STT - NYSE

Good afternoon, and welcome to State Street Corporation's Second Quarter 2025 Earnings Conference Call and Webcast. Today's call will be hosted by Elizabeth Lynn, Head of Investor Relations at State Street. Today's discussion is being broadcasted live on State Street's website at Investors statestreet.com. This 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 part or in whole without the express 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 hand the call over to Elizabeth Lynn.

Thank you, Ron, and good afternoon, everyone. Picking up on Slide 3. Before turning to our second quarter financial results, let me briefly walk you through the notable items we recognized this quarter. Notable items totaled $138 million pretax or $0.36 per share, primarily driven by a $100 million repositioning charge associated with our ongoing operating model transformation. This action relates to the severance of approximately 900 employees and as we noted in June, is expected to drive expense savings mostly in 2026 with a payback period of roughly 4 to 5 quarters. We also recognized roughly $40 million of notable items related to a rescoping of an alpha client contract along with a few smaller items as detailed on the slide. Turning to Slide 4. Excluding notable items, second quarter EPS grew a robust 18% year-over-year to $2.53 a share. Total revenue increased 9% and fee revenue increased 12% year-over-year, each excluding notable items, reflecting strong business momentum across the business. Expenses increased 6% year-over-year, excluding notable items. Approximately half of the year-over-year increase was driven by a combination of higher performance and revenue-related costs associated with the more constructive revenue environment in the second quarter and to a lesser extent, the unfavorable impact of currency translation. The remaining increase primarily reflects continued investments in the franchise, including technology and infrastructure. This performance enabled us to deliver meaningful fee and total operating leverage, 526 basis points and 241 basis points, respectively, excluding notable items. Accordingly, our pretax margin expanded to nearly 30%, while ROTCE was approximately 19% excluding notable items. Turning now to Slide 5. AUC/A reached a record $49 trillion, up 11% year-over-year, driven by higher period end market levels and client flows. AUM also reached a new record in the second quarter, increasing 17% year-over-year to over $5 trillion reflecting higher period end market levels and positive net inflows. Key market indicators reflected the dynamic operating environment in the second quarter, with higher period end market levels and elevated FX volatility across both developed and emerging markets. Against this backdrop, our markets business performed well, supported by record quarterly FX volumes as we help clients navigate a shifting market landscape, which I'll speak to in more detail shortly. Turning to Slide 6. Servicing fees increased 5% year-over-year, supported by higher average market levels, net new business, improved client activity and the favorable impact of currency translation. We were encouraged by the strong sales momentum in our Investment Services business this quarter, with $145 million of servicing fee revenue wins. These wins were well distributed across regions with key new mandates in Europe and North America and are closely aligned with our strategic priorities, particularly in core back office solutions and private markets. Installations progressed steadily and as expected during the quarter. Onboarding our $441 million of [ to be ] installed servicing fee revenue, the highest on record remains a key priority as we aim to drive consistent, sustainable servicing fee growth. In addition, we reported 2 new Alpha mandates representing $380 billion of our AUC/A wins this quarter. Our interoperable front-to-back Alpha platform remains a key enabler in deepening and expanding client relationships. Moving to Slide 7. Management fees increased 10% year-over-year, primarily reflecting higher average market levels and the benefit of prior period net inflows. For the quarter, net inflows totaled $82 billion, driven by solid performance across ETFs and institutional. In ETFs, we saw healthy inflows across the product set, including U.S. low-cost, gold, SPY and U.S. fixed income. Our U.S. low-cost offering achieved continued market share gains in the quarter, reflecting the strength of our strategic positioning in this segment. As Ron noted, the market volatility in the second quarter further highlighted the deep liquidity of State Street Investment Management's ETF franchise, which led the industry in U.S. ETF trading volumes. In our institutional business, we delivered a record $68 billion of quarterly net inflows driven by continued momentum in retirement, including our strategically important U.S. defined contribution business. Overall, we were pleased with the strong performance of our investment management business in the second quarter, which generated a pretax margin of approximately 33%. Turning now to Slide 8. FX trading revenue increased 27% year-over-year, excluding notable items. This strong performance was driven by record client volumes with solid activity across our trading venues, reflecting heightened FX volatility in the quarter. Securities finance revenues increased 17% year-over-year, with strong balanced growth across both agency lending and prime Services. Within our prime services business, fee revenue increased 29% year-over-year, supported by higher balances and continued momentum in client engagement. Moving to Slide 9. Software and processing fees increased 19% year-over-year in the second quarter, excluding notable items. Front