State Street shares sink 10% after it says it must pay more to depositors

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Shares in State Street, the global custody bank, fell more than 10 per cent on Friday, the largest drop since the early days of the pandemic, after it warned that it was having to pay higher interest rates to customers to retain deposits.

While other big banks are still reporting increases in the profit they make from charging more for loans than they have to pay out for deposits, State Street’s net interest income dropped by 10 per cent quarter on quarter to $691mn.

“It’s all NII. It’s going down faster than anybody thought and I think that’s what is freaking people out,” chief executive Ron O’Hanley told the Financial Times. “Investors love NII because it is very high-margin revenue and they don’t like to see it go away.”

State Street, which also has a large fund management business, narrowly beat analysts’ consensus expectations with net income of $763mn, up 2 per cent year on year as assets under management rose 9 per cent to $3.79tn. The bank draws about 80 per cent of its revenue from fees, which were up 2 per cent year on year and roughly in line with consensus.

But that was overshadowed by concerns about deposits and interest income.

Deposits were down $1.3bn, or 0.6 per cent, at the end of the quarter, to about $222bn, after a 5 per cent drop in the first quarter. The decline was particularly stark for non-interest bearing deposits, which were down 20.5 per cent from March 31, with another $5bn in outflows expected in the third quarter.

State Street clients tend to be large institutions, which are particularly sensitive to rate changes. They are more likely to move their money or demand higher interest rates than the retail customers who make up a large part of the deposit base at most US banks.

“We have sophisticated large clients coming back and saying, look, some of our . . . rate levels are something that they’d like us to adjust,” chief financial officer Eric Aboaf said on an analyst call.

He said that what the bank described as a “catch up” in the deposit book would peak in the next few months before it starts to moderate by the end of the year. State Street recorded receiving $766mn in net interest income in the first quarter, but now expects it to fall back below $600mn per quarter.

Compounding the problem for State Street, it gave downbeat guidance on fees for the third quarter, with asset servicing fees expected to drop by 1-2 per cent, and revenue from front office software to fall 7 per cent.

O’Hanley argued that investors’ concerns about net interest income should settle down if the US Federal Reserve finishes raising interest rates and, as he expects, holds them steady for a while.

“We would welcome that stabilisation of rates,” he said. “We do not live and die by a quarter. Quarters are very important milestones in which we check in. But as we look forward into 2024 and beyond. We couldn’t be more excited.”