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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 Fourth Quarter of 2017 Earnings Conference Call and Webcast. Today's discussion is being broadcast live on State Street's website at investors.statestreet.com. This conference call is also being recorded for replay.
State Street's conference call is copyrighted and all rights are reserved. This call may not be recorded for rebroadcast or distribution, in whole or in part, without the expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on State Street website.
Now, I would like to introduce Ilene Fiszel Bieler, Senior Vice President of Investor Relations at State Street. Please go ahead.
Thank you, Nora. Good morning and thank you all for joining us. On our call today, our Chairman and CEO, Jay Hooley, will speak first. Then, Eric Aboaf, our CFO, will take you through our fourth quarter and full-year 2017 earnings slide presentation, which is available for download in the Investor Relations section of our website, investors.statestreet.com. Afterwards, we'll be happy to take questions. During the Q&A, please limit yourself to two questions and then re-queue.
Before we get started, I would like to remind you that today's presentation will include operating-basis and other measures presented on a non-GAAP basis. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measures are available in the appendix to our 4Q 2017 slide presentation.
In addition, today's presentation will contain forward-looking statements. Actual results may differ materially from those statements due to a variety of important factors, such as those factors referenced in our discussion today, in our discussion today in our 4Q, 2017 slide presentation under the heading Forward-Looking Statements and in our SEC filings, including the risk factor section of our 2016 Form 10-K. Our forward-looking statements speak only as of today, and we disclaim any obligation to update them even if our views change.
Now, let me turn it over to Jay.
Thanks Ilene and good morning everyone. As you've seen today, we ended 2017, which is our 225th year with strong operating results reflecting momentum across our asset servicing and asset management businesses and continued strengthened equity markets as we advanced our digital leadership.
As you're also aware, although we think tax reform will have a significant positive for us going forward. It did result in a onetime net impact in the quarter related mostly to deemed repatriation of foreign earnings, partially offset by the revaluation of our deferred tax liabilities, which we'll go into shortly in the presentation.
Right now, we will be discussing our business performance on an operating basis, which excludes the onetime tax impacts. Fourth quarter and full year results included strong EPS growth and improved return on equity. We continue to see momentum across our core franchise. Strengthened equity markets and new business lifted our asset under custody administration to record levels at year-end, with growth of 15% from the end of 2016 to $33.1 trillion.
We achieved new servicing commitments of $445 billion in the fourth quarter of 2017 and $800 billion for the year. Our total new business yet to be installed at quarter end was $350 billion, which was roughly the same as last quarter. And importantly, new business opportunities remain robust across the franchise.
State Street Global Advisors finished the year with record assets under management of $2.8 trillion, up 13% from 2016 year-end driven by strengthened equity markets, follow on wins from the acquired GE Asset Management business and higher yielding ETF inflows of $28 billion.
Furthermore, 2017 results reflect success and realizing the benefits from State Street Beacon. Our multiyear program to digitize our business, enhance our client experiences and gain efficiencies. Importantly, as a result of the efforts we have made to expand and accelerate Beacon, we now expect to complete the Beacon program and realize the related financial objectives by mid-2019, 18 months ahead of schedule.
Now turning to Slide number 5, I'd like to review some of our key achievements for the year. I'm very pleased with our performance this year, as we achieved or our exceeded all of our 2017 financial objectives. Fee revenue growth of 8% was driven by continued market appreciation and new client business, enabling us to exceed our fee revenue target for 2017 by healthy margin. We remain committed to expense control, as evidenced by full year positive fee operating leverage of 2.1% and Beacon expense savings of approximately $150 million.
Net interest income growth of 14% exceeded our financial goal for the year by 8 percentage points as we actively manage our balance sheet. We also achieved a pretax operating margin of 31.4%, surpassing our 2018 Beacon target one year ahead of schedule. These results demonstrate our commitment to achieving our financial goals, advancing our digital leadership through Beacon and continuing to drive growth in our business by creating new product solutions to support our clients.
We delivered full-year EPS growth of 25% and improved return on equity by 210 basis points to 12.9%. And during 2017 through share repurchase and common share dividends, we return 2 billion of capital to shareholders. Beyond the achievement of our financial goals in 2017, we marked our 225th Anniversary with employees and clients around the world, celebrated the 40th anniversary of our foundation. And with fearless growth, State Street Global Advisors advanced an important agenda to achieve greatest stewardship and diversity in our industry and beyond.
Before I turn the call over the Eric to review our financial performance for the fourth quarter and our outlook for 2018, let me take a moment to talk through the recent tax reform change and how we will deploy some of the benefits. The majority of the benefits will flow through our financials and result in higher earnings. We are targeting a small percentage of the game to three specific initiatives that will benefit our employees and the communities where we live and work.
First, we will invest in an employee retirement plans by enhancing the matching contributions from for our defined contributions plans. Second, we will introduce new technology and content to provide employees a customized learning experience to build the skill they need for future success. And third, we will increase our State Street Foundation matching gift benefit for employees and increase our global grant making to support the communities in which we live and work.
And with that, Eric over to you.
Thank you, Jay, and good morning everyone. Before, I begin my review of our 2017 results, I'd like to take a moment on Page 6 to discuss notable items in 4Q '17 and 4Q '16, and the related impact on our financials.
In 4Q '17, we recognized 270 million of onetime tax cost and revenue adjustments based on estimates associated with tax reform. The primary impact from our GAAP basis results include, a repatriation tax expense of 454 million which was partially offset by a tax benefit of 197 million associated with the revaluation of our net differed tax liability due to lower future tax rates.
We also had a revenue reduction of approximately 20 million associated with the onetime accelerated amortization of tax advantage investments. Together this resulted in a 30 basis point impact to asset funds and a 15 basis point reduction on Tier 1 leverage. Just to remind you, a year ago, our 4Q '16 results included the tax benefit of 211 million and the acceleration of incentive compensation expense of a 161 million. The net effect of these two items was a benefit of 50 million in the year ago quarter.
Now please turn to Slide 7 where I will start my review of our operating basis results for 2017. Overall full-year 2017 results were driven by client fee revenue momentum and increased in net interest income supported by higher U.S. interest rates coupled with disciplined pricing as well as a continued focus on prudently managing expenses while reinvesting in the business. Key performance metrics for full-year 2017 excluding the impact of tax legislation and last year's items that I just mentioned are as follows.
EPS increased 25% $6.41 a share supported by fee revenue growth of 8% and NII growth of 14%. ROE increased 2.1 percentage points to 12.9%, now nicely in our targeted range. Positive fee operating leverage came in at 2.1 percentage points. Pretax operating basis margin reached 31.4%, which is now ahead of our 2018 Beacon target of 31%.
Turning to 4Q '17, EPS of a $1.83 increased 36% from a year ago quarter, driven by strength in servicing and management fees and higher net interest income. Return on equity for the quarter measurably improved to 14.1%, up 2.7 percentage points. Just like last quarter, 4Q '17 results also benefit from lower than expected tax rate of 27%, primarily due to the higher share of lower tax foreign earnings and benefits related to stock-based compensation, which was worth approximately $0.07 per share.
