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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, and welcome to State Street Corporation's Second Quarter of 2018 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 rerecorded or 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 the State Street website.
Now I'd like to introduce Ilene Fiszel Bieler, Global Head of Investor Relations at State Street.
Thank you, Lisa. Good morning and thank you all for joining us. On our call today are Chairman and CEO, Jay Hooley; and our CFO, Eric Aboaf, will speak first on our second quarter 2018 earnings highlights followed by this morning's announcement of our agreement to acquire Charles River Development. Presentations on each of these are available for download on the Investor Relations website, investors.statestreet.com. Afterwards, Ronald O'Hanley, President and COO will join Jay and Eric for Q&A.
Before we get started, I would like to remind you that today's presentation will include adjusted basis and other measures presented on a non-GAAP basis. Reconciliations of these non-GAAP measures to GAAP are available in the addendum included in the 2Q '18 financial materials released today.
In addition, today's presentation will contain forward-looking statements. Actual results may vary materially from those statements due to a variety of important factors such as those factors referenced in our discussion today. Our forward-looking statements speak only as of today, and we disclaim any obligations to update them even if our views change.
Now let me turn it over to Jay.
Thanks, Ilene, and good morning, everyone. As you've seen, we've announced our second quarter results as well as a definitive agreement to acquire Charles River Development, a premier front office investment management software solutions provider.
Our acquisition of Charles River represents a key milestone in our digital and technology transformation aimed at leading the evolution of the investment servicing industry. We're very pleased with this transaction and we'll take you through the details a little later on the call.
First, let me cover some of the highlights of the second quarter and then I will turn it over Eric to walk you through the 2Q '18 financials. We'll then discuss the announced acquisition in more detail.
Our second quarter and year-to-date 2018 results reflects strength across our asset servicing and asset management businesses as we continue to deepen client relationships, win new business and advance our digital transformation. Second quarter earnings also included substantial EPS growth and increased return on equity.
We continue to see strength across our core franchise. Equity market appreciation and new business lifted our assets under custody administration with growth of approximately 9% from second quarter 2017 to nearly $34 trillion. We saw year-to-date servicing commitments of approximately $1.5 trillion, of which approximately $105 billion were won in the second quarter with new business yet to be installed of approximately $300 billion as we installed the large Vanguard win and begin the BlackRock transition. And we are recognized as a number one FX provider to asset managers in the Real Money FX survey with the best overall customer satisfaction rate.
State Street Global Advisors finished second quarter 2018 with assets under management levels of $2.7 trillion, up approximately 5% from second quarter 2017, driven by strength in equity markets and ETF flows with continued traction in our low-cost ETF products launched late last year.
Furthermore, we continue to realize benefits from Beacon, our multi-year program to digitize our business and drive new solutions and innovations for our clients while creating greater efficiencies for State Street. We achieved a net benefit of approximately $60 million in both the first and second quarters of this year and now expect full year 2018 savings to be approximately $200 million, which exceeds our previously announced guidance of $150 million.
Additionally, our ability to deliver new tools and functionality is proving to be a meaningful factor in point of differentiation and client decisions as demonstrated by the Vanguard win.
Building on the success of Beacon, we are monetizing our digitization accomplishments and reducing manual processes. We are continuing to focus on achieving greater organizational effectiveness and streamlining as we move into the next phase of opportunities, which Eric will discuss further.
To conclude, I'm very pleased with our financial performance to date. Revenue growth was strong, driven by both fee revenue and net interest income, reflecting the higher U.S. market interest rates, continued market appreciation, new business wins and higher trading activity. We remain focused on expense management, which you saw this quarter as we actively calibrated cost to revenues while prudently investing in new products and solutions.
We also declared a common stock dividend of $0.42 per share in the quarter. And yesterday we declared a 3Q '18 dividend of $0.47 per share, representing an increase of 12% from 2Q '18 dividend. Importantly, we continue to be well positioned to achieve our financial objectives in 2018, including delivering full year positive fee operating leverage.
And with that, over to you, Eric?
Thank you, Jay, and good morning, everyone. Please turn to Slide 4 where I will begin my review of 2Q '18 and year-to-date results. We have highlighted a few notable items, which we believe provide investors insight into specific initiatives as well as our underlying business trends.
As you can see on the right, 2Q '18 results included net charge of $77 million or $0.17 per share consisting of $61 million of compensation expenses related to the organizational realignment and management delayering and $16 million of occupancy costs as we continue right size our real estate footprint. I'll also remind you that the quarters of 2018 reflect the impact of the new revenue recognition accounting standard. This has increased both total fee and total expense by $70 million year-over-year but as EBIT neutral.
Now let me move to Slide 5 where most of my comments will focus on year-over-year results. 2Q '18 EPS increased to $1.88, up 23% compared to 2Q '17. Excluding the $0.17 related to the repositioning charge, 2Q '18 EPS increased to $2.05. Both 2Q '18 and year-to-date results reflect continued strength across servicing fees, management fees and trading services as well as continued improvement in net interest income supported by the higher interest rate environment.
We continue to prudently manage expenses related to the revenue environment as demonstrated by an increase of 1 percentage point in 2Q '18 pretax margin. We achieved positive operating leverage of 1.4 percentage points compared to 2Q '17. Fee operating leverage was negative largely due to lower 2Q '18 securities and seasonality relative to 2Q '17, which were up 1.1 percentage points. Return on equity reached 14.7%, up 2.1 percentage points relative to 2Q '17.
Now let me turn to Slide 6 to review AUCA and AUM performance. 2Q '18 AUCA of $33.9 trillion increased 9% from 2Q '17. Growth was primarily driven by a combination of market appreciation, strong new business and client activity especially in EMEA and our middle office outsourcing business. AUCA increased 2% sequentially driven by the insulation of a significant portion of the bank Vanguard in the first quarter offset by the previously announced BlackRock transition, which is about 50% complete and lower market levels.
In our Asset Management business, AUM increased 4% from 2Q '17, driven by market appreciation and higher yielding ETF inflows partially offset by outflows from lower fee institutional index assets in a subdued market environment.
Please turn to Slide 7, where I will review 2Q '18 revenue. Total fee revenue increased 6% relative to 2Q '17 reflecting solid performance across most of our businesses. Let me take you through some of the details. Servicing fees increased 3%, reflecting higher global equity markets, increased client activity and new business, partially offset by continued modest hedge fund outflows. On a sequential basis, servicing fees decreased due impart the lower global equity markets as well as the transaction of the previously announced BlackRock assets.
Management fees increased 17%, benefiting from higher global equity markets as well as approximately $45 million related to the new revenue recognition standard. Management fees decreased on a sequential basis, reflecting lower global equity markets as well as net outflows in line with muted industry close this quarter. Trading services revenue increased 9%, primarily due to higher FX client volumes, driven by the depth of our FX capabilities and platforms, which continue to differentiate our offerings. Securities finance fees decreased, driven by lower seasonal activity into 2Q '18 relative to 2Q '17.
Moving the Slide 8, NII was up 15% on a GAAP basis and then increased 19 basis points on a fully tax-equivalent basis relative to 2Q '17. NII benefited from higher U.S. interest rates and discipline liability pricing, partially offset by a mix shift to HQLA assets. NIM increased due to higher NII and a smaller interest earnings asset basis we reposition the investment portfolio at the end of first quarter. Deposit betas for the U.S. interest-bearing accounts continue to move a bit higher but stayed in line with our expectation. We continue to expect good growth in NII.
Now let me turn to Slide 9 to review 2Q '18 expenses. Year-on-year expenses increased $21 million due to currency translation and $70 million related to the new accounting for revenue recognition. When considering these two effects, year-over-year expenses were well controlled, increasing just 2% from the year ago quarter as we actually manage the cost base and calibrated to revenues this quarter. Relative to 1Q '18 expenses decreased 4%, which included 1Q seasonally elevated compensation costs and the 2Q management delayering charge.
