State Street Corporation (STT) Earnings Call Transcript & Summary

Okay. Good morning, everyone. Thanks for joining. My name is Rob Wildhack. I'm from Autonomous. I'll be leading our discussion today. I'm delighted that we have Ron O'Hanley and Eric Aboaf from State Street joining us. Ron has been the CEO since 2019. And prior to that, he was President and CEO of State Street Global Advisors. Eric has been State Street's CFO since 2016. And Eric, you added the title of Vice Chairman to your portfolio a little more than a year ago. Just a quick note for the audience, we'll be using Pigonal for Q&A again this year. You can submit your questions there. You can vote on questions that have already been submitted and then we can get the questions directed to Ron and Eric as appropriate. But with that, we can get started. And Ron, we're clearly in a very volatile and dynamic market environment today. State Street and you guys have a front row seat to all of that. What are your clients most focused on today? And how is State Street responding to that need and demand?

Rob, first of all, thanks for having us here. This is always a conference that we look forward to. I think that you've characterized the environment correctly. In fact, maybe with a little bit of understatement. There's a lot of uncertainty out there amongst our clients, both in terms of where is growth going to come from extraordinary pressure on the expense line from. Amongst all our clients, every one of you in this room is experiencing that. So our clients, I think, would be focused on a few things. And let me focus first on our servicing clients. There, it's around where is growth going to come from and how are they thinking about their portfolios. And so what are they doing about that? Certainly, you find traditional asset managers that were in the traditional institutional space, maybe some mutual funds, lots of work in ETFs. And there's some real major ETF conversions that occurred or very traditional long-only managers that are going into active ETFs. Second area is in privates [indiscernible] . There's still enormous growth in private, notwithstanding the pressure on the private equity market. Some of that is coming from infrastructure. Private credit continues to grow unabated. And with everything that's going on in the banking industry, we should expect to continue that. So growth would be the first. Second would be around their expenses. I mean everything has become more expensive, whether it's distribution, it's the cost of delivering Alpha, the technology and operational base. So it's how do we -- how do they manage those costs. And at the same time, how do they either future proof it or limit the amount of time that they're spending on it. It's always been striking to me the number of our clients. And if we gave you the names of them, you'd say, well, those guys have nothing to worry about from an expense base. But even they're asking the question, is this a good use of our time and resources? And should we be spending our time doing this? Or do we work with a partner on that? So that's what I would say that it is it's growth, it's expenses and then how do we think about future proofing technology and operations. On the investment side, it's really around fundamental questions on, does asset allocation work as we thought it would? So we do a fair amount of work in hard core asset allocation and its State Street Global Advisors. So really thinking about what is a different way to think about the positioning of our portfolios, particularly among institutional clients would be one area. And then second, how do we think about fixed income after 10-plus years of no rate and 40 years of declining rates, how do we think about fixed income going forward? So lots to think about. And I think a good market and a good opportunity for high-quality asset servicers and high-quality asset managers.

I'm sure we'll talk plenty more about interest rates and market levels, too. But if I were to give you a blank canvas, what is the best macro environment for State Street and why?

Yes. So I'll start that, and Eric will have an opinion on this. I think that we are inextricably tied to financial markets, and financial markets in some ways are tied to economic markets. They're not always dollar-for-dollar percentage tied. But probably the most important thing is, if you think about equity investors, it's not so much that will we need a rising economy. It's we need certainty, right? It's times of uncertainty is when you've got there's lack of direction, investors aren't ready to make big significant new bets. So I think having clarity on direction, whether that's clarity on interest rates, clarity on where market moves are likely to take place, clarity on where the economy is going, would be one. Secondly, we are a bank, right? So having a normal shaped yield curve would be nice to have. I mean we're less reliant on that than others because many of our deposits are extremely short term. But again, having a normal shaped yield curve would be useful. And then last but not least, and this is maybe counter to the other two things I just said, we make some money off of volatility, right? And so in our markets business having a little bit of volatility, not an excessive amount, is always good. And I think those same characteristics probably would carry over into the asset management world. So I think that's probably it. Would you add, Eric?

