Not all financial institutions seem to be opposed to the idea of tighter regulations for the industry. In fact, going by what State Street’s top boss Joseph Hooley had to say at the Barclays (NYSE:BCS) Americas Select Franchise Conference earlier this week, the global custody banking giant is actually looking forward to increased regulations and accompanying complexity that have been hotly debated by regulatory authorities and financial institutions around the globe since the economic downturn of 2008.  Hooley’s comment that “the complexity in the financial markets is growing. That’s good for us. The more complex things are, the more things we can do for our customers” makes his views on the situation crystal clear – the changing regulatory regime will only bring in more business for the trust bank.
While Hooley acknowledges that some regulatory changes like higher capital requirements for all banks will have a negative impact on State Street’s business, the minimal implications for custody banks compared to banking groups focused on retail and investment banking operations fuels his optimism to benefit overall from these changes thanks to State Street’s role as a banker for banks.
We maintain a $61 price estimate for State Street’s stock, which is about 5% below the current market price.
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State Street is the second largest custody bank in the world after BNY Mellon (NYSE:BK) and is also one of the largest asset managers in the world thanks to its strong presence in the ETF industry – second only to BlackRock (NYSE:BLK). And as can be seen clearly from the chart above, State Street’s custody banking operations (investment servicing) contribute to nearly half of its total value.
A custody bank makes money by providing services to institutions for safekeeping their assets. In the process, it also generates fee revenues through other related services like taking care of accounting, back-office and middle-office activities. The revenue growth for a custody bank is hence directly linked to growth in the size of its assets under custody, as new customers bring in more assets on which State Street can charge a fee.
Now as tighter regulatory requirements for financial institutions around the globe begin to phase in, it will add to the complexity of various ground-level activities for these institutions – primarily compliance and reporting. This is where State Street comes with its value proposition of helping institutions outsource all these functions – for a tidy fee of course.
State Street’s assets under custody have grown considerably over the recent years, witnessing a near-12% jump in 2012. Going forward, we expect the size of these assets to increase by around 8% annually as we show in the chart below. However, if the assets grow at a faster rate, there will be marked upside to the bank’s share price – something you can understand by making changes to the chart.Notes:
- State Street Corporation at Barclays Americas Select Franchise Conference, State Street Website, May 22 2013 [↩]