State Street Corporation (STT) Earnings Call Transcript & Summary

Good morning. It's still morning. Yes. For those of you joining us via webcast, I'm Susan Katzke. I cover the large-cap banks at Credit Suisse. Next up for the banks is State Street as we switch gears into the land of the trust banks. I'm pleased to be joined by State Street Vice Chairman and CFO, Eric Aboaf. Ilene is here with us from Investor Relations as well. We've had a productive morning thus far. We've got a lot of ground to cover, new ground in this session. We're going to do this as a fireside chat. Don't hesitate to raise your hand if you have questions along the way. And I will do my best to work those in. You have a question?

I have a disclaimer.

Please.

Courtesy of our legal team. Just to remind everyone before we get started, today's discussion may contain forward-looking statements, and you know that actual results may differ materially from those statements due to any number of important factors, including the risk factors in our 10-K and our SEC filings. Our forward-looking statements speak only as of today. We may not update them even if our views change. And with that, over to you, Susan.

You did that very well. So let's get started. I think we're going to start at the same place. I've started with everybody this morning, and that's on the macro. Just given how dynamic the environment has been, I think it's helpful to start by level setting against your view of the macro, rates and the markets kind of the month post earnings. And if you want to start with your view of whether we're going to see macro slowing or the path of interest rates, you pick your spot.

It's really tough to call. And I think what I'd share with you is we're prepared for a range of scenarios. As you know, in January, we gave an outlook because we felt like some point estimate would be helpful. So we assumed point-to-point equity markets would be up 10%. It's still down on average year-on-year. We seem to be moving in that direction. Rates were going to float up with another couple of rate hikes. There's a lot of anxiety or optimism depending on what side of the trade you're on right now around whether the Fed is going to hike a little more. Whether they're going to hike and pause, whether they're going to hike, pause and cut. And I think we'll see maybe that's trending up a little bit. Some of the international central banks a little less aggressive maybe. It's -- I think it's too early to change our views that in general equity markets will typically drift up, rates will move up. And I think the real question is just how far, how fast and what happens next.

Okay. Well, on the markets, I have to tell you that the guidance being predicated on 10% up markets. I thought that was a little bit aggressive. And now, as I told you, I think we're going to put you to work as an investor as you've been quite correct on that. So I assume you feel pretty okay with that expectation at this point, given where we are now in mid-February.

I feel better than I did when I said it.

Okay. Okay. We'll just -- we'll leave it at that.

And I do have a full-time job as a CFO not as an investor, and I think I'm going to stick to it.

I think so. Okay. So let's go to the balance sheet and we'll let you do your CFO job. So we're going to talk about NII resilience, and we're going to get to your guidance. But let's just start with the fact that the trust banks were early to experience beta and mix shifting in the deposit base. And I think that's quite natural given your customer base, so we're going to start there and dig around deposit flows, beta, the NII guide. If look at HA data in total, you see industry-wide deposits in decline, but your business is global. So I know we don't want to focus on the HA data alone. Why don't you tell us what you're seeing in the last few weeks in terms of the flows and the mix shifting.

The last few weeks, the first , which is really the first 6 weeks of the quarter have been in line with our expectations. So I think to just rewind the tape a little bit. Clearly, during the -- I'll call it, the COVID experience with the Fed intervention, we saw a ballooning of deposits in the banking system that followed rate cuts and quantitative easing and so forth. Through the third quarter of last year, we saw that balloon kind of taper back down. We've been running deposits in the $210 billion, $215 billion range. We saw that relative stability into the fourth quarter. And then we said this year, we'd expect roughly the same. Part of that is just you've got client behavior under the surface playing out, right? Noninterest-bearing deposits tend to float down this time of the rate cycle. Interest-bearing deposit balances tend to float the other way. And I think in aggregate between just our -- the macroeconomic and monetary policy situation, which is quantitative tightening on one hand on the Fed's balance sheet, seemingly offset by some of the reduction in the Fed reverse repo operations, right? There's a bit of an offsetting effect. Continued quantitative, I don't know whether to call it openness, continuation in international markets. We're seeing a decent amount of deposits out there. I don't think we're seeing the deposit growth that we normally see. But instead, it's -- we expect it to be relatively flattish. And part of that is that as we engage with our clients, we don't only engage with them about what they might have in their particular deposit account. As I said at earnings last month, we've got about $1 trillion of client cash that we help them with, right? Some of that's in deposits, some of that's in money market sweep some of that's in repo, right? Some of that is in our asset management cash business. And so in fact, we're helping clients and we're engaging with them about where is the best place to put their cash. They typically want to rate in different areas. And that gives us a way to engage with them, find the right servicing, the right price points and so forth. And that's made for a healthy and relatively stable deposit base at this point of cycle.

So and you've touched on some of this now. But when you think about how your customers' behaviors have changed and how your business mix has changed to drive a different pacing around the mix and the flows and the beta relative to the -- maybe not even the last but 2 cycles back in terms of rate cycles. What's changed?

