State Street Corporation (STT) Earnings Call Transcript & Summary

Okay. Good morning. Again, I'm pleased to welcome back both Lou Maiuri, COO; and Eric Aboaf, the CFO of State Street as our next presenters. Lou, you were here with us 3 years ago as the Head of Global Markets and Exchange -- of the Global Market and Exchange businesses. Today, you return as the COO of State Street, having moved into that role in February of 2019. I think you're going to get us started here with the lay of the land from the operations and COO standpoint, and then we'll go to an abbreviated fireside chat, and we've got Eric here for that as well. So with that, let me turn the podium over to you, Lou.

Thank you, Susan. Thank you. Good morning, everyone, and thank you for the opportunity to address you today as State Street's Chief Operating Officer. I have -- held the position now for almost a year, and I want to do a couple of things today. First, I'd like to review the progress we've made against the strategic priorities I outlined for operations and technology when I first took over the role about a year ago. And second, provide a view into where we're going. And how that will enable our relentless pursuit of becoming the #1 asset servicing provider in the world. In doing so, becoming the #1 in service productivity. We're also building the industry's first front-to-back asset servicing platform from a single provider. We've branded it Alpha, and it's not only helping our clients, but also simplifying how State Street works, while making us more productive at the same time. Now before I begin, I will remind you that today's discussion will contain some forward-looking statements. Actual results may differ materially from these statements due to a number of important factors, including the risk factors in our Form 10-K and other SEC filings. Our forward-looking statements speak only as of today, and we may not update them even if our views change. So let me begin with Slide 3. And I'd like to share with you some of the context and texture around our operations and technology organization, and our key focus areas for 2020. And since I was named COO, I've been laser-focused on simplifying all aspects of what we do across technology, processes, our organizational model and our client interactions. And with this attention to simplification, we've demonstrated disciplined expense management coupled with prioritization of investments in order to modernize our technology estate, create innovative tech-enabled solutions for our clients and protecting the bank. And specific to operations, we will continue to focus on driving productivity and quality for our clients and further leveraging our global processing hubs. Our aim is to create technology-enabled solutions that eliminate the need for manual intervention, thereby improving quality and enhancing our productivity across the operations, and not just in the back office but across the front, middle and back office. Now specific to technology, our mission is to be an integrated trusted partner and a key enabler of State Street's strategic vision to the delivery of world-class innovative technology in a cost-efficient, resilient and highly scalable way. We won't be successful in executing this mission by just focusing on one area. Rather, it is a concerted and prioritized effort around running, growing and protecting the bank and optimizing our workforce and simplifying and modernizing our technology estate. And this, in turn, should drive scale and quality for our clients and enhance client retention and drive new business. Now moving to Slide 4. We're pleased with how we've turned the corner on expenses over the last year. And on the top left panel of the slide, we are showing our total expense base, excluding notable items and including Charles River Development. On this basis, our 2019 expenses were up approximately 1% year-over-year. However, when excluding CRD, a business we acquired in 4Q 2018 and where we are making significant investments, our total expense ex-notables was down approximately 2%. And as you can also see, we're expecting our 2020 expenses, ex-notable items and including CRD, to be down approximately 1% year-over-year. Now impacting our expense mix, as you can see, within our operations and business segments and corporate functions, we made material progress towards underlying expense reduction. And we'll continue to work on managing our expenses across the organization, and we have now turn specific attention towards technology expense. On the right-hand side of the page, we provided summary of our 2019 actions and 2020 focus areas within both technology and operations. I want to take the next few slides to talk more about these in greater detail. Now turning to Slide 5, and I'll walk you through our accomplishments in 2019. And as I explained earlier in my tenure as COO, there are 4 areas of simplification focus with technological, process, organizational and clients. And I'm pleased to say that we met or exceeded all of our objectives we set for ourselves in 2019. But we recognize there's still much more to do. In 2019, we exceeded our application rationalization goal of reducing approximately 230 or 10% of our applications, and we exceeded that by almost 4% or nearly an additional 90-plus applications, which means we are operating in a simpler environment and continuing our journey to have an integrated consolidated platform construct with anticipated cost reduction. And additionally, across technology, we optimize our real estate footprint and consolidate it for 4 high cost IT locations. We have further demonstrated expense management by addressing our vendors and reducing IT contractor spend by 20%. From a process perspective, we are driving a culture of productivity. Lowering unit costs across key processes, thus increasing our funds for fund accounting by 7% and reducing reconciliations by approximately 30%. And we have migrated 88% of our funds to a new technology, up from approximately 40% from the beginning of last year, which means that we can take advantage of scale automation across most of the accounting process, yielding better quality for our clients and greater productivity. In terms of organizational simplification, we flattened our management layers by reducing 15% of the senior leadership pyramid, thereby enhancing our operating model to become more agile with less bureaucracy. And as we look ahead and want to continue to drive the organization towards a more agile operating model with multidisciplinary teams that are skilled and well equipped to execute their priorities together under one accountable leader, thereby reducing decision times and driving better execution. [ However, our ] simplification efforts has been streamlining the client experience and interaction by reducing the number of touch points. That's eliminating manual intervention, reducing risk and errors while creating capacity for our workforce. And in 2019, we met our goal of reducing 1 million manual touch points through processing client data, straight through, eradicating faxes and applying robotics to manual processes. As you can see on Slide 6, we've entered the optimization phase of our technological simplification plan. We expect the gross reduction in IT spending of approximately $150 million to $200 million from the optimization phase will come from 2 areas, each accounting for approximately half of the targeted gross saves. First, infrastructure optimization continues from 2019. We will continue to simplify the environment by driving down application complexity, reducing friction points with existing technology, leveraging automation opportunities enabled by AI, and creating new capabilities for emerging technology. We will also focus on driving our cloud strategy forward, delivering enhanced security and quicker time to market for our client solutions while driving down mainframe cost. And by way of example, we're aiming to rationalize another 5% to 10% of applications over the course of 2020 and continue to migrate remaining applications to the cloud with 30% to 35% migrated by year-end, something we believe will deliver enhanced security, enable faster time to market for client solutions. Second, resource optimization. It's about designing and implementing a modernized operating model, thus optimizing our workforce and placing the right talent with the right skills in the right global locations to deliver better service quality to our clients. To complement this, we must also focus on driving operational efficiencies through the consolidation and optimization of our vendors. Now moving to Slide 7. Let me pivot to our operations focus area for 2020. We expect this plan will result in approximately $125 million to $150 million in gross savings in 2020. The 2 main areas of focus for us are: first, increasing our service quality for our clients; and second, enhancing our productivity. Increasing service quality starts with improving the client experience. In order to understand how we will more efficiently deliver better for our clients, we have implemented a rigorous set of KPIs to pinpoint problem areas before they happen and ultimately drive client quality and consistency. Enhancing productivity is core to achieving our goals. And by standardizing and digitizing the way we receive and process data from our clients, we will continue to drive up the productivity across operations. In addition, we expect that front-to-back Alpha platform will further reduce the number of manual touch points and human intervention of a transaction. Thus, creating efficiencies for our clients. And you can see on this page, some of the objectives that we have set out to achieve this year. As we gain internal scale through our focus on productivity, we expect to further drive down unit costs and overall expenses in our operations. So in closing, while there is -- we've made a lot of progress in 2019, there is still a lot more to do -- to be done to further simplify our operations and technology at State Street. Our efforts in 2019 have positioned us well to deliver on our objectives in 2020 and beyond. And through our Alpha platform, we are uniquely positioned across the front, middle and back offices to enable a level of simplification of service delivery that will truly be industry-leading and industry changing. And delivering service quality to our clients and shareholder value to our investors. So with that, I'm going to hand it back to Susan for some Q&A. So thank you.

