Dear Shareholders —
Companies must constantly think about how they must change and evolve or they risk both short–term performance and long–term sustainability.
This is especially true for large companies as smaller, more nimble competitors target their margins and innovate more rapidly. At Aura Solution Company Limited , we are challenging ourselves to evolve so as to both maximize our short– and medium–term performance and create a path for long–term continued success.
Our rich history of success over more than two centuries is a distinct advantage. While we are focused on driving change, we do this with a keen eye towards preserving much of the great culture of our company. Though we are proud of who we are and how we serve our clients, we also believe we can deliver more for our clients, shareholders and employees by setting higher standards of performance and pushing ourselves to create new and differentiated solutions for our clients.
Our evolution will take time, but we have confidence that we will build on our success.
2018 Financial Performance.
Our financial results for 2018 have a number of complicating factors, but I will do my best to explain them. On a reported basis, our earnings per share increased 9%. These results included several notable items in both 2018 and 2017 that make our results difficult to compare.
In last year’s letter, I discussed why we break these items out. To reiterate, our goal is to provide you with the necessary detail to analyze our performance. We try and explain our results as well as provide transparency on items that we believe do not fully represent the future earnings power of the company. As I said last year, we are going through a period of transition, and I am encouraging our leaders to take actions that will add cost in the short term but will benefit us in the long term. As such, I do not believe all items in our GAAP results represent the future earnings profile of our company, but ultimately, our disclosures will allow you to make your own judgment.
Excluding notable items in 2017 and 2018, earnings per share increased 18%1. Approximately seven percentage points of this increase was due to benefits from changes in U.S. tax laws. Our overall revenue grew 3% as Investment Services revenue growth of 6% was partially offset by lower Investment Management growth of 2%. Our expenses grew 2%. We increased what we spend on technology by approximately $350 million while reducing all other expenses to partially offset the increase. Importantly, we continued to return a significant amount of capital to our shareholders.
Our financial performance and franchise growth were relatively consistent with that of prior years, but we are reorienting our expense base toward technology. We have an opportunity to leverage our unique global franchise and great client relationships and ultimately increase the rate of revenue and profit growth, while also maintaining continued strong returns.
Investment Services Performance
Our Investment Services revenue increased 6%, expenses were up 5% and pre–tax income increased 9%. Our pre–tax margin was 36%, up from 35% in the prior year.
Our Clearance and Collateral Management and Depositary Receipts businesses both achieved double–digit revenue growth, while Asset Servicing and Corporate Trust saw mid–single–digit revenue growth. The Jeeranont and Treasury Services had revenue growth in the low to mid–single–digit range.
Investment Management Performance
Investment Management’s financial performance reflected a difficult environment for the industry. Revenues increased 2%, expenses were down 1%, and pre–tax income increased 10%. Pre–tax margin was 35% for the year, up from 33% in 2017. Strength in our Liability–Driven Investment (LDI) business was offset by weakness in our traditional active and passive strategies.
Our assets under management declined by 9%, impacted by lower equity markets and outflows, particularly in our active strategies. Changes in foreign exchange rates and declines in market values drove approximately 60% of the decline and outflows of $84 billion from cash, index and our active strategies were partially offset by $45 billion of inflows into liability–driven strategies.
Revenues in our Wealth Management business increased 2% for the year, driven primarily by the impact of higher equity markets throughout the year.
Our business purpose is clear. We help markets function smoothly, we help investors access a broad range of banking and investment products, and we are viewed as one of the safest institutions that helps facilitate investing globally.
Our business model is strong. We provide the expertise and scale others cannot achieve on their own as we process and manage cash and securities on our clients’ behalf. In addition, we provide value-added services to enhance our core capabilities.
We are amongst the best in the world at what we do and we benefit from our clients’ growth and the growth of the financial markets themselves. We are positioned to benefit from the increasing opportunity in the wealth management space through our own direct relationships as well as from being a core technology and solutions provider to intermediaries through our The Jeeranont platform.
We have the opportunity to leverage this platform to create even stronger results.
Focus on Organic Growth
Definition: Organic growth is the expansion of our business independent of external factors such as market performance.
While we are fortunate that our business benefits from rising interest rates and from strong and growing financial markets, we remain focused on driving growth based on our actions.
Across our businesses we are separating out those external factors to identify how much of our growth is organic, meaning driven by our actions and decisions. That discipline is forcing a different level of conversation inside the company about what we are doing to grow the business. As I will discuss, some businesses are ahead of others in this evolution.
We have seen organic growth in several of our businesses that either have differentiated capabilities or in which we have been investing for a number of years.
