State Street Corp (XLF) Q3 2022 Earnings Call Transcript

Good morning, and welcome to State Street Corporation Third Quarter 2022 Earnings Conference Call and Webcast. Today’s discussion is being broadcast 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 Ilene Fiszel Bieler, Global Head of Investor Relations at State Street.

Good morning and thank you all for joining us. On our call today, our CEO, Ron O’Hanley, will speak first. Then Eric Aboaf, our CFO, will take you through our third quarter 2022 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 requeue. 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 GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP or regulatory measure are available in the appendix to our slide presentation, also available in the IR section of our website. 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 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.

Thank you, Ilene, and good morning, everyone. 2022 continues to unfold like no other year in recent memory, with the challenges faced today arising partly out of, but acutely different from, those the world faced in 2020 during the onset of the COVID-19 pandemic. And while the global operating environment continues to be very challenging, our third quarter results clearly demonstrate the resilience of our business model and our focus on maintaining and further improving State Street's pre-tax margin, which was a solid 29% in the third quarter, excluding notable items. During the third quarter, financial markets were negatively impacted by the adverse effects of the ongoing war in Ukraine and several macroeconomic headwinds, including continued price and wage inflation, dramatically higher interest rates, significant U.S. dollar strength, and heightened fears of a global recession. These factors collectively drove heightened uncertainty which contributed to meaningful declines in both global equity and fixed income markets, as well as increased market volatility, which in turn impacted flows. We continue to carefully navigate the business for this environment. While the operating climate created a number of fee revenue headwinds for our business in the third quarter, the savings and efficiency of our Alpha and enterprise outsourcing offerings make our value proposition even more attractive to asset managers and asset owners in the current market and inflationary environment. We maintained a solid balance sheet and strong capital position, delivered significant NII growth as well as healthy FX trading revenues, and remained laser-focused on intensely managing what we can control as demonstrated by our expense management. Turning to Slide 3 of our presentation, I will review our third quarter highlights before Eric takes you through the quarter in more detail. Starting with our financial performance, third quarter '22 EPS was $1.80 or $1.82, excluding notable items, compared to $1.96 or $2.00, excluding notable items in 3Q '21. Double-digit year-over-year declines in average global equity market values drove most of this decrease. Total fee revenue for the third quarter declined 8% year-over-year, primarily reflecting the impact of significantly lower global equity and fixed income market levels on servicing and management fees as well as the stronger U.S. dollar...

Thank you, Ron, and good morning, everyone. I'll begin my review of our third quarter results on Slide 4. We reported EPS of $1.80 or $1.82, excluding acquisition and restructuring costs, as detailed in the panel on the right of the slide. As you know, the operating environment in the third quarter remained challenging, with persistent market volatility related to ongoing geopolitical tensions, inflationary pressures, rapidly rising interest rates, and concerns about the global economy. Despite these challenges, as you can see on the left panel of this slide, strong growth in both net interest income and our FX trading services business enabled us to partially offset the significant headwinds from lower equity and fixed income markets in the quarter. Additionally, we continue to demonstrate prudent expense management in the third quarter even as we experienced ongoing price and wage increases, while we continue to invest in the franchise...

Thanks, Eric. Operator, let's open the line for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. We will take our first question from Glenn Schorr with Evercore. Your line is now open.

Hi, there. So maybe just a wrap up question on BBH, and I appreciate all the transparency along the way, but regulators would hate it, more complex, market values have fallen. I definitely went with you on the strategic merits. But I guess the question people have is why not just walk away? It seems like you could do some really creative stuff with the capital now. And at what point do you just say, not worth it, not as good creatively, too complex, enough said?

Glenn, it's Ron. Maybe needless to say, we go through that calculus that you're describing every day. And that's part of what led to this. Obviously, the regulatory environment is driving the timeframe here. But what's driving our work is that tradeoff, the tradeoff between the opportunity to consolidate on a global basis a very attractive firm versus what's the alternative uses of the capital, including returning it back to shareholders. We believe there's still the possibility that we can structure this transaction in a way that it will work out for shareholders and achieve that strategic objective. But as we've said in the disclosure, the likelihood of that happening is going down. So I think what you can take away from this is one of the reasons that's driving that decreased probability is the calculus that you're describing.

Glenn, it’s Eric. We’ve carefully considered what portion of the investment portfolio move to held to maturity and in what amounts. But we do as we make that consideration is the benefit is that you largely don't give up NII, right? By and large, you're earning the coupon on whether they're treasuries or agencies or MBS, just in a different accounting form and structure, but the earnings of the corporation are the same and that's what's quite attractive about HTM...

