State Street Corporation (STT) Earnings Call Transcript & Summary

Okay. Thank you very much for joining us. We are pleased to have with us today from State Street, Brian Franz, Chief Information Officer; and Eric Aboaf, Vice Chairman and CFO. As you probably know, Eric is overseeing all financial functions and M&A for the bank, and he was also recently promoted, I should say, appointed to Vice Chairman with expanded responsibilities for State Street's global markets. So we will get into quite a few things as we go through the Q&A. But first, Brian will be kicking it off with a presentation. So Brian, thanks very much.

Great. Thanks, Betsy. Well, good morning, everyone. Thanks for the opportunity to address you today as State Street's Chief Information Officer. Today, I'll focus on 2 key areas: progress made to date to deliver a simplified and standardized technology operating model. Sorry, just to make sure I'm on the right page -- yes, and how we're developing the infrastructure for the future, one that will enable State Street to optimize and advance our competitive position on our journey to be the very best at what we do. Before I begin, I'll remind you that today's discussion will contain some forward-looking statements. Actual results may differ materially from those statements due to any number 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. Beginning on Slide 3, I'd like to discuss -- I'd like to share our broader strategy and how technology plays a role in delivering on State Street's financial targets. Our vision is to drive growth and efficiency through technology innovation achieved in 3 ways. First, we're delivering operational efficiency and productivity by simplifying our technology landscape, modernizing our infrastructure and leveraging AI and automation. Second, technology is a key enabler for profitable business growth. We have specific initiatives underway to evolve our business model by further developing the capabilities and progress of State Street Alpha and improving the client experience through enhanced technology capabilities and services. We're investing significantly in building advanced cyber capabilities to further protect our clients and our data while developing a number of digital capabilities to enable growth. Third, we're developing a technology engineering-led and diverse organization that can efficiently drive business objectives through a focus on culture, development, diversity and flexible work. Before we dive deeper into our strategy, turning to Slide 4, I wanted to provide a sense for the scope and scale of our technology estate, which is the foundation that enables State Street to deliver on its vision to help create better outcomes for the world's investors and the people they serve. As a global technology organization supported by approximately 7,000 technology professionals, we're driving digital transformation across State Street and creating the financial infrastructure for the future for our clients. For example, over the last 12 months, we settled 128 million trades for traditional equity, fixed income and cash transactions with 97% delivered via straight-through processing. We store more than 45 petabytes of data across an environment that demands a high level of technology change and executes approximately 35,000 changes per year to our production environments and applications, representing a critical measurement for planning, developing and releasing code into production for our clients. They are just a few statistics to provide some insight into our technology breadth and depth. Now let's turn to how we're investing in technology for the future. Turning to Slide 5, we have demonstrated disciplined expense management, coupled with prioritization of investments in order to modernize our technology estate and create innovative solutions for our clients. Our IT expense for fiscal year '22 is expected to be approximately $2.4 billion, which will be relatively flat to 2021, while absorbing business growth and other headwinds through productivity, including both resource and infrastructure optimization. We spend a little over half our expense based on running the bank activity, while the remainder is spent on enhancements and strategic investments focused on 6 key areas: continuing to expand State Street Alpha capabilities and opportunities; modernizing our infrastructure, leveraging cloud to optimize reliability and resiliency for our clients; adoption of artificial intelligence technologies to increase process efficiency and accuracy; building advanced cyber capabilities to further protect our and our clients' data; critical engineering talent; and developing technology to support our clients' digital needs. We're keenly focused on reducing our run-the-bank spend, which includes application and production support and maintenance and reinvesting that savings into strategic and new capabilities. Moving over to Slide 6. We've been on a journey to simplify and modernize our technology and processes while increasing investment in automation and AI capabilities to drive greater productivity and efficiency. We have much more to do and expect to continue on this journey to drive further productivity. We expect to do this across 3 main areas: first, simplifying the technology footprint; second, modernizing our platform; and third, further automating our processes. Well, I won't go into every accomplishment on the page, let me highlight a few of them. In our relentless