State Street Corporation (STT) Earnings Call Transcript & Summary

Moving right along. Very pleased to have State Street. From the company, John Woods, Chief Financial Officer. John did this conference last year with a week or 2 into the job. This year he's a year and 2 weeks into the job, so we get to grill him a bit more. And John, maybe the best place to start, in July, you laid out new medium-term targets for State Street: 35% pretax margin, 20% ROTCE. As you think about the path to achieving those targets, what gives you confidence in the ability to get there? And what do you see as the 2 or 3 most important drivers of success over the next several years?

Yes. Thanks, Jason. Really great to be here. And just 1 year into the job, just an incredible platform that we can talk about, that we laid out our medium-term outlook in July. I mean I think I'd start off with the global franchises that are part of State Street and drive State Street at scale. So whether it's the #2 custodian in the world, #4 asset manager in the world, #1 FX provider to asset managers in the world as well out of our Markets business. So pretty incredible collection there that really drives it. And it all starts with that at the foundation in the core. I think the second one that I would highlight is some very distinctive strategic initiatives that we think will diversify and accelerate growth and returns over time. So we talked about our presence in the alternatives business, what we've got going for us in terms of investing in digital and infrastructure and products. And then more recently, a lot of investment being put into the wealth services space. So that's the second one that comes to mind, just really strong strategic portfolio on top of the core. And then we did talk about transformation, which I think is something that allows us to invest in those strategic initiatives while still maintaining margins. And I guess I'd hasten to also add, I mean, recent performance has been really strong. I mean we -- after basically new leadership over the past 2, 3, 4 years in each of our biggest businesses, you're just seeing some of that momentum really kicking in, in terms of the investments that they've made. And there were records set in the second quarter across all of our businesses in one way or another. And that momentum has been really good. And if you just take a little step back just a few years ago, our pretax margin was in the mid-20s. And when you look at where we are now, it's basically low 30s. Just significant progress in a short period of time. And so I think you put all that together and I'm feeling very good about our ability to deliver on those medium-term goals that we laid out in July. So yes, those are the top ones that come to mind.

Maybe if I could just double-click on a few topics you mentioned. But wealth services, digital assets and alternatives, big strategic areas of focus for the firm. Just how are you positioning the business to capitalize on these initiatives? And where are you seeing the strongest potential to drive growth over the medium term?

Yes. And maybe I'll do that in reverse order. I think in the near term, I would say alternatives is the one that really is delivering, right? So you've got 15% to 20% of our servicing fee revenues actually coming out of the alternatives business. And we're really investing to make that a platform business and improving capabilities along the way. So things like leading into a product where we would drive daily NAVs, as an example, in the alternative space, which is pretty typical in a traditional world, but not quite as typical in alternatives. So we're continuing to invest there. We've had a lot of success. The growth profile is attractive. The return profile is attractive. And so I'd say over the near term, that's the one that really contributes. The next one if you think about digital, products and infrastructure. From an infrastructure standpoint, we launched our digital asset platform earlier this year. And we're continuing to invest there from an infrastructure standpoint where we're heading into a multichain capability in digital. So by the end of the year, we'll be in a public permissioned space from a blockchain standpoint, and we'll have public permissioned lists to follow. But we'll be in a multichain infrastructure. And we sit at the center of our clients' workflows managing that kind of on-ramp, off-ramp between the traditional world and the digital world. I think what you'll -- where you're going to see that contribute is really just being relevant to our asset manager clients around the world and continuing to see organic growth by making sure we can play that role over time. The last one that you mentioned, wealth, is the one that is really starting to gain momentum and gain steam. It's not a huge driver of profitability today, but I'd say over the -- like alternatives is. But I'd say over the medium term, you can really keep an eye on wealth being a needle mover. We started off with our Apex investment late last year, and that was driving back-office capabilities. We've recently announced a State Street integrated offering here in the U.S. And we've got a mandate from one of the largest RIAs in the U.S. to be an anchor client. And our front-to-back wealth services offering, we're extremely excited about that. We've got a pipeline building behind that as well. So when you think about broadly the things that really drive that strategic initiatives portfolio, is probably alternatives in the near term, digital throughout, and wealth picking up steam over the medium term.

Got it. You've also spoken about the power of the core franchises across investment services and asset management markets and the benefits of this One State Street. Just how does that show up in practice today? And where can connecting the businesses more tightly drive the greatest incremental value over the medium term?

