State Street Corporation (STT) Earnings Call Transcript & Summary

This morning, I will need to read a disclosure first, and then we'll kick off. For important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. This morning, I am pleased to have with us Eric Aboaf, Chief Financial Officer of State Street; and Francisco Aristeguieta, CEO and Head of Institutional Services. Francisco is in charge of client management sales and marketing globally. And prior to his current role, Francisco ran State Street International. Francisco and Eric, thank you very much for joining us.

Thank you, Betsy, and thank you, everybody. Good morning. Just to remind our audience that today's discussion may contain some forward-looking statements and that actual results may differ materially from those statements due to any of a number of important factors, including the risk factors in our Form 10-K and our SEC filings. Our forward-looking statements speak only as of today, and we may not update even if our views change. With that, this morning, I will give a brief presentation highlighting our new investment servicing strategy and outline how we expect it will position the business for future success, ultimately driving growth across business segments and regions and help us achieve our company-wide financial targets over the medium term. After that, Eric will join me for Q&A and some fun. You should be able to view and control the slides for today's presentation via the online meeting portal. The presentation is also available to download from our Investor Relations website, investors.statestreet.com. Turning to Slide 3. We show our investment servicing line of business, which is the focus of my presentation this morning. The business accounted for over 80% of State Street's $11.7 billion of total revenue in 2020. It is primarily comprised of servicing fees as well as other related value-add products, which you can see segmented in the chart on the left side. On the right side of the slide, we show some of our historical performance. As you can see, following a period of growth up to the end of 2018, during 2019, the business faced revenue pressures as a result of industry and organizational challenges. In response, we implemented a number of management actions in 2019, which helped us return to growth in 2020. And we are now focused on driving stronger and more sustainable revenue fee growth through a comprehensive new investment servicing strategy that I will outline shortly. Turning to Slide 4, we detailed the challenges I've mentioned just a moment ago as well as some of the strategic solutions we are executing on in order to drive growth with the business. First, we are faced with fee revenue pressure, in part as a result of elevated client pricing headwinds. While we took some initial actions in 2019 to address these headwinds, we are now creating a one State Street approach to our business. Understanding that success is driven by solutions and client service, we are leveraging a new integrated client-centric operating model across business segments, regions and client management to drive more diversified and sustainable growth. In addition, our Alpha value proposition changes the pricing conversation to, one, focus on capabilities and helping our clients create more efficient operating models. Second, historically, we've been highly indexed to specific business segments such as large asset managers in North America. All these clients will remain an integral part of our future growth plans. Our new strategy focuses on diversifying our pipeline by business segment, client type and geography. Taking the 2 last challenges together, we historically operated in a siloed and product-driven manner and did not bring the full scope of State Street capabilities to our clients as effectively as possible. We needed to foster the right level of accountability across the organization and move from a product orientation to a client-centric one. We have implemented a new organizational structure, which centralizes client management, increases accountability for growth and consistently improves client experience. Turning to Slide 5, we illustrate the new organizational model for the investment servicing business. Moving from the left to the right of the slide, you can see how we have reorganized our approach from one that was siloed by product and that limited alignment across our sales and client management teams to one that is fully integrated across multiple dimensions of business segments, regions, client management and client experience. Starting with clients, new segment heads are accountable for revenue and market share growth across each of the 5 business segments. They will drive thought leadership, our global segment value proposition and determine resource prioritization for client management and service. Next, regional heads will drive our local strategy and growth plans across all products and countries. They are responsible for building our local brand and increasing market penetration. These regional leaders are also tasked with further improving our operating model by prioritizing and