office software and data revenue increased 27% compared to the prior year quarter, excluding notable items. This strong performance was primarily driven by higher on-premises renewals, largely associated with CRD wealth clients. In addition, software-enabled and professional services revenues increased 10% year-over-year, excluding notable items, reflecting continued momentum in SaaS client conversions and implementations. We are pleased with our ongoing success in transitioning clients to our cloud-based SaaS platform with annual recurring revenue increasing by approximately 10% year-over-year to $379 million in the second quarter. Moving to Slide 10. Net interest income of $729 million was down 1% year-over-year, primarily due to the impact of lower average short-end rates and changes in deposit mix. These headwinds were partially offset by continued loan growth and securities portfolio repricing. On a sequential basis, NII increased 2% supported by growth in non-U.S. deposit balances, securities portfolio repricing and loan growth, partially offset by the impact of lower average short-end rates. As detailed on the right of the slide, the average balance sheet size expanded relative to 1Q driven by a 7% increase in average deposit balances. The sequential increase in average balances was partly a reflection of the more uncertain macro backdrop that we observed early in the quarter, which moderated through May and June. We remain committed to supporting our clients with our strong, highly liquid balance sheet. Looking ahead, while we expect deposit balances to remain somewhat elevated relative to our expectations coming into the year, we do anticipate that balances will continue to moderate over the coming months and quarters subject to market conditions. Turning to Slide 11. Expenses increased 6% year-over-year, excluding notable items, as I mentioned earlier. Compensation-related costs were up 7% year-over-year, excluding notable items, mainly reflecting higher performance-based costs and the impact of currency translation, while total headcount was down slightly. Information systems and communications expense increased 11% year-over-year, excluding notable items, as we continue to invest in technology and infrastructure to modernize our platforms while enhancing data delivery and user experience. At the same time, we continue to execute on our productivity and optimization savings initiatives, which generated over $150 million in year-over-year savings during the quarter. Year-to-date, these efforts have delivered approximately $250 million of savings towards our $500 million full year target. Our ability to consistently generate productivity and optimization savings reflects the intense work of recent years and is a key enabler of strategic investment fueling technology modernization, supporting revenue growth and helping us drive 6 consecutive quarters of positive operating leverage, excluding notable items. We expect the repositioning actions taken in the second quarter to build on this momentum and support the continued transformation of our operating model in the quarters and years ahead. Moving to Slide 12. Our capital and liquidity levels remain strong, enabling us to continue supporting our clients as we look ahead. As of quarter end, our standardized CET1 ratio of 10.7% was down approximately 30 basis points from the prior quarter. Risk-weighted assets increased approximately $8 billion from the prior quarter, reflecting growth in our lending and securities finance businesses as well as higher volumes and volatility in our FX trading business. The LCR for State Street Bank was a robust 136% in the quarter. Capital return increased to $517 million during the quarter, consisting of $300 million of common share repurchases and $217 million in declared common stock dividends for a total payout ratio of 82%. As Ron noted, following our strong performance in this year's Federal Reserve stress test, we also announced our intention to increase our first year quarterly common dividend by 11% in 3Q, subject to Board approval. Looking ahead to the second half of the year, we continue to expect a progressive cadence of common share repurchases, targeting a total payout ratio of approximately 80% for 2025. In summary, we are encouraged by our second quarter and first half results, which highlight our ability to execute on our strategy, driving sustained business momentum while delivering positive fee and total operating leverage, excluding notable items. With that, let me turn to our improved full year outlook, which as a reminder, excludes notable items and remains subject to significant variability given the current economic and geopolitical environment. Over the first half of 2025, we have demonstrated our ability to drive sustainable growth across our core businesses. Given this strong performance, plus the current more constructive market environment and the anticipated impact of currency translation, we now expect 2025 total fee revenue growth in the 5% to 7% range, which is an improvement to our prior 3% to 5% full year outlook. We expect full year NII to be roughly flat to last year's record performance, with the potential for some variability driven by global monetary policy and changes in deposit mix and levels, which are difficult to predict. With our improved revenue expectations, full year expense growth is now expected to be roughly 3% to 4%, up from our prior full year outlook of 2% to 3%, reflecting higher revenue-related costs as well as expectations of a negative impact from currency translation. And importantly, we continue to expect to generate both positive fee and total operating leverage this year. And with that, operator, we can now open the call for questions.