Now let me turn to Slide 8 to briefly review growth of two key drivers. Business momentum continued in 4Q '17 in both AUCA and AUM. Record AUCA of $33.1 trillion at year-end increased 15% from 4Q, '16. Growth was primarily driven by a combination of market appreciation and client activity. Flows were particularly strong in EMEA and middle office outsourcing.
At State Street Global Advisors, AUM increased 13% from 4Q, '16, driven by market appreciation and higher yielding ETF inflows, partially offset from lower yielding institutional mandates during the year. Our new low cost ETF offering added $5 billion of inflows in just 3 months. These 4Q, '17 levels in both AUCA and AUM positioned us well for 2018.
Please turn to Slide 9, where I will cover 4Q, '17 fee revenue results on a year-over-year basis. You'll also find additional detail in the appendix with the sequential quarter comparison to 3Q, '17. Total fee revenue increased 6% from 4Q, '16 driven by strength in asset servicing, asset management and securities finance fees.
Servicing fees Increased 7% from 4Q, '16 reflecting higher global equity market, broad based new business wins and the benefit of a declining dollar partially offset by modest hedge fund outflows. Management fees again demonstrated strong growth in 4Q, '17 increasing 16% relative to the year ago quarter. The increase was driven by higher global equity market, and higher revenue yielding ETF inflows, including $28 billion in 4Q, '17 alone. Compared to 4Q, '16 both servicing and management fees benefited from the weaker U.S. dollar, as we outlined in the table below.
Trading services revenue decreased from 4Q, '16 primarily due to lower volatility as well as a modest impact from the businesses exited in 2017, partially offset by higher client FX volumes. Securities finance fees increased from 4Q, '16 primarily due to higher client volumes in both our agency and enhanced custody businesses partially offset by lower spreads.
Moving to Slide 10, NII was up 20% and NIM increased 31 basis points from 4Q, '16. NII benefitted from higher U.S. interest rates, disciplined liability pricing and loan growth partially offset by a small balance sheet. The U.S. dollar interest bearing client deposit betas remain relatively low around 25% when compared to 4Q, '16. As I've previously commented, we expect deposit betas to increase overtime as they have in past cycles.
Relative to 3Q, '17 non-interest bearing deposit balances declined only slightly, while interest bearing deposit balances remain relatively flat. U.S. dollar interest bearing client deposit cost increased by only 2 basis points sequentially.
Notable in our financial supplement you'll see a decreased in our non-U.S. domiciled interest bearing deposit and a corresponding increased of the U.S. domiciled interest bearing deposits this was the result of the transfer of approximately 14 billion or foreign denominated came in brands deposits that transfer had no impact or a deposit rate paid. Overall, we continue our price deposits carefully in order to manage and size of our balance sheet while providing the necessary value for our servicing clients.
Now I'll turn to Slide 11 to review 4Q '17 expenses. Expenses increased 4% on an Ex-FX basis from 4Q '16 excluding the acceleration of compensation expense year-ago, which I mentioned in my remarks. The increase was driven by new business activity merit an incentive and additional investments in technology, partially offset by Beacon related savings and lower professional services cost.
Compensation and employee benefits increased from a year-ago quarter, primarily due to increased costs to support new business, annual merit and incentive comp and the impact of the weaker U.S. dollar, partially offset by Beacon savings. Information and systems, transaction processing and occupancy costs increase as the result of new business activity and technology related investments.
Other expenses decreased from 4Q 2016, primarily reflecting lower professional services cost. 4Q 2017 GAAP results also included a pre-tax $133 million Beacon restructuring charge, which will provide payback on average within the next seven quarters. Program to date Beacon related restructuring charges now totaled about 385 million at December 31st 2017.
Let me now move to Slide 12 to review our progress on State Street Beacon. Starting on the right side of the slide, we achieve the $150 in Beacon savings in 2017, including 50 million in 4Q. This exceeded our 2017 target by 10 million. We now expect an additional 150 million in savings in 2018, and we now expect our previously targeted 550 million in aggregate savings to be realized to 18 months ahead of schedule by the middle of 2019.
Shifting over to the left side of the slide, I'll briefly touch upon notable achievements we have realized since the inception of Beacon. We continue to digitize how we receive and process data from clients and use speed as a way to differentiate our service. Key accomplishments include improving efficiencies from advancing our global accounting platform and creating the global workforce to service clients 24 hours a day. We've also expanded Beacon to our asset management and corporate divisions including procurement and real-estate and we expect to build further attraction on these areas as we move forward.
Now let's turn to Slide 13 to review our balance sheet and capital position. We continue to maintain a high quality balance sheet our capital ratios remains healthy which enabled us to return capital to shareholders through dividends and common stock repurchases including buying back 350 million of common stock and declaring in common share dividend of $0.42 in 4Q. We ended the year strong with our common equity Tier 1 ratio, up 30 basis points from last quarter and last year even with the impacts related to the recently inactive tax law. Notably, you can see that our Tier 1 leverage ratio increased to 80 basis points from last December to 7.3%, which positions us well for this year's CCAR.
Turning to the Slide 14, let me touch upon notable items that will impact our financials going forward. First, let me start with the impact of the tax law change. We expect based on our current guidance our 2018 GAAP basis effective tax rate to be approximately 16%. This reflects a 4% to 5% benefit to our core tax rate, which I would define primarily as federal state and foreign tax rates combined, resulting in the 2018 benefit of approximately $150 million. As Jay commented in his remarks, while the large majority of the benefits from the after tax law will be realized by our shareholders. We are putting key initiatives in place to share some of the benefits with employees and the communities in which we operate.
Next, starting in 2018 on a perspective basis, the new FASI revenue recognition standard take effect, in which certain costs previously presented on a net basis will now represented on a gross basis. We expect the revenue recognition standard to impact both revenue and expenses by about $225 million.
Lastly moving to the bottom of the slide, we will not be presenting our financials on an operating basis in 2018. We will provide primarily GAAP basis presentation. We will continue however to present certain non-GAAP measures such as pretax margin as well as call out additional notable items such as acquisition restructuring costs in line with industry practice. They should offer investors the more streamline presentation with enhanced clarity.
Now please turn to Slide 15, where I will discuss our 2018 financial outlook. In 2018, we remain focused on continuing our revenue momentum, investing in our business to drive growth in our core franchise and deliver additional capabilities to our clients while at the same time prudently managing expenses including executing on Beacon. On this page, you can see on the left and illustrative 2018 operating basis outlook on a like-for-like basis of 2017, which excludes the impact of the revenue recognition standard I just mentioned as well as the impact from the changes in our tax law. We're providing this view because we believe we continue to have strong momentum in the business and expect to deliver our Beacon pretax margin goal that was made on this basis.
In the right column, you can see our 2018 outlook as we intend to present it going forward on a GAAP basis, which factors in the new revenue recognition standard, the new tax law and addresses the 2017 gains on sale.
