State Street Corporation — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010; comparisons are with the same 2009 periods unless noted. State Street provides investment servicing and investment management services to institutional investors. At quarter-end, it reported $172.96 billion in assets, $105.03 billion in deposits, $17.57 billion in shareholders’ equity, $20.23 trillion in assets under custody and administration, and $1.90 trillion in assets under management.
Financial results and condition
- Q3 revenue: $2.31 billion, up 3%; fee revenue was $1.57 billion, up 7%. Q3 net income was $546 million and diluted EPS was $1.08, compared with $327 million and $0.66 a year earlier.
- Nine-month results: Revenue was $6.91 billion, up 9%; net income was $1.47 billion and diluted EPS was $2.93. The 2009 comparable period included a $3.684 billion after-tax extraordinary loss; excluding that item, 2009 net income was $1.305 billion and diluted EPS was $2.45.
- Expenses and margins: Q3 expenses were $1.53 billion, 12% lower, largely because Q3 2009 included a $250 million legal provision. Excluding that prior-year provision, Q3 expenses increased about 3%. Q3 pre-tax income was $782 million versus $487 million; return on common equity was 12.9% versus 10.2%. Fully taxable-equivalent net interest margin was 2.36% versus 2.47%; excluding former-conduit discount accretion, it was 1.77% versus 1.56%.
- Revenue mix: Q3 servicing fees rose 19% to $989 million, while management fees fell 3% to $213 million, trading services fell 15% to $228 million, and securities finance fell 35% to $68 million. Servicing growth reflected acquisitions, installed new business and stronger equity valuations; declines in trading and securities finance reflected lower foreign-exchange spreads and securities-lending spreads and demand.
- Credit and investment securities: Q3 provision for loan losses was $1 million; the nine-month provision was $26 million, down from $114 million. Net investment-securities gains were $17 million in Q3 and $62 million year to date. Q3 included $74 million of impairment losses, largely on non-agency mortgage-backed securities. Available-for-sale securities had $80.72 billion fair value and $10 million net unrealized pre-tax loss at quarter-end.
- Balance sheet and debt: Since December 31, 2009, assets increased from $157.95 billion to $172.96 billion, deposits from $90.06 billion to $105.03 billion, and equity from $14.49 billion to $17.57 billion. Long-term debt was $8.57 billion, down from $8.84 billion. The investment portfolio was approximately 82% rated AAA or AA.
- Cash flow and liquidity: For the first nine months, operating cash flow was $992 million, investing cash flow was negative $6.00 billion, and financing cash flow was positive $6.95 billion. Management reported $88.38 billion in liquid assets and considered liquidity sufficient for current commitments and business needs. These cash-flow totals reflect significant securities, deposit and borrowing movements.
Changes, outlook and material matters
- State Street completed acquisitions of Intesa Sanpaolo’s securities-services business in May and Mourant in April. Together, these businesses contributed approximately $120 million of Q3 revenue and $90 million of expenses, excluding merger costs. Acquisition-related goodwill and intangibles increased; integration costs were $42 million from acquisition dates through September 30.
- Former-conduit discount accretion was $189 million in Q3 and $573 million for the first nine months. Management said it will remain a material, potentially volatile component of net interest revenue; excluding accretion, nine-month net interest revenue was flat year over year.
- A $414 million pre-tax securities-lending charge was recorded in Q2, including a $330 million contribution to SSgA lending-fund collateral pools and a $75 million reserve for potential agency-pool redemption-policy inconsistencies. SSgA lifted redemption restrictions on its funds in August. Agency collateral pools remained below $1.00 per unit on a market-value basis, with a weighted average of $0.993; State Street planned changes to pool liquidity arrangements by year-end 2010 or early 2011.
- Legal and regulatory matters include pending securities-lending litigation and investigations, foreign-exchange pricing claims and other proceedings. The California Attorney General asserted $56 million in damages plus penalties; State Street agreed to a $12 million Washington settlement in October 2010. Management said certain matters could materially affect earnings in the period resolved, though it did not believe pending proceedings would materially harm consolidated financial condition.
- Other risks include possible further mortgage-related impairment, commercial real-estate loan losses, market and interest-rate changes, client deposit withdrawals, counterparty risk, and evolving capital and liquidity regulation. State Street and its bank subsidiary met applicable capital requirements; ratios declined from year-end 2009 but remained above minimum and “well-capitalized” thresholds. The filing provides no specific earnings guidance.
- The interim financial statements were reviewed by the independent registered public accounting firm, not audited. Management concluded disclosure controls were effective as of September 30, 2010.
Key facts investors should verify
- How much reported earnings and net interest revenue depend on former-conduit discount accretion, and how sustainable the underlying revenue growth is.
- Whether the Intesa and Mourant acquisitions deliver expected growth and efficiencies relative to added expenses, goodwill and integration costs.
- Developments in securities-lending collateral pools, redemption arrangements, client claims and related litigation or investigations.
- Credit and valuation trends in non-agency mortgage-backed and other asset-backed securities, including impairment assumptions and guarantor exposures.
- Liquidity, capital ratios, deposit stability and the effects of proposed regulatory requirements and interest-rate changes.