State Street Corporation — Q2 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and six months ended June 30, 2013, compared with the corresponding 2012 periods. State Street is a global institutional financial-services company operating Investment Servicing and Investment Management. At quarter-end it reported $227.30 billion in assets, $166.52 billion in deposits, $20.08 billion in shareholders’ equity, $25.74 trillion in assets under custody and administration, and $2.15 trillion in assets under management. The interim financial statements are unaudited; the independent accountant performed a review, not a full audit.
Key financial results
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $2.560bn (+6%) | $2.423bn | $4.995bn (+3%) | $4.844bn |
| Fee revenue | $1.971bn (+11%) | $1.778bn | $3.828bn (+7%) | $3.563bn |
| Net interest revenue | $596m (−11%) | $672m | $1.172bn (−10%) | $1.297bn |
| Expenses | $1.798bn (+1%) | $1.772bn | $3.624bn (approximately flat) | $3.607bn |
| Income before taxes | $762m (+17%) | $652m | $1.371bn (+11%) | $1.238bn |
| Net income | $579m (+18%) | $490m | $1.043bn (+14%) | $917m |
| Diluted EPS | $1.24 (+27%) | $0.98 | $2.22 (+21%) | $1.83 |
Q2 pre-tax margin was 30%, versus 27% a year earlier; return on average common equity was 11.3%, versus 10.0%. Fully taxable-equivalent net interest margin fell to 1.42% from 1.72%. The six-month effective tax rate was 23.9%, compared with 26.0%.
Cash flow and balance sheet. For the first six months, operating activities used $2.147 billion; investing activities provided $2.433 billion; financing activities provided $2.603 billion; and cash and due from banks increased $2.889 billion to $5.479 billion. The operating cash outflow included substantial movements in collateral deposits and foreign-exchange derivatives. Total assets rose to $227.30 billion from $222.58 billion at year-end 2012. Loans and leases, net of allowance, increased to $16.41 billion from $12.29 billion. Long-term debt was $8.84 billion, compared with $7.43 billion.
Management-defined consolidated net liquid assets were $146.19 billion, down from $149.02 billion at year-end; management considered liquidity sufficient to meet commitments and business needs. The company issued $1.50 billion of long-term debt in May: $500 million of 1.35% senior notes due 2018 and $1.0 billion of 3.1% subordinated notes due 2023. Commercial paper outstanding was $1.26 billion.
Material changes versus comparable periods
- Revenue growth was led by servicing fees (+11% in Q2) and management fees (+13%), supported by stronger equity markets, installed new business, and the October 2012 GSAS acquisition. Assets under custody and administration increased to $25.74 trillion from $22.42 trillion a year earlier.
- Trading services revenue grew 16% in Q2, with foreign-exchange trading up 33%, mainly reflecting higher client volumes and currency volatility. Securities finance revenue fell 8%, reflecting lower spreads and slightly lower lending volumes.
- Net interest revenue declined as low global rates and repricing of floating-rate securities reduced yields; reinvestment of securities pay-downs into lower-yielding assets also weighed on results. Lower funding costs partly offset the pressure.
- Expenses were broadly flat: lower compensation costs were offset by higher technology and transaction-processing costs. Q2 processing fees and other included a $20 million joint-venture investment-sale gain.
- Available-for-sale securities’ pre-tax net unrealized gain decreased to $115 million from $1.119 billion at year-end, primarily due to interest-rate changes. Six-month other comprehensive loss was $883 million; comprehensive income was $160 million, versus $1.039 billion in the prior-year period.
Capital, outlook, risks and contingencies
- Capital and shareholder returns: State Street and its bank subsidiary exceeded then-applicable minimum and “well capitalized” capital requirements. State Street’s Tier 1, total capital and leverage ratios were 16.6%, 19.1% and 6.9%; State Street Bank’s were 15.0%, 17.7% and 6.1%. Ratios were lower than at year-end 2012, primarily reflecting growth in risk-weighted and average assets and shareholder distributions. The company repurchased approximately 15 million shares for $920 million in the first half and declared $0.52 per common share in dividends.
- Regulatory outlook: Management’s preliminary Basel III Tier 1 common ratio estimates at June 30 were 10.0% under the standardized approach and 10.9% under the advanced approach. Management said Basel III, including higher risk weights for securitization exposures, could materially affect capital ratios, profitability and portfolio composition; estimates and implementation remained subject to regulatory interpretation and qualification. A proposed supplementary leverage rule could also apply to State Street.
- Management outlook: No specific earnings or revenue guidance is stated in the provided filing text. Management forecast approximately $220 million of additional 2013 pre-tax savings from its transformation program versus the 2010 expense base, and estimated annualized savings of $575 million to $625 million by the end of 2014, with the full effect expected in 2015. These are program-specific estimates, not forecasts of total expenses.
- Market and portfolio risks: Moody’s placed State Street and State Street Bank’s long-term ratings under review for possible downgrade in July 2013. Lower ratings could affect funding access and client deposits. The investment portfolio was approximately 76% mortgage- and asset-backed securities; 88% was rated AAA or AA. Management considered unrealized losses temporary, but impairment estimates depend on housing, unemployment, interest rates, collateral performance and other assumptions.
- Legal and contingent exposures: Pending foreign-exchange pricing litigation and government inquiries include a California action asserting approximately $100 million in actual damages plus potential penalties, including treble damages; no reserve was recorded for the indirect-FX proceedings. The filing also reports $15 million and $10 million reserves for specified securities-lending matters, $8.5 million for a U.K. transition-management matter and $9 million for TAG-related matters. Aggregate indemnified securities on loan were $319.41 billion, supported by $330.68 billion of collateral held as agent; these are off-balance-sheet activities and entail counterparty and indemnification risks.
Important facts for investors to verify
- Whether servicing and management fee growth persists as markets, client flows and the GSAS integration evolve.
- How continued low rates, deposit behavior and portfolio reinvestment affect net interest revenue and margin.
- Progress against transformation savings targets, and whether technology outsourcing costs or other expenses offset savings.
- Actual capital effects of Basel III and supplementary leverage requirements, including portfolio actions and any impact on earnings.
- Developments in foreign-exchange pricing litigation, regulatory inquiries and other contingencies, including potential losses not reserved.
- Changes in unrealized securities losses, impairment estimates, liquidity, and the consequences of any credit-rating downgrade.