On a GAAP basis, considering the gains on sale, we expect 2018 fee revenue to increase 7% to 8%. We are assuming good equity market growth as well as continued low volatility trading divisions. The primarily difference between the historical operating basis fee growth outlook of 4% to 5% and our 2018 outlook is the impact from revenue recognition standard plus the small impact from the changing tax equivalent growth.
We expect positive fee operating leverage of 75 to 150 basis points considering the gains on sale in 2017 that I mentioned. I would also note that fee operating leverage will vary by quarter. We are committed to calibrating expenses against the revenue backdrop over the course of the year.
Turning to NII, we expect NII to grow within a range of 10% to 13%, reflecting higher expected interest rates in the U.S. Balance sheet growth in 2018 will largely depend on new business and related client deposit activity.
Lastly, we expect the GAAP basis tax rate to be approximately 16% in 2018, which as I mentioned reflects a 4 to 5 point improvement over our core GAAP tax rate which is the $150 million benefit I referenced.
To help to clarity the differences between the historical operating basis outlook and GAAP basis outlook, we’ve also included Page 19 in the appendix, which has reconciliation between the yield operating basis and GAAP basis outlook for your reference.
Now a word on first quarter, we expect first quarter 2018 to be broadly in line with this full year guidance, but let me remind you that as increase this year, 1Q '18 compensation benefit expense will be seasonally higher due to the effect of the accounting treatment of equity compensation from retirement eligible employees as well as payroll taxes.
Finally to Page 16, in summary we're very pleased with our 2017 results, strong 2017 results included operating basis EPS growth of 25% as well as returning $2 billion to shareholders for common stock dividends and share repurchases. Strength in our asset servicing and asset management businesses and our focus on calibrating expenses against the revenue backdrop enable us to achieve our 2017 financial objective including generating approximately 200 basis points in positive fee operating leverage.
Importantly, we continue to invest in our businesses to enhance client experience. We also achieved our 2017 Beacon related savings targets and now expect to realize the full program benefits 2018 month ahead of schedule.
As we look forward to this year, we're well positioned to achieve our 2018 financial objectives and key strategic priorities including advancing our digital leadership, while controlling expenses and delivering on behalf of clients.
And with that, let me turn it back over to Jay.
Thanks, Eric. Nora, I think we can now open the call to questions. Nora?
We have first question comes from the line of Alex Blostein from Goldman Sachs. Your line is open.
Great and good morning everybody, thanks for all the additional color obviously and trying to streamline the reporting, I think it's definitely very helpful as we kind try to compare you guys against the industry, so appreciate that. I guess along those lines, Eric, question for you around the margins. I guess if you look at the new reporting some more kind of under GAAP basis excluding any significant charges. Stage Street pretax margin is in the high 20s kind 28% to 29%, obviously with some room for improvement given Beacon initiative still, but when we look at the peers, the margins there again on a similar basis look to be in the low to mid 30s. And I just want to get your take on a; either do you see anything structural about State Street business that prevents you guys from getting closer to those kind of industry averages? And if not, would you see the margins going overtime once kind all the Beacon savings around the run rate?
Alex, I appreciate the question it's Eric. On margin I think a couple of different parts of the answer to your question. I think first, we're pleased with where we came in on margins for the quarter and the year. Those are ahead of our Beacon expectations by full year and I think we're confident that as part of the outlook we gave, margins should continue to trend up in a positive direction and that’s certainly part of the business model that we design when it comes to top line revenue, fee operating leverage and benefit in NII.
In terms of comparison, the comparisons are kind of -- have a good size range and part of that is as you probably know well, the tax advantage investments which go through the GAAP line have varying effects on margins for different companies, partly based on how much they are doing the tax advantage investments and partly because of our couple of different ways to account for them. And I just encourage you to factor that in and to the comparisons.
I think if you do -- we show that or within the range, I think from a perspective of should we'd be at the high middle or lower end of the range, business mix matters U.S. international, more middle office versus the classic custody operations, having asset management or not. So I'm not overly fussed with where we are in the range. I think with the view of that we’re -- we are within it. And our perspective is, margin is one of the key indicators of our business and our expectations with that, it should continue to widen overtime.
And then second question around NII, just a clarification I guess. Your comment around deposit betas in the U.S, I think you said about 20% it still seems pretty low again relative to what we've heard from some of the other so far. Is there something against structural about State Street business that, that's keeping it that ways? Or is there something that you guys are doing proactively keeping to slow? And as we think about your commentary on the forward, should it be more over ramp? Or could we see a bit of a catch-up on the deposit cost because you guys have done obviously quite a good job of maintaining that at a fairly low level?
Yes, let me first reemphasize what we've said over the last couple of quarters and what I just said in the call summary is that our deposit betas have ranged about 25% over the last year, right. So that kind of the current state, and couple of quarters back it was at the a bit lower than that and that's why where we are at today. I think what we factored into our outlook is continued uptick in deposit betas, so I think we've seen that around the industry, we've seen that in corporate deposits quite a bit, we've seen that in wealth management deposits, we've seen some of that in custody deposits.
While we think custody deposit betas will tend to be somewhat less than some of the other price oriented deposit categories that I just mentioned, deposit betas have to rise overtime they have to rise into next year. We don’t think they rise -- well, I guess we said, they just are going to rise and the question is a little bit of how much and how fast. And part of the reason we've put out NII range in place in the outlook is to accommodate that uptick that we expect.
Your next question comes from the line of Brennan Hawken of UBS. Your line is open.
Just a follow-up on Alex's question there on NII from a different direction. So we saw the balance sheet decline again this quarter although slower pace than last quarter. Could you maybe let us know how much of balance sheet growth or decline you have reflected in your outlook for NII growth? And whether or not the rate rises are only in the U.S. or whether or not you might have some tailwinds from that in Europe and UK as well?
Brennan, it's Eric. Let me start with the backend of the question. I think the rate rises that we've expect in the outlook are primarily in the U.S. I think we're fair that about we are expected. There was a rate rise in sterling in the fourth quarter which is a rate we start to factor into 4Q results that we just released and obviously will help next year in 2018. But for the time being, we haven't expected much more in sterling or euros. And I think that's consistent we look forward.
In terms of balance sheet side, we made a conscious effort several years back and then we emphasized that over the last year. It just around what I'll describe as a compact and efficient balance sheet. I think you saw us deliver on our objectives for this past year. I think at this point, we feel confident in the site for our balance sheet. You could see the capital ratios and leverage ratios in particular are at a nice place, which gives us the room we like.
I think our pricing is fair and we'll continue to share some of the benefits of rate rises with the clients as they'd expect. And so there is a range in the NII guidance and part of that range accommodates some of the range that we have in deposit betas, some of not in a range in balance sheet growth. I think the balance sheet at one end could be roughly around where we are today. It could grow modestly. I don't think there is anything, there is going to be any dramatic shift, but there is a range of outcomes that we're just preparing for that range.
That's fair. And then second question, you've referenced to capital and how you feel quite good about things, Eric. How should we think about potential for capital relief? We've heard in the press that regulators are preparing to moderate leverage ratio calculations and requirements. Is there a way in which you could help investors frame that potential release and how that would translate into capital return policies at State Street?