Excluding these 2 items underlying expenses were well controlled, decreasing 1% sequentially. A top priority continues to be the actively managed expenses relative to revenues. From a line item perspective, let me cover the year-over-year trends quickly. Compensation employee benefits decreased 1% relative to 2Q ‘17 due to continued Beacon savings and lower performance related incentive compensation, partially offset by costs to support new business. Transaction processing increased relative to 2Q '17 reflecting higher client volumes and market levels as well as the impact of the new revenue recognition standard.
Information systems increased relative to 2Q '17 as a result of higher Beacon related investments. Occupancy costs were up compared to 2Q '17, primarily driven by $16 million in the occupancy expense charge related to the continued rightsizing of our footprint, partially offset by a few discrete items that will not reoccur. Other expenses increased primarily due the new accounting for revenue recognition. Our intention is to keep second half expenses roughly in line with first half as of 1Q '18 seasonally deferred compensation bump.
Let me now move to Slide 10 to review our progress on State Street Beacon. On the left side of the slide, you can see that we achieved almost $16 million in net Beacon sales this quarter by optimizing our core servicing business, transforming our IT infrastructure and by gaining efficiencies within the corporate functions and SSGA. Notably, we now expect to realize approximately $200 million savings in 2018, which exceeds our previously announced guidance of $150 million.
Shifting to the right side of the slide, building on the success of Beacon, we are now transitioning to the next phase of efficiency initiatives that come as we begin to implement the organizational changes we announced in November, when we moved from a regional product structure to a single global highly functionalized business. We've thus recorded a $77 million repositioning charge related to management delayering as we implement this organizational change. We expect this repositioning charge to payback in about a year.
Moving to the next slide, let me touch on our balance sheet. Our capital ratios remain healthy and all ratios increased. Also, as you are aware, last month, our 2018 capital plan received a non-objection from the Fed as well as some taxable conditions. The non-objection was based on our CCAR submission including a strategic change that contemplated the acquisition of Charles River as a potential transaction and the related capital ratio.
Moving to the Slide 12, let me briefly summarize results. Both 2Q and year-to-date reflect continued business momentum resulting in year-to-date EPS growth of 30% and an increase in ROE of 2.5 points. Year-to-date total revenue increased 10% supporting over 3 percentage points of positive leverage as well as an increase in pretax margin of over 2 percentage points.
Before turning the call back to Jay, let me briefly touch on our current outlook, which excludes any contribution from today's announced acquisition of Charles River Development. We remain on track to deliver on our 2018 financial objectives, including fee revenue growth of 7% to 8%, fee operating leverage of 75 to 150 basis points, NII growth of 10% to 13% and a tax rate of 15% to 17%. It remains the top priority to actively manage the expense base relative to revenue. And you can expect us to continue to do so.
Now, let me turn the call back to Jay to start the discussion of our acquisition of Charles River, and then I'll be back to take you through the transaction details.
Thanks, Eric. And let me ask everyone to please turn to Slide 3 in the second section of today's presentation on our acquisition of Charles River Development. Today's announcement represents an important milestone in the digital and technological transformation aimed at providing clients with differentiated solutions. And importantly, this transaction will allow State Street to address a fragmented and underserved approximately $8 billion front office revenue pool opportunity.
Against the backdrop of significant industry change, institutional investors are relentlessly focusing on delivering better investment returns. At the same time, these investors face increasing complexity and regulatory expectations coupled with the needs to upgrade technology and manage costs while still focusing on product or geographic expansion. To address these challenges, they want solutions that add value across the front, middle and back-office.
We believe that the combination of State Street and Charles River will create an unparalleled platform for our client that uniquely positions us as the first ever global front, middle and back-office solution providers in the industry. Importantly, our platform will be interoperable, meaning that will connect and exchange data with other industry platforms and providers as well as the client's proprietary systems.
Charles River provides leading investment management software solutions to institutional asset managers, insurers, pension funds and wealth managers with a single investment platform for improved decision making, better risk management and greater efficiency while lowering costs. Building on our digital efforts, Charles River capabilities also include a comprehensive suite of advanced data management services.
In addition the strategic benefits I just mentioned and Charles River's leading position in the industry, we believe the transaction is financially compelling. We expect to recognize significant cost and revenue synergies that will drive attractive long-term financial returns for State Street shareholders.
In addition, the transaction generates an internal rate of return of approximately 14% with cost synergies only and greater than 28% with full costs in revenue synergies, excluding our cost of capital -- exceeding our cost of capital.
Moving to Slide 4. Let me spend some time further highlighting Charles River’s business model. As I mentioned, Charles River is a leading provider of investment management software solutions, and importantly, the acquisition provides a leading front office platform and builds on our digitization efforts. Charles River’s capabilities also include a comprehensive suite of advanced data management services. Charles River has more than 300 clients, many of whom are also State Street clients with an aggregate asset under management of over $25 trillion. Revenue was $311 million in 2017 and notably 85% of Charles River's revenue base is recurring, providing a stable revenue stream, which is not dependent on market levels.
On the bottom right of the slide, you can see Charles River’s broad client base and business segments. Charles River's reach by market segment in region is highly aligned with our target markets. We’ll also allowing opportunity to both expand share of wallet as well as the potential to add new clients. Notably, the acquisition will also enable us to meaningfully address the large adjacent revenue pool of the wealth advisor market.
Let me briefly highlight how the acquisition enables us to create an integrated front to back platform by combining State Street's data and analytics and those are Charles River and third party providers.
On Page 5, you can see what we mean by an integrated platform that optimizes the front, middle and back office. I’m often asked about our front, middle and back office capabilities. I think this slide helps bring those categories to life. On the left side of the slide you can see key activities within the front, middle and back office. Charles River's core front office capabilities for the investment management industry include portfolio modeling, construction and analysis, trade management and execution, order generation and pre-trade compliance aimed at an approximately $8 billion front office market. Charles River’s capabilities expanded to the middle office comprised of functions such as risk monitoring, client reporting, and post-trade support areas that complement our existing middle office offerings.
As you’re well aware, State Street’s front, middle and leading back office competencies begin with data and analysis. It include middle office functions such as investment accounting as well as core back office functions of custody fund administration and fund accounting. On the far right of the slide, you can see that the acquisition will create a powerful new combination. Charles River enables State Street to further expand meaningfully into the front office and ultimately deliver an integrated front to back office platform, a compelling proposition to help those client's rationalize front office systems, enhance investment and risk management, extract meaningful insights from data and access additional sources of liquidity.
With that, let me turn it over to Eric to further highlight why the acquisition is a compelling strategic opportunity. Eric?
Thank you, Jay. Let me review the deal terms and go into some detail on the points that Jay just highlighted. As you can see on Slide 6, the purchase price is $2.6 billion. This will be financed by sustaining buybacks from 2Q to 4Q '18, which is worth $950 million and the balance will be financed with roughly two thirds common equity and a third preferred stock. We will look to offset the preferred by a similarly size redemption is more expenses preferred in late 2019. Lastly, we expect the transition to close by 4Q '18.
We are paying an attractive price for our premier front-office franchise. The PE with just cost synergies is 14 times and with full synergies is 10.5 times. The IRR in the transaction, which is a good benchmark on how we think about deploying capital, is about 14% with just cost synergies alone. This exceeds our cost of equity, which makes us confident an attractive use of capital. With full cost in revenue synergies the IRR is over 20%.
The financial metrics of this transaction are attractive because we're bringing together two leading companies with highly complementary product offerings focused on exactly the same top-tier client base. So first, we expect Charles River to help accelerate State Street's annual fee growth by 75 to 125 basis points as we deliver on revenue synergies worth $80 million of EBIT by 2021, which I will detail out in a moment. Notably, Charles River's significant recurring revenue streams adds to and diversifies our current servicing fee revenue. Second, we planned to create efficiencies that will ramp up overtime, which results in cost synergies of $60 million in 2021. EPS accretion is also expected within 2 years.
