State Street Corporation (STT) Earnings Call Transcript & Summary

Thank you, everybody, for joining us. We'll get started with our next session. I'd like to welcome Eric Aboaf, State Street's Vice Chairman and CFO. State Street is one of the largest global asset servicing and asset management firms with over $40 trillion in assets under custody administration and $3.7 trillion of assets under management. While 2023 has clearly been a turbulent year for the markets broadly in capital markets, in particular, State Street is starting to see a meaningful in service and sales and some signs of stabilization in net interest income, all while controlling expenses well and returning substantial amount of capital to shareholders via share repurchases. Eric will make a few prepared comments, and then we'll jump into Q&A. So great to see you. Thank you for being here. Podium is yours.

Thanks, Alex, and good morning, everyone. Just to reminder our audience that today's discussion may contain some forward-looking statements, and the actual results may differ materially from those statements due to a variety of important factors, including the risk factors in the Form 10-K and our other SEC filings or forward-looking statements speak only as of today, and we may not update them even if our views change. So with that, this morning, I'd like to make some brief opening remarks on some of our key areas of focus, after which, I'll hand it back to Alex for Q&A. As we approach the end of a turbulent year and turn our thoughts to the coming year, we're intensely focused at State Street on executing our growth strategy, achieving a number of meaningful fee revenue and productivity goals which will position our business for long-term success and finally driving positive fee operating leverage in 2024. Back in September, we outlined four areas of our Investment Services strategy that we expect will enhance our ability to drive organic fee revenue growth. Those actions include driving market share gains across key regions and products, increasing our back-office custody wins and alpha wins and accelerating our onboarding backlog to drive faster growth and creating further scale in our private markets businesses. To make these areas and efforts measurable, we've introduced servicing fee sales targets of $300 million this year and a $350 million to $400 million in 2024, which provides an external benchmark that all of you as our investors can track and give us line of sight to 2% to 3% organic fee -- servicing fee revenue growth upon full installation. With that frame of reference, we're pleased with the $91 million of servicing fee revenue wins that we achieved in the third quarter and are working towards our goal of increasing sales this year. We also expect to see private markets year-on-year fee revenue growth of 15% in 2024, faster alpha onboardings and an increased focus on traditional back office wins in the third quarter. In fact, 90% of our wins were in the back office products, which demonstrates tangible progress on our back-office strategy. Now let me turn to our multiyear transformation journey to drive increased productivity, which helps us both to improve our business processes and to drive margin performance and is where I'd like to spend the bulk of my time today. Our productivity actions will play a key role in our plan to achieve positive fee operating leverage in 2024 and provide long-term efficiency for State Street and benefits for our clients. We continue to make progress across the three key productivity pillars that we outlined last September. Simplifying our operating model, reengineering and automating our processes and optimizing resources in order to create efficiencies. Let me provide a few examples of some of the work currently underway as we pivot to the next phase of productivity, particularly in our operations area, which we call Global delivery. On simplifying our operations, we expect to achieve sustained productivity changes in two ways, which will enable us to further enhance our client service model. First, consolidating and integrating joint venture operations and second, increasing spans of control and consolidating subscale operations. Regarding the first action, as we announced in the third quarter, as part of our ongoing transformation and productivity initiatives, we're streamlining our operations in India and have now assumed full ownership of our India operations joint venture with the Atos Group. We also just announced earlier this week that we intend a similar undertaking with our joint venture with HCL. As you would expect, consolidating these joint ventures will increase our headcount. However, these costs are already in our expense base today reported under our comp and benefits expense line items. Importantly, these consolidations will enable us to unlock productivity in the years ahead, generate immediate savings and lower operating costs. The consolidation will be a catalyst for significant improvements in our operating and operations globally. In terms of increasing our span of control, we plan to go from the current management span of control of 1 to 5 to a more streamlined span of control of 1 to 8, thus flattening the management organizational structure. The reduction in organizational layers will facilitate faster decision-making while also increasing employee engagement and development opportunities by co-locating smaller operations teams and further improve our response times and client service levels. To deliver these productivity efforts, we expect to take a charge in the fourth quarter of approximately $175 million to $200 million attributable to severance costs, primarily related to about 1,500 headcount reductions. This will be a notable item in 4Q, but with an expected average payback of under 6 quarters for each action with actions beginning at the start of 2024. Roughly 2/3 of the payback will be realized by the end of 2024. Next, we will continue to build on the successful reengineering and automation efforts through further standardization, redesign automation of our processes. These efforts are expected to be further enhanced and accelerated as our new State Street COO more fully integrates our technology capabilities into our operational processes. And finally, we're still optimizing our resources, which includes realigning new and existing resources to higher-growth areas, workload rebalancing to improve employee productivity in addition to rationalizing the level of third-party spend. As we look to 2024, taken together, we feel confident that our continued emphasis on our strategic priorities to serve our clients drive organic servicing fee growth as well as the next phase of productivity that I just outlined will help us to achieve positive fee operating leverage in the coming year. And with that, I'm going to go turn it back over to Alex for Q&A.