[Operator Instructions] Our first question will come from Ken Usdin with Autonomous.

And Ken, it's Mark. Maybe I'll just add to that just to make sure. This is -- it was very contained to a software client contract rescoping, so it had no impact on the servicing fee revenue to be installed, did not have an impact on our assets to be installed that was very contained, as Ron said, to one particular aspect of a software agreement, which we renegotiated and took the appropriate kind of actions on our -- that we've talked about here [indiscernible] notables.

Our next question comes from Glenn Schorr at Evercore.

Maybe we could step back and ask just a big picture question of NII that feels a little different for you guys. And you've been consistent in talking about something in the range of flat year-on-year after good '24. But feels like the NIM has moved lower more so than others and balances, your thought process on moderating is more so. Is there something maybe related to your client base that's a little bit different? I appreciate the full package of operating leverage and better margins and all that. I just want to focus on the NII for a second.

Yes. Thanks, Glenn, it's Mark. Let me take you through this kind of 2 part of there. One was kind of our overall NII guide. And then secondly, there's, I think, a specific question on NIM, which I can get at as well. So first, I'd say our guide, as you mentioned, is generally consistent with our original outlook of flat year-over-year, and I said roughly flat because there's still some amount of variability of the factors that we always talk about in terms of rates and deposit mix and levels. I think now that we're halfway through the year, you expect that we'd be able to start to narrow, possibly narrow the outcome that we're seeing here. But again, we feel good about being able to continue to deliver on our guide of roughly flat standing here today. If you look at the first half of 2025, NII has been roughly flat to slightly down versus again the record year we had in 2024. First half was down about 0.6% versus the first half of last year. So we're tracking well to our guide, given some puts and takes that I can get into in a little more detail. So again, holding NII flat to a record year after 6% growth last year, it means we're delivering on our guide and executing well in terms of what we've laid out for you. And we understand how important NII is, obviously. But if we unpack the NII guide with a little more detail, and I'll frame it in the same way that we've been doing it since January and then again in April, using kind of the 4 buckets of drivers and describing what the impact is to us as a firm in terms of tailwinds and headwinds. So the first one would be deposit levels. And obviously, you saw those go up this quarter. So interest-bearing deposits have certainly provided upside versus our expectations in what we talked about in January and then again in April. While noninterest-bearing deposits have actually largely played out as expected, notwithstanding an early pop in the second quarter. We did have a near-term benefit in April during the peak of market volatility, uncertainty. However, in May and June, and then again, as we sit here in mid-July, we have seen some normalization in deposit balances since the quarterly high point in April. I'd also point out the majority of the spike in assets and deposits that we saw happened in lower spread buckets like market rates and exception rates. And so they did carry a more limited benefit for us. So mix is important. So while deposits are up about 7% sequentially, our noninterest-bearing balances where we have the widest liability spread that was down sequentially roughly $1 billion. So we think deposits will remain like somewhat elevated, but we do expect to see some leveling off over the coming months, and we'll obviously continue to track that closely. In terms of other impacts, again, to us as a firm, our loan growth we've talked about that's also played out as expected. It's been a tailwind year-over-year, and I can talk about that a little bit more in depth. The investment portfolio reinvestment. We talked about $4 billion a quarter at 100 to 150 basis points in terms of benefit there, given where rates are, we're seeing it more at the lower end, around 100 basis points. which brings us then to like the major bucket for us, which is short-term rates. And as we've discussed previously, we are an asset-sensitive bank. We've seen rates come down faster than expected. If you look at the U.S. treasury curve, the 2-, 3-, 5-year rates are down 50 to 60 basis points over the first 6 months of the year on a spot basis also non-U.S. central banks. While the ECB and the Bank of England have largely been in line with expectations, albeit a little more aggressive in the case of Bank of England in terms of timing, other central banks have actually been relatively more aggressive in the lowering of their rates such as the Reserve Bank of Australia and Canada. I've talked previously about a cut at the ECB or Bank of England being worth about $5 million to $10 million per cut per quarter for 25 basis points. And while Australia and Canada may not be that large to us when you start to look across several of the central banks, it does start to add up as headwind. So hopefully, that helps and that we're putting all this together, we're kind of standing back from it. We have some positives, like short-term pop in interest rates and interest-bearing deposits, some negatives like the pacing of cuts. But we see it as being relatively balanced, which brings us back to a guide of roughly flat to our record year of NII in 2024. So again, we understand how important NII is. We've been pleased with our ability to deliver on our guidance. This is 20% of the revenue of the company.