Yes, Brennan. We're clearly optimistic like others around regulatory reform and refinements here with the current administration. And we're pleased to see both movement in the agencies, the treasury department and congress around leverage ratios and some of these other constraints that are important to us including some of the most recent announcements of and intentions. I don't think we can translate that into direct actions that quickly until we see what might come out.
And part of the question will be is it supplementary leverage ratio? Is it leveraged ratio? Is it CCAR that changes, which part which one? I think we recently saw that there are 22 capital rules out there and ratios. And I think you all can feel that just like we can. So I think hard to translate it directly. I think we're optimistic that we'll see some changes what we'll need to work through. If we have changes in one ratio, the questions is that ratio are binding constraint or can we find the way to expand it in a certain manner that is that's offered to us in that way.
So hard to tell, apologizes, I can't answer that until we see more. But I think when we see more we'll be able to give you more background, Brennan.
And Brennan, this is Jay Hooley. Just as we saw the regulatory rules coming on a kind of a slow basis, I think they are going to go out on a slow basis. I think what is overwhelmingly clearly though is that trend is positive. The leverage ratio which is front incentive for the trust banks is got the special attention, I think from our good efforts and they should probably note they will work its way through the senate which is a broader banking bill which has in it somebody for the trust banks from our leverage ratio. So I think the trend is quite clear, but it's going to take longer than any of us would hope to get some of this regulatory adjustments implemented.
Another question from the line of Ken Usdin of Jefferies, your line is open.
I just want to ask you just on the spending side. It's great to see guys accelerating the recognition of the Beacon sales, and embedded within I guess the operating leverage is still a pretty healthy rate of cost growth. And I'm just wondering, can you help us understanding how much of that is? Is any of that a pull-forward layered against the pull-forward on the Beacon sales? And how much of it is putting a little bit of tax benefits back into the business? And just where do you think you are on just kind of tax spend needs and versus your prior thoughts any changes because of the tax changes?
Ken, let start that. This is Jay and I will turn it over to Eric. I've always believe, we’ve always believe that you need to spend in this business to continue to drive the revenue line, and in addition to Beacon, we're still making some pretty steady investment. They tend to be technology oriented. I will just give you some flavor for that. We talked before about the investments we’ve made in our ETF platform, which are paying great benefits as we compete in the servicing of the ETF world.
Most recently we just finished for Japanese accounting system and we just brought our first Japanese mutual fund account on to the system in the fourth quarter, we think that’s a robust future opportunity. I guess the last one I might spike, the last couple I might spike would be, Eric referenced the European offshore markets which continue to run at great speed, and we're the recipient of that. We're the largest provider of services in places like Luxembourg and Dublin, and we have embark recently on an investment in our transfer agent platform, which is a differentiator to continue to differentiate ourselves when we compete for new business and serve existing customers.
On a regulatory front, MiFID rules recently and even more recently SEC modernization have caused us to spend money to put in place administrative platform. So, there is a fair amount of spending that goes on, and we think that’s the good thing, that’s going to serve to serve our client's well, get in front of opportunities in the market which to us look like growth opportunity. So that’s where this bank comes. I will let Eric pick up on the Beacon says and some of the other offsets.
Yes, Eric, I'd just add that we've been careful and I think considered in how we operate the business within the revenue growth envelop that we have this year, which had revenues in the 7% or 8% a little higher than we would typically had expected. We have expense growth about 4% adjusted for FX. And if you think about what drives that, there is a couple of percent call it to for net new business, there as we brought onboard clients, there is a couple of percent call it to for merit and incentive that we have.
There is a couple of percent again call it to just to keep it simple but it's literally how the map works for technology and some of the business investments that Jay described. And then there is a couple of points that go to the other way, right, in Beacon savings and yet that together and it's actually good business system and it lets us both do the right thing by our business and our clients and also work within the operating leverage that we would like to deliver.
And then just one quick one core business flows and transaction activity, I think you mention that hedge fund outflows continue to be slightly negative. Can you just give us the flavor for that activity and flows component of hedge fund emerging market? And what -- how that trended sequentially and if you've seen any stabilization ahead?
Yes, let me I'll take it more broadly Ken and then I'll get into hedge funds. The flow the direction of the flows remain pretty consent in the fourth quarter so you've got that the rapid ETF inflow, you should got the U.S. mutual fund outflows. We are in the middle of both of those. I mentioned the in Europe that, European particular focus on the offshore markets and you can see, the numbers, if you look them up there quite robust. In the alternative world, you were asked about hedge and you've seen throughout 2017 the hedge outflows have moderated, in fact there were some quarters where there was even a handful of inflows, and we are largely seeing that we've seeing still little bit on the outflow side, but considerably diminished from 16 to 17 and we are hopeful. With the outflows that have occur that we've reached the trough, we even see some more recently some new fund introductions on the hedge fund world, which is a positive sign so and we're declaring a turn yet but the trend is pretty positive.
I'd just add over the past year we've seen the servicing fee line on hedge fund outflows across this more than a percentage point of growth we're still seeing some of that in fourth quarter and we expect to see some of that into next year. And the question is when does it balance out stabilize fully in turn, but we've seen some improvements. But it's still there and we're just obviously navigating through it, and you see some positives from some of the other parts of the franchise, which Jay described as offsetting that, which I think gave us some good overall results on the servicing fee line this quarter.
Another question from the line of Glenn Schorr of Evercore. Your line is open.
Maybe first the question in enhanced custody prime brokerage lands. Curious how you would define where enhanced custody begins and ends versus prime brokerage? And then, as I've seen some competitors Dublin certain asset classes like doing FX prime brokerage, how you think about different asset classes and where State Street's aspirations might go there?
Glenn, it's Eric. I think it's a good question because it's an area that clearly we've expanded into in the last couple of years. We think as a custody provider where we have where hedged funds have their assets with us that actually provide a platform by which we can provide a portion of the classic prime brokerage services directly for them. I don't think there are bright lines as to where we play versus where some of the traditional broker dealers play. I mean they start from a position often times of having to borrow collateral to lend it, right.
So in a way that you start with the two sided model, we have the collateral. We have our clients' collateral sitting right there which helps facilitate that. And it gives us some advantages it gives us some advantages with some of the 40 Act or some of the clients we already serve. But it's a good sized market. I think we are we continue to explore how to both strategically and tactically compete. In our perspective, it's been attractive. And we just need to make sure we balance some of the capital rules, some of which may change overtime, which could be beneficial with how we go to market.
So no need for further technology build that's more of the, is it a ROE accretive event?
Well, it's actually it's an area where we've invested in the technology years ago. I think that's what in a way we got our business off the ground as we're able to access directly from the custody system and what our clients already had with us. So we created that access. Overtime it's been and I think we've described it as 9 or 10 systems. So you have to actually pull together and we've actually integrated a good part of that. It's one of the areas where we've actually developed some block chain technology to actually connect the lenders and lending pools that are either in our asset management or away from us in the market to our custody system. And so it's an area which I think continues to have developments technologically. And we're finding that clients are quite pleased and responsive accordingly with the business that they've brought our way.
