Eric Aboaf
Vice Chairman and Chief Financial Officer at State Street
Thank you, Ron, and good morning, everyone. I'll begin my review of our second quarter results on Slide 4. We reported EPS of $2.17 for the quarter, an increase of 14% relative to the second quarter a year ago. As you can see on the left panel of the slide, revenue grew by 5% year-on-year, driven by the expansion in our front office solutions area where we're an industry leader, continued momentum in securities finance business as well as strong growth in net interest income. This growth enabled us to offset some of the headwinds we saw in other fee areas given the relatively mixed macroeconomic backdrop.
We also had the benefit of an accounting change for tax credit investments, which simplifies our reporting going forward. While our overall year-on-year fee growth was less than we would have liked to deliver, we did see sequential quarter revenue momentum and a step up in the sales pipeline, which we expect to build upon in the coming quarters and which I'll discuss later in today's presentation. As we drive growth, we continue to prudently invest in the business while remaining focused on managing costs given the current operating environment and we stand ready to further intervene on expenses should the softness in the global environment persist.
Turning now to Slide 5. We saw period end AUC/A increase by 4% on a year-on-year basis and 5% sequentially. Year-on-year, the increase in AUC/A was already driven by higher period end equity market levels and client net inflows. Quarter-on-quarter AUC/A increased as a result of the significant $1 trillion Alpha installation and a higher period end market levels. At Global Advisors, we saw similar positive dynamics play out in the quarter. Period end AUM increased 9% year-on-year and 5% sequentially. The year-on-year increase in AUM was largely driven by higher period end market levels. Quarter-on-quarter the increase in AUM was also due to higher period end market levels as well as strong sequential net inflows.
Turning to Slide 6. On the left side of the page, you'll see second quarter total servicing fees down 3% year-on-year as net-new business in the quarter was more than offset by lower client activity and adjustments largely due to lower custody and transaction volume and better than usual pricing headwinds. Positive year-on-year equity markets were offset by the negative impact of fixed income markets. Sequentially, total servicing fees were up 3%, primarily as a result of higher average market levels and net new business, slightly offset by better than usual pricing headwinds this quarter.
We had a more constructive market environment relative to the first quarter as well as a significant onboarding of $1.2 trillion of AUC/A related to an Alpha client in the asset manager of client segment, which comes at a modest fee rate, but which services are expected to be added in the coming years. Within the servicing fees, back office servicing fees were generally consistent with total servicing fees and largely driven by the factors I just described. Middle office services performance was meaningfully more positive for the quarter. On a year-on year basis, fees were up 3%, primarily reflecting net new business and up 10% sequentially, largely driven by the installation that I just mentioned.
On the bottom panel of this page, we've again included some sales performance indicators, which highlight the business momentum we saw in the quarter. While total AUC/A wins in the second quarter were not as robust in volume terms, client engagement remained healthy and we saw wins across strategic segments, including mandates and asset owners, official Institutions and alternatives, which are key growth areas for us as we previously mentioned. The wins including those in the Alternatives segment which are more complex as service come with above average fee rates. We've also seen a healthy uptick in our pipeline this quarter.
Turning to Slide 7. Second quarter management fees were $461 million, down 6% year-on-year, primarily reflecting the impact of net outflows from prior periods, a of certain management fees into NII as previously described and some pricing headwinds, partially offset by higher average market levels. Quarter-on-quarter management fees were up 1% as a result of higher market levels and cash net inflows. As you can see on the bottom right of the slide, our investment management franchise remains well positioned with very strong and broad based business momentum across each of our three lines of business.
In ETFs, we saw very strong net inflows of $27 billion into SPY and our sector suite of ETFs as well as our SPDR portfolio low-cost suite. In our institutional business, we saw net inflows with continued momentum in our well-established index fixed income and defined contribution franchises. Across our cash franchise, we continue to see strong demand for our money market funds. We recorded net inflows of $10 billion.
Turning to Slide 8. Relative to the period a year ago, second quarter FX trading services revenue was down 8% year-on-year and 11% sequentially, primarily reflecting lower client FX volumes and lower industry FX volatility. Relative to the period a year ago, both volumes and volatility were more muted as the start of the war in Europe last year caused unusually high FX trading activity in the first half of 2022. Many clients were also risk off during the debt ceiling discussions in April and May with a rebound in June and client volumes following its resolution.
