State Street Corporation (STT) Earnings Call Transcript & Summary

Okay. Terrific. I have to read a disclosure -- a disclaimer first. Just to remind our audience that today's discussion may contain some forward-looking statements and that State Street's actual results may differ materially from those statements due to a variety of important factors, including risk factors in State Street's Form 10-K and other SEC filings. State Street's forward-looking statements speak only as of today and may not be updated even if views change. With that behind us, I want to look forward and say thank you so much to Ronald Hanley, Chairman and Chief Executive Officer of State Street Global.

Thank you, Betsy.

Thank you so much, Ron, for joining us today. And Mark Keating, Interim Chief Financial Officer. Mark, thanks so much for joining us this morning.

Thank you, Betsy.

All right. Well, there's so much to talk about, Ron, but I did want to kick it off with some strategy questions and where you see the biggest opportunities for growth in asset servicing and asset management.

Well, first of all, Betsy, thanks for hosting this, and thank you all for being here. From a strategic perspective, we are very encouraged by the marketplace where it stands now. And I'll start with our largest business, which is investment servicing. And if you think about even as recently as 5, 6 years ago, when we would have had this discussion, we'd be talking a lot about custody fund accounting and the traditional kinds of back-office things, which are still very important, drives a lot of core revenue. But we've spent time thinking about how and executing against how do we actually expand the total addressable marketplace. So where have we done that. Alpha has been the big strategic move we made, starting with the acquisition of Charles River, but then building out this front-to-back offering, which is driving not only a lot of new revenue, but it's driving a lot of back office revenue. And when we talk about our sales results, we actually talk about that, while Alpha is a big component, a very large percentage of that is also associated back office. Secondly, with the growth and the increased complexity in privates, all sorts of alternatives, that complexity has created opportunities for us, just like we are in the core services business, we've become an enterprise outsourcer. We're now become that in private, not just with the private firms, but actually large asset owners that invest in private. Thirdly, software. We don't even -- again, 5, 6 years ago, software was minuscule on this. It's now a significant single-digit number approaching -- we talked about we have a $1 billion goal over the next several years, and we're well on the way there. And if you think about those last 2 in terms of revenue growth, they're growing at a multiple of our core revenue growth. So software was 10% last year. Private was 15% last year, and you talked about those same kind of things. Investment management, we are at our core and our roots or we're an institutional manager. And we've spent a lot of time expanding from that. Today, if you think about we're just about $4.7 trillion in assets under management, about $1.2 trillion of that is actually related to wealth. It's -- these products and services has found their way into wealth portfolios. So again, thinking about how do we participate in -- where revenue is growing. And then finally, in markets. We always think about markets as a very important companion to our servicing business, and it is. I mean, that's where the fact that we are the servicer gives us the right to participate and compete there. But we've invested a lot, as you know, in various channels. We can meet our clients basically in any way they want to trade in terms of how they think about foreign exchange or how they think about securities financing. And certainly, volatility drives a lot of those volumes, but we're also continuing to expand our share within those client base, and we remain today in foreign exchange, the largest real-money trader foreign exchange. So we feel very good from a strategic perspective. But what I would maybe end this question on is the big change over this time has been becoming more of an enterprise outsourcer. And then the second big change is we're much more integrated now across State Street in terms of how we deliver 1 State Street to our client base.

Okay. And so as I think about some of the other areas you didn't discuss about. Digital, digital strategy. I know for a decade plus you've been very heavily invested in digital tokenization efforts. And maybe you could speak to where that is going? And how does this stable coin element that is coming through right now fit into that?

