the 157 in the second quarter?
spk14: I think you'll have to help me. I think in the second quarter we had NII of 467. In the third quarter, 487. And I think the range I gave you was... you know, 475 to 490 for the fourth quarter. That's total NII. I think what I'm trying to message is there are pieces below the surface, and we could, you know, we could get into a great amount of detail, but that's kind of where the net falls out.
spk03: Okay. So on money market fee waivers, can you tell us what the money market fee waivers in asset management were in the third quarter?
spk14: Sure. In the third quarter, the money market fee waivers were about 19 million. Back in the second quarter, they were close to 25 million. And that's why we thought at current levels of front end rates, which have stabilized, we said that fourth quarter is likely to be around the 19, 20 million that we just saw.
spk03: And what about the other fee waivers that were 21 million in the second quarter? Do you have what that was in the third?
spk14: I think we're focused. The biggest driver of money market fee waivers in our systems for GA, for a global advisor's business, that's the one we've spent the most time tracking, I think, is material, I think, and dominates. So I think that's the area to focus on.
spk03: Okay. Thanks a lot, Eric.
spk14: Sure.
spk13: Your next question is from Brian Bedell with Deutsche Bank.
spk06: Great. Thanks. Good morning, folks. First one is just on the asset servicing side. Eric, if you can maybe just sort of maybe give us a view on that step up of asset servicing fee growth at Legacy State Street, not including Brown Brothers, in 22 and 23, given that the new wins have been so strong and you're running at more than double the pace required to offset the pricing headwinds. So, I mean, I guess the short question here is, should we expect a step up in organic growth of asset servicing in 2022 and again in 2023, given that pipeline and not factoring in any kind of, you know, or ignoring the market side of it?
spk14: Brian, it's Eric. I think it's a little early to get out and start to forecast 22 and 23. I think what I was trying to signal is we're very pleased with our sales performance this year. We've been able to book, and that clearly is going to be part of the components of delivering growth in 22 and 23. I would say, and I've said this before, we need to earn our keep every quarter by continuing to drive sales and wins. And you saw that in the first quarter we had 343 million of AUCA wins. We're very pleased with that. We're pleased again with the second quarter, with the third quarter. We need to keep at it because if you step back, remember a portion of every year's wins gets implemented in that particular year. It's something like a third. About two-thirds of a year's wins typically is gets reported in the following calendar year. And then you still have some, it's probably like a sixth in the year after that. So we're in a business where what we sell, we then start to implement, and then we need to keep up that progress. And that's what drives growth. And so I'd say we're on a good trajectory. We're pleased with this year's successes. And we'd like to continue to be successful. We expect to be given our pipeline, but it's still early to forecast actual growth for next year and the year after.
spk06: Okay, that's fair enough. And then Ron, back on SSGA, obviously you made a good case for the growth in that business longer term, but as you just think of strategically State Street as a whole, Obviously, you've been the clear and away leader in the core asset servicing business, and you continue to enhance that lead with CRD and BBH and other investments for organically growing it. So as you think about State Street longer term, maybe would you prefer to be more of a pure play on that leadership position? Or would you prefer to have the balance of the asset management business, you know, within that? And I guess also, is it really critical that you need SSGA for, you know, preferential capital treatment for, you know, going through the Fed stress test and CCAR?
spk07: Well, Brian, I mean, if you think about our portfolio of businesses, we're far and away the narrowest of the both the US and the total GCIPI population. So we're pretty focused to begin with. And if you think about those two broad businesses, because I would put markets underneath our investment servicing business, because it's really there to support that business. So if you think about those two businesses, they really fall under that single purpose of helping institutional investors achieve better outcomes. So we start out from a position of being very focused. And then we ask ourselves all the time, first, are we satisfied with our performance? And second, are we the right owner for these businesses? And at this point, as we look at it, we think and believe that given the performance, given the somewhat symbiotic relationship between two businesses, that having this participation in that business is actually enhancing. And as you note, it certainly is helpful from a capital perspective. And relative to our investment servicing and related activities, it's a capital-light business. So when you add it all together, We like the business, but we recognize that, you know, you as shareholders can take care of diversification. It's not up to us to diversify for you. We have to make sure that, you know, that as owners of these businesses that we're good owners and we can continue to grow the business. And we are looking at this all the time.
