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Stock Strategist

Massive Scale Benefits State Street

Few competitors can match its profit margins or breadth of product offerings in custody.

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 State Street (STT) is one of the three largest custodian banks in the United States, built on a series of large acquisitions begun in 2003. As a dominant player with some $28 trillion in assets under custody, State Street has the scale and scope necessary to serve institutional clients, which few competitors can hope to match. Asset custody and asset servicing is a business with naturally sticky customers who are loath to risk changing providers and who value the one-stop shopping that State Street can provide. As such, it is a naturally high-return and highly scalable business. However, revenue growth has been a challenge in recent years as a result of persistently low interest rates and increasing client attention on fee levels. We expect fee levels to stabilize as the economic environment improves and investors will see the benefit of the business' operating leverage as net interest margins rise. We expect returns on equity to improve from 9.7% in 2014 to around 15% in the medium term.

The company's asset management business, about 15% of group profits, is floundering despite positive trends in passive investments, a market where it is a major player. State Street, which focuses on institutional investors and charges premium pricing, has struggled to adjust strategically as industry pricing has marched ever lower. Moreover, it is heavily concentrated in products, like its S&P 500 index, which are easily copied and vulnerable to swings in investor preferences. Recent moves, such as price cuts and acquisitions aimed at building out its portfolio of offerings, may help stem the bleeding, but we think the firm may continue to lose market share.

Stephen Ellis does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.