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Morningstar | State Street Focusing on Expenses as an EPS Lever

Wide-moat State Street reported second-quarter results that continue to highlight the revenue challenges for the custody banks. Total revenue came in at $2.87 billion, a decline of 2% sequentially and 6% from the year-ago period. Fee revenue was flat sequentially and down 6%, while net interest income was down 9% sequentially and 7% year over year. The firm revised its guidance in June, so the decline in net interest income was expected. Given these revenue challenges, State Street is using expenses as a lever to drive earnings growth and increased its estimated savings from expense initiatives. Overall, the firm’s non-GAAP net income declined 28%, and return on tangible equity finished at 15.8% for the quarter.

Digging deeper into fee revenue, asset-servicing fees were flat sequentially as fee pressure offset higher client flows and activity and the firm is expecting this flat sequential trend. Assets under custody or administration were flat compared with the first quarter at $32.8 trillion, as equity markets offset the near completion of a previously announced client transition. Fee pressure continues to be a theme. State Street expects fee pressure of 4%, similar to 2018 and above the historical range of 1%-4%.

Investment management fees did benefit from higher equity markets. Securities finance revenue and foreign exchange trading services revenue both dropped double digits year over year because of balance sheet repositioning and lower volatility, respectively.

State Street’s net interest margin declined to 1.38% from 1.46% in the second quarter of 2018. On the asset side, a tighter yield curve hurt reinvestment yields. As expected, State Street saw a mix shift from non-interest-bearing deposits to interest-bearing deposits. The overall level of the firm’s deposits was roughly flat year over year. State Street expects a 1%-3% decline in the third quarter, much less dramatic than the 9% sequential decline in the second quarter.

Excluding seasonality, notable items, and acquisitions, expenses were flat sequentially and up 2% year over year. State Street is implementing additional expense initiatives for 2019 and now expects $400 million (versus $350 million previously) of in-year savings from these initiatives. State Street’s headcount is down 2% year to date, and the company is focused on automation to increase savings.