State Street Corporation (STT) Earnings Call Transcript & Summary

Good afternoon. I'm Susan Katzke. I cover the large-cap banks at Crédit Suisse. Thank you for joining us at the 22nd Annual Credit Suisse Financial Services Forum. I'm pleased to be joined by Eric Aboaf, the CFO of State Street. We've got lots to cover in this session. We're going to do a fireside chat format, but please by all means e-mail to make questions you have along the way, and I'm going to do my best to work those into the conversation. So Eric, let's get started. I know you have a disclosure to read, and then we'll get to the questions.

Sure, Susan. Good morning, and good morning, everyone. I just want to remind everyone that today's discussion may contain some forward-looking statements. And as you know, actual results may differ materially from those statements due to any of the number of important factors, including the risk factors in our 10-K and SEC filings. Our forward-looking statements speak only as of today. We may not update them even if our views change. And so let's jump in.

Great. We're always all in favor of forward-looking statements. So let's start and focus first on growth. So earlier this month, you and I actually had a chance to meet and discuss the bank's medium-term targets. And so let's start there in the context of a more intense focus on revenue growth for the bank and let's start with the medium-term targets for revenue growth and the derivation of those targets. What's embedded in them in terms of the macro as a starting point here?

Sure, Susan. We're -- we always try to factor in some basic macro assumptions that are reasonable but fair. And so this time around, as you saw in our earnings presentation for 2021, let's call it, the start of getting to those medium-term targets and the continuation, to be honest. We thought of equity markets up 7%, 8% point-to-point begin to end of the year. We thought of interest rates grinding up. We thought probably 25 basis points up during the year at the back end and no move at the short end, and we've been seeing that directionally play out. And then for the next couple of years, we're trying to just be careful but also reflective of, I think, the general consensus. So we generally think of equity markets beyond this year, up 5% a year going forward. But there'll be some swings, obviously, interest rates at the long end continue to grind up maybe another 0.25 point per year or something of that sort.

Okay. And I know you always factor in client attrition and pricing pressure to the baseline. So let's just upfront kind of discuss what would be a bit of an elephant in the room here, which was the 10-K disclosure last week around a -- is this transition in ETF custody. So let's just start -- most of us have assumed, I know I assumed it was BlackRock. Is it BlackRock?

Yes, that's a correct assumption.

Okay. So clearly, look, it's going to be a process. We've seen this before, it occurs over a 2- to 3-year period. And clearly, you are and are intending to generate new business, net new business along the way. But will the transition itself factored into your medium-term guidance and consider when you set your targets, given that it's 1.5% of total fee income, which is a headwind nonetheless?

The answer is yes. We factored in a wide range of scenarios as we contemplated and reaffirmed our medium-term targets. We looked at economic assumptions, tailwinds, generally, we looked at our sales capacity, our retention, the occasional loss or movement of a client. So that was well factored in. And we also, to be honest, factored in the continued and increasing intensity of our sales and growth efforts. And we've talked about those. We've talked about our initiatives around Alpha. We've talked around our segment focus, asset managers, asset owners, insurance, our coverage expansion, right? All those are factored into the -- what we intend to deliver around the medium-term targets.

Got it. And we're going to get into all of that in a little bit more detail, but let's just stay with the BlackRock piece of business for one more minute here. And I want to clarify because I also know there's a range of expectations for what this will ultimately cost you. And you gave us the revenue, you didn't give us the expense piece, so you kind of left us at the moment to our own devices. Can you talk about whether or not any expense grows with this piece of business as well? So we can get to a more accurate EPS impact?

Let me do this, Susan. I want to be respectful of our client relationships or nondisclosure agreements. I think you all could understand those well, and talk a little more broadly in terms of how we think about what happens if a piece of client business moves away from us, or to be honest, when client business comes our way. I think you just saw in the last month, we announced a very large deal with Vontobel, one of the large Swiss asset managers, another one with Intesa Sanpaolo yesterday, right? So there's always movements in our book in and out. Let me describe the revenue and expense scenarios broadly. And I want to make sure that no one goes and says look for this particular client or that particular client how it works. But I think it's -- this is maybe what tends to happen. What happens on average and let me just be clear that I'm speaking in those terms. If we were in a situation where we will have 1.5% roughly exit of revenue or 1.5% inflow of fee revenues, you're looking at roughly $140 million, it could be a range around that, but just roughly of fee revenues. What we do is we always dig deep into what the expenses would be to -- needed to add -- added -- to add that revenue or what we could reduce if that revenue has moved away from us. And we think about it as variable costs and fixed costs, kind of like I think you think about it as well. And for a business activity, which generates revenues of $140 million, there's a good chunk of variable cost. There's probably $50 million to $70 million of variable costs embedded in that kind of business. Again, speaking broadly and without any kind of specificity, whether it's ETFs or mutual funds or all. So I just want to talk broadly about it, which is 30% to 50% of the revenues. And then there's always some fixed cost. Now fixed costs, you all know are stubborn. They're easy to add. They're hard to pull back. But with that kind of revenues, is you're saying, there's going to be $10 million, $20 million of fixed costs that could be -- that might need to be added or might need to be subtracted. And so that's the range of what we're looking at. And I'd tell you, as we do this deep down in the organization and in our thinking. If you think about variable costs, what are variable costs, they could be coverage expenses for our people. Their market data costs and some of these activities that we do have a lot of market data flows because of the daily nature of it. We have sub custody expenses, which directly come back to us. And then we have IT expenses. So they're very kind of specific areas where we tackle the cost structure and where we manage. And into that level that we really assess what can be done if we were to lose a particular piece of business? Or when we add business, how do those -- how much of those we need to add as well.

