State Street Corporation — Q2 2012 Form 10-Q
Business context and reporting period. Unaudited results cover the quarter and six months ended June 30, 2012, compared with the corresponding 2011 periods. State Street provides institutional investment servicing and investment management. At quarter-end, it reported $200.8 billion in assets, $143.8 billion in deposits, $19.9 billion in shareholders’ equity, $22.42 trillion in assets under custody and administration, and $1.91 trillion in assets under management. The independent accountant performed an interim review, not an audit.
Key financial results
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $2.423 billion | $2.491 billion | $4.844 billion | $4.852 billion |
| Net income | $490 million | $513 million | $917 million | $984 million |
| Net income available to common shareholders | $480 million | $502 million | $897 million | $968 million |
| Diluted EPS | $0.98 | $1.00 | $1.83 | $1.93 |
| Net interest revenue | $672 million | $572 million | $1.297 billion | $1.149 billion |
| Total expenses | $1.772 billion | $1.774 billion | $3.607 billion | $3.476 billion |
- Q2 fee revenue fell 6% to $1.778 billion; six-month fee revenue fell 3% to $3.563 billion. Trading services declined 18% in Q2 and 13% year to date, while securities finance rose 4% and 18%, respectively.
- Q2 net interest revenue rose 17%; fully taxable-equivalent net interest margin was 1.72%, down 4 basis points year over year. Six-month fully taxable-equivalent margin was 1.68%, versus 1.80%.
- Q2 return on average common equity was 10.0%, compared with 10.6%; six-month return was 9.4%, compared with 10.6%. Q2 Investment Servicing and Investment Management pre-tax margins were 31% and 26%, respectively; six-month margins were 28% and 24%.
- For the six months, operating cash flow was negative $1.449 billion; investing activities provided $21.090 billion and financing activities used $15.746 billion. Cash and due from banks ended at $6.088 billion.
Financial condition, debt and capital
- Total assets decreased to $200.8 billion from $216.8 billion at December 31, 2011. Deposits declined to $143.8 billion from $157.3 billion; noninterest-bearing deposits fell to $41.2 billion from $59.2 billion.
- Long-term debt was $6.392 billion, down from $8.131 billion. The filing attributes lower average debt principally to maturities of previously issued notes.
- Consolidated net liquid assets were $129.19 billion, down from $144.15 billion at year-end; management considered overall liquidity sufficient. Commercial paper outstanding was $2.45 billion. The company reported $24.55 billion of excess central-bank balances at quarter-end.
- State Street’s Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 19.9%, 21.5% and 7.7%; State Street Bank’s were 18.1%, 20.0% and 6.9%. Both exceeded regulatory minimum and “well-capitalized” thresholds.
- The investment securities portfolio was approximately 89% rated AAA or AA. The $22 million loan-loss allowance was unchanged from year-end; the six-month provision was a $1 million credit.
Material changes, outlook and risks
- Revenue was down 3% in Q2, as lower fees and a $27 million net investment-securities loss outweighed stronger net interest revenue. The fee decline reflected weaker non-U.S. markets, euro depreciation, asset mix, lower FX volatility and reduced transition-management revenue. Six-month revenue was approximately flat.
- Net interest revenue benefited from higher client deposits and interest-earning assets, lower funding costs and conduit-security discount accretion. Q2 included $74 million of such accretion. The filing estimated about $900 million of remaining aggregate accretion over the securities’ remaining terms, with roughly half expected over the next four years; actual timing depends on prepayments, credit quality and portfolio actions.
- Management said the multi-year operations and technology transformation had produced $86 million in annual pre-tax run-rate savings in 2011 and expected an additional $90–$100 million in 2012, measured against the 2010 expense base. It projected $575–$625 million in annualized savings by end-2014, with the full effect in 2015, alongside expected program restructuring charges of $400–$450 million over 2010–2014. These are estimates, not earnings guidance.
- On July 17, 2012, after quarter-end, State Street agreed to acquire Goldman Sachs Administration Services for approximately $550 million in cash, subject to adjustments, approvals and customary conditions; closing was expected in Q4 2012. The target had approximately $200 billion of hedge fund assets under administration.
- The company sold all Greek investment securities, with an aggregate carrying value of about $91 million, recognizing a $46 million pre-tax loss. It reported no direct sovereign debt exposure to Spain, Italy, Ireland or Portugal, but had approximately $872 million of indirect exposure to those countries, including $697 million in mortgage- and asset-backed securities. It recognized $6 million of expected-credit-loss impairment on these securities in Q2.
- Material risks include prolonged low interest rates and margin pressure, volatile markets and client deposit flows, European sovereign and counterparty risk, mortgage/consumer-credit performance and impairment estimates, regulatory capital changes, and litigation or regulatory inquiries. Proposed U.S. Basel III capital rules could materially increase risk-weighted assets under the proposed securitization formula and reduce capital ratios; final impacts remained uncertain.
- Legal matters include indirect foreign-exchange pricing claims and investigations, securities-lending and investment-strategy disputes, and other litigation. The filing cautions that outcomes may affect results or reputation; some exposures were not reasonably estimable. A Massachusetts court had ruled that Prudential was entitled to $28.1 million, subject to possible interest and costs; State Street intended to appeal.
- Common dividends declared were $0.24 per share in Q2 and $0.48 per share for the first half. The company repurchased 11.1 million shares for $480 million during the first half under a $1.8 billion authorization running through March 31, 2013.
Most important facts for investors to verify
- Whether fee trends, particularly servicing and FX/trading revenue, stabilized and whether awarded but uninstalled business converted into recurring fees.
- How much net interest revenue depends on low-cost client deposits and conduit discount accretion, and how margins respond to interest-rate changes.
- Progress, realized savings, remaining charges and execution risks for the transformation program.
- Credit performance, impairment assumptions and valuation sensitivity across mortgage- and asset-backed securities, including European exposures.
- Final U.S. Basel III requirements and their effect on risk-weighted assets, capital ratios and the investment portfolio.
- Developments in FX-pricing litigation and other contingencies, and the purchase price, approvals, closing and integration economics of the GSAS acquisition.