Good morning and welcome to State Street Corporation's Third Quarter of 2017 Earnings Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website at investors.statestreet.com. This conference call is also being recorded for replay. State Street's conference call is copyrighted and all rights are reserved. This call may not be recorded for rebroadcast or distribution, in whole or in part, without the expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on State Street website. Now, I would like to introduce Ilene Fiszel Bieler, Senior Vice President of Investor Relations at State Street.

Good morning and thank you all for joining us. On our call today, our Chairman and CEO, Jay Hooley, will speak first. Then, Eric Aboaf, our CFO, will take you through our Third quarter 2017 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 your questions to two and then re-queue. Before we get started, I would like to remind you that today's presentation will include operating-basis and other measures presented on a non-GAAP basis. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measures are available in the appendix to our 3Q 2017 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, in our 3Q 2017 slide presentation, under the heading Forward-Looking Statements, and in our SEC filings, including the Risk Factors section of our 2016 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 Jay.

Good morning, everyone. Before I begin my remarks, I'd like to take a moment to thank Anthony Ostler, who has moved into a business line role and also to welcome to State Street our new Head of IR, Ilene Fiszel Bieler. Ilene recently joined us and has over 15 years of experience in the financial services industry and is reaching out to those of you she doesn't already know. Now, to my remarks, we have delivered another very good quarter. Our third quarter results, including EPS growth and a meaningful increase in return on equity reflect continued strength in equity markets and strong business momentum. We are continuously advancing new product solutions to support our client success, which in turn has helped drive new servicing commitments of $105 billion. Importantly, new business opportunities remain robust across both our asset servicing and asset management businesses. We remain well positioned to achieve our 2017 financial goals, including objectives associated with State Street Beacon. Through Beacon initiatives, we are focusing on delivering what matters most to our clients and their clients in less time and with less risk. By improving speed, adding data and analytics capabilities and upgrading client-facing technologies, we are enhancing the end-to-end client experience. While we continue to invest in our business, returning capital to our shareholders remains a key priority. In 3Q 2017, we purchased approximately $350 million of our common stock and declared quarterly common stock dividend of $0.42 per share. Now, turning to Slide number 5, I'd like to review some of the progress we made on our strategic priorities and key achievements this quarter. Our core franchise continues to grow. Strength in equity markets and new business lifted our assets under custody and administration to record levels with growth of 10% from third quarter of 2016…

Thank you, Jay, and good morning, everyone. Please turn to Slide 6, where I will start my review of our operating basis results for 3Q 2017. EPS for 3Q 2017 increased to $1.71 per share, up 27% from 3Q 2016. Return on equity for the quarter improved to 13.4%, a 2.3 percentage point - 2.3 percentage point higher than last year's third quarter. 3Q 2017 results reflect continued strength in equity markets and new business activity in both our asset servicing and asset management businesses. 3Q 2017 results also benefited from the rising interest rate environment and disciplined liability pricing, resulting in an expanding NIM and strong NII, which I'll discuss further in a moment. 3Q 2017 expenses continue to be well controlled, the weaker U.S. dollar added 1% of expense growth relative to 3Q 2016. As a reminder, the currency impact associated with expenses is largely offset in revenues. 3Q 2017 results also benefitted from a lower than expected tax rate of 28%, primarily due to a higher share of lower tax, foreign earnings, which was worth approximately $0.04 a share. We delivered positive operating fee leverage relative to 3Q 2016 as we continue to focus on calibrating expenses relative to the revenue environment. Importantly, pre-tax margin improved meaningfully to 32.9% increasing 2.2 percentage points from 3Q 2016. And on a year-to-date basis, we continue to see good progress against our financial goals demonstrated by delivering EPS growth of 21% and 2.7 percentage points of positive fee operating leverage. Now let me turn to Slide 7 to briefly review growth of two key drivers. Both, AUCA and AUM increased again this quarter. AUCA of $32.1 trillion, increased 10% from 3Q 2016, growth was driven by a combination of market appreciation and good business momentum. New business activity was particularly…

Thanks, Eric. Victoria, we will now - we are now available to handle questions.

Certainly. [Operator Instructions] Your first question comes from the line of Ken Usdin with Jefferies.

Thanks, good morning. Hey, Eric, I was wondering if you could just talk us through some of the balance sheet permutations. I know you've been purposely trying to get the leverage ratio up going into CCAR 2018 versus where it was a year ago. Going into the fourth quarter at 7.4%, can you just talk to us about how you're trying to still hold back the rate of growth in the overall balance sheet and what we should expect for the mix going forward?

Sure, Ken. Let me give you a little context. I think a year-and-a-half, two years ago, we made a - decided choice to reduce the size of the balance sheet and bring deposits down to the tune of $20 billion to $25 billion. I think it's an ongoing process and we saw a little bit of a tick up towards the end of last year during third quarter and fourth quarter, which is why we signaled in January that we wanted to bring the balance sheet to trend it back down. And I think we're making good headway. You saw that fourth quarter last year our balance sheet was about 5% higher than it is now. So we feel like we made good progress, our tier 1 leverage, which tends to be our binding constraint under CCAR and some of the stress test, was that 6.5%. And the kind of the work that we've done, both with clients and then with non-client deposits, including the CD book that, that we had built several years back has really positioned us well now with a tier 1 leverage ratio of 7.4%. Going into the fourth quarter, I think those efforts continue. Nothing dramatic, but we continue to expect a mild trend downwards as the - as we continue to unwind the CD book, as we continue to compress the current - a couple of higher cost deposit areas. And our view is that, it will set us up well for the coming year. And then it's - to be honest, it sets us up well for growing naturally, right, over the course of the coming years, as AUCA grows at a nice pace between market and new business wins, clients expect to be able to leave a little more deposits each year with us and I think we'll kind of get back into more of a business as usual mode at that point.

