State Street Corp., like other custody banks, has struggled to increase its revenue in an era of perennially low interest rates and investor caution. And while its $485 million deal to acquire GE Asset Management will diversify its revenue sources and provide an entrée into new business lines, it will do little to alleviate the short-term pressures the bank faces, observers said.
Under the deal, announced March 30, GE Asset Management's 275 employees and more than $100 billion in assets under management will move to State Street Global Advisors, the bank's investment management division. The acquisition would allow State Street to expand into more active asset classes, such as private equity and real estate, where it currently has little presence and where fees are healthier.
"This acquisition is part of our strategy of allocating capital to higher-growth and higher-return businesses," said Anne McNally, a State Street spokeswoman.
The acquisition will pay for itself within the first year, predicts Jeffery Harte, an analyst at Sandler O'Neill, and at a purchase price that is only 0.49% of GE's total assets under management, "it's a pretty reasonable cost to bring that growth opportunity in." What's more, State Street's passive investment side could start feeding business to the higher-fee active side, Harte said.
Still, it will do little to boost near-term revenue for the bank, which reported revenue growth of just 1.5% last year and total revenue of $10.36 billion. For a company with $2.2 trillion of assets under management, the $100 billion GE has been managing for foundations, retirement plan sponsors, sovereign wealth funds and other institutions will not move the needle enough to help State Street overcome its broader challenges.
"To materially improve their earnings or revenues, you need some environmental help, whether it's interest rate [hikes] or less investor risk-aversion. You need international cross-border investing to really pick up again," Harte said. "This transaction in and of itself is not all that material."
Custody banks continue to face a tough operating environment. The Federal Reserve's policy of keeping interest rates low has held down State Street's custody fees. At the same time, investors have remained largely risk-averse since the financial crisis, and it's "the one-two punch of low interest rates and the lack of a sustained increase in investor risk appetites" that is suppressing revenues, Harte said.
The decline in cross-border transactions, which State Street facilitates, has not helped. Nor has the fact that some sovereign wealth funds, particularly those of oil-reliant nations, are liquidating assets in order to have more cash on hand.
There is even a sense in which State Street is a victim of its own success: It already has such a global presence that there are few markets left into which it can expand.
The bank is also sporting a black eye this week over news that two of its former executives — including the onetime head of its U.S. broker-dealer operation — were indicted on charges of criminal securities fraud for allegedly bilking six clients out of $20 million in improper trading commissions. In 2014, the company agreed to pay a $37.5 million fine imposed by the British Financial Conduct Authority in order to head off further investigation.
But Argus Research maintains that State Street is well-positioned for the long term. It's particularly encouraged by a cost-cutting program called Beacon, which aims to reduce pre-tax expenses by $550 million annually by the end of 2020. Of those savings, $75 million should come in 2016 and another $125 million in 2017, according to Stephen Biggar, an Argus analyst.
"If the rest of the business improves because of market conditions, or if they cut more deeply into costs, that will be a bigger conduit for earnings improvement" than the GE acquisition, Biggar said.
Nevertheless, the timing of the deal benefits both parties. For a while now GE has been trying to simplify, paring away many of its businesses as it refocuses on manufacturing. Last April, it sold off GE Capital's real-estate assets for $26.5 billion, with Wells Fargo and the private-equity firm Blackstone taking the lion's share at $23 billion. GE Asset Management is a wholly owned subsidiary of the conglomerate, not part of GE Capital.
In a research note sent to investors after State Street announced the deal, Keefe, Bruyette & Woods said that it was raising its earnings-per-share estimate for the bank by 3 cents this year and 8 cents next year. Even so, KBW analyst Brian Kleinhanzl cautioned that some of GE's assets under management may not stick with State Street once the lockup period expires. The success of the deal, he wrote, would be measured on whether the bank could grow its newfound active management business.
"It's not like they now have Aaron Rodgers as a quarterback," Harte said. "It's more like they got a good backup lineman in case one of their linemen gets hurt. It's good, they need it, I like everything about it, but don't try to translate it into they made some blockbuster deal that's really going to transform the firm."