State Street Corporation (STT) Earnings Call Transcript & Summary

I'm Jason Goldberg and I cover the U.S. large cap banks here at Barclays. I'm very pleased to continue with our Financial Services Conference this morning with State Street. Some housekeeping items before we jump into it. But on the left-hand side of your screen is our audience response polling questions. Feel free to answer those during the course of our discussion. And that way, towards the end, time permitting, we can actually go through some of the answers. If you have to answer a question, just go back towards the top and hit the Next button. You will be able to push the next question, there should be about 4 questions. [Operator Instructions] With that, I'm very pleased, representing State Street today, to have Ronald O’Hanley, Chief Financial Officer; Eric Aboaf, Chief Financial Officer; and Ilene Fiszel Bieler from Investor Relations with us today. Before we jump into it, I'm going to turn it over to Eric to read a disclaimer.

Yes. Let me just do the standard legal disclaimer for everyone. I'd like to remind you that today's discussion may contain forward-looking statements. Actual results may differ materially from those statements due to any number of important factors, such as those referenced in our discussion today and in our SEC filings, including the risk factors in our 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. Back over to you, Jason, now that the legalities are behind.

Super. Maybe the best place to start this morning is just maybe offer some perspectives in terms of how you're able to support clients throughout this pandemic. Clearly, kind of unprecedented times came upon it very quickly. You had people kind of all of a sudden working from home. We had market activity, market volatility shoot through the roof. And just how are you able to support clients through that? And I think kind of looking out what maybe longer-term implications this pandemic will have for your businesses?

Jason, why don't I take that? And in some ways, you framed the question exactly how we think about the time that we're in and the time that we're facing. I mean the crisis was unprecedented, and there was a lot we needed to do, first, for our clients but, second, for ourselves. Unlike many other businesses, as you know, our business, and we knew this going into this crisis, was likely going to face a lot of volatility, transaction volume goes up. So just as we were moving, about 90% of our people from home is when that volume started spiking. And it affected our clients quite extraordinarily. I mean I don't need to recount what happened, but the speed with which everything happened, this was like 2007 and 2008 and early 2009 all compressed into a few weeks. And beyond the transaction volume, there was an awful lot that needed to be done on the -- to address liquidity concerns, whether it was asset management portfolios or asset owners who all of a sudden we're facing the prospect of not being able to meet benefits payments without going into the portfolio and having to sell the portfolio. That was inopportune time. So probably more so than ever, we were involved with our clients in terms of coming up with innovative financing solutions, a little bit outright loans but more repo, cash solutions, et cetera. And so that continued on for quite a period of time. But what's also happened is that this is -- it's accelerated some long-term trends. And we've talked to you before about whether it's asset managers or asset owners taking fundamental looks at their operating model and saying, how do we do better? How do we scale, how do we reduce costs? How do we shed some share-of-mind that we're spending on our middle and back office and focus more on our -- what we're doing for clients? So that -- I think we thought at the beginning of this crisis that it would slow down a lot of those very fundamental outsourcing discussions that are going on. If anything, that accelerated those and in fact, started some that haven't even been started before. So I think what we will see out of this is there was a direction that have been set before the crisis in terms of a much more holistic look at the operations of these asset managers and asset owners. And it's the larger, more established ones that have the most work to do, right, because they've tended to grow over time, sometimes over decades. They've got systems and operations that don't talk to each other, that don't really make sense. And most importantly, they don't have good data flow. So it plays into our overall strategy, and we're seeing acceleration of that. And then finally, I think what -- where we -- in terms of a response to the crisis is what we did with the Fed. The money market liquidity facility was the first one up. We were very close to the Fed on that. And I think in the end, ended up facilitating about 50% of those transactions. And then we're the administrator for 4 of the Fed program. So the Main Street Lending Program, the Commercial Paper Program and the primary and secondary bond programs. So the third element of this is just supporting the system and helping the system work.

I guess you mentioned some of the larger, more established players have more work to do on the active servicing front. I think on the second quarter call, you kind of alluded to some pretty healthy pipelines for that business. Can you maybe just kind of maybe talk more to that? Should we expect some announcements on that front? And just maybe talk to kind of what kind of pricing that we're seeing -- I know last year or the year before, pricing pressure was kind of more acute, kind of what are you seeing on that front as well?