spk06: That's great, Collier. Thank you.
spk13: Your next question is from Jim Mitchell with Seaport Research.
spk02: Hey, good morning. Maybe just on the security servicing side, outside of one-off large outflows like the BlackRock biz, can you speak to your efforts to reduce client attrition and kind of get that $1.5 trillion bogey of annual gross outflows down to really start to enhance the net growth from that side of the equation?
spk14: Jim, it's Eric. Let me start. You know, there's a long history here in serving our clients, serving them well, and being incredibly focused on what they need. And that, you know, that's what both, you know, creates sales and sales opportunities because we've said, you know, over time, something like two-thirds, three-quarters of our sales come from our existing clients. And the other side of that coin is, you know, staying close to our clients, understanding their needs, being there, you know, when they add funds or when they consider other options, you know, is also a big part of what we do. Now, sometimes, you know, our clients are involved in, you know, in M&A and we need to, you know, rebid what we've got. And so, you know, we have very active programs when that happens. And, you know, that's part of the industry. We've got a set of client NPS, Net Promoter Score, work that we do that we've expanded over the last two years to now take on a very large portion of our clients. So that provides real-time feedback to us from the C-suite down to the operational portions of our clients. And then, you know, it's our coverage program. I think you saw us back in June describe how we do coverage with our, you know, our global client division, our premium, our preferred, and each one of them is geared towards making sure that we're staying close and supporting our clients and, you know, making sure they're as, you know, satisfied and as can be. So those are some of the elements, and I'd say it's a It's deep in our culture and something we work on. That said, you've got to keep, you know, if we want to grow and deliver core growth like we've done the last few quarters, you know, we've been able to drive core growth, which we're very pleased with. We've got to keep expanding and selling both to existing and to new clients, and you've seen us do that successfully. And then, you know, on the other side, I think we feel quite good about our retention rates and That's always an area of intense effort, and I'd say this year has been successful as well.
spk02: Okay, that's helpful. Maybe just the second question on enhanced custody. If I'm reading the balance sheet correctly, it seems like you've had very significant growth there. Is there any constraints on growing that business from a balance sheet perspective, capital perspective? How do we think about what's driving the growth and the outlook for that? over the next year or two.
spk14: Sure. Jim, it's Eric again. I think for all of our balance sheet businesses, we always need to be careful about how much they consume in risk-weighted assets versus the earnings and the opportunities that they can provide us. You know, we do that certainly on a standalone basis because you've got to look at every asset on the balance sheet, whether it's lending asset, you know, for our loan book, for example, or securities finance business or enhanced custody business or FX business. And then you also have to think about it within the context of the client relationship, because there's always a give and take. And for a client that may not borrow very much, were they to do more securities finance or enhanced custody, that can be a reasonable mix and a way to serve them, but to serve them with decent returns. I'd say there's certainly room in these businesses, but I think what we are doing is going into the end of the year as we close the Brown Brothers acquisition. We are being a bit disciplined about our risk-weighted asset position, right, because we want to close that deal and we want to land within our capital ratios. And so I think while you've seen some very heady growth in the last couple quarters. Just in the next one to two quarters, I think you'll continue to see some discipline. You've seen a little bit of that on the quarter-on-quarter balance sheet in some of the areas like securities finance. And you can imagine we'll do that going into the beginning of next year. But what I would say is I think the franchises as we continue to grow the fee portion of the revenue base, manage our expenses, we can continue to put more capital to work over time, but sometimes there'll be some ebbs and flows, and I think I've given you a little bit of an indication where we see some of those.
spk02: Okay, great, thanks.
spk13: Your next question is from Steven Chewbacca with Wolf Research.
