State Street Corporation — Q1 2017 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2017; comparisons are with Q1 2016 unless stated otherwise. State Street provides institutional investment servicing and investment management through Investment Servicing and State Street Global Advisors (SSGA). At quarter-end, assets under custody and administration (AUCA) were $29.83 trillion and assets under management (AUM) were $2.56 trillion. Total assets were $236.80 billion, deposits $183.47 billion, shareholders’ equity $21.29 billion, and employees 34,817. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial results and key metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Total revenue | $2.668 billion | $2.484 billion | +7% |
| Fee revenue | $2.198 billion | $1.970 billion | +12% |
| Net interest income (GAAP) | $510 million | $512 million | Flat |
| Total expenses | $2.086 billion | $2.050 billion | +2% |
| Income before tax | $584 million | $430 million | +36% |
| Net income | $502 million | $368 million | +36% |
| Net income available to common shareholders | $446 million | $319 million | +40% |
| Diluted EPS | $1.15 | $0.79 | +46% |
| Return on average common equity | 9.9% | 6.8% | +310 bps |
- Fee growth reflected market appreciation, new business, higher-yielding ETF flows, and GEAM, acquired July 1, 2016. Servicing fees rose 4%; management fees rose 41% to $382 million, including approximately $71 million from GEAM.
- Fully taxable-equivalent net interest margin was 1.17%, versus 1.15%. Higher domestic rates and liability pricing were offset by lower foreign portfolio yields and other factors.
- Operating cash flow was $3.51 billion; investing cash flow was $3.21 billion; financing cash flow was negative $5.12 billion. Cash and due from banks ended at $2.91 billion. Cash flows include substantial balance-sheet movements; they should not be read as a simple measure of recurring free cash flow.
- Quarter-end long-term debt was $11.39 billion, down from $11.43 billion at year-end 2016. Deposits declined to $183.47 billion from $187.16 billion. Loans and leases rose to $22.54 billion from $19.76 billion.
- State Street’s CET1 ratio was 11.2% under the advanced approaches and 11.5% under the standardized approach; its tier 1 leverage ratio was 6.8%. State Street Bank was reported as well capitalized. Regulatory methods and phase-ins affect period comparisons.
- Liquidity coverage ratio exceeded 100%; high-quality liquid assets were $94.55 billion. Parent Company net liquid assets were $4.08 billion. Approximately $950 million of Parent Company and bank senior notes and junior subordinated debentures mature within 12 months.
Material changes versus the prior comparable period
- EPS and common-shareholder income increased substantially, supported by fee growth, lower Beacon restructuring charges, and fewer average common shares following repurchases.
- Investment Management revenue rose 41%, with GEAM contributing to both revenue and expenses. AUM increased 12% year over year, partly reflecting acquired GEAM assets and market appreciation.
- Processing fees and other more than doubled, partly due to approximately $30 million in aggregate pre-tax gains from the IFDS sale and BFDS disposition, plus favorable foreign-exchange swap costs.
- State Street sold $2.7 billion of available-for-sale securities and recorded a $40 million pre-tax loss as it repositioned the portfolio for the interest-rate environment.
- The allowance for loan and lease losses declined to $51 million from $53 million at year-end; the quarter recorded a $2 million benefit from provision for loan losses, versus a $4 million provision in Q1 2016.
Outlook, management commentary, risks and contingencies
- State Street Beacon is expected to deliver $550 million of annual pre-tax net run-rate savings by the end of 2020, relative to 2015, with full effect in 2021; at least $140 million of annual pre-tax savings was expected in 2017. The company recorded $16 million of Beacon restructuring charges in Q1 2017 and estimated total program charges of $300–$400 million through 2020.
- GEAM integration costs were expected to total approximately $80 million through 2018. The company also expected elevated regulatory-compliance and resolution-planning costs to continue.
- Management reported approximately $375 billion of won asset-servicing mandates not yet installed, and $110 billion in new mandates secured in Q1. A large client is expected to transition approximately $1 trillion of assets to another provider by 2018; State Street expects to remain a significant provider but will no longer earn revenue on the transitioned assets.
- The ongoing review of historical client invoicing errors was expected to result in at least $340 million of client reimbursements including interest. Approximately $47 million remained unpaid and accrued at March 31. The review continues, including evaluation of other billing practices; client claims, class actions, and government investigations could lead to additional costs, sanctions, restrictions, or reputational damage.
- State Street paid a $32.3 million DOJ fine and entered a deferred prosecution agreement, including an independent compliance consultant and monitor for three years, subject to extension. A further $32.3 million SEC penalty was agreed in principle and accrued, subject to final terms and SEC review. A separate GovEx SEC matter had a $3 million penalty agreed in principle and accrued, also subject to final resolution.
- Other notable exposures include a 2015 Federal Reserve/Massachusetts banking-agency written agreement on BSA/AML and sanctions compliance; legal and regulatory accruals of approximately $58 million, excluding the $47 million client-reimbursement accrual; and potential tax-authority adjustments.
- The July 1, 2017 resolution-plan submission was a key regulatory milestone. Failure to meet regulators’ expectations could result in higher capital, leverage, or liquidity requirements, restrictions on growth or operations, or required divestitures.
- Principal risks include fee pressure and market sensitivity, client losses and outflows, interest-rate and deposit volatility, securities and counterparty credit risk, operational and cyber risk, regulatory change, litigation and compliance matters, and successful execution of Beacon and GEAM integration.
Important facts for investors to verify
- Whether fee growth and margins persist after separating market effects, GEAM contributions, and the IFDS/BFDS transaction gains.
- Final reimbursement amounts and outcomes of the invoicing review, class actions, and DOJ, SEC, DOL, and state investigations.
- Actual Beacon savings, restructuring charges, and GEAM integration costs against management’s stated targets.
- Timing and revenue impact of the approximately $1 trillion client asset transition, compared with installation of the $375 billion servicing pipeline.
- Liquidity and regulatory-capital trends, including the upcoming resolution plan and effects of capital-rule phase-ins.
- Whether investment-portfolio repositioning, client deposit levels, and interest-rate changes alter net interest income, liquidity, or realized securities losses.