Eric, thank you so much. I appreciate it. So a decent amount of things to unpack there, maybe starting with the servicing business. And I really appreciate you guys providing incremental color. I think the comment that you probably got from a lot of investors over the years that the custody bank is a business is more opaque than it should be. And so providing extra stats around sales and the efforts you guys are doing is definitely help them from a revenue perspective, not just from an asset perspective. So you just talked about changes in sales organization. So let's dig deeper into that a little bit. So 2024, you're targeting $350 million to $400 million range in sales in terms of revenues. That's almost a 7% growth on a gross basis on your kind of installed base, so obviously very healthy improvement. What's changed? So what is driving this kind of improvement? And more importantly, how do you think about sustainability of that kind of gross sales revenue momentum beyond '24?

Yes. Alex, I described it this way. There have been years if you go back 5, 6, 7 years when we've had more robust sales. And so part of this is adjusting and shaping our sales capacity for the current environment, the current competitive environment, our current product set and also our organization. I think the biggest things that we're doing that are different is -- could be described this way. First, there are some leadership changes that we've made, putting all of sales coverage really parts of client service that front end under Chief Commercial Officer, right, who can really bring those units together. Secondly, we've actually built out and learn how the organization structures and capabilities and incentive plans that we've had in Europe and Asia, which have been particularly fruitful. We've begun to bring those and port those into the U.S. And we've learned on compensation, for example, we need very defined incentive plans for sales. But the client executive and relationship management need a related net new revenue growth set of incentives, but then can really bring the focus of State Street to those clients. We've realized that there is some administrative work that we can offload from the sales force and actually centralize right inside sales versus front sales. And so there's a series of changes that we've made that we think will sharpen what we're doing. The envelope of all that is the product offering that we have, which is a combination of traditional back office and alpha. And that is incredibly powerful with our clients. And what we've learned there is that as we lead with alpha, we need to make sure that the back office comes early in those deals that, that is part of the package, not a potentially or maybe or afterwards because that actually can be installed actually faster than any other part of the offering and has the right margin characteristics for us to then make the full alpha offering really viable for both us and for our clients. So how we sell Alpha top down from Ron's role, our Chief Commercial Officer's role, our client executives role and our alpha product team's role is really shifting to actually be a fulsome sale and one that actually includes the back office is a predicate. And often as the beginning of the installation as opposed to the back end. So some motivational changes. And then I think there is some leveraging of our distinguishing product and functionality capabilities that we have that are unique in the market. And actually then building off of some of those successes because we've had areas of success there that we've seen, for example, in Europe, it's been particularly strong, we've talked about in Asia and making sure that we have that across all of our regions and key segments.