Yes. Well let me start on the first part of that and then Eric will pick up here. I think we did talk about in the second quarter about the growing importance of our Alpha front-to-back platform. And to put this in perspective now -- and we've been talking to you for a while now since the deal with Charles River was announced and we used that occasion to lay out our vision for the front-to-back platform. Well that's almost 2 years ago now and a lot of technology development has occurred, but more importantly, it's growing and growing. It's a more important part of our pipeline. So as we sit today, about 50% of our pipeline would be Alpha front-to-back kinds of activities. And will they all translate into full front-to-back on day 1? Maybe not, but what tends to happen in these things is there's a direction of travel that gets set. And it's a long-term change program that the asset manager might have in place. It's -- you've done these results at Barclays. We've all done these in terms of how you think about core fundamental technology change-out and operational change. But we believe that a fair amount of that pipeline will actually get translated over time into full Alpha front-to-back. In terms of pricing, and I'm now talking pricing overall is where I'll start with, which is probably what you're most interested in. Again, we went through this -- historically, custody fund accounting pricing has faced about a 2% headwind annually. That's what you've kind of seen is this kind of steady 2% down. As you know, we and most of the rest of the industry saw that spike up -- or spiked up to about 4%. We're down now, and what we're seeing now is much less pricing pressure. There's a lot of reasons for that. One is just the quality of the offering and the quality of the prospect of moving them over to the Alpha platform. So it's less about can we grind down prices and what you're doing for us in custody? And more, how can you help us do other things? Secondly is we've just become much more disciplined about that. We've talked to you about that now for over a year, and it's having impact. We've got a full-fledged pricing committee that gets involved with all these. And the pricing committee isn't just about no, but it's about bringing expertise to the RMs who may not face these kinds of pricing things. I mean if they face 1 every other year, that would be a lot. We've got a group of people that have expertise and can help them figure out, well what can we do instead of just grinding down the pricing here, whether it's getting consolidation so we get more assets at a slightly lower volume. So we expect to see far less pricing. Eric, I don't know if you want to pick it up from there.

Yes. Let me do that. So Ron shared some of the context. Historically, as an industry, we saw pricing headwinds of about 2% a year. It ticked up to about 4% in '18 and '19. And as we were -- as a number of clients rolled over and we're navigating through that. I think what we had expected to see this year was that, that 4% would actually tick down to about 3%, right, because we're trying to see if we can get back to some historical norms. And now with half the year under our belt and another couple of months through, we now expect that pricing headwind to be not at 3% but at probably 2.5% for 2020. And that is literally, I think, because of some of what Ron described, the kind of the process and managerial changes and then supported by this product feature functionality, right? That's what you get with a front-to-back offering, and that's starting to play through in our clients' minds. So we're going to see over time if we can get pricing back to the long-term averages, but we're pleased that we're doing even better than expected this year.

Jason, the other thing that we're seeing out there which ties into both questions that you've asked us in terms of coming out of the crisis and what does it mean for pricing is, I think before March, the work with our clients was around how do we take core operations and improve them? How do we improve the access to data, improve the use of data in there? The added kind of twist in all this is that now our clients are recognizing that and it needs to be a mobile-first strategy. And very, very few institutions are prepared for mobile-first. So again, this is, we believe, will push much more of an outsourcing trend than we've seen before.

And that -- it's interesting. That outsourcing strength is going to put pressure on some of the smaller providers, right, because it's only the largest of us who's got global operations in India, in China, in the U.S., in EMEA, in multiple locations. Can we load-balance, right, in this kind of crisis that was unprecedented? And I think this is where you see a kind of a 1-country provider or even a 2-country, 2-region provider have more challenge. Or to be honest, with a client who's done it historically internally, and they may have had only 1 service center, is really finding that servicing during a dislocation, and it may not be the pandemic next time, right, is actually not particularly something that they're good at. And so we think that, over time, is going to encourage more outsourcing and more outsourcing to the largest providers and maybe even some share-shift between the smaller players and the larger ones at the same time.

So I guess, Eric, on that point, and I'll maybe jump ahead here, but I think you brought up with the question a fairly good point in terms of pressure on some of these smaller providers in the current backdrop. I know historically, State Street has kind of used that to be acquisitive. And obviously, a lot of uncertainty given the pandemic, but with kind of Charles River, which you alluded to kind of very well ingrained and off to a really, really good start, do you think acquisitions become part of the kind of the growth opportunity ahead?