Yes. Digital is a big topic. We could spend all the time on this. But let me kind of -- we think about it in 2 ways. The core of digital is the digitalization of transactions. And that, like a lot of things, there's a -- I think everybody sees the promise, but the time it's taking to convert everything, for example, to blockchain contracts and those kinds of things. It's taking time, but it's happening. And there's lots of interest in digitization of assets and those kinds of things. And we are fully prepared for that and ready to go. Crypto and currency and stable coin, again, that's gone through its ebbs and flows. It seems like with the current administration, there's a lot of support for that. And we think that you'll see more there. And for us, the way we think about it is we need to go where our clients are, where do our clients want to invest if our clients are an investment manager or operating as a sponsor, how do we support them in their activities. As you know, the regulatory environment has been unclear on this. It's starting to emerge. You've got an SEC now that's trying to provide some clarity on all this. The bank regulators probably have a little bit more than they need to do. And we need to see where this whole Genius act comes out. But I would anticipate that we would continue to grow in that space, too, in support of our clients.

Okay. Great. And maybe we could just spend a few minutes on the current environment and what you've experienced year-to-date with the extreme volatility we had earlier this year, did that shake out some incremental new client inquiries. I'm wondering your point on the servicing front to back across a variety of different asset classes, including private. How's the outlook there?

Yes. So you go through these periods, and you do 2 things. One, you buckle in yourself and prepare for what you need to do for your own firm, but you also have to be very mindful of your clients and how you're going to support them through this. And as you know, I mean it feels pretty good now. We were just talking about this before we started. I didn't feel it was highly, highly uncertain at the beginning part of this quarter. What we have found with clients is that in these kinds of instances, this idea of being the essential partner really comes to the fore, right? There -- we want to understand if we're going to be there as it relates to either financing. But the more important thing is on transaction volumes. There were just enormous volumes, record volumes that the industry had never seen through this time period. The obvious ones would have been around asset servicing volumes and how you thought about all sorts of transactions. But even in areas like in ETFs. I mean, ETF volumes went to record highs during the first part of April. We are largely an institutional ETF provider. So we had a couple of days where our volumes were higher than the collective volumes of BlackRock and Vanguard combined. And that just reflected that we have a higher share of institutional than those 2 firms. So my point being is that what your clients look for is how are you standing up during those kinds of things, 0 NAV failures during that time. There were no restated NAVs or anything like that, which again is very important and reaffirms the importance or reaffirms their choice in choosing us because ultimately, particularly when you think about investment services. Everybody talks about it being it's price competitive, it's commoditized. It's markets like that, it's sure it's not commoditized at all, right? It's -- have we seen the kind of -- have we delivered the kind of service quality that our clients expect. So we expect good things coming out of this period.

And so congratulations on that with that historic volatility and coming through [ whistle ] clean. You are in a transformation process, right? Could you help us understand how far along that journey you feel you are? And given that you experience that high vol without any issues, how much more work is there to do on transformation?

Yes. So how far along are you? I'm not sure you're ever done. I mean, in the sense that transformation is somewhat like a garden and you continue to look for opportunities to make it better. But if you think about our experience, I'll just go over the last 3 years, we've viewed transformation as a way to improve quality, increase lower cycle times. And we've used it as an opportunity to not just reduce costs but make the operating model better with a high degree of focus on quality. Over the last 3 years, and now I'm giving you kind of an estimated number that we've already talked about for 2025, it's $1.3 billion in expenses that we've taken out. And these are recurring expenses much of which we put back into the business in the form of investments. Some of those around resilience, but a lot of those around capabilities and the areas that I've just talked about, right, in terms of private software. We haven't talked much about wealth services, but some in there. And I would describe that technology -- excuse me, that transformation is some of it was early on with the low-hanging fruit. A lot of it since then has been around how do we engineer and reengineer what we're doing and apply technology to it. The technology we've applied, I would describe at this point, at least in the years prior. It's the last generation of AI, a lot of machine learning. And so for example, today, in the striking of the NAV, which is one of the more important things that our clients expect of us, that is largely done by machine and machine reference. AI and generative AI provides a whole new level of opportunity. And so when you talk about how far along you are, I think in terms of running our business based on the technology that was available a year or 2 ago, we're right there. In terms of the promise that we see out of AI, it's actually quite high. So we talk about a next-gen transformation for us. Where will that be? A lot of it will start with our operating models and how we actually get stuff done in the firm. And here, I'm talking about those day-to-day operations, which is a big part of what we deliver to our clients. And there's a reason why we call our operations function global delivery because that's what we're delivering to our clients. Enormous opportunity to use agentics, to use prompt engineering actually to accelerate what we do. And if you start out with the objective of going to increase quality, we're going to reduce cycle times, cost will come out of them. If you think about -- we've talked about this in the past, but last year, head count was down 4,000 people. A lot of that was in places where these are I wouldn't call them commoditized role, but their entry-level roles where we've been able to take that work out and replace by machine, and we see much more promise on that. So if you ask me for a percentage, how far along are we, I don't know, 60%, 70%, but I also expect that the technology is actually going to create new opportunities. We've rolled out AI broadly. And so this transformation will be -- this kind of next-gen transformation we're anticipating will be this combination of these top-down areas that we're going to look at. But when you arm your employees with this technology, it's amazing the things that they are coming up with that you look at and you say, well, this is actually quite good, makes sense for this little subfunction here, but it's something that we can expand on broadly.