Got it. And my second questions, just on the U.S./non-U.S. point, you've had the benefits of the currency mismatch and then you have the swap that kind of works that out. Can you just help us understand if the BOE and ECB, who have been getting more hawkish start to hike rates? How will that actually flow through the NIM and net interest income?

Hey, Ken, it's certainly something on our minds, right, because the U.S. has clearly moved 4 times over the last year, which we're quite pleased to see. The Bank of England is starting to signal and market expectations are probably a bit better than half that they'll move. It's been moving around. And the ECB is really talking about - at some point slowing down their expansionary policy. I think for the way to think about it, is about half of our net NII interest rate exposure to rising rates within the U.S. and the other half is in international markets which is primarily sterling and euros. You saw us take up NII just from rising rates in the U.S. by $20 million to $25 million a quarter. So it's sizable and if you think about - sterling will help a little bit if it moves and euros even more. But you could see, as and when that happens, I think some more NIM expansion, which would be a good result.

Got it. Thanks, Eric.

Yeah.

Your next question comes from the line of Jim Mitchell with Buckingham Research.

Hey, good morning. Maybe we could just talk a little bit about the fee rate. I appreciate the color on hedge funds. I think even if we think about adding the 1% drag back, AUCA was up 10%, fees were up, say, normalized 5%, if normalized for hedge funds. Do we see - I know ETFs have been a growth area that's probably lower margin. But is there some sense that we could start to see those move more in tandem at some point going forward?

Hey, Jim, this is Jay. Let me start that one. I'll let Eric jump in. So the one thing I guess I'd just reorient you to is the third quarter 2017 versus 2016 up 4%, year-to-date up 4%. Third quarter little bit of a softer quarter from a service fee standpoint. I'd say, I'd point to a couple of things, one, the mix which you mentioned is mixed and you see - in the U.S., you see U.S. fund outflows offset by ETF inflows, almost one for one if you look at the industry. And then if you - we reference hedge funds, which continue to see outflows, although industry data would suggest maybe that has hit the tipping point. We haven't yet seen that in our book, but were - a pretty good reflection of the overall hedge fund industry. And if you go outside the U.S., I'd point to, Eric mentioned that in his comments, EMEA, or more specifically Europe played out through the offshore centers of Ireland and Luxembourg, continue to see very strong flows, which is a mix of long-only product hedge and ETFs as well. So I would say the mix has been pretty consistently like that. I wouldn't read anything into the quarter itself. I look more on the year-on-year to look at the reflection of kind of the service fees. The only thing I would add before I ask Eric if he wants to add to this is the - the pipeline is good. It's good. It's well diversified. And it's probably proportionately a little heavier in big deal activity, which you know for me is a reflection of more folks looking to consolidate work among fewer custodians, and an interest in doing a deeper level of outsourcing, think about middle office is one component of that. So I'd say, generally, pretty steady as it goes. I don't know what you'd add to that.

Yeah, Jim, I'd just add on the fee rate. Just remember, this isn't the - the servicing business is a little different than the asset management business, in asset management the fee rates are linear, right, as you add more assets you get automatically higher revenues in services. You kind of get 10% higher market. AUCAs is only 3% in equity. It's 10% [ph] and 1% [ph] in fixed income. So you kind of have that denominator effect. And then you have the mix of whether it's hedge funds, whether it's emerging markets are at higher rates than the U.S. and so on and so forth. So I think the way we think about the fee rate is it's something to track, because the question is, as Jay described, are you doing more business with clients, more business with existing clients and the more business you do with existing clients tends to offset the mathematical reduction you'll get in fee rates just from the way the numerator and denominator work through.

Okay, well, that's all helpful color. And maybe just my second question, Eric, you've been now at State Street for a little while. What's your sense of Project Beacon? Do you feel like there is - are there any more opportunities as you look into this more over the course of the next few years or do you feel like it is good target or an easy target, trying to get a sense of - your sense of the expense line as you dig into it?

Yeah, Jim, I think the - my perspective on Project Beacon, like you say, I've dug into it now. I've dug into it at a couple of levels of details as you'd expect and it's something that Jay and Mike initiated a couple of years back and really was a follow on to that original ITOT effort. I have a lot of confidence to be honest that there is a lot to do. And why is that, because we run a servicing process and system that has become more and more automated over time. But you remember, we take on very large mandates from very large asset managers, pension funds, insurance companies. And they usually hand them over to us in a fairly bespoken customized manner. And they like it when we execute on them in that basis. And so, there is a lot of work to do as you march across one large client to the next large client, to the group of medium sized clients, as you march around the world to continue automate and digitize and simplify those processes over time. And so, as I looked underneath, Beacon isn't one effort, right, it's actually dozens and dozens of effort. So there is a lot there. And I think it will be something that we keep at. We originally announced it as a four, five-year program. I think our view is Beacon will continue, right, because it's got to be part of our DNA and how we manage the business. And then I think I did say in my prepared remarks, there are also new areas of Beacon that we continue to push on, whether it's the corporate functions, right. We spend a $1.3 billion or so of our $8 billion expense base in the corporate functions and so that needs to be under scrutiny as well, carefully, but under scrutiny. Ron O'Hanley is driving Beacon into the asset management business. So there is always more to do and I think we see good opportunities in the coming years.

Okay. Great. Thank you very much.

Your next question comes from the line of Glenn Schorr with Evercore.

Hi, thank you. Quickly on the assets under custody and administration, the insurance and other products is down another 5% in the quarter. The markets have been doing good, something unique in the quarter to point out?

Yeah, Glenn, it's Eric, and I think for the others on the phone, I think you're pointing to the supplemental information package on the assets under custody are on Page 7. There is actually nothing significant going on with the insurance clients. I think the line you're looking at, which is the fourth one down, is actually - has three sub-lines, got insurance, got private equity and it's got other - insurance and private equity are actually flat sequentially, so some upticks offsetting some - just the usual movement. And then the other line which you kind of can see underneath the surface is more volatile and that's due to timing of installations. What effectively happens as we bring on new business, right it gets categorized in other and then you need to do a detailed categorization up into the lines above and that just plays over a couple of months. So you've seen this - I think we've seen this volatility a little bit before and just think of it as classification volatility, nothing more than that.

