State Street continues transformation into outsourced trading hub as interest rates ding Q3 profits

October 16, 2020.

Boston-based said Friday that it is continuing to cut expenses and is focusing on increasing fee revenue amid low interest rates as the bank forges ahead on pivoting its business from primarily fund servicing to being an enterprise outsource provider for trading operations.

CEO Ron O’Hanley said in a conference call that the strategy, driven primarily by technology and software, is following a trend of investment managers, asset owners and sovereign wealth funds “really taking a hard look at their operating model.”

“What we’re positioning ourselves strategically for is that as these operating models need to be overhauled, we want to be the enterprise outsourcer that is doing it for them, taking on as much as we can on the front, middle and back office,” O’Hanley said.

State Street first unveiled its plans to provide outsourced trading last year, shortly after completing its acquisition of data and analytics provider Charles River Systems.

O’Hanley said it will likely take a while for the outsourcing revenue to be realized, but it will likely begin showing up in future quarters.

“These things take longer because … you’re actually working with the management company on overhauling the way they work, the way they invest, the way they employ data, the actual tools that they’re going to be using, the actual tools they’re not going to be using,” he said.

O’Hanley said it’s too early to start talking how much of the firm will end up dedicated to enterprise outsourcing.

“We haven’t really thought about that,” he said. “But … you should expect to see it be a higher and higher percentage of what we do.”

O’Hanley said, though, a part of State Street’s business will always be as a traditional custodian bank.

“Ultimately, as long as you believe that investment markets are going to continue to function and grow, what we do will still be there,” he said.

State Street’s expenses continued to fall in the third quarter, down 4% year over year to $2.1 billion. A 26% year-on-year decline in net interest income and 28% decline in securities finance revenue, though, brought total revenue down 4% to $2.8 billion, for a profit of $555 million in the third quarter — down 5% year over year.

A bright spot, however, was State Street’s fee revenue, which saw a 2% year-over-year increase to $2.3 billion in the third quarter. Software and processing fees saw particularly strong growth, up 21% year over year to $172 million.

State Street also saw a 7% year-over-year increase in assets under management in the third quarter, totaling $3.1 trillion.

“We are successfully executing on our strategy to improve State Street’s financial performance and create shareholder value, all the while temporarily holding elevated capital well above our regulatory requirements,” Chief Financial Officer Eric Aboaf said.

State Street is required to have a common equity Tier 1 ratio of 8%, but in the third quarter the ratio was 12.4%.

Though the U.S. Federal Reserve restricted banks from initiating share repurchases through the end of the year, O’Hanley and Aboaf both said they are confident in State Street’s capital position and will consider a “full range” of capital return actions in the coming months. 

Aboaf said guidance for 2021 won’t be available until January, but he expects State Street to continue cutting costs and reinvesting in various parts of the business in order to drive efficiency and productivity.

In the first nine months of 2020, O’Hanley said productivity investments have led to gross savings of 5% compared to 2019’s total expense base.

O’Hanley added, though, that the firm has “been very clear” that reinvestment “is not a one-and-done kind of thing.”

“Sure, there’s some tactical things that if they’re there and low-hanging fruit, you grab at it,” he said. “But we’re on a sustained program to transform our business. Much of it is around productivity improvement. … You should expect us to be thinking about this and implementing this on an ongoing basis."