State Street Corporation (STT) Earnings Call Transcript & Summary

Good afternoon, everyone. This is Gerard Cassidy. We're here for the 2020 RBC Capital Markets Global Financial Institutions Conference. Obviously, it's going virtual with what's going on in the world today. We have with us today, State Street Corporation, their CFO and Executive Vice President, Eric Aboaf, is with us today. As many of you know, State Street's headquarter is, of course, in Boston, and it has an asset balance sheet size of about $245 billion. It's one of our leading custody banks in the country. And it has assets under custody of approximately $34 trillion and then assets under administration of just over $3 trillion. So Eric, thank you so much for joining us.

Good morning, Gerard. Good to be here.

Great. Obviously, we're seeing some volatility in our markets over the last couple of weeks primarily due to the outbreak of, of course, the COVID-19 coronavirus. And we saw some incredible moves in the treasury yield curve in this past week. So maybe starting off with that, Eric, can you share with us what you're seeing in your business from this unprecedented decline in the 10-year treasury rates? How it's affecting your balance sheet? What are your customers, in talking to them, what are they saying? And we'll open it up with that.

Gerard, thanks for the question, and good afternoon, everyone. Let me just, at the request of our lawyers do the standard predicate statement that we need to do. As you know, this discussion may include forward-looking statements. And as you know, actual results may differ materially from those statements due to any number of important factors, including the risk factors in our 10-K and our SEC filings. Our forward-looking statements speak only as of today. We may not update them even if our views change. And so let me jump in with -- given that standard set of statements. Gerard, absolutely a fair question because, like many other banks and financial institutions, we're engaging and navigating through some fairly different and unprecedented times. I think if you ask the question from State Street's perspective, we really think of it in 3 different levels, and happy to explore each of them as you'd like. But the first priority, our first order of business is really for us to be supporting our clients. So we're doing everything you'd expect, which is how do we continue to process net asset values? How do we continue to invest their cash or asset and portfolios in our asset management business? How do we execute trades spotlessly in FX and sec lending? And so that's the first priority for them and making sure that we provide to them all the support that they'd expect, no matter what. And to do that, we're obviously doing what many other institutions are doing, we're insulating our operations and making sure that they can run every day, every hour, every minute. We're taking additional actions to make sure that those operations are even more robust now than they were a month ago, and they'll be even more robust tomorrow, next week as we split sites, as we find alternative arrangements and find ways to navigate. And I think the current procedures have -- that we had on the shelf have worked particularly well. And that's a testament to our team and our colleagues and employees. And at the same time, that's what we do every day for our clients. So I think first order we're there to support our clients, and that's been moving along smoothly as we navigate these times. I think from a second kind of level, we're also deeply engaged in watching how the financial system is shaping out and evolving in this scenario, in this situation that we're working through. So obviously, as one of the world's largest custodians, we have a unique view into fund flows, into transaction volumes and our ability to see is quite deep and broad. And I would tell you that we continue to see smooth functioning of the financial markets. We've continued to see the regular way of flows in and across our clients' accounts, which are largely the -- our asset managers and the pension funds. And so we continue to see normal movement of funds into custody accounts. We continue to see movement in the -- in FX flows. So those have been elevated relative to what we're typically used to. But we've seen those. We've seen a little less leverage, obviously, as markets have become volatile and fallen. And so we've seen leverage tamp down a bit. But I would tell you, the financial system is operating quite smoothly and relatively consistently with how it's operated over the last couple of quarters. It's not as if we're seeing a massive move from equities to cash or bonds, rotating from one asset class to another. And I think that gives us some comfort that clients and the clients' clients are actually navigating through this in a thoughtful and deliberate manner. And then the third level is, obviously, to think through, and this is after the first two, how might this play out and impact some of our revenue lines. And you can imagine, we've been doing that since we saw some movement in rates. We saw the Fed cut rates. We've seen stock market levels adjust. But I'd tell you, as we've seen some of the central bank actions that have cut rates, we've also seen some amount of offsetting actions like clients leaving a bit more deposits with us and leaving higher cash balances. So while there's a lot of activity out there, we actually think that the patterns that we would have expected in this kind of scenario, at least the financial patterns have been relatively stable. And I mean stock market levels, that's not been stable. But most of the other expectations have been relatively predictable. And the system is functioning well.

In fact, that's very, very helpful, Eric. And to circle back on a couple of things you said and you reiterated. Because of this volatility we're seeing in the equity markets, of course, you saw it in the price of oil, the 10-year government bond yield, as we've talked about, there seems to be sometimes, an assumption that because of that volatility, the system won't be able to handle it, and you're going to have maybe a liquidity problem or a breakdown in the system, but it sounds like from what you said from your position and what you guys see every day, the system is functioning well.