Okay, okay, and then quickly on balance sheet, I noticed, the rate paid on your U.S. deposits is down the last couple of quarters, which is also in a raising rate environment. I'm just curious if you could talk towards how you manage that dialogue and what type of clients that is.

Sure. Glenn, there's a couple of things in the U.S. deposits on the average interest earning balance sheets, right? There is the - I'll call core client deposits and then there is the wholesale CD book that we had built up to the tune of a bit over $15 billion year-and-a-half, two years ago. So what's happening on that line is you actually see a mix effect. As the CD book comes down, the overall rate paid on total U.S. deposits is coming down. And that's offsetting the slight increase that we're seeing quarter-on-quarter, as we adjust rates up a little bit every time the Fed has moved. If you wanted to unbundle that the cost of deposits for just the U.S. client deposits is up 5 basis points, right, against a 25 basis points move in at the Fed and that's where we - that's how we quote the beta of 25%. So kind of it's moving up exactly as we would have expected at this - given the external dynamics.

Awesome. Thanks, Eric.

Yeah. My pleasure.

Your next question comes from the line of Alex Blostein with Goldman Sachs.

Hey, good morning, everybody. So I had a follow-up around just the servicing business either for Jay or Eric. Totally get the fee rate dynamic, obviously more of an output and as we've learnt over the years. But I guess taken a step back given the mix shift dynamic with hedge funds. The BlockRock issue coming up, I guess, next year with some of the loss business, but then clearly some positives on the non-U.S. side, et cetera. Holding kind of market's effects flat, what do you guys see as a reasonable organic growth for the servicing fee revenues over the next couple of years?

Alex, it's Eric. It's hard to tell precisely, which is why we have - we've stuck to our general view that we should focus on overall fee growth, we said 6% to 7% now that was up from 4% to 6%, there is obviously some market movement in there. You see the - I think, if you want to dive down into servicing fees specifically, you see those were up 2% on a currency adjusted basis year-on-year, and up 4% year-to-date, right. And so the - in our mind 4% for a little more representative. Now clearly, there's a number of factors in there, right. There is some market appreciation, there's some inflows and outflows, and we called out more than a percentage point from the hedge fund business, there is some amount of new business activity, and then there's a very important amount of expanding activity with existing business, and then there's a little bit fee headwinds, more or less than we've seen before, but it's always been a little bit of that over the last couple of decade. So it's - I think, it's hard to be precise and part of what we're trying to navigate through is, we're always looking at what business can we bring on, at what fee rate. But in particular at what margin, right, because it's the margin that really matters at the end of the day. And then, as we think about new business at the right margin, and then, we kind of get to fee operating leverage, and we feel like we have a business system that is remunerative. So anyway hopefully that's enough guidance to start.

Got it. Thanks. And just quick follow-up around the NIM and the balance sheet dynamic. So clearly, very nice job on kind of remixing the funding and optimizing the strategy a bit, it sounds like there is a little bit more to do here in the fourth quarter as well. But also taking to step back kind of assuming the composition of the funding structures in place more or less so in the U.S. now, how should we think about the kind of NIM sensitivity to next - to near future funds and hikes given kind of changes we saw on the funding side now?

Sure, Alex. Let me - it's Eric, let me continue. I think, we're comfortable with our NIM sensitivity and in particular the position where we expand NII in the rising rate environment. I think, we've done - we've captured that benefit in the U.S. for the first three or four hikes, and that's been quite positive for us, and has helped us buoy NIM, but also margins and ROEs, that's important. I think, we'd like some amount of NIM sensitivity for the U.S. going forward, if we got a December hike, then we might as well stay open, right on from a rate position. And I think the Fed has signaled they want to get to - maybe not 3% terminal Fed funds, but two and three quarters. And we feel like, there is a big distance between now and then. And you remember the opportunity cost of running an open sensitive position to rising rates for us. As a custody bank is not very high, because at the front end of the curve, right? The front end of the curve is not particularly steep. So anyway long way to say that I think we'd like the open position in the U.S., we talked on one of the earlier questions being open in sterling and in euros, is helpful. It doesn't mean that if the 10-year doesn't spike up or we see some volatility where we have some nice uptick. We invest a little bit, but I think directionally we like the open position to rising rates.

Got you. I understood. Thanks very much.

Your next question comes from the line of Brennan Hawken with UBS.

Good morning. Thanks for taking the questions. So first, Glenn had asked about the U.S. deposit costs, which you walked through nice, Eric. Thank you. On the non-U.S. side though, I think, if we adjust for the FX swap costs, we saw pretty decent pickup in the deposit costs there. Could you - number one, is that right? And then, if it is could you maybe walk through us going on there? Thanks.

Yeah, I think on the international - what we've called the non-U.S. deposits on the interest bearing schedule, which is the Page 13, the math you'll want to do is to isolate the FX swap, which we put in the footnote, because remember the currency swaps, while they're tied the deposits from an accounting standpoint are offset on the interest earning asset size primarily they're in the deposits of the banks or in securities that we hold. If you were to, though - and if you do that math and we're happy to follow-up Brennan, as a - to help out with that. And you were to strip out the currency swaps, the change on the international side is, I think, literally 1 or 2 basis points, so it's relatively flat and within the scheme of what you'd have in any particular quarter. So we're not seeing much there, and we don't expect to see much there until either the Bank of England moves or ECB moves. And what I think it'd be a good day when that happen to be honest.

Sure, sure. Thanks. I'll follow-up on the math there. Another question on the deposit front would be non-interest bearing, we saw that decline. I think, you spoke about how there was some remixing and some clients that were rotating out of the non-interest bearing and into the interest bearing side. Do you guys have any view about ultimately where that might end up shaking out with the mix or look like non-interest bearing to interest bearing. How should we think about that going forward? Thanks a lot.