And so AI is rolled out to the firm, and there's more that can be done with it. Are you anticipating an impact on the expense ratio in the next several years?

Yes. Yes. And we'll have more to say about that as the year goes on. But again, we spent a lot of last year as it relates to Gen AI on testing it. testing it ourselves. I mean a big difference between this form of technology and any prior form of technology is with these large language models, the danger of client data leaking out. So we spent, which I suspect a lot of our -- my colleagues did in the industry, getting that risk framework, right, while we were in effect practicing on ourselves. We now feel confident where we are and do believe that it will not only, again, improve quality, reduce cycle times, but take out a lot of costs. And just enable us to scale the business better. It will enable us to -- as you know, we're a large player in middle office. Middle office is a complicated business when you're working with the kind of client base that we have, very sophisticated asset managers and asset owners. You end up being able to standardize a lot more than you thought you could before because AI provides an effective level of standardization.

And do you see AI driving incremental expense ratio improvements or step function?

Well, I believe over time, it will drive step function, but it will probably come in the form of incremental. I mean, we should -- least you can tell I'm enthusiastic about this, but I'm also a realist, right? I mean I'm old enough to remember the advent of the Internet here. Remember, we all thought that the Internet was going to change everything. 1999 came, we ran into a wall and everybody said, well, it didn't change anything. And then 5 years later, it had changed everything. And I suspect you'll see that same kind of it's kind of a zigzag but improvement in terms of business results with AI.

Okay. Great. Looking forward to hearing all about that. And as we pull back to 2025, the expense ratio guide for this year is -- or I should say the expense guide for this year is plus 2% to 3%, right? And that's still intact.

Correct.

Right. Okay. If revenue growth were to disappoint for whatever reason, given -- where is there flex in your expense stack to deliver the positive operating leverage that you would like to?

Yes, I'll start on that. Mark, you should come in behind me. As I -- as I said in the talking about -- in answering your prior question, Betsy, we've got $500 million of CAU expense reduction baked into this plan, and we're executing against them. We feel good about that. A lot of that is going into other investments. There's a couple of levers we have. One, we can accelerate some of our expense reduction. We can also take a pause on some of the investments, take a pause on some of the hiring that's associated with that. So we feel like we have plenty of levers in order to deliver on our commitments around operating leverage.

Yes. No, I agree. I think the -- on the investment side, again, all of our investments are important to us, but we really know which ones are the kind of critical strategic investments, and we have an ability to phase and replan things if we need to.

Okay. And just ticking through the rest of the guidance that you have, I wanted to get an update if there are any on net interest income for the full year.

Sure. Why don't I just give you kind of an update overall.

Sure. That would be fantastic.