Okay. That's very helpful. So let's move on to the broader business. And one of the things that we've been talking about are the secular trends that are actually supporting the business, right? We spent a lot of time over those last 10, 15 years talking about the secular headwinds, the active to passive, the pricing pressure. But you can't get to a 4% to 5% medium-term growth rate given the size of your business if you don't have some secular support. So let's talk about the secular tailwinds to your business as well as the revenue pools that you intend to go after because it has to be broader. And simply the basic custody business today in order to -- it really reinforce your level of confidence and investors' confidence in that 4% to 5% fee revenue growth rate.

Sure. Maybe there are different ways to ascertain the opportunity, the headwinds and tailwinds as you describe. Let me start with the revenue pools. And how we think about them and where there's growth. Part of what comes with the revenue pools is what's outsourced versus in-sourced today, what's fragmented, what's up for grabs and so forth. So the core revenue pool we've historically operated in is the core custody and accounting, and we think of that as a $35 billion revenue pool. And it tends to be growing slowly at low single digits. Beyond that, there is a $7 billion, $8 billion middle office revenue pool, which is growing closer to high-single digits. And what is that? That is the asset managers, asset owner saying, look, I don't really want to do much of the processing outside of what my traders or PMs do. It's everything that you all think of as the middle and back of your operations. And we're the largest outsourcing -- outsourcer of that. I think we have close to $9 trillion of assets under administration in that area. And then there's another $7 billion or $8 billion of front office revenue pool, which is really the area where Charles River as we brought that business on is focused, and that's growing in our minds at the low double digits. And so what we have is we have different revenue pools at different levels of growth. We also have -- if you think about the headwinds and tailwinds and the opportunities, custody and accounting tends to be more concentrated. Although it varies by product, product type, region, alts tend to be more fragmented. And so there's both a tailwind, for example, in the alts business, and there's a fragmentation that leaves more of it up for grabs. You've got the front office revenue pools, which is probably 75% either in-sourced or in-sourced plus many, many small software companies. And so a natural area for us to both grow with the market as well as consolidate. And so in our minds, each of these are opportunities. There are different ones, in core custody and accounting. You're -- it's highly competitive. You're fighting -- small feature functionality differences make a difference. We're always trying to find the new one and driving forward. We've talked about ETFs a little earlier. You got ETFs and you got semi-transparent ETF. So who's the first to get those up and running. So it's that kind of innovation on the margin in the core that we're doing, and then you have the middle and the front office where you have real growth. I think the overlay on all that is that everyone, including ourselves, have always had some sort of open architecture plugging in. If you're a back-office provider into the middle office and the front office, but what we've finally done over the last 2 years, it's really created a front-to-back offering, right, that we call Alpha, which is driven by Charles River. But it's really, Charles River at the front end, a data layer that connects to the middle office and the data flows of the investment book of record, the accounting book of record, the trading book of record, all those pieces and then connects to the back office. And in our minds, that is really the change that we're seeing in the marketplace that clients at the C suite level, not just the Head of Operations or not just the head trader who's looking at functionality and saying, look, I need to actually get out of all this morass below what I do. I need to focus on the -- what I'm best at, which is the investment selection. And what we're finding is that, that is what -- that's the transition that we're seeing in the marketplace. Now you put all that together, and I've described growth rates by the revenue pools, right, sort of back, middle and front. I think the other way we think about it is we're seeing a path to get to 4% to 5% fee revenue growth and total revenue growth in the medium term. I'd tell you if -- with Charles River and that Alpha front-to-back platform, we're a lot more likely to get there. If we didn't have it, my guess is growth rates would be half of that or maybe somewhere in that area. Why? Because you don't have something that's differentiating. You don't have something that actually provides real transformation for your clients. And we think that's where the market is heading. And just as an example, what we've been doing is not only measuring our new wins and new wins deal by deal, but we've been starting this for ourselves, and we've shared that with you. As we bring in new assets under custody every quarter, what percentage of those are Alpha assets under custody that actually connect the front with the one back. And you've seen in the second half of last year was about 1/4 of our new business, and we think that's going to grow quarter-by-quarter and year by year.