pursuit to drive simplification across the firm, we remain committed to the rationalization of retirement of applications. Since fiscal year 2019, 5% to 10% of our application estate has consistently been decommissioned per year, and we expect to continue to decrease at the same rate over the next 2 years. A key initiative for us is the consolidation of our data centers. Over the next 2 years, we aim to reduce the number of data centers by 25% from 46 to 34. Modernizing and standardizing our technology infrastructure is an ongoing transformation journey. We'll continue to leverage automation and a combination of private and public cloud capabilities. For example, by accelerating the migration and modernization of applications, we expect to deliver 10% to 15% in infrastructure cost savings, enabling the reallocation of resources, deliver on growth initiatives and greater innovation. And finally, AI and automation remains front and center in our transformation efforts as they are critical components for achieving efficiencies and eliminating manual work. Our future plans will drive simplification across our operations, applying AI and automation to more than 50 processes, resulting in increased process accuracy while delivering operational excellence. Turning to Slide 7. As a tech-led bank, technology is not only fundamental to the delivery of efficiency and productivity, it also promotes growth as we work to enhance the client experience, provide new features and functionality and innovate for the future. We're enhancing the client experience through dedicated production management function to elevate client service levels and provide 24/7 support while improving the rate of change success. As many of you are aware, the Alpha proposition has been a key driver of our pivot to becoming an enterprise outsourced solutions provider for our clients. To further improve our client experience, we'll look to accelerate Alpha client onboarding by leveraging automation and standardization. At the center of Alpha is our cloud-native Alpha Data Platform for managing our clients' enterprise data. Managing the quality, coherence and timeliness of data is a fundamental client need for executing their own strategy, and it remains one of their biggest challenges. The initial release of our open Alpha Data Platform went live last year and not only integrates data from our State Street solutions, but also manages the data of our clients' third-party solution providers. In addition to the innovation we are driving through our Alpha Data Platform features and functionality, we expect that digital assets will be a significant force that will impact finance in the future and are becoming integrated into the framework of financial services. As such, it is critical that we have the tools in place to provide our clients with the solutions for both their traditional investment needs and their increased digital needs. To date, we have deployed funding and administration across 23 funds that invest in cryptocurrency assets. And in the future, we'll continue to focus on commercializing digital wallets, blockchain, tokenization and smart contract capabilities. We're leveraging blockchain and tokenization technologies to further innovate and deliver solutions to tokenize financial instruments and process improvements around liquidity management, security settlement, fund distribution. Lastly, as part of our continued efforts to make all of our core platforms digital capable, we are also developing the infrastructure to support digital custody for our clients. Turning to Slide 8. Establishing a high-performing organization is key to our overall strategy, aims at investing in our most important asset, our people. Our globally diverse workforce leverages a follow-the-sun model, located in time zones to support our clients and our business 24/7. Our workforce strategy is focused on driving our 4 main pillars: driving diversity, inclusion and equity to develop an engaged working environment with a focus on technical engineering skills; creating a flexible work environment focused on a hybrid work model with modern collaboration tools; increasing our employee learning and development by establishing a continuous learning program and apprenticeship programs; continuously simplifying our internal processes and equipment and streamlining software development to promote work accessibility and a fit-for-purpose model. Creating an innovation lab and sandbox environment continues to drive ideation for us. This strategy has enabled State Street to bring in technology professionals by in-sourcing critical skills and driving a highly engaged workforce, which has helped us as we hold attrition rates down. In fact, in certain key geographies such as India, we're tracking materially below industry levels. In closing, I wanted to reiterate that we've made tremendous progress to create the foundation for a resilient, stable and secure platform while delivering on client commitments globally. There's more work to do, and we continue to deliver against an ambitious agenda to create a technology-led financial institution and deliver against our digital transformation. And with that, let me hand it back to Betsy for some Q&A.

Thanks, Brian. I guess as you move over to the chair, I just wanted to follow up on a few points that you made here. First is, how are you deciding which part of your agenda to do? What is the decision process to how you are stack ranking your tech priorities?

