State Street Corporation

Good morning and welcome to State Street Corporation's second quarter 2019 earnings conference call and webcast. Today's discussion is being broadcasted live on State Street's website at investors.statestreet.com. This conference call is also being recorded for replay. State Street's conference call is copyrighted and all rights are reserved. This call may not be recorded for rebroadcast or distribution in whole or in part. without the expressed written authorization from State Street Corporation. The only authorized broadcast of this call will be housed on the State Street website. Now, I would like to introduce Eileen Cissell-Buehler, Global Head of Investor Relations at State Street. Thank you, Operator. Good morning. Thank you all for joining us. On our call today, our CEO, Ron O'Hanley, will speak first. Then Eric Abloff, our CFO, will take you through our second quarter 2019 earnings slide presentation, which is available for download in the investor relations section of our website, investors.statestreet.com. Afterwards, we'll be happy to take questions. During the Q&A, please limit yourself to two questions and then re-queue. Before we get started, I would like to remind you that today's presentation will include results presented on a basis that excludes or adjusts one or more items from GABS. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation. In addition, today's presentation will contain forward-looking statements. Actual results may differ materially from those statements due to a variety of important factors, such as those factors referenced in our discussion today and in our SEC filings, including the risk factors in our Form 10-K. Our forward-looking statements speak only as of today, and we disclaim any obligation to update them, even if our views change. Now, let me turn it over to Ron.

Thanks, Eileen, and good morning, everyone. Turning to slide three, you will have seen we announced our second quarter financial results this morning, reporting second quarter EPS and ROE of $1.42 and 10.1% respectively. Relative to the year-ago period, our results reflect challenging industry conditions, including client pricing, global industry outflows, and volatile interest rates, as well as weaker international average market levels. When compared to the first quarter, our results stabilized somewhat and were supported by market tailwinds within our asset servicing and investment management businesses, as well as a slight seasonal uptick within our markets business. Assets under custody and administration reached $32.8 trillion, and we are encouraged by strong new wins in the quarter of $390 billion, with assets yet to be installed at $575 billion. At global advisors, assets under management increased by 4% quarter-on-quarter to $2.9 trillion, supported by higher period-end equity market values as well as institutional client wins and cash inflows. At CRD, we are encouraged by our first front-to-back investment service client agreement and six additional exclusive discussions that are in advanced negotiations. At the same time, the pipeline continues to grow as evidenced by another quarter of increasing client engagements. Following our strong performance under the 2019 CCARS Trust Test, we anticipate increasing our common dividend by 11% in the third quarter, while conducting 2 billion of share repurchases through the second quarter of 2020, as our proactive balance sheet actions in 2018 contributed to our ability to return an increased level of capital to shareholders. We continue to believe our front-to-back strategy positions us well for success in the medium and long term. And while we may currently be seeing some stabilization in servicing fees, we have not yet returned to growth. As such, we will be updating and sharpening our core business strategy, as well as conducting a fundamental reassessment of our technology ecosystem. We have established teams to focus on reinvigorating revenue growth accelerating the simplification of our operations model, and reducing non-personnel expenses. At the same time, we continue to act with urgency on the things we can control while fostering a culture of execution and productivity, with reinvigorated attention to delivering industry-leading client service. I believe we are making progress in these areas. For example, Disciplined expense management continues to be one of my top priorities. The firm-wide hiring freeze for all non-critical roles outside of CRD has been very effective. Year to date, we have already reduced high-cost location headcount by more than 1,800 staff and expect that as a result of our actions, we can increase that number to 2,300 by year end. Process automation efforts are in full gear, allowing us to decrease headcount while delivering even better service and outcomes for our clients. Furthermore, year-to-date, the $350 million expense savings program we announced in January 2019 has already achieved just over $175 million in total year-over-year savings, and we are now increasing our targeted expense saves under the program by an additional $50 million to $400 million for 2019. Our focus right now is finding better ways to reignite revenue growth and generate additional expense reductions while driving sustainable improvements in our operating model. This means addressing and surmounting the wave of asset manager pricing pressure, completing our executive client coverage rollout, using the increased capacity we have achieved for balance sheet optimization to restart growth in securities lending and trading, and leading in alternatives and ETF servicing, where we are second to none. Our vision remains becoming the leading asset servicer, asset manager, and data insight provider to the owners and managers of the world's capital. I am confident we are strategically aligning the organization with the fastest-growing and most attractive client segments but we must continue to find ways to better serve these and all of our clients in a more holistic and scalable way. We have to continue to innovate and by doing so grow more diversified revenue streams. We must continue to reduce complexity across our operating model for increased automation and by simplifying our technology stack while reengineering our client and organizational processes in order to drive efficiencies while delivering industry-leading client service. There are a number of areas we are examining, such as leveraging our IT partners to create better technology outcomes at lower cost. We also have an opportunity to leverage process improvements and expertise within our global hubs to drive further efficiencies while being constantly focused on resource discipline. As we drive these initiatives forward, I and my team will provide strategy and progress updates in the fall, including a reassessment of our technology plans. And with that, let me turn it over to Eric to take you through the quarter in more detail.

