Business Context and Reporting Period
Company: State Street Corporation
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Quarter and nine months ended September 30, 1998
Business Overview: A financial services corporation providing banking, global custody, investment management, administration, and securities processing services. Operations are divided into three lines: Services for Institutional Investors, Investment Management, and Commercial Lending.
Key Financial Metrics
| Metric (in millions) | Q3 1998 | Q3 1997 | 9M 1998 | 9M 1997 |
|---|---|---|---|---|
| Total Revenue | $704 | $612 | $2,029 | $1,711 |
| Net Income | $111 | $101 | $325 | $280 |
| Diluted EPS | $0.68 | $0.62 | $1.98 | $1.71 |
| Operating Expenses | $528 | $451 | $1,509 | $1,260 |
| Net Interest Margin | 1.79% | 2.17% | N/A | N/A |
| Total Assets | $50,607 | N/A | N/A | N/A |
| Stockholders' Equity | $2,218 | N/A | N/A | N/A |
| Return on Equity (Q3) | 20.0% | N/A | N/A | N/A |
Note: Revenue figures in the table reflect the taxable equivalent basis used in Management's Discussion and Analysis (MD&A), which differs slightly from the GAAP basis in the Consolidated Statement of Income ($694M vs $704M for Q3).
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 15% in Q3 1998 and 19% for the nine-month period compared to 1997. This was driven by growth in both fee revenue (up 16% in Q3) and net interest revenue (up 13% in Q3).
- Fee Revenue Drivers: Fiduciary compensation rose 17% in Q3 due to expanded customer relationships. Assets under custody increased 15% year-over-year to $4.3 trillion, though they declined sequentially due to lower securities market valuations. Foreign exchange trading revenue was flat in Q3 but up 26% for the nine-month period.
- Net Interest Revenue: Increased due to a 38% rise in average interest-earning assets ($43.9 billion in Q3 1998 vs. $31.9 billion in Q3 1997), driven by growth in non-U.S. deposits and securities sold under repurchase agreements. However, the net interest margin compressed by 38 basis points to 1.79% due to narrower spreads.
- Operating Expenses: Increased 17% in Q3 and 20% for the nine-month period. Salaries and benefits rose 19% due to staffing increases and acquisitions. Equipment expenses jumped 34% to support business expansion.
- Credit Quality: The allowance for loan losses decreased from $93 million to $83 million in Q3, primarily due to a $15 million charge-off of a single troubled loan. The provision for loan losses was $4 million for the quarter.
Guidance, Outlook, Risks, and Unusual Items
Management Commentary and Outlook
Management expects continued growth driven by cross-border investment activity and new business installations. However, they note that sequential asset growth may be dampened by declining securities market valuations. The company anticipates that the adoption of the Euro in 1999 will not have a material impact on financial condition, though it may affect foreign exchange trading volumes.
Year 2000 (Y2K) Compliance
State Street is executing the "Resolution 2000" program. As of September 30, 1998, cumulative costs were $69 million (estimated to be less than 2% of total operating expenses for 1996-2000). Internal testing is expected to be completed by March 31, 1999, with external testing concluding in Q3 1999. Management believes failure to comply could have a materially adverse effect on the business.
Risks and Contingencies
- Market Risk: The company uses Value at Risk (VaR) to monitor trading positions. Average daily VaR for foreign exchange contracts was $0.8 million in Q3 1998. No trading losses exceeded the VaR estimate during the quarter.
- Regulatory Capital: State Street Bank remains "well capitalized" with a Tier 1 risk-based capital ratio of 12.9% (minimum required 4%) and a total capital ratio of 13.4% (minimum required 8%).
- Legal: The company is subject to pending legal actions but believes they will not have a material adverse effect.
Investor Verification Checklist
- Asset Valuation Impact: Verify the extent to which declining securities market valuations are offsetting new business growth in the custody and investment management segments.
- Margin Compression: Monitor the trend in net interest margins, which declined 38 basis points in Q3, to assess the sustainability of net interest revenue growth.
- Y2K Execution: Track the progress of external testing and contingency planning for the Year 2000, as failure could disrupt core operations.
- Expense Management: Review the trajectory of operating expenses, which grew faster than revenue in the nine-month period (20% vs 19%), driven by salaries and equipment.
- Loan Portfolio: Assess the credit quality of the remaining loan portfolio following the $15 million charge-off in Q3.