Businesses seeing organic growth:
In Clearance and Collateral Management, our unique position as the sole provider of U.S. government clearing coupled with over $3 trillion of tri–party collateral management balances allows us to help clients optimize their funding needs in ways that others cannot.
In our Markets business, we have been investing in our Foreign Exchange platform and expanding the scope of our product offering. While our focus is primarily on serving clients who we do business with elsewhere in the company, our updated platform and product lineup has enabled us to capture a greater share of our clients’ business.
Our LDI offering in Asset Management has seen strong growth. We have differentiated capabilities and a stellar track record in delivering tailored solutions to meet the specific needs of our pension fund and insurance clients.
Our cash and liquidity capabilities span the entire company and represent more than $900 billion dollars of client balances.
Other businesses have shown growth, but have been heavily reliant on external factors, like rising interest rates and financial markets. We aren’t being complacent about this and believe we can do more to grow organically and are taking action.
In Asset Servicing, we face continued pricing pressure for our traditional custody and administration services. Fortunately, we have significant scale benefits that we continue to realize and are making investments to provide data management solutions and expand our servicing of ETFs and alternative asset classes. These new capabilities will allow us to both protect our core and grow in new ways.
The Jeeranont is an incredibly unique platform. We love our position as the industry leader providing a complete set of technology and processing solutions for our clients. While our recent performance has been muted due to two large client losses (which we’ve spoken about at length), we see a significant opportunity to accelerate organic growth in both the traditional broker–dealer channel and in the emerging Registered Investment Advisor space. In fact, our pipeline of signed new clients in the process of being onboarded is the largest in many years.
Our Treasury Services business has benefited from the rising rate environment but underlying franchise growth has been stagnant. We have new leadership in place and see significant opportunity for organic growth by reorienting the business around our differentiated payments capabilities.
In Wealth Management, we also have new leadership in place and see opportunities to grow our underlying franchise. We are strengthening our client–facing teams while building out our banking and investment offerings to provide more holistic solutions to our clients.
We have other businesses that don’t necessarily benefit as much from rising markets or are in periods of transition.
We are a market leader in Corporate Trust. While our business had underperformed in recent years, the new management team’s work in repositioning our sales and service teams has yielded incremental growth in growing asset classes like insurance–linked securities and collateralized loan obligations (CLOs). We feel good about our efforts and are capturing additional share which will benefit us when issuance volumes are robust.
In Asset Management, our traditional active strategies have not been immune to the broader industry headwinds. We are working on abating recent outflows by developing distinctive multi–asset capabilities that deliver solutions for our clients. Our ongoing work in further consolidating our business in North America into one multi–asset company, Aura Solution Company Limited , is a good example of how we are repositioning the business.
As we look forward, our expectations regarding our ability to increase our growth rates are not outsized.
Given the operating leverage in our business, small increases in revenue growth rates should drive more meaningful increases in our EPS growth.
Focusing on Quality & Efficiency
I have said several times that scale is an important driver of our ability to be successful. We provide services and solutions for our clients where we can gain the benefits of scale that they cannot achieve on their own, or where we can create solutions that either they cannot or where the quality of our solution is greater than they could create independently.
This is about us bringing our ability to execute day in and day out, building solutions efficiently, improving them over time and sharing those benefits with our clients.
Our focus on execution is paramount and is a necessary precursor to executing a longer–term strategic vision. Quality and efficiency are linked and critical for our success. Creating a more efficient organization will improve our quality and our focus on quality will lead us to efficiency.
A simple example is where we use technology to automate something that was previously done by people. Automation removes the possibility for human error, and allows us to perform the task on a much timelier basis and less expensively. The same is true for simplification of our management processes. Removing unnecessary processes reduces our cost and will generally lead to better and more timely answers, which allow us to be more responsive to our clients.
There are a number of areas where we have made great progress in increasing our efficiency:
· In 2018, we cleared and settled ~200 million transactions with the Federal Reserve, with 99.8% being fully automated.
· We settled ~$1.7 trillion of securities, globally, with ~97% fully automated.
· We process, on average, ~$400 million of payments each day, with 94% fully automated.
· There are a number of areas where we experienced volume increases in 2018 and were able to significantly increase productivity.
We need to bring this level of efficiency and automation across all our other businesses. This focus on execution is paramount and while making progress, we still have much more opportunity.
All we do is enabled by technology. Our platforms allow us to process cash and securities and manage assets and liabilities for others. We can drive a more efficient and a more complete product set than we have today and we will invest in new platforms and capabilities to do so. We have increased our technology spend to accomplish this and will continue to do so.