Altogether, 2Q is needed. We are optimistic about 3Q, but it's hard to predict. Securities finance performed well in the second quarter with revenues up 9% year-on-year, driven by higher agency spreads. Sequentially, revenues were up 7%, again mainly driven by higher agency spreads, as well as higher prime services or enhanced custody revenues from deeper client engagement and specials activity, partially offset by lower balances.
Moving onto software and processing fees. Second quarter software and processing fees were up 18% year-on-year and 34% sequentially, primarily driven by higher front office software and data revenue associated with CRD, which I will turn to shortly. Lending fees for the quarter were down 5% year-on-year, primarily due to changes in product mix, but up 5% sequentially, mainly driven by strong client demand for lines of credit. Finally, other fee revenue increased $101 million year-on-year, primarily due to a tax credit investment accounting change and the absence of negative market related adjustments. This includes the impact of the new accounting adoption.
Moving to Slide 9, you'll see on the left panel that front office software and data revenue increased 29% year-on-year, primarily as a result of higher on-premise renewals and continued growth in our more durable software enabled and professional services revenue as we continue to convert and implement more clients over to our SaaS environment. About 60% of our clients are now on our SaaS platform. Sequentially, front office software and data revenue was up nearly 50%. About two-thirds of this uptick was driven by wealth management mandates that are becoming an increasingly important growth segment for us. Our sales pipeline continues to grow and remained strong for our Charles River Development front office solutions products.
Turning to some of the other Alpha business metrics on the right panel. We were pleased we had three more Alpha mandates go live, which brings our total live Alpha clients to 15. And as I previously mentioned, we installed a significant portion of assets related to Alpha this quarter. We expect to provide more services related to these assets in the future helping us increase the share of our clients' wallet.
Now turning to Slide 10. Second quarter NII increased 18% year-on-year, but declined 10% sequentially to $691 million. The year-on-year increase was largely due to higher short-term rates, an increase in long-term rates and proactive balance sheet positioning, partially offset by lower average deposits. Sequentially, the decline in NII performance was primarily driven by our continued rotation of non-interest bearing deposit balances and rate pressure in the U.S. back book, partially offset by higher short-term market rates from international Central Bank hikes.
On the right side of the slide, we show our average balance sheet during the second quarter. Average deposits declined 2% quarter-on-quarter in line with industry total deposit trends, which also fell by 2% in the second quarter and reflect client preferences to shift from cash to other products during periods of rising rates. Our operational deposits as a percentage of total deposits remained consistent at approximately 75%. Our global floating rate loan book provides upside at this stage in the cycle and our investment portfolio positioning provides a tailwind as long rates roll-through. We now also have the opportunity to selectively add some duration across the curve as we see good entry points, which could enhance NII over time.
Sequentially, U.S. dollar client deposit betas were 100% during the second quarter leading again to some sequential NII compression. We are now at the point in the U.S. rate cycle where we expect to adjust back book pricing to accommodate our larger clients, but do so in a disciplined manner and usually as part of a broader relationship discussion of balancing trade for fee opportunities. Foreign currency deposit betas for the quarter continued to be much lower in the 45% to 50% range.
We've also included a new slide in the appendix, Page 16, that shows our NII trends over the past few rate cycles. I think it will be-- it will put the larger NII increases and decreases in context, which are driven by many factors, including changes in interest rates, the pacing of hikes, deposit levels and mix, Fed balance sheet changes, as well as equity markets. You can see from that page that our recent quarters have come with a much higher than usual level of NII and we're now normalizing to a more typical level of NII that is inherent in our business activities.
Turning to Slide 11. Second quarter expenses excluding notable items increased 6% year-on year. Sequentially, excluding seasonal expenses, second quarter expenses increased just over 1% as we actively managed the expenses and continued our productivity and optimization savings effort, all while carefully investing in strategic elements of the company including Alpha, private markets, technology and operations, automation. On a line-by-line basis year-on year, compensation and employee benefits increased 7%, primarily driven by salary increases associated with the wage inflation and higher headcount attributable primarily to operational staff for growth areas, technology staff insourcing and lower than-expected attrition rates.