spk04: Hi, good morning. So, Eric, I wanted to start off just discussing some comments you made actually a bit ago at the BAB conference. You talked about the servicing fee growth algorithm and you framed it based on expectations around new store and same store sales growth, pricing pressures, what have you. And I was hoping you can maybe just update us on how your thinking has evolved with regards to that algorithm, whether it's strengthened just given the improved outcomes that we're seeing in terms of new business wins. at least relative to what you've seen historically.
spk14: Yeah, Steve, I think the algorithm that you're referring to that I've described and we've described as a company is that servicing fee growth comes from a mix of equity market tailwinds, client activity and flows, net new business, which can either be positive as it has been the last couple of quarters, neutral or negative, and then pricing headwinds. It's that four-part structure. I think the way I'd update that is to say that the structure is still there and I think been fortified I think the different areas move around a bit. I think equity market tailwinds, we've seen a very strong equity market tailwinds this year. I don't think we're going to see that every year, but, you know, we'd like to see flat to up equity markets. So you can imagine that part of the tailwind was very positive this year, which we're pleased with. And, you know, the way we monetize that is we didn't take our expenses up with equity market uptake. The second one is client flows and activities. I think a couple years back, this was a positive by a couple points. I think a year or two ago, as we saw outflows from packaged products in both, especially in the U.S., as mutual funds were on the wane and we saw less inflows in Europe, I think we felt less confident in client activity and flows of the tailwind. I think that's actually rebounded nicely this year. And, you know, we expect that to continue given the current market dynamics. Net new business, as you referenced, I think we've got a strong year here in terms of wins. That will now start to get implemented next year and the year after. So, you know, that takes time. But we're pleased with the backlog. And then pricing, I think, as I said, I think on the first question this morning, has been well controlled. And we just work on that intensely every day. So I think the structure is intact. Every year will bring a little change. you know, different mix and different elements of the, you know, of that framework.
spk04: Thanks for that color, Eric. And just for my follow-up, I know you provided some helpful color on the BBH rate sensitivity, additional flex from having the off-balance sheet suite option. I was just curious how the improving rate backdrop, just taking the forward curve, informs your willingness to onboard more than the $10 billion of deposits, which you disclosed at the time of the deal, And just speak to the relative attractiveness of onboarding a larger percentage of deposits versus maybe other forms of capital return like buybacks and dividend increase.
spk14: Sure. And let me open up the aperture a little bit. Remember, the core of our capital constraints are around CET1, right, our common equity tier one ratio, which is really a risk-weighted asset-based measure, not a leverage ratio measure. So on the leverage ratio, we just need to be kind of within bounds. And so, the decision on deposits and NII within reason is really around what rate levels we're sitting at. I think the way to think about deposits is when prevailing short rates, call it Fed funds, is that, you know, the current levels, you know, near zero, you're not incentive to have deposits on the balance sheet. And that break even tends to flip at around two or three rate hikes, around 75 basis points of Fed funds. You start to be in a more neutral position. And at 100 basis points of Fed funds, you start to be the right way around where you'd prefer the deposits on the balance sheet. And so it's somewhere in that area, call it two, three rate hikes from now, where we begin to seriously thinking about the benefit of adding more deposits instead of being, instead of holding them off. And so I think the question that we will, the decision criteria that we'll get to is where are prevailing rates in the first quarter, in the second quarter, in the third quarter next year? And at that point, we'll make some conscious decisions and trade off additional NII, which we'd like to bring in because it helps with our margin and our And we'll just have to just be careful about the balance sheet size. But you've seen us manage the balance sheet size you saw at this quarter. And in fact, it's not like we, well, we know where to judiciously manage the balance sheet. I think we'll continue to do that while bringing on deposits and serving our clients as best we can.
spk04: That's great color, Eric. Thanks so much for taking my questions.
spk00: Sure.
spk13: Your next question is from Gerard Cassidy with RBC.
spk08: Good morning, Ryan. Good morning, Eric.
spk07: Hi, Gerard.