Well, there's a few things. So thanks for that question. But I think as we look at ranking all of our tech spends and our objectives, there's a few things. So we have to look at client needs and revenue objectives. We look at all the efficiency and productivity. We look at resiliency and regulatory obligations. But there's a few things around how we execute that I think are really important. We think about the client experience every day. So we have to make sure that we deliver on that. Simplifying the entire technology footprint is really one of the keys to positioning for the future in terms of our ability to take advantage of new technology, but also to provide sort of the fuel for how that we can continue to deliver in strategic investments. And then as we modernize, we really do it through digital adoption with our clients, and we design it all for security, resiliency and stability. I think there's a few things I tried to mention in my presentation that I think give a little bit of flavor for that. So I think as we do it on a go-forward basis, I also drive a lot of sort of continuous improvement DNA in our organization. And I'm sort of an old Six Sigma guy. And so having sort of done a bit of like Master Black Belt in Six Sigma in my past, how we are really going to drive that continuous improvement, I think, really gives us a lot in terms of how we prioritize, but like deliver on a consistent basis.

You did mention something along the lines of 10% to 15% infrastructure cost save, is that the result of your Six Sigmaness?

Well, it's a couple of things. I think, being process-oriented, it is important how we deliver for clients and how we deliver on efficiency. But today in sort of the environment, I would say, a legacy environment, there's a lot of physical steps. There's a lot of things that you have to do to be able to deliver physical infrastructure. Even when you virtualize it, there's a lot of internal touching of things. When you move to a cloud environment, actually, it's almost on demand. So really, it's an automated process that's on demand. So you go from -- we estimate 20 to 25 days, that kind of range, to build new infrastructure today, and they'll be in like minutes and hours in the future. We do that with some of the largest third-party cloud providers in the world.

So given that benefit, does everything move to the cloud?

Yes. I wouldn't say everything moves to the cloud. So we try to think about -- we have mainframe platforms. We have public and private cloud. We really focus on Alpha and moving it to cloud native. But actually, when you think about like what we process every day, it's a workload. And if you break it into what's the best fit-for-purpose place for that workload to be executed, sometimes it's on the mainframe although we still want to simplify it. And sometimes it's in a public cloud environment like what we do with Alpha. And then sometimes it has to be in a private cloud environment, and there's different requirements that we try to adhere to and we think about regulatory stability, resiliency, et cetera, as all part of like that whole ecosystem we create.

And when you're thinking about the investment spend that you're doing, what do you see as some of the biggest revenue benefits?

Well, I think in revenue, there's a few areas. I mean -- probably our largest opportunity is around Alpha and -- managing the complexity of data is probably the #1 thing for our clients. When we look at core investment servicing across the board, there's a lot of opportunities, maybe to highlight sort of in private markets, thinking of alternatives and all the growth there, we're really focused on that. And so we drive a lot of our tech spend and what we're trying to build out to try to solve those problems. We built sort of a front end so that we could have clients and portfolio managers look at sort of all of their public and private exposure on 1 screen. We have a company we acquired called Mercatus that helps us do that, but then we integrated it into the whole backbone of our core investment servicing. So I think those are some good examples. And then lastly, digital, so my goal -- although there's a lot goes on in the world to figure out, well, what's going to happen to the digital aspects of the financial system, I want to make all of our platforms digital capable so we can be there and ready when we need to for all sort of the right client functionality and all the things that are demanding of us of the financial system. So I'm really focused on that and I think we're on a really good path. And then I would just highlight cyber capabilities and resiliency are really important to our clients, both today and in the future. So we'll continue to invest in that quite a bit.

I know you made a point of highlighting digital custody. What did you mean by that?

Yes. So we think there's a lot of different aspects of sub-custody, self-custody, et cetera. So we're really trying to think about how do we create a blockchain tokenized assets and be able to trade, for example, in the blockchain so that we can look at exploring the efficiencies and really take the idea of reconciliation out of the equation and really scale as we need to. So today, I think we need to make sure that we can service our clients in today's world and in tomorrow's world. So we're looking at the digital capabilities, custodies being one, and we look at sort of the digitization of everything that we can around that whole ecosystem.

