EUR 850.00 For Business Accounts Only

Morningstar | State Street Announces Aggressive Cost-Cutting Measures in the Face of Steeper Pricing Pressures

Wide-moat-rated State Street reported, somewhat expectedly, uninspiring fourth-quarter results. The bank recorded a restructuring charge, assets under custody and administration as well as assets under management were both hit hard in the quarter, and servicing fees remained under pressure. Even so, despite a difficult quarter, rising interest rates did boost interest revenue. This, along with tax cuts, allowed the bank to grow net income 19% for full-year results. The return on equity was 12.2% for the year, an improvement over last year's 10.6%. Earnings per share were up 22%. The bad news is that we are expecting much less of a net interest income boost going forward, and we will have lapped the one-time benefit of tax reform. 2019 looks to be a much tougher year for the bank, and we believe the focus on expense reduction is the appropriate route to take. After updating our model with the latest results, we are decreasing our fair value estimate to $82 per share.

It was Ron O’Hanley’s first earnings call as CEO, and he wasted no time spelling out the market dynamics leading to fee compression within the industry. He cited the relentless pressure on asset managers, which affects them directly as State Street is a sizable asset manager. This also pressures State Street's asset management clients, who then look to State Street to help solve these issues via cheaper and more efficient solutions as an asset servicer. The bank is obviously feeling the pressure, and O’Hanley stated that he has instituted a hiring freeze. He also plans on flattening existing management layers, and plans to get rid of 1,500 employees, or roughly 6% of the total employee base. The bank took a $223 million restructuring charge in the quarter related to these initiatives. We have adjusted our forecasts to account for lower fee growth, along with decent cost control, as the bank tries to navigate this difficult environment.

The most disturbing piece of information from the call was that pricing pressures in the industry have roughly doubled, from State Street’s perspective. It is not clear to us when this trend of increased pricing pressure will abate. State Street did claim that they are getting larger portions of business and better deal terms, which should help offset some of the negatives, but overall it remains a challenging environment.

State Street has a more sizable equity exposure than some peers, and it showed as equity AUM was down 11.5% year over year, and 13.7% quarter over quarter. The bank also saw declining AUM within fixed income, alternatives, and multi-asset-class solutions, leading to total AUM being down 10% for the year. While we don’t think declines on this level will be the norm every year, we do believe the overall environment, particularly within equities, will remain challenging over the medium term.

It is a combination of all of the above factors that is leading us to be more conservative on State Street. We appreciate that management admitted they were overly optimistic in the past and are now adopting a more cautious stance, but nonetheless, we think caution within our projections is indeed the right approach to take. We are giving the bank very little credit for fee growth over the next five years, expecting growth of only 1% on average per year. This is not an optimistic projection, and we expect some market declines to occur in the medium term, which will help lead to this result. We do still expect some net interest income growth, and we are giving management credit for aggressive cost-cutting and do not project much expense growth over the next five years. This leads to a net income growth rate of roughly 4% per year, and some deterioration in returns on tangible equity.