Although we were displeased to see State Street Corporation's (STT) share price slip by 4% after it released its results, we were content that it was able to bounce back and close the day's trading .71% higher than the prior day's close. State Street continues to be our trust bank of choice. While we have always had a strong level of respect for its two closest competitive peers (Northern Trust Corporation (NTRS) and The Bank of New York Mellon (BK)), we continue to see that State Street Corporation offers a better risk-adjusted investment opportunity relative to BK and NTRS. When State Street passed the 2012 Federal Reserve CCAR stress tests, it was allowed to buy back $1.8B shares of stock, versus $1.1B for Bank of New York Mellon and $240M for Northern Trust. State Street also increased its dividend per share by 33%, versus 0% for Bank of New York Mellon and 7.14% for Northern Trust. In 2013, State Street was allowed to repurchase $2.1B worth its shares and increase its dividend by 8.3%. This compares favorably to BNY Mellon ($1.35B in repurchases and a 15% dividend boost) and Northern Trust ($400M in repurchases, 3.3% dividend increase).
Source: Our August Report on State Street Corporation and MRQ Reports for STT, BK and NTRS
Notable Items that Investors Have Been Focused on With State Street Corporation
Although State Street's revenue of $2.47B was slightly below the $2.479B projected by the analyst community, its adjusted operating EPS of $.96 beat the average analyst estimate by $0.03. Furthermore, its reported EPS of $0.98 was two cents greater than its adjusted EPS due to the exclusion of discount accretion from its adjusted EPS calculations. We were also pleased that its trading services revenues have appeared to have reached a bottom. STT's competitors The Bank of New York Mellon and Northern Trust saw trading services revenues decline by 16% and 4% respectively so it's not like STT is alone in that boat. Although State Street's year-over-year revenue growth of 0.6% was nothing remarkable in relation to what BNY Mellon (-0.9%) and Northern Trust (1.14%) achieved, State Street's operating expense management (-0.49%) during the quarter was well ahead of BNY Mellon (+2.6%) and Northern Trust (+0.73%).
Source: MRQ Reports for State Street, BNY Mellon and Northern Trust
State Street's Intractably Recurring "Non-Recurring Charges"
With regards to the intractably recurring "non-recurring charges," State Street incurred $14M in restructuring costs associated with the acquisition of Goldman Sachs Administration Services (GS). State Street also harvested $31M in discount accretion related to its former conduit securities, down from $49M in Q1 2012. The good news for BNY Mellon was that its restructuring charges declined from $109M in Q1 2012, to $39M in Q1 2013. The bad news for BNY Mellon was that it incurred $854M in charges relating to the disallowance of certain foreign tax credits. Northern Trust had a $12.4 million write-off of certain fee receivables resulting from the correction of an accrual methodology followed in prior years, as well as restructuring and integration related charges of $1.8 million. These current quarter items total $14.2 million ($8.9 million after tax, or $0.04 per common share). The prior-year quarter included restructuring, acquisition and integration related charges of $3.9 million ($2.6 million after tax, or $0.01 per common share).
State Street Global Services
State Street Global Services is State Street's bread-and-butter asset servicing business and it reports revenues that increased by 9% due to a stronger equity market, net new business and the October acquisition of Goldman Sachs' alternative asset servicing business. It was awarded $223B in new asset servicing mandates during the quarter and it installed $180B of these mandates in Q1 2013. SSGS has $43B of its Q1 2013 mandates that will be installed in Q2 2013, as well as $70B in mandates won in 2012. SSGS also won 39 new alternative asset servicing mandates as well and 33% of SSGS's new mandates came from outside of the U.S. SSGS saw its assets under custody and administration increase by 4.3% in the linked quarter and by 11.75% year-over-year, which was above its peer group average and each of its competitors [Bank of New York Mellon, Northern Trust Citigroup (C) and J.P. Morgan Chase (JPM)].