So I'm curious, when you give us the $7 billion to $8 billion revenue opportunity for the front office, what's different about Alpha as opposed to piece by piece by piece added together as Alpha, there is a data overlay that ties the business together to make Alpha something more than the flow of the parts, right? Is there an additional revenue pool that ties to that data overlay? Or do you embed it in that $7 billion to $8 billion of the front office.

The answer is there is an additional revenue pool. It's worth a couple of billion dollars. So it's not enormous relative to the others that I just went through. What it is, though, it's a revenue pool, a, that you can -- that climbs value and they're willing to pay for. But b, and this is what's most important. It's the composition, the collection of those offerings that we see as raising our win rates, literally making us more competitive and actually either adding or take away more business than we did before. And we think that's what the value of that data layer with the component parts provides.

And then you add in, not just that the product is changing, Eric, but you've also changed the process for managing your clients pretty significantly over the last few years. Do you want to talk about that for a minute?

And you're talking about coverage and stuff?

Coverage and -- yes.

Yes. What we've realized and just to bridge between product and sort of coverage process is, part of what we've learned here with Charles River and this kind of -- this front-to-back offering that we've put together is that this is a solution sell. This is a solution that -- transformation that we're doing with individual clients. And not just, hey, I'm going to sell you back office custody of x for y price, it's actually going through and saying, here are your processes internally and here is how we can actually help you simplify your process, put in place this product offering and data layer and actually make it better-for-you and actually cost-effective for us to provide. We don't want to be out there trying to automate a crooked line, right? We want to be actually straightening and simplifying that. And that is the process that we're going through. What we've realized as we do that is we need to pivot how we actually cover our clients. And so we saw us 2 years ago, a rollout of client executive effort to focus on our top and largest -- our 50 largest clients. Why? Because they're so complex globally by product and so forth. And just put in place all the scaffolding you want, whether it's P&L, sales management, coverage, NPS and client satisfaction reviews, detailed account plans. That was the first stage. What we've realized is that every grouping of our clients is -- can benefit from that. So we've moved now to -- we move to the next 100. We're now down to 350. And then there's certainly a coverage of the -- of the smallest clients. And what we're finding is that, that coverage organized by segment, right, because there are still asset managers, asset owners, insurers, is where we get the most benefit, partly because it helps us serve our clients better. It lets us ascertain opportunities around share of wallet and what we could potentially expand the relationship with. And then to be honest, it lets us then, as we think about product and product innovation and evolution, develop specific products for those clients. An example is we can sell Alpha to some of the largest asset managers. We're doing that ourselves as we implement Alpha and front-to-back for SSGA, our own asset manager, right, which is in the top 3. But there's a version of that package for the midsized, right, $50 billion asset manager that we're developing and rolling out. And so we're operating, I think, at another level of granularity than what we have had historically. And to be honest, we're measuring and intensely managing at that level as well. You can imagine, we don't do a report internally every month on our financials. At the State Street level, we break it by segment, by coverage, by coverage size, by region. And it's across that, I'll call it cube , where we can really look for opportunities, look for execution and provide the feedback that we need to spot new opportunities in areas where we want to adjust.

Perfect. Perfect. So I have a question coming in here as well. Just to clarify, as we close out the discussion around growth in asset servicing related revenue, the $1.5 trillion of gross new business each year that you need to attract to neutralize the pricing headwind. Let's just revisit the expectations around what that $1.5 trillion does, it -- is it an average custody piece of business? Is it an Alpha business? What is that $1.5 trillion?

It's all the above. Yes, it's really all of the above, Susan. We put that out there because this hasn't been an industry in our minds, where we've not had enough disclosure. I think some of you have actually mentioned that to us. Assets under custody and administration is a way to look at the business. And what we described is that we need at least $1.5 trillion to really drive the kind of growth that we'd like and it's -- we were clear that it was on average, right, on average across the product sets that we offer. And what I'd just remind you is sometimes we sell custody only, sometimes they sell the full front-to-back offering, and you've seen that in some of our press releases. And those just come with different levels of fee and fee rates. And so we went back and said, what our wins on average in the last 1, 2, 3, 4, 5 years, that's disclosed, what kind of fees come with those. And we said to ourselves, let's put a line in the sand, both for you as investors and for us internally as to what do we need at least to really deliver on the growth that we'd like. And that's where we came out. We'll certainly update quarter-to-quarter or year-to-year, how we're doing. We'll try to share, I think, a good amount of information, but that's at least on average, what we would expect to need from an AUC/A standpoint. And I do like at least because, in our mind, we're trying to hit that 4% to 5% as soon as we can and as industriously as we can. And we think that we need to be intense about it.

Okay. Fair enough. So let's switch gears a little bit and talk about strategic initiatives and maybe a little bit how you might expect your business mix or revenue mix to shift over time, which takes me to asset management, if you will. So the business is about 20% of your revenue in earnings. It's revenues compounded at a 6% average annual rate over the last decade, inclusive of the GE Asset Management acquisition. So let's discuss how you expect that business to contribute to the anticipated 4% to 5% growth rate?