spk08: Eric, can you share with us, when you guys look at your asset under custody wins, can you break it out geographically? And also, are the wins coming from competitors, or are they coming from just companies that were doing it internally and now have chosen to go with somebody like yourself? And how do the numbers in this quarter look compared to the prior couple of years? Is there a shift going on in either of those two dynamics?
spk07: Gerard, maybe I'll begin, and Eric will add in color. If you look at this quarter, the standout, obviously, from an AUCA was legal in general. So mostly UK, but some, you know, there's, there's an American element to that also. In that case, it was, for the most part, a new client to us, we did not have, you know, we had a nominal existing relationship to it. And it's, you know, it's an alpha driven mandate. So lots of activities will be coming our way over time. If you look at the prior quarter, again, the standout there would have been Invesco, which was more of a U.S.-based global client where we had an existing relationship on the servicing side. We are consolidating much of that and expanding into the middle and front office. So I would say that what we've seen over the past couple of years in terms of the alpha-related kinds of wins, it's been nicely mixed geographically. And as importantly, there's been more new client wins than we would have expected from the beginning. So it's enabled us to drive new client growth. And what's incumbent upon us then is to make sure that Obviously, if it's a new client, they've got the traditional servicing business with somebody else, so what we are doing strategically is we'll have the discussion on alpha, we'll win the alpha, and then say, now we want to move the servicing business over. In terms of the core wins, I would say that there's been a little bit of a cycle here, and Eric will correct me if I'm getting this wrong, but if you go back a couple, three years ago, EMEA was relatively light relative to the U.S., and we've seen actually over the past couple years a lot of activity in EMEA. And it's not so much that it's been less U.S., it's just been more activity in EMEA. So, you know, that had a lot to do with changing out and rebuilding a sales force and things like that that had been done in the U.S., hadn't quite been done until more recently in EMEA. So, you know, what we like is it's nicely mixed. And, you know, more recently we're starting to see some activity in EMEA. in Asia Pacific, and we're really excited about Brown Brothers because of the truly leading position that they have in Japan that we'll be able to leverage to spur even more growth there.
spk08: Thank you. Very good. As a follow-up question, and I apologize if you guys have addressed this already, in the revenue growth of servicing fees and management fees, 7% for servicing on a year-over-year basis, 10% for management. You mentioned that a client flows, new business growth, higher market levels contributed to this growth. How much of that growth was attributed to the higher market levels?
spk14: Gerard, it's Eric. It varies by business. On servicing fees, a large proportion of the Up 7% was driven by the, you know, the equity markets tailwind, you know, a smaller proportion from, you know, client flows and net new business. And then, you know, in the other direction, you have the usual, you know, smaller amount of pricing headwinds. And we also call that a little bit of divestiture activity. So it's kind of, you know, it's kind of two-thirds, one-third, but... What I think I'm particularly pleased with is we're able to hold expenses flat, notwithstanding that, and that's not been our history here as we've managed. On the management fee side, it was just the way that business tends to be priced. The market tailwinds tend to come in and are a very important part of the tailwind. But we also had, I think, very nice, you know, net new business performance on the revenue side. You see it in flows. We also counted in revenues. But you saw there, you know, us taking up our margin in the asset management business. And so while we're creating the environment for either an equity market tailwind or a flow tailwind in asset management, it's the, you know, we're also managing the other side of the P&L, and that's been quite remunerative for us this quarter.
spk08: and uh and pleasing very good thank you and eric we all are looking forward to seeing you at the bank balance association of boston conference in about three weeks so we'll see you then thank you see you shortly your next question is from rob wildheck with autonomous research good morning guys um just one more on the expense side you highlighted some productivity savings this quarter and that's been a trend recently
spk05: How much more is there left to do on the productivity side? And how much do you think that can continue to serve as an offset to any increases in other expenses going forward?