Great. Okay. So yes, as we're sitting here today, I think we're very pleased with the way that the year has been playing out from a core business performance point of view. We're very confident in our overall guide that we gave at the beginning of the year. I just remind folks, that's on an ex notables basis. So if you think about it, it's our fee revenue growth, we're confident in that 3% to 5% range. NII, we still expect to be relatively flat year-over-year. Remember that 2 years of record NII coming out of the last 2 years. So we're still within a range of up or down, plus or minus low single digits. Expense, as you mentioned, we're targeting 2% to 3% of growth for the year. I would highlight that can be somewhat lumpy kind of sequential quarter-to-quarter. So I'd just keep that in mind, but the 2% to 3% is intact. And I think most importantly, we are targeting and confident with the full year positive fee operating leverage and positive total operating leverage. And again, with the caveat I've given in January and April around NII not becoming a material headwind. But so far, so good from that point of view. Certainly, it's been a -- the macro environment has been very dynamic to say the least, over the last 5 months, whether it's interest rates, changes, market volatility, market levels, weakening dollar. But if you stand back from all of that and kind of where we've come back to at the end of -- almost to the end of the second quarter, broadly speaking, that kind of environment is like relatively intact for us in terms of how we look at the year. And the most important thing is that our core business momentum remains very much intact. So that's very encouraging as we head into the middle of the year. So we're going to continue to monitor things, and we'll be looking forward to updating anything on in July when we do the second quarter earnings. But on the balance of everything in terms of how we look at our business, we're on track, including the $350 million to $400 million servicing sales target that we talk about, which really kind of helps power forward the organization into the future.

And with the volatility that we had earlier in the quarter, across a variety of asset classes, including foreign exchange. Should we expect a bit of a pop -- positive Q2 result in trading revenue.

Yes, sure. Let me -- maybe I could take that opportunity to talk a little bit about how the second quarter is beginning to shape up. And again, there's still a few weeks left, and I'll kind of talk on an ex notables basis. But again, we've been very encouraged with the underlying business, and I'll talk a little bit about foreign exchange. But we're going to be delivering positive fee operating leverage. We expect to deliver positive total operating leverage as well. We expect total revenue to be up both sequentially and year-over-year. We expect expenses will be up year-over-year. Expenses will be down slightly kind of sequentially. We are like looking at our servicing and our management fee like fee revenue business, we expect to be up nicely on a year-over-year basis. And it's very encouraging, including, as I mentioned, back in April, I had highlighted I expected us to have a pretty very solid second quarter when it came to our servicing fee sales. So we expect to deliver that as well with only a few weeks left to go in the quarter. In terms of foreign exchange, I mean, certainly, as you'd expect with a lot of market volatility early in the quarter, especially, we benefited from some from that. Not just volatility over the last few years, we've also been building market share amongst our clients. So even taking the volatility, we expect that to continue kind of higher as well over time. So that's kind of the core of the quarter from a revenue and expense point of view. I would also maybe take the opportunity on a couple of housekeeping items for the quarter to kind of highlight. We expect to be booking additional provision expense for the quarter of roughly $20 million over a sequential quarter. That's reflective of an evolving macro environment, but also a small number of loans in our commercial real estate portfolio. And then also, we expect to book a few notable items in the quarter. Primarily, those are around our ongoing operational model transformation that Ron's been talking about. And that will actually start to drive additional expense reductions, mostly starting in 2026. So if you stand back from all that, in general, like we're very positive about how we're seeing the year play out, notwithstanding the volatility and the uncertainty we've seen our core business in terms of sales and transformation and productivity. We're very focused on delivering on our full year guide, positive fee operating leverage and total operating leverage. And so what we're focused on is delivering another good year in 2025 on top of a good year in 2024, but even more so, making sure when we talk about our sales targets and our transformation and our productivity that we're setting ourselves up to keep it rolling into 2026.

Excellent. Thank you for that update, Mark. So Ron, back to you, and I'm just interested in understanding how you're thinking about medium-term outlook, medium-term targets. In the past, you've spoken to EPS growth of 10% to 15%, ROE of 12% to 15%. And that's on the base of a revenue growth of 4% to 5% year-on-year growth. And are these still the right targets for investors to reference.