Yes. I mean the way I think about that is if you think about our top 3 businesses, and I look at it as the intersection between those businesses and our top line segments. So you've got investment services, investment management and markets. And then you think about our -- the client segments that we want to serve, it's asset managers, traditional and alternatives, asset owners and wealth managers and intermediaries. And so when you think about asset managers, that's our kind of collaboration primarily between Investment Services and Markets. So where you see Investment Services with the front-to-back capabilities serving asset managers, but institutional-grade markets capabilities from a liquidity and financing perspective, that -- where we go to market together. And there isn't -- Investment Management provides distribution capabilities as well as supporting fund launches for other asset managers. And so that's kind of an exciting way to think about on a day-to-day basis how we serve the asset manager client base. When I flip over to asset owners, same capabilities poured over from Investment Services and Investment Management. But you think about from a One State Street standpoint where a bigger part of the story is the investment management capabilities, where whether it's ETFs, portfolio construction. You basically have indexing, multi-strategy, outsourced CIO, lots of very rich portfolio of products that the Investment Management business provides to asset owners. But nevertheless, we also can bring, again, institutional-grade markets capabilities for liquidity and financing to the table at the same time. So on a day-to-day basis, you see that playing out with asset managers and asset owners. And I think the third one, and I referenced -- I alluded to this a little earlier, the third one being wealth managers and intermediaries. I would look at that as not only a customer segment, but also, as I mentioned, one of our top initiatives. And it's probably one of the clearest examples of One State Street really -- and certainly one of the more recent more exciting ones, where each of the businesses has a big role to play. And where Investment Services, we're, as I mentioned, we've launched a front-to-back capability with CRD wealth supporting the front office, we have the State Street capabilities in the back office where we have that resident within State Street proper, but also supported by Apex. So very exciting in terms of that Investment Services approach. But increasingly, these wealth intermediaries appreciate the institutional-grade capabilities that we bring from a liquidity and financing perspective that we can, at the same time, support them with, and then all of the Investment Management products in the wealth space from a distribution standpoint and products. And I should hasten to add, I think approximately 30% of our Investment Management outstanding is -- comes from the wealth channel. So you look at that and it's really exciting from a One State Street standpoint. Rounding things out, I mean, I'll circle back to alternatives where I already mentioned what we're doing from an Investment Services standpoint, but Investment Management as well, partnering with alternative asset managers to actually distribute private markets products and get greater access to that. And in the digital space, all the capabilities I already mentioned, but I would add to that Investment Management's tokenized money market fund launches that they recently did. And they also launched a stablecoin reserve money market fund that targets stablecoin issuers. So I mean, just to wrap all that up, I mean, One State Street on a day-to-day basis is very exciting, but these recent initiatives are all examples of One State Street at work, whether it's alternatives, digital or wealth.

Very comprehensive.

Yes. I'm excited about it. Yes.

You talked about AI as an important part of the kind of the transformation agenda. Can you talk to where you are in terms of implementation, where you see the greatest opportunities to improve productivity, enhance client outcomes and just create capacity for future growth?

Yes. I mean I'd put it in a couple of buckets. I mean the first one that comes to mind would be the developer productivity from an AI standpoint. It was a pretty straightforward intangible. We've referenced 30% to 40% productivity expected out of the developer community within State Street. And that comes from code generation, modernizing legacy code and as well as vulnerability assessments, which is increasingly an incredibly important capability to have in-house. And so that's the first leg of it. I think the second leg, when I think about the rest of the employee base. We've invested in this in a significant way recently. And so much so that the AI-enabled workforce that we track, which is not just day-to-day access to things like Copilot, but more sophisticated tools, has grown significantly. Over the last -- in just the last couple of quarters, I think we classified over 80% of our employees is being AI-enabled. And that's driving the ability to convert that into certainly more efficient knowledge retrieval, data extraction, analysis, et cetera. But it's playing out in products and client experiences as well. When you put in the -- example. So from a product standpoint, I would say our data intelligence product price stats is now -- has AI-enriched data incorporated in it. It helps anticipate inflation readings, increasingly important for our clients to think through. So that's AI-enabled from a product standpoint. And from other client experiences, I mean, we're a huge cash transaction processor, as you know, and we're bringing out a significant amount of manual interfaces where, whether it's sanction screening or reconciliations and auto matching, reducing manual interventions so it increases controls and speed of delivery for clients. So that's very exciting. And maybe the last thing I'll close it out with is we did launch our agentic platform internally earlier this year. That plus the end-to-end process redesign work that we're doing in the transformation space, that's underpinning the confidence in that transformation journey as well. So it's a -- our transformation journey is process-led, but it is AI-enabled.