Sure, Brennan. I think, you are - what you've seen so far is actually even better or kind of within expectations or even a bit better, right. We saw a pretty slight $2 billion move out of non-interest bearing, which actually all ended up in interest bearing, when we actually did the detail tracking. And that's well within the bounds, it actually continues to positively surprise, how little has actually moved. And in truth if it moves, it's not that big of a deal. A couple billion a quarter would not be - is kind of well within, in fact it continues to be below expectations. In terms of terminal questions sort of where does it go, I got to say really hard to predict, I think, we don't see a fast move. So the question is, what's the - how much does it move and at what pace. And you've seen some - you've our results here, which are down just $2 billion quarter-on-quarter and about twice that year-on-year. I think, you've seen some of the industry results, which are probably a little bit more than that, but I think we fared well. And so it's hard to say, what that's going to be, I think you can look at the long range percentages of non-interest bearing to what the interest bearing. That's said, I think, pricing is different in this cycle, because we are pricing more adroitly for different types of deposits, right. Deposits that our LCR valuable, those that our non-LCR valuable. So I'm not giving you a sharp answer, because I think there is a range of results, and our view is, we should just work closely with our clients and to the extent they have a little bit in those pools. We'll help them, adjust them if they'd like to at the right time.

Okay. Thanks for the color, Eric.

Yeah.

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

Hi, good morning.

Good morning. Go ahead, Betsy.

Hi, good morning. Hi. Question on the outlook. I know that on Page 13 of the slide deck, you reiterated the guidance you gave in 2Q 2017 call. But then at the end of this call, you were highlighting that you thought you would exceed the 6% to 7% total fee growth range. Can you just give me a sense as to whether or not you're anticipating that full year could actually come above the high end of the range you've got here? Maybe you could speak a little bit to the operating leverage that you're looking for in the quarter.

Sure. Betsy, it's Eric. Let me start. I think, we feel good about the results overall on fee growth year-to-date. A little bit - bounce around a little bit quarter by quarter. But the way we've described this is that we feel like, on a full year basis for fees, which have been running about 8% year-to-date, we're going to be over the 6% to 7%. I think, I also said that if you wanted to put aside the BlockCross sale and the other first quarter IFDS, BFDS transfer agency sale, that if you put those ex slide, you're closer to the top end of the 7% range. And so it just gives you a little bit of data by which to calibrate what we expect.

Okay. So your Page 13 is more organic versus - the results will be obviously organic plus some inorganic activity. Is that fair to say?

Yeah, that's a good way to frame it.

Okay. And then, the follow-up is just on the SLR in the prefs. If the rule changes with SLR and we're - you are able to eliminate cash or reduce cash in the denominator of the SLR, is there any action you can take on your outstanding prefs? Or do you have to wait for them to mature?

It's Eric again. There - each of the series of prefs that we have out there, and there are several have a call date. The call date was typically five years out from the original issuances. So I think, there is some calls coming through over the next 12 to 18 months. And it actually gives us, I think, a nice bit of flexibility. So I think what we put out there was good at the time. And if the rules change, we can always adjust a bit.

Okay. Thank you.

Your next question comes from the line of Mike Mayo with Wells Fargo Securities.

Hi, I have one question about a negative trend and one question about a positive one. So the negative would be foreign exchange. It stays - it's staying very low. And do you see any change in that? And if volatility were to increase, say, 10%, what's the sensitivity of those revenues? And also, I - just on the topic of foreign impact. Emerging market asset values were up 8% quarter-over-quarter and I thought that would have had more of a positive effect on your custody fees.

Sure, Mike. It's Eric. Let me start on both of those. So first, on foreign exchange trading. I think there's just some evolution here given the volatility that we're seeing in the marketplace, right. And that's primarily what we attribute the changes to. If you recall, we had a particularly strong second quarter as we saw a very large shift to emerging markets. Emerging markets have typically much higher volatility and much wider spreads wider spreads, and I think we took full advantage of that in 2Q. And then a year ago, obviously, we had the backdrop of Brexit. So we're just seeing a lower level of volatility, and I think we're cautious. Underneath that market-driven kind of environment, though, we're seeing good volume growth - we're seeing good volume growth in developed markets. We've been drilling down. We've seen good volume growth in emerging markets. You see some of the results from the Euromoney survey, which isn't perfect, but it's indicative. And so we're actually, I think, quite pleased, and our view is if volatility comes back, we'll see some uptick. Hard to give you a percentage uptick. I'd do more of - 2Q was a standout. You can look at how much volatility spiked and kind of do some math, and we're happy to kind of be a sounding board for you as you do that. So I think what we're focused on is building that franchise. The franchise has been building. It feels like it's - by our estimate, it's picking up 0.5 point to a percentage point of market share over the last year or two, which in FX is actually significant. Maybe to the second question, on servicing fees, yeah, the equity markets were up nicely. Remember, bond market is not so much, alternative markets were kind of still are relatively flattish. So you got to do a weighted average kind of math here on the market indicators. That's why in the press release we actually give you a table of six different indicators, because it's a mix of those that really affect our business. And then, over and above that, there is the mix, how much are we taking on in ETF versus mutual funds, how much in the U.S., emerging markets. And so, the math kind of just moves around quite a bit, which is why we're focused both on a quarter but also on a year-to-date basis. And just we're kind of navigating through as we go here.

And then the other question, management fees are up quite nicely linked quarter and year-over-year. What's happening in asset management and with the GE acquisition? And would you consider more asset management acquisitions?