I got you. Let's talk about the other side of the coin, which is retention of business. Again, it's a strategic priority for you guys because even though 6% to 7% organic kind of gross sales is great, but you got to retain the back book. And you put out some targets there as well. I think you said you're aiming for a 97% retention up from 96%, which has been a guess kind of historical average. So walk us through kind of key initiatives aimed at improving retention rates, maybe discuss some of the issues that drove elevated level of some of the exits in recent years. And as a kind of follow-up to that, I think we should just hit on price as well because will higher retention come potentially with more pricing pressure? Or are you still baking in about that 2% price pressure kind of point over time and the growth algorithm?

Sure. Let's pull them apart. So retention has always been part of our DNA and what we do. We did have a period really during the COVID era, right, where we had more turnover of staff. It was harder to work remotely. We had -- we all had attrition and trying to find the right staff to do the right amount of work or the right type of work as we grew was harder and harder, and that actually created some impact on our clients and impact on us in a way that we couldn't serve them quite as well as we would have liked. I think we've gotten past that, which is why our retention now is back up to the 97% versus the 96% that it felt to, percentage point matters in our business, right? It's another version of a percentage point of organic growth. So that was the most recent element that we had to navigate around tactically. Now the more systemic effects or elements that help drive high retention rate are really twofold. It's about client service on one hand and how we do client service, with whom, how effective it is, how well we can connect the right experts to clients, right, and the questions they have or needs they have or just the daily NAV process, the functionality that they see. And then it's around product, really product and functionality, making sure that's always distinguished. And that's an area that we're always innovating on. One of the initiatives we've taken, for example, recently, as I've just mentioned, is to consolidate some of our joint venture operations. Why? Because they actually would create multiple layers before you got to clients, right? And there was -- there were too many handoffs in the process. And in fact, the other part of managing the and delayering and actually flattening part of the organization and so that we can have the right client service experts directly connected with our clients as opposed to having a set of handoffs. So client service is an art. It's an art, especially in a very complex business with very many products, multiple geographies, different legal entity sets that clients were operating in. But it's one that we've mastered, but we think we can keep getting better at. And that will tighten the relationships. Product feature functionality is something we continue to invest in, whether it's with Charles River, whether it's with Alpha, whether it's back-office custody functionality. Every year, you're adding a little more either to keep up or to differentiate yourself versus peers. And then finally, I think retention comes from the offering that we solidified with our clients. We talked about our alpha offering front to back, right? Those tend to have longer tenure deals, longer maturity deals. They tend to -- we expect will roll over with even more frequency and need to be even higher in terms of retention, because at that point we're so embedded with our client and what we have to offer. So that's the approach. And I think, to be honest, the success we've had on retention. And our goal is to maintain it at this 97% level, which we think is both important and something that we can continue to do.

Yes. And I guess, in terms of pricing, so would the pricing level also make -- play a role in the ability to retain or pricing is what it is and the retention efforts are really just functionality driven and some of the things you talk about...

Yes, I describe pricing as table stakes. Clients, especially the clients that we have, medium-term and long-term relationships with on a fair price. They want to make sure that we are conscious of their economic situations. But they also don't want to switch, right? They don't really want to switch just for switching sake. And so in many ways, pricing in our minds is table stakes for what we do. And we just need to keep -- make sure that we're current on market practices. We've got a lot of data on that and transparency. And we'll continue to manage that, I think, in a healthy way as we have.

Yes. Let's talk about private markets for a couple of minutes. It's an important strategic growth priority for you. You highlighted a 15%, maybe over 15% growth in those fees for the firm into 2024. Walk us through kind of your medium-term outlook for this business? What differentiates State Street versus competitors. We obviously all talked about private markets as an asset grown substantially. Where do you typically play? Are these the larger players that you're trying to sell into medium, smaller players? Just help give us a little more lay of the land on what that business looks for you guys?

