Almost 40% of State Street’s Stock is Custody & Admin Srvcs
With over $21 trillion worth of assets under custody & administration (as of Dec 2010), State Street (NYSE:STT) is the second largest custodian of financial assets after BNY Mellon. State Street Global Advisors (SSgA) also provides investment advisory on over $2 trillion worth of assets and competes with BlackRock (NYSE:BLK), Fidelity Investments, Goldman Sachs (NYSE:GS), Morgan Stanley (NYSE:MS) and UBS (NYSE:UBS).
We estimate that investment servicing & administration fees charged on the assets under custody make up almost 36% of our $56.40 Trefis price estimate for State Street’s stock, which is about a 20% premium to its current market price. Here we take a closer look at this division and how contributes to our optimistic outlook for State Street.
What are Investment Servicing and Administration Fees?
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These are fees earned by State Street for serving as the custodian for assets of institutional investors. State Street charges a fee based on a percentage (often a single basis point) of the daily average valuation of assets under custody and administration for rendering services such as custody, daily pricing of collective investments such as mutual funds and outsourcing of back office operations from other financial services providers.
Investment servicing is a very scalable business as the IT support needed for this business can handle huge volumes, which explains State Street’s role as a leading custodian of assets globally.
What Drives These Fees?
We highlight the below factors that will lead fees to marginally by the end of 2012 and for assets to recover.
1) Macroeconomic Recovery
As the global economy moves out of recession, we expect the size of assets under custody to exhibit double-digit growth in the short-term (2011-12) on account of the rising valuation of financial securities and institutions allocating more of their capital to financial markets (as many institutions are still sitting on a fair amount of cash). As the fixed costs incurred on infrastructure and technology setup get diluted over a larger asset pool and investor base, we expect the investments servicing & administration fee (%) to decline as custodians compete for assets.
2) Discounted Fees Will Attract Funds
Since the contracts with institutional clients are long term in nature, we expect State Street to offer highly competitive investment servicing fee to attract new assets for custody as new contracts are renegotiated. We expect State Street to compensate the shrinking commission on investment servicing by adding other value-added services such as trading and securities financing, which includes securities lending and collateral management.
3) Economies of Scale Make this Attractive
The custody industry essentially involves processing and dissemination of information on customers’ securities holdings and transactions along with value-added services that provide liquidity, financing and yield-enhancing solutions (analytics and returns from securities lending, etc) to clients, all of which require large investments in information technology. Once the technology investment has been made, processing additional volumes requires minimal, if any, incremental costs. Hence, rising assets under custody will lead to a drop in investments servicing & administration fee as a % assets under custody.
You can see a detailed analysis of our State Street’s stock.