Let me start that one, Mike. This is Jay. It's a factor of really shifting out of lower-revenue-generating assets and into higher-generating revenue assets. So if you look at SSgA in the third quarter, which had a net $25 billion in outflows, $40 billion, went out of largely passive institutional mandates, which has been a bit of a trend. And on the other side, you saw $12 billion into positive flows into cash, and $2 billion, positive flows into ETF. It's out of the lower revenue into the higher revenue, which results in management fees up 14% and AUMs up 9%. And that's not a one-quarter trend. We continue to see that, and it's been part of our strategy to focus on the higher-revenue-generating asset pools. I don't know if you'd add anything to that.

Yeah, I think it's a good result and you mentioned GE. Even there, we've bought it on. We've gone to accretion sooner than expected by a quarter. So that was, I think, good work by the team. But we also added some of the - some additional mandates, in particular some of the GE UK pension, the OSRAM [ph] pension and so it's been a nice platform and a good result. I think you also asked about acquisitions. Let me maybe start there, Jay will probably weigh in, too. But we like this, the kind of tuck-in asset management space, it's attractive. The accretion works out pretty well. Given the relative PEs of ours versus the asset management space, that was a nice size deal. And so clearly, they've come up from time to time, but it's certainly a good use of capital from our standpoint.

Yeah, I'd agree with all that, Mike, and I would say that if you look at where the gaps are and our asset management capabilities, we've got a bunch of gaps on the fixed-income side, a little bit on the equity and alternatives side. So to the extent that we can backfill those gaps, it makes us a more relevant player on the solutions space. I might just go one other place, Mike, on the asset management, which is, we recently announced that we were entering the low-cost ETF marketplace, and organically, although with a partner. The ETFs, 60% of ETF flows over some period of time have been on this low-cost ETF space, and State Street really hasn't participated because we haven't had the access to retail distribution. And so, we think it's a good move to enter a new distribution channel by taking 15 of our ETFs, translating them into low fees in concert with the TD Ameritrade partnership. TD is the third largest retail distributor. So it takes the ETFs, repurposes a handful of them, very low revenue give-up and positions us into this part of the market that's driving 60% of the flow. So not acquisitions we made there, but we do think that fills out a segment of the distribution market that we haven't been present in, and we think this enables that.

Well, we'll watch that. Thank you.

Your next question comes from the line of Geoffrey Elliott with Autonomous Research.

Oh, good morning, thank you for taking the question. Maybe the first one on the operating basis EPS number. Perhaps you could remind us the logic for stripping out the restructuring charges, which feel like they occur to a greater or lesser degree most quarters but not stripping out something like the BlockCross gain on the business sale. And then any thoughts about whether it makes sense to continue posting operating EPS or switch away to GAAP, which is what most banks do?

Geoffrey, it's Eric. Let me take that and I think you and I talked about that, and I certainly got a lot of feedback as I started back in December and January. I do agree that over time, GAAP results are something that we want to move towards. I think as you know, we've run a mix of both operating and GAAP results, we show them both so you can kind of see them both ways, so there are no surprises. I think what you've seen me do this year so far is actually narrow the difference, and we've done that both on some positives and some negatives together. And I think you can always kind of find one thing or another to add back. But I think what we'd like to do is move to a more standard presentation, and you'll see us doing that in the coming time periods. I just need to make sure that we're all - we design that well and we also do that with you all in mind so that it doesn't fluctuate with your models. I will say that we will want, though, to continue to be able to identify some of the restructuring charges not because we shouldn't include them in the GAAP results or the final tally of how we do. But one of the reasons we have carved them out and carved them out of operating is actually just so that you can see the underlying momentum of the business and expense management and not color that with whether a charge is $35 million or $70 million in another quarter. And so, we're just conscious that. I guess, the way I'd say is either way you are going to need to see the information. But because we are going to continue to optimize the business and drive Beacon, right, where are going to take a series of - I don't think it will be - well, series of expected charges. And we just want to make sure those are out there and everyone's expecting those.

Thanks, very helpful. And then, on the Ameritrade partnership, I noticed a few of the ETFs there are shifting to self-indexing. Do you think there is a longer-term trend there towards self-indexing to reduce the cost of ETFs? Is that going to be something that we see more of?

Geoffrey, this is Jay. Yes, I do think though. I think that in a world of low cost ETFs where every expense line matter to the extent that you can internalize or create some synthetic of an index or create your own indexing. I do see that as a trend, not just for State Street, but for others.

Great. Thank you very much.

Your next question comes from the line of Gerard Cassidy with RBC.

Good morning, guys.

Good morning.

Hi, Jay. I had to jump off the call for a minute, so I apologize if I you had addressed these questions. But the first question is, obviously, you've started to restructure the liability side of the balance sheet, as you mentioned. I noticed the non-interest-bearing deposits in the quarter fell to about $39.7 billion on an average basis from $42.2 billion in the prior quarter and about $44 billion last year. Aside from the obvious, interest rates are higher, were there any other factors that drove the non-interest-bearing deposits down.

Gerard, it's Eric. No, it's literally an interest rate effect and clients are conscious of what accounts they have. They typically have multiple accounts, right, sometimes for the various fund family, sometimes geographically and sometimes just for operational purposes or preferences. But this is the moment that we've seen, which is kind of 5%, 6% in the quarter, we think, it's pretty modest given that the Fed moved, in effect, 25 basis points here. So nothing more than rates and kind of all within the bounds if not even less of a move than we would have expected at this point in the cycle.

If the Fed continues to raise rates, should we expect this line to continue on this kind of rate of decline? Or should it slow down, accelerate?

Very hard to predict, right. We - the kind of the structure of what exists out there for clients to hold in terms of deposits versus money market funds versus prime money market funds, right, they're kind of options that has changed since the last set of rate increases more than a decade ago. I think for kind of a general view, I think this pace feels about right for the time being, but there could be a range of results around that. But this pace feels realistic as we see rate raises play through.

Great. And then my second question, I know this is not a significant part of the balance sheet, but in the other interest earning assets for the quarter of $23 billion, you had a nice jump from the second quarter yield from 76 basis points to 118. Okay, any color behind what drove that nice improvement.