Moving to Slide 7, our combined client base will provide a natural opportunity to gain share of wallet among State Street and Charles River's existing clients, leveraging our platforms and delivering several additional services. To level set here at State Street we'll ready to serve about 75% or 155 of the top 220 institutional asset managers where we have senior relationships with CEOs, CIOs, COOs and business heads. Only half of the 155 are served by Charles River today as we detailed in the summary note at the bottom of the page.
So let me outline several areas of opportunity. First, we can help Charles River to grow their client base by leveraging our 155 top tier relationships, which could significantly increase their penetration of our top clients. Second, we have the ability to further expand the existing relationships with more than 70 shared top-tier clients, which provide us with a unique opportunity to rollout a true front, middle and back-office platforms. No other custody bank can do this. Third, with this combination, we have the opportunity to operate in State Street platform to mid-sized institutions that represent the additional 45% of global asset management outside the top 220 institutions.
Lastly, another exciting opportunity is to scale Charles River's established presence in the high-growth wealth management in private banking space. Here we can also leverage Charles River's Wealth Management solution to expand State Street's costing and accounting services into this attractive segment.
Turning to Slide 8, let me provide a bit more details on how we will execute on these opportunities and the expected revenue in cost synergies as a result of the enhanced platform. By 2021, we are targeting annual revenue synergies to deliver EBIT of $75 million to $85 million and annual cost synergies of $55 million to $65 million.
On the left side of the slide, you can see the components of the targeted revenue synergies. We have outlined these opportunities across five key categories each of which has a specific execution plan. $70 million to $75 million of the expected revenue synergies are driven by upgrading about 10 Charles River clients from client-sold software to the State Street Cloud and introducing Charles River to 10 to 15 State Street clients. We expect $55 million to $60 million of synergies to expanding our core, middle and back office services into Charles River’s existing base of top-tier and midsized clients. Approximately $70 million of revenue synergies are driven by expanding State Street data and analytic offerings. Gaining significant front office capabilities here supports our current front office data offerings allowing us to accelerate the growth of our global exchange business. This is particularly powerful for our joint clients. $35 million to $40 million will be achieved by integrating State Street’s premier trading platforms FX Connect, Currenex, Fund Connect into the part of our client investment workflows with Charles River’s platform, driving increased transaction volumes and trading fee revenues. And another $30 million to $35 million by penetrating the wealth management segment, which I just described. For each of these revenue opportunities, we conservatively assume product delivery cost base on fully loaded margins.
Moving to the right of the slide, there are three main drivers contributing to the target $55 million to $65 million of cost synergies. First, we expect to drive operational efficiencies by streamlining existing custody, accounting and middle office operations lowering unit costs by $35 million. Second, Charles River enables State Street's retire legacy systems to achieve an additional $10 million to $15 million savings.
And lastly, we expect $10 million to $15 million in expense savings related to the implementation of Charles River’s front office solutions within SSGA. This is a sort of benefit that many clients will see. And we've detailed this opportunity in the appendix. All of the savings can be realized from State Street’s existing cost base.
Turning to Slide 9. Let me wrap up by highlighting the strategic and financial points to support the value that Charles River provides the State Street's businesses and shareholders. Overall, this transaction represents a significant milestone in our technology transformation, which creates a first ever front, middle, back office solutions and generates attractive financial returns.
We are expanding into an $8 billion revenue pool, which is fragmented and underserved today. We expect to accelerate State Street's fee revenue growth as we round out asset management and asset services with a third nature of business. We expect EPS accretion within 2 years of the acquisition supported by various specific revenue and cost synergies. And while times accretion is a bit outside our traditional financial envelope, the intrinsic value and IRR are consulate above the cost of capital with cost synergies alone.
Let me now turn it back over to Jay and we’ll be happy to take your questions.
Thanks, Eric. And Lisa, we are now open for questions.
[Operator Instructions]. Your first question comes from the line of Glenn Schorr with Evercore.
So question on Charles River deals. With Eze Castle and Bloomberg being other big independent players, I’m curious on why timing is now for vertical integration or I don’t know vertical is the right word, but the integration of front-to-middle-to-back. And then I’m curious on how pricing will work? Will Charles River continue to charge explicitly or will this being woven into the overall State Street relationship pricing?
Yes, Glenn, this is Jay. Let me start that. I might ask Ron to comment as well. There is a clear trend, and it’s not a new trend in the world of front, middle, back to create more integration. You mentioned Eze and Bloomberg and BlackRock. We work with BlackRock on a similar solution where we were integrating front, middle and back office. Investment managers are under considerable pressure to get more efficient to gain greater access to data, to do more things for the single touch. So I think this front, middle, back integration is clearly the wave of the future. And up till now, it's been it's all fragmented with the custodians going into the middle office, but not all the way into the front office, you got some front office players working with middle and back-office players. So I think it's very clearly the direction of travel in this industry. And it will come together probably overtime even more so.
I think it's also true that we mentioned the word interoperability, which is we have a series of clients and now with Charles River we have a combined series of clients that we can better link together the three components of middle, front and back office. But we also will continue to work with Bloomberg and we've got a significant partnership with BlackRock and Aladdin, where we're the largest custodian in integrating the lab provider and service. So it's going to happen in different forms.
One last point I would mention is that one of the things that led us to Charles River was the State Street Global Advisors who a couple of years ago was looking to rationalize their front-office, which is something that most firms are in some form of doing. And landed on Charles River and that's what led us to Charles River. And SSGA will be one of the places where we'll integrate and where we'll control the front, middle and back-office to create a streamline interface, which will not only create efficiencies, free of data, but give us access to the front-office for the first time for some of our liquidity products and trading products. Now, would you add anything to that Ron?
Sure, Glenn. This is Ron. What I would add to Jay's comments are that, in terms of your question on timing, it's a combination of pull from clients and where we are in our own digital and data journey. On that pull from clients, you need to be very well aware of this. Large asset managers and large asset owners that act like asset managers are operating with very complicated both technology and operations stacks. And there is a strong desire to simplify, a strong desire to get more straightforward processing and a strong desire to make better use of data in a timely way, which leads to the second point in timing.
As you know we've been on this road now for a while with Beacon and there's a lot of things that Beacon is driving. But one of the things that it's driving is our ability to take client data and present it back to the clients in a highly usable form whether to reinjected back into the investment process for analytics et cetera. So it's this data-enabled platform that will work with Charles River, but as importantly as Jay said we'll interoperate with other providers because what that means not all investment managers are going to want the same thing, but the one thing they do want is some kind of platform that enables them to work with their providers of choice and not have to deal with the number of reconciliations.
And Glenn, let me just pick up the second question which was about pricing. We will keep Charles River as a standalone entity their uptake. There's a convenience of their local. They're right at the street from us. And it will continue to be Charles River, a State Street company. And in fact, we will combine some of our existing capabilities largely in the GX world into Charles River to make sure that from a pricing standpoint that is for the state and set of capabilities, which will have distinctive pricing separate from our middle and back office capabilities.
One last one, Eric. What cost of capital used in the IRR calculation?
Just typical 10% to be conservative, so we think that’s appropriate for our business and then the other important part of the model of the IRR is always professional growth rate, which we tagged at 4%, which I think is overall on the low end of the range. But we thought, when we do these kinds of deals, we need to do it conservatively.
Your next question comes from the line of Ken Usdin with Jefferies.
Question for you just as around the capital side of things here, Eric. I was just wondering if you could walk us through. What happens to capital ratios on a pro forma basis at closing? And just wondering you’re moving off the buyback in the 950 for this year. Why the decision to issue rather than just not buyback going forward in terms of saving that extra capital? Thanks.
Sure. The capital ratios are actually embedded in our CCAR submission. So you can actually take the controls as a pro forma. Obviously, I think we came in a little better in the second quarter than expected and that’ll flow through. When we, you can imagine this deal has been in process for a series of months and quarters that predated our CCAR submission. So as we were gearing up for the April, the early April submission of CCAR, this was a strong possibility but by no means assure. And so what we felt we should do Ken is to submitted as one of those strategic changes that is the specific form in the Fed filings for that. And effectively do it on auto call a capital ratio neutral basis. And so that’s why you see to spend buyback plus issues some amount of common equity plus top-up with preferred to get the $2.6 billion. On a Tier 1 ratio basis is the neutral -- on a leverage ratio basis it'll be neutral, on a set one ratio basis it'll be down by roughly about 50 basis points literally because of the preferred piece of the stack.