Sequentially, however, we have managed headcount to be flat. Information systems and communications expenses increased 3% mainly due to higher technology and infrastructure investments, partially offset by benefits from ongoing optimization efforts, insourcing and credits related to vendor savings initiatives. Transaction processing decreased 2% mainly reflecting lower sub custody costs from vendor credits. Occupancy increased 7% as we relocated our headquarters building temporarily resulting in overlapping cost and other expenses were up 7% mainly reflecting higher professional fees.
Moving to Slide 12. On the left side of the slide, we show the evolution of our CET1 and Tier 1 leverage ratios followed by our capital trends on the right side of the slide. As you can see, we continue to navigate our operating environment with very strong capital levels, which remain well above both our internal targets and regulatory minimums.
As of quarter end, our standardized CET1 ratio of 11.8% was down 30 basis points quarter-on-quarter, largely driven by the continuation of our share repurchases and modestly higher RWA, partially offset by retained earnings. Our LCR for State Street Corporation was flat quarter-on-quarter at 108% and decreased 4 percentage points quarter-on-quarter, but still quite high at 120% for State Street Bank and Trust. We're also very happy with our performance in this year's CCAR with the calculated stress capital buffer well above the 2.5% minimum resulting in a continued preliminary SCB at the floor. This demonstrates we have one of the strongest balance sheets in the industry.
In keeping with our results, in June, we announced the planned 10% increase for our 3Q '23 quarterly common stock dividend subject to board approval and it remains our intention to continue common share repurchases under our current authorization of up to a total of $4.5 billion in 2023 subject to market conditions and other factors. We plan another $1 billion buyback in third quarter. Lastly, we are quite pleased to return roughly $1.3 billion to shareholders in the second quarter '23 consisting of just over $1 billion of common share repurchases and over $200 million in common stock dividends.
Turning to Slide 13, which provides a summary of our second quarter results. While there is certainly still work to do, we're pleased with the durability of our business this quarter against the mixed and divergent backdrop, robust expansion of our front office solutions area and continued momentum in securities finance as well as strong growth in net interest income enabled us to offset some of the headwinds we saw on the other fee areas highlighting the resiliency of the franchise.
Next, I'd like to provide our current thinking regarding our third quarter. At a macro level, while we know that rate expectations have been moving, our rate outlook is broadly in line with the current forwards, which suggest that the Fed, the ECB and BOE will all continue to hike in 3Q to varying degrees. In terms of average equity markets, we currently expect U.S. equity markets to be up about 5% quarter-on-quarter as we're expecting equity markets to remain flat from now to quarter end and we expect international equity markets to be flattish on average.
Regarding fee revenue in 3Q, on a sequential quarter basis, we expect overall fee revenue to be down approximately 1% to 1.5% with servicing fees down 1% to 2% as the below average fee repricing headwinds we saw this past quarter is expected to normalize in 3Q. This will also include a revenue headwind from the previously disclosed client exit. We expect management fees to be up around 0.5% to 1.5%. We expect front office software and data quarter-on-quarter to be down 7% as we do not expect the level of on-premise renewals in 3Q that we saw this quarter.
We expect the other fee revenue line to come in around $30 million to $35 million in 3Q, which is higher than prior years, but down post the accounting change impact in 2Q. Regarding NII, after three double digit sequential increases in NII last year, we now expect NII to decrease 12% to 18% on a sequential quarter basis, driven by lower deposit levels and continued rotation as rate hikes continue into 3Q. Our outlook assumes that average non-interest bearing deposits decline by approximately $5 billion from 2Q to 3Q.
As we look forward to 4Q, we do expect to see some moderation to the amount of deposit rotation as we work through most of our back book and most central banks begin to pause. With that context, we expect that 4Q's NII decline to be much less, somewhere in the range of down 2% to 6% versus 3Q and we expect NII to then stabilize around those levels, but it will depend on market conditions and our expectation is that 4Q declines in non-interest bearing deposits will be smaller as well likely in the down $2 billion to $3 billion range versus 3Q.
Turning to expenses. We remain focused on controlling costs in this environment and we expect to take action in 3Q to bend the cost curve. As such, we expect that expenses will be down 0.5% to 1% on a sequential quarter basis and intend to continue to actively manage expenses. As always, this is on an ex-notables basis and we're keeping an eye on the FDIC assessment, which could be a 3Q notable item. And as I noted previously, given the accounting changes we adopted this quarter, we expect our effective tax rate to be between 21% and 22% for third quarter.
With that, let me hand the call back to Ron.
