State Street Corporation (STT) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Gerard Cassidy with RBC Capital Markets. I want to welcome everybody to the State Street presentation to our 25th Annual Financial Institutions Conference. And as many of you know, State Street is about the 10th largest bank in the United States. It has almost -- or close to $40 trillion of assets under custody, $3.5 trillion of assets under management. It is truly one of the premier custody banks here in the United States. As of Friday, the stock is trading at about $80 -- just under $80 a share. And it's trading about 1.2x its stated book value. The company is also very well capitalized. It has a strong CET1 ratio of just over 12% and has recently announced also a $475 million common stock repurchase program for the first quarter of 2021. We're very pleased and I'm very privileged to have with us Eric Aboaf. Eric, as many of you know, is the Chief Financial Officer of State Street Corporation. He joined them in early 2017. He was with Citizens Bank for a short while prior to that. But for many years, he was with Citi Group. Eric, welcome.

Thanks, Gerard, and good afternoon, everyone. And I think just to remind everyone, today's discussion may contain some forward-looking statements. And as you know, the actual results may differ materially from those statements due to any number of important factors, including risk factors in our 10-K and SEC filings. Our forward statements speak only as of today. We will not update them [indiscernible].

Very Good. Thank you for that disclosure, Eric. And maybe we can start off with, obviously, last year was a year that is unprecedented in any of our lifetimes. And aside from the obvious issues with the pandemic, what were some of the surprises, Eric, that you saw for State Street and for the management team and how it was handled? And what do you think it may hold for the immediate future?

I think, Gerard, all of us experienced an event that we never expected. And as I think back, I think there were 3 or 4 things that surprised us in retrospect. I think, first, the ability to just move our staff to a work-from-home environment literally over weeks, nights, I think, was striking. And we could do that in our corporate functions. We could do that our business functions. We could do that while still connecting with our clients. And we could do that in every one of our major hubs, first, China, then India, then Poland. So that was probably the, I think, the most immediate change. I think secondly, the sheer amount of volumes we were able to process in a resilient way. You always stress test your operations, your technology, your processes. But for us to have back-office volumes up 50% literally within a couple of days, FX volumes almost double and then to be able to deliver on that without significant operational events, losses or what have you, I think, speaks to the diversity and the robustness of not only State Street but of the financial system and all the interrelationships that we have and how well we're able to operate. And then lastly, I think the silver lining for us here is that our clients were affected. Now we clearly helped our clients, whether that was to take in their cash as deposits because they needed to place it somewhere safe, overdraft lines, money market liquidity facilities. But I think the silver lining is our clients realized that the stress for them tended to be even more poignant than for us. Why? Because they often operated in one service center if they operated on their own and their own infrastructure as opposed to being able to leverage a global bank like ours. They -- so I think the -- our clients have started to think back and say, "Look, what if I had more of my business outsourced to State Street, to a global custodian who could load balance and rotate and move processing from the U.S. to India, back to Poland, back to the U.S. and have that kind of resiliency and reliability?" And I think that's opened up, to be honest, some conversations with clients who have still, in some cases, still in-source some of their operations, still in-source some of their processing. And I think that gives players like us who have been so effective during the pandemic an extra calling card.

Very, very insightful. That's very true. When you think about your business going forward, what do you think is an optimal return on tangible common equity? Or if you prefer return on equity, that's okay. But when you kind of think about the ideal business environment, what can State Street -- if you had your capital at the levels you think is appropriate, what do you think that ROE -- since as we know, ROE is so important for delivery -- for driving valuation for banks. I'm just curious about your thinking of, in an ideal world, where do you think it could go? And what would that ideal world be?

I think there are a couple of ways to think about that, Gerard. I think if you just look at this past year, we had a return on tangible common equity, ROTCE, right, in the 16% range. So quite high relative to most banks. And then our ROE, which is actually the measure we focus on the most because we feel like we need to be accountable for every part of the equity on our balance sheet, tangible or not, was at 10%. At least, it was at that threshold of double digits. The goals we've set out for ourselves, Ron and I set in -- back in 2018 when he took on the CEO role, was to drive our ROE, so return on total common equity of 12% to 15%. And so that's still what our goals are. We clearly have a range in that 12% to 15%. Why? Because you don't know what interest rates are going to be. Are they going to be high? Are they going to be low? Are they going to be somewhere in the middle? And for us, the path to higher ROE is really what you'd expect it to accelerate some of our top line growth so that we have the revenue trajectory. That's important to continue to drive productivity so that we build and widen our margins and then, finally, to continue to be real disciplined about capital and capital return. And we've said we'd like to take most of the capital. And we have more than we need right now on the balance sheet. Get that back to shareholders and always be a large returner of capital year-after-year.

