Wide-moat-rated State Street STT reported an uninspiring quarter with revenue of $3.10 billion and adjusted EPS of $1.52 falling short of the FactSet consensus estimates of $3.12 billion and $1.64, respectively. Net interest income of $766 million was down 3% sequentially, which was worse than flat guidance as deposits, particularly non-interest-bearing deposits, declined. State Street’s asset manager and asset owner base are sophisticated, and we view State Street’s challenges monetizing deposits as a form of pricing pressure and our rationale for a negative moat trend rating. We view this quarter as a reminder that deposit trends, particularly for non-interest-bearing deposits, can be choppy for the custody banks. As we trim our net interest income forecasts, we are reducing our fair value estimate on State Street’s shares to $80 from $90.
While net interest income is only about one quarter of State Street’s total revenue, there is little direct expense associated with this income, and as a result, changes in net interest income tend to flow to the bottom line and have a disproportionate effect on the firm’s profits. Average deposits were $210 billion, down from $217 billion in the fourth quarter. Non-interest-bearing deposits averaged $38.7 billion in the quarter versus $44.0 billion in the fourth quarter and finished worse than the company’s expectation of a $3.5 billion decline. Net interest income appears to have peaked in the fourth quarter of 2022 and will likely continue to decrease in the coming quarters. State Street still expects net interest income to be up for 2023 with a 5%-10% increase in a more pessimistic scenario and a 10%-15% increase in a more optimistic scenario. We note that this is well below the initial expectation of a 20% increase in net interest income for 2023.
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