Sure. Let me start kind of outside in, as you've described, right? The private market servicing business is a $6 billion, $7 billion revenue pool out there. So it's large. Right now, private market sourcing for us is about 7% or 8% of our servicing fees. It's a large market space. We think it's growing at 10% to 15%. You get slightly different indications from different areas. What it's characterized by is it's still largely fragmented, right? There's no dominant player, no players got more than even 10% share. Most -- I think all of them have less, in fact. And it's one that's highly in-sourced, right? So in a way, it's a classic business that we participated in over the last years much like core custody. Core custody used to be in-source that used to be fragmented. And over time, it's gotten consolidated by us and other providers. So there's a real attractiveness to it all and you all know the level of growth and expectations that you see in that marketplace. From our standpoint, we've got tremendous client access to those who need private markets and alternative servicing, right? On one hand, you've got the alternative players, some large and public, some medium, some smaller. And we know them all, right? And we usually do something for someone, right? And then you've got the traditional players that have increasingly barbelled, right? And some of them have $1 trillion in total assets, but they might have $100 billion of alternatives and to complement their other $900 billion more traditional activities. And so we have very significant client access all the way up through the C-suite in just about all of the alternative providers. And I say it that way because it's not as if we're going after just the medium-sized lines or just the alts-only players. It's actually really a wide range of clients that we serve today. And then in terms of client prospects, we generally know and do something for just about everyone out there. In terms of differentiation, this is what's shifting in the market, and I think where there is a -- I'll call it a race to differentiate even more. The historical base of differentiation is around client service. Why? Because we're serving a set of highly bespoke and customized structures. Those are often structures that are very different between private credit, infrastructure, real estate, private equity can keep going. Regionally, they're different because of the legal structures. And so it's been around putting people at work in a systematic manner, but very customized. And so over time, the innovation that we've been doing is to take areas of alternatives. Private credit is the one where we're probably the most advanced in today. And literally automating more and more of those processes, right, and making them systemic in a way that they become scalable. Because the challenge our clients have is not can someone do their servicing today. It's if they're in high-growth mode and some of them are growing 20% to 30% a year, right, can they get the servicing they need 2 years from now and 3 years from now? And what we're finding, to be honest, is these clients, they don't want to be in the servicing business of their alternative assets. Why? Because it's actually -- it's ballooning their headcount base. It's creating a different kind of organization that they're not as interested in -- they want to focus on what they're good at, right? And so there's a real opportunity here. But over time, it will be around service and technology automation. And we're in the best position, we're in the pole position to be honest, to be able to do that. And what we're doing is doing it area by area because it's at that level that you can really make a difference and differentiate yourself and accelerate growth.

Just to maybe piggyback on that a little bit. A lot of wealth managers are obviously venturing out into the wealth channel. Over time, that might require more standardization and it feels more like a traditional product, which you guys obviously dominate the typical mutual fund and ETF landscape. Does that accelerate your prospects when you look at your pipeline? Are you talking to a lot of the firms that are launching a next version of an nontraded BDC, nontraded REIT interval fund? Is that the bulk of your pipeline? Or there are other things that may be less related to that?

That's absolutely part of our pipeline. It's actually what is making the business growth prospects even more attractive. And to be honest, one of the ways that we differentiate ourselves is we're having a lot of discussions with those alternative providers about those sorts of products, right? And they look at us not just as a custodian, but with many of them were having a very senior conversations about, hey, can we jointly launch interval fund, right, that have liquidity and illiquid characteristics built in. Why? Because we are one of the largest index providers. So there's both a relationship set of discussions that we have, right, about co-creating and co-developing products and launching and using each other's distribution forces. And then when it comes to servicing, I think the democratization of the alternative products is actually one which then forces the need for the technology development. And in some ways, because we spend 1/4 of our expenses each year, right? We spend $2 billion a year on technology, right? We're -- we've got both the resources, we've got the know-how. We've got the capabilities and to build the functionality that's necessary. And I think that kind of the wealth evolution of those products or to kind of broad-based wealth clients and even to just high net worth or affluent clients is going to continue to accelerate the needs for servicing because it just can't be done in the old fashion way anymore. And that to us, creates yet another impetus for change. And it creates an impetus for refined and new servicing products. And it creates an impetus for more and more of these alternative providers to say, look, you know what, I need someone else to do the servicing stuff because it's become so capital intensive. It's become so scale-driven that I'd rather focus on what I'm great at, which is investing.

