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Why State Street Beat Earnings Estimates

One of the largest asset managers and custodian banks in the world, State Street (NYSE: STT), posted strong fourth-quarter numbers and beat analysts' earnings estimates. State Street saw solid growth across the board with increases in assets under management (AUM), investment servicing assets, revenue, and earnings -- in addition to significant expense reductions.

The Boston-based company has $3.1 trillion in AUM in its investment management arm -- up 24% from the end of 2018. Its investment servicing division, which provides custodian bank services, fund accounting, and administration, saw assets climb 8.7% year over year to $34.3 trillion. State Street is the world's second-largest custody bank, behind BNY Mellon.

State Street saw earnings per share climb 68% year over year in the fourth quarter, beating analysts' estimates. That gain was driven by a couple of key factors. Can those forces spur continued success for investors?

Boston-based State Street Corp. is one of the world's largest investment management companies. Image source: Getty Images.

New business wins

State Street's earnings story starts with revenue, which climbed about 1% over the previous year's quarter. This was buoyed by a 2% increase in fee revenue due to higher servicing and management from overall stock market gains and several major new business wins. The company scored $294 billion worth of investment servicing business in the quarter alone, bringing the total of new business for the year to $1.8 trillion -- similar to the record year it had in 2018 for wins.

State Street saw strong growth in its new front-to-back investment management and servicing platform called Alpha platform, which it launched last year. It combines the middle- and back-office servicing that State Street has traditionally provided with front office research, trading, and portfolio optimization capabilities on a single platform.

These wins offset losses in interest income due to three successive interest rate cuts in 2019. Net interest income (the difference between the revenue generated from a bank's interest-bearing assets and expenses associated with paying out interest) declined 9% in the quarter. State Street also had net outflows of $3 billion from its investment management business. The outflows from institutional and cash funds were offset by $24 billion in net inflows into the firm's ETFs. Overall, net income improved 61% year over year to $704 billion, driven by an aggressive expense reduction plan.

Expense reduction

State Street managed to cut expenses by $219 million, or 9%, compared to the fourth quarter of 2018. Most of it came from cuts to compensation and employee benefits, which decreased 12% year over year. For the year, the company reduced expenses by $415 million, reflecting several initiatives, including a 3% reduction in staff over the course of the year. There were also savings from automating certain functions and moving offices to less expensive locations, among other cuts. It was beyond initial projects of reducing expenses by $350 million.

The blueprint for 2020 is similar as expense reduction will continue, explained State Street President and CEO Ronald O'Hanley on the fourth-quarter earnings call. The plan is to cut expenses by another 1% with expense reductions targeted in IT, among other areas. "We expect that our global reach and expertise in servicing and data analytics, combined with our unique front-to-back Alpha strategy, will enable us to realize our vision of becoming the leading asset servicer, asset manager, and data insight provider to the owners and managers of the world's capital," O'Hanley said.

The company also projects increased growth in its asset servicing business, particularly through its Alpha platform, which O'Hanley said has a strong pipeline. While the market outlook is uncertain in 2020, State Street is a solid buy as it's in a good position to grow earnings through its diversified business mix, innovations, and balance sheet management.

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Dave Kovaleski has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.


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