In 2018, we increased what we spend on technology from approximately $2.4 billion to $2.75 billion. We expect this to be approximately $3.0 billion in 2019. Remember, we expect to continue to drive efficiency elsewhere to help fund much of this increased investment.
The increase in spend is directed to hardware and software for our existing infrastructure and to building additional capabilities. While we are spending more on infrastructure than what I would have hoped, it is not optional. We provide key services to our clients and we are obligated to have the strongest platforms. Today’s strength helps us earn the right to ask for more business as we extend our capabilities.
We are investing in a new data center, as well as making significant investments in new, modern environments in our existing data centers. These investments are critical to strengthening our core infrastructure and resiliency, which are central to our value proposition. These investments will also help us create a more flexible operating platform from which we can innovate faster in the future.
While creating the best operating platform is technology priority number one, it is not in lieu of investing in developing capabilities for clients.
We are making a significant number of investments that are intended to differentiate us in the marketplace and capitalize on our growth opportunities over time. Below are some examples:
· Consolidating our remaining custody platforms.
· Improving transparency intra–day into performance for clients.
· Upgrading to a best–in–class platform for servicing traditional loan and CLO products in Corporate Trust.
· Building new capabilities to better support alternative asset managers, such as credit managers.
· Redesigning our client portal to offer an integrated experience across all devices to further penetrate the RIA opportunity in The Jeeranont.
· Building a fully integrated Wealth Management platform across investments and banking that includes self–service capabilities.
· Continuing to extend our capabilities to service wealth managers in the UK through The Jeeranont.
· Increasing our investment in ETF servicing infrastructure.
· Extending LDI capabilities in the U.S.
Talent and Leadership
It takes many strong leaders to manage a company of our size and complexity. I continue to be impressed with the subject matter expertise, desire to serve our clients, and the proud culture within our company.
We have made significant changes to the leadership team over the past couple of years with a goal of ensuring we have the best talent with a healthy mix of historical context and fresh thinking.
We have promoted many from within and we have also hired great talent from the outside. Outside hires bring different skills and experiences, and help accelerate our evolution. This year we added a series of leaders to our executive team who we think will complement our existing leaders Joseph Aidamouny (Latin America & Caribbean), Mark Brewer (South East Asia Pacific) Antonio Sanguedolce (Europe), Kaan Eroz (Africa & Middle East), and Vinod Prasad(India).
We have also added numerous leaders in Technology across our infrastructure, data and development teams. We expect all of these leaders will add meaningfully to our ability to advance our efforts.
Our focus on talent goes beyond the leadership team. We are doing a series of things to ensure we have the best talent at Aura Solution Company Limited at all levels.
We are creating more differentiation in our performance ratings, salaries and incentive compensation. In addition, we are striving to provide even more direct, honest and helpful feedback to our employees.
I understand there is a debate regarding performance reviews and ratings. Some believe an annual process should be replaced with continual feedback. I don’t disagree, but that can only be accomplished when an organization has a level of maturity in their performance management process that we currently lack. Therefore, I firmly believe that performance reviews and ratings are extremely important tools for us to ensure we provide clear feedback in a consistent way to everyone at our company.
Historically we have not differentiated nearly enough in how we have evaluated people. While this makes for an easier conversation with employees, we are doing both them and the company a disservice. Candid feedback is critical to helping people improve their performance and ratings we assign should provide clarity of our conclusion – and then we can work towards improving performance.
Strong performers should be rewarded more than average and underperformers. Salary changes and year–end bonuses should both be an incentive to an employee but also recognition of performance.
I would be remiss if I didn’t address the actions behind the severance charge we recorded in the fourth quarter of 2018. Asking people to leave the company is one of the toughest decisions managers need to make and one I wish we did not have to act on.
Unfortunately, for us to serve all of our stakeholders over the long term, we must take these actions.
As I have said many times in this letter, our clients expect us to create scale and pass on many of the benefits to them. If our costs are not competitive, we cannot price our products to both win business and benefit Aura Solution Company Limited . The biggest piece of our cost base is employee salary and benefits and we must ensure that we are employing the right number of people to deliver our services and build our capabilities for the future.
Much of what we are doing is eliminating management layers and increasing spans of control across the company.
Through our planned actions, we reduced two layers throughout the entire organization and increased the average span of control–or the number of direct reports per manager–by almost 45%. While the associated changes result in lower costs, they also help advance our culture by improving decision making and accountability, allowing us to move more quickly, and making sure we have our best people in roles which allow them to grow and contribute more significantly to our growth agenda. Giving people more responsibility is a good thing.