Thank you, Ron, and good morning, everyone. Let me start on page four. On the top left panel, we show our gap results as well as certain results, notable items, and seasonal expenses for those of you who want to see some of the underlying trends. On the right panel, we summarized notable items, including $12 million pre-tax or $0.03 per share in 2Q19 of acquisition and restructuring costs, primarily related to Charles River. Turning to slide five, we saw period and AUCA levels decline 3% year-on-year and remain flat quarter-on-quarter. The quarter-on-quarter move in AUCA was driven by the impact of the previously announced BlackRock transition, partially offset by higher spot market levels. In regards to the BlackRock transition, please note that the 2Q19 saw the departure of approximately $450 billion of fund-to-fund AUCA, which was part of the previously announced deconversion and had no material revenue impact this quarter. AUM levels increased 7% year-on-year and 4% quarter-on-quarter to a record $2.9 trillion, driven largely by higher equity market levels and institutional wins. 2Q19 saw inflows of approximately $20 billion, the second sequential quarter of positive flows, and were driven by institutional wins in cash. Moving to slide six, servicing fees were down 9% year-on-year, but flat quarter-on-quarter. While challenging industry conditions persist, the pace of the quarter-over-quarter servicing fee pressure moderated somewhat during 2Q19. Unpacking the drivers of 2Q's flat sequential quarter results, we estimate that market levels were a 1% tailwind, flows and client activity taken together with net new business were a slight positive, while client pricing was less than a 1% headwind. We are pleased that the actions we have taken since late last year are having some impact. These include the rollout of our new client coverage model, which has opened up more share of wallet opportunities. and our newly formed Pricing Review Committee has strengthened discipline, leading to some moderation this quarter, which we expect to continue for a couple quarters. Nevertheless, as Ron mentioned, we are not satisfied with these servicing fee results and recognize that we need to do more to restart fee growth. On the bottom left panel of this page, we added some AUCA sales performance indicators to provide a little more texture to our servicing fee dynamics. As you can see, AUCA wins total $390 billion in 2019, up significantly on a quarter-on-quarter and year-on-year basis, while at the same time, our AUCA to be installed this past quarter was also up to $575 billion. While we're encouraged by these sales performance indicators, we also know that we need to maintain similar such momentum going forward. I would add that Charles River continues to help drive our investment servicing client dialogues, and we are excited about our first agreement to provide front-to-back investment servicing for Lazard Asset Management. More on that in a few minutes. Turning to slide seven, let me discuss the rest of our fee revenues. Beginning with management fees, 2Q revenue was down 5% year-over-year, driven by the ongoing impact of the late 2018 outflows and mixed changes away from higher fee products, partially offset by higher equity market levels. Quarter-on-quarter management fees were up 5%, driven by higher equity market levels, day count, and $20 billion of net inflows. FX trading was down 13% year-on-year and 3% quarter-on-quarter, mainly due to lower market volatility. Securities finance revenues were down 18% year-on-year, largely reflecting the CCAR-related balance sheet optimizations made in the second half of 2018. but up 7% quarter-on-quarter due mainly to seasonal activity. In regards to the CCAR-related business actions taken last year, we've now made some trade structure changes to mitigate the CCAR counterparty limitations and are confident that we are creating room for incremental capacity for growth going forward. Finally, processing fees were up year-on-year, reflecting approximately $86 million in revenue contribution from CRD. Quarter-on-quarter processing fees were down 12%, driven by the absence of prior quarter one-time items and lower revenue recognition in CRD. Moving to slide 8, you'll see in the top left panel a summary of CRD's operating performance in 2Q19, generating $91 million of revenues on $46 million of operating expenses, resulting in $45 million of pre-tax income. The business also saw $31 million in new client bookings during the quarter, including significant bookings from our asset