And Betsy, I'd just add, digital is still undefined in some ways, right? We're knee-deep into fund administration for digital assets. Why? Because we have a number of large clients who actually have multi-asset funds. They buy crypto within that, and they're already administration clients, right? And so we're servicing those kinds of funds. Some of them come to us with specialized funds, ETFs, et cetera, and other administrative area. The next frontier is custody of crypto. That one is more delicate and complicated, partly because of the SEC and accounting rules, which have been put out there, which we think may evolve over time and become more risk sensitive because they need to be. But that's another area where we're building capability, developing our product offering, partnering with sub-custodians, right, who can help. And then when the market is ready, we'll be -- our plans are to be ready to go.

Okay. And when you're talking about digital, you're talking beyond crypto, right? Is that fair?

I think from an immediate revenue standpoint, crypto fund administration and crypto custody, right, are new, potentially developing in large revenue pools, right? So that's 1 portion of how we think about digital. I think, as Brian said, digital though spans how we operate, it spans technical capabilities, client interfaces. There's a whole slew of capabilities that digital offers us.

And perhaps [ see out ] at some point if we get central bank digital currencies?

Yes, there could be. I mean I think you've heard -- we've heard different perspectives on central bank digital currencies, right? Some central banks are saying, look, I'd like to create one. Others are saying, look, it's not a bad idea, but I actually don't want to be an intermediating central bank. I actually want banks to intermediate with clients. And as a central bank, I want to be the -- I want to play the traditional central bank role. So I think we'll see how central bank digital currencies evolve. I think there's a fair amount of regulatory thinking and evolution there, but it will take some time. It will take some time.

So Brian, a few lightning round questions for you. Okay. first is...

I'm going to get out of the way for this.

Well, I'm just thinking through some of the comments you made in your presentation and one of them is on cloud. You were mentioning that you work with cloud providers. How important is it for you to be in cloud in each of your businesses? And how far along that journey to cloud are you?

Yes. I would say -- I think I alluded to a little bit earlier. So we think of this idea of what we're processing as workloads and a fit-for-purpose model. And I would say, in the 3- to 5-year time frame, we'll have all of our workloads and what we do in their target environments. And some, as I said, will be public cloud. I would say a lot of client-facing technology will all be cloud-based, and we have a commitment to sort of open interoperability in all of our platforms. So building that API framework is really important to us, and then making sure that we think about utilizing an ecosystem of the most strategic partners to deliver for our clients. And then lastly, the mainframe and the throughput and the scale, although we are going to minimize it, I believe it will still be present. So I think we'll get to our target model in the 3- to 5-year time frame, and we're on our journey right now for that.

And second question, how many lines of code do you have today? And what's your goal 3 years out?

Yes. We don't -- so -- I mean I don't measure all lines of code, but I can give an example. I mean our main custody platform is probably 40 million lines of code. But again, like if we think about how do we reduce that and how do we make sure that we take advantage of all of the newer technologies to provide it faster at a lower cost to serve. So when I think about what I said before, like process reengineering, we need to sort of reduce data that's redundant. We need to use it in a consistent way across the whole of the firm and for our clients and then we have to make sure that we really think through the idea that a simpler environment allows us to secure it even more, and then we build a lot of the capabilities around resiliency. So that's sort of what I think about. But we are definitely going to reduce lines of code, but that's not, I don't think anymore, the best measurement.

When will we get off faxes?

Well, some would say in the next few years and some would say never. But I -- so my job, I think, is to make sure that it's a decision for us and for our clients. So we have to make sure that we really take that into consideration. We're moving as many clients and as much factoring out of our environment as possible. But we do the idea of ingesting. So how do we take in data? Fax is one, e-mails and other, different sort of venues where we electronically move information. We bring it into a standard way that we can see it and use it and then we apply AI and machine learning to make sure that we can see all the patterns and protect it the right way. So I would say faxes, I don't think, my personal view, is not going to go away for a long time, but it's going to be a lot more minimal in the next 3 years than it has been, but we will see.

Okay. In line with your time frame of 3 to 5, very good. All right. Eric, we're going to flip over to you. First question I have is the State Street's statement about denying Crédit Suisse M&A rumor. So can you give us your sense on that situation just to clear the air here?