And then just a choice between issuing versus just not buying back into next year CCAR, just -- how do you, what’s the economics of that decision?
It’s not dramatically different. There’s a little bit of question, underwriter fees and discount when you go out to the market. On the other hand, we felt like it’s important to get on with this acquisition and to bring it together by the end of the year. And to be honest, we wanted to -- we’re also signaling that we’re confident in our earnings stream and our go forward earnings stream. And so while we temporarily suspend the buyback this past quarter and then two more quarters, we're fully committed to continue to return capital to shareholders on a go forward basis.
Okay. And I’ll just one more on the capital front middle and I’ll stand aside. Just on coming back to CCAR this year and the counterparty number, which was candid like you guys have to go back and just look through that more. Can you tell us about the backend forth about that? What do you think was in the results? What do you have to do now? What is it mean if anything as you go forward? Thanks.
Yeah, on the counterparty condition, I think the first observation which is make -- which I think the Fed made in its summary is they clearly felt comfortable enough with our capital planning processes, our management processes, our risk processes, our business processes to give us non-objection. So I think the kind of the strategic clarity is there. And in fact this was also embedded in this mission was an acquisition. And so they felt, I think, you have to ask them obviously, but it's our understanding is they signal with their actions which were quite positive.
They have asked us to do some more work on the counterparty loss paths. We've obviously been doing that since we've seen in January, so that's not new. We've started by adding more measurement and scenarios to our kind of pool of our arsenal of monitoring mechanisms we're sharing that with the Fed. And I think we'll refine the exact deliverables that we have over the next month or two and then execute on those in line with their expectations.
Your next question comes from the line of Alex Blostein with Goldman Sachs.
Hey good morning guys. A couple of more deal related questions. I guess the first one on Charles River, pretty robust operating income growth over the last couple of years. It looks like 11% CAGR. Can you guys talk a little bit about what do you contemplate for their growth to be on a standalone basis in your kind of accretion math through 2020? And then secondly, maybe sentimented on just the nature of the contracts they have with clients kind of like what's the average length? And is there anything of the contracts related to change of control that could lead them to negotiate, so just kind of thinking for any sort of revenue attrition you might have on the back of this.
Yes, Alex, it's Eric. Let me start on this one. So as you've observed and we showed in the deck, we had nice top-line revenue growth, which obviously was a sweet part of our interest in them as a franchise. They are kind of leading an established franchise but they have nice growth dynamics. And that's largely because they operate in a fragmented space, right, a typical, call it $500 billion institutional asset manager may have 15 or 20 systems and subsystems and providers in everything from portfolio constructions, the compliance, the straight quarter optimization and routing to risk measurement. So it's a space that in our minds is open to strong growth by a leading player. And that's why we chose Charles River as we've been watching and scanning this space.
If you then take that and say, well, how do we think about the revenue growth synergies? Revenue synergies, we feel deliver about $80 million of EBIT over the first three years and that comes from about $270 million of top-line revenue. And then obviously we try to be conservative with the cost to serve. If you go to the buckets of revenue synergies on Page 8 that we've provided and kind of take through them, I guess, maybe the way I would answer your questions the first bucket and the last bucket are really the on Bluefin revenue synergies, so together about $100 million. And second, third and fourth of the middle buckets are really about the -- on State Street revenues. And so if you think about it that way what we’re effectively doing is taking Charles River, it’s got a revenue growth rate, at least based on the history, of about 7% a year. We’re effectively doubling that to about 14% based on the kind of on Bluefin or on Charles River assumptions.
Alex, the thing, this is Jay. A couple of things I’d add to that is, there were very few if any client termination clauses in the contracts. That’s the legal side of it. I’d say the non-legal side of it is, as you might expect, these are disruptive things if you wanted to change and unwind. So we think there’s more than ample of time not only with the introduction of State Street as a significant provider of resources to Charles River and with knowledge of most of these clients anyway to not only secure what we have but to expand upon it.
And then just another clean up question. When it comes to synergies, I think in the deck, you guys gave 2020 run rate numbers for revenues and costs came from a timing perspective. How quickly do you guys expect how to come in?
Alex, it’s Eric. We didn't go into details of that because obviously it’s going to play out overtime. What I tell you is the synergies ramp up, it’s not completely linear and on the other hand it’s not a hockey stick either. Obviously the first year it takes a little time to get things going, in the second year we expect a real significant chunk of expenses. So that tends to lead a little bit relative to what I might describe is a linear trend line. Revenues will go the other way early year's bills then they build on subsequent years. So hopefully that’s enough just to help with the modeling.
Your next question comes to from the line of Brennan Hawken with UBS.
Quick question here on -- as a follow-up Ken’s question on the common. Deal close is expected in 4Q, but do you have any timing for when you expect to issue this common and preferred and what you’d expect the cost of preferred would be?
Brennan, it’s Eric. I think because we’re now in this open period here, I think the larger would resist if I ask them to name a day, a week, a month. So I think we’ll be on the market in Q4. It's an obviously, we’re watching markets to find a good opportunity. On the preferred, I think you could probably take some of the current yields and some of the new preferred issued by other similarly sized banks or you can look at some of ours that are out there and currently some of the required yields. We do think that the market is favorable relative to some of our historic; perhaps, we've got some that are callable now. We have some that become callable over the next year and obviously we’d be inclined to call the more expensive ones there.
Okay. Thanks for that. And then thinking about one more here on the deal. The rise on revenue synergies is one that financial investors usually don't greet with open arms. So could you give us maybe a little bit more color on how you intend to insulate Charles River from maybe some of the pricing dynamics that we typically see in the trust bank world? How do you intend to allow for -- is the idea here that end-to-end will allow for greater insulation on the trust bank side? And how is it that you -- where do you expect the relationship to be owned if you're coming in front to back? Is now the ownership going to shift from the back office on the client side to the front office? Do you have any visibility on that? Thanks.
Let me start that one Brian, this is Jay. I would start with the point I made earlier which is while State Street is acquiring Charles River. Charles River as an entity will continue to exist as an independent entity with the connection with State Street. And in fact as I mentioned, we're going to push more of the product capability this front-office leading into Charles River. So the first thing is clear separation.
I think the Charles River has a series of relationships where State Street is not involved. And then State Street and Charles River have a number of -- a large number of clients where we jointly provide services. And I think we'll sought through to determine where the better relationship is. I would say generally, you'd lean more towards the front-office. And investment management firms, well, if those relationships are different the front-office tends to carry a little bit more weight. And one of the things that beyond the front, middle, back connection, which I think we all understand, I think one of the things that I think will provide upside to this deal overtime is gaining access to the front-office platform world. Some of the new innovations that we've created in our markets business around peer-to-peer lending, access to one button touch, access to specials and securities lending, to the extent that we can stream those all the way through on a highly automated basis. It's going to be differentiated. So I think the relationships will go through one-by-one determine where the lead is, but my leaning is towards the front-office from the standpoint of where the lead relationship would be. Ron or Eric, would you add anything to that?
Well, the only thing I would add to that is that, I think it's important to remember the pricing was all about value delivered. And there is euro familiar as anybody with the challenges that investment managers are facing. And to the extent to which this platform is delivering value enabling them to not only cover costs but to streamline and improve their own investment process. We don't see this necessarily being subject to the same kind of commodities like pricing pressure that you see in other areas.
Yes, I appreciate that Ron. It's just I wonder about once it's all under the same roof keeping it separated, but seems like you guys are going to try to keep separate at least initially. That's at least where it seems to me.
Correct.
Okay. Thanks. And then how about we take a refreshment twist to actually the results here this quarter? Deposit costs ticked up a bit. It looks like 13 basis points for the total deposit base. I believe it’s roughly two thirds for you guys, deposits that are in U.S. dollar. So is there any noise in that, Eric? And how much of that should we attribute to the U.S. dollar deposits? And am I right in the two thirds number?