management and asset servicing units, which will drive important deal synergies. While CRD continues to perform well, I would remind you of the lumpiness inherent in the 606 Revenue Reporting Standard and to not read across any one quarter's results. Turning to the upper right panel on this page, we wanted to again provide you an update on our active client discussions. As you can see here, our client discussions continue to advance. We're now actively engaged with approximately 140 clients representing approximately $40 trillion in assets. As anticipated, these dialogues are resulting in a variety of revenue opportunities, and we remain confident in the revenue and cost synergy goals announced at the time of the acquisition. On the bottom two panels of the page, we've also listed some of the growth and synergy milestones achieved this quarter. As I mentioned earlier in the call, Our new front-to-back agreement with Lazard Asset Management is an important milestone and reflects the sort of new growth opportunities envisioned when we acquired CRD. We currently have a strong front-to-back pipeline and are currently in exclusive negotiations with several clients and expect more announcements to come. Turning to slide 9, NII was down 7% year-on-year and 9% quarter-on-quarter, with our NIM declining 8 and 16 basis points respectively. In regards to NII, the decline on a sequential basis was primarily driven by the level of mix for deposit balances, as well as our lower long-end rates that resulted in higher than usual MBS premium amortization and lower reinvestment yields. In terms of client deposit behavior this quarter, as expected, we continue to see a mix shift out of non-interest-bearing deposits in an amount similar to what we saw in the last quarter and much of the quarterly rate in 2018. At the same time, we would note that our average total deposits were up slightly quarter-on-quarter as we saw some lift from our deposit initiatives, though some came at higher rates. In terms of our balance sheet priorities going forward, we have a series of additional deposit initiatives underway, including efforts to drive diversity of our deposit base and ongoing client-share while discussions to drive deposit balance growth. These initiatives supported our average total deposit balances this quarter, and we're confident that there are incremental opportunities available going forward. And on the earning asset side, we continue to target careful growth in client lending while modestly increasing the size of our investment portfolio. Now turning to expenses. As Ron emphasized in his remarks, we continue to be laser-focused on expense management in this challenging revenue environment. and we're executing on a number of expense initiatives designed to generate durable efficiency and productivity gains every year. On slide 10, we've again provided a view of expenses this quarter, X notable and seasonal items, so that the underlying trends are readily visible. Year-on-year, our underlying expenses excluding notable items and seasonal deferred compensation were up 2%, but down 1% excluding CRD and flat quarter-on-quarter. As you can see, this result was again achieved across almost every major line of the expense base with information systems and communications, where we continue to make technology infrastructure investments effectively the only expense line that saw material growth XCRD. The hiring freeze implemented earlier this year, combined with the ongoing reduction in our senior ranks, has also resulted in two consecutive quarters of total headcount declines, with our total headcount down 1% quarter-on-quarter and 2% year-to-date. We are now harnessing the benefits of previous automation initiatives across more and more operational processes while we deliver higher and higher service quality. Moving to slide 11, we are pleased with how we turned the corner on expenses over the last year and to provide more color on where we've realized expense reductions to date and where we see incremental opportunities going forward. Starting with the stack bar charts on the left, we've provided a view of our underlying expenses categorized by IT, operations, as well as business segments and corporate functions. As you can see, due to our cost management efforts for 2019, we expect to achieve year-on-year expense declines in two of these three segments, with significant efficiencies realized in operations, as well as reductions in our business and corporate functions. That said, the growth in our IT cost is currently too