Yes, Gerard, I think that's a good summary. I mean the money markets are operating smoothly. Certainly, there is movement between cash and treasuries, and that market is more -- is somewhat more active. FX markets have -- volumes are up and -- but they may be up 10%, 20%, 30% in a day or 2 and then kind of readjust. So it's all within the bounds of what we would expect when we have volatility that the volumes tend to be somewhat higher, but within a reasonable boundary condition, and we find that the system is operating smoothly. Our -- all the folks that we custody for, the asset managers and pension funds, they tend to be operating quite smoothly. When we transfer funds or securities in some of the repo operations, the counterparties are operating smoothly. It's actually been good to see quite a robust system, I think.

That's very good to hear. There has been some commentary in the investment broker-dealer business that with these elevated volumes, trading revenues for these firms will be probably greater-than-expected in the first quarter. There was a Bloomberg story yesterday talking about a few of them doing very well in the equity derivatives business. When it comes to your business, how important is the volumes, as you've mentioned, your FX trading volumes are elevated, how important is that to drive revenues to a level that, in December, you may not have been expecting in the first quarter. But because of what's going on now, you're seeing a benefit from that.

Yes. So I think -- so the way I think about it is, clearly, the larger effects are around stock market levels and interest rates. But the silver lining, so to speak, of economic volatility or financial volatility are higher volumes. And I think if I go through some of the more volumetric activities that we have relative to what we would have expected, our FX business is handling more volumes, and so there's more commission and spread income. That will generate our agency lending and securities lending operation, actually a bit less volume, why? Because market levels are lower and so the balances that we may help clients borrow or lend will be lower, and they're deleveraging a bit. So that goes a bit the other way. We've also seen more clients leave frictional cash with us. And so deposit levels have tended to come in higher than they would have -- we would have expected just a month ago. We've also seen that in some of our asset management operations around the cash pools that we manage as well as a couple of specific products, right? Our SPDR Gold product tends to do well in these times. So there are certainly some areas that will -- we'll push positively relative to expectations, that are all areas where we're actively trying to serve our clients.

Very good. I recall that when you guys did your fourth quarter conference call, there was talk about the direction of net interest income and fee revenues for the full year 2020. And if I remember correctly, I think you said for the year, NII could be down around 5%, 6% or so. Has that outlook changed in view of what's going on with the interest rate environment?

Gerard, it's hard not to recalculate an outlook every day given what's going on, and I'm sure every bank's CFO has been doing some version of that. I think if I have to sort of outline some of the updates that we would share with you and investors, I think, I'd certainly say that the market environment is much different than what we would have expected, right? We had actually expected in January just a preface, a Fed -- perhaps one Fed cut, we've already seen 2, right? And we've got another 4 rate cuts priced in by the end of the second quarter here. And long rates are clearly 100 basis points below where they were back in January. So quite a different interest rate environment. Equity markets, I would say, are clearly lower than they were back when we reported earnings in January. But I would just take the opportunity to remind everyone that our custody book tends to be priced off of average, equity market levels. And if you just think about average equity markets, even if the current levels persist through the end of March, our average equity market levels at least across the kind of U.S., international emerging markets that we custody for are relatively flat, first quarter here relative to fourth quarter of '19. And that's as opposed to being up, but they're still relatively flat, which I think gives us some confidence. And if you compare the first quarter averages that we anticipate relative to last year as full year average, you're up closer to mid-single digits. So there's still a bit of a kind of embedded, I think, stability or tailwind, just if you think about the averages, which is the basis for how we operate. Now that's the -- those are the macro effects. I think your question to be concrete is how do they play through into your P&L. And so let me share with you the outline of how we're thinking about this and try to go from there. So there's probably 3 areas. We provided an outlook for the first quarter on fee revenues, which at the time, we had expected to be down, largely due to some of the seasonality we expect, and then some of the patterning. We had originally expected that to be down 2% to 3% for the quarter relative to fourth quarter and given some of the lower equity market levels as well as some of the bounciness that we're seeing in some of the fee revenue line. I think that's going to be off by another percentage point beyond the lower end of that range. So right now, we're looking at fee revenues to be down around 4% on a sequential quarter basis. Obviously, some of that is due to the standard seasonality that you see in Charles River and other areas. And that would include probably a small tick down in servicing fees because there, we had expected that line to be relatively flat. And now we're probably going to be down around 1%, given the market dislocation. But again, the average is what matters for our book. If I then pivot to NII, we would've actually expected better-than-expected quarter-on-quarter performance than we had originally forecast. And if you recall, we had expected NII to be down 5% sequentially when we released earnings in January. And now we're looking at the NII down only about 2%. And what's driving that is certainly lower rates have played through, in particular, on the front end, but also in the long end. But at the same time, we've had an inflow and kind of higher levels -- higher-than-expected levels of deposits, both noninterest-bearing deposits and interest-bearing deposits and that's created an offset to the rate effect, at least for the first quarter. If I do bridge this out for the full year, and this is the only area that, I think, we really do a lot of prediction on a full year basis, we originally said, as you pointed out, that NII would be down 5% to 7% on a full year basis, and just playing through the effect of long rates, which, remember, are important to us, just like all the other banks, and I think, the sensitivity we have to long rates are in the order of about $75 million for every 50 basis point drop in long rates. And they've obviously come down twice that. We now expect that the NII for a full year will be down around 10% for the year. So a few points more than what we had expected. But I think within a set of -- within an area that we think shows the strength of the franchise, because some of that is driven by just long rates falling and playing through the interest sensitivity of the balance sheet, but it's also offset by, I think, better-than-expected levels of deposits because our instinct, and obviously, we're in turbulent times, is that deposit levels will be relatively stable, maybe better, but at least relatively in the range that they are today, which has been a bit better than we had expected. And then just to round it out, and because I think there's always the question of, you work on the topics and areas that you can control, we had originally said that we were continuing our good progress on expenses, which we had expected to be down 1% for the quarter relative to the prior period and prior year. But currently, first quarter expenses are running a bit better than that and down 1% to 2% relative to the prior periods, adjusted for the usual lumpiness and seasonality that runs through our books. But obviously, that's an area that we've been focused on, given the volatility we've seen in the last month. So anyway, that's a -- kind of a long answer to a short question, but let me stop there.