Okay. I appreciate that. And just a follow-up on the fee operating leverage conversation, I think the year-on-year numbers impacted just because tough comps in the fourth quarter last year, so for the full year is really good. But I did notice that your target went from I think 100 to 200 of the operating leverage to 75 to 150. Is that just, it's harder to do as margins have moved up or maybe that lead into Ken's past question on, are you accelerating some of the investments?
I wouldn't read anything in particular into that to be honest. So I think this past year, we had both a strong view as to what we could do on the expense side. And I think we saw early on that markets were going to be quite favorable. If we have that kind of favorability again, I mean that would be great to have. And if you can assure us we take it. But it's -- we’re trying to be I think careful and vigilant in a way we don’t want to overestimate what the market will do and sort of say looked in the top range should be higher and higher and higher.
I think we actually want to run a conservative business model, as we have been over the last couple of years and have realistic expectations of revenues and then make sure that we both investment and save at the same time. So I wouldn't read anything into it. I think where we're at the 75 to 150 is kind where we're comfortable. I think it's where it’s a good range for the last few years, and I think at least an indication of where we’re going to be running the business this year and likely going forward.
Another question from the line of Betsy Graseck of Morgan Stanley. Your line is open.
Couple of questions, one on the NIM side, I know we discussed the deposit angle. I'm just wondering, Eric, as you're thinking about reinvesting, if there any interest in, you'll be going little bit longer duration and picking up some yield that way?
Betsy, it's Eric. We’re always reassessing our position against rates and in the market, we certainly do that across the curve as you're suggesting. We do that in dollar sterling, euro, yen and so forth. I think if you look carefully our duration expense a little bit this quarter is an example, I don’t think its trend but it's an example. We've seen some steeper curves in euro and sterling and given that we have good size deposit base as there is natural for us to take advantage of that. And so we've done that a bit, but I think we also want to be careful and keep the front end of the curve position open, so as the rate drives they come up. So I don’t think you should expect some large changes in positioning but that’s an example of the tax adjustment that we make and will continue to make and look for opportunities accordingly.
And as we think -- had little discussion on Europe as well, I realize that you're taking in the forward curve. Just wondering given some investor and discussion around inflation and global inflation will that pick up. What remind us, if the European rate structure were to move up 25 bps let's say beyond what forwards are currently estimating what that impact is on your financials?
Yes, I think the best way to describe it is and we try to share the bases the balance sheet, but we describe in our Qs and Ks that we’re open to interest rates, right. And we say about half of that in the U.S. and half of that is non U.S. The value of 25 point move in the U.S. has been in the $20 million to $25 million kind of the last over the last year. I think more currently it's going to be in the $10 million to $15 million, but it's these are ranges, right. And given that is half of our exposure, if there is 25 base point move instantly in euro, you'd expect something in that order of magnitude while it have to euros and sterling because I'd say half of balance sheet is U.S. half is about non-U.S. But I think you can probably build off of that would be an indication.
Okay and then just lastly on the tax guidance that you've got on the forward look nice decline there when we pencil that out. I think we had a slightly a larger decline and obviously you have more information than I do. Just wondering, if this tax rate outlook for 2018 is similar to what you are thinking 2019 and 2020 is? Or is there any migration and your structure there would drive different tax rate outlook for 2019? And could you also discuss a little bit about the beat and whether or not there is any impacts on you?
That's a tough question. We will give the award of the call for that. Here is how I'd say it. The tax law is new. I think we've had every tax expert right here and around the world trying to work through it and understand the implications for us. We've made both over constant and our good estimates of this point for 2018, and we don’t see large movements going forward from them, but I think it's just too early to tell, it's just too early to tell. And as we learn more we certainly share that with you, but I think we're confident that there is a nice $150 million benefit in '18, that's going to fall primarily to the bottom line and shareholders, as we learn more of that we will certainly share that.
Okay so is this tax outlook for '18 more like your other guidance conservative would that be a fair statement or?
Our guidance is our guidance we're trying to be -- we're trying to be off course fit in and how we characterize our expectations, and hopefully that's a good bit for you to work off.
Another question comes from the line of Jim Mitchell of Buckingham Research. Your line is open.
Maybe I don't think you've mentioned it to. Can you discuss what your equity market assumption is on the fee income line, and if that also includes BlackRock in that equation?
Jim, it's Eric. Are you asking about the outlook are you asking about the '17 results?
I am trying to looking in your 4% to 5% guidance range for fee income just wanting to see what your equity assumption is and what your assumption is around the walls of the BlackRock contract?
Yes, here is how I'd what we had incorporated. We've incorporated basically all the known market expectations and client activity. So we have market expectations of where we have market and elsewhere where we are today on equity markets and fixed income markets from both are important to our book of business. And there is some consensus we believe some continued growth we've factored that in. We've factored in new business that we've already sold but has to be installed, we've factored in business that as migrating away from us and as you would expect. And then we've factored in some mix of flows some of good continued positive flows for example in EMEA, strength in the ETF activity, little of headwind in hedged funds. So I characterize it as an outlook that factors in all the various parts that you'd expect.
And then maybe, you did have very nice improvement on the standardized ratios and leverage ratios sequentially and year-over-year. Does that I think last -- you guys were flat with your buyback. Does that give you some legal room particularly with the tax cut to up to buyback this year? Is that a fair way to think about it?
Jim, it's a little early to say. What I tell you is that we're quite conscious about our capital position under CCAR. I think we made a decision early in the year that that would be just like revenue growth and operating leverage in Beacon managing a compact balance sheet would be a priority for this year. We've done that I think with pretty good results. So it's certainly positions us well and so we did that purposefully. I think we'll soon to jump to what you're going to ask for in CCAR. We actually have to we're waiting maybe even this week, it's not next week we'll see the CCAR instructions and see if there are various to more past year or is if there is anything new, so a lot of moving parts. And obviously as we know more we'll let you know more.
Another question comes from the line of Mike Mayo of Wells Fargo. Your line is open.
Hi. This is the first conference call since the CEO change has been announced. And I was just hoping to get some kind a discussion on that. And I guess, Jay, if 343 more days to go, that's 40 steps down to CEO, but who is counting. I guess the question is. Ron or Henley, I'm not sure if Ron is there on the line, but historically Ron, you've run three of the largest asset managers globally. Generally, the GE acquisition gone better than you guys expected, you have record AUM, so no issues with that. But some questions I would come up. The first one is for you, Jay, you'll be leading before Beacon is done and granted that you've accelerated targets, but you still have $75 million left in 2019 and your pretax margin target of 33% is not target against until the end of 2020. So you're leaving before you actually gotten everything done. And then for Ron, I mean its three years at State Street for our 225 year old company that's not as long a tenure as you've seen in the past of State Street. And the third thing to Ron also, you've overseen asset management, but you haven't overseen the rest of the Company. So, what was the discussion of the board and your thoughts Jay, and Ron your thoughts in the accepting the job?