high, and as Ron mentioned, we have embarked on a top-to-bottom review of our technology cost structure. We see an opportunity to intervene on our technology infrastructure costs while investing in core business functionality and continuing to invest in resiliency. Turning to the right-hand side of the page, with the various resource discipline and process reengineering initiatives we have underway, we expect to continue to see headcounts come down over the coming quarters and believe that we can further reduce our high-cost location headcount by an additional 800 beyond our target to a total of approximately 2,300 in 2019, albeit while delivering quality service as we automate processes. We are committed to simplifying our operations and technology model. We currently support an application-intense IT architecture, which we need to consolidate with a goal of driving cost reduction. including an initial rationalization of 10% of our applications globally by the end of this year. But we believe there is more that we can do. We are now ruthlessly assessing every development program against strict payback criteria while investing in client functionality. Taken together, we now see our 2019 expense plan yielding an additional $50 million in savings by the end of 2019. totaling $400 million for the year and resulting in a 1.5% reduction in our underlying expense base year-on-year, excluding notable items in CRD, as compared to the 1% target identified earlier this year. Moving to slide 12, our capital ratios were again largely consistent quarter-on-quarter, with our standardized set 1 sitting at 11.4% and our Tier 1 leverage at 7.6%. We returned a total of approximately $475 million of capital to shareholders during the quarter, $300 million of which were share buybacks under our remaining authorization from the last CCAR cycle. On the left side of the page, you can see that we consciously rebalanced our investment portfolio in 4Q18, and we're now holding a relatively higher percentage of HVLA, which has created significant CCAR stress capital capacity. As you are aware, we are pleased with our 2019 CCAR results released last month and expect to increase our dividend to $0.52 per share beginning third quarter and to repurchase an incremental $2 billion of common stock through Q20, thus delivering on our priority to significantly increase capital return to our shareholders. I would note that we are confident in our capital position. And as proposed changes to the leverage ratio rules are finalized, we anticipate sharing a more fulsome perspective on our capital position and any associated optimization opportunities going forward. Before turning to slide 13, I'd like to cover our third quarter outlook. On a sequential quarter basis, we expect servicing fees will be flattish and management fees will be up low single digits. This assumes current equity index levels While markets' revenues are always difficult to forecast, we currently expect them to take a seasonal step down quarter over quarter given the summer months, similar to what we experienced last year. Processing fees and others are expected to be down sequentially, but still within our quarterly guidance of 70 to 80 million ex-CRD, with CRD expected to be in the low 80s. In regard to NII, given the expectation of lower long rates, continued rotation of deposits into interest-bearing, and two rate cuts, we currently expect sequential quarter NII to be down 1% to 3%. And turning to expenses, we expect expenses X notable items to be flat on a sequential quarter basis, including the CRD build. Finally, we expect to see the tax rate between 19% to 20%, similar to our year-to-date tax rate. Moving to our summary on page 13, While we remain unsatisfied with our revenue performance, we did see some moderation in servicing fee headwinds that helped result in flat total fee revenues quarter-on-quarter. Moreover, the underlying expense reduction we've achieved to date demonstrates our ability to further bend the cost curve as we've now reduced headcount 2% year-to-date while also raising this year's expense savings target to $400 million. And we achieved a non-objection to our 2019 CCAR submission and will be able to deliver on our priority of increasing capital return to shareholders. Finally, as Ron noted in his opening remarks, we will be providing updates on our current business strategy and the results for our technology reassessment. We look forward to coming back to you in the fall with our progress. And with that, let me hand the call back to Ron. Thanks, Eric.