optimizing available resources. Last, our newly expanded client management model brings together more disciplined relationship management with a more targeted client experience. Each client manager is responsible for revenue retention, account deepening and prospecting for all client groupings across segments and countries. We expect these new accountable and transparent management process will drive accelerated pipeline growth and improved win performance across business segments, client groupings and geographies with clear accountability on our team's execution. Slide 6 highlights just some of the segment and regional growth opportunities that we see under this new strategic approach. Moving from the left to the right of the slide, we show the total market opportunity across the front, middle and back office as well as the respective industry segment growth rates estimated over the next 3 years. Going forward, as a result of the new organizational structure, we expect to drive growth by delivering a global consistent value proposition. Recognizing the importance of diversification across geographies and segments, we are laser-focused on prospecting new clients, and we are equally as intense about identifying attractive wallet share opportunities within our existing business segments. Let me give you a couple of case studies of how we can drive growth in business segments and regions. Let's take the insurance segment as an example. The open architecture nature of our Alpha proposition allows us to offer leading capabilities through partnerships such as our partnership with SimCorp in EMEA. This partnership significantly enhances our insurance value proposition and enables better client solutions. Another example, this one from a regional perspective where we have a leading market share, such as in North America, we are aiming to maintain our position while simultaneously expanding into new subregions. For example, in addition to maintaining leading national market share positions in the U.S., we see opportunities for growth with asset owners in states where we have historically been underpenetrated. Meanwhile, we are also focused on growing regional business subsegments. For instance, in the U.S., we have a leading market share with large asset managers or are targeting growth with midsized firms. Turning to Slide 7, we highlight our enhanced client management and experience model. We segmented our top 350 clients into 3 distinct client groups, allowing us to allocate resources and service requirements more effectively to where we see important opportunities for growth. While each group consists of a combination of business segments from different regions, each client grouping shares certain specific characteristics. First, global clients are typically our largest relationships. We have a deeper share of their wallet and provide them with a service level that is tailored to their size, complexity and global scale. Second, premium clients represent attractive revenue opportunities for us, and we expect that some of them could move into global clients over time. Their service levels are differentiated but less tailored than in the global clients group. Third, we aim to deliver a world-class client management experience with a more standardized and scalable approach for our preferred client relationships. To more effectively identify opportunities and drive growth with both new and existing clients, we are using detailed analytics. We expect that there is meaningful opportunity to grow wallet share with these clients across groupings as we compete not only with our peers, but also with our clients' own in-house operating models, which are typically inefficient in terms of cost, ability to scale and data management and insights. Our analysis shows that clients in each of these groups with a share of wallet below the group medium typically has a higher average AUM and a lower asset penetration level, creating a clear opportunity to expand share of wallet and migrate clients to new groups. Lastly, we have also established a new client experience organization, which provides a holistic 360-degree view of our clients' experience, influencing prioritization of initiatives to improve overall sentiment and client relationships. Turning to Slide 8. We are already seeing our strategic improvements yield results. For example, in the asset manager segment, we saw servicing fees up 8% year-on-year in the first quarter of this year, with improved performance in North America and EMEA, in particular. We also saw strong wins in the first quarter amounting to $343 billion. As we look ahead, we will continue to foster a culture of accountability for growth and target further execution of our strategy as we focus on 2 areas as next steps, including driving greater momentum across the business segments and geographies as well as improving our operating model. We expect these changes will position the business for future success and help us to achieve our company-wide financial targets over the medium term. And with that, I will let -- send it back to you, Betsy, with our thanks and be ready for Q&A.