I just round that out with it. If you kind of say what will drive kind of revenue growth naturally, right, because we are exposed to these cycles, right? And you guys all look through those cycles and work through and determine what's core growth? How much are you driving? Equity market and bottom market appreciation would be tailwinds, right? We'll see what happens if we get through this debt ceiling cycle. And we've got some amount of lift. Last year, we saw both of those come down for the first time in 30, 40 years. Interest rates, as Ron said, tend to be a benefit for us. We've got a global balance sheet, right? So continued rate rises in noninterest -- I'm sorry, in non-U.S. markets, euro, sterling, et cetera, those are valuable to us. In the U.S., we'd like some stability, right? The Fed pauses, maybe even cuts, but at least pauses, that gets us to a good place. I think there's also a sense for Fed intervention matters in our business, when they drive towards quantitative easing, right, deposits tend to flow in, quantitative tightening, you get some reversal Fed RRP as an intervention in the marketplace. I think kind of a neutral Fed is actually constructive for us because we and our clients can operate there. And then we don't mind some of volatility in the markets, right? We have a very large capital markets business, which is deeply embedded in our custom accounting clients. And there, we can monetize those flows. So there's times in the cycle when we get those -- many of those to line up, and we just navigate through different combinations.

Certainly, certainly. And irrespective of markets, you've talked a lot about an abundance of new business wins, I think, almost $4 trillion in AUC/A to be installed currently. Where are those wins coming from? And how sustainable would you say that trajectory is?

So those wins, in many cases, are driven by some of the factors that I just mentioned, and we had anticipated that several years ago as we were spending time with our clients, and the core of our client base tends to be the most sophisticated asset managers or asset owners that act like asset managers, where they're actually not just allocating assets but they may be actually managing some money on their own. And what were they focused on? They're focused on just the -- their costs, how do they deploy and employ and manage data in an effective way. So much of this is coming from our so-called Alpha offering -- our Alpha front-to-back offering. And if you think about what that is, I mean, we've -- we are transforming the firm from the investment services part of the firm from being a back-office services and product provider to really an enterprise outsourcer. So an awful lot of the growth has come from that. And this growth has come in parallel to while we are still developing the product. So it's been an interesting set of years -- the past couple of years is because many of these early clients have, in effect, been co-development partners with us in terms of advancing the capabilities that we have working with us really is software development partners. We're developing the software, they're the user. We're able to use it live with them in terms of modifying that. And we think there's much more left to go there. I mean as much as we've sold there just looking at our installed client base, I mean, we're only partially penetrated in our installed client base in terms of the full Alpha front to back. And again, it's -- we've made some recent additions to the product line. So we've launched an Alpha for private markets. And if you think about a market that truly needs to be changed and transformed, I mean, much of it is in-sourced today. There's an incredible lack of standards. I mean we've all experienced it, right, as LP investors. I mean we might as well be on different planets every time we're signing the paperwork and doing things like that and think about the experience for a large pension fund or a large sovereign wealth provider. So it's -- where the growth is coming from is how do you actually inject technology kind of standardization, hard core operational processes into the needs of our clients is where it's coming from.

And how would you say the competitive environment -- or let me rephrase that. What's the competitive intensity like today? And how does it vary across products and geographies?

Yes. So let me start on that. And then Eric will add to it. So with the Alpha offering, on the one hand, we can say, and it's true, we are the only ones that have the true front-to-back capabilities. Nobody's got that, but we've got some formidable competitors that are trying to figure out ways for partnerships and others to do it. So we don't rest easy or -- and we do look over our shoulder and watch what they're doing. But the ability to have everything and therefore, to be able to provide a true data solution to our clients really is a competitive advantage. If you go away from that outsourcing environment, there are markets that are where we're very strong in, but we think we can be stronger. I mean Europe is still a very attractive marketplace, right? It's still behind the U.S. in terms of an investing market as opposed to a savings market that has changed over time. Their 10, 12 years of 0 interest rates or negative interest rates really did cause many people to become investors. So there's a lot to do there, the rise of PE in all these places. Geographically, continuing around the world. APAC is a place where we've got a lot of presence, and we're now starting to deepen that presence. We've added some -- we've moved some capabilities there, added some people there. I think a place where we'd like to do more and we don't have as much there as we'd like to, would be in Latin America. And there's some interesting things going on in Latin America now. So from a product perspective, if you think about the extreme where we're at in terms of this Alpha front-to-back enterprise outsourcing offering, if you go to the other extreme kind of custody only, that's an interesting business. It's an interesting business, particularly when you get deposits with it, right? 5 years ago, maybe providers weren't as interested in it. But our custody-only offering is something we're putting a lot of money and effort into because it's a nice complement to everything that we do. Eric?