Got it. When we look at the market backdrop, we've seen a mix of market volatility, changing rate expectations, dynamic equity markets. I guess as we sit here today, how does the operating environment compared to our expectations coming into the year? And what are you watching most closely as we head into year-end?

Yes. I mean, well, things changed a fair bit. When we were thinking about things at the end of '25 or early '26, just equity markets were around 6,800, 6,900. Our assumptions today, if you fast forward, are more like 7,600, 7,700 is end of August, where you look out the window here, it's about where what our assumptions are for the rest of the year. So that's changed a lot. And I think outlooks from Street firms, which I think kind of get updated, might even imply 8,000, but our assumption is 7,600, 7,700 in the equity markets. I've got to jump to the rate markets again. So earlier in the year, I think we were thinking about cuts. And you fast forward to where we are today where there may be as many as 3 or 4 cuts -- I'm sorry, hikes incorporated into the outlook for the Fed. And it's not just the Fed, the ECB is in a similar place. I think we had ECB on hold this year, and they've already hiked once. And I think there's 3 more hikes in the outlook even for the ECB. So I think the idea that we would be continuing on the easing cycle has really pivoted to more of a higher for longer outlook, not just -- and not just on the short end. I mean I think the -- we had the 10-year coming in probably 1,025 or so -- I'm sorry, 425 or so, at the end of '26, and it looks like that's over 5% today. So very different backdrop when it comes to the equity markets and rates. But I would say that those things tend to be tailwinds for us. I mean higher equity markets, if you add in higher rates, we're asset sensitive, both within the U.S. and in Europe and outside the U.S., generally. And I'd also add that a lot going on that we're keeping an eye on for the rest of the year, volatility, midterms, keeping an eye on what's going on with geopolitics and all of that stuff. But the higher volatility tends to be somewhat of a tailwind for us as well. So kind of a constructive outlook for the rest of the year.

You know the next question. In July, right, you raised your outlook for 2026 following strong performance in the first half of the year. We're getting closer into the third quarter against the backdrop you're discussing. Just any thoughts on how the business is tracking relative to your expectations?

Yes. I mean pretty good momentum there. I mean things playing out very well, and I'll make a few comments about where we're seeing this come out. Just from a headline standpoint when I think about fee revenues, I think we're going to see that come in basically a little better than where we had 2026 before. So maybe something along the lines of 13% to 14% range versus the original 12% to 13% from a fee standpoint. NII, we had it originally at around 14% to 15%. I think we're going to see that coming in towards the upper end of that range. And so feeling very good on the revenue story. Expenses come in slightly higher in reaction to some of that revenue and other factors. And when you put all that together for the year, I think we -- in July, we mentioned that we would come in around 500 basis points of operating leverage. That probably plays out to be slightly higher based upon those forces from a 2026 standpoint. Maybe just what we're seeing in the quarter, I could add to that. I mean in the quarter, I'd say that a good way to think about it is pretty stable quarter-over-quarter and somewhat across the board. So whether it's fees, NII or expenses, you could kind of look at 3Q versus 2Q, seeing stability there. And a couple of themes on the fee side of things, I'm doing a little better in the servicing and management fee space, maybe as an offset to some moderation in the markets business. And those are a continuation of expectations that we had in July. And then as I mentioned, stability on the expense side of things. And I articulated that 2Q was 10 quarters in a row of positive operating leverage and 3Q is going to be the 11th. Very excited about that and feeling good about the outlook there.

A lot to unpack. Let's start on [ NII ], continue to outperform expectations. Maybe delve in a bit and just talk about deposits, what you're seeing there and just kind of what gives you confidence in the durability of the trends we've seen, and maybe just the most importance of drivers of NII performance this year and just how you're thinking about coming into next year.

Yes, just maybe unpack that, starting with balance sheet, and interest-earning assets tends to grow highly correlated with deposit growth. And so we saw pretty strong deposit growth in the second quarter versus the first quarter and articulated an expectation of deposits being in the neighborhood of $270 billion for the year. I mean, I think that's still a pretty good number. That does imply growth in the second half compared to the first half. And we're seeing good trends in the deposit portfolio, that really allows us to think about interest-earning asset growth in '26 being a tailwind for NII. And so that's one -- that's really the main driver and contributor to the upper end of the range of getting closer to 15%. Net interest margin is going to be range-bound, in the 110 to 115 basis point range. And so those are some of the, I think, forces you'll see play out that are supporting that upper end 14% to 15% from an NII standpoint. And broadly, the expectation over time and over the medium term is for some -- that growth to continue on the interest-earning asset side of things and for net interest margin to really migrate towards the higher end of that 110 to 115 range over the medium term.