State Street Corporation — Q1 2011 Form 10-Q
Reporting period: Three months ended March 31, 2011; compared primarily with Q1 2010. The 2010 comparison excludes Intesa and MIFA, acquired in Q2 2010. State Street provides investment servicing and investment management services. At quarter-end, it reported $22.61 trillion in assets under custody and administration and $2.12 trillion in assets under management.
Financial results
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Total revenue | $2.361 billion | $2.296 billion | +3% |
| Fee revenue | $1.791 billion | $1.540 billion | +16% |
| Net interest revenue, GAAP | $577 million | $661 million | -13% |
| Expenses | $1.702 billion | $1.579 billion | +8% |
| Income before tax | $660 million | $702 million | -6% |
| Net income | $471 million | $495 million | -5% |
| Diluted EPS | $0.93 | $0.99 | -6% |
| Return on average common equity | 10.5% | 13.4% | Lower |
The reported pre-tax margin was approximately 28.0% of revenue, versus 30.6% in Q1 2010. Fully taxable-equivalent net interest margin was 1.85%, down from 2.34%; excluding former conduit-security discount accretion, management reported margins of 1.66% and 1.62%, respectively.
- Servicing fees rose 22% to $1.095 billion, primarily reflecting acquired businesses, installed new business and stronger equity valuations. Management fees increased 12% to $236 million; trading services grew 25% to $302 million.
- Securities finance revenue fell 8% to $66 million as average securities on loan declined 13%, partly offset by improved spreads. Processing fees and other revenue decreased 23% to $92 million, largely because Q1 2010 included tax-advantaged investment revenue.
- Net interest revenue declined chiefly because former conduit-security discount accretion fell to $62 million from $212 million. Excluding that accretion, fully taxable-equivalent net interest revenue increased 14%, to $546 million from $481 million.
- Expenses increased partly due to acquired-business staffing and costs, higher benefits, technology spending and transaction processing. The effective tax rate was 28.7%, compared with 29.5%.
Financial position, cash flow and capital
- At March 31, total assets were $171.80 billion, deposits $107.41 billion, total liabilities $152.62 billion and shareholders’ equity $19.18 billion. At December 31, 2010, these were $160.51 billion, $98.35 billion, $142.72 billion and $17.79 billion, respectively.
- Long-term debt was $9.53 billion, up from $8.55 billion at year-end. In March, State Street issued $2 billion of senior notes. It also completed a capital restructuring involving approximately $500 million of junior subordinated debentures and $500 million of non-cumulative perpetual preferred stock.
- Operating cash flow was negative $1.35 billion, investing cash flow negative $5.59 billion and financing cash flow positive $6.27 billion. Cash and due from banks decreased $674 million to $2.64 billion. Cash flows reflected substantial balance-sheet activity, including securities purchases and changes in deposits and borrowings.
- Management reported $95.24 billion of liquid assets, compared with $83.41 billion at December 31, and considered liquidity sufficient for current commitments and business needs. State Street reported no conduit-issued commercial paper outstanding at quarter-end; corporate commercial paper outstanding was $2.65 billion.
- State Street’s tier 1 and total risk-based capital ratios were 19.6% and 21.6%; State Street Bank’s were 17.4% and 19.7%. Both entities exceeded regulatory minimum and “well-capitalized” thresholds.
- Available-for-sale securities had a $318 million pre-tax net unrealized loss. Approximately 90% of the investment portfolio was rated AAA or AA. The allowance for loan losses was $80 million, down from $100 million at year-end; the quarter included a $19 million charge-off related to foreclosure on an acquired credit-impaired commercial real estate loan.
Changes, outlook and material risks
- State Street acquired Bank of Ireland’s asset management business (BIAM) on January 10, adding $23 billion of assets under management. Intesa and MIFA acquisitions completed in 2010 also contributed to year-over-year revenue and expense growth.
- The company won mandates for approximately $300 billion of asset-servicing business in Q1; about $115 billion had been installed by March 31. Management expected the remaining $460 billion of new asset-servicing business referenced in the filing to be installed during the remaining three quarters of 2011. It also won approximately $170 billion of asset-management mandates during Q1.
- A multi-year operating-model and technology transformation is expected to generate $400–$450 million of restructuring charges over four years. Management estimated annualized operating-expense reductions of $575–$625 million by the end of 2014, excluding restructuring charges; the workforce reduction was expected to be substantially complete by year-end 2011.
- The Board increased the quarterly common dividend to $0.18 per share and authorized up to $675 million of common-stock repurchases in 2011. These are capital-allocation actions, not earnings guidance.
- Management noted that future net interest revenue and margin depend on interest rates, client deposit levels and mix, reinvestment yields, and the timing of remaining conduit-security accretion. It estimated $1.29 billion of future accretion over the remaining terms of those securities if held to maturity, while cautioning that timing and actual recognition are uncertain.
- Key risks include regulatory changes, including Dodd-Frank and Basel III capital and liquidity requirements; market, interest-rate and currency movements; securities credit and valuation risk; client deposit withdrawals and liquidity demands; operational and technology risks; and litigation and regulatory investigations.
- Management expected housing prices to decline a further 5%–10% from peak, based on its outlook at the filing date. It estimated that specified adverse default and prepayment assumptions could add $20–$40 million of credit impairment for non-agency prime and Alt-A mortgage securities and $5–$10 million for sub-prime asset-backed securities.
- Contingencies include ongoing investigations and litigation concerning securities lending, foreign-exchange pricing, SSgA-managed funds and Lehman-related investments. A $75 million reserve remained for potential effects of agency-lending redemptions. The California Attorney General asserted $56 million in actual damages, plus penalties, in a foreign-exchange pricing matter; a separate client class action sought unspecified damages, including treble damages. State Street said outcomes could affect results in the period resolved, while it did not expect pending proceedings to materially affect consolidated financial condition.
- The IRS agreed with State Street’s treatment of SILO transactions for tax years 2000–2006; the company expected the 2004–2006 audit to close in 2011 and did not expect ultimate exposure to differ materially from amounts accrued. An Italian tax assessment of approximately €130 million relating to a pre-acquisition year was indemnified under the Intesa acquisition agreement; State Street had not accrued the assessment.
Important facts for investors to verify
- Whether mandate installations and asset growth translate into recurring fee revenue, and how much depends on market valuations versus acquired or newly won business.
- Whether net interest revenue stabilizes as conduit-related accretion declines, and how rate changes and deposit behavior affect margins.
- Progress and realized savings from the transformation program compared with its projected charges, savings and timetable.
- Credit performance and valuation assumptions for mortgage- and asset-backed securities, including sensitivity to housing prices, defaults and prepayments.
- Developments, reserves and potential financial effects from the disclosed litigation, investigations and tax matters.
- Liquidity and capital resilience under regulatory changes and adverse client-funding or market conditions. The filing reports management’s assessment of sufficient liquidity, but does not provide a single general-purpose liquidity ratio.