I think the external environment has changed quite a bit, right? We know that, right? Last time over -- what, 3-year cycle, rates moved up, what, 2, 2.5 points now, it's over -- in 1/3 of that time, they moved twice as much, right? So it's -- that's quite different. And last time, we had no movement in rates in the international geographies of node. And now we've actually seen sustained growth. So I think the market is different and clients are reacting to that and saying, "hey, how do I manage my cash". And literally, that's the conversation we're having with them. And what we've done over time is actually we've built a client coverage and client executive team that actually can engage with clients on that topic. And that's actually helped bring us closer to our clients and give them more avenues. Right now, we're continuing to see that rotation, noninterest-bearing into interest-bearing. We're continuing to see some amount of, "hey, if I leave more deposits with you, will you pay me a little more on that amount." And we don't mind separating, right, laddering deposit, so to speak. We've seen betas higher in this cycle than we did last time, but that's because we're further through the cycle in some ways. So in the U.S., for example, we've said that excluding some specific initiatives, our client -- interest-bearing deposit betas in the 65% to 70% range, which is kind of what you'd expect at this point. Internationally, it's interesting. There, it ranges between 20% and 50% betas probably because we're earlier in the cycle, probably because those markets tend to have, I think, a little more just stability in how prices evolve and balances evolve. And so in some ways, as a global bank, we've seen the big part of the tailwind from the U.S. rate rises, we're still seeing some of the tailwind from the international rate rises. And we try to operate -- we operate in all those geographies that matter where you're seeing those rates, whether it's pound sterling, Canadian dollars, Aussie dollars, euros, of course. And that, in a way, is a way to monetize our balance sheet as rates continue to float down.

Okay. And before we get to guidance, let's just touch on loan portfolio and securities portfolio growth and what your appetite is at present?

Yes. The way I describe is our portfolio, our investment portfolio to start there is typically geared in size to the deposit base, right? Deposits go up, we leave more at the Fed or the central banks and we invest more in the investment portfolio and vice versa. So you've seen that float up and float back down. I think we're relatively comfortable with the kind of general ZIP code that we're at. Over time, we get a tailwind from long rates, right? Even though we have an inverted curve, we got a tailwind from long rates because we're tractoring through as the old investments mature, we're reinvesting at a higher rate, so that's constructive. I think what we're going to continue to do is just monitor what we think is going to happen with the belly of the curve in the long end and see, is there a time that we'd want to put a little more duration on. It doesn't feel quite yet, but we're keeping an eye on it. If inflation expectations rise and we see some steepening, could be an interesting point. But for now, we're kind of in the right zone in terms of size of the investment portfolio, average duration of 2.5 years or so. Loans, I think, is actually a different category for us. That's where we're supporting our clients, private equity, capital call financing, fund financing, lines of credit we do some real estate lending for our clients. We do some CLOs for our clients. Those are appealing. And to be honest, it's a very high-quality book. It's kind of very integrated with our business. And as we look out, that's an area where we want to grow. We want to grow the loan book, high single digits, maybe a little more or a little less depending on opportunities. But that's a way to continue to take advantage of our balance sheet and add to NII into earnings.

Okay. So let's go to the guidance. I know it's only halfway through the quarter but I have to ask on NII, if there's any change in your thinking, your existing guidance, just so we're reminded is that you were looking for NII to be flattish fourth quarter to first and then kind of decline 1% to 2% quarter-to-quarter in the second to fourth quarters.

Nothing really changed at this point. It's just -- it's early. We booked one month that was in line with our expectations. We're a couple of weeks in. And I think we'll just take it as it comes. But for now, it's within the boundaries of what we have expected as we've looked at the figures, and we'll just continue to update as we go.

Okay. So let's then shift to, I think, a more fun, interesting topic and talk about new business. You had solid new business generation again in 2022 coming in over the $1.5 trillion target pace. How do you see 2023 shaping up? And really, is there any change in terms of what your customers are looking for or competitive dynamics or where you expect the new business to come from.

I think I've described the business environment as continuing to be attractive for us we continue to see the business momentum that you just highlighted. Last year, we had $1.9 trillion of assets under custody wins in the core servicing business. The year before that, it was north of $3.5 trillion. And so now we're really focused on 2 things. One is about almost $3.5 trillion of that is in the backlog, right? It's kind of won and contracted but not yet installed. So there's a big focus on working with those clients to onboard that, onboarded in stages across their product lines, their geographies and then continue to be active with our clients. And I tell you the pipeline is strong. Clients are certainly managing their franchises, but they're looking for places to grow on one hand, the risk managing on the other. And finally, they continue to think about their economics. When they think about their economics, that's a natural time for them to talk to us about our alpha proposition of front to back of potentially consolidating business with us. Or, in some cases, new clients coming our way and say, Hey, you guys at State Street have something a little bit different. Let's talk. And so I tell you the business environment is positive. And we feel the momentum will continue at pace.