Yes, the other interest earning assets will include the Enhanced Custody activity, right, which is part of the sec finance business. And so as that - as we expand that business, we get paid both on the interest rate line as well as in fees.

Great. Thank you.

Your next question comes from the line of Brian Bedell with Deutsche Bank.

Okay, great. Thanks for taking my question. Eric, just on that last one, maybe if you can differentiate what's happening with the repurchased securities line. I think that went up 97 basis points on a core basis. And then the Enhanced Custody dynamic on the other interest earning asset line, and if you can sort of parse out the Enhanced Custody contribution to that other line, that'd be great.

Sure. Yeah, let me do those in reverse order. I think the - in interest earning assets - or other interest earning assets, which is about $23 billion, I think the large majority is Enhanced Custody and then you have a little bit of derivative balances and some of the other knits and gnats there. And so that's what's happening, and kind of underneath that in other interest earning assets, you'll find that derivative balances move around, but Enhanced Custody has actually been just moving up at a regular pace. And I think we can expect some amount of expansion there as we continue to grow the business at a modest pace, and you saw it up 8% year-on-year on revenue side, and I think we kind of - we think about the balance sheet scales accordingly. In terms of the securities purchase for resale agreements, right, the repo line, I'll just remind you that what you have in there is the on-balance sheet repo and reverse book. And then, the piece that is run through that FIC [ph] program or the - effectively sponsor a client, but it's the client's actual position and risk. We disclosed that in the footnotes and pretty well. I think what you'll see, as those rates continue - will continue to tick up in line with prevailing interest rates. So as the Fed moves, you've got movement in Fed funds, you've got movement in general collateral repo rates. And so what you're literally seeing is just the movement in market rates play through that activity.

Okay, okay, thanks. And then, maybe just to go back to the security servicing. I know, it's been asked - and I appreciate all your detail on it. But if we just think about sort of how the new business trends are coming forward, and maybe if, Jay, you can chime in on this as well, but with the shift towards ETFs, and I think, Jay, you mentioned some larger pieces of new business in the potential pipeline. How should we think about that fee rate going forward? It looks like, of course, it's kind of dropped down sort of in a trough level in the third quarter. I was just trying to sense if that's a little bit of an abnormal drop. And - or do see that rates sort of being a good sort of go forward?

Let me start that one, Brian. Let me start with your question about - I interpret it as being pipeline and activity in the marketplace, which, as I would say, quite good, quite diversified, proportionately more kind of big deal activities, and as I referenced a minute ago, I think that to me, it stands for firms in the asset management industry that are looking to get more efficient, looking to create more front-to-back straight through processing, and therefore consolidating with fewer providers. There's a - it's rare that these big deals don't happen today without middle office, something that you know well as a component of that, we view that as all quite positive, because the deeper you get into the middle and front office, the more differentiated we are, particularly if you had to that multi-geographies. And therefore pricing - better pricing goes along with that. So I would say that deal activity, deal pipeline quite good. I'd also call your attention to we've got a little bit higher pipeline of deals committed, but not yet installed at just under $400 billion, which we'll roll in over the next 18 months. I'd say that when I add all that up, I look at 4% kind of year-to-date service fee revenue growth, 4% quarter-on-quarter. That feels to me more like a number you should focus on in the quarter itself and the sequential effects of that. And would you had anything to add, Eric?

I just add that we do feel good about the momentum of business. We're trying to be clear about that notwithstanding the lumpiness that you get quarter-to-quarter. And so we have some confidence, because we do have some visibility. Obviously, in what's the backlog, what's coming from the pipeline, and so forth. On the fee rate specifically, I'll just remind you that as we add new wins, right, if we add - if we had the custody business for a big firm, and remember we have 40% share in the U.S. asset managers and the mutual fund business, right, if we had a custody and we're adding the accounting, right, you get fees with no incremental AUCA. So you kind of get a positive effect on the fee rate. If instead what we're doing is, if we had half the book and somebody consolidating it, right, and had half of the custody book, and now you're adding the other half of the custody book. You're actually adding both a numerator and a denominator. So there's a lot going on there, which is why I think the fee rate's indicative. But I'll just - it's indicative, but I think there's a lot going on in terms of whether you're expanding new clients, share of wallet with existing clients, and then all the ins and outs of geography and product type.

And then you mentioned you focus on the profitability, obviously, and improving that. For the some of these new deals that are in the pipeline, and how should we think about the on-boarding expense run rate? Should that be a little bit lumpy and high initially before we get to bring those in or more sort of this the same pattern?

Yeah, it's Eric. I think, it depends on the deal sizes. So I think the small and medium sized deals, you kind of just roll into, and there's nothing particularly significant. I think with the larger deals, it depends how they're structured. And so we called out one from the middle of last year, and what regionally came over was literally a lift-out of business activity with rent costs, and people costs, and technology. When you get them that way, you often get them with a TSA, because they literally can't move all the sub-pieces. And so it comes over as a step change. And then what happens is that you then convert from the TSA to the actual line items, right. But as you're doing that, you're effectively digesting. So you might take on 400 people, which is kind of a percentage point of additional headcount. We know that we won't operate it that way in the subsequent years, but that's how we need to take it on. So kind of the bigger the deals, and I guess, we'll describe as we have big deals or - from time-to-time, we'll describe whether there are step changes, I don't think they are - they're enough to disrupt the full year expense growth story, but on a - and kind of trend. But on a quarter - a one quarter basis, there may be a little more or a little less. And so I point to this quarter. Sequentially, we had no growth in expenses when you adjust for currency, right, and that's because there wasn't any big deals just coming in, in a lumpy way. In another quarter, you might easily put in for a percentage point of expense growth, because they were a big enough deal in a particular quarter. And so it's that kind of dynamic or range that we're talking about.

Okay, great. Thanks very much.

Yeah.

