State Street Corporation — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017 unless stated otherwise. State Street provides custody, investment servicing and investment management services to institutional investors. At quarter-end, assets under custody and administration (AUCA) were $33.28 trillion and assets under management (AUM) were $2.73 trillion.
Financial results and key metrics
| Metric | Q1 2018 | Q1 2017 / comparison |
|---|---|---|
| Total revenue | $3.019 billion | $2.668 billion; up 13% |
| Fee revenue | $2.363 billion | $2.198 billion; up 8% |
| Net interest income (NII) | $658 million | $510 million; up 29% |
| Income before tax | $763 million | $584 million; up 31% |
| Net income | $661 million | $502 million; up 32% |
| Diluted EPS | $1.62 | $1.15; up 41% |
| Pre-tax margin / return on average common equity | 25.3% / 12.8% | 21.9% / 9.9% |
| Total expenses | $2.256 billion | $2.086 billion; up 8% |
| Operating cash flow | $4.836 billion | $3.509 billion |
| Investing / financing cash flow | $(8.973) billion / $4.576 billion | $3.210 billion / $(5.124) billion |
Quarter-end total assets were $250.29 billion, deposits $191.52 billion, long-term debt $10.94 billion and shareholders’ equity $22.40 billion. Deposits increased from $184.90 billion at year-end; long-term debt declined from $11.62 billion. Cash and due from banks was $2.55 billion. The cash-flow statement reports a $439 million increase in cash and due from banks during the quarter.
The CET1 ratio was 10.8% under the standardized approach, down from 11.9% at year-end; management attributed the decline primarily to a temporary increase in overdraft exposure, which clients covered after quarter-end. The advanced-approaches CET1 ratio was 12.1%. The tier 1 leverage ratio was 6.9%, versus 7.3% at year-end. State Street reported an SLR of 6.0% at the parent and 6.5% at State Street Bank, and an LCR above 100%.
Material changes and drivers
- Revenue growth reflected higher servicing and management fees and NII. Servicing fees rose 10%; management fees rose 24%; NII benefited from higher U.S. rates, disciplined deposit pricing, higher client balances and reduced wholesale CDs.
- Processing fees and other revenue fell 78%, largely because Q1 2017 included a $30 million business-sale gain and Q1 2018 had $22 million of higher FX swap costs outside the NII deposit-hedging program.
- Expenses increased 8%, reflecting new-business investment, compensation, technology and transaction-processing costs, currency translation and revenue-recognition presentation changes. There were no restructuring charges in Q1 2018, compared with $17 million in Q1 2017.
- AUCA rose 12% year over year, while AUM rose 7%. Market appreciation and FX contributed to AUM, while net flows were negative $26 billion in Q1 2018.
- Operating leverage was 5.0%; fee operating leverage was negative 0.6%. Average common shares outstanding declined year over year, and the company repurchased 3.3 million shares for $350 million.
Outlook, risks and unusual items
- Outlook: The filing provides no specific quarterly or full-year earnings guidance. State Street said Q1’s newly announced servicing mandates were unusually high, partly reflecting previously contracted business whose disclosure was delayed; it expected new mandates for the rest of 2018 to return to more historical levels. Approximately $1.6 trillion of servicing assets and $22 billion of awarded AUM remained to be installed.
- Client concentration/retention: One large client plans to move approximately $1 trillion of assets to another provider, principally in 2018 and beyond; State Street expects to remain a significant provider but will lose revenue on transitioned assets.
- Interest-rate exposure: A modeled instantaneous +100 bps rate shock was estimated to increase 12-month NII by $524 million; a −100 bps shock was estimated to reduce it by $356 million. A +200 bps shock produced estimated EVE exposure of $1.375 billion. These are model estimates and assume no mitigating management action.
- Liquidity and funding: Potential liquidity demands include deposit withdrawals, client credit-line drawdowns, settlement advances and collateral needs. Approximately 73% of $26.83 billion in unfunded credit commitments expired within one year; contractual amounts do not necessarily represent expected cash outflows.
- Credit and market risks: Loans and leases rose to $29.58 billion, mainly from overdrafts and senior secured lending. The senior secured loan portfolio included speculative-rated exposures; management reported no impaired, non-accrual or 90-days-past-due loans. Investment securities had $1.26 billion of gross unrealized losses, which management considered temporary; Q1 OTTI was approximately $1 million.
- Legal and regulatory matters: The company continued remediation and investigations related to historical client invoicing, and estimated cumulative customer payments would be at least $360 million. Legal and regulatory accruals were approximately $15 million; estimated reasonably possible losses for certain matters ranged from zero to $30 million, but some significant matters—including the invoicing matter—could not be reasonably estimated. The filing also describes a DOJ deferred prosecution agreement, an SEC compliance consultant and a Federal Reserve/Massachusetts written agreement concerning compliance programs.
- Accounting and cost program: Adoption of the new revenue standard increased both revenue and expenses by approximately $65 million, with no impact on cash flows and no material effect on earnings. Beacon had delivered $385 million of its targeted $550 million in net annual run-rate savings by quarter-end; management expected the target by mid-2019.
Important facts for investors to verify
- Progress, timing and potential additional costs or penalties from the invoicing review and related regulatory, criminal and civil proceedings; some potential losses are not estimable.
- The pace and revenue impact of the large client’s planned $1 trillion asset transition, and the installation and fee contribution of new mandates.
- Whether overdraft exposures remain covered and how capital ratios respond; the filing attributes the CET1 decline to a temporary quarter-end exposure.
- Whether NII growth and interest-rate sensitivity persist as rates, deposit pricing, client balances and asset reinvestment change.
- How much of reported growth reflects underlying business performance versus market movements, share repurchases, currency effects and the $65 million gross presentation impact of the new revenue standard.