I think the -- just to go outright, I think, deposit rates came up as if they continue to raise rates. I think these are well within the bounds of our expectations. The U.S. interest bearing deposit data was just a snitch over 50%, which we think at this point in the rate cycle, was makes a good bit of sense. We need to share some of the benefits of the industry environment with our clients. We need to keep it, sells as well to continue to build our returns. I think we’re seeing good activity with clients on the balance sheet. And so, we’re very well engaged with them. And I guess the other metric to keep an eye on is the non-interest bearing deposits. And we continue to see the slow rotation, but that continues to move more slowly than our internal model. So I think all-in-all, a good quarter on interest-bearing deposits given we’re in the middle of the cycle. And as I said in my prepared remarks, we expect NII to continue to build from here.
I’m sorry, Eric. Could you walk me to the math on that just over 50% because the 13-basis-point increase would -- I would assume applies just to the U.S. dollar deposit. So I would think that based upon that the math would drive that deposit ratio -- that deposit data higher for the U.S. deposit? Isn't that right or is there some other noise that’s in 13 bps?
There’s more to that. So if you and others actually go through the average interest rate earning balance sheet in our financial supplemented Page 7 for those, but deep into this. I’d actually take a look at U.S. versus non-U.S. This is a domiciled view but it’s directionally right. So I focus on the U.S. rate, which went from 28 basis points to 37 basis points. If you actually have all the internal data, which effectively here the data on that was effectively 50% for U.S. interest bearing deposits. Just remember the non-U.S. domiciled line has the FX swap costs in there, right, because we’ve now -- in that line with footnoted at the bottom of page. And so you kind of have to -- if you want to start with that, you got to back those out and then split it U.S. non-U.S. But I just go to the U.S. line because it’s the simple and more direct approach and we’re off of that.
Your next question comes from the line of Mike Carrier with Bank of America.
Eric, just maybe one on the core business first. Just on the asset servicing fees, it seems like sequentially it became a little weaker, I know you had the international and their currencies weight on it. But just wanted to understand maybe for the quarter like the timing of both -- like the BlackRock and Vanguard assets, like how much was that in there and just trying to get you maybe more of a run rate. I know that’s tough with the markets in the FX, but just maybe anything that kind of weight on that besides the beta?
Sure. It’s -- let me just kind of give it to you sort of broadly and then try to be as specific as possible that provides so that we’ve historically felt. So I'm not appropriate to go client-by-client, win-by-win, transition-by-transition, but let me see if I can be helpful here. I think I was trying to be clear that the quarter-on-quarter change in servicing fee revenue, which is down about $20 million, was a mix of market effects and this transition of BlackRock, which we had announced, I think over a year ago. And there is always a mix of other factors, right. There is kind of underlying product mix, there is client flows, there is a better shift between the U.S. and EM and vice versa, and there is always a set of new business and business flowing through. I think just for this time and I'll probably not be terribly attempted to do this every quarter, but the effect of the BlackRock transition for this quarter was about half of the $20 million and I think that can kind of be at the least the starting point if you think about the results.
Okay. That's helpful. And then just one more on the Charles River acquisition. So on the revenue, on synergies, like strategically or conceptually that can make sense. Just wondering like when you come up with those revenue opportunities, how much of those revenues are like new for the client, meaning new services versus how much are they currently using another provider? And when you make that assumption at the potentially shift into the Phase 3. What is that like maybe the pricing assumption? You mean you have to be more competitive to kind of allure them away from another provider. And then I don't think and this will be a huge issue just given like Charles River's client base, but from a concentration issue, when you're doing the back-to-middle-front-office, do you run into any of those issues similar to, I mean it's very different, but just similar to like the BlackRock, your move in terms of some of these assets?
Hey, Mike, this is Jay. I'll start and then I'll hand it over to Eric. Your first question which is, are these new services that they're not currently employing today? I would say largely they're not. They're using either someone else's platform or someone else's custodian or the trading with some other counterparties. So most of the synergies on the State Street side, which are almost two thirds of the revenue synergies, are areas where they've got a counterparty today who have some sense of changing out of middle-office or back-office provider of State Street becomes like a custodian or State Street has part of the custody work. And we can show a more integrated value proposition as we've seen with some consolidation that's likely that we'll see more of that. I think to the extent that we can stream trading and lending and other credit activity from the front all the way through the back, which doesn’t exists today, but will exist once we get in and wire that together. They're trading with other counterparties they'll be compelled I think to trade more with State Street given the simplicity of execution and lowering of risks.
So I think a lot of this one is being done today somewhere else. And the transition and the lift it would cause one to make a change depends on the different services but it's not extraordinary in any of those different areas.
And let me just add, it's Eric. I think if you go through the synergies, I think we tried to put some real detail on Page 8a. I think there is really a nice mix of different tax fix here. And that's why I like as a CFO, because then we’ll be able to execute and measure progress on every one of them. So take the first one, scaling the Charles River front-office solutions. Some of that is taking their existing clients and moving them into our cloud and that’s software as a service. And so, that’s just -- there’s an old way to do it in a new way. And we’re going to be able to accelerate that because we give Charles River kind of an institutional credibility, right that they may not have had, right, when you’re out there offering software to large asset managers. Those large asset managers want another, you’ll be here for decades and decades and they’ll get the next releases and so forth. So that’s part of the way this works. And then there’s a series of these where they have other providers, they tend to be smaller. I mentioned for the typical $500 billion asset manager is still often 20 providers, but there’s a range, it could be 25 or 30. And it tends not to be a price sell because this is a software service, there’s implementation, there’s functionality. And if you think about the CIOs and front office portfolio managers, their expectations are quite high. And I think this relative to some of the other services in the market. This is kind of front office capability, functionalities, the narrowing performance attribution where folks want the functionality, and I think, are willing to pay a fair price. And so, I think this is one where we’ve taken those kinds of risks into account in the synergy models but are quite comfortable.
The one other thing that I’ve mentioned because we haven’t talked about it that much is that we have put a global franchise here and Charles River has a nice U.S. franchise, I think, it developing European and Asia franchise. And if you think again, the institutional brand and reputational backing that we can bring to them as we help scale that international expansion is another part. I’ve not kind of overlaid that, but there is an overlay behind it in the execution plans against these synergies that really have a progression that as I’ve built out in Europe and Asia.
Your next question comes from the line of Brian Bedell with Deutsche Bank.
Maybe just to start off with the Charles River, so just looking at that in the front-office pool that you’ve identified about $8 billion and Charles River share that looks like around with the $311 million, just under 4%. And then looking at the revenue synergies that you’ve outlined some of that obviously is State Street revenue. But you still only imply maybe a 5% to 6% market share of that $8 billion pool. So can you talk about, you mentioned obviously and we all know this industry is incredibly fragmented and has historically been driven by sort of traders' decisions in usage of the products. Can you talk about the potential of actually increasing that market share and much more significantly? If you really believe that’s a decision making move to the corporate office of the asset managers where we'll be looking to really synergize this suppose to sort of on the trading course?
Brian, this is Ron. We're -- we want us to be conservative here in terms of how we think about the acquisition and not overstretched. But I think that you actually implied in your question is the answer. There is -- we see this everyday with our clients. There is a real desire to simplify to take the complexity out of the fact even amongst the largest asset managers who by any definition are exceeding what they're thinking about is how do we position ourselves for scale. So I think you're right that overtime particularly assuming that we deliver on this vision of a data-enabled platform that's interoperable with our technology and other technologies that the client might choose to use. We think there is a lot of upside here.
I'd also agree with your point that the decisions -- these front-office decisions are moving in many respects at least they're centralizing to the CIO as oppose the individual portfolio manager decisions. And in many cases that's a CEO, CIO and Chief Operations Officer kind of decision that again is around the idea of simplification and long term scalability.
And the regulatory approvals, who else is -- which do you need -- which regulators need approvals some of this.