Hi, good morning, guys. I wanted to come back to putting the deal into context with the buyback that you announced, which you would have been clearly saying you'd want to get back into the buyback this quarter. So can you just help us understand the $1 billion sizing and if that has anything to put in context with your thoughts around how the pricing and eventual outcome if the deal goes through might end up coming through? Or is it completely separate and just based on where capital sits regardless of the deal outcome?

Ken, it's Eric. As I said in my prepared remarks, the buyback was larger than anticipated. And part of that is we do two things. We look at our current capital levels, which have trended towards that 13% CET1 mark that we had guided to. Remember that discussion we had in the first quarter. And then because partly as we consider the capital uses over the next couple of quarters, including the possibility of the Brown Brothers Investment Services transaction. You would expect us to factor in any downward adjustments or purchase price that we would expect, and that's effectively what we've done.

Hi, Ron and Eric. Good morning, guys. I was hoping we could speak a little bit more broadly around State Street's capital allocation strategy. If BBH does not go through, what's your appetite for any other deals, whether it's in the services space or asset management space? Obviously, macro conditions are pretty volatile. So I'm sure that'll impact that as well. But curious how you are thinking about the tradeoff between the accelerating buyback or other deals?

Yes, Alex, why don't I begin on this just on how we think about M&A? It's not like we have a shopping list here. BBH is a unique opportunity to consolidate the market on a global basis. And by that I mean it's not just about adding to some particular geography, but it really does bolster us in all the major geographies that we're in. Having said that, we've got our own what we believe is a distinctive, organic strategy in the servicing area, led by our Alpha proposition, which continues to grow.

Good morning, Ron and Eric. Thanks for taking the questions. I'd like to ask on BBH. It seems somewhat unusual to be getting regulatory approval before the approvals within the company. So why is that happening? And given that there's risk of deterioration, loss of talent, customers, Ron you made reference to this during the last quarter call when you guys first said you were renegotiating. Would you have the ability to adjust price further if this process drags, or has that been set already?

Yes, on the approvals, our Board has been actively involved in this brand as has the BBH partners on their side throughout this process. So obviously, there was an approval before we announced this in September of '21. There's an ongoing consultation with our Board...

Thank you for that, Ron. My second question is a straightforward one. What makes this situation strategically compelling? It appears to be primarily a scaled deal, but it seems to have deteriorated. You mentioned earlier, Ron, that the expected accretion will likely take longer and be lower than initially anticipated. There also seems to be a lot of operational and legal complexity involved now. I understand you're reducing the price, but is this really the best use of our time and management's focus? Wouldn't it be wiser to acknowledge that the environment has changed, the regulatory approvals haven’t materialized, and the initial plan is no longer viable? Perhaps it would be better to step away from this.

Again, I'm probably repeating myself a little bit, Brennan, here but that's exactly what we ask ourselves every day. And you're right. It is taking a lot of management time. I think what's compelling about it is several things. One is its footprint. Many of the things that are out there or supposedly out there or rumored to be out there tend to be single geography kinds of things. And if you have a strong desire to be in that geography, maybe there's something useful there. I would describe at best tactical.

Hi. Good morning. So why don't I ask one clarifying question on NII. Some of your bank peers they've indicated 4Q exit rates could be close to the peak this cycle just as lag deposit pricing begins to catch up with rate hikes. You noted that the '23 NII Eric will be up nicely year-on-year. But do you see the potential for '23 NII coming in above that annualized 4Q level, suggesting that that fourth quarter NII guidance is not going to be representative of the peak?

I believe it's a bit early to delve into our forecasts for 2023. Let's observe how deposits change in the upcoming quarter. We need to see if the U.S. central bank and other central banks will be able to manage inflation effectively, which is crucial. The outcome is quite reliant on these factors. My optimistic outlook for 2023 stems from our expectation that the fourth quarter will not represent the peak for us.

Hi, afternoon. Thanks for taking my questions. I guess on BBH, I suppose it's been a while since we've gotten a financial update on the business and how it's performed in this volatile environment year-to-date. And clearly there's a possibility that we have a resolution that could not end up moving forward with the acquisition. So as we think about our models here and getting those kind of aligned with how BBH is performing, anything you can share on how the company has performed year-to-date?

Yes, we are closely monitoring the business performance on a monthly and quarterly basis. You can refer back to the materials we shared last September as a baseline, and consider what you've observed in our book of business. We operate as an asset management-oriented custodian, and if you compare us to some of our peers, you'll notice that many have experienced a significant increase in net interest income along with fees, driven by the types of programs they manage for their clients' cash. This growth is somewhat tempered by a decline in servicing fee rates in equity and bond markets.

This concludes today's question-and-answer session. I'll now turn the call back over to Ron O’Hanley for any additional or closing remarks.

Well, thank you, operator and thanks to all of you for joining us on the call.