We think they are. I mean if we think about -- and again, taking apart a little bit of what Mark just said in terms of those numbers and what that means is we've grown our servicing fee sales steadily since 2020, but really on an accelerated basis, '23, '24. And as Mark has signaled, looking positive for 2025. That then does a couple of things. One, it gets at the -- how do you think about fee revenue growth. But more importantly, it's driving with the kind of scale that we have it's accreting to margin and accreting to ROE. So yes, we think those are the right ways to reference the business, and we're confident in those.

Okay. And some of the levers to get you into that midpoint of that ROE of 12% to 15% is the operating leverage we discussed earlier.

Yes. I mean it's -- we're fairly straight forward business, if you think about it, largely driven on the revenue line by fee revenues. And we've -- last year and as we're talking about this year, we're seeing across-the-board fee revenue growth. So it's not isolated in 1 area where other areas aren't, right? We're seeing this across the board positive fee revenue growth. You then marry that to the kind of expense management and the promise that we see about being able to continue to do that with some of the things that I talked about earlier. That's all accretive to both margin and ROE.

Okay. Great. Maybe you could talk a little bit about capital and excess capital and capital utilization. But first off, we do have a new supervision head at the Fed, Michelle Bowman, who has outlined some ideas for changes to capital rule set. Could you help us understand what you're hoping for in that regard?

Well, I think certainly what all of the banks, particularly the large banks, we'll be hoping for is some kind of clarity and stability around what are the rules. And I think you're going to see that from Mickey. I think that she's been quite clear very early on that she wants to see kind of a stable capital regime. As importantly, she's a former bank supervisor. And I think she wants to see supervision in the rule-making process. One remains separate. Supervision is not rule making and vice versa, but two, to become more steady and more predictable. So I think that you're going to see clarity pretty early on in areas like the role of the stress test, what the capital regime will be. I think there's probably a debate on where Basel III end game can come out. I think where -- what I would like to see is, let's just put it to bed because it's been out there for a long time. We operate in not just State Street, but all of us operate in international markets. So we'd like to see that put to bed. And I think with the kind of frameworks that Governor Bowman is implying, I think that will be a fairly good result. But I think this idea of just certainty and taking a lot of the uncertainty around all these things, capital regulation and supervision will be very welcomed.

So the way we calculate it, you have about $4 billion of excess capital. And is that -- do you need the certainty to unlock that excess capital?

So I mean you always think about capital and capital buffers really in reference to the environment that you're in. And there's been enough uncertainty in the environment. And I don't mean just regulatory uncertainty. I mean just look at the period that we went through, you and I were talking about this beginning of April, certainly didn't feel like what the middle of June feels like. So -- and that kind of uncertainty, we are cautious and we do carry more capital. So we'll look at this as -- let's see how the environment plays out. Let's see how the regulatory environment plays out. So we'll look at this. We acknowledge that we're carrying significant buffers.

And you have also indicated the 80% payout ratio this year on buybacks, right? And so you are going to be delivering back some to investors?

Oh, yes. No. And we're committed to that. We've been committed to that now for a couple of years in terms of the 80% total capital return dividends and share buybacks. Last year was 87%. So -- and that's assuming that we keep the capital levels where they are. So take that for what it is, a significant capital return even with those capital buffers.

I just might add on top of that the -- and we've talked before about the patterning of it. I mean what we did in the first quarter, we expected to have a significant step up in the second quarter, and that's what you'll be seeing.

Yes, that's a good point. Again, call us overly cautious, but we typically return capital at an accelerating rate through the year. And that's the pattern we're following.

And anything on M&A in terms of products at geography, customer facing technologies, just thinking about, is there anything that we should be thinking about as to how you could utilize the excess capital inorganically.