Yes, Mike, thanks for the question. And you're right this is the first call since we announced our transition. And just be clear, the transition which I instigated is that, I will leave at the, before the end of 2018 and likely chair the Board through '19. When we began that discussion a year ago with the Board, they went through a pretty extensive evaluation looking at internal talent, looking at external talent. As you pointed out, Ron has been with us for three years. He's done a terrific job with us as Jay, but he casted even broader shadow over the bigger State Street. And so the Board and their valuation concluded that Ron is the right person to take over the CEO ship of the State Street at the end of 2018.
We decided Mike to announce it early just kind of unusual that we would announce early because we wanted to get Ron situated in the core businesses, both the asset servicing, trading and the global exchange business and in this transition period all over see asset management business just so he can come fully up to speed. But as you pointed out running three of the largest asset managers over the past 20 years and having been the first, McKinsey consultant that started there asset management business, he is deeply knowledgeable and tons of asset management and has overseen a great deal of front assets, middle assets, back assets transformation. So he certainly understands the business from our client prospective and understands the core components. I think this transition is designed to give him even more time to focus on as you point out the key core back office middle business. So, we're working together throughout 2018 with the plan to turn over the baton in beginning of '19.
To your comment Mike about Beacon, I think Beacon will never end in my opinion. I mean we declared a premature completion Beacon mid '19, but Beacon represents the digitization of State Street. I would say Beacon as we know it in my view is simply down payment. We have a long way to go to fully digitize the 33 trillion in assets that we oversee for our clients and the ability to mine that information and this is not something that just State Street is looking at. Everybody is looking to take that critical information incorporated with other datasets in order to provide insights that our clients can benefit from.
So that journey is underway, but it's far from complete and I am not sure I'd live long enough to see the end of the Beacon as I know it. So I think we're on the right track, I think Ron and more importantly the Board thought that Ron was the right guy to carry the ball for the next period, and I'm excited to work together with him to make sure they hand office smooth and that Ron takes over the execution of Beacon and driving growth in the core business.
And a follow-up then, I mean if you leave with a pretax margin of 31%. I can't imagine that's when you want to leave at the end of 2018. So can you give any guidance for that other than 33% by year end 2000 or that’s where it comes out and that’s where it comes out to leave in that note?
I think Mike where I would say that, it will lend up or ends up based on the guidance that we gave you on based on factors that are outside of our control, market factors. But I would also say that margin important to keep focus on but to me it's as important that we continue to invest in this business. And so I would think it would be bad advice to just pushing margin at the expensive not investing in the business. So I think State Street has been around for 225 years because we've kept some amount of balance between understanding client needs and inventing in those things that represent future growth opportunity. So we're focused on margin improvement but we're also focused on creating the right balance between investing in areas that will provide long-term payback.
Mike, it's Eric. I'd just add if you go through the outlook and you'll build up to the model with the revenue growth we've given and the operating leverage guidance, right. That adds to the margin in '18, does it get and in the nice way, does it pull-forward the 2020, 33% by full one year or two year's. I think we will see as we get to the end of this year, but there is -- I think there is a nice, there is another is more than down payment or recurring payment that we are going to make on margin improvement this year in '18.
Another question comes from the line of Mike Carrier of Bank of America. You may ask your question.
Just a question on the management fees, the year-over-year the growth was impressive, but just sequentially I mean it was flattish just given the markets. And I didn’t know if there was anything that was unusual given the quarter-over-quarter numbers. It's going to need a little a little odd?
It's, Eric. Let me just start and I think and Jay may participate on this one as well. There is -- just remind you, there is always a little bit of lumpiness in management fees whether it's performance base fees whether it's a accruals and so on and so forth and between two quarters until a little bit of positive and one and a little bit of negative and the other. So I wouldn’t read too much into the quarterly performance, if you look at the fee rate on management fees which I think is a good indicator was that I think 6.1 basis points that's nicely in line with the first half of this year. I think their quarter with little bit of was little lumpy and nicely above where we were last year. So we are feeling I think we’ve got good results in management fees and ask asset management on the revenue line.
And Mike let me just unpack a little bit the quarter which I think was quite a strong quarter. We noted net flows of the 6 billion in the quarter in asset under management, but importantly we had ETF flows of 29 billion, which is I don’t know that we've had that ever, but it's been a long time. The institutional business has that 2 billion and negative flows and then cash was 21 billion in negative flows. And importantly the cash two thirds of that cash outflows was came from our securities lending collateral and its clients, increasingly using non-cash collateral which we don’t view as a negative thing it's really neutral to us. So I think that your question was about sequential quarter I would say the quarter itself from a standpoint of flows was quite strong.
And then to follow up, just in terms of the outlook on some of the investments that you guys are making. I think throughout the industry, if there is a lot of commentary on key pressure whether it's on the asset management servicing business. But I guess on flipside when you look at some of the areas that you are investing, where do you see some of these opportunities for the best growth and maybe I mean on pricing power but pricing stabilization where you can still grow the business is demanding for the products given that there is some areas in the industry that with everyone you've seen some pressure?
Let me start there with Mike I mentioned a few of them earlier but the ETF industry is obviously growing and is likely to continue to grow and so the investment were making on our platforms to provide enhanced really their data and analytic services to authorize participants and planned sponsors I think is a differentiator. I referenced the offshore markets which markets that were quite prominent in and are making investments in the areas that our differentiating transfer agent being a specific. Japanese fund market which is historically internalized servicing, we're starting to punch through the outsourcing there.
And then the last one I would kind of spike out for you is, the whole data and analytics world. So we have Beacon and Digitization represents us getting the information we hold on behalf of clients in a more real time basis. We established GX, Global Exchange, probably three years ago now. And one of the products one of the seminal products was something called Data GX which is an aggregation platform, which we can keep up with the demand. It represents the capability to aggregate data across not only State Street for the other custodians.
And so I point that out, because that's if we secure that position, which we're in the position to do. The ability to get into the front office with data and analytics services which not only provide some revenue uplift but importantly protects the core franchise that provides differentiation. So those are the three or four things I would just highlight that the things that we're investing in which we think have revenue accounted to them, but also importantly differentiate the core products.
We have another question comes from Brian Bedell from Deutsche Bank. Your line is open.
Just to clarify a couple of things in the guidance. For the expense guidance given that you see operating leverage. I assume that includes the charges for Beacon. And Eric, if you just want to outline what you think those might be? And then also I think the prior question asked about market return assumptions within the guidance. And I didn't get exactly what that was if you could reiterate that?
Sure. On the expense side on Beacon, the fee operating leverage guidance is I think pretty free down the middle of the fairway, right. We know what we expect on revenues and is and against that our expectations so quarterly expenses. I think you saw that this quarter we had a good sized restructuring charge, that's partly because we tend to look forward. The accounting guidance that encourages us to do that and also we were laying out our plans for 2018. And so we saw through what are -- what's the range of areas in which we're restructuring, and we follow the guidance to take that on.
The guidance here on operating leverages exiting future restructuring. And I think what we've tell you as we don't want to restructure every quarter, that's a little clunky. We do want to be mindful though as new operating is come up what are they and take action on those. And I think our perspective is if there are new opportunities that come up from time-to-time, we'd expect additional benefits that come and add to the $550 million of Beacon benefits accordingly.