spk07: Yeah, Rob. Service productivity is hard work. And we have been at it now for a couple of years. And despite the progress that we see, we actually see more opportunities. You know, it's not as easy as just like in manufacturing, just substitute a people-driven assembly line with a bunch of robots. It's really activity by activity. substituting AI, substituting other kinds of automation, trying to eliminate reconciliations. And we're making progress against that, and we see the opportunity to do more. So we see this as it requires work, ongoing work and ongoing engineering, but we see opportunities over the next several years to continue to do more and more of this.
spk14: And Rob, it's Eric. I'd just add, as we adjust our outlook a little bit, part of that was just year-end incentives. We need to reward really strong performance. But we also talked about starting to leg into investments. And we like to invest behind the revenue, not ahead of the revenue, but behind the revenue. And that's what we're doing. One of those investments, to be honest, is is engineering work, right? Development work to actually automate processes, simplify processes, and so forth. And so, you know, part of what we're doing even into the fourth quarter is beginning some of that work so that, you know, several quarters from now, a year from now, two years from now, there's actually an engineering benefit. And so that's where it comes together as well. But as Ron says, it takes real hard work and it gets done in phases.
spk05: Got it, thank you for that. Sure.
spk13: Our next question is from Vivek Junja with JP Morgan.
spk10: Hi Ron, I have a couple of questions for you folks on BBH acquisition. I remember you saying on the announcement of the call something about earnouts. Can you talk a little bit about are these, is this additional payment over and above the purchase price? Or is it something else for the partners who would have presumably gotten a part of that purchase price and cash that you're getting? Can you give us some color on that? What's the driver of that? What is it tied to and over what time period?
spk07: So there's not an extra contingent payment here. So let's put that aside. But what we have put in place, and it was part of our, you know, as we talked about expected accretion here, we have put in place an incentive plan that's quite broad-based. Basically, it's a success-based pool with the factors being contingent. client onboarding and retention, as well as staff retention. And everybody, well, all of senior management fairly deep into the BBH management participates in that. And there's targets out there in terms of client retention. There's targets out there in terms of desired staff retention. So it was really meant to align BBH people around what we're aligned about, which is growing our client base and keeping our best talent.
spk14: And the fact is, Eric, you'll see those costs in the acquisition restructuring line. So we're purposely bounding it but including it in our financials. But they're modest. They're what you'd expect us or any other acquirer to do in a deal, and given the combination, there's a real benefit in the execution here.
spk10: Another one on BBH, and Eric, maybe this is more for you. The BBH sweep program that you mentioned previously too, how much of those deposits How much of that sweep is at risk with banks who would not want to renew it because of capital constraints? So how much of that would you need to take on? And if you couldn't, what's the alternative to that?
spk14: Yeah, Vivek, as part of our diligence, we looked at every part of this acquisition, how the revenues come together, and, you know, there's a lot of shared wallet opportunity, expenses, how it comes together, and certainly the sweep program. You know, the sweep program is modest when it comes to the bank counterparties. It's not enormous for any one bank provider. I think, you know, the top ten bank providers are important, but if you think about what swept away I think we said about $60, $70 billion is swept away today across 10 large banks. You're not talking about a real capacity constraint. And we have done and we've actually engaged with each of those bank counterparties, most of whom we know extremely well and who we do business with. We often do business with those counterparties on the sub-custody side. or in terms of other arrangements. And so there's a bidirectional set of relationships that we have. So we don't see a lot of risk at this point and see more of an opportunity to actually sweep a little more or sweep a little less. What I would say is the core of the sweeps in U.S. dollar And I don't need to be patriotic to say that the U.S. dollar is an extremely valuable deposit and cash currency. And so they're certainly valuable to U.S. and global banks. And so I think we've got a good program set up, and we see it continuing with some upside optionality for us. Thank you. Sure.
spk13: Your next question is from Mike Mayo with Wells Fargo.
spk17: Hi. If you can provide more color on your phrase, you know, business investment for the next phase of growth, that sounds like something more significant than simply, you know, tweaking budgets going into year end or anything like that. So when you talk about this next phase of growth, I know you talked about alpha, private markets, the digital space, but If you maybe just give more color on the overall tech strategy and the tech budget, how much are you looking to increase the tech budget from where it is now, how much of that is to change the bank, and which areas of tech are you investing, such as the cloud or other areas? Thanks.
