State Street (NYSE:STT) reported its performance figures for the first quarter of 2013 on April 19, and the global custody banking and asset management giant’s performance is laudable despite revenue and net income figures remaining flat, compared to the previous quarter.  This is because the company reported growth across all its revenue streams for the period, with the improvement not showing in the top line only due to a reduction in net interest income, something which is a direct result of the prolonged low interest rate environment.
Most notably, State Street’s servicing fees generated a record $1.18 billion in revenue this quarter backed by continuous strong growth in the size of assets under custody/administration (AUC/A), which was well above $25 trillion by the end of the quarter. The asset management division also saw a healthy improvement in its asset base, fueled by a near 8% quarter-on-quarter jump in assets, managed by its various passive equities funds.
We maintain our $61 price estimate for State Street’s stock, which is less than 10% above the current market price.
Investment Servicing Fee Growth Shows State Street Is On The Right Track
State Street churned out record servicing fees this quarter – $1.18 billion for this quarter, compared to $1.15 billion in the previous quarter and $1.08 for the same quarter last year. The servicing fee is earned by State Street for its services as the custodian of financial assets on behalf of institutional investors such as mutual funds, insurance companies, foundations, endowments and other investment pools. And its importance for the company becomes immediately evident from the chart above, as these fees contribute to nearly half of State Street’s total value.
Intense competition in the custody banking industry, especially among the giants BNY Mellon (NYSE:BK), JPMorgan Chase (NYSE:JPM) and Citigroup (NYSE:C), along with State Street has resulted in a reduction in fee revenues as a percentage of assets for all market players. They have, hence, had to resort to strong growth in the underlying asset base, to increase revenues over recent years. State Street’s performance this quarter only highlights this fact, as it grew the size of assets under its custody & administration (AUC/A) to $25.4 billion by the end of Q1.
Opportunities Exist On The Expenses Front To Boost Value
State Street’s operating expenses of $1.8 billion for the quarter were a tad higher than the figure for Q1 2012, and about $100 million more than that for Q4 2012. While operating expenses for the first quarter of any year are notably higher due to an increase in compensation for the period, the hike in other expenses like IT costs, transaction procession costs and occupancy-related costs hint towards possible low hanging fruits that can be picked. More so, given an environment where most financial firms are trimming costs to improve profitability.
State Street’s stock value is quite sensitive to its operating margins, something that can be best understood by making changes to the chart below. We believe that the company should take a harder look at its expenses and see where it can improve operating efficiency.Notes: