State Street set a negative tone for the big trust banks this earnings season, disclosing first-quarter declines in fee income and cheap deposits that could cost it tens of millions of dollars in revenue over the full year.
The Boston-based company reported first-quarter net income of $549 million or $1.52 per share Monday. Analysts had projected a number closer to $1.64 per share.
The results "weren't up to our expectations," Chairman and CEO Ron O'Hanley said on a conference call with analysts. "We have to do better."
Investors appeared to agree. Shares of Boston-based State Street nosedived as much as 17% in early-morning trading Monday, though they had recouped much of that loss by midday. State Street's stock closed at $72.68 Monday, down about 9%.
State Street was not the only big custody bank to be bruised by the market Monday. Shares in Chicago-based Northern Trust fell 2.5%, while Bank of New York Mellon Corp.'s stock slid nearly 5%. Bank of New York Mellon is scheduled to report its first-quarter earnings Tuesday; Northern Trust is set to follow April 25.
According to analysts, State Street's first-quarter miss was due largely to softness in fee revenue, which totaled $2.3 billion for the three months ending March 31, a 9% year-over-year drop. O'Hanley linked the decline to "headwinds from significantly lower average market levels."
Additionally, the $322.4 billion-asset company reported a higher-than-expected $44 million provision for losses on credit, investments and other holdings — attributable mainly to a $1 billion deposit in the San Francisco-based First Republic Bank. Part of a
"Though $44 million is not a high number relative to the company's balance sheet, it is high for a custody bank like State Street, in our view," Gerard Cassidy, who covers the company for RBC Capital Markets, wrote in a research report.
State Street reported $37.6 trillion of assets under custody and/or administration on March 31, down 10% year over year. The decline is hardly surprising given the drop-off in market valuations over the past year. The trend lines looked more promising on a linked-quarter basis, with custody assets up more than 2% since the end of 2022. State Street also reported $3.6 billion in custody and/or administration assets that have yet to be installed. As the company brings more of that backlog online, it should see "a meaningful amount of servicing fee growth," O'Hanley said.
Serving its massive custody portfolio is State Street's biggest revenue producer, generating fees totaling $1.2 billion in the first quarter, up 1.2% from the fourth quarter but down 11% year over year. State Street is forecasting a 1% to 2% increase in servicing fees in the second quarter, Chief Financial Officer Eric Aboaf said on the conference call.
State Street will need the added servicing revenue to offset a projected decline in net interest income, which could fall as much as 10% in the second quarter due to the ongoing movement on noninterest deposits out of the bank or into interest-bearing vehicles. State Street's noninterest deposits fell $5 billion in the first quarter to $39 billion, Aboaf said.
Aboaf is forecasting another $5 billion drop in the second quarter and said the total could fall to $30 billion later in 2023. "When you earn 5% or more for those kinds of deposits on the asset side, and then pay zero, that can be significant," Aboaf said. "Every $1 billion [of noninterest deposits] is worth $12 million, sometimes $15 million per quarter." While State Street is seeing "good inflows of interest-bearing deposits," that money isn't as valuable as the noninterest cash, Aboaf said.
The trend is hardly unique to State Street, of course. The $562 billion-asset PNC Financial Services Group reported Friday that the
PNC CFO Robert Reilly said on a conference call Friday that his company's noninterest deposits were declining at a "somewhat faster pace" than expected, a situation that is also playing out at State Street, where Aboaf said he had anticipated the first-quarter decline to be limited to $3.5 billion.
State Street will work to counter any drop-off in noninterest income with added fee income and tighter expense controls, O'Hanley said.
Despite the earnings miss, State Street has no plans to suspend its current $4.5 billion share buyback program. "While there is certainly still work to do, we are pleased with the durability of our business this quarter against a very challenging backdrop and the continued competitive strength of our global franchise," Aboaf said.
"Based on what we know now and our financial strength, we think it's actually quite prudent," to continue buying back shares, O''Hanley added.