Yes. That makes perfect sense. Let's touch on the second kind of big theme you hit on, which is driving more operating leverage in the business in a more kind of systematic way. So let's talk about expenses for a second. On the last call, and you reiterated just now you're looking to drive positive fee operating leverage again into 2024. I think that implies a fairly modest pace of expense growth again next year. I don't know, reasonably 1% to 2% maybe something at range. So can you talk us through the ability to sustain this kind of positive fee operating lange model more systemically, right? Like if you go beyond '24, what are you doing in the business to kind of let that roll beyond the charges you guys are taking this quarter and that's going to drive some efficiencies. But beyond '24, is that something -- does something change in the business model to enable you to do that more consistently?

Yes. I think you've seen -- the way I describe it is, you've seen us launch what I described as a wave of productivity initiatives and transformation initiatives dating back really to 2019, right? And now we're 3, 4, 5 years into it. And each year, you've seen us re-up, right? Part of that comes from -- we've really changed the DNA of the company. To say, look, we're a large manufacturer almost, right, a servicing player. And so over time, we actually need to roll down that scale curve, right, and get the efficiencies that are necessary to continue to serve our clients. How we do that has evolved, right? When we started, it was around the very top layer of the company and the senior bureaucracy we had created. Then we did a lot of work around third-party vendors and using our purchasing power more effectively and thoughtfully and that created a set of opportunities. Real estate, right, was very important as a driver. And so each year, there is kind of a new area. And I think what I described to you, and then we go back to some of the original ones and say, what is the next stage of whether it was vendor or real estate or layers that are important. So that's why I think we have a lot of confidence that we can continue on for multiple years, in fact, just as part of our business model. I think the other is that over time, what we've been doing more and more of is automation and engineering and redesigning our processes because that's actually where you get the most sustained changes. And those are ones that actually help us from an efficiency standpoint, but they help our clients because our clients then get the best of State Street nearly instantly, right, as opposed to with a bunch of handoffs and checks and balances that make sure it works. And that's where we're spending more and more of our time. The reason I described the joint venture consolidations is that we built those up as we grew over the last 15 years. But what we've realized is that it created a set of separate and processes with big handoff points. And then groups checking other groups as opposed to a more systematic process, and I can go into loan accounting, recons, different elements of what we do in core accounting. And every one of those had a set of steps that had big breaks. And so with the consolidation, it lets us actually take the operations area and pull it back apart and then reconstitute it. And that will be not a 1-year effort. That will be really a 3-year effort, but with a very substantial benefit in the first year, but that will come from full process redesign. And this consolidating our joint venture is really the catalyst for letting us do that. I won't say once and for all, but in a real dramatic way that we've been inhibited in -- or been restricted on until now.

Got it. Okay. So let's zoom in a little bit to Q4 given the time of the year. Maybe spend a couple of minutes giving us an update on how you're thinking about the quarter. You guys always give a lot of specific guidance, so I'll let you take it away.

