State Street Corporation — Q1 2010 Form 10-Q
Reporting period: Three months ended March 31, 2010; balance-sheet figures are as of March 31, 2010 unless otherwise noted. State Street provides investment servicing and investment management services to institutional investors. It reported $19.04 trillion in assets under custody and administration and $1.93 trillion in assets under management.
Financial results
| Metric | Q1 2010 | Q1 2009 / comparison |
|---|---|---|
| Total revenue | $2.296 billion | $2.002 billion; up 15% |
| Fee revenue | $1.540 billion | $1.422 billion; up 8% |
| Net interest revenue, GAAP | $661 million | $564 million; up 17% |
| Net income | $495 million | $476 million |
| Net income available to common shareholders | $495 million | $445 million |
| Diluted EPS | $0.99 | $1.02; $1.02 in 2009 compared with $0.99 in 2010 |
| Return on average common equity | 13.4% | 15.7% |
| Provision for loan losses | $15 million | $84 million |
| Total expenses | $1.579 billion | $1.304 billion; up 21% |
| Effective tax rate | 29.5% | 22.5% |
Servicing fees rose 15% to $880 million and management fees rose 25% to $226 million, benefiting from higher market valuations and previously won business. Securities finance revenue fell 60% to $72 million amid lower lending spreads. Foreign-exchange trading revenue declined 30% to $134 million, while brokerage and other trading fees doubled to $108 million. Processing fees and other revenue rose to $120 million, principally reflecting tax-advantaged investments and a leasing-transaction gain.
Fully taxable-equivalent net interest revenue was $693 million, up 16%, and net interest margin was 2.34% versus 2.01%. However, $212 million of discount accretion from securities added in the 2009 conduit consolidation contributed 72 basis points to the 2010 margin. Excluding that accretion, net interest revenue would have been $481 million and margin 1.62%; management said accretion was expected to remain material in 2010 and future years.
Cash flow, balance sheet and capital
- Operating cash flow was $1.755 billion, versus cash used of $2.735 billion in Q1 2009. Investing activities provided $2.896 billion; financing activities used $5.195 billion. Cash and due from banks ended at $2.097 billion.
- Total assets were $153.971 billion, down from $157.946 billion at year-end 2009. Deposits were $90.336 billion, and shareholders’ equity was $15.410 billion.
- Period-end short-term borrowings were $16.514 billion and long-term debt was $8.815 billion. The filing reports $79.18 billion of liquid assets, up from $75.98 billion at year-end. Management considered liquidity sufficient for current commitments and business needs.
- State Street’s Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 18.0%, 19.5% and 9.0%, respectively; State Street Bank’s were 17.6%, 19.3% and 8.7%. Both met applicable well-capitalized thresholds.
- Available-for-sale securities had a $1.324 billion pre-tax net unrealized loss. About 81% of the investment securities portfolio was rated AAA or AA; management identified housing prices, delinquencies, defaults and prepayment assumptions as important impairment sensitivities.
Changes, outlook and material risks
- Revenue growth reflected market recovery and new business, but earnings per diluted share and return on common equity were lower than the prior-year figures. The EPS comparison is affected by the 2009 TARP preferred-stock allocation: common earnings were $445 million in 2009 versus net income of $476 million.
- Expenses increased largely because cash incentive compensation accruals resumed, alongside higher payroll-related benefits, contract services, transaction processing, securities processing and professional fees. The 2009 quarter had no cash incentive compensation accrual as part of a tangible-common-equity plan.
- Net gains on investment securities were $95 million, comprising $192 million of sale gains and $97 million of credit-related impairment expense. Most impairment related to non-agency mortgage-backed securities. Management estimated that specified adverse assumptions could add $30–$40 million of credit impairment for certain prime/Alt-A securities and $45–$55 million for subprime securities.
- Management said lower securities-lending spreads were expected to continue to affect revenue and profitability in 2010. Direct-lending collateral pools remained below $1.00 per unit, with a weighted-average NAV of $0.991; SSgA lending pools’ weighted-average NAV was $0.988. Redemption limits remained in place, and the filing does not specify when they would be lifted.
- State Street reported $164 billion in servicing mandates won during the quarter, with revenue expected as the business is installed and serviced. Assets under management increased 1% from year-end, with market appreciation offset partly by $14 billion of net outflows. No specific earnings or revenue guidance was provided.
- Following an April 2010 transaction, State Street ceased consolidating certain asset-backed securitization trusts on April 23; the company said this was not expected to materially affect results or financial condition.
- Legal risks include pending securities-lending, foreign-exchange-pricing, investment-strategy and Lehman-related claims and inquiries. The company said it could not reasonably estimate potential exposure for certain matters. It had completed regulatory settlements concerning active fixed-income strategies, including a $313 million fair fund; combined with prior customer settlements, compensation totaled about $663 million, and no related reserve remained at March 31.
- Other risks include uncertain tax disputes, including SILO transactions; unrecognized tax benefits of about $419 million could change significantly over the next 12 months, though management did not expect a material adverse effect on the effective tax rate. Interest-rate sensitivity models showed estimated next-12-month net interest revenue declines under both plus-100-basis-point and minus-100-basis-point shocks.
Most important facts for investors to verify
- How much of reported net interest revenue and margin depends on conduit-related discount accretion, and how quickly that accretion may change.
- Whether fee growth persists if equity valuations weaken, and whether securities-lending spreads and collateral-pool redemption restrictions improve.
- Whether higher compensation and other operating costs are offset by durable revenue growth.
- Future credit impairments in mortgage- and asset-backed securities, commercial real-estate loan performance and related allowance needs.
- Developments in pending litigation, regulatory inquiries and tax matters, including any new reserves or payments.
- Liquidity and capital levels under adverse deposit, funding-market and interest-rate conditions.
The interim financial statements were reviewed by Ernst & Young, not audited; the reviewer reported no material modifications that should be made for conformity with GAAP.