State Street Global Advisors
State Street Global Advisors reported encouraging results. Investment management fee revenues grew by 1.2% in the linked quarter and by 11.4% on a year-over-year basis. The firm won $5B in net new mandates, which represented 0.24% in organic growth during the quarter. SSgA's net client inflows were driven mainly by securities finance cash collateral pools. SSgA experienced net ETF outflows of $6 billion from both its gold ETF amidst declining gold prices and from its S&P 500 ETF, which historically has outflows in the first quarter as institutions reposition their risk profile in the market. These net ETF outflows were partially offset by a strong start to the year in Europe, where it has been focused on expanding its ETF product offerings and inflows into SSgA's sector -- select sector ETFs in the U.S. SSgA saw its assets under management increase by 1.16% in the linked quarter and by 10.1% year-over-year. Although SSgA's results underperformed Northern Trust during this period, it still outperformed BNY Mellon and J.P. Morgan Chase. Citigroup is not included as an asset management peer since it sold its Smith Barney Asset Management business to Legg Mason. We don't think State Street should spin-off SSgA and MutualFundWire.com agreed with us.
Sources: MRQ Reports for State Street, BNY Mellon, Northern Trust and J.P. Morgan Chase
State Street Corporation's Capital Position
State Street's capital ratios are among the highest in the financial services industry and we can't stress enough how State Street's dividend increase and share repurchase program was greater than what Northern Trust and BNY Mellon offered to shareholders after all three trust banks passed the Federal Reserve's CCAR stress tests. State Street restored its dividends per share back to the pre-crisis peak of $.96 last year and its new dividend per share of $1.04 represents a split-adjusted all-time high. Although Northern Trust was able to avoid cutting its dividend per share during the crisis, it was forced to freeze its dividend for 4.5 years. State Street's current dividend is 8.3% higher than its pre-crisis dividend. Although this is less than the 10.7% increase that Northern Trust has seen, at least STT's dividend is above its pre-crisis levels whereas BNY Mellon's current dividend is still 37.5% below its pre-crisis level.
Source: Morningstar Direct
State Street's 2012 share repurchase program of $1.8B exceeded the combined $1.34B that BNY Mellon ($1.1B) and Northern Trust ($0.24B) offered in March. We were a little worried that State Street's management wasn't going to follow through on it last year but we were pleased to see that STT and its competitors were allowed to repurchase more shares in 2013 than in 2012. STT's buyback in 2013 will be $2.1B, which is higher than the combined repurchase programs of BNY Mellon ($1.35B) and Northern Trust ($0.4B). STT's estimated pro forma tier 1 common ratio under the recent U.S. Basel III Notices of Proposed Rulemaking was 10.6% as of Q1 2013, a decrease of 20bp versus Q4 2012 levels.
STT's tangible common equity was 7.1% during the quarter, which was a little bit lower than the 7.6% TCE ratio for Northern Trust and both were significantly higher than BNY Mellon's 3.9%. State Street's ROE of 8.9% was slightly higher than Northern Trust's 8.8% and was much higher than BNY Mellon's 7.8% adjusted ROE. State Street continues to have a higher net interest margin than its two competitors although its advantage has ebbed a bit.
Sources: MRQ Reports for State Street, BNY Mellon and Northern Trust
In conclusion, State Street continues to be our top choice in the trust bank space. We like this sector because the scale of these companies has created a wide economic moat that enables these companies to generate strong levels of free cash flows. We see that our thesis points supporting our investment in State Street continue to remain in place. We have shown that State Street offers better risk-adjusted return prospects to investors versus BNY Mellon and Northern Trust and here are the reasons why we believe that State Street has outperformed its two trust banking peers since Nelson Peltz released his October 2011 White Paper [pdf]:
- State Street announced a larger share buyback than its two peers combined in March 2012 and 2013 when all three passed the Federal Reserve CCAR Stress Tests
- State Street's only acquisition in 2012 was Goldman Sachs' alternative asset management business
- State Street's acquisition of GSAS was at a 53% lower price per assets served than SS&C's acquisition of GlobeOp
- State Street has improved its executive communication to the investment community
- State Street has officially sworn off acquisitions for the near term
- State Street completed its $1.8B stock buyback
- State Street increased its buyback and per share dividend payment in 2013 versus 2012
- State Street's H2 2012 performance has been better than its peers.
Sources: Morningstar Direct
Additional disclosure: This article was written by an analyst at Saibus Research. Saibus Research has not received compensation directly or indirectly for expressing the recommendation in this article. We have no business relationship with any company whose stock is mentioned in this article. Under no circumstances must this report be considered an offer to buy, sell, subscribe for or trade securities or other instruments.