I'll let you to comment, and then we'll jump right in here. So you started your comments by speaking to a goal of being the #1 asset servicing provider. And being #1 can mean a lot of things. But how would you actually define #1? Is it having more assets under custody? Is it having higher returns? Is it more customers? What defines it?

Yes. I think I'd first say, we're #1 in a lot of positions today. And if you just allow me, I think if you look at our foreign exchange franchise, we're #1 with asset managers based on 2019 Euromoney Survey. We're the #1 provider of accounting and custody services asset managers in the world, #1 in lending of equities in securities lending business, #1 in ETF servicing. So we have a lot of #1 positions. And so what I'm saying here is we want to broaden that out across everything that we do. And for me, it simply comes down to, and I'll do it simply and you can dive in if you like it, it comes down to the best people, the best client service, the best products. And our clients, especially in these times, asset managers and asset owners are going through effective change and they're looking for us not only to help them be more efficient, but there's an element of product development when you think about ESG and you think about blockchain, it's the future of our business and the future of cash. Are we in front of this? Are we leading them? And are we helping them today? And so for me, it's all of that in the product space. And so we've spent a lot of time in 2019, amping up our products, if you will, by segment and by geography, because not all products play in every segment. So that's an important factor. And then the last part is the culture and the people. You have to have the best people. And so Eric and I are in a call this morning, it's all about engagement. How do we get people to try their best to do the best every day. And for me, it's -- and when I through -- looking through my lens, I want the organization to be this productive machine that thinks about how can I actually be more efficient and more productive every year, year-on-year. We didn't call this a program. There's no project. There's no beginning, middle and end. This is a continuum that we'll do every single day, every single month, every single year. So providing -- we're creating a culture that way. We're training people to look at productivity. We're training them to think about how they can benchmark and optimize their workforce. And then we're providing automation to do that. So the culture is a big part of it. You need the humans, if you will, to power that up and then you need the products. Of course, if we do all that really well, I think we'll retain our revenue, we'll grow revenue, and that will show up in the management information that Eric shared with you with respect to growth in margin and effectiveness.