Brian, it's Eric, just a customary approvals from the Fed. And now there is obviously we've been approved this and include as I mentioned in CCAR and received the non-objection. So that -- I think that's informative. Obviously, we keep the Fed and all of our regulators up to speed any particular activity. This is clearly one that we've been discussing with them since at least since the early part of this year if not before that. And we've gone through a definitive agreement. We feel confident that of the value here. We feel confident that we can close in the fourth quarter.
Okay. And then just to go back on the asset servicing. Thanks for the color on the BlackRock transition. Is it, if I heard you correctly, did you say the BlackRock transition was from an asset perspective halfway done? And then if they also read correctly, I think, you've only got $300 billion left to install of the $1.5 trillion to the $1.2 trillion of the new deals over the last 2 quarters is installed? And is that going to be fully in the run rate for 3Q versus …
Yes. You've got that right. You got that right.
And since you have a tailwind in 3Q from installations other than you have another half of BlackRock to canal?
Yes. And this is where if you remember on our last call. There was a lot of questions and interrogations on who is the client will be now I would have tell you that it's Vanguard. We are quite proud of that win. I think it's quite clear in that call that there is always a range of different services that we offer, right, and both in different regions in the U.S. And so the basis point range on pricing if its custody only versus full vertical stake is quite different. And so I think I did that purposely right to give you a sense that in many cases. And I'm not going to comment on a second client now, but in many cases we start with the custody only offering, because sometimes that's the easiest one in which to start with. And then we -- for many clients, we scale that into accounting or administration or middle office or performance and analytics. And so obviously those are discussions we have on with all clients. We won’t comment on Vanguard in particular. But we’re excited to have them. We think they really were impressed with the automation and technology and so forth, but kind of functionality we’ve brought to the custody over the last few years for Beacon efforts and they have they're on a real growth trajectory, which is also constructive.
Your next question comes from the line of Geoffrey Elliott with Autonomous Research.
Can you give us some thinking on how you look at M&A as part of your strategy more broadly? I guess the regulatory environments moved on a bit over the last few years, which may be makes it a little bit easier than it would have been a few years ago and GE asset management, which was quite smaller now. But I was kind of curious to see how it fits into the strategy and if this could be in the several transactions we might see over the next few years?
Jeffrey, this is Jay. Let me start that one and maybe invite Ron to jump in as well. We’ve -- I think we’ve said over the last couple periods that the two areas where we thought, we might be all that advance our strategy through an acquisition was both in asset management where we thought there were some select capabilities if we could acquire would enhance our solutions capabilities. And we specifically characterize those as smallish. That’s still an area where if the right thing came along that might be interesting. And the second area with this area that is really represented by Charles River, which is catapulting into the front office, which we’ve all, we’ve had a desire to do because we think that’s where this business is going. And we made a big move into the front office. And so I wouldn’t see other than maybe some small stuff or I’ll turn it over to Ron because, what even with the rumors of State Street and Charles River coming together, you have a lot of other front office providers that are looking to engage with an interface with us. Not necessarily that we would need to acquire but we would integrate to create more functionality in the front office. So I wouldn’t see anything more big on the front office, maybe some smaller capabilities and probably more likely partnerships.
Yes, Geoffrey. What I would add to Jay’s comments is that from where we sit now, we don’t need to do any M&A. And as we’ve, I think, consistently said we’ve got a business strategy, real growth focus in both the data analytics part of asset servicing as well as an asset management. And I think what you’re seeing here is relatively focused -- in both cases relatively focused acquisitions to basically accelerate a strategy that we’d already talked about. Jay’s last comment there about the platform that we’re creating is very important, because -- and I said it a couple times on this call. Our overall strategy even before we started talking to Charles River, has been about data and about this idea that information and information delivered in an inappropriate way and in an unusual way is the most powerful tool we can provide to the market. And as we build out this platform, which Charles River as a part where it goes way beyond Charles River, firstly, it's enabling clients, enabling us to bring lots of solutions to clients including their own solutions or including the solutions of third parties. And as we rollout more of this platform in perfective, it will be very easy for us to have a conversation with the provider like interest in us. And we don't need to buy it. They can come on the platform, we have to look at the pricing of all that. But it's a platform itself that provides the ability to bring all these things together rather than us having to acquire things to bring it together.
Thank you. And then maybe just to follow up. You mentioned Charles River is going to stay as a separate entity. Who is going to be running that business?
Yes, we will install a Chief Executive into that business somebody who is deeply experienced and running the software companies, the founder, will stay on in a consulting role to help us do the transition given he's got a keen interest in making sure this is successful.
And you mentioned making keen interest on the part of I guess the fellows are making sure it successful. Is there any kind of announce or anything like that? Could it -- it kind of looks like a cash deal? And I guess what is that kind of tied to each of the fellows to the success of this given they're not getting State Street stocks are not going to participate in the hopeful upside of the shift.
Let me separate the founder, who has an interest because he's built this company over 30 years. He feels good about State Street and feels good about State Streets being able to take this to the next level and he's obviously got an interest in that? It's not a financial interest, an emotional interest in it. But as you expect, we have spent a fair amount of time with the team and have put in the appropriate retention schemes to make sure that the core asset that we're buying, which is really intellects embedded and the engineers and the software designers are -- we think they're going to embrace State Street as a theme because we're going to invest in this business. This is about taking it to the next level. Ron, would you add to that?
Yes, what I would have add to that is that the founders here own virtually all the equity. There is very little that he doesn't own. So the ongoing retention here and the work with the team that Jay just described is there is a group of very high performing people are excited about them, they're great engineers. We have worked out a compensation plan that we think will be very attractive to them. And they like everybody else at State Street will share in their success.
I think that probably that just one more point, Jeffrey. I mean this is a growth opportunity. I think you see it, hopefully you see it, they'll see it. I think growth in itself is exciting theme for the team at Charles River.
Your next question comes from the line of Jim Mitchell with Buckingham Research.
Hey, good morning. Maybe to talk a little bit about 2019 impact, so maybe before we contemplate synergies if I kind of think about the before gone buyback the issuance, I guess the implied net income you expect for 2018 assume some growth. I guess putting that all together again about 3% EPS or earnings dilution. Is that a fair way to think about the numbers? Or is there anything and obviously building in the amortization in that number? Is that the right way to think about it? And if so, are you expecting to get any synergies in 18 to add to that?
Tim, it’s Eric. I think it’s early days on this question. And you’re -- you've just started the modeling, I think, in probably in 2, 3 hours. And you're asking this question. I think you’re approaching it correctly, right. You’re kind of going out. What’s the earnings stream you're going to take the 2017 operating earnings? You got to adjust for some of the 606 adoptions, so you got to get that into the mix, you got to adjust for taxes and then you’ve got to build a growth rate on that. So and I think you, as I covered on one of the earlier questions, there’s some revenues that starts to come in but it tends to ramp up overtime expenses some in year one, I think real nice amount in year 2. So I think you’ve got the pieces right. I think what I would prefer to do just to try to be more helpful is when we get to our October call for third quarter, we can give you a good indication of select quarter EPS or I guess, or kind of earnings contribution from this because by then we’ll have completed the deal. We’ll know the exact timing. We’ll have concluded on all the financials. And then I think we’ll have in a good basis either a back call or the January call. It's something that's give you some ranges for '19. So I think, I’d rather take it in steps, but I think you’ve got some of the components, right. And we’re certainly happy to iterate with you on that basis.
And then I think about compensation expense getting to the quarter was down quite a bit ex the charge. Is that a good run rate or was there some true up there for you mentioned incentive comp that we shouldn’t annualize that kind of number that we had saw this quarter?
