State Street Corporation — Q1 2019 Form 10-Q
Business context and period. The filing covers the three months ended March 31, 2019; balance-sheet comparisons are to December 31, 2018 unless noted. State Street provides custody, investment servicing and investment management globally through Investment Servicing and Investment Management. At quarter-end, assets under custody and/or administration (AUC/A) were $32.64 trillion and assets under management (AUM) were $2.81 trillion. The interim financial statements are unaudited and were reviewed by Ernst & Young.
Key financial results
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Total revenue | $2.932 billion | $3.056 billion | (4%) |
| Fee revenue | $2.260 billion | $2.415 billion | (6%) |
| Net interest income (NII) | $673 million | $643 million | +5% |
| Expenses | $2.293 billion | $2.268 billion | +1% |
| Income before tax | $635 million | $788 million | (19%) |
| Net income | $508 million | $659 million | (23%) |
| Diluted EPS | $1.18 | $1.62 | (27%) |
| Pre-tax margin | 21.7% | 25.8% | (410 bps) |
| Return on average common equity | 8.7% | 12.8% | (410 bps) |
The effective tax rate was 20.1%, versus 16.4% in Q1 2018. The reported diluted EPS includes $9 million of net acquisition and restructuring costs and approximately $14 million of legal and related expenses. The filing reports operating leverage of negative 5.2%.
Financial position, cash flow and capital
- At March 31, 2019, total assets were $228.33 billion, deposits $162.47 billion, long-term debt $11.18 billion and shareholders’ equity $25.04 billion. Total assets and deposits were down from $244.60 billion and $180.36 billion, respectively, at December 31, 2018.
- Cash and due from banks ended the quarter at $4.47 billion. Cash flow from operations was negative $495 million, investing activities provided $21.67 billion, and financing activities used $20.30 billion; cash increased by $872 million. The filing attributes substantial balance-sheet and cash-flow movements to client collateral, deposits and securities activity.
- Standardized CET1 ratio was 11.5%, down from 11.7% at year-end; tier 1 leverage ratio was 7.4%, up from 7.2%, and supplementary leverage ratio was 6.6%, up from 6.3%. The company reported that it and State Street Bank exceeded applicable capital requirements.
- Parent-company average daily liquidity coverage ratio was 110% for the quarter. The investment securities portfolio was approximately 91% rated AAA or AA; portfolio duration was 2.8 years.
- Common dividends declared were $0.47 per share, up from $0.42. State Street repurchased $300 million of stock, or 4.2 million shares, and said it may repurchase up to another $300 million in Q2 under its existing program.
Material changes and management commentary
- Fee pressure and weaker market conditions weighed on results: servicing fees fell 12%, management fees 11%, FX trading services 8% and securities finance 16%. Management cited fee concessions, weaker average equity markets, lower activity and flows, a client transition, and lower FX volumes and volatility.
- NII rose 5%, supported by higher U.S. interest rates and disciplined liability pricing, partly offset by lower average deposit balances. Average total deposits fell to $155.34 billion from $165.01 billion a year earlier.
- CRD, acquired in October 2018, contributed approximately $99 million of revenue and $41 million of expenses in Q1 2019. Processing fees and other revenue increased 148%, primarily due to CRD.
- Management reported $78 million of gross savings in Q1 toward its $350 million 2019 expense-savings program. It cited technology infrastructure spending and CRD as expense pressures, partly offset by savings from resource discipline, process re-engineering and automation.
- AUC/A was down 2% year over year, including the effect of FX translation and a client transition involving approximately $1 trillion in assets, which was largely complete. AUM increased 3% year over year. New servicing mandates announced in Q1 totaled about $120 billion, with $310 billion of servicing assets awaiting installation.
- State Street changed its LIHTC investment accounting method retrospectively to proportional amortization. The change altered the presentation and timing of certain revenue and tax expense; Q1 2019 net income and EPS were unchanged versus the former method. The 2018 comparative figures were revised.
Outlook, risks and contingencies
- No specific revenue or earnings forecast is provided in the supplied filing text. Management expects challenging market and industry conditions to remain a consideration and identified interest rates, deposit mix, client flows, markets and reinvestment decisions as drivers of future NII and margins.
- State Street expects approximately $200 million in CRD acquisition, merger and integration costs through 2021; $44 million had been incurred by March 31, 2019.
- Legal and regulatory matters include the historical client-invoicing review and government investigations. Accrued legal and regulatory loss contingencies were approximately $53 million. Estimated reasonably possible loss in excess of accruals was up to approximately $300 million, excluding matters for which a loss range could not be estimated. The company said cumulative customer reimbursements for invoicing errors were expected to be at least $380 million, all paid or accrued; further remediation and potential penalties remained uncertain.
- Other disclosed risks include regulatory and capital requirements, client deposit withdrawals and funding access, credit and counterparty exposure, market and FX volatility, technology and cybersecurity, operational controls, and competitive fee pressure. A downgrade could increase funding costs and trigger additional collateral requirements; the filing estimated up to $0.7 billion of additional derivative collateral could be required under specified rating triggers.
- The filing disclosed $29.95 billion of unfunded credit commitments and $2.97 billion of standby letters of credit. Indemnified securities on loan were $387.31 billion, supported by $405.30 billion of collateral held as agent; these arrangements carry counterparty and operational exposure.
Important facts for investors to verify
- Whether servicing-fee pressure, the large client transition and market levels continue to affect revenue, and whether announced mandates are installed on schedule.
- Progress and sustainability of the $350 million savings program, including whether savings offset technology, regulatory and CRD-related costs.
- CRD’s revenue contribution, integration progress, expected benefits and remaining costs through 2021.
- Developments in the invoicing investigations, proposed settlements and any additional client remediation, fines or sanctions.
- Capital and liquidity headroom as regulatory requirements and risk-weighted assets change; confirm the applicable ratios and their calculation basis.
- Deposit trends, NII sensitivity and the effect of changing interest rates, deposit pricing and balance-sheet mix.
- The effects of the retrospective LIHTC accounting change when comparing reported results with earlier periods.