State Street Profit Jumps 27% but Shares Tumble as Fee Revenue Misses Estimates

State Street reported third-quarter net income of $1.09 billion, up 27% from a year earlier, on Wednesday, with diluted earnings of $3.69 a share, as record custody and management assets cushioned a fee line that came in just below what Wall Street had penciled in.

The miss was narrow, and it was specific. Earnings of $3.69 a share edged past the $3.68 analysts expected, and revenue rose 13% to $4.00 billion, a hair under the $4.035 billion analysts were looking for, according to FactSet comparisons reported by Investor's Business Daily. The shortfall sat in fees: total fee revenue of $3.14 billion compared with the $3.163 billion analysts expected, according to FactSet, and servicing fees of $1.492 billion compared with $1.505 billion expected. Net interest income beat, rising 20.8% to $864 million against a projected $853 million. Investors focused on the fee line anyway: the shares tumbled about 8% in premarket trading, according to MarketSurge, toward a multimonth low near the stock's 200-day moving average, after State Street stock had climbed more than 30% this year before the print.

Record assets, thin new flows

The balance-sheet side of the story was stronger than the income statement. Assets under custody and administration rose 15% to a record $59.2 trillion, and assets under management rose 16% to a record $6.3 trillion from a year earlier, mainly on higher market levels. Sequentially, though, the growth was mostly markets rather than new money: total net flows were just $7 billion in the quarter, as $68 billion of ETF inflows and $67 billion into index strategies overall were largely offset by $62 billion of cash outflows, leaving assets under management up 0.4% from the second quarter. Even that flat sequential step beat the setup: analysts had expected assets under management to fall 4.9% from the second quarter and to rise 9.6% from a year earlier, according to FactSet figures reported by IBD, and the company delivered $6.306 trillion instead.

Where the fees landed

Inside the fee line, the biggest businesses grew and the smaller ones slipped. Servicing fees increased 10% to $1.49 billion and management fees increased 20% to $797 million, and the company said servicing and management fees both set quarterly records. Foreign exchange trading services revenue rose 17% from a year earlier to $427 million, with client volumes at a record and up 31%, but fell 14% from the second quarter on a lower mix of emerging-markets revenue. Securities finance rose 9% to $151 million and software services rose 5% to $175 million, while other fee revenue fell 29% to $98 million, including market-related adjustments. The quarter was better than the stock's reaction, and thinner than the headline growth rates suggest: the two record fee lines carried the quarter, and the miss came from everything around them.

Margins and the eleventh straight quarter of leverage

Revenue rose 13% while expenses rose 8%, producing 531 basis points of operating leverage, and management counted its eleventh consecutive quarter of year-over-year positive operating leverage excluding notable items; there were no notable items in the quarter. The pre-tax margin widened to 34.6% from 31.1% a year earlier, return on average common equity was 16.4%, and return on average tangible common equity was 25.1%. Expenses of $2.62 billion rose 8% on higher revenue-related costs and strategic investment, including a 15% rise in information-systems spending, partly offset by a 4% fall in occupancy. The credit provision was a $4 million release tied to commercial loan sales and repayments, and the effective tax rate eased to 21.5%.

Pipeline, deals and capital

The forward book grew even where the quarter's fees did not. New servicing wins in the quarter carried $68 million of fee revenue and $429 billion of custody assets, led by back-office and alternatives work, and the company ended the quarter with $332 million of servicing fee revenue and $2.98 trillion of custody assets still to be installed. State Street also won its first Wealth Services mandate, with one of the largest registered investment advisors in the United States, building on an existing Charles River relationship, announced an agreement to acquire the Santander CACEIS Latin American securities-services joint venture, subject to regulatory approvals, and said software annual recurring revenue rose about 8%. On capital, the standardized common equity tier 1 ratio ended the quarter at 11.0%, and the company returned $651 million to common shareholders, including $400 million of share repurchases and $251 million of declared dividends, or $0.92 a share. In the same filing, State Street said it will redeem all of its $500 million of 1.684% senior notes due 2027 on November 18 at par plus accrued interest, funded with cash on hand, and that its board elected Alexander Vollert as an independent director on October 9.

What to watch next

Management discusses the results on an 11:00 a.m. ET call on Wednesday, and the first question is whether the fee shortfall is mix or momentum: foreign-exchange revenue fell sequentially on emerging-markets mix and other fee revenue fell on market-related adjustments, neither of which management has yet quantified as one-off. The second is installation: that installed-but-not-yet-billing backlog is the claim the next quarters will be judged against, because $2.98 trillion of custody assets to be installed only becomes revenue as it goes live. The third is market sensitivity: with custody assets at a record $59.2 trillion mostly because markets rose, a flat or falling tape would test how much of this quarter's 13% revenue growth was State Street's own doing.