Our next question will come from Jim Mitchell with Seaport Global.

Our next question will come from Alex Blostein with Goldman Sachs.

And it's Mark. Maybe I'll just jump in to offer a couple of maybe proof points and some context on that. And to kind of maybe talk through how this has been building. This is not a kind of just recently, we've started looking at posting these type of sales results. And I think I've talked about this before. Back in 2019 and 2020, we were doing $140 million, $160 million in servicing fee sales, and then we started to take that up in $250 million, $260 million in '21 and '22. And that's when we started talking to all of you about setting a more aggressive target for that of the $350 million to $400 million. And again, that came from understanding our business, and we've talked you through this before, the kind of rubric we have around fee compression and deinstalled business each year. And we knew that, that number needed to be much higher. So then we did $300 million in '23, and then we did $380 million last year. And if I put it in context, we just talked about $145 million for the second quarter, and it was a very good quarter, and we've talked about how it can be lumpy and all that, but it was a very good quarter. And you go back and put that in context. That's more in the second quarter than we did in all of 2020. So to me, that's a real change. That didn't just happen. We changed our organization, our incentives. We focused on service excellence, like Ron talked about, and we invested in products and features and functionality. So we expect the performance to stay in that range, and we know we need to target that going forward. And with proper execution, that's going to really power the business forward.

Got you. Great. That's very helpful. Mark, I wanted to follow up with you on your answer to Glenn's question around NII and sort of how you guys are thinking about it on a forward basis. So obviously, no 2026 guidance just yet. But as you sort of pointed to being asset-sensitive bank, the forward curve is what it is. So help us maybe think about what are the things you guys could do and what are you working on to perhaps mitigate the effects of lower interest rates as you look out beyond this year. And importantly, is the interplay between NII and operating leverage, you guys have been focused correctly on both positive fee operating leverage and positive total operating leverage. Is that kind of total operating leverage dynamic still possible if NII sort of peaks and starts to go down from here?

Yes. Thanks, Alex. I guess, obviously, don't want to get into anything around 2026. I mean there are things that we have been doing in terms of looking at our client deposit pricing. We've been looking at our balance sheet strategy. We've been looking at our investment portfolio. So there's many things that we can look at on all those things that we have been in trying to gauge where we're going into 2026 with NII. But I think it's just -- it's pretty early to start talking about that now.

Our next question will come from Mike May with Wells Fargo.

I just wanted a clarification, just with all the discussion here. So did you benefit from [ heightened ] volatility and how you see that going down and NII is at a peak and now you see that going down? I guess, are you overearning the way you look at things or not?

[Operator Instructions] Our next question will come from Beth Graseck with Morgan Stanley. .

Our next question will come from Ebrahim Poonawala with Bank of America. .

Just a couple of follow-ups. One, on capital, and I apologize if you clarified on this, but I think I heard you talk about 80% payout for the full year. Just give us a sense -- remind us in terms of from a capital perspective, what we are managing to. In terms of the ratio, it feels like you have a lot of flexibility there? And what stops you from leaning in and doing more in buybacks than the 80%.