Sure. Maybe I'll do it in 3 parts, Betsy. First, there's no basis for the article. It was somewhere between foolish and factless, to be honest. And I was surprised by how much was written on so little facts. I will say, it was nice to see you and a few others, but you have some wisdom and not bother to write up something on so little. I will say that we -- on the second day of the story, we actually deviated from our historical practice of not commenting on market rumor. And we did that why, because in this particular case, we're in the midst of a pending acquisition, a large one. And employees and clients, in particular, were asking. Felt like we had to do something. So we decided to make an exception to our policy. I will say, and maybe this is the third point is, we have a policy of not commenting, not to be difficult, not to avoid the topic, but we have a policy of not commenting because occasionally, we do, do a deal, right? CRD was done a few years back. Brown Brothers was done recently. And if you start to comment, you'll get into a loop where you're always commenting, and it would be awkward when negotiations for an occasional deal that we're doing are sensitive to have to -- or be in a situation where you need to comment, right? That would put a negotiation to jeopardy potentially it -- and raise a series of complicated questions and situations. And so that's why we and, to be honest, why most companies have a policy of not commenting on what I'll call the, in this case, the random market rumor.

Got it. Okay. Great. Moving on to NII and the balance sheet. You're one of the most rate-sensitive banks based on the 10-Q disclosure. But I just want to understand how you think this is going to play out over the next 100 and 200 basis points of rate hikes?

Yes. You have seen our rate sensitive come down as the forward curve has moved up dramatically. The reason is that we include in our interest rate forecast the current forward curve, right? So the question is, when we do our interest rate sensitivity tables is what will happen over and above the current forecast. So that's just part of what you'd expect at this point in the cycle. I think we've put out some significant NII growth forecast for the year, which were -- which we continue to be comfortable with. You've seen that for the first couple of rate hikes, we expect around $20 million per quarter of tailwind from U.S. rate hikes. When you get to the fifth, sixth rate hike, it will be maybe $10 million per quarter as those come through. And in the later stages, it starts to trend down to $1 million or $2 million or even 0. I think what's interesting this time around for this cycle though is we've got not only the U.S. and the Anglo-Saxon central banks raising rates, but we have the European Central Bank. I think for the first time, it feels like in a generation, more than a decade, right, contemplating some serious rate rises, and that could be a tailwind for banks at the right time.

So when you say fifth or sixth rate hike, is that actual rate hike? Or is that measured in 25 basis point increments? In other words, the first rate hike was 25, the second was 50.

Yes. I think that would be around the 25 basis point increments.

Got it. Okay. Good. So the step down in rate sensitivity kicks off sometime at the end of this quarter after we get through 125, right?

After this quarter or sometime in the next quarter, to be honest, right, because we've got to see -- we've got 50, another 50. It's when you get to the -- past the third 50 that you start to get a step down.

Got it. And so when the ECB does turn positive, could you give us a sense as to how big a benefit that is for you?

Yes. Now the ECB rate hikes are a little different, right? Because first, they have to get out of negative territory, right? And it's really only when they get -- when their rates are positive 25 basis points or more that you begin to pick up a tailwind of NII. When that happens, it's worth about $10 million per hike for a quarter. They were a 25 basis point move, and we'll see, right? They've been signaling actively that they're moving forward. I don't think they want to be left behind as the U.S. tightens and they lag. We've seen Japan with some difficulties running that kind of policy, and it feels more and more like there will be some tailwind at the right point with euro rates.

Can you talk a little bit about deposit flows and what's going on there?

Yes, deposits have been relatively stable. You've seen the H.8 reports where we were in a period of deposit growth as the Fed was easing. The H.8 reports, it's a little hard to read weekly, but they're kind of relatively flattish. We've seen our deposits to be relatively flattish. There's a little bit of a change because the U.S. dollar is appreciating, right? And so we've had some movement there, but I think you got to put that aside. But you've got a movement of a couple of billion here, a couple of billion there on $250 billion. Hard to see a trend just yet, right? For the time being, we see it as relatively flattish, given the usual seasonality and client activity.

So we have a couple of weeks left in the quarter, maybe you can give us some updates on guidance or color with what you're seeing quarter-to-date?