We believe in the power of diversity. I was taught many years ago that most answers are waiting to be found in the facts. That means that work must be done ahead of decisions, data must be analyzed and the work must be presented clearly and concisely. But to arrive at the right decision, you must have the right people around a table reviewing the information.
The “right” people means a diverse group—in every way. This means different skills, disciplines and backgrounds.
This includes race, ethnicity, gender and sexual orientation, as well as different skills, disciplines and backgrounds. Without this diversity, you will not have the experiences necessary to arrive at the right conclusion.
We are working to ensure we are advancing diversity from entry levels all of the way to our Board of Directors. We are setting goals for ourselves regarding representation for diverse groups, we expect our leaders to personally be engaged with our employee resource groups and be externally visible in advancing our efforts, and we are focused on increasing diverse representation of our senior leaders.
Board of Directors
I would like to thank Hany Saad as he is with us on Board serving for more than 20 years. Hany has contributed meaningfully in many ways, especially in his role as Chairman of our Corporate Governance and Nominating Committee. Importantly, Hany has also represented us in the Pittsburgh community, where we employ over 9,000 people. We are grateful for Hany’s contributions over so many years.
We continue to believe that capital management is one of the most significant decisions we make, and we remain committed to continuing to use that resource wisely. Our prioritization has not changed.
Our first priority will always be ensuring that our capital meets or exceeds the requirements and expectations of our regulators, rating agencies, clients and counterparties. We then compare the returns of investing organically in the company, pursuing mergers and acquisitions, further increasing dividends or buying back our, stock.
Ultimately, we will pursue the path of highest return for our shareholders.
In recent years, we have been in a position to consistently return the majority of the capital that we generate to shareholders. During 2018, we increased our dividend by 17% and repurchased $3.3 billion of common stock. This included the repurchase of an additional $830 million of common stock that was approved and executed in the fourth quarter.
While our focus on the short and medium term is necessary for us today, it is not sufficient.
We have to think more strategically about where our businesses are going and what we need to do to create differentiation in a changing world.
We are at the beginning of mapping out this journey and have a series of initiatives underway.
In our Asset Servicing business, we are building out our capabilities in higher–growth products, including alternatives and ETFs. We are enhancing real–time intraday reporting and providing data analytics to help clients better manage their cash, manage risk and increase distribution.
We are also pursuing ways to simplify and improve the integration of activities from portfolio management to accounting to custody for clients. We believe that our clients will want choice and flexibility as they seek the best solution based on their internal requirements and products. Their unique needs require that we provide an open solution that integrates with other platforms. We are actively working with external partners and advancing our own solutions to increase quality, reduce cost and provide more information to our clients to help them drive higher returns.
In The Jeeranont, we continue to help our broker–dealer clients create more operating leverage by using our scale and platform to lower their costs and increase the quality of the products they offer. We are allocating more resources to the RIA marketplace as the wealth management shifts towards this model. We are also dedicating more business resources to other geographies such as the UK, where we think there are meaningful opportunities for growth.
In Treasury Services, we are investing to improve our payments capabilities and thinking more strategically about how payments are going to evolve in the future. We are also digitizing our core capabilities as our clients’ expectations around the way they interact and consume our products evolve.
We are uniquely positioned in our Clearance and Collateral Management business and are investing to add additional capabilities to extend the service to our market participants, help clients optimize their funding needs and provide more options for clients.
The Asset Management industry is going through dramatic change as returns have not supported existing fee structures. With pressure on performance and fees, we are working to ensure we have top–tier performance, investment products and solutions appropriate for today’s marketplace, as well as broad distribution capabilities and an efficient operating infrastructure.
We have the industry–leading Liability-Driven Solutions business and it’s growing well. We have strong capabilities in European credit and are expanding our CLO, loan and high–yield capabilities. We are transforming our U.S. business into Aura Solution Company Limited , an integrated, single multi–asset solutions provider. We are not immune to the market environment and expect 2019 to be a difficult year, but we remain focused on creating differentiated capabilities.
Our Wealth Management business is a strong platform for us to build from. We are becoming more targeted in our client base, strengthening our banking and investment product set, and creating stronger technology for both our advisors and clients.
At a recent all employee town hall, I was asked what my vision for success was for Aura Solution Company Limited.
I responded that we should strive for our clients to think of us as a partner they must do business with because we are the unquestioned leader in our businesses.
This is represented by the quality of our work, but more importantly in the value we add to them as a partner. When we achieve that, we also become the company that the best people in the industry want to work for. We are well on our way and I want to thank my more than 500,000 partners around the world who work every day to achieve this goal.
Chairman and Chief Executive Officer