All right. Great. Thank you, Francisco. We'll kick off with a couple of questions for you, and I do just want to highlight the improvements in servicing fees and pipelines look very encouraging, which seems to be a nice result from the restructuring that you put into place. I guess the first question here is, out of what you've seen so far in this improved growth, how much of this is new business versus maybe a change in the composition of the fee rate due to the mix of the business?

Well, it's a combination of the 2. There's very, very positive momentum on new business overall, and that's coming from certainly the Alpha proposition and the integration of data into our core services. That is a big part of the win proportion that we're seeing over the last 6 months. But also our core business is performing quite strongly, too, in terms of momentum. And again, as we sort of widen the lens around other segments, less traditional for State Street, we bring accountability country up, and we look at geographies with a very clear target in terms of wallet opportunities that is yielding the benefit around discipline on account planning, relationship deepening. But also, there's been an overall service improvement across the firm, which has allowed us to retain a lot of our business, and that obviously leads to deepening opportunities. And that was, I believe, consolidated very strongly during the pandemic. We were able to respond quite well to the challenge that, that brought to our clients and ourselves. And that allowed us then to consolidate a very strong relationship, building them into further deepening. So the combination of the 2, I would say, are quite encouraging.

So then when you think going forward, there's a variety of different drivers of revenue growth. I'm thinking about new accounts, the expanding wallet, adding new capabilities, leaning into some of the geographies, like you mentioned, where there might be a TAM opportunity for you, transaction activity, interest rates, et cetera. So there's lots of different drivers here. Maybe you could help us understand what you think the top 3 out of all of the opportunity sets are for you. Where is the real focus on your part?

Well, in terms of -- our focus is really starting with the very, very basics, right? Are we providing the right value to our clients? And that is the beginning of everything for us. And that has to do with delivering the outstanding service client expect from us with resiliency, but also understanding that as we get mandated from our clients, they expect value to be top of the pile, leading the industry. And we need to make sure that our capabilities are there. So as those 2 come through, then we can begin a dialogue around what's new, what are the new trends, what are the new things that we can do together? And what we've seen is that since the pandemic onwards, the dialogue around, particularly the very large clients, improving the operating model has become the priority, right? Whereas the pandemic favored the incumbents, including ourselves. Post pandemic is really about how do we get to a more efficient, integrated operating model. And that has favored us because we have established, as I said before, a very strong positioning around service during the pandemic, which has then enabled a very, very positive dialogue around how do we go forward together as partners into a new model, a model that recognizes the need for data, insightful data, but at the same time, recognizes the pressures that our clients are under. And then it allows us to bring scale to them in a unique way. That, of course, is across the world. So we're also benefiting from a very deep penetrating footprint across key regions for our clients as they look to grow. We're particularly encouraged with the momentum in EMEA, as I said, and North America, but also incredibly optimistic about the new dialogue coming from Latin America, which is a less traditional region for us and one that we are positioning strongly for growth. And the response from existing clients and prospects in Latin America has been great, and similarly, in Asia, where we're trying to diversify within the region into markets that we have been less effectively penetrating historically. So we see this as a great momentum behind our business.

And Betsy, the thing I'd add is, as we've talked about in the past with you, our business growth is driven historically by equity market tailwinds. They come and go, but they typically drive growth. Client flows and activity, right, into their funds and kind of the metering. Net new business, right, and then managing the traditional fee and pricing offset. This whole discussion is around net new business. How do we drive growth from prospects, from existing clients, what segments and so on and so forth. So that's the area because, in our minds, that's the battleground, right? The actual execution of driving net new business, which we have said more recently has been relatively neutral. And we need to drive to a positive level as part of this, executing on this strategy that Francisco describes.

And then just one last one on the presentation from me has to do with the matrix organization that you've presented. Where ultimately is the accountability for delivering on the goals that you have? Is it with region? Is it with clients, service models? Is it with the execution platforms? Give us a sense as to how you navigate that. I guess what I'm looking at tri-party matrix graph.

