State Street Corporation (STT) Earnings Call Transcript & Summary

Okay, great. Good morning, everybody. Thanks for joining us for our next session here. I'd like to welcome management from State Street. With us today, Ron O'Hanley, Chairman and CEO; and Eric Aboaf, State Street's CFO. Over the course of 2021, State Street has been on an improvement path, when it comes to organic growth, particularly with respect to a few very sizable wins within asset servicing. In addition, the firm recently announced plans to acquire Brown Brothers Harriman, further expanding its global leadership within asset servicing around the world. I think, Ron is going to open us up with a couple of prepared remarks, and then we'll go into a Q&A. So Ron, over to you.

Well, thank you, Alex, and good morning, everyone. Just to remind our audience, this is the disclosure that today's discussion may contain some forward-looking statements, and that actual results may differ materially from those statements due to a variety of important factors, including the risk factors in our Form 10-K and other SEC filings. Our forward-looking statements speak only as of today, and we may not update them, even if our views change. With that, I'm going to make some brief opening remarks, after which Eric will join me for some Q&A. 2021 has been a very busy year for State Street. We have accomplished a great deal as we delivered on our strategy. I'm particularly pleased with the improvement in our revenue generation and execution against both client retention and sales effectiveness. As a result, we have achieved strong sales growth and business momentum, which bodes well for future revenue growth. For example, by the end of the third quarter, our year-to-date AUC/A wins amounted to a record $3.2 trillion, reflecting the benefits clients see and our innovative front-to-back Alpha value proposition, our traditional back-office offerings and our enhanced investment servicing strategy. Additionally, SSGA continued to enjoy strong organic inflows, revenue growth and margin expansion. This successful execution enabled us to deliver strong fee revenue growth, which also -- while also building a strong pipeline for future growth. Total fee revenue increased by 6% year-over-year during the 9 months ending at the end of the third quarter as our strategic pivot to an enterprise outsourced solutions provider across the front, middle and back office manifest itself in revenue growth. We have a well-established track record for productivity growth and expense discipline in recent years, with total net expense reductions in 2019 and 2020, excluding notable items and adjusting for the acquisition of CRD. This expense discipline continues in 2021, and when combined with notably improved fee revenue performance, it has helped us to achieve positive operating leverage and 1.4 percentage points of pretax margin expansion for the first 9 months of 2021, compared to last year, excluding notable items and despite a double-digit decline in NII. And we expect to see positive operating leverage for full year 2021. Productivity improvements and expense discipline will continue to remain a focus for us, even as we invest in our people and business for future growth. We are also focused on further extracting the benefits of scale within our business, which will be enabled by the proposed acquisition of Brown Brothers Harriman Investor Services business. Our goal now is to close the acquisition, which we announced in September, in the first quarter of 2022, subject to regulatory approvals and closing conditions. We remain excited by the opportunity, presented by this transaction. In addition to being a financially-compelling use of our capital, once closed, BBH Investor Services will strengthen our market leadership by creating the world's largest custodian, expand and deepen our international reach and propel our Alpha strategy. To conclude, I'm very proud of the progress we have demonstrated to date in 2021. As we look ahead, we are encouraged by the opportunities we see within our industry, our sales wins, the momentum in our pipeline and what this means for our ability to generate both positive fee and total operating leverage in 2022, as we continue to progress towards achieving our recently enhanced medium-term financial targets. As previously disclosed, our medium-term targets include achieving total revenue growth of 4% to 5%, and expanding our pretax margin to 31%, in addition to good capital management, lifting ROE to 12% to 15% and driving EPS growth of 10% to 15%. And with that, Alex, I'll hand it to you, and we'll turn to Q&A.

Wonderful. Thanks, Ron, for the introductory remarks here. So look, maybe we'll get started with a question on asset servicing, probably not surprising. That's usually the way these things go. And the good news is, this time around, I think we're talking about a meaningful improvement in the trend versus what we've seen a couple of years ago, right? So Ron, you pointed out that you guys have $3 trillion plus of new wins, over the course of this year, nicely ahead of the $1.5 trillion number that you've, kind of, pointed us to in the past, which is what you need to replace to, kind of, grow the business. So I guess, I was hoping to dig in a little bit more what specific areas you're seeing improvement in. So what's driving the improvement we've seen this year? What supports your optimism to '22? That's something that has come through in your prepared remarks as well. And then, Ron -- that's public for you. And then, Eric, when we pivot over to you, I guess, along the same lines, do we think that we have finally, sort of, turned a corner, where the servicing fees, excluding the markets, can start to grow organically, on a more sustained basis?

