State Street Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods unless noted. State Street provides investment servicing and investment management to institutional clients worldwide. At quarter-end, it reported $294.57 billion in assets, $230.59 billion in deposits, $21.50 billion in shareholders’ equity, $28.65 trillion in assets under custody and administration, and $2.37 trillion in assets under management.
Financial results and position
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Total revenue | $2.614 billion | $2.598 billion | $5.219 billion | $5.083 billion |
| Net income | $422 million | $622 million | $831 million | $985 million |
| Net income available to common shareholders | $393 million | $602 million | $770 million | $958 million |
| Diluted EPS | $0.94 | $1.38 | $1.84 | $2.19 |
| Total expenses | $2.134 billion | $1.850 billion | $4.231 billion | $3.878 billion |
| Net interest revenue | $535 million | $561 million | $1.081 billion | $1.116 billion |
| Provision for loan losses | $2 million | $2 million | $6 million | $4 million |
- Quarterly revenue rose 1%, while net income fell 32% and diluted EPS fell 32%. For the first half, revenue increased 3%, but net income declined 16% and diluted EPS declined 16%.
- Fee revenue increased 2% in Q2 and 5% year to date. Servicing fees rose 3% in both comparisons; foreign-exchange trading revenue rose 16% in Q2 and 33% year to date. Net interest revenue declined 5% in Q2 and 3% year to date.
- Q2 return on average common equity was 8.3%, versus 11.9% a year earlier; the first-half return was 8.1%, versus 9.6%.
- At June 30, long-term debt was $9.09 billion, down from $10.04 billion at year-end 2014. Total deposits increased to $230.59 billion from $209.04 billion.
- For the first six months, operating cash flow was negative $4.53 billion, investing cash flow was negative $16.84 billion, and financing cash flow was positive $22.59 billion; cash and due from banks ended at $3.08 billion. The filing attributes substantial cash-flow movements in part to collateral deposits and deposit balances.
- Parent-company net liquid assets were $5.94 billion. The company reported a liquidity coverage ratio above 100% and high-quality liquid assets of $142.27 billion.
- Under the Basel III standardized approach, State Street reported a common equity tier 1 ratio of 11.6%, total capital ratio of 16.1%, and tier 1 leverage ratio of 6.0%; State Street Bank reported 13.8%, 15.2%, and 5.7%, respectively. The company said it exceeded applicable capital requirements.
Material changes and notable items
- A $250 million Q2 legal accrual for legacy indirect foreign-exchange matters drove much of the quarterly expense increase. Together with a $150 million first-quarter accrual, the indirect FX accrual totaled $585 million at filing; aggregate accruals for legal loss contingencies and regulatory matters were approximately $611 million at June 30.
- The stronger U.S. dollar reduced Q2 revenue by approximately $88 million versus 2014, while reducing expenses by approximately $71 million. Management cited currency translation as a partial offset to fee growth.
- Assets under management declined to $2.374 trillion from $2.448 trillion at year-end 2014. First-half net outflows were approximately $104 billion, including $43 billion from ETFs, $40 billion from long-term institutional portfolios, and $21 billion from money-market funds. Management cited seasonal SPY outflows and dollar strength; approximately $32 billion of awarded business was not yet installed.
- Shareholders’ equity was nearly unchanged from year-end, at $21.50 billion versus $21.47 billion. The company issued $742 million of net proceeds from Series F preferred stock and repurchased approximately $820 million of common stock in the first half. The Q2 common dividend was $0.34 per share.
- Accumulated other comprehensive loss increased to $1.01 billion from $507 million at year-end, primarily reflecting foreign-currency translation and changes in investment-security marks.
Outlook, risks, and contingencies
- The filing provides no specific consolidated earnings or revenue guidance. Management said elevated client deposits, low global rates, central-bank balances and a strong U.S. dollar pressured net interest margin; the fully taxable-equivalent margin was 1.00% in Q2, versus 1.17% a year earlier. Management noted that continued low European rates or further dollar strength could extend or worsen pressure.
- Management expected remaining discount accretion from former conduit securities to contribute to future net interest revenue, generally in declining amounts. Assuming the securities are held to maturity, estimated future accretion was approximately $276 million, about half over the next four years.
- State Street entered a written agreement with the Federal Reserve and Massachusetts Division of Banks concerning Bank Secrecy Act, anti-money-laundering and sanctions compliance. Required remediation and an independent review may lead to additional costs or sanctions if deficiencies are identified or the agreement is not met.
- The SEC staff issued a Wells notice concerning solicitation of public-retirement-plan business; State Street said it intended to respond. Indirect FX claims and investigations remain unresolved; management cautioned that settlements, claims or adverse outcomes could exceed accruals and harm results or reputation. Other litigation and regulatory matters also remain pending.
- Other identified exposures include interest-rate and currency movements, client deposit withdrawals, counterparty and credit risk, operational and cyber risk, securities-lending indemnities, and regulatory changes. The company reported $23.32 billion of unfunded credit commitments and $331.55 billion of indemnified securities on loan; collateral and related protections do not eliminate exposure.
- Volcker Rule compliance could require changes to certain fund and trustee relationships, with potential costs and lost revenue. State Street held approximately $3.52 billion in CLO investments and noted that classification or divestiture requirements could adversely affect results.
- Management reported effective disclosure controls as of June 30, 2015. The independent accountant’s interim review stated it was not aware of material modifications needed for GAAP conformity; this was a review, not an audit opinion on the interim statements.
Important facts for investors to verify
- Track the outcome and adequacy of the $585 million indirect-FX accrual, related settlement negotiations, and the separate public-retirement-plan and compliance matters.
- Assess whether servicing and trading fee growth can offset continued net interest margin pressure, including the effects of deposit levels, rates, currency movements and reinvestment yields.
- Monitor asset-management flows and installation of the awarded but uninstalled business, particularly ETF and institutional flows.
- Review regulatory capital and liquidity ratios as Basel III and G-SIB requirements phase in; reported period-to-period ratios use changing calculation methodologies.
- Evaluate the quality and sensitivity of the securities portfolio, including CLO and structured-credit exposures, and the growth and credit quality of speculative senior secured loans.
- Reconcile reported cash-flow volatility with changes in collateral deposits and client funding, and monitor capital returns against capital needs and regulatory constraints.