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In Q4 2020, State Street’s revenues decreased to $2.9 billion - 4% lower than the year-ago period. While there was a slight growth in fee income, it was more than offset by a 22.5% drop in net interest income.
State Street is a custody banking giant that generates most of its revenues from asset servicing fees, which it charges as a percentage of Assets under Custody & Administration (AUC/A). It generated around 65% of its revenues from asset Servicing business in 2019 and has roughly $33.2 trillion in Assets under Custody & Administration. As a result of the economic uncertainty and widespread panic, the company’s stock initially suffered losses due to a drop in asset valuations driven by net market losses. However, the recent rally in the securities market has improved the asset valuations to a large extent. That said, The bank's net interest income has suffered in 2020 due to the lower interest rate environment. While the company’s revenues for Q1 and Q2 2020 saw some increase, Q3 and Q4 revenues were lower than the year-ago period. This resulted in a marginal drop in full year 2020 revenues on an year-on-year basis. We believe that the Q1 FY2021 revenues will follow the same trend.
In Q1 2019, State Street changed its accounting method for investments in low-income housing tax credit from the equity method of accounting to the proportional amortization method of accounting. We have updated the Trefis model accordingly to reflect the revised figures for 2016, 2017, and 2018.
Below are key drivers of State Street’s value that present opportunities for upside or downside to the current Trefis price estimate for State Street:
State Street provides investment servicing and investment management services to institutional investors such as mutual funds, corporate and public retirement plans, insurance companies, and endowments.
State Street’s primary business is Investment Servicing, which entails global custody, fund services, liquidity services, and securities lending. The company earns a fee from its customers, generally a small percentage of total assets under custody.
State Street’s Investment Management business includes advisory services and investment research and management of assets such as equity and fixed income securities, ETFs and cash, and money market instruments.
State Street’s main competitors include Bank of New York Mellon, JPMorgan Chase, Citigroup, BlackRock, and Vanguard.
Since State Street has an in-house investment servicing business, it can offer investment management service at lower advisory fees. Most asset managers have to outsource trading and execution functions to other custody banks. They are forced to charge higher fees to compensate for the costs associated with custody, trading, and executing transactions. Additionally, State Street’s Investment Servicing business helps it attract institutional clients, to whom it can provide advisory services in addition to the custody of financial securities.
State Street is a leading custodian of assets with assets under custody and administration in excess of $32 trillion. It manages assets worth almost $2.7 trillion and is present in over 100 markets across 29 countries. State Street benefits from economies of scale, which enable it to dilute operating costs (those associated with people and technology setup) over a larger asset pool and investor base, thereby improving operating margins.
Global assets under management (AuM) are expected to cross $111 trillion by 2020. As economic conditions improve, we expect fund inflows to increase. Additionally, growing wealth in emerging markets like Asia-Pacific and Middle East & Africa will likely result in additional demand for asset management services (and as a result, asset servicing).
Investors increasingly invest in cross-border assets, in emerging markets, and in more complex (structured) financial instruments. These generally require the presence of large global custodians and not local/regional players or financial service providers’ in-house investment servicing teams. Larger custodians like State Street and BNY Mellon will benefit greatly from this trend.
In many countries across the globe and mainly in emerging economies, the state is withdrawing from its role as a primary pension provider, which is causing the people to invest in defined-contribution pension plans and mutual funds. Since custody providers serve the institutional investors such as mutual and pension funds, custodians exhibit promising growth prospects in terms of the size of Assets under Custody.
The recent financial crisis has resulted in more transparency in the pricing of asset management services. As a result, we expect performance fees (which look at longer investment horizons than before) to increase as a percentage of fees as opposed to management fees, which are simply charged as a percentage of AuM.