No. Eric, no, very insightful, very helpful. I really, really appreciate that kind of color. Coming back to the deposits, how quickly can you lower those deposit rates, particularly with, like you said, there's an elevated inflow of them coming in, can it happen very quickly? I mean meaning, if the Fed, obviously, they cut the 50 basis points, and can you pass on that cut within days to some of those customers?

Yes. Gerard, the deposit pricing actions literally happened and communicated at the end of the day, right? So the Fed acts typically in the morning before they open, or let's say, they do. Then we would make our pricing decisions during the day and notify our client constituents by the end of the day, and then they would have an effect the next day. Deposits, as you know, there's a series of different deposit offerings that we host for our clients or deposits that are tied to LIBOR and might have a LIBOR less X or some kind of mechanically based formula, and those with just calculations redone instantly and effectively plays through. There are other deposits that we have on more of a managed basis -- managed rate basis where we have a good bit of discretion, and we've got -- we've always been clear with our clients of what those are. And those are, remember, deposit rates that those metrics that we've taken up over the last couple of quarters and couple of years. And we're effectively reversing that trajectory, but that will literally happen within 24 hours. And so it's all, I think, partly because we've gotten used to movements in interest rates here again after -- well, over the last few years. It's a fairly mechanical and effective process. And I think it's good for clients so that they know exactly what they're going to be paid and good for us just to operate that way.

Knowing you as being a custody bank and having a large portfolio of securities, obviously, fixed income securities, primarily, can you share with us on the comments on your net interest income revision guidance, does that incorporate increased levels of mortgage-backed security amortization that is likely to happen with the refinancing activity that's picked up?

Absolutely. The -- I think we've got very -- we've added over the year very detailed disclosures in our 10-K and 10-Qs. We've divided up the interest rate exposure into dollar and non-dollar, and we've added good disclosure on the front-end moves of the rate curve as well as the back-end moves so that the investors can do a good amount of scenario analysis. And all that information does include the effect of premium amortization on the securities books. And so if you just want to think about it roughly, I think, I gave you the figure of about -- for long rates down, if that were the only event in the U.S. that has, for every 50 basis point move, $75 million impact on our next year's NII, I think, almost half of that is just the natural effect of premium amortization and is fully factored into those disclosures.

Very good. If we could pivot from current events, if you will, to more strategic, longer-term type questions in the time that's remaining. Can you share with us -- obviously, you're winning new clients every day, every quarter. And when you see that those new clients coming on, what percentage would you say are actually existing clients, but they're taking on new products, and that obviously adds to the revenue growth versus entirely new customers that are not a customer of State Street, and you bring them into the State Street Company for the first time?

