STATE STREET CORP annual report, FY2011

Business context and reporting period

State Street Corporation’s Form 10-K covers the fiscal year ended December 31, 2011; it is an annual report, not a standalone quarterly filing. The company provides investment servicing and investment management to institutional investors worldwide. At year-end, it reported $216.83 billion in assets, $157.29 billion in deposits, $19.40 billion in shareholders’ equity, $21.81 trillion in assets under custody and administration, and $1.86 trillion in assets under management.

Financial performance and position

Metric	FY 2011	FY 2010
Total revenue	$9.594 billion	$8.953 billion
Fee revenue	$7.194 billion	$6.540 billion
Net interest revenue	$2.333 billion	$2.699 billion
Net income	$1.920 billion	$1.556 billion
Net income available to common shareholders	$1.882 billion	$1.540 billion
Diluted EPS	$3.79	$3.09
Total expenses	$7.058 billion	$6.842 billion
Net interest margin, fully taxable-equivalent	1.67%	2.24%

Profitability: Return on average common equity before extraordinary loss was 10.0%, compared with 9.5% in 2010. The effective tax rate was 24.3%, versus 25.4%; FY 2011 included a $103 million discrete tax benefit.
Fee trends: Servicing fees rose 11% to $4.382 billion, management fees rose 11% to $917 million, trading services rose 10% to $1.220 billion, and securities finance revenue rose 19% to $378 million. Processing fees and other declined 15% to $297 million.
Interest income: Net interest revenue fell 14%, largely because conduit-related discount accretion decreased to $220 million from $712 million. Excluding this accretion, fully taxable-equivalent net interest revenue increased year over year, reflecting lower funding costs and more client deposits.
Cash flow: Operating activities provided $3.374 billion; investing activities used $53.895 billion, mainly reflecting increased deposits with banks and securities purchases; financing activities provided $49.403 billion, primarily from deposit growth. Cash and due from banks ended the year at $2.193 billion.
Liquidity and funding: Management reported consolidated net liquid assets of $144.15 billion, up from $83.41 billion, and considered liquidity sufficient for current commitments and business needs. Deposits increased to $157.29 billion from $98.35 billion. Excess central-bank balances were $50.09 billion at year-end.
Debt and capital: Long-term debt was $8.131 billion, down from $8.550 billion. Total contractual cash obligations were $11.394 billion. Consolidated tier 1 and total risk-based capital ratios were 18.8% and 20.5%; State Street Bank’s ratios were 17.6% and 19.6%. Ratios remained above applicable minimums but declined from 2010.
Quarterly context: In Q4 2011, revenue was $2.315 billion, net income was $381 million, net income available to common shareholders was $371 million, and diluted EPS was $0.76. Q4 2010 revenue was $2.043 billion and diluted EPS was $0.16; that quarter included significant investment-security losses.

Material changes versus the prior comparable period

Annual revenue increased 7%, as higher servicing, management, trading, and securities-finance fees more than offset lower net interest revenue.
Total expenses increased 3%. Expenses from operations rose 10%, with higher compensation, technology, transaction-processing and professional-services costs; acquisition and restructuring items also affected comparability.
Investment securities increased to $109.15 billion from $94.13 billion, while total assets rose to $216.83 billion from $160.51 billion. The increase in assets and deposits reflected unusually high client deposits and the investment of those funds.
Assets under custody and administration increased modestly to $21.81 trillion from $21.53 trillion. Assets under management fell 8% to $1.86 trillion, reflecting net outflows, the U.S. Treasury’s reduction of agency mortgage-backed securities, and market depreciation.
Common dividends increased to $0.72 per share from $0.04. The company repurchased approximately 16.3 million shares for $675 million; no authorization remained at year-end.
The loan-loss provision was zero, versus $25 million in 2010; the allowance for loan losses declined to $22 million from $100 million, following charge-offs primarily related to acquired commercial real estate loans.

Outlook, management commentary, risks and unusual items

Cost program: The multi-year operations and technology transformation generated approximately $86 million of annual pre-tax run-rate savings in 2011. Management sought an additional $94 million in 2012 and projected approximately $575 million to $625 million in annualized savings by the end of 2014 versus 2010, with the full effect expected in 2015. These are targets, not guaranteed results.
Restructuring and business exit: FY 2011 restructuring charges totaled $253 million: $133 million for the transformation program and $120 million for expense-control measures, including withdrawal from a fixed-income trading initiative. The remaining initiative portfolio included derivative assets of about $1.89 billion and liabilities of about $1.78 billion; its wind-down could create further valuation or execution effects.
Acquisitions: State Street completed acquisitions of Bank of Ireland Asset Management, Complementa, and Pulse Trading in 2011. Integration, client retention, acquisition valuations and realizing anticipated benefits remain risks.
Interest rates and portfolio: Management cited the low-rate environment and a weaker net interest margin as constraints. The investment portfolio represented about half of total assets and included substantial mortgage- and asset-backed securities. Approximately 89% was rated AAA or AA. Management estimated that a more severe housing-price decline could increase impairment by approximately $10 million to $50 million.
Regulation and capital: State Street was designated a systemically important financial institution and a global systemically important bank. Basel III and Dodd-Frank requirements were expected to increase capital and liquidity demands; final rules were not yet available. Future dividends and repurchases were subject to Federal Reserve approval and capital-plan review.
Legal and contingent exposures: Indirect foreign-exchange pricing faced government inquiries and class actions. The company reported $331 million in indirect FX revenue in 2011 and had not established reserves for the related proceedings; California alleged $56 million in actual damages, in addition to potential penalties. A Washington matter was settled for $12 million. Other disclosed matters included an estimated $0–$90 million exposure across four fixed-income lawsuits, a $28.1 million Prudential ruling that State Street intended to appeal, and TAG-related claims seeking more than $100 million.
Securities-lending pools: At year-end, participant return obligations in agency lending duration pools exceeded the market value of pool assets by approximately $198 million; the company expected this shortfall to be eliminated as assets matured or paid down. Claims or further valuation deterioration could adversely affect results.
Economic and operational risks: The filing highlights European sovereign and financial-sector stress, concentrated counterparty exposures, deposit and short-term funding variability, securities-market liquidity, cyber and technology risks, litigation, reputation, and regulatory change. Standard & Poor’s had revised its outlook on State Street’s credit ratings to negative.

Important facts for investors to verify

Whether the $86 million realized and $94 million targeted transformation savings are delivered, and how costs and savings compare with the program’s targets.
How the fixed-income portfolio wind-down affects future fair-value adjustments and earnings.
Whether the reported net liquid assets and elevated client deposits remain available and stable, and how they affect net interest margin.
Developments in indirect FX, fixed-income, securities-lending and TAG litigation, including any reserves, settlements, or judgments.
Changes in securities-lending pool shortfalls, investment-portfolio credit quality, housing assumptions, and impairment estimates.
Final Basel III and Dodd-Frank requirements, Federal Reserve capital-plan decisions, and their impact on capital ratios and shareholder distributions.