All right. Well, why don't I begin? And what -- where is this confidence coming from? And why do we feel so good about the business? I mean, if you go back to 2018, when we announced the acquisition of Charles River, what we said then was, this was part of our strategy of adding to our back- and middle-office capabilities and bolting on the front-office capabilities of Charles River, but also tying it all together in this notion of the front-to-back offering. Why is that so important? Because what you see in our industry, starting with asset managers, but including sovereign wealth funds, asset owners, et cetera, is this desire to be able to run their operations more smoothly, run technology, better future-proof these offerings, and to be able to do it in a way that enables them to manage their data sensibly. This is all driving this mindset of enterprise outsourcing. And we've been able to position ourselves to do that, the 18 Alpha wins to date, the 7 installs to date, really demonstrate why we feel good about that. In terms of the future revenue, again, just think about the numbers, 18 to date, 7 installed. That means, there's a lot more to be installed. So it's a little bit of a first-world problem and that we've got a lot to be installed. That pace is picking up. We like what that means for us, but it also gives us visibility on the revenue line, quite a bit out there. And finally, the -- it's taken off with our clients, right? We're able to have conversations with almost any client, whether it's ours or not ours or whether it's a deep relationship or not a deep relationship. So we just feel like we're well-positioned. We're meeting the market where it wants to go, and we've got an offering that we think, is -- and we know, is actually quite distinctive, relative to everybody else.

Great.

And Alex, I had a couple of thoughts here. First, the wins and what I call the win momentum, right, the sales win momentum, has been picking up here now for 1 year, 1.5 years. You saw this year. It's also broad-based, right? First quarter, a large win with a large European bank, second quarter, one of the premier asset managers in the U.S. That was an Alpha win. The first quarter was a traditional custody and accounting win. Third quarter, one of the premier British, right, asset owners. So you see regions, you see different segments of the market, and that's what we're really looking to accomplish, both in the traditional trust and custody offering. And then, in parallel with that -- with the Alpha offering, which links the front, middle and back and provides that enterprise solution that Ron described. And I think, what you're seeing is, the sales momentum has started to pick up. And clearly, as we really feel like we're hitting our stride this year, in particular. And as that has happened, what I'll call the installation -- the revenue installation momentum has also picked up as well. Last year, I had said, we were roughly neutral on net new business or what could be thought of as core growth. I think, we had a -- there's a year -- a couple of years back, where it was negative, right? We had net outflows. This year, we're confident we're going to be in the positive territory for net new business. And as we think about the to-be-installed wins that we have already recorded, right, that bodes well for another year, next year, of positive organic growth again.

That's great. Let's talk about the other side of the coin a little bit, which is client retention. This is something that, again, you guys framed it as, look, every year, you need to replace about $1.5 trillion from new sales. But a part of the net dynamic is obviously, what you can retain. So can you spend a couple of minutes on what are the reasons for typical attrition? And what are you working on to actually improve the statistics to help the net number?

Yes. Why don't I begin on that. So if the broad -- why does business attrit? First reason, and really, historically, what's been the most common face in the industry, has been consolidation. I mean, most providers -- with one exception that we all know, most providers are actually consolidating their custodian. So in that regard, somebody is going to suffer, as a result of that. Second would be around capabilities and servicing, either the client now has capabilities and views, the incumbent’s capabilities is not satisfactory, or it's just not satisfied with client service and delivery. And then, the third is, particularly in the asset owner space, where you've got, oftentimes, prescribed periods, in which the business has to be put out to bid. Public funds would be a great example of this. It's price, right, where we -- where they go out to market rate to be able to get a better price. So if you think about those three, in the first, we have more often than not -- we've been the beneficiary of consolidation, overtime. I mean, if you look at a lot of our growth, it's -- we've been the beneficiary of consolidation. In the second, we are bringing more capabilities to the market, and particularly as we start to bring in Alpha. So we're well-positioned on that. On the price side, Alex, we have scale. We've got a very good offering. But we're also quite disciplined. So we -- there are times, where we will say, we're going no further on this. And it's fortunate, you never want to part ways with the client, particularly over that, when everything else is working well. But that's how we think about retention of this business. So what have we done to improve and strengthen it? Because as in any business, the current client is way more valuable than the client that needs to be sold to. So this ongoing effort to improve and strengthen the offering, has been at the heart of that. Second has been around how we're servicing clients, and trying to wrap more into the offering, such that it makes the business stickier. And again, this is an example where Alpha has proven to be quite beneficial, right? Because once these are converted, you really are actually linked up to your client in a way that undoing that becomes more difficult. Again, it's not a substitute for strong service. And then on pricing, we continue to manage our expenses, and we continue to lower our unit costs. So if we -- if it meets our hurdles, we'll do it, and we found that we've been able to be even more price-competitive over the last several years. But that's the place where we're willing to walk away.