I think because of our kind of large established position, remember, the $33 trillion of assets under custody administration. And I think we custody probably 10% of the world's assets. If you think about it in some of the core segments that we operate, so the asset manager segment, as an example, we literally are the custodian or the accountant in some way or form for, I won't say every asset manager. But the -- I'm trying to think of the vast majority. The -- like it's in the 80% to 90% plus range of clients -- of asset management clients that we touch. So almost by definition, it is typically a question of bringing more to us as we win business. And you saw some significant wins last year, the $1.8 trillion, $1.9 trillion mark for assets under custody administration. So it tends, primarily, I will say, to be about clients bringing more to us, like, I would say some of those are clients where we might have half the custody and accounting and they're saying, look, I want you to have all of it or I want you to have 3/4 of it. So there is some of that going on, right, which is a real consolidation because they -- clients realize we can bring even more scale to them. And then there are other situations where we might have 10% or 20% of the book. And we're in a situation, where we're displacing one of the other large incumbents, those are the ones we're obviously seeking out. But there's a range of those different types. And I think part of what has made us successful at stabilizing the revenue environment and even driving some upticks in the revenue environment in -- starting from the second into the third and fourth quarter of last year is that we've upgraded how we go-to-market the clients, how we cover them. And that's actually been a very powerful mechanism to actually engage clients where we might have a very strong share of wallet, and we're rounding it out or where we have low share of wallet, but we're displacing another player. And part of what we've also done to support our coverage for us is we've built up a data set over the last, I'd say, was probably started about 2.5 years ago. And I think it fully came up online about 1.5 years ago, full share of wallet mappings -- full wallet mappings of our clients across all their different fund families, all the different services that they likely buy, we obviously can impute estimate, what they might be paying the market for those services. And so there's a rich set of data that we've created, and that obviously helps our coverage for us in driving some of those wins that we seek out and that we've been successful in garnering.

The mapping, that must be pretty -- I mean with the breadth of your customers, is probably pretty broad -- kind of like the New York City subway map, I bet?

It does have that feel to it. I'd tell you, it wasn't 1 or 2 people that we put on it, right? This is a dozen-and-half person operation that we've built up, but it's been very constructive because it -- in a way, we have the equivalent of a New York City subway map for every one of our top 60 clients, and then we might have a somewhat simpler map for the top 200, but it's an area of investment in MIS that we found colorful and fruitful.

That's great. Speaking of those top clients, you guys have always indicated that when a customer has multiple products, it's obviously a more profitable relationship for State Street. And I guess, a 2-part question as we wrap up here. One, does it also suggest those customers, it makes the relationships stickier when you have multiple products with one customer? And then second, of the top 60 that you just referenced, what's the typical amount of products that one of those customers would have?

Yes. The breadth of products absolutely helps with stickiness. But I think what we have found in our industry that clients buy. And at times, we've tried to define the products, but I'd tell you, we're the -- when I tried to count them again a little while ago, I got to 35 different products within custody and accounting and middle office. There's just a lot of sub-products, in a way, all of those sub products matter. So it's hard to come up with a standard definition. What I would tell you though is the more products that you offer and that you serve your clients with, the stickier they are. But on top of that, I think what we have found over the last couple of years is that some of the products that we have in our -- in the industry and in our, sounds like, custody, tend to be a little less differentiated and a little less sticky as a result. On the other hand, when you couple that with accounting and then middle office, in particular, you get some real stickiness. And so that's why out of the $33 trillion of assets under custody and administration, about $9 trillion of that in our book has been around middle office. So it's still quite a big piece. And we've purposely done that because it's an important service for our clients that they value, but also because of the stickiness. And then I think more recently, with the advent of the Charles River offering, which is in the front office and actually is connected not only to the operations and the COO, kind of complex in a client, but also the investment office and the CIO of our client. We found that clients who actually -- we can support with that front-to-back offering, right, the front office offering of Charles River, the middle office that we've been providing and the back office are particularly prone to stay with us and to be sticky. And actually, they're prone to actually engage with us and purchase a broader set of products. And I think if -- I think one of the reasons we've been so pleased with the success of the Charles River acquisition is actually it added a product -- part of the product array that we didn't previously have. And to be honest, no other custodian can really replicate. And so that range of products we really see from front to back has been a real -- a powerful combination.

And it sounds like, Eric, that clients are embracing this opportunity to go front-to-back because of the Charles River with you guys?

Yes. And I would say, it's -- when we say clients, what's different now is that it's not just the operations head, who we've always been close with and excited about serving. But it's the operations head, it's the COO, it's the Chief Investment Officer at the client, it's the CEOs. So the kind of the client connection has kind of moved up further into the C-suite and broader across our clients with the advent of the Charles River acquisition. So they're more interested, and they're more interested at even more senior level because it's at that level that they're making very commercial decisions around how do they evolve and transform their own business. And that's -- those are situations where we're particularly excited to partner with our clients on.

Well, with that, Eric, I really would enjoy speaking to you for all afternoon, but we've run through our time, and it's a real privilege to have you participate this year, and hopefully, next year, if you can do it again, and do it in person, would love to have you. So thank you so much.

Gerard, thank you very, very much and thanks for hosting, and thanks for finding a way to do this virtually, given everything going on. So thanks again.

You're welcome. Take care. Bye.

Bye-bye.