So in thinking about that, you just touched on client service and client retention. And from State Street, we hear a lot of focus on reducing unit operating costs and reducing the expenses. But there has to be also a pretty significant benefit on the client service side from retention of clients. Can you factor in kind of when you think about your success and how you perform in this role. How -- where is retention of the clients? Or where is attrition? And how much can that be reduced?

Yes. So I think of it in a couple of ways. I'll answer your question. The first thing is we're constantly measuring through NPS, Net Promoter Scores of our clients. We're getting feedback throughout the year, understanding where we're performing well and where we're not and adjusting. And there's a maniacal focus, if you will. I'll talk a little bit about the agile teams. We're constructing our servicing and operations teams to be empowered to deliver for our clients, but also bring scale. So watching the client scores is important, talking to investors is important and getting a feedback. Today is a really important day for us to get a sense of what you care about and what you're thinking about. And the last one is that we pay a lot of attention to engagement scores. So if I flip the whole thing around in my simple mind, I think about it, if I have highly engaged people constantly trying to serve the client excellently and thinking about productivity, that will actually help us retain business and grow business because we'll be best-in-class, which I think will lead to the investor outcome that you're looking for. So I think that's how I think of it, and that's how we're focused. And that's how we're taking the organization. Eric, do you want to?

I would just add, Susan, that retention in terms of the strength of the relationship with our clients is part of the growth model, right? I've described the growth model broadly as we've got flows in client activity. We got market appreciation. We have net new business. And then there's always pricing that goes a bit the other way. It's in that net new business where you got close wins. Yes, there's always a little bit of churn. There's been churn in this business because there's the competitive behavior out there. And our view is if we can -- it's not a lot of churn, but it's a churn of 2 percentage points. And we can get that down to 1% less than a few percentage points so that's meaningful, right? Because that's a percentage point of growth. And part of what I think Lou is describing is how do you actually operate such a broad and interdependent operations and technology function so that efficiently, productively, but with such a firm view with the clients that clients actually don't want to shop. They don't want to go elsewhere. They don't want to consider other alternatives.

I mean I was just going to say, I agree with you, Eric, that clients still will pay you for quality. They don't pay us the way they used it, but what they'll pay you with is their wallet. You'll get a share shift. You'll get more of their capabilities because they trust you more and need you more. And that's why it's important to have service quality for a lot of reasons. But when you think about revenue growth and revenue intention, it really plays right into that. So it serves everyone, serves all the constituents, our clients, our shareholders. So...

Absolutely. Absolutely. So I want to touch on scale for a minute because I think there's been some debate as to whether really all of your businesses are as scalable as you might have liked for them to be, including something like middle office outsourcing. Is it really scalable and kind of across the spectrum of your products and services? What's more scalable? And where is the challenge?

Yes. So let me answer this one. I think one thing we've done to sort of get at this question, and I'll unpack where we have scale and where we don't have scale in a quick second is we brought technology and operations together. But just not organizationally, we're literally bringing them together to think about productivity. And they work through one lens and one team and that's hugely different. They actually really didn't do that in the past. It was -- there are pockets of it, which I'll cover. So that's a great accomplishment because I think we've seen a lot of benefits this year. Secondly, where we have scale generally is where we put the energy, and to simplify, where we've invested in technology. So when you think about accounting and custody, I think Eric said in our 4Q earnings, we booked $1.8 trillion. We onboarded $1 trillion in the fourth quarter. But you saw the expense, we're under control. That's a good example where there's productivity and scale. If you look at our foreign exchange franchise or even in markets, we've applied a lot of technology there. And even though markets were choppy and volatility was like, volumes actually were increasing. So we were running it with the same people, or in fact, it's actually less. Our cost per employee or revenue per employee, we're hanging in there and moving in the right direction. If you look at SSgA, they had a really solid year with money markets and ETF flows. Again, so we do have scale in a lot of different places. Where we don't have scale is where there's subsidy. We take your OTC market, your derivative processing. That's an area where we're attacking right now. And also, middle office is an area where we've had some scale, but there's more to do. And this is where the whole Alpha strategy in Charles River comes into play. So if you -- we're the only company on the planet that has all of the assets from a front, middle and back office from an investment decision that needs to be implemented right through financial reporting and clearing and everything in between. We possess all the data assets, servicing assets and software assets. So we are literally taking that complexity of OTC markets, working with the front-end platform in Charles River, and saying, how could we make that more efficient for State Street and take out friction and be more effective and really shrink our middle office, as we know it today. So it's very much going after, to your point, the areas where we have less scale. There is scale there, but I actually want to see it sort of turbocharged here in the next several years. And we're seeing some benefits as we move forward.