I think, Jason, first and foremost, what we're focused on is growing the core and doing that organically, right? Because we've got real scale and capability and I think marketing prowess now and sales capacity with Charles River and the front-to-back offering that we're doing. We're -- and I think we've got to do that well, and we've got some real opportunities ahead of us. Are we always going to keep an eye out for bolt-ons or tuck-ins in the custody space? Yes, absolutely. We know how to do those. We know that they're accretive within the first year. And so we're always looking to those. And in fact, there's 2 kinds of bolt-ons that happened in a way in custody. It's the large client who's done maybe most of what they've done historically internally and are saying, "Hey, can you lift out what I'm doing?" I mean, that's almost a kind of -- it's a version of custody M&A. But I think the more natural one that you described is that some of these international banks, in particular, are under pressure. They want to refocus on what they're best at and they can't quite afford the ongoing technology investments that are needed to be scale in this area. Certainly, bite-size deals here and there are certainly the kind of things that we'd be happy to do. And we've always got feelers out. I think it's an industry that knows each other. And I think there is a time here, as you described, where perhaps there's a little more going on than usual just as folks have to navigate through the crisis here and perhaps think about that a little more than usual.

You appear to be having success with the Alpha front-to-back CRD offering. I guess what sort of responses have you seen from your competitors?

So I mean the responses have been interesting, Jason. The -- when we first started talking about this and we used the term front-to-back, we spent a lot of time defining it to everybody, to the investor community, even to our clients. And now it's fully adopted in the Lexicon amongst all the asset servicing providers. So I guess imitation is the best form of flattery. The -- what you're seeing is, I think everybody is recognizing that there's a desire for more connectivity. And the reason for that is it's all about the data. And if you think about the journey that a security takes when it's just an idea in an analyst's mind to when it's actually traded, put into a portfolio, accounted for and then the feedback in terms of some kind of reporting to the client, there's just a massive amount of reconciliation that occurs in that 3 books of record that have to be reconciled. And that becomes very problematic for the usage of data. So I think all the providers are recognizing that. The challenge is that anybody that's tried to build one of these, they don't happen overnight. Charles River wasn't built overnight, Aladdin wasn't built overnight, Bloomberg wasn't built overnight. Those are the 3 largest ones. And so what most competitors done is some kind of partnership with other providers. Those partnerships, we think, are important. We're part of all the same partnerships. So we're working closely with Aladdin, which is a very, very good platform. We've been involved with Aladdin right from the beginning in terms of our middle office connecting to their offering. So you'll see more of that. You'll see, I think, platforms emerge, of which various providers are plugging into in some way, employing in some way. But I don't think you're going to see 12 or 10 or 8 platforms. I think you'll see a relatively small number with different providers accessing them and utilizing them in some way. And we've said right from the beginning, open architecture and interoperable. So a lot of the technology development we've been doing has been around that to make this Alpha platform truly interoperable not just with other custodians but with other data providers, other analytics providers, so that you can actually ensure that it works fine even though you've got somewhat different applications in there. I mean think of it as any consumer platform, whatever you happen to be on at home, if you're a Mac person, think of it as the macOS platform, and that's the vision here.

And Jason, what I would add is that, remember how the economics work here, when it's interoperable and we have a piece and plug into another provider then the other provider, and we have our piece of the economics. When State Street provides the front-to-back offering, right, the front office, middle office and the back office, then we actually garner all the economics, I think that's a bit of how State Street is different. When we offer that, we've got the top-to-bottom economics as opposed to just the piece. And so there's different ways to participate here. And I think that's where we, in some ways, have a financial advantage.

Yes. And Eric makes a good point. And those are different economics, right? The custody industry has traditionally serviced the back office. And if it was an asset manager, you were traditionally servicing the funds, right? This is all about serving the management company or the actual pension fund and what they do all day every day. So it's a different and additional set of economics than the traditional fund custody accounting kinds of economics that are still there but aren't growing anywhere near what they used to be.

Before I shift topics, I guess on that, there is a question from the audience that I'll give you. But agreed. So given the driver of your 50 basis point of pricing outperformance, is there a world where you can get to 1.5%, i.e., 50 basis points of your initiatives driven by outperformance versus the 2% average before you've had those efforts?

Yes. I mean it's a good question. Actually, picking up on what I just said, the fact that a growing part of our business is a different set of economics, and I don't want to make predictions at this point as to how pricing pressure will occur there, but there's historically been less of it, right, in terms of the front office kind of thing. So it's a possibility. It's not something we're planning for at the moment. Eric, I don't know if there's something you want to add about.

Yes. I think we got the high levels of pricing pressure. We've managed that down to 3% and now to 2.5%. I think we've walked before, we've run before, we sprint, and I think we're making good headway. And we'll -- it's certainly in our interest, and I think we have a product arsenal now to do even more with. Hard to predict it. And I think it's the kind of thing that every year we'll take inventory and be sharing with you our perspectives, and we'll do that again in probably January 2021.

Makes sense. And maybe shifting gears to the asset management side of the house. 2Q saw significant flows. Obviously, ETFs have been in focus. Can you maybe talk to, maybe give us an update in terms of what you've seen in that business overall and how you're positioned vis-à-vis your peers?