I'd just add, in a way, Ron covered front to back, our unique offering, kind of a regional cut, including some of the segments that we go after. And then I think the one other product/segment is really private. It's a growing market, as you all know, it's fragmented. It's still relatively in-sourced. And so we've demonstrated 10%, 15% type growth there in the last couple of years and one where I think there's not a defined success yet, right? It's manual, it's fragmented and bespoke. And as a result, we've got an opportunity over time to actually define that market, define the product standards and leverage that into a real scale offering. So that's an area of focus for us and continued investment.

Last year, Rob, that we should, of course, mention is the whole capital markets area. Foreign exchange, in particular, I mean, we're the leader in that business. And that's still a growth area. When we look at our share of our clients' wallet, what are we doing versus what are others doing? And there's still opportunities to grow there. So we continue to increase the number of platforms we have in terms of electronic platforms, ways to make it easy for our clients to trade with us. So -- and again, you look at the margins, that business is quite high. It's obviously -- it's -- we have to manage capital in that area carefully. But it's a very nice complement to what we do, and it's easier for our clients if we do it for them as opposed to going to a third-party provider.

Certainly. So stick with core custody for just a second. From 2019 to 2022, quarterly average AUC/A, I think, is 15% higher. But investment servicing fees over that same period are only up about 5%. Why is there such a divergence there? Do you think you can narrow the gap? And what will it take to improve the difference between those two?

Yes. So the -- let's start with why there's a divergence and then what are we doing about it. I mean, the divergence is pretty understandable. If you look at where the growth has been over that time period and even a little bit longer, very, very oriented towards ETFs as opposed to the traditional kind of packaged products, and ETFs just don't have the same kind of fees associated with them. We're the leader in the ETFs because we are the leader and we have scale. It's a very profitable area for us. And now you're seeing yet another generation of new ETF products out there. Fixed income in all geographies, but particularly Europe. And then active ETFs, I talked about earlier. I mean this is a -- there's been a lot of talk about active ETFs. I mean, in the 30 years, which ETFs been around, probably people were talking about active ETFs for 29 of them, but it finally seems to have happened in terms of real important substantial players that are saying we're going to offer an ETF alongside our packaged products. So that would be the -- it's the mix shift change, I think, that's causing that rough. So what are we doing about it? We've invested heavily in our private's capabilities. And clients are very interested in taking some of this burden off them. And that's a fundamentally different economic proposition. You're talking about fees that are multiples higher than anywhere else. So that would be the major area in which we're trying to where we're trying to offset that trend.

And you noted that ETFs are maybe lower revenue or lower fee, but higher margin. Is the margin difference enough to offset the revenue difference? In other words, like net profitability is about the same?

Yes. I mean if you look at -- I mean just look at our results over that same time period that you just talked about, I mean we've had positive operating leverage. We've had expanding margin over that time at expanding ROE. So that would indicate that, yes, it is. But still, we focus a lot on that revenue line. Revenue line is not where we wanted the revenue growth line. And so looking for areas like we've just described, we think will help us get there and help get growth.

In the last year -- sorry, Eric, do you have anything to add there? Okay. In the last year, you've spoken in a fair amount of detail about actually increasing price in certain areas of the business. It seems like you've been successful to date. Is that correct? And if so, why is -- why are clients in those particular areas so in elastic?

Yes. So I'll start on this. And we've been very careful about that because, like I just said, there are certain areas where we get a lot of scale. And yes, we've all been affected by inflation and rising prices, but we also -- we want to maintain that scale. So that's not been an area we're focused on. On the other hand, there's other areas like, again, alternative servicing or even within a long-only area. Remember, just because it's a long-only institution, what they have underneath in terms of instruments may be different than somebody else. I mean if it's all listed equities, that's one thing. If it's all a bunch of derivatives that are in there, that are really hard to process. So we've been very rifle shot on the price increase in terms of lots in the alternatives area, lots in those hard-to-process areas. And I think the inelasticity comes from that it's not like anybody else these costs haven't gone up, right? So -- sure, you could switch. I would expect that anybody else is suffering -- any other provider is suffering from the same thing and probably having to do the same thing, I can't speak for them. So -- and I think there's also a recognition on the part of clients that this -- the kinds of things that I've just described. They're hard to do. It's vitally important they get them done right. If they're not done right, whether it's just being able to invest the next day or being able to report out to their clients in terms of whether it's the actual reporting or whether it's performance measurement, et cetera, we've got to get it right. So we're willing to pay more for it.