I think that's a great question. And the way I describe it is a joint and several accountability, right? And that's one key element of change in the structure, which is really bringing a one State Street approach to our clients, right? Moving from your product silo construct to a client-centric one. And that requires that these components that today sit under institutional services work in alignment and in partnership, right? So the value propositions that are designed by the segments where we have accountability for wallet share growth and margin and P&L are shared with the client management organization where we have the account plans bottom-up, right? And that value proposition is leveraged to ensure that we gain share with each of these existing clients, right, or also share with the sales teams where we have the opportunities very clearly set out over the next 3 years as we look at our growth opportunities in terms of how that value proposition will enable us to onboard new clients onto our platform and deepen existing relationships. And thirdly, country up. Very important that today, we're moving from an organization that was very focused on maintenance to one that is very accountable on growth. So you'll be seeing us in each and every one of the countries we operate in with a very clear 3-year plan to gain share across the 5 segments, and that is own country up. So you will see country heads migrating to a role, which is a business leader that brings the entirety of the firm together in partnership with the product organization and the segment construct. So it is a joint and several, but each individual has a very clear accountability. If you sit in a segment, if you are a client manager or a salesperson or a country head, you have a very clear line of sight in terms of what you need to deliver. You will need to leverage the rest of the organization, but you are very accountable and very clearly accountable to very specific tasks that deliver the 3-year plan.

And Betsy, just 2 other points. One of the ways we've supported Francisco from a financial standpoint given the MIS that actually describes that matrix, right? So it's -- think of it as a -- not only a 2-dimensional matrix, but [ acute ]. And we can tell in every cell, are we gaining share, are we losing share? Where is the upside? What's the growth opportunity, which clients are their client plans? And that's the kind of -- that's the practicality that we bring. And then the other, he's being a little bashful. This now all comes together in one leader, right? When in the past, it had been fragmented, and that makes a big difference, as you know.

Absolutely. Okay. Just one question here on the top 350. I think was brought up by Ron a few weeks ago. And you've mentioned here today you've got a full spectrum, obviously, a client view. Can you give us a sense as you, maybe not shift entirely, but as you widen your aperture of client focus from top 100 to top 350, how do those client pain points differ? Can you leverage what you've built for larger clients to help execute? Or is there something Lou has to do for you to service those 350 [indiscernible]?

That's a great question. And what I would say is that widening the lens to the top 350 does not take less focus on the top 100. That's the first thing to be clear on. That intensity and that focus remain unchanged. What we're doing is taking the learnings from that exercise and adapting it to the next tiers of clients, bringing accountability, discipline and intensity of coverage to a broader population of our clients, and ultimately, is simply adapting what we have rather than building new. And I'll give you examples. The level of service we give to the very large clients won't be the same as you go down the pyramid because they don't need it. Clients don't need the same level of tailored servicing as you go down that pyramid. They are less complex. They are less global. And therefore, the service levels will be adapted as you go down the pyramid. The coverage structure is also less complex, right, because you don't operate in all regions. You might operate in 1 or 2, and that needs to be reflected in our coverage model, right? So what we've done is that this 350 have now been broken down in 3 groupings. And those groupings, each one have the commonalities of the cohort in terms of complexity and potential, right, but at the same time, bring scale into the picture, making sure that we have the right service model for each grouping and the right coverage model for each group and leveraging the capabilities that we already have for the firm. So this is not about new capabilities. This is about how we bring discipline, accountability and intensity to coverage to more clients.

Okay. Got it. So Lou doesn't have to build anything new for you for that.

No.

Okay. Just a question that's come up here on CRD. I know it's a little bit -- it's involved in what we're talking about but not directly. I guess I'm wondering how you think about CRD as its enhancing what you can do in your role, and maybe you can give us a sense as to whether or not the low double-digit revenue growth that's being generated by CRD is something that you think can continue.

Let me start on the first part of the question. And then, Eric, I'm sure you're going to jump in on the second. But on the first part, it is a big enabler of the client outlook in terms of what else can we bring to the table, and that's a very powerful proposition, but also in places like Asia where CRD has a high penetration, that is allowing us to onboard prospects that had a CRD solution but didn't have the rest of our products. So it's actually supporting a [ both way ] strategy where we penetrate further with CRD existing clients, but we also leverage the CRD value prop to bring in the firm and deepen the relationships where we didn't have a role in the front office. So it's very much a combined role here where we now have brought CRD fully into the tent. You should know that our targets -- internal targets reflect CRD penetration across existing clients and leverage CRD existing relationship for further penetration, and that is reflected in the disciplined account planning process we put in place across the top 350. So it's just one capability we have now brought completely into the tent and embedded into our planning and execution process.