And I hopefully that clarifies the on the expense side, we're expecting market growth I think in line with consensus, I think there is a general point of view that markets will continue to take up this year, there is a range of economist out there. We’ve looked at that range and said let's think about the midpoint of that and there is -- I just said there is optimism in that general optimism and we've included that in the outlook.
On the expenses, you had 385 million through the Beacon charger now. What do you expect terminal Beacon charge to be in? And again, is that actually in 2018 expense guidance?
I think the way to think about this is as Jay described. I mean Beacon is becoming, right, has become kind of a way of life and way we do business. And so we can try to keep announcing a program or adding to the program or new program, but what we would like to move to is certainly as we communicating with you all in the analysts and investor community is that we want to do Beacon every year, right. And you've seen the rate of savings, the $175 million two years ago, 150 last year, we expect 150 this year it's about 2 percentage points of improvement each year, right, on our expense base. And obviously that accumulates through which is really valuable from an earnings and shareholders prospective.
I think as we go forward, there are well occasionally be some restructuring charges, if I knew enough now and I had to find actions, I know the account rules, I would be taking charges. Now I will say we try to look forward and we try to look forward over the next few quarter, as I just said it's hard to me to say that we will not come up with new initiatives and new benefit. And so if we see areas of benefit I can take a 550 of benefit. At that point, we will do the right thing and if necessary, not all initiatives take restructuring, but if necessary, we will consider some amount out more. We just don’t want to do that every quarter and we certainly call it out, if we haven't.
Okay that's fair enough. And then on the fee revenue growth of 4% to 5%, just can you parse it out just between the recurring business the asset servicing, the asset management versus the volume and volatility related business whether you think you see better growth in the core asset servicing, asset management versus the volatility. I think you mentioned you'd expect volatility to remain retain. And then maybe just to tack on, Jay, what you said about you gave a good example with data GX as an example of digitization, helping the revenue growth profile. Is that, is the incremental revenue growth opportunities from the things that you done with Beacon, also a significant part of the 4% to 5% fee growth for '18?
Let me start on the fee outlook. I think you’re looking for enormous amount of detail and in truth, we don’t really know that the future will hold. So we're trying to give you an overall fee guidance, which is why we gave a range. I think within that there is servicing fee, you seen the pattern. Over the last year or years all I think you can use that as some trending. On asset management that’s done well and with market with positive markets, it does positively well to just as you will think about last year versus next year you've got the GE acquisition that helps by half of the year, so that you should factor that in. And then trading, it's just could be what it could be. And I think we would always want to be careful there, but we're not going to give guidance kind of line by line and because I think it's at that point it's a little to precise in an accurate and we're just trying to give you some new directional implications, hopefully that's enough.
Another question comes from the line of Geoffrey Elliott of Autonomous Research. Your line is open.
So I guess just to clarify on the restructuring charges. It sounds if I'm hearing what would you said the right way like there is a bit of the change in mindset. I mean historically they've been almost every quarter, it sounds like going forward there going to be more occasional when there is something really specific that you want to work on. Am I hearing that right?
Yes, I think that's a good way to summarize.
And then just on BlackRock and that business exiting, can you give a quick update on kind of how that flows out over the course as 2018? And is there any lumpiness that we are going to see in the numbers as a result of that.
Yes, Geoffrey, this is Jay. I will make a comment on that. As I think we've said in prior quarters, we would expect the transition to commence sometime mid first half of the year and these can take a year or longer to progress, that's probably the best I can give you. But importantly it's all factored into as Eric mentioned our fee revenue guidance. So it takes time for these things to happen.
Another question comes from the line of Gerard Cassidy of RBC Capital Markets. Your line is open.
This is Steven Duong for Gerard. First question just on your dividend, your payout ratios is around 25%. Is there a level and you guys expect to bring it to in the long run especially given your valuations?
Steven, it's Eric. There is not a level at this point that we feel wedded to either on our percentage basis or a dollar basis. I think we'll continue to do the financial and economic work on one hand just doing through as you have a higher and higher PE and to adjust the mix of buyback and dividend, but there is on one hand of that's we do and I think all the other banks are probably going to consider doing that given market trading level. On the other hand what we have also been doing is being in touch with some of our largest share holders and certainly valuing your opinion about, do they prefer a certain mix of dividends versus buybacks because we're certainly open to input. I think what's important to us if I step back is that as earnings grow and EPS grows that we share that with shareholders as much as we can, and that's why you see us taking the dividends up. Certainly, we're going to consider shareholders actively we as we go into CCAR this year for example.
Thanks for the color there. And then just in your presentation you'd mentioned that you guys had reduced manual touches on trades by 30% since 2015. Is there a dollar amount you're aware of that that's bucked through the bottom line? And is there a further target of reducing the manual touches too?
Steve, let me, this is Jay. Let me comment on that. We put that out there as just more symbolic to what we're trying to achieve here, which is we get a lot of input client trade data. And our goal is that that enters electronically and passes through our system electronically. And what we've referenced there is eliminating manual transactions, transactions that have to be manually fixed in order to see them balance sheet internally. So we have internal metrics, none of which will be particularly helpful for you, but we do measure all the stuff. And the more important thing is this whole straight through processing, which is to connect our systems internally which is in some respects what Beacon is all about so that as information enters as electrically that passes all the way throughout the other side. And that has all the obvious benefits of better service, lower cost and it enables this, it frees up this information so the data can be used for other purposes.
And I would just add, there is a host of metrics one and two levels down below that. And across our accounting platform and systems across our product line and businesses around unit cost as you'd expect. Straight through processing is important but can actually measure at many, many individual points in the chain. And our perspective as we continue to build out Beacon on one hand, but now with our as you seen, we've refined our organizational structure where we've added more to the operations on a global basis. We creating a real operations and production organization which is almost quite so size of what it was relative to the client facing business activity. That gives us even larger area in which we can systemically drive that straight through processing in those kind of unit cost improvements and efficiencies.
Another question from Vivek Juneja of JP Morgan. Your line is open.
Jay, first question for you. You talked a little bit about where you are in the whole processes digitization. You had a competitor who's talked about stepping things up. Where do you stand and given that you're leaving a lot of a tax reform benefit stuck to the bottom line? And even sort of give us an outlook where you expect to be on that?
Sure, Vivek, happy to do that. I mean as you, now I don't have perfect visibility on to the competitive landscape, but I do feel pretty good about where we are relative to Beacon. And I build a little bit of a story starting with for a long time States Street has had good discipline around common systems. We made a number of acquisitions in the last 15 years as we acquired, we've moved to common accounting systems cash and security system, so we have great starting point. Beacon as I was mentioning earlier represents the digitization of connecting all these systems up together and taking advantage of through processing.