Yes. So I mean, we we've been quite consistent about this. We don't view M&A as a strategy. We view M&A as a way to execute our strategy or, in some cases, propel our strategy. Most of the M&A that we've done recently has been fairly small in the sense that a lot of it is around technology investments, building capabilities or taking positions in firms that either we want to learn from the technology, we want to adopt the technology in those cases where they're wanting to come to us because they want us to deploy it. We structure the deal so that as they grow, we grow or our position in the firm grows. So -- and we see a lot of opportunity there in terms of some of these fintechs and enabling the kind of wealth services that we're trying to do. And to accelerate the build-out of our platforms in that space. So we'll continue to do these relatively small and modest things. In the asset management space, to the extent to which we can tactically build a position or bring in a capability, we'll do that. But you shouldn't expect to see kind of large sweeping kinds of stuff because we like what we've done. I mean we made a very significant investment back in 2018 with Charles River. We've used that not just to accelerate the growth of Charles River, but to build a very important capability for us. So we're still reaping the benefits of that in investing in that. So we wouldn't anticipate something like that.

And is that front-to-back technology offering and capability set at 100%? Or is there more to do to...

There's still more to do, but I would -- on that percentage, I can be a bit more certain, I would call it at 85%, 90%. There's more that we're building out and delivering this year in fixed income. There was a big built out last year. So -- but that's working quite well. The other thing that we've built out around that is what we call the Alpha Data platform. And again, this is interesting when you think about a strategic move. When we talked about this back in the 2019 time frame, we talked about front to back with front being Charles River trading, pre-trade and post-trade analytics, our middle office, which is basically the outsourcing of back office from investment managers and asset owners and finally, the traditional back office. But the interesting product that's emerged from this, that is getting a lot of take-up in the industry of the Alpha Data platform because in our partnership with Snowflake, we now have the ability to create data platforms for our clients. We've done this to date, mostly in conjunction with some of these front-to-back things, but we now have clients coming to us that this is the reason why they're first talking to us is help us manage our data. And that's only going to become more complicated for these firms as their own underlying complexity grows. Or in the case of an asset owner as they go from being asset allocators, hiring a lot of external managers to actually managing some of that themselves, the need to actually manage their data and provide security around their data has gotten quite a bit greater. So that part we have built out, we're really pleased with that.

And are these new to the firm clients?

Some of them are, yes.

Excellent. And on investment management, is there any product breadth expansion that you're thinking of.

Yes. So over the last several years, we've very much stepped up the number of product launches. Some of that has been the markets affording new opportunities, particularly around active ETFs. We have continued to build out our ETF presence outside the U.S. in fixed income. We've also built up a lot of wealth products. Again, our legacy and history was around institutions. We were early on in the ETF business, and as these were institutional buyers, we have continuously gained share over the last 3 years in wealth. Today, wealth represents about $1.2 trillion of our assets under management. And we would expect to continue to see that grow. And the other area that we will expect to see more. So in that area, some of the innovation you're aware of this, what we've done with Apollo, what we've done with Bridgewater in terms of this idea of democratizing access to alternatives. But the other is retirement. Everybody is talking about this. We have about $1.6 trillion in retirement-related assets, it's about half and half DV versus DC. So we're a very large DC player. And this idea of bringing alternatives and affording the illiquidity premium to retirement investors is something that's been out there for a long time. But the -- really, the regulatory framework hasn't been there. You've got, I think, a much more thoughtful department of labor in place now. that's thinking not just about expenses, but what's the after expense return to the investor. So I think you'll see a lot more product innovation there, and we feel like we're at the lead on that.

Excellent. So in conclusion, how is 2025 shaping up for State Street.

So again, you and I talked about this, notwithstanding what we've seen in terms of some of the volatility. We came into the year with a lot of momentum. And we feel like we're riding that momentum. Mark made a very important point that I would underscore Much of what we do in any given year is about laying the foundation for next year. We've got to execute on what we said we're going to do, but you're laying the foundation for next year. With sales continuing at the pace that we've been talking about, servicing fee sales in the $350 million to $400 million range. We've committed to that target. That gets installed for the next year when you start to think about the transformation, we're delivering on what we said we were going to for this year. So you'll see that in the quarters and in the remaining quarters for the year. But more importantly, we're laying and doing more transformation for the years on. So we feel very good about what we've accomplished strategically, but we feel even better about what we're setting in place for '26 and beyond.

Excellent. Thank you so much for joining us this morning, Ron and Mark. Appreciate it.

Thanks.