Very good. Obviously, State Street's revenues are driven by the fee-based products as other custody banks. But before we get to those questions, can we talk a little bit about the net interest margin and what's going on with interest rates? Obviously, we've seen a steepening in the curve, as you well know. There's no expectation for the front end of the curve to go up anytime soon. But -- and maybe someday that comes sooner than currently expected. I think the market -- the forward curve is calling for some rate increases in '23. What's your view on what's going on with rates? And I don't know if you'd like to tie that into your outlook for net interest income that we're seeing for the quarter or for the year.

So let me start with net interest income. And I'm also happy to update you, Gerard, if it'd be helpful on the rest of our outlook as well. But let me start with NII and then we could perhaps broaden if that would be -- if makes sense. Clearly, we've seen some movement in interest rates. We've seen the long rates move up. And we know that will aid our portfolio over time. But we've got real maturity in our portfolio so it takes time. We've also seen short rates come down, right? And all of us have a bit of exposure to short rates, whether they're fed funds, LIBOR, et cetera. And then finally, we've seen balances on our balance sheet of deposits, in particular, continue to run high. You saw that from third quarter to fourth quarter and then that's continued. So regarding NII, we now expect that first quarter NII will be at the better end of our previous guide, which was down 6% to 8% sequentially. As we get the benefit from the long rates beginning to have a positive impact, slightly offset by some of that tightening at the short end. And then as we look forward, we continue to expect to see NII stabilization after the first quarter step-down. And that should prove healthy for the year.

You talked about the deposit growth between third and fourth quarter, that you're seeing continued growth here in the first quarter. If the Fed continues with this quantitative easing of about $120 billion a month -- obviously, we're about to see another stimulus package passed, more deficit spending by this government. Does that suggest that your deposits have to continue to grow because the way the system is set up and the banks being an integral part of the system?

I think that's a direction of travel. I say "I think" because we're living in quite a different time than we have before. And as you've described, the Fed's out there, expanding the money supply and buying securities to the tune of $100 billion a month and literally continuing to leg into that trade. And if that continues, all else being equal, right, that cash liquidity ends up in the money supply. And then a good bit of that comes back to the banks. And I think what you have seen is that as a custody bank, the custody banks have been particular beneficiaries of that liquidity over the course of the last, I'd say, 4, 5, 6 months, even more so than the rest of the banking system because, in a way, we are the first call for where clients leave that cash.

Can we -- sticking with revenues, obviously, moving from net interest income into the fee revenue area. Clearly, you have articulated State Street and yourself about the continuous pricing pressure that's been around for many, many years. So it picked up a little bit a couple of years ago. But it seems to come back to this normal trend. Can you give us some flavor for what you're seeing in your fee-based areas and where you see of the growth opportunities in growing that fee revenue, whether it's Charles River or some other parts of the business?

Sure. We see a number of opportunities ahead of us. And part of what we described at first quarter earnings and over the last couple of quarters is the kind of execution that we need to deliver upon to actually monetize and create the revenue growth that we'd like. We've put out medium-term targets of revenue growth in the 4% to 5% range. That's a couple of years out. We think we need to build into that. And if you pull that apart and you say, "Where is that going to come from? What are the different fee areas as you described?" there are several. There's core servicing fees, which we think will grow 3% to 4% but probably with even a range within servicing fees. Middle office is growing closer to high single digits in terms of revenue growth on average. And some areas, some segments like alts are growing more quickly. There are other areas of more traditional custody and accounting that might be growing closer to 2% to 3%. So there's a range within servicing fees. And part of our execution plan is where do we focus by segment, by region, by product category because each one of those has an impact on the lift and the trajectory we can have. I think if you then open up the lens further, Charles River, we think in the software space can grow on average in the low double digits. And that's up from what the franchise wants to deliver that we had purchased. So we've been able to accelerate that growth because of the brand we bring and the relationships we bring to Charles River. So I think our software and data analytics kind of revenues can grow at that low double-digit rates. And then the other part of State Street' is our asset management business, our FX trading business, our SEC finance businesses. Those tend to be a little more volatile given the environment. Whether it's driven by equity markets or volatility in different instruments, those will have a range. Those sometimes will grow 3%, 4%, sometimes 5% or 6%. There could be some spikiness on either side of that but probably in that 3% to 6% range. And we think, together, that creates a franchise that can grow in that 4% to 5% range, all in.

And which ties into obviously positive operating leverage, which is I know a focus of State Street, to be able to drive better bottom line growth than the top line growth. What are some of the efforts that are continuous at State Street to try to deliver that positive operating leverage?