Yes. It’s a clear 2 part answer to that. I think on compensation expenses specifically, we did it just downward a bit for performance related incentives. We feel like we need to deliver on the financial commitments we have. We're I think ahead on Beacon and ahead on NII. And I think we’re conscious of the revenue environment and see operating leverage was neutral in the first quarter bit negative in this quarter. And so we obviously match incentive with results. We think that’s the way to run a company. And so there is a bit of an effect there. I think the best way to give you some indication of expenses is given we’re here in the middle of the year. This is the natural time for us to think about second half expenses versus first half. I think you could take a look at what we reported in our view is. We -- and I think, I said it, we intend to keep second half expenses at about the level first half. You got to just out that that first quarter bump that you get. But that to us is the right level of expenses, but we got to be careful. We don’t know markets are going to go up or down. We don't know what kind of macroeconomic environment that we're likely to operate in. And so we think it's best to be prudent on expenses.
Okay. But should we exclude the $77 million in that comparison as well?
For the repositioning charge?
Right.
Yes. We think about that as a specific item. That address some delayering that we feel was -- is important and real valuable to do as we transition into a more global and functionalized operating model, yes.
Okay. So you adjust that out. Okay, thank you very much.
Your next question comes from the line of Betsey Graseck with Morgan Stanley. Ms. Graseck, your line is open.
Yes, thanks. Two questions. One question I'm getting from folks this morning is the build worse by. And I know you decided on buy, but maybe you can give us a sense as to why that made sense versus building something else like this on your own?
Betsey, it's Ron. I would say that we're doing both. We've built out a fair amount over the last several years, built out or brought out actually if I think about it. Lots of what we've done in Data GX. Lots of the markets platform that we built FX Connect, Fund Connect, Currenex which will all be integrated in this platform I've described. It really came down to a decision that we see so much activity here so much pull clients. And as we got to know Charles River through the work that SSGA was doing was that we felt that this would really accelerate us to market and enable us to occupy just more of the space quicker than we couldn't on our own. So it was the classic build versus buying. It was really about timing.
And Betsey, part of the answer is the capabilities the software and the products and services, but the other part is excess to 300 clients that are kind of in our sweet spot from a standpoint of asset managers, asset owners. In an addition we pick up access to this wealth advisor segment, which is a new segment for us and it's kind of exciting.
Okay. Got it. And then the follow-up question was just on the synergies on Page 8, a couple of them are related to streamlining and cash at synergies out of State Street's middle and back office. So maybe you could help me understand how that works because you're buying someone who is more of a front office operator. So just want to understand that.
Yeah, Betsey, it's Eric. Let me describe those on Page 8 on the right side there is a series of different synergies. I think at the bottom of the page, right, one of them is just implementing Charles River within SSGA our own asset management is factored in something that we've been considering for over 2 years now. So if you could imagine we actually did product and functionality diligence right with our CIO and PM teams long before we even consider this as an acquisition. So and if you think about SSGA we got $1.3 billion expense base in SSGA. If you look at just technology narrowly defined, it's $100 million. And so we're looking at some consolidation benefits from simplifying that what we have built, which is decent overtime, but not at the level of what we have here, so that's kind of one example. I think when you get to the operational efficiencies at the top, remember, and the systems, remember, we have a set of middle office systems today because we are in the middle office business, and so does Charles River. If you remember the slides that Jay showed earlier on, we’re both in that middle office area. For example, we both have a compliance system that helps with compliance processing. For the -- for asset managers, they have one we have one, a natural ones retired turns out that’s an expensive system to run and to operate. And so just something like that is worth in the $15 million range. So it’s those kinds of overlaps that exist. And then the last is, obviously, as we work on this middle office area, which is full of reconciliations and data flows in comparison as soon as we begin to offer a service that streamline some of that, there’s real costs to take out. And so we’re quite confident on the expense synergies there off of a relatively large base of what we do. And this is -- and it’s also an area we have a lot of experience extracting efficiencies off of.
Okay. And the data analytics piece, I know you have been building out your data analyst front end platform. I think you showcase some of that several years back at an Investor Day here in New York. So just wanted to understand if the acquisition means that those efforts then go away or just get layered on to CRD because you don’t need to do that anymore? Is it -- in other words is it, is the acquisition a replacement of your internal efforts for building up data analytics platform or is it adjacent to?
Betsy, this is Ron, I’ll take that. I think it’s a little bit of both in the sense that there’s some capabilities that Charles River brings that are additive. There are some capabilities that didn’t have that with some what we have -- it just rounds out the sweet. And then there are some things that are by the dense back to work together. We can actually build something together that we probably couldn’t build, either one of us could have built on our own. So if you think about going back to Eric’s point on where the front office leads, and so the middle office would be a post trade workflow management. That’s probably a space where Charles River has some tools in it, but now that they’re exposed to our very large middle office business. We can build up even a better tool than they have had or include that matter than anybody else has.
Your next question comes from the line of Vivek Juneja with JP Morgan.
A couple of questions for you folks. How is Data GX service price buying folks today when you pitch it to your clients?
I would say it's -- Vivek, this is Jay. Subscription base as a recurring fee associated with add-ons, if you add custodians or expand the base, and then in addition, once you get Data GX, which is the data aggregation layer. And then on top of that, we have a number of analytic platforms that actually apply some analytics to the aggregated data and that has a separate revenue stream, which is all subscription based. All of this is recurring based on usage.
So not tied to the rest of the middle back office contracts that you may have?
Not at all.
Okay. Ron, a question for you. I just heard you saying or maybe it was Eric, that for SSGA, your tech spending was $100 million and you're going to say $10 million hereby using CRD. So does this -- are you saying that this would cut front office costs for your clients by about 10%? Is that the right extrapolation?
Vivek, it's Eric. I think every client will be different. We've been able to kind of interrogate our own base of expenses. You actually have to when you do the math even on SSGA of $1.3 billion our expense base. There is technology base for $100 million. There is also an operations expense base that's associated with that. And I was trying to just focus on the system just to kind of compartmentalize this and give us an estimate. But I think this could be representative of the value. And obviously, we think a value that way. We think that CEOs and CIOs are going to think about value that way. But remember this is partly an efficiency play for institutions and asset managers because they're all under examination on those fees for in the active space. But it's as much a functionality and what are the benefits and do I get the functionality that I need. And so, our view as we've got a premier property here that can help do both. And that's what makes an attractive for the range of constituents you have. And at least as an example, we think this is in the range of what someone could expect but it would depend on what they have, they build it internally, how fragmented, how many little providers do they have. And so there is probably a range around that.
And Vivek, I would just add, this is Jay, that, I do think that the cost and the efficiency is important, but if you think about our own synergy model, it's only a third of what the value is. And I think of this as giving states to access to the front office platform world. And the network effect that can be created by having a Charles River through 300 client connected to State Street's liquidity and trading engines. I think it's a pretty powerful concept. And that's just the start, that doesn't include the other relationships and partnerships that will wire into this as Ron referenced earlier.
And as a lead time for getting these kinds of follow ups, getting CRD contracts similar to what you have to go through on the rest of your business which can be multi-year process?
Yes, let me take that. I think it depends is the answer Vivek, this is Jay. CRD is the system that has multiple components. And so when you changing out a software platform that's a careful exercise that has some lead time to it. And I would say that the short to long lead time will be defined by the complexity of the environment. SSGA is a reasonably complex environment both globally across asset classes. And I'd say once that gets lined up that's probably 1 year, 1.5 year kind of implementation cycle with deliveries along the way. It doesn't all the way and it happened in the final day.
I guess I was trying to think off, Jay, the whole idea of pitching and winning business, which I know for traditional middle and back office as a multi-year. So that's what I was trying to get a sense of CRD so much similar.
Yes. This is Ron, Vivek. I think that, again, it will be quite client-specific, but if there’s a situation where we're already doing a lot of transformation work with a client and working with them, for example, in moving their middle office, you could see this is being a pretty rapid add-on to that because a lot of the things that you do or if we already have the middle office, a lot of the things that would be required to plug that in, we’d have already done. So I think, if you’re asking one, will the pipeline build fairly quickly? Yes, probably will although to be clear what we're focused on how in the first few months after the close. We want to make sure that they’re continuing to serve their existing clients very well. And then we’ll add to the pipeline has it makes sense.
