State Street Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2009; filed November 6, 2009. State Street provides investment servicing and investment management to institutional investors. At quarter-end, it reported $163.28 billion in assets, $91.77 billion in deposits, $13.44 billion in shareholders’ equity, $17.94 trillion in assets under custody and administration, and $1.74 trillion in assets under management.
Financial results and condition
| Metric | Q3 2009 | Comparable period |
|---|---|---|
| Total revenue | $2.236 billion | $2.771 billion, Q3 2008; down 19% |
| Fee revenue | $1.471 billion | $1.899 billion, Q3 2008; down 23% |
| Net interest revenue | $723 million GAAP; $754 million fully taxable-equivalent | $525 million GAAP; $550 million fully taxable-equivalent |
| Net interest margin | 2.47% fully taxable-equivalent | 1.83%, Q3 2008 |
| Net income | $327 million | $477 million, Q3 2008 |
| Diluted EPS | $0.66 | $1.09, Q3 2008 |
| Return on common equity | 10.2% | 13.6%, Q3 2008 |
For the first nine months, revenue was $6.36 billion, down 21%; net income before extraordinary loss was $1.305 billion, or $2.45 diluted EPS. Reported net loss was $2.379 billion, or $5.45 diluted loss per share, reflecting a $3.684 billion after-tax extraordinary loss related to consolidating asset-backed commercial paper conduits. The prior-year nine-month period included a $350 million CitiStreet sale gain.
Expenses were $1.733 billion in Q3, down 10% year over year, including a $250 million legal provision. The loan-loss provision was $16 million in Q3 and $114 million year to date; $98 million of the year-to-date provision related to commercial real estate loans.
At September 30, total assets were $163.28 billion versus $173.63 billion at December 31, 2008; deposits were $91.77 billion versus $112.23 billion; long-term debt was $8.85 billion versus $4.42 billion; and equity was $13.44 billion versus $12.77 billion. Cash and due from banks was $5.03 billion. Management reported defined liquid assets of $69.70 billion, down from $85.81 billion at year-end, and considered liquidity sufficient for current commitments and business needs. Nine-month cash flows were $4.66 billion used in operations, $30.43 billion provided by investing, and $23.93 billion used in financing; cash and due from banks increased $1.85 billion.
State Street and its bank subsidiary met regulatory capital requirements. At quarter-end, State Street’s Tier 1 risk-based and total risk-based capital ratios were 15.3% and 16.5%; the bank’s were 14.2% and 15.7%.
Changes and management commentary
- Fee revenue remained pressured by market declines and lower activity: Q3 servicing fees fell 14%, management fees 16%, trading services 26%, and securities finance 57% year over year. Securities finance weakness reflected lower spreads and lending volumes.
- Net interest revenue benefited substantially from $279 million of conduit-related discount accretion in Q3 ($391 million since consolidation). Management expected accretion to remain a material contributor through the rest of 2009 and 2010.
- Assets under custody and administration increased 13% from year-end but were down 3% year over year. Assets under management rose 20% from year-end and 3% year over year. The company reported $626 billion of gross new servicing business and $106 billion of net new asset-management business during the first nine months.
- Cost reductions, including workforce reductions, lowered salaries and benefits expense. Management expected Q4 salaries and benefits to rise from Q3 as incentive compensation accrued, and expected securities finance revenue to decline below Q3 levels because of lower spreads and anticipated flat lending volumes.
Risks, contingencies and unusual items
- Active fixed-income litigation and SEC investigation: Following an SEC Wells notice and settlement discussions, State Street added a $250 million provision; the related reserve was approximately $443 million at quarter-end. No regulatory settlement had been signed. A proposed $89.75 million ERISA class-action settlement remained subject to court approval and was not deducted from the reserve.
- Securities-lending collateral pools: Withdrawal limits remained in place. Unregistered pool NAVs ranged from $0.93 to $1.00 per unit, with a weighted average of $0.979; purchases and redemptions continued at $1.00. The filing describes related litigation and regulatory inquiries.
- California foreign-exchange lawsuit: The state Attorney General asserted $56 million in actual damages, plus penalties, over pricing for pension-plan transactions. State Street disputed the claims; similar proceedings elsewhere were possible.
- Investment and credit exposures: About 73% of the investment portfolio comprised mortgage- and asset-backed securities; 8% was rated below BBB, versus 1% at year-end. Q3 included $99 million of credit-related or other impairment losses recognized in earnings. Commercial real estate conditions could lead to further loan provisions.
- Conduit consolidation and funding: The May consolidation added commercial paper liabilities and securities to the balance sheet and generated the extraordinary loss. The company also relied on wholesale funding, including $4.0 billion of Federal Reserve term-auction borrowings at quarter-end. Credit-rating downgrades could constrain market access and increase funding costs.
- Other disclosed uncertainties include tax disputes, claims involving Lehman-related funds, fair-value estimates for illiquid securities, regulatory changes, market and interest-rate risks, and operational and counterparty risks.
Important facts for investors to verify
- Progress and ultimate cost of SEC and other active fixed-income proceedings, and court approval and reserve treatment of the proposed ERISA settlement.
- Collateral-pool NAVs, redemption restrictions, customer activity, and potential consequences for securities-lending clients and State Street.
- Durability of net interest revenue after conduit discount accretion, and the effect of rates, deposit mix, and reinvestment activity.
- Credit performance, impairment assumptions, and valuation of asset-backed and mortgage-backed securities, including commercial real estate exposures.
- Deposit and wholesale-funding trends, liquidity levels, regulatory capital, and the effect of the share issuance and TARP repurchases.
- Reported nine-month loss versus results before the extraordinary conduit loss, and the extent to which Q3 earnings depended on accretion and other nonrecurring or market-sensitive items.