Really, 2 sides of that equation that we're continuing to work on. One is the revenue side as we've just talked about, which is probably where we're positioned. And partly, where do we spend extra energy, extra effort because that helps us drive the top line revenues that we like to see. And that's in particular on the fee side. And that's about execution, market share, share of wallet, new business and so forth. There's the work we're doing in NII, right, to continuing to try to offset the interest rate headwinds. And you've seen us expand our balance sheet in a careful way and continue to grow our loan book. And that, we'll continue to do because that can create the -- not only an offset to the lower interest rates but a tailwind over time. And then I've got to say on expenses and in productivity, I think we have a well-established set of processes, a culture, really now a program, such that we don't call it -- we don't have a fancy name for it anymore of Program A or Program B. It's just our ongoing productivity efforts. And you've seen us, starting in 2019, we -- on a core basis, putting beside the Charles River acquisition, we're able to bring expenses down in that 2% range. You saw it last year in 2020, expenses down 1.5%. And we've guided for expenses down again this year. And what is that? That's a series of different initiatives, everything from automation and simplification of our core operations. It's around consolidating footprint. And now we're leaning even further into occupancy savings and opportunities. It's around productivity at every level. 2 years ago, we said we're going to compress the senior ranks of the top 500 folks at State Street. We reduced that group by about 15%. Why? Because we felt like we had globalized a number of functions and we didn't need a decentralized structure that we once had. Over the last couple of years, we've moved selectively roles to some lower-cost locations, where we actually have a quite high productivity and very strong capabilities. And then more recently, this past year, we did some work around the middle of our pyramid to simplify our organization, which makes us not only more productive, more effective. So those are the kinds of examples. But what I'd tell you is the list is long. The list is 20, 30, 40 initiatives. And they usually have a 1-, 2-year run of them. And then you continue on, you deepen, you go back. And there's a full range, and a full range that covers our $8 billion cost base of -- comp and benefits costs are about half of the cost. So it's around principle and people productivity, right? How do you get -- and people like that, they want to be productive. And then there is all the non-comp and benefit spend, right? Their third-party spend, our vendors, where we have a significant set of efforts.

Very helpful. Very good. Coming back to deposits, in the fourth quarter, we're talking about how different this year has been in so many ways. And for many investors and bank stocks, to see a bank post a negative average cost of deposits -- I think yours was maybe minus 17 basis points. Can you share with us just the dynamics of that? Obviously, I'm guessing it's coming from your business overseas. And just what that may mean for the go-forward rates as we go into this year?

I think when we think about deposits and deposit pricing, we're obviously a bank who takes in deposits and reinvests in securities or loans. And we're looking to earn a fair return on our balance sheet. We need to. We've got leverage ratio, capital requirements. And to be honest, it's part of the economic model with our clients. Our clients pay us in deposits in the form of NII and they pay us in the form of fees. It's a combination of both. And so when rates came down, we brought deposit rates down, what we paid out. And that makes sense. When rates in Europe, in particular in the eurozone, went negative, right, we had to begin the tougher introspection and communication, which is, hey, do we have -- do we subsidize deposits? Or if we can only reinvest at the European Central Bank at minus 40 basis points or minus 60 basis points, then why is it not fair for us to take deposit rates negative? And so that's what we've done. And so what you see on our balance sheet is the average deposit rates across the globe. And I think what it demonstrates is that we're just disciplined. We're disciplined but we also want to be fair. We need to earn some reasonable return on our -- on deposits we take. There are leverage ratios. We have to hold capital against those. So going back to your ROE question, it's part of the fundamental equation in banking. And I think what you'll see is that we're still operating in an area where deposits and deposit earnings are compressed relative to what would have been a through-the-cycle experience or where we were just a couple of years back, when prevailing rates were at 1% or 2%. And I think until then -- until we get back to some level, we're going to need to be quite disciplined on deposit rates and don't see any change. We might see long rates float up. But it's not until short rates move, and I don't think any of us expect that anytime soon, is there any real consideration for adjusting deposit rates.

I have another question that I just thought of as you're answering your question, Eric. Because you're on the front lines, you're dealing with all these different deposit rates around the world. You're operating in a negative deposit rate environment, as you just described over in Europe. Our policymakers, the Federal Reserve, in particular, has stated they're not planning to take our short end of the curve negative. What's your personal -- I mean, again, you see -- you're right there in the driver seat. Do you tend to agree with that thinking? Or could there be a chance of us having negative short-term rates in this country?

You never say never, right? And so we, probably like other banks, occasionally run sensitivities and scenarios and stress scenarios on our balance sheet around what happens if freights go negative. We've actually -- in our 10-K, we disclosed the impact of the negative rate environment. And that's part of our risk processes. I think we've seen negative rates. And I think we in the U.S. have seen the Europeans experiment, experiment for a long time. We've seen very low rates in Asia as well over the course of the last decade or 2. And it's not -- I don't think it's -- I think the prevailing view in the U.S. is that it doesn't seem to create the benefits you'd really like to see. And so we don't think it's a likely outcome at this pace -- at this point for U.S. rates to go negative. But it's -- as bankers, we don't discount any possibility and we always try to be prepared. But not -- we don't think it's a likely outcome at this point.