Your next question comes from the line of Marty Mosby with Vining Sparks.

Thanks. I had a one very particular question, one big picture question. But Eric, first, the tax rate dropped off considerably this particular quarter to one of the lowest levels we've seen in several years. The explanation really doesn't talk about discrete benefits, but says it's really mix and energy investment. How would that cause a temporary kind of downdraft? Those things seem more permanent, whereas if you look at the guidance, you're saying it's going to bounce back up to the 30% kind of level?

Marty, it's Eric. I've learned to love taxes over the years given how they come in and the lumpiness versus the non-lumpiness. What happens during the year, if you remember, is there are also re-forecasts of expectations with regard to the full year, because you have to set your tax rate based on the full-year expectation of your earnings. And so what happened this quarter is, as we saw more foreign earnings than U.S. earnings in the current quarter and expectations for that to continue into fourth quarter, you effectively have to reset your tax rate to that amount and effectively do a version of what feels like a catch-up. So I think that's probably the best way to explain it, and I'm happy to take a little time off line. But it was - it creates a lumpy catch-up in the particular quarter there. I think on a year-to-date basis, we're running a little north of 29% on the tax rate, and I think we're - we still think we'll end up somewhere around the low end of the range - near the low end of the range that we've described.

So more of a permanent improvement as you move forward, putting it at the lower end of the range that makes that consistent. And then Jay and Eric, I have a bigger picture question in the sense that there's been a lot of talk over - since the financial crisis and recession that the trust business model was just broken. There was things that were falling off, and that you would never recreate profitability like you did it back in the golden days. If you kind of look at what you're doing, as soon as rates are starting to come off the floor, your returns are returning to, if not the highs, pretty close to that. So you're getting within reach of - now you're well into the middle 13s, 14, 15 is kind of upper end of that range. So you see rates driving you back to that. So was there really anything broke about the model other than just interest rates are really low and now we're getting that benefit back?

Yeah, I would say - This is Jay, Marty. I would say that nothing was broke, but a lot has changed. When I think back 10, 12 years, and I look at the upward slope of things like mutual fund flows, ETFs weren't even in the frame yet, I looked at a time when there was a fair amount of revenue generated in the market base revenues, foreign exchange, securities lending, net interest revenue, as you talk about, I think that from then to now, the business of asset servicing, asset ownership has become more challenging. Returns are a little bit more difficult. So as we being a downstream - having downstream effect of that, we've had to change our operating model to be much more focused on creating efficiencies, creating straight-through processing, which - and also moving our business model from the back office to the middle office, heading to the front office, I might add. The value that customers see and what we provide on the servicing side today is much more around the data and analytics, which is why we're investing so deeply into Beacon because it's moving to a place where our ability to aggregate custodian data, inform it with data and analytics allows our customers to compete more effectively. So I think that another backdrop comment I would make is that, if you look at the world as we see it, which is not a North American, but a global world, our estimate is gross assets are growing in the 6%-ish range. So the asset pools are up, but they've shifted from traditional products to ETFs, solutions, all of which requires a higher level of sophisticated technology to support our customers' needs in the future. So I'm as bullish as I've ever been about our prospect and outlook from a standpoint of meeting our financial targets, but the underlying business has changed. And I think it provides a firm like State Street with a clear path to further distinguishing and differentiating ourselves as we move to middle, front office data and analytics informed by Beacon.

I guess, Jay, what I'm looking at is if you do all those changes what you've done in the operating model and expenses, and then you look at really at the bottom line, 80% of the your bottom line comes from net interest income. So everything else kind of nets out and it reminds me much of what we used to have in mortgage servicing where we did a lot of work. There is a lot of fees. The business always changed, always adapted to that. But at the end of the day, escrow balances was where we got our profitability. So I'm just wondering if at the end of the day that those deposits really are where the value comes and it produces a majority of what you see in the actual pre-tax income.

Marty, it's Eric. I'd just be a little cautious about going as far as you're going. But remember, you didn't have a custodial asset. There will be no reason for client to hold deposits with you. If you didn't have a custodial asset, they wouldn't hold your current - foreign currency trade with you. If you didn't have a custodial asset, you couldn't do custody accounting administration, front office data analytics, so highly inter-dependent business. And does how you get paid adjust and evolve over time? Maybe, but our perspective I think is we should make sure we need - we understand well how we get paid in that business and make sure we get paid fairly. I think you saw returns on equity north of 13% this quarter, you've seen us do that a couple of quarters here. Return on tangible common equity, which is a traditional bank measure is like in the 19% range. I mean, pretty - I don't know what the golden era was like that you refer to, but it's pretty attractive returns for an institution here with very nice EPS growth.

Now, on you returning to those golden age kind of return is what I was getting at as all it took was rates. But, yeah, I appreciate the time you spent on it. We'll talk about it little bit more offline.

Good. Thank you.

Your next question comes from the line of Mike Carrier with Bank of America.

Thanks, guys. Just one quick one here. Just on the servicing, maybe the overall relationship. Thanks for the color on the quarter, just on the products and asset classes. But it does seem like the clients are under more pressure, whether it's them facing fee pressure, new regulations. I just wanted to get an update like when you think about the other like offerings that you have, we look at one line item, but obviously you can generate revenues in other areas. So I don't know if you have any update on how that shifted over time with the clients, the number of products and services that are being used. And then probably most importantly, given what you guys are doing on Beacon, like the incremental margin on clients today versus maybe three or four years ago before you went down this path, just so we can kind of get more of a holistic view versus just the one part of the business.