Great. And on retention, Ron, you mentioned one of the customers that has, kind of, gone the other way. Obviously, we know BlackRock has made a decision to move a considerable amount of assets out of State Street. We found out, I guess, last night or early this morning, they kind of made the decision of where that's going to go. It's not new news, but I figured it might be helpful to flesh that out a little bit more implications for State Street, when that's going to hit revenues and any sort of updated revenue estimates we could have from that impact?

And maybe, before we get into the revenues, just to make sure -- remind everybody that this is not new news. We've been working quite closely with BlackRock from the day they said that they were interested in diversifying. They have a view, given how large they are and given how large -- what their growth aspirations are for iShares, that having a sole provider was not something that they and their fund board wanted to do. So we have partnered with them, throughout this, in terms of helping them put the [ RFP ] together. We're actually partnering with them now, in terms of helping prepare some of the new custodians that are coming in, to actually be able to service this in a way that BlackRock likes its service, when this is all over. BlackRock is an important client today, and they will remain a very, very important client in the future. We continue to do -- we will continue to service M&I shares. We continue to be one of their top providers in fixed income. We continue to be their top, if not leading, provider in alternatives. So it's a very important relationship to us, and one that even after all this, when it's all said and done, we still will be the largest servicer of ETFs in the world.

And if I can just update on the financial implications, which we've shared before, dating back more than a year ago. The size of the iShares business has drifted -- has grown. So at this point, our current estimate is that -- roughly represent about 2% of fees on our fee base. The transition's been pushed back, so delayed relative to original expectations. Originally, it was, principally, 2023. Now, it's split 2023 and 2024 with a little more of it at the -- in the latter year. As I said before, with -- whenever we add clients or we occasionally lose a client. We got variable costs associated with it. 30% to 50% has been our typical estimate. There are also some fixed costs that we target. So we manage this economically as you'd expect. And notwithstanding this, I think we'll still be the leading global servicer of ETFs. I think, though, if you open up the lens, we've always factored this into our medium-term targets, right? Getting to that 4% to 5% top line growth, the margin expansion. That's been factored in. And as part of what we expected at the time. And I'd also say, going back to the first question you asked, as you think about our wins, why did -- why are we so intensely focused on coverage and sales momentum. We booked $3.1 trillion of wins this year, year-to-date. That's the kind of momentum that in our mind, is core to our franchise. And it's always going to be there -- needs to be there to offset some occasional attrition. But we've got confidence that we see our path through this, partly on Alpha, partly traditional. It's part of what we've factored in.

Right. Makes sense. Let's speak about Alpha and CRD, a little bit more. Clearly, a big driver of success for you guys, this year. You've outlined a number of, obviously, significant wins that are still on the come, gives you a lot of revenue visibility. So that's great. Now that you've owned CRD for a couple of years, maybe help us contextualize a little bit more, what other adjacencies and revenue synergies you could see over time from the wins that you're seeing today, right? There's going to be, kind of, like an immediate uplift in things like servicing fees, maybe if it's a customer you win, et cetera, it's part of the relation, but could there be other things we need to keep in mind? And when you think about the addressable market for CRD, a quick update on that would be helpful as well, whether it's within your network of customers or outside.