Yes. Plus, as you've shown, you can adapt to those environments like you've done. So if it does get thrown at us, obviously, State Street has the capability of adapting to it since you've already been doing it over in Europe.

We have more experience than we'd like with negative rates.

Understood. You've touched on capital and the CET1 ratio a few times in your commentary today. And can you share with us how State Street approaches capital management, managing the balance sheet and the capital levels? And your targeted -- if you can remind us your targeted CET1 ratios. And how you strive to get to those ratios? And how long it may take just to reach those targeted levels?

Sure, Gerard. Let me answer that question. Then let's reserve a little bit of time on the rest of our first quarter outlook update on the P&L. That's always an interest at your conference and we're always happy to provide it. But let me first touch capital. So capital ratios have obviously been running high. We run at north of 12% on a CET1 basis. And we're looking to bring that down over time. Part of it is the SCB rules provide us a minimum of 8%. Obviously, that gets updated every year. That includes a G-SIB requirement, which also gets updated. So there are always some moving parts. But I think we've got a -- we've got some good evidence. I think you all have as investors good evidence that we don't need to run at this 12%-plus level. And I've said in the past that we'd like to get down to the 10% to 11% range. We don't feel like we need to run lower than that. We're a trusted custody bank. And so there's a reputation and a kind of expectation of some of our clients. We're always managing our risk position. So we want to have the right amounts of capital. And then the question just will be about when and how. And that will partly depend upon the Fed's restrictions. Whether they lift the first quarter restrictions around buybacks, we'll see. It will then -- depending on how that plays out, it will play out into CCAR and the recalculation of the SCB. And so I think we'll know more in the upcoming quarters. But our intention is to continue to return capital and bring those capital ratios down over time.

Very good. And sure, that's one of the real themes investors are looking to from State Street and your peers. And now we are running out of time. But we have time for the last question, which is maybe to give us an update, Eric, if you would, please, on what you guys are seeing in the first quarter.

Sure. And let me just start with the macroeconomic kind of overview. Now with less than a month left in the quarter, average equity markets, as you know, have been up a little more than some of us have expected. We've also seen some good business performance so far. And I'd also remind you that as expected, the U.S. dollar, right, has been considerably weaker than this quarter as compared to the same period a year ago, right, which affects the comparisons. And there's always been a known tailwind for revenues going into this year and a known headwind for expenses. So starting with fee revenues. We currently expect that first quarter total fee revenue growth will now be flat to up 1% year-over-year, which is better than our prior guidance of down 2% to 4% given some of these macro tailwinds and our business performance. This includes first quarter servicing fees being up close to 5% year-over-year. And while there are still some relative headwinds in some of our trading businesses this quarter as compared to the record first quarter a year ago, right, we're seeing better performance than we had initially expected. And the good news is that while it's still pretty early in the year to see how much of that will carry through given better-than-expected fee revenue this quarter, we now expect full year total fee revenues to be up 1% to 3% for 2021. And that's better than flat to up 2% that we previously guided to. And that, of course, provided -- or assumes equity markets stay elevated where they are. On NII, I think I gave an update a little earlier. So we've covered that. And then regarding expenses ex notables. Given the significant appreciation of foreign currencies to the U.S. dollar this quarter as compared to last year, we expect that first quarter expenses will be up 1% to 1.5% over first quarter 2020, which includes a 2% to 2.5% headwind from currency translation. That said, we still expect to be within our full year guidance of total expenses ex notables of flat to down 1% year-over-year. And that still includes a currency translation headwind for the full year of about 1%. And then there's always taxes. And first quarter taxes should be in the middle of 17% to 19% full year range.

Yes. Eric, just to make sure I understood your expense comment on the first quarter. If you didn't have the currency issues, it sounds like operating expenses in the first quarter '21 would have been below first quarter of 2020. Is that correct?

Yes. That's correct. And as we go through our disclosures for earnings in April, we'll obviously do the calculation both on a nominal basis and then adjust it for the currency translation, which as you say, we'll show that our -- were it not for the currency translation, expenses ex notables are down year-over-year.

No. That's very good. And thank you for giving us a new updated guidance today. We greatly appreciate it. And as always, I'm very pleased to always have you join us. And it's our pleasure to have you here. So again, thank you so much for joining us. And have a good rest of the day.

Thank you, Gerard. We really appreciate being at your conference and look forward to staying in touch.

Okay. Thank you, Eric. Have a good day. Bye-bye.