State Street (STT) continues to be the best-in-breed of the trust and custodian banks. While we've 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 BNY Mellon and Northern Trust. 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 BNY 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).
Notable Items that Investors Have Been Focused on With State Street Corporation
State Street's revenue of $2.56B was slightly ahead of the $2.54B projected by the analyst community and its adjusted operating EPS of $1.24 beat the average analyst estimate by $0.05. We were also pleased that its trading services revenues grew by 16.1% year-over-year, including 32.6% for foreign exchange services revenues. STT's competitors BNY Mellon and Northern Trust saw its trading services revenues increase by 15% and 20% respectively so it's not like STT is alone in that boat. State Street's had year-over-year revenue growth of 4.9% while BNY Mellon (5.5% adjusted) and Northern Trust (3.23%) also checked in with revenue growth. State Street's operating expense management (+1.47%) during the quarter was well ahead of BNY Mellon (+5.6% adjusted) and Northern Trust (+1.73%).
State Street's Intractably Recurring "Non-Recurring Charges"
With regards to the intractably recurring "non-recurring charges", State Street incurred $45M in non-recurring charges associated with the acquisition of Goldman Sachs Administration Services (GS) as well as litigation and restructuring activities. State Street offset those "non-recurring charges" by harvesting $47M in discount accretion related to its former conduit securities, down from $74M in Q2 2012. The good news for BNY Mellon was that its restructuring charges declined from $378M in Q2 2012 to $13M in Q2 2013. The bad news for BNY Mellon was that it incurred $854M in charges relating to the disallowance of certain foreign tax credits in Q1 2013. Northern Trust didn't have any "non-recurring charges in Q2 2013.
State Street Global Services
State Street Global Services is State Street's bread-and-butter asset servicing business and its revenues grew by 10.6% due to a stronger equity market, net new business and the October acquisition of Goldman Sachs' alternative asset servicing business. SSGS won $201B in new asset servicing mandates during the quarter and it has $98B of new mandates that it won in that will be installed in H2 2013. SSGS also won 30 new alternative asset servicing mandates as well and 33% of SSGS's new mandates came from outside of the US. SSGS saw its assets under custody and administration increase by 1.2% in the linked quarter and by 14.8% 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 5.3% in the linked quarter and by 12.6% on a year-over-year basis. The firm won $11B in net new fund flows (excluding outflows from the SPDR GLD fund), which represented 0.5% 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 $12B from its gold ETF amidst declining gold prices and $7B of inflows into its other ETFs. SSgA saw its assets under management decrease by 1.4% in the linked quarter and increase by 12.5% 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. Unlike Nelson Peltz, we didn'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 Q2 2013 and was comparable to levels in Q1 2013. State Street's ROE of 11.3% was higher than Northern Trust's 10% and BNY Mellon's 9.7% 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. Although State Street and its peers are fairly valued, we like this sector because of the scale of these companies have created a wide economic moat that enables these companies to generate strong levels of free cash flows. 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:
- 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 & H1 2013 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 commercial or pecuniary 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.