Yes, sure. It's Mark. Let me just maybe a 2-parter. I'll talk a little bit about our capital return, and then I'll talk a little bit about CET1, which is really the ratio that we're managing to here. So you're right, I mean, we previously talked about 80% payout. So we've also highlighted previously that our intention is to return capital at a progressive cadence through the year. So you saw that going from Q1 up into Q2 now at $517 million, which was an 82% payout, was $320 million in Q1. So we expect to move through the third quarter and then into the fourth quarter, anticipating additional step-ups as we move to deliver on our overall payout target of 80% subject to market conditions and other factors, obviously. So that's kind of still our guide, and that's what we're committed to. In terms of CET1, I think we've talked about this before. Current -- given the current environment, we are continuing to prudently manage toward the higher end of our 10% to 11% CET1 target range. You should generally expect us to continue in that range and managing to that as our clients really appreciate the value, financial stability and soundness and appreciate us running the business at healthy capital levels. And also, I'd say, we're cognizant of our own sensitivities around our RWA stack, which can swing several billion at quarter end with market volatility, and that's what you saw this quarter, right, with our 10.7% print. So still, again, very much in line with what we've talked about over the last few quarters.

Thanks, Mark. And just one quick. I think you talked about deposit balances elevated, but maybe drifting lower in the back half. Just give us a sense of when you think about noninterest-bearing or overall deposit balances, what gets them growing again? Is there a trough that we should look at from a cycle standpoint or just how you're thinking about it, yes?

Yes. So maybe a couple of things. First, in terms of overall levels, so Ron mentioned it earlier, too, April was really the month that had the most volatility, and we saw the quarterly like period spike, right? That's what happened in April. And then we saw deposit levels overall come down in April -- sorry, in May and then again in June. And then sitting here in mid-July, our deposit levels are not too far off, like our expectations that we had given back in April around the kind of high end of the [ 230 to 240 ]. It's not quite down back to that high end of that range, but it's approaching it, sitting here kind of middle of July. So that's number one. Number two, on noninterest bearing. Again, it was down $1 billion quarter-to-quarter. We expect that -- as we've said before, we expect that to continue to moderately decline, maybe into the low 20s is what we've talked about that's kind of generally deposit levels. Your question about raising deposits, the best way that we can raise deposits is to sell and install back-office business. right? Custody brings deposits, custody brings FX trading revenue, securities finance revenues, all the kind of good stuff that goes around custody as the hub of the company. So $444 billion in [ to be installed ] revenue, of which roughly 60% of that is back office, which means custody. That's a good sign in terms of our ability to generate custody client-related deposits. And if we keep the flywheel spinning on the servicing fee sales target, that's what we'll see.

Our next question will come from Brian Bedell with Deutsche Bank.

Just 1 housekeeping 1 quickly and then a longer-term one. The housekeeping is just the -- your assumptions on market returns for the second half that underpin the 5% to 7% guide.

Yes, sure. Let me take the opportunity to maybe take you quickly through kind of the macro points that are underpinning the guide? And I guess I will just start with the equity market. So entering the year, right, we expected 5% point-to-point, which implied average market levels up 8% for the year. Obviously, as we sit here today, we're tracking a bit better than the assumptions we had coming into the year. So that's constructive in our current guide. So you expect that to be a tick higher. That said, we've seen considerable volatility over the past quarter. So we'll continue to monitor developments there and see how the averages go up from here. So that should cover the equity market appreciation side.

Our next question comes from Gerard Cassidy with RBC Capital Markets.

Can you guys come back to the sensitivity of revenues to market moves? I think in your 10-K, you give us that 10% increase in equity -- global equity valuations generally leads to maybe a 3% increase in service fee revenues. When you look at your service fee revenue growth this quarter of 12% ex notable items, how much was associated to market conditions moving higher?

Gerard, it's Mark. I guess I'd just say that 10%, 3% is servicing fees. And so our servicing fee growth year-over-year is 5%, the 12% is total, including software and trading and asset management. So obviously, the -- I don't have it in front of me, but obviously, the impact year-over-year of where markets have been has been positive. It's been a positive to us, and that has generally been pretty consistent in terms of the -- if you see a 10% growth, again, over time because quarter-to-quarter can be -- we've talked about this before in terms of billing cycles and whatnot. But the 10%, 3% for servicing fees, and it's like 10%, 5% over from asset management has been pretty consistent.