Let me start on the market sizing and growth opportunities because if you think about it, we've historically operated in the custody and accounting revenue pool that we've defined. Ex-NII, it's about a $27 billion market space. We've got a very substantial share of that today at -- depending on how you count, 15%, 20%, right? It's -- there's still room for us to grow. We'll do that. But what Alpha and Charles River has allowed us to do, is move up the value chain. We've historically, also operate in the middle office, but we had paused on our growth in the middle office because what we found is, the middle office alone doesn't really feature in the same kind of benefits and economics that we'd like. But the middle office is another $7 billion revenue market pool. And we're actually the largest provider there. I think, we got $9 trillion, $10 trillion of assets under administration in the middle office. And I think, the next largest player, maybe, is that 1 or 2, right? So it's a large opportunity, and one now that we can lean into. And then the front office, the data and analytics pool, that's another $6 billion or $7 billion of market opportunity, and what we've, historically, not played it. And if you think about that, Charles River at $500 million of revenues, has got a small share wide because it's such a fragmented market. And so what we did with Charles River is, we bought a premier franchise in the front office. We've now found a way with Alpha to connect it to the middle-office offering and then sell the back office at the same time. And what's, I think, attractive for us is, it will, over time, average up our revenue growth. Why? Because back-office servicing, we know, is lower, maybe mid-single digit, but probably low single-digit top line growing activity. Middle office is a solid middle office -- I'm sorry, a solid mid-single to upper single-digit growth market. The front office is high single digits, low double-digit growth. And so what it allows us to do is to lean into those faster-growing markets, and actually create a market that doesn't exist. People have asked, Alex, like you have, just like how big is the Alpha services, right, the front-to-back market. It's hard to define that because we're creating it, right? And its impact -- it's a slice of the front office $7 billion. It's a slice of the $7 billion middle office, and it's a slice of the $27 billion in the back office. What we see is Alpha marching across into all three of those market spaces, some of which are growing quite nicely. While we continue to emphasize and drive growth in the core, in our traditional offering, at the same time. And it's that combination that we feel, gives us the revenue lift that we're looking for.

Great. Next topic I want to spend a couple of minutes on, is BBH. Obviously, the acquisition you guys announced a couple of months ago. It sounds like the deal is not going to close in the first quarter versus your earlier expectations, by the end of the year. So maybe help us, kind of, flesh out, what's behind the delay? But also more importantly, as you're starting to think through the integration and maybe starting to hear some feedback from their customers and relationship managers, et cetera. What are you guys doing to make sure that you retain the revenues, which, again, with any transition, there is customer attrition, things like that, that you got to take into account? So what are you guys doing to do to ensure that doesn't happen to a great extent? And also, early thoughts on the revenue synergies, from just the fee side. I mean, I think you talked about $40 million of net synergies outlined in this transaction. Then, there's all balance sheet conversation. We'll get to that later, but maybe we'll start with this first.

Why don't I start, in terms of the timing, this is all about regulators and regulatory approval. We have regulators around the world, some of them are coming in. But looking at the timing of them, it's just not going to happen by year-end. So right now, we're targeting first quarter of -- when that will be in the first quarter, who knows, somewhere though before the end of the first quarter, is what our expectation is. And it's tracking a long time. The -- in terms of going back to a little bit why we're so excited about it, is that everybody talks about deals having strategic synergies and all those kinds of things. This one actually does, right? It's -- if you think about the footprint, it's virtually identical, geographically. But we bring lots to it that it doesn't have, and it brings many things to us that we don't have. So what we're excited about is, first of all, there's some capabilities that they have, particularly some technological capabilities, that they are a little bit one-off kinds of things. But there are things that we now can plug into the Alpha platform. We can bring things to market faster than we had anticipated to and actually devote our -- the development dollars that would have been towards that, towards things that are further down the road. So we're bringing in everything, as a result of that. Secondly, they've got a very interesting operating model and one that, as part of our productivity and transformation, we've been aiming towards. They've now got it right there for us, and we think it will help us in our whole journey towards transforming and lowering the unit cost and just taking the complexity of our own operating model. And then finally, as you note, there's just a number of synergies that can be brought to bear. BBH, as you know, has a limited balance sheet. We've got a bigger balance sheet. So some of them, we can have further and additional penetration in the market area, which is, of course, very high margin. There's -- again, we keep talking about it, but it's real. There's the whole Alpha offering to their clients that we can now bring. Third, they've got a very interesting kind of offering with financial institutions and banks, much bigger than ours. So we now feel that we'll be able to develop that out and have a bigger offering to the actual financial institution channel than we've had before. So in terms of working with clients, the good news is there's a fair amount of overlap here. And so that's actually been quite easy to do. But all of us have been on the road, throughout the fall. I spent a month in Europe and the Middle East, a lot of that with their clients and people, nor as equally worried about people. I mean, nobody feels good, on either side, in this period between an announcement and a close. So we've been spending a lot of time trying to signal to people as much, the roles they're going to have and introducing them to their counterparts. The fact that there's been, again, this overlap in footprint, at least we've been able to introduce them to each other in that footprint, notwithstanding COVID. So it's proceeding along well, but we're sure looking forward to the flows.