And your question of where are we in that journey, we're third the way into it, just pick a number and we've got a very high percentage of those incoming trade that I referenced earlier come to on an automated business but in my perfect world I think about the fund accounting activity that we do for 10's of 1000 of portfolio is all over the world. A trade would come and it would hit the accounting books, it would hit the cash books it would hit the pricing books and you will have a virtual system where you could place a portfolio virtually throughout the day.
So that’s my and once you get there you essentially have hands free fund accounting operation where everything is virtual and automated which would take all the manual cost out, it would as I say allow one to calculate in net asset value throughout the day and most importantly and real price here, I said this consistently over the years is freeing up that data, if you have that data available on a real time basis what you can do through data GX and other sources is where the future is in this business.
So that’s I think on a relative basis but we seem to be ahead of the pact from my standpoint, we had a better starting point, I think we got to add this earlier. The other thing to your question as that I would say is, we're going as fast as we can go, we don’t feel constraint by investment but when you're changing systems the way we're that we're operating day in and day out is that there is a certain pacing and there is so much, you can always go so fast without getting damage. So we're investing at the optimum or maximum pace that we can give in the change that we're invoking.
Eric, a question for you on the tax front. I hear you you're getting some of the benefits from the tax reforms. We're just trying to triangulate all the operating and GAAP and future one metric. As I step back and think about it, are you changing the amount of tax advantage investments? Are you reducing it? Are you increasing it? Are you trying to get a sense of what's going on underneath? And because you're going down 4% to 5%, but you have the GAAP rate doesn’t going up quite as much, if you can just help with that?
Vivek, let me try to describe how you get to the GAAP rate. I think tax advantage investments for us will be roughly comparable in '18 versus '17. And if you put that in with the new stated rates on federal state and then for together that what gives us the about 16% rate that we expect in '18, and the roughly $150 million of benefit. I think there is complexity in tax rates. The headline rate that I think go down by about that 5 points because of the tax advantage investments tend to be dollar base credit, those don’t go to the effective tax rate in the same way as net income continues to grow and you need to have a version of that but they are also affected by the tax rate.
So there is couple of different moving parts, parts. I think as we step back we are pleased with the landing and we expect to be a 16% tax rate in '18 we think that's going to be with that said that's better than many other banks but I think that's certain by the tax planning we've done over the years and that rate and we are going a bit of the range right 15% to 17% I'm just using the midpoint we'll see where that goes going forward. I think specifically as it gets to tax advantage investments we have we intend to continue but if that activity.
Clearly, we're going to employees or benefits of that activity under the old rates but they are certainly still benefits and then the new rate on a volatile pre-return spaces, it's still attractive. I think there is going to be a question of do you get the same amount of tax managed deals out there that are available in the marketplace, do you get more win, less solar or vice versa, light tech. We think there is going to be some amount of market adjustments and I think if that ends up, that was market adjustments end up changing the amount that we will do, we will certainly signal that. But for the time being in at least dollar terms, it will be roughly consistent last year versus expectations for '18.
Another question comes from the line of Brian Kleinhanzl of KBW. Your line is open.
It is one clarification question on your outlook on Slide 19. The way we're looking at when you give the 7% or 8% revenue growth and 10% to 13% NII growth. Is the base that you're using just simply those for your numbers on Slide 18?
It's Eric. For the left column right on Page 19 which is the historical operating base of outlook, it's still like for like-for-like outlook then you would use the figures from Slide 18 because that's the historical basis that we just reported in '17. When you move the right side of 19 which is a GAAP based outlook yes if you go back into our financial supplement and we can the IR team is concerning hope you do that and use those amount as the basis so that you have an apple-to-apples per trial. I think then on the EPS basis and net income basis you are close the line items sometimes a big different and we can I think those are well described in the supplement because we show both operating and GAAP and we can certainly help you walk through it if you have any questions.
And then on the tax reform I know you outline three different ways that you are investing the savings from the tax reform and it is the way why we think about that it's going to be year one investment I expected some acceleration and year two especially in light what some of the competitors maybe doing what's greater investment that what you are doing in your one?
And I think you have to probably unpack those three different line items, the adding to the matches and the refine contribution would be a recurring kind of a cost of the investing and training, some of that's technology so that's front ended it trails off a little bit. And then the third which is just to increase the match, we would make that determination in this year into the future, so it's a little bit of a mix Brain.
But are you expecting more wage inflation I guess in the second year above and beyond where we did not expect from that increase?
No, I think if you from an outlook standpoint I think we've got wage inflation from a merit standpoint in '15 to '17. We had it in '14 and '15 to '16. We have some into '18. And I think there is a tradition in some amount of merit increase. So we were supportive of that tradition. I don't think we see an acceleration or deceleration at this point.
We have a last question from the line of Steven Duong of JP Morgan. Your line is open.
Hi guys. Actually, Vivek asked my question, but I'm just going to ask one little additional add-on to that. If you did decide in the future to reduce the amount of tax advantage to investments because basically the tax rate is now lower. So arguably of the value of this was less. Would you then see an offset on the revenue side? Because the way I've been thinking about is that, I mean you guys have been very aggressive user of tax advantage securities, which is why you have this little tax rate. And I just wondered if the appetite in '19 and '20, is there for those type of securities or would you rather let the tax rate drift up and instead investment securities got higher yields and would that be a net neutral?
It's Eric, Steven. Let me answer this in two ways. I think if you do less tax advantage investment then you're right. We have less revenue amortization less of counter revenue and then less tax benefits. So you have the right way around the there. I think if you step back, there is I think number of different tax advantage investment areas. There is Muniz, there is light tech, there is wind and solar that's the major category. And each of those we think may or may not adjust to some extent.
And each of those we run through a kind of return screening process. Now Muniz somewhat say won't adjust very much because it's primarily consumer based market, we'll need to see if that's the case or does it adjust. Light tech, there is a long tradition in. I think wind and solar, many would say there would be some realignment because of expectations of investors as what they need to earn.
So I think it's early to tell. I think we say though that the returns have always been quite attractive impact and tax advantage investments. And if you adjust the rate by the amount we have, there is still healthy returns. And so we feel we need to quickly change our tactics and strategy. And our perspective is that they are still valuable to do at these tax rates and in this form. But obviously as some market evolves, we'll always be we're always reassessing and we'll do accordingly.
So, is it fair to say that you continue to invest at the same level and then there will be no upward creep all else being equal and 15% to 17% in the tax rate?
No, just to be careful there, if you invest at the dollar amount in each year as you have higher net income, your effective tax rate starts to creep up. Alternatively, if you invest the same amount of growth in tax advantage income, if that growth in dollar term and percentage terms is similar the growth in EBIT then the effective tax rate stays relatively constant. And I think that's a bridge for us across '19 and '20, as we learn about how the market evolves and it goes back to Betsy's questions about where we think tax rates will go.
And I think as learn more this year, there will be a lot -- there're number interpretations we need to see from the treasury department right, but regard to this taxable change, we need to see if there are some market adjustments. And all these and some of asset management investment then once we do that, I think like this year we should have a better bid on '19 and we will share that with you and all the other.
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Thanks, Nora, and thanks everybody for spending time with us this morning. We look forward to talking to you after the first quarter. Thanks.
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