Sure. And it's always nice to do this at your conference and share where we are because we really haven't guided since mid-April, right? So a lot has changed. So starting with the macroeconomic environment, which is, I'll say, just constantly changing, maybe an understatement. With a little more than 2 weeks left in the quarter, equity markets have been volatile with average global markets down 7% to 8% quarter-on-quarter, right? And that's instead of flattish as of my last guide in mid-April, right? So quite a bit has changed. Interest rates have continued to rise at a rapid pace this quarter, and we've seen sequential increases of about 100 basis points across 2s, 5s, 10s, and that's on an end of period basis, right? So another significant move. So just to go through the P&L, I'll start with fee revenue. Due largely to the significant downward moving markets, relative to the first quarter, we now expect total fee revenue to be down 6% to 7%, and that's instead of down 2% to 3% that we signaled at -- in our April guide. And that now includes servicing fees down 4% and management fees down 5% quarter-on-quarter, again, due to the market declines. I would remind you and as we've previously mentioned, we'd not expect to see a repeat of last quarter for on-premise renewal revenues and our front office software fee line, and we would expect that other fee revenue to be negative by about $25 million, primarily due to the absence of positive adjustments on certain minority investments that we saw last quarter. If you step back on fee revenue, because I think it's important to do that, I would note that on a year-on-year basis, adjusted for currency translation, we'd expect the total fee revenues down only 2% even with global equity markets down average -- on average almost 7%, right? So we're trying to navigate this environment, and you can kind of see some of that when you think about it on both the quarter and a year-on-year basis. To fill in the rest of the P&L, right? Regarding NII on a sequential quarter basis, we expect second quarter NII will now be up 9% to 11%, which is better than our previous range of up 7% to 9%, primarily driven by stronger loan balances and the use of HTM to manage OCI risk instead of swap positions. On expenses, we expect expenses ex-notables and ex-seasonal compensation expenses will be up around 1% quarter-on-quarter, which is better than our previous guide of up 2% to 3%. And this is in part due to our efforts calibrating incentive compensation, other spend, right, in this revenue environment, while we're continuing to need to offset higher and higher wage inflation costs and annual merit increases we're seeing this quarter. On margin, we expect to achieve a healthy pretax margin in the second quarter. I think the modeling that folks are doing would bear that out. And then finally, on taxes, not to be remiss, we expect second quarter taxes to be in the 19% to 20% range. So this may be improved due to some tax planning that is in process, and it always depends on timing.

What about the AOCI hit in 2Q? What do you think that's going to be?

Yes, rates have continued to move upward, as I said in the last 2 weeks and quarter-to-date, about 100 basis points. At this point, the AOCI mark is around $400 million. And I'd say that's dramatically lower than it would have been, given where we were last quarter. Last quarter, you remember, it was $1.3 billion on almost a similar move in rates. And why is that? It's because we've reduced our AOCI risk by about 2/3 through a series of changes in the portfolio, primarily with a significant move of investment portfolio bonds into HTM during the course of April.

Okay. So that was done earlier in the quarter?

Yes.

You also, at one point, talked about RWA having some flexibility because of high trading activity in 1Q. Trading activity is still pretty high in 2Q? Do you need that RWA there still?

No, we don't need to deploy the extra RWA that we put in to work in the first quarter. We did that largely because January and first part of February started off particularly strong. We had some forward in derivative positions that we found attractive to put on in support of our clients, but the team there is doing quite a nice job, kind of living within a more normalized RWA limit. And so we're on a good path to slim down on RWAs this quarter. Obviously, it's across trading, lending, overdrafts, there's a series of different drivers. But we're on a good path to slim that down a bit as a way to manage capital ratios on an ongoing basis.

And anything you can help us understand with regard to the dollar and how that's impacting you? I know you mentioned the currency translation adjustment benefit. Well, using that, your revenues aren't down as much. But help us understand what we're going to see with regard to that?

Yes, we'll see dollar appreciation quarter-to-quarter is larger than usual. I'm trying to think it's worth more or less about a percentage point, but it will depend by line. So revenue is lighter, expense is lighter and then it does have an effect on RWA, a good bit of which is hedged down. But like many banks, we operate a little bit of impact on capital ratios as well. We'll describe earnings both with and without the currency translation effects to be real clear.

All right, super. Well, thank you very much, Brian and Eric. I appreciate you joining us this morning.

Thank you.

Thank you.