Yeah, Mike, this is Jay. Thanks for the question, the - it's a good question, because in addition to the traditional packaging in the servicing business of accounting and custody, augmented by foreign exchange, trading and securities lending, more recently Enhanced Custody. I would say the package has been enhanced recently with - I mentioned, middle-office, which is where almost 24 years into middle-office, we were the pioneers and still the market leader by a long stretch. As clients, as you rightly point out are faced with more pressure. There is more consolidation of providers, but the value they see is, now into the middle-office, our ability to aggregate custodian data and provide them a platform for front-office analytics. All the other stuff are still relevant, with the trading, the lending. But increasingly, the value proposition is in that middle and front office data aggregation, which is why we talk about Beacon. And rightly, we're all focused on Beacon as an efficiency play, but it's much, much more than that to the extent that we can get our data, the $32 trillion in assets that we hold on behalf of clients or a specific client normalize, made available on a real-time basis, aggregate it with other custodian's data. It's a huge differentiator. And so, I think that that's what we're playing for and we think that long-term the big global asset manager is going to look for partners like that that can span global locations, that can move from the back office to the middle office, into the front office, all the while keeping all those other revenue pools intact, the trading, the securities lining and Enhanced Custody.

And, Mike, it's Eric. I'd just add that to support that effort and those trends and those - that progress, we have fairly intense performance measurement that we do, sort of number of products, number of products per client for asset managers versus pension funds versus insurers. And we actually shared some of that at the early September conference just so you have a little bit of kind of tactical feel, but we generally think about 30 products or so that are out there that we offer. And the performance measurement gets us at that level so we can target and grow kind of at that level.

Okay, thanks a lot.

Sure.

Your next question comes from the line of Vivek Juneja with JP Morgan.

Hi, Jay, Eric. I want to get back to the servicing fee question. So if you look at constant currency versus year to date, in 2Q you were running at about 5% growth year on year. Now, you're running, again, constant currency year to date about 4% and you said you're comfortable with that. So there's been a little bit of slowdown there. What is causing that? Is there something, can you give some color on that? And what gets us to be - what's causing the slowdown and what gets us comfortable that it's staying at 4% and not going a little bit slower?

Sure. Vivek, it's Eric. I think I just caution on individual quarters just like I would on individual months, because you got a fair number of small things going on. You got accruals, which are occasionally little lumpy. You've got new business that you install and which kind of has to tip in. You may have an old deal that is winding down that comes out. So - or a little - we just want to give a little caution to a particular quarter's results. And if you think about the little lumpiness that you might get in one quarter, if that lumpiness went the other way in the previous quarter, then you kind of get a little more than you might expect, which is I think what happened this quarter, so just a little kind of cautionary note to take it in perspective. In terms of why we had some confidence for the fourth quarter and the year is, we put aside new business pipelines, but we have a backlog of business that needs to be installed and when it gets installed, we begin to accrue for. We obviously have good visibility into that. And so, that's off of which we're doing some of our modeling and off of which we gave guidance for fourth quarter. And we think that will play through.

So, Eric, keeping that in mind, do you think we're better off going back to where you were running first half of the year? Or is that too fine - cutting it too fine to go from where that's four or it's five or is there some kind of range in that - between those two?

Yeah, I'd keep it in the range. This is a business that you win over quarters that become years, that become multiple years. You saw what year-on-year was 1Q, year-over-year 2Q, year-over-year 3Q. I think the year-to-date is a good indication and is our expectation for - is our expectation.

And the FX swaps, Eric, for you, that you mentioned earlier that caused some of that impact on the deposit costs, was that because of the weakness in the dollar versus the pound or the euro or any color on that?

No, the FX swaps and the reason why the FX swaps which are linked from an accounting standpoint to the deposit, cost more in the third quarter than the second quarter is because the interest rate differential, right, between U.S. markets and European markets. And so as the Fed moved, but the ECB did not move, the cost of the swap goes up. That said, when you invest in dollars you can invest at higher rates than you did in euros, and so it neutralizes, but the accounting shows it on two different lines.

Okay, great. Thank you.

Yeah.

Your final question comes from the line of Brian Kleinhanzl with KBW.

So now, you mentioned earlier that you were reducing the credit securities and adding direct loans. Can you just size what the ultimate goal is of that strategy and the timing of it as well?

Sure, Brian, it's Eric. We're gliding the balance sheet. I think you saw us glide a bit on deposits in a very purposeful way and we think that that's accretive to ratios and for the annual stress tests. And then on the asset side, on the investment portfolio side, I think you've seen that we have a kind of broad diversified mix of securities. You've seen us adjust by about $2 billion, $3 billion this quarter. And we have a capacity to continue to do some of that to the extent that we want to create room. I think if you step back, what we're trying to do here is optimize multiple ratios, right? Right now, tier 1 leverage is the binding constraint, since you see a lot of activity there. As tier 1 leverage becomes less of a binding constraint, then we have to think about the SLR constraint and the RWA constraint. And what you see us do is in a kind of in a forward thinking way, begin to tailor the balance sheet for those as well. So I think I describe the investment portfolio as a modest adjustment. We have the capacity to do more because we have a little more of a high quality, credit-intensive portfolio than others. And if there's good client business to be done and we want to grow that a little more quickly, it's a natural part to say should we do both or should we offset a little bit. I tell you, both changes are accretive on earnings and both are positive in our stress testing and so that's - that was some of the logic and something we'll continue to work on and refine.

And just a second question, yeah, I heard you mention the impacts of the sale of BlockCross on the processing fees, but didn't hear the dollar amount. Did you give the gains on that sale?

Yeah, the pre-tax gain was just around $25 million and it's in one of the footnotes. The - what I will remind you is it's in processing fees, which this quarter we're $145 million. A year ago, processing fees were $139 million, so there is - that's the fee line where we have lots of small items. We have software fees. We have loan fees. We have BOLI. We have tax-advantaged investments. It's a little lumpy. But - so BlockCross didn't have a significant move on a year on year basis. It does have a - it is, it does have a pre-tax effect in an absolute way in the current quarter though.

Good, thanks.

And there are no further questions. Are there any closing remarks?

Yeah, just quickly, Victoria. Thanks everybody for your time. And good questions this morning and we look forward to getting together in January to discuss our fourth quarter results. Thank you.

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