Great.

And Alex, I'd just add, the financial performance of the franchise is performing nicely, in line with our estimates. Remember, we showed you first half results -- the first half results time 2 as an estimate for a full year, this year, and they're trending in line with that for the current year. And then we've started, as you can imagine, the budgeting process with our new colleagues at Brown Brothers. And that looks like it's in line with our revenue forecast, our early synergy estimates, our earnings expectations, from a deal model perspective. And so while things will be pushed out a quarter, and so that affects all the usual financial metrics by a quarter. In fact, the franchise is performing well, and we can see that in the financials and some of the early forecasts.

Yes. And just a quick follow-up on that. Just speaking of timing, I think you guys were expecting to start the buyback later in the year, in 2021. Does the later closing of the transaction change at all, the time frame, when you expect to be back in the market with share repurchases?

We'd like to get back to the buyback as soon as possible, right? That's our intention. I think, it shouldn't have a material impact on our intention to try to begin that in second quarter. But we just have to see, right? It will just depend on exactly where our risk-weighted asset position is, exactly where our -- where the marks are on OCI and the investment portfolio. So I think, all those things will factor in, but it shouldn't materially change it for the time being. And we'd like to get back to initiate a buyback in the second quarter, which was our intention. We'd like to still do that. And then we'd like to go back to full buybacks, third quarter, fourth quarter. We just need a little time to get there.

Got it. Great. Another one for you on BBH. This is a topic that definitely, is very top of mind for investors around. The balance sheet strategy, their deposit base, and clearly, the interest rate outlook feels a little bit better, and we'll get to that in a couple of minutes. But as part of the synergies, you talked about $35 million in NIR benefits by bringing some of the deposits off balance sheet to State Street's balance sheet. Can you just help us with the underlying assumptions that you guys had supporting that 35, sort of, what kind of rate scenarios you assume? And then, bigger picture, that's not all of the deposits that they have. So the flexibility that, that might create for State Street to bring in more deposits and perhaps make you more asset sensitive, and the right point in the cycle is something we could consider, I guess. But how are you thinking about the opportunity to go beyond that original estimate?

Yes. I think, you got -- the point that you made that at the right time of the cycle, this gives us quite a bit of optionality that we're looking forward to. If you just start from the beginning, right? This past year, we estimated that the franchise has about $45 million of NII on roughly $7 billion of deposits. And you got to think about the deposits kind of half invested in investment portfolio and then half held as cash at the central banks. And so the spreads are modest, as you'd expect. As we put the franchises together, the immediate benefit is we have a larger capital base. We have a larger earnings power, right, an earnings EBIT [indiscernible]. And that lets us actually take up to expand our investment portfolio, and actually modestly increase the size of the investment portfolio and the duration positions we brought. And we want to be careful about exactly, when we leg into that, but that's what it lets us do. And what that effectively then does, is get that larger investment portfolio that might be running $4 billion or $5 billion against a $7 billion, $8 billion, $9 billion deposit base today, on a pro forma basis. You, kind of, take that investment before you double it, and then you bring deposits along to fund it, right? So the deposits are the funding mechanism. This is really about adding to the investment portfolio over time and where we see the opportunity. So that's the first order approximation that gets us from $45 million of 2021 NII, add another $35 million as we expand that investment portfolio and fund it appropriately with deposits. I think the real opportunity, though, is that right now, they've got a sweep program that sweeps $65 billion plus of deposits to other banks. Now, we want to continue that because it's a very attractive offering. It provides fees for us, funding for counter-party banks, so it's beneficial. But that -- the value of those fees is a little less than the NII, just because of how it plays out in the low-rate environment today. What happens though is, as rates rise, right, the value of those sweeps, if they were held on balance sheet and invested in an investment portfolio, grow quite nicely. Why? Because we've got a deposit beta that we're effectively playing through. And it's really -- in an interest-rate environment, when interest rates are at, let's hope, 75, 100, 125 basis points, where you start to have real benefits in that, in moving the sweep deposits, somewhat, into the balance sheet. Now, you've got to hold preferred against that, right? So there are some activities that need to come together. But it's really -- I think, it's an option on future interest rates. So I think, we're all confident we'll get higher rates, just don't matter exactly when and how much. But once you get to that 100 basis point range, plus or minus, there's a real benefit, and I think that's where there's some out-year impacts that really weren't in our acquisition model. Because at the time, right, the forwards were quite light for the out years. Now, the forwards for the third year, let's say, even the second year of the deal, are much more positive. And so that's where we see, over time, some upside, and we'll monetize that.