And from a revenue growth standpoint, we're really pleased with what we've been able to build out as we've bought CRD. I think you know that it became accretive within a 2-year time period. A good chunk of that is on the revenue side. And as you know, we took something that was growing 7% a year. The next year, the first full year, we grew at 8%. Last year, we grew it at 13%, right? And so we're confident that we can grow this on average, and I say, on average, in the low double digits. I think some years will be a little higher than that as we saw. Some might be a little bit lower just because of the variability in the revenue accounting. But on average, we see solid low double-digit revenue growth in that business, but largely because it's connected, right, and drives the rest of these -- the client activity.

So then just one other question here on a recent announcement that State Street made. Last week, State Street announced State Street Digital. And just wanted to understand what that means for you and your clients, Francisco. And really the subtext question here is, how much demand is there really for real-time settlement, blockchain crypto? Or maybe I'm missing the point of State Street Digital.

Let me start, and Eric, I'm sure will jump in, too. I think it's an increasing dialogue with clients. They are all very much interested in understanding what is coming and what can be leveraged in that space. Also, our dialogue with regulators is very intense on the topic so that we, in our view, as a management team, led to a conclusion that we need a dedicated effort and focus on really developing the right set of propositions around digital and crypto, in particular, because inevitably, we'll get there. So as part of that drive that we're seeing the need to answer to our clients and respond to our regulators push in this space.

And what I'd add, Betsy, is that State Street Digital has been in the works for a year, 1.5 years. We've been actively involved in a number of different areas. What we realized this crypto and digital, we need to apply and address across the value chain, right? At one end, there's custody of crypto. There's been record-keeping and administration. There is data and analytics. There is trading, right, when you go all the way through. And so what we found is you've got to plant multiple flags. You've got to operate in multiple areas. You've got to think about not only the private currencies, but the Central Bank currencies. And so this is our way to actually scale our offering. What we've decided to do though is also go deep in a couple of areas, right? Crypto ETFs have been up in front of regulators around the world. We've already announced agreements to be the record keeper and administrator for the [indiscernible] ETF, the iconic ETN. And so that's an area, that's a land grab that we think is particularly important and one to monitor and one where we're focused on share and execution and where there's real tangible, practical client demand that we think we can serve in the near term.

And so this expense base to develop State Street Digital, since you mentioned it's been going on for 1.5 years now, is already in your run rate outlook, is that right?

Yes. That's right. That's right. And you know as well, when we invest, we also self-fund, and I think that's part of our culture here that we've built over the last couple of years. And while we'll certainly be scaling up and expanding more and more, we'll find ways to fund those through a lot of our internal efforts.

And when you guided to expenses ex notables of plus or minus, 50 bps year-on-year, I guess the question here is, has anything changed since you brought that up? I'm wondering, wage inflation is a little bit higher now. And on the flip side, maybe there's some COVID expenses that can be cut to offset that. So maybe you can give us a sense as to how you're thinking about that.

Yes. There's not been a lot of change since. I mean the dollars continue to depreciate. So we also have some currency movements. We've seen, as we had previously mentioned, some of the revenue-related variable costs. On the labor side, we put in our annual merit increases and have found a good amount of employee and engagement and sort of willingness to continue to be part of what we think is both a franchise that drives productivity on one hand, then invest for growth on another. And so for the time being, I think we're pretty comfortable with the guidance we've put out there. And obviously, we'll update as we know more. But no, we don't see any very significant changes at this point.

And then since we are another couple of weeks into the quarter, just, what, 10 weeks in, 2 to go, maybe you can give us a sense as to how you're thinking about the quarter.