And then I'd just add that clients want a partnership. They want a long-term partnership. They want strong service levels. They're looking for our ability and commitment to reinvest right and scale some of those investments in our businesses. And so when they and we operate in manual intensive areas, they get the notion of wage increases and wage inflation and turnover. And we're aligned with our clients in those cases. Turnover is not good for us, not good for them. And so I think this has been a partnership set of conversations that we've had in some of those discrete areas that Ron mentioned that have made a difference. And in our mind, it's a way for us not to price too actively. We just want to do enough to preserve our margins and solidify the business, make sure we can continue to reinvest and bring clients the value that they're looking for and put both of us as partners and keep us both in the right place.

Let's jump over to your front-to-back offering. And like you noted, Ron like, obviously, a real differentiator versus peers. You've mentioned that 30% of the top 65 clients, that group making up a large portion of your overall revenue, have the full front-to-back offering. Where do you think that penetration can go to? And what's sort of the rate limiting factor on increasing it?

Well, in terms of what it can go to, we think it could go up, right? And the pipeline is very strong. I mean I have to say, remember, over the same period of time, we've been in full-scale development. So we -- as ambitious as we were when we launched this in '18 and '19, we actually have been surprised at how successful and how much penetration we got, particularly from some of the largest, most sophisticated clients. Well, by the way, they weren't all existing clients. I mean some of them are new to us. So it proved the proposition that we could actually gain share in the marketplace overall with this offering. There's been this what I would describe this period of, you could call it digestion. I call it that there's just a lot of software that needed to be developed. This is a big year for software releases, which will -- you'll start to see it then as we report quarterly. You'll start to see that in the installations what that number looks like in terms of where we are there. So -- and it's not that we're not selling, but we got a very healthy pipeline, and we're happy with the pipeline. We want to get through this year, and then we'll grow it even more.

And you've highlighted investing in Alpha, especially in private markets today and in the past several quarterly calls. It sounds like you've had nice share gains and wins there as well. I'd imagine that's a fairly bespoke marketing solution. So where do those market share gains come from? And what's the legacy product or functionality that you're replacing and improving?

Yes, that's a really good question because unlike the public markets, an awful lot of this is still in-sourced, right, where firms have -- it started out, they had 1 or 2 or a dozen LP investors and it was done on spreadsheets. And that process that was established many years ago, it may be a lot larger, but you can find the revenues of it 10, 15, 20 years later. So a lot of it is you'd be surprised at how much of it occurs in very expensive real estate here in New York. So a lot of it is taking something that's in-sourced, very tightly bound into the operations of the firm and pulling it out. So -- and I think the other thing that it's going to entail is really the -- I want to say imposition, but it's -- maybe it's the agreement to standards. And I think here, the LPs need to drive. We need to co-op them, and we're working with them in terms of trying to come up with standards that they all can live with so that the industry itself can adopt some standards in terms of basically even how an LP agreement looks and things like that.

Okay. Late last year, you ended up terminating the proposed BBH acquisition for myriad reasons. And rather than have you repeat them here, I'm kind of more interested to know what learnings you took away from that BBH process and how that experience will frame your approach to M&A going forward?

Well, let me focus on the latter part of that question first and come to the former. I mean we have been always very clear about the role of M&A. One, it's not a strategy in and of itself. M&A is to support our strategy. So we have a very clear direction in which we're trying to go. And if something -- if an acquisition can help us get there quicker and provide appropriate returns to our shareholders, then we'll consider it. So that ends up having a very high bar. I think if there's a lesson learned out of this, it's that the bar is even higher. I mean it's -- the regulatory uncertainty associated with M&A is just extraordinary. And it's not that we didn't spend a lot of time with regulators beforehand. The challenge is, I don't remember what the number was, but it was a significant double-digit number of regulators that had to approve this. And the problem is it only takes one, right? And it's nobody ever disapproved it. But at some point, when you started to look at the timing, and what was happening in terms of decay everywhere, right, decay in terms of clients were frustrated on both sides of the house. Staff was uncertain. Shareholders were uncertain. And without some kind of sense that it was going to get better, our view was that the best thing to do would be terminate it and move along. But Eric.