Okay. So let's dig in on Alpha a little bit. So 12 existing, 2 new ones in the fourth quarter. How do you think about your capacity to continue to take on new big Alpha mandates at this point? And how are the installations going? What are you learning? How scalable is it?

I think the capacity is flexible, right? So as we win business, we have an ability to scale up implementation teams internal resources, external resources. And in fact, what's in some ways, unique about the Alpha proposition is the clients also need to scale up, too, right? Because they're adjusting their processes, they're adjusting, in many cases readjusting and changing their internal systems, right, and taking ours on and so forth. So there's a fair amount of collaboration that has to work. I think we've learned a couple of things as we have -- down this path with the Alpha front-to-back proposition now for the last few years. I think one is that it's a collaborative effort, and we need to get clients very much into the project management role resourcing role and so forth because they make as many changes we make. And so that -- that's the first learning. I think secondly is it takes time. And I think when we first sold the Alpha front-to-back proposition we had custody on the brain. Custody can get implemented in 3 months, 4 months, it's fast. Some of these Alpha propositions because it's so transformative for our clients is 24 months, 36 months. So it takes time. I think as we've now done and announced about 20 of these, implemented a dozen, as you've described. We've also realized that standardization really matters, right? And part of this is, I think we've refined the proposition over time. We've standardized more of it. We'll continue to standardize even more of it. And that makes it both easier to implement on one hand, which is kind of the existing pool. It helps us go to the next stage of clients and describe what we're going to do in a way, as I've just described, where we've learned and made it even better. And finally, it lets us have confidence in the investments that we're making because the more we can scale those investments over more clients, the stronger it will be. And so as an example, the heritage for Charles River, which is the tip of the spear on Alpha front to back is that it came from an equity environment. It moved into fixed income, right? And Aladdin was the opposite. It came from a fixed income investment moved to equities. We're now at the point where the releases in Charles River this year that we've invested in, we think will make it as strong or stronger in some cases, on the fixed income side. And that's the kind of investment we can scale across the platform, the more clients we bring in, the more we'll benefit from that. The more we'll be able to invest in the next round of feature functionality. And that's a way we're -- how we're looking at it as a way to use Alpha as a growth engine for the company.

So I gather that the standardization helps from an economic standpoint, do you but also part of Alpha was that over time, these clients will actually do more and more with you. And so the goal was to be, I assume, in line with your target 30% pretax margin, if not net accretive to it. And I think when we sat here last year, you spoke to the Alpha clients within 2 years being accretive to that target. Any update around the time line or how those relationships are progressing and seasoning?

No, that's right. We still expect the same amount of accretion and contribution to margin. I think what we've learned and refined over time is our view that in custody, core custody in the back office, we have very high margins, especially on an incremental basis because it's such a fixed cost structure. In middle office, we tend to have lower margins. Why? Because it's very manually intensive, right? And you go back to how do we standardize really matters there. And then in the front office Charles River space, it's quite accretive to margin. And so what we're refining over time is, hey, we need the right combination of the front, middle and back with clients because we don't want just the lower margin pieces right? And clients, to be honest, are economically rational. They don't want to just give us the highest margin pieces too. And so there's a good collaboration now, but it's actually sharpened our go-to-market strategy, sharpened the kind of instructions that we give our client coverage and sales force and helped us make even better decisions. But we're comfortable. I mean, part of what you've seen is you've seen us as a company raise margin by about a percentage point in each of the last 3 years, right? 3 years in a row of margin appreciation or expansion by about 1 point per year, ROE is up by about 1 point per year over the last 3 years. And part of that is I think we've gotten the right configuration of the Alpha proposition on one hand. And then we've obviously been highly engaged on some of our productivity and standardization efforts on the other.

Okay. We're going to get to that in a minute. But before we go there, any new or different opportunities in 2023 kind of even alpha aside.

I think the way I'd describe the growth opportunities ahead of us, which were -- which are quite appealing is that there's a range, right? I think on one hand, there is private markets, right, growing at low to mid double-digit teens, right? So a very attractive area, growth areas where there's a lot of value we bring our clients as a kind of a real growth engine. That's one. Secondly, there's the Alpha proposition, which I think is particularly strong with asset managers with some of the large asset owners who act as asset managers because of how they're configured and organized and that's been very positive. And then finally, I think the global and international dimension is particularly strong for us from a growth standpoint. Asia has always been an area that's particularly strong in growth. We had a great year in 2022 in Asia, the Middle East and the sovereign wealth funds, particularly strong brand for State Street in that part of the world. Latin America, right, new offices in Chile, we just celebrated our fourth year anniversary of having a bank in Brazil. Right, where we can now build a broader and broader set of propositions. So I think it's really private markets. It's Alpha in it's kind of really intensely strong areas around asset managers, asset owners and then the international is really the 3 areas that I spend my time on. And with that, we think over time, that gets us to that fee revenue growth target that we have about 4% to 5% per year.