Yes. No, definitely exciting part of the story. Look, with a couple of minutes left, I want to make sure we got to the guidance point. So Eric, why don't we run through the usual. It's late in the quarter. NII fees, expenses, whatever else is top of mind, you could share with us.

Sure. I agree. It's coming to the end of the year. We'd like to put a bow on the year, and then we'll get into 2022 in January. So thank you for giving me a buy there. As you know, we're budgeting. We're planning.

We still have 3 minutes.

I know. All right.

But thanks for the diplomacy.

So let me cover 2021 on a full year basis because that's how we guided to in October. And then, as so -- but to lay the groundwork, as a reminder, daily average equity market has been mixed this quarter, right? The S&P has been up but less positively up than previously, so up 3%. International equity markets have actually been down as well as emerging markets have been down, sequentially. And so overall equity markets, I think, are roughly flattish. Our prior guidance remains largely unchanged. We think that full-year total fee revenue is pretty much spot on, our prior guide of up 5% year-on-year. And within that, we expect servicing fees will be at the lower end of the prior full-year range we gave, partially due to the U.S. dollar appreciation over the course of the last couple of months. And so servicing fees, on a full-year basis, should be up about 7.5%. There'll be some puts and takes in the software and processing line, but for a full-year basis, it will be consistent with our expectations for full-year total fee revenue performance as well. We expect 4Q NII to be roughly in the middle of the range we gave of $475 million to $490 million. And you remember, Alex, we lifted the range for NII during the course of the year, as we've expanded the loan book, reinvested the higher level of deposits and feel like we're in a good place there. We also expect to deliver on our full-year expense guide, ex notables, in the range that we previously provided. And I will say, better than the industry, at large, right? We are -- continue to be focused on managing the expense base while continuing to invest in the business. And then finally, we expect taxes to be at or below the low end of our previous full-year tax guide, given the possibility of some episodic items that we're always working on.

Great. All right. Done at down with 50 seconds to spare, I guess. So I know no '22. I'm not going to ask you explicitly, but rates obviously moved around a lot. The forward curve is in a better place, is still thing versus where we were, even a couple of months ago. Balance sheet strategy, to an extent, you still feel there's opportunities to further invest in the securities portfolio or any comments around loan demand you could share with us, from especially the sponsor community. I think that's been a decent source of loan growth, just so the way we can start thinking about the framework for '22.

Yes. I think, the -- you've seen us lean in on the balance sheet, this year. We've had a lot of loan demand that you've described, from private equity sponsors, in particular. But across the franchise, we've now seen that loan demand in Europe as well. We'll keep doing that. NII will be mostly driven by what happens to short rates, right? Do we get a short rate increase in London, in Australia and Canada. That's what will make the difference. And does that come in December, is that get pushed off to March or April or May? And then, when we get the first U.S. rate? We're hopeful, but I don't like to give guidance or build a budget on hope. And so we're -- we've got to be a little hopeful, a little optimistic, but we'll take it one day at a time. And I hope actually, we'll learn more over the coming weeks and should be able to give you a more fulsome view. But we'll do everything we can. That's how we're running our balance sheet and trying to lean in.

All right. Perfect. Well, we'll stay tuned for that. Thank you both for joining us, making a trip down in New York. I appreciate it. Good seeing you in person.

It's good to be in person. Thank you.

Yes. Perfect.

Thanks again.