I think I'll take that as a compliment. But let me update you with some -- a little bit of background as we're in the midst of -- we just closed the books for November. We still have another full month to go. I'd say that our outlook for the fourth quarter is stable in aggregate. But I'd make a couple of observations just to help with some of the line items in area. As you think about our guidance on a year-on-year basis and excluding notable items as usual, we currently expect total fee revenue to be flat to down slightly with some puts and takes on some of the line items relative to our prior guide. So let me just itemize those. We expect that servicing fees will be in line with our previous guide of roughly flat year-over-year, reflecting higher average equity markets, offset by a little client activity. And then the expected normalization of pricing, which we noted earlier this year. Management fees are expected to increase approximately 2% year-on-year, which is better than our previous expectations for roughly flattish performance, primarily reflecting higher equity markets. Our tradings and markets businesses. We now anticipate a more pronounced year-on-year decline in revenues as compared to our initial expectations reflecting subdued market volatility, which we see as relatively industry-wide. Software and processing fees should be up about 10% year-over-year, reflecting the timing of some on-premise renewals and expected new SaaS installations. And we think that the other fee revenue line will come in slightly above the higher end of the $30 million to $40 million range in the fourth quarter. In regards to NII, while we have a few more weeks to go, at this point, we now expect fourth quarter NII towards the higher end of our $550 million to $600 million range as noninterest-bearing deposit rotation repricing are moving a bit slower than initially expected in the quarter. This year, as we move through the credit cycle, there have been some puts and takes with provisions. And this quarter, we expect it to be around $20 million. Turning to expenses. We remain laser focused on controlling costs in the current environment and continue to expect relatively flat quarter-over-quarter expenses on an ex notables basis. And lastly, we currently expect our 4Q effective tax rate ex notables to come in 1 to 2 points below our prior guidance of approximately 20%.

Great. Awesome. Super helpful. Let's impact that a little bit, but maybe talk about '24 while we add it, and I'm not sure if you are ready to give us a full-fledged guide in the [indiscernible]. But even just kind of thinking philosophically, you talked about NII being at the higher end of that $550 million to $600 million range. Obviously, the rate curve is really all over the map, right? So it's really hard to know exactly where things will fall out. But does that upper end of the range still holds, now and what we know today?

It's really to be definitive about 2024. We're doing a lot of preparation for our January call. The current indications are positive for NII. But we'd like to see, to be honest, a few more months of stability in deposit levels that before calling it definitive. So I think we're comfortable with our previous statements, and you've described them fairly. But we're at an inflection point with regard to rates, with regard to noninterest-bearing balances. We've seen them float down again this quarter, but a little more slowly than we had expected. But we want to kind of see how that plays out and the same thing with total deposits. So I think we're getting closer to having a good understanding of next year, but it's still a little early. And I'd rather actually just give guidance or clarity on where we are today and give some indications of what we're seeing along the lines that I've described.

And the slower rotation in noninterest-bearing deposits that you just highlighted, do you think that's just largely a timing thing? Or you're just getting more granularity and more sort of kind of feedback maybe from your customers to get more confidence that we're closer to the trough in this rotation.

I think it's both. And it's just -- it's hard to unpack it month by month, to be honest. And so we had expected $3 billion to $4 billion of reductions in noninterest bearing. We're not even seeing half of that movement yet. But -- and we have lots of data on specific client positions, negotiations, discussions. And then on the other hand, we've got 30,000 deposit accounts so we've got our machine learning tools navigating through those. So -- but it's a mix, it feels like. It does -- I don't think we're in a position where we were a couple of quarters ago, right, where the declines were rapid right, which just were offsetting the increases that we saw 1.5 years ago, right? So we're -- I think we're watching this evolution and are seeing the -- with a little more confidence what to look out for. And I think we're comfortable with our -- with the guidance we gave until now, and we'll take it from there.

We have a couple of seconds left, but I'll squeeze another question on buybacks. Expectations for Q4, but also you guys continue to be in a really healthy excess capital positions or any early thoughts you have for '24 in terms of share repurchases?

I think we're -- we clearly had to do some catch-up on buybacks this year. That was important to us and to many of our shareholders, and we thought we proceeded that at pace, including at the start of the year. I think next year is really around our medium-term target approach that we've taken, 80% of earnings should go back to shareholders and the 8% or more of earnings to go back to shareholders in the form of capital buybacks and dividends. Obviously, we got to be careful what's the environment look like? What are the external factors, right? There's always a set of those. But we'd like to get back to our medium-term kind of target approach, which we think is very healthy set of both capital trajectory.

Great. All right. Eric, thank you very much. Thanks for being here.

Thanks very much.