Yes, because I noticed, your compound annual growth is almost 7% to 14%. So I’m trying to get a sense of over what period should we expect that to happen?
Yes, I think certainly over the 3-year time period for that, we have to, we gave you a CAGR on that, right. So the first year it'll be closer to the seven and the year, a little higher. But we think of this as mid-teens growing stream. At least as we are broaden them into our clients whether it’s our U.S. clients, and I showed you the overlap data, which I think is quite striking. We can bring them into half of our top-tier clients where they’ve not been able to get in the door where we know the CEOs and CIOs and then internationally. So it’ll build overtime and our view is it provides a nice stream. But as Ron said, we got to be careful, right. We got a first really invest in current clients, serving them as well and building this business.
Your next question comes from the line Brian Kleinhanzl with KBW.
Just one quick question first maybe, I'll take you back to what Vivek just asked. How long one from integration, we will actually go out to clients and say this is our end-to-end solution that we have for you. May I know how you want have deal closed in the fourth quarter, but when can you actually bring that solution to clients? Like what quarter, what year?
Brian, I would say, this is Jay. I would say we’re working on this already. I think we said it a few times but the fact that SSGA is two years into -- SSGA, obviously, a middle and back office client of State Street and has been working on this for a year, has given us a chance to really understand the connect points and understand the things that can be delivered in a relatively short period of time and those things that will happen overtime. So I think it will evolve. But probably pretty quickly, we’ll be able to show some linkages to the existing Charles River client base and to the State Street client base, which will show some value and it will grow over time. And I think, if you think about not only wiring this together from a State Street's standpoint, but wiring additional capabilities from other firms into this, it’ll just continue to grow.
Yes, and what I would add to that is, I think the important thing to know about this client base and this segment is that, even those firms that have are starting to outsource the middle office, they haven’t, most actually haven’t put in an integrated solution into their front-office. So this isn't about necessarily displacing somebody else. It's often times what we're displacing is proprietary systems or spread sheets that have been built up overtime. And as we're, given again that we're working with them in the middle office, it's a pretty easy conversation to say here what's contributing to the complexity of your middle office. It has to do with your front-office and what's help you figure this out.
Okay. Great. And then maybe just one quick on the financials from the deal, Eric, you mentioned that the CET1 dilution was 50 basis points. But can you help us break that down. I don't know if I recall what the total intangibles were from a deal. I don't know if there would be any RWA impacts from the deal? Thanks.
Yeah, it's Eric. I think the easiest way to think about this is $2.6 billion of goodwill and intangibles, right, and obviously all those are deducted from capital and a regulatory reporting. And so we've developed a fully kind of ratio neutral financing of equity on the other side. So that those -- that could go on intangibles. So if -- Brian, if everything was contemporaneously -- it'd be neutral in Tier 1 capital and leverage capital basis and that would be that deterioration on the set 1 ratio. I think the next part of that is overtime, there is a mix of goodwill and intangibles. The intangibles come through expense base unless the deduction is lower. And then if you can just model it out based on, I think, we've given the intangible split is roughly 800 to 900 over the 10 years. And I think you can just work through on a model how that plays out. And so that will come through our expense base, but the deduction from capital will come out. And that will play through kind of a classic multi-year model, but we can surely help you with offline.
The next question comes from the line of Gerard Cassidy with RBC Capital Markets.
I apologize if you've asked this question I jumped on late. I understand that you're going to keep Charles River separate, as a separate entity and I'm assuming they're not a bank holding company or any do not have a banking license. Are there any regulatory issues that you have to address with them as you integrate them as part of your bank holding company? Any added costs or anything like that because they're not regulated by the bank regulators today?
Gerard, it's Eric. Within the financial guidance that we've given you here on revenues or cost to deliver the revenue and the expenses, we've actually factored in what you've usually have to do to take a private company and put it into a public setting. So I think there is a usual work we have to do on the accounting and auditing and financial reporting side for the various implementations that we have. And then we got the same thing on the more bank regulatory side, clearly, it has grown from safety and soundness standpoint and data security and so forth at the level that you'd expect a bank of our size and scope to have until we get back to that.
Okay. And then the second, I know you've given us some good data about the revenue synergies on Slide 8. And the internal rate of return that you guys calculated and the expectation that this was accretive. With a run rate today of your total revenues of about $12 billion, it seems like, and this happens in other acquisitions for your company and others that these benefits are hard for investors to kind of extract down 2, 3 years down the road to see if it’s really working. Are there any objective measures that you can share with us that we should look at that we can really see that? Yes, this deal was a great deal or no it’s not coming as expected. Aside from what you’ve given us in this slide, since again, they can blended into your regular numbers?
Yes, I think, Gerard, we’ll be doing exactly you’d like to see, right. Because we need to make sure that we extract the value from this acquisition and it’s not just combined with other activities. Now, like you say, it’s not a perfect science to do that. But our perspective as each one of these, because there are 5 buckets we’ve given you, they’re actually dozen buckets behind that, I think that we'd like to track. But take them by example, the liquidity services that we put against the platform. That comes through and defined revenue streams against defined clients and through specific systems that we need to track, actually just book it on the GL in the right way and that should be something that we can trace back, we need to trace it back just for our own data lineage standpoint. And so that’s the kind of thing we can share. I think wealth management is compartment. I think if you go back to the top of the list, we talked about converting additional clients from the on-premises to cloud application that we will be able to find clients, client counts, what were they, what are they now, what’s under implementation, so with some view of the trajectory. So we’ll do everything we can. We’ll be doing it, anyway, internally, right. And we’ll certainly find ways to share that with you on some kind of regular basis to bring it together. I think if you step back though, at the end of the day, I think we've given guidance as to what we think our underlying growth rate is before the acquisition. We did that in January. And that gave you some sense for how we think of the toxicity and accounting and management businesses, end markets businesses to grow. And our perspective is this can add percentage point on top of that. But we’ll do everything we can to show you with the transparency that’s possible whether we’re achieving it or how we end up at what pace.
Your final question comes from the line of Jeff Harte with Sandler O'Neill.
Good morning, guys. Most things have been covered, but just a couple. Can you talk a little bit about the revenue terms in the front office space now? I mean, is this potentially big offering, but I’m kind of wondering how that compares to your more traditional businesses were from the outside. We kind of still calculate the fees as a percent of assets under custody continuing to decline?
I’ll start Jeff and maybe ask Ron to weight in. I think that, if I compare the back, middle and front, I would say the back office pretty mature as far as the set of services and the set of competitors. The middle office, maybe, 40% of that outsourced today. There’s more to go. I’d say the front office is even more immature. And that, and Ron referenced this earlier the front offices are up and running, but the pressure that people have feeling to consolidate systems get that data replaced, all tier proprietary systems caused us need to say the front office is probably has the most explosive growth opportunity in it. We size the market at a billion but I would say from a standpoint of change, churn and growth, the front office has the most attractive growth of those three segments. Bur Ron, what would you think?
I'd agree with that Jay. And Jeff, what I would add is that, if you think about it, many of the kinds of tools and capabilities that we're now able to offer in the data space. They just weren't able to be offered 5, 10 years ago in terms of particularly some of the Big Data analytics and the unstructured data analytics kinds of tools. So you're creating basically -- it's a relatively new market with new offerings. And as Jay noted, in many cases you're taking things that either weren't being done or were being done in a fairly primitive way in the front office and now putting it together in a much more industrial strength kind of data analytics and platform package.
Okay. And in client retentions, can you talk bit about, a) how important it is and b) the financial impacts? I mean our retention packages and things like that included in $200 million of acquisition and restructuring costs?
Yes, it's Eric. Yes, absolutely. There is about $50 million that we put aside for that kind of that the talent that we're bringing on. And we're we'd like to expand on that talent actually overtime because that's what's going to drive additional growth in the business. So that's the important part of the $200 million that we summarized there.
And there are no further questions at this time.
Thanks, Lisa, and thanks everybody for joining us this morning. We look forward to providing you an update in October after the third quarter. Thank you.
This concludes today's conference. You may now disconnect.