And in this process, is there -- when you think about making the platform better to service your existing clients and realizing the scale of the existing clients, is there any need to take a step back and maybe not take on a new client while you fine-tune this platform? Or are you equally as going to market to bring on kind of the next new big elephant that you'd like to bring on over that, disrupt your ability to move forward?

So it's a great question. And there's a couple of ways that you should think about this. So when we announced front-to-back deals, there's 2 things happening here. There's actually a share shift happening. So we're picking up business where we have scale. In every single one of the deals that we have, some things come our way, whether it's accounting or custody. And so we can onboard that because we have that scale. When you get into the -- to your point, are you getting to the bigger and more complex, multi-geo, multi-asset class customers? And what's your capacity to onboard that and engineer that? And so we're very thoughtful about that and making sure we have the capacity. The last thing you want to do here is fail. I won't mention the name, but there was one client at the end of the year. And I'd like to tell people, I'm not in the business of not doing business. But we actually walked away from a part of -- we got a component and we walked away from a part of it because it's -- it was just -- it wasn't going to fit our model, it's very bespoke, and we just felt we're just not going to go back to that model. So again, we did win actually the front and the back, where the middle was the one that we walked away from. And I think that was good deal discipline. We got a Deal Committee, and we look at this holistically to make sure we have capacity. If a customer is challenging us and some capability that we think is leverageable across the firm, that goes into product management and we'll do it. But if it's one-off, most of our clients don't want us doing bespoke work anymore. It just doesn't make sense.

And so what I want to add is, as you think about scale, I think where do you have the minimum efficient scale in our business and where do you have real powerful amounts of scale, right? And part of what we learned, we first got into the middle office outsourcing business. We didn't have minimum efficient scale, right, at $1 trillion, $2 trillion, $3 trillion, you don't have it. And you also don't want to kind of bring it together and what to do and what to walk away from. I think in most of our business, we now have minimum efficient scale. And the question, how do you get then the next piece? And so when a new piece of business comes on, that the marginal cost of bringing that on are small. And that's the engineering that we're doing now. Because in a way, State Street is not a universal bank franchise with 10 different businesses, right? We've got a core custom accounting business. We further integrated it into middle office, we have to make sure that was at minimum efficient scale. We bought Charles River because we wanted to move into the front office because it was the same client set. And we didn't actually want to attack the front office in a subscale manner, right? So we've gone to minimum efficient scale. And now it's actually how do you take that and actually make it highly scalable, right, as opposed to just the starting point.

Okay. The -- I'm curious, walking away from a client, is that a first on those orders of magnitude?

Obviously, I don't know, but usually, it's -- we're not in the business of not doing business. Usually, you can get into a situation where you work with a client on what good looks like. In this particular case, we just couldn't. And actually, it's a good outcome. I think what will happen in the end, we'll deal with the front and the back, and there's a share shift happening on the back. We'll get them up and running. And I think that conversation will continue down the road. And as -- if you think about most CEOs of asset management firms, they care really about 3 things: generating Alpha, distribution and managing risk. Everything else, they're basically looking for scale. They're looking for efficiency. This particular one just wouldn't fit our model at that time. So we'll revisit it. But again, I go back to the productivity measures that I measure myself on, we measure ourselves, and it's something that's going to take us off course. We just have to be disciplined enough.

I do think that's good to hear.

And so the -- I guess what I'd add is, usually, it's shades of gray. Sometimes, as we describe this, we just -- we're not ready. We don't think the clients are ready to do a certain kind of business, right? And we describe an example where we want to say, not right now, right? What has happened over the years is we were historically willing to do any business with anyone in any way. So we'll just hand it over with a version of kind of your mess for less, or even in custom accounting, here's how my own facility did it, hand it over, can you do it the same way as part of winning the business. And I think that's where we become much more thoughtful and sophisticated because we've now -- we've run the hard way, the downstream implications of just taking over in which way. And so that's the discipline that, as we've talked about, this kind of deal -- this large Deal Review Committee. We've talked a lot about pricing and how we address pricing and price negotiations, balance of trade and so forth. The other part of that is actually to be much clear about how we want to take on business? What we mean that we'll really do? What our expectations of clients are? What changes we need them to make, right, as part of the rollover point? And that's actually, I think, what's different in the way we've operated. So it's not as black and white as do the business, not do the business. It's much more about how do you do the business in an efficient way for us, which then, to Louis' point comes back to [ a low risk weighted to the client ]. Because anything that's inefficient for us needs brakes and recons and what have you. But that's the last thing the client needs. And so we're actually aligned with our clients that kind of efficient and automated and standardized actually benefits them in a way we can give them the right price, but we can actually take the [ risk factor ] at the State Street level is even more important.