State Street Corporation: Q3 2007 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended September 30, 2007. State Street Corporation is a financial holding company providing investment servicing and investment management services to institutional investors. The period is significantly impacted by the acquisition of Investors Financial Services Corp. on July 2, 2007, which added approximately $1.9 trillion in assets under custody and $17 billion in total assets to the consolidated balance sheet.
Key Financial Metrics
| Metric | Q3 2007 | Q3 2006 | 9M 2007 | 9M 2006 |
|---|---|---|---|---|
| Total Revenue | $2,240 million | $1,515 million | $5,857 million | $4,689 million |
| Net Income | $358 million | $278 million | $1,038 million | $797 million |
| Diluted EPS | $0.91 | $0.83 | $2.91 | $2.38 |
| Total Assets | $139.89 billion | N/A | N/A | N/A |
| Shareholders' Equity | $11.25 billion | N/A | N/A | N/A |
| Assets Under Custody | $15.15 trillion | $11.27 trillion | N/A | N/A |
| Assets Under Management | $2.00 trillion | $1.63 trillion | N/A | N/A |
Operating Expenses: Total operating expenses were $1,689 million for Q3 2007, including $141 million in merger and integration costs related to the Investors Financial acquisition. Excluding these costs, operating expenses grew 42% year-over-year.
Liquidity: Liquid assets totaled $59.36 billion as of September 30, 2007. The company intentionally increased liquid assets by approximately $7 billion during the quarter in response to market instability.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 48% in Q3 2007 compared to Q3 2006. Fee revenue grew 43%, driven by a 37% increase in servicing fees, 26% in management fees, 87% in trading services, and 90% in securities finance.
- Net Interest Revenue: Increased 74% to $464 million, with net interest margin expanding 51 basis points to 1.73%. This was driven by a favorable funding mix and the addition of interest-earning assets from the acquisition.
- Acquisition Impact: The Investors Financial acquisition contributed approximately one-third of the increase in total fee revenue and significantly boosted assets under custody and management.
- Market Conditions: Trading services and securities finance revenues benefited from increased volatility and customer volumes driven by disruptions in global fixed-income markets (sub-prime mortgage concerns).
Guidance, Outlook, and Risks
Financial Goals: Management adjusted full-year 2007 goals to target operating-basis revenue growth of 20-22%, operating-basis EPS growth of 10-15%, and an operating-basis return on equity of 14-17%. As of September 30, 2007, the company reported operating-basis EPS growth of 21% and an operating-basis return on equity of 17.3%.
Outlook: Management noted that actual experience in the first nine months differed from earlier assumptions, with servicing and management fee revenues performing more favorably due to equity market performance and non-U.S. deposit spreads. However, these trends may not continue.
Risks and Contingencies:
- Asset-Backed Commercial Paper (ABCP) Conduits: The company administers four unconsolidated conduits with total assets of $29.21 billion. Due to market disruptions, liquidity in the ABCP market has tightened. State Street has provided liquidity support by purchasing commercial paper from the conduits. While no draw-downs on liquidity asset purchase agreements occurred, the company estimates a potential after-tax loss of approximately $215 million if all conduit assets were consolidated or purchased at fair value.
- Sub-Prime Exposure: State Street Global Advisors (SSgA) had approximately $8.2 billion in assets under management in strategies adversely affected by sub-prime holdings and market illiquidity. Three customers filed litigation claims in October 2007 regarding investment losses; the financial impact cannot currently be estimated.
- Market Risk: The company holds $789 million in pre-tax net unrealized losses on available-for-sale investment securities, attributed to higher interest rates. Management believes these declines are temporary.
Investor Verification Checklist
- Verify the extent of exposure to sub-prime mortgage-backed securities within the unconsolidated ABCP conduits and the potential for consolidation under FIN 46(R).
- Monitor the status of litigation claims filed in October 2007 regarding SSgA bond fund performance.
- Assess the sustainability of the 51 basis point expansion in net interest margin given potential changes in the yield curve and Federal Reserve policy.
- Review the integration progress and cost synergies realized from the Investors Financial acquisition.
- Track the company's ability to maintain liquidity and funding costs in the event of further fixed-income market disruptions.