Business context and reporting period
State Street Corporation filed this unaudited Form 10-Q for the quarter ended June 30, 2019. The company provides institutional investment servicing and investment management services worldwide. At quarter-end, assets under custody and/or administration (AUC/A) were $32.75 trillion and assets under management (AUM) were $2.92 trillion.
Financial results and condition
- Second quarter: Revenue was $2.87 billion, down 6% year over year; net income was $587 million, down 20%; diluted EPS was $1.42, down 24%. Net income available to common shareholders was $537 million.
- First six months: Revenue was $5.81 billion, down 5%; net income was $1.10 billion, down 21%; diluted EPS was $2.61, down 25%.
- Margins and returns: Q2 pre-tax margin was 25.0%, versus 29.1% a year earlier; return on average common equity was 10.1%, versus 14.7%. Six-month pre-tax margin was 23.3%, versus 27.4%, and return on average common equity was 9.4%, versus 13.7%.
- Revenue mix: Q2 fee revenue fell 6% to $2.26 billion and net interest income (NII) fell 7% to $613 million. Servicing fees declined 9%, management fees 5%, foreign-exchange trading services 13% and securities finance 18%. Processing fees and other revenue rose 110%, largely reflecting the CRD acquisition.
- Expenses and credit: Q2 expenses declined 1% to $2.15 billion; provision for loan losses was $1 million. Information systems and communications expenses increased 14%, partly reflecting technology investment and CRD. Six-month expenses were approximately flat at $4.45 billion.
- Cash flow: For the six months, operating activities used $80 million, versus providing $3.40 billion in 2018; investing activities provided $8.55 billion, and financing activities used $8.33 billion. Cash and due from banks rose $145 million to $3.74 billion.
- Balance sheet and debt: Total assets were $241.54 billion, deposits $170.59 billion, total liabilities $216.09 billion, long-term debt $11.37 billion and shareholders’ equity $25.45 billion. Deposits declined from $180.36 billion at year-end 2018.
- Capital and liquidity: Standardized CET1 was 11.5%, down from 11.7% at December 31, 2018; the tier 1 leverage ratio was 7.6%, up from 7.2%, and the supplementary leverage ratio was 6.7%. Average parent-company LCR was 111% for the quarter. Management reported the company and State Street Bank exceeded applicable regulatory capital requirements.
Material changes, outlook and risks
- AUC/A declined 3% year over year, primarily due to a large client transition that was nearing completion; the transition represented approximately $1 trillion of assets. Newly announced Q2 servicing mandates were approximately $390 billion, with $575 billion of assets awaiting installation. AUM increased 7% year over year, supported by higher equity markets and institutional and ETF inflows, partly offset by cash outflows.
- CRD, acquired in October 2018, contributed approximately $87 million of Q2 revenue and $46 million of expenses. State Street expects approximately $200 million of CRD acquisition and integration costs through 2021; $54 million had been incurred by June 30, 2019.
- The expense-savings program delivered $100 million of gross savings in Q2 and $175 million in the first half. Management raised its 2019 gross savings expectation to $400 million from $350 million.
- Following Federal Reserve non-objection to its 2019 capital plan, the Board authorized up to $2.0 billion in share repurchases from July 2019 through June 2020. Management expected to raise the quarterly common dividend to $0.52 per share beginning in Q3, subject to Board approval. These are plans, not assurances of future distributions.
- Management’s NII sensitivity analysis assumed three Federal Reserve rate cuts over the next 12 months. It showed benefit from rising rates, but exposure to lower rates and to changes in deposits, deposit pricing and securities prepayments. The filing does not provide specific revenue or EPS guidance.
- Legal and regulatory matters remain significant. State Street reported approximately $8 million of accrued legal and regulatory loss contingencies and estimated reasonably possible losses above accruals of up to approximately $300 million; some matters could not be reasonably estimated. In the historical billing matter, the company expected total customer reimbursements of at least $380 million, paid or accrued, and agreed to SEC and Massachusetts penalties of $40 million and $5.5 million. DOJ discussions were expected, and further penalties or reputational consequences could be material.
- Other risks include fee pressure and client activity, interest-rate and foreign-exchange volatility, deposit outflows, investment and counterparty credit risk, evolving regulatory capital and liquidity requirements, technology and operational risks, and potential adverse outcomes in investigations or litigation. The filing reports one trading VaR back-testing exception in Q2. The interim statements were reviewed by the independent accountant, not audited.
Most important facts for investors to verify
- Whether servicing and management fee pressure, the client transition and client flows continue to weigh on revenue, and whether announced mandates convert to installed assets and fees.
- Whether the $400 million 2019 savings target is achieved and how savings compare with CRD integration costs and technology spending.
- Whether deposit trends, funding costs, interest rates and securities premium amortization support or further pressure NII and margins.
- Progress and potential financial consequences of the billing-practices matter, DOJ and Department of Labor matters, and the stated contingent-loss estimate.
- Actual execution of the repurchase authorization and proposed dividend increase, alongside capital ratios, liquidity measures and regulatory requirements.