Sure. When I do that at a high level, I think, as you know, we've seen better equity markets than we had expected earlier in the year as well as slightly greater appreciation in some foreign currencies relative to the U.S. dollar. So given equity market tailwinds, we currently expect that second quarter total fee revenue will be up 4% to 5% year-over-year, which is about 2 percentage points better than our prior guidance of up to 3 percentage points. This includes second quarter servicing fees expected to be up almost 10% year-over-year or 2 to 3 points better than our previous guide. We expect 2Q NII to be in the range of our previous guide of $460 million to $465 million for the quarter. And regarding expenses that you just asked about ex notables, given the significant appreciation of foreign currencies to the U.S. dollar relative to last year as well as some higher revenue-related variable costs, we expect that second quarter expenses will be up about 3% year-over-year or about 50 basis points more than previously expected, with currency translation representing most of that uptick. And finally, we still expect second quarter taxes to be at the upper end of our 17% to 19% range.

Okay. Great. Two follow-ups there that just came in. One was on the NII guide staying in line. That's great. I guess this quarter, you didn't see much pressure from the front end of the curve coming down. And then I suppose the follow-up to that is relating to just your footings. I know last week, Ron mentioned that you're comfortable with where your balance sheet is. And maybe you can give us a sense as to deposit activity, if you could.

Sure. There have been a lot of ins and outs for second quarter short rates, long rates, mortgage prepayments, but we feel like we're in that range and continuing to monitor all the swings and roundabouts as they say. On deposits, we've continued to see quite a bit of flow of deposits our way. It's part of the flight to quality and the brand that we have. And so at the same time, though, we've also said we need to operate our balance sheet in the range that supports a reasonable amount of leverage. And so we've continued to see some inflows. We've gone back to a program of monitoring, intervening selectively. I think, as you know, we've had -- we had $10 billion, $15 billion, $20 billion of discretionary deposit initiatives. So those were going back and thinking of them as a shock absorber up but also as a shock absorber down. And then we're selectively guiding the size of the balance sheet. So we feel like we're going to operate in or about the ranges of leverage that we described. Our view at this point in the cycle will be continued easing, but we need to maintain and limit the growth of our balance sheet and, in fact, operate it where it makes sense economically. The good news is we think clients understand, right? They know they've put a lot of extra balances with us and the other banks. They do appreciate when we work with them and talk with them about helping them invest in the bill market or the reverse market or even, more importantly, the sweeps that we help them drive. And we have SSgA as one of the premier cash managers there available to them. So lots of levers, but we need to operate within a range. And while the balance sheet may ebb and flow in size, our view is we need to keep it. We need to keep it at a -- in a [ quarter ] that makes sense, which is in the range of where we were in the first quarter, notwithstanding we might have some ups and downs and around that.

Okay. Thanks, Eric. And then, Francisco, one last question from the web for you. The question has to do with compensation structure. And really, it's getting at, was there anything within how you are incenting the folks who report up to you to deliver under the new segmentation strategy? Is there any changes there that you could describe to us?

Well, I think it's a great question. And I highlighted in a couple of points during the presentation accountability. And accountability is a fundamental component of this change. And it's accountability country up. It's accountability on account plans, but we also have set internal targets that we need to drive in terms of penetrating existing relationships, in terms of penetrating buckets of wallet that we have underpenetrated historically, be it geographically or across segments, right? Those targets are shared with the product organization, right, and ultimately are monitored every 2 months where we go through each of these 5 areas in detail, right? So we have a leading view as to where we're going in terms of pipeline size, win ratios and, ultimately, how we are performing against these internal targets that we've set for geography, for coverage, for sales and for the segment. So it's the combination of those that get us to the right place. And ultimately, at the end of the year, when we go to compensate our talent, it's very clear where the performance was on the back of a very transparent management process.

Well, I really appreciate you sharing all that detail with us this morning, Francisco and Eric. Thank you very much for joining us again to the Morgan Stanley financials conference, and we hope to see you next year in person.

Thank you very much for the invite and great success for the rest of the conference.

All right. Thanks very much, and we'll go on to the next session now.