spk07: Mike, as I said earlier, we've been investing all along through this most recent period, these last several years. And as Eric has noted, we've invested behind our revenue growth. So the gates in our investment have not been necessarily opportunities. It's been, what can we do to fund this growth off of our BAU spending? And second, where and how is the growth coming in? In terms of what we're investing in, it really isn't changing much other than from a balance perspective. I would say that much of the investment that you've seen over the past several years, if you think about the whole resilience area, the whole, I mean, this is imposed on all of us, resilience area, the cyber area, would probably fall under the BAU or run the bank. Alpha has certainly been a change the bank kind of thing. And I think we would anticipate a little bit of a mix shift from run to change in terms of total amounts. But really, it's not going to be a kind of peanut butter thing where everybody gets a little something here for their pet project. It really is about those things where we see it positioning us for meaningful growth, meaningful additional growth. So we explain why, but that would be alpha private markets and State Street Digital kind of primarily. You know what I would add to that? continuing to selectively invest in global advisors. I mean, the investments we've made there in the past, particularly, you know, for example, in the active ETF space, the investments we've made in European ETFs and in low-cost ETFs, all of which are growing and we're gathering a disproportionate share in those space. So that's how we think about it. I mean, you shouldn't expect us to be throwing a lot of money at things that we don't know anything about or that are new to us, but it's about things that we've already established can give us growth and that with a little more investment, we expect to be able to accelerate that growth.
spk17: Okay, so don't spread around the peanut butter too much. But when you look at it by function, I know this predates you, Ron, but when you talk about the cloud, or the back office and you talk about digitizing your operations, how are you looking at the cloud today in terms of public, private, how much of the workload has shifted? Where are you in that thought process and how much does that play as part of your transformation?
spk07: I mean, Mike, we've been very active in the cloud and we've, I think, talked about this in other contexts. I'll use an example, what we're doing in Charles River and Alpha, which is an entirely, right from the beginning when we said we were going to be open architecture and interoperable, That, by definition, meant that it had to be cloud-based. So we have quite aggressively gone to the cloud. We've talked about our partnership, which was one of the first in this whole security services area with Microsoft and their Azure products. So that is very much a part of it, and we think about it as being how can we, certainly there's a cost element to it, How do we advance the business strategically and grow revenues?
spk17: All right. Thank you.
spk13: Our final question is from Rajiv Bahagia with Morningstar.
spk09: Good morning. Just one quick question from me. There's some headlines that hedge fund flows are pretty strong. So can you comment on your alternative fund administration business and what kind of growth you're seeing there?
spk07: Yeah, why don't I begin, and Eric will pick up, Rajiv. I mean, you're right. Hedge fund flows have been strong. And, you know, going back to Mike's effort, that would be another example of where we've invested fairly significantly in new technology there. And in this case, using an outside provider. And, you know, we're enjoying the benefits of those flows. And I think that you will see We expect to see more and more flows into alternatives, alternatives of all types. You know, there's a further push to, you know, to see this, if you will, go into smaller, smaller accounts and, you know, the so-called democratization of it. And we want to be positioned for that.
spk14: And, Rajiv, it's Eric. I just add, you know, the private markets, the hedge funds are all attractive asset classes for us. You know, year on year, you know, we saw 7% growth this year across the servicing fee franchise. You know, in the private markets, you're seeing, you know, 2%, 3% point higher growth than the average for the company. And that's one of the reasons why, you know, over the last year or two and certainly going into the fourth quarter next year, you know, we're investing more in private markets because we see, you know, those opportunities, and that adds to the growth trajectory of the company.
spk09: Got it. Thanks.
spk14: Sure.
spk13: And we have no further questions at this time. I'll turn the call back over to our presenters.
spk07: Well, thanks to all on the call for joining us, and we look forward to speaking with you further. Thanks very much.
spk13: Thank you again for joining us today. This does conclude today's presentation. You may now disconnect.
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