State Street Corporation — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. The filing is an annual report; selected fourth-quarter results are also summarized below. State Street provides institutional custody, investment servicing and investment management globally. At year-end it reported $31.62 trillion in assets under custody and/or administration (AUC/A) and $2.51 trillion in assets under management (AUM).
Financial results and condition
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Total revenue | $11.982 billion | $11.170 billion | +7% |
| Fee revenue | $9.305 billion | $8.905 billion | +5% |
| Net interest income (NII) | $2.671 billion | $2.304 billion | +16% |
| Total expenses | $8.968 billion | $8.269 billion | +9% |
| Net income | $2.599 billion | $2.177 billion | +19% |
| Net income available to common shareholders | $2.410 billion | $1.993 billion | +21% |
| Diluted EPS | $6.40 | $5.24 | +22% |
| Return on average common equity | 12.2% | 10.6% | Up 1.6 percentage points |
| Pre-tax margin | 25.0% | 26.0% | Down 1.0 percentage point |
| Fully taxable-equivalent net interest margin | 1.47% | 1.29% | Up 0.18 percentage point |
- Fourth quarter: Revenue was $2.986 billion, net income $439 million, and diluted EPS $1.04. Fourth-quarter expenses were $2.474 billion and included approximately $223 million of repositioning charges.
- Cash flow: Operating activities provided $10.457 billion, compared with $6.933 billion in 2017; investing activities used $4.496 billion and financing activities used $4.471 billion. Cash and due from banks ended the year at $3.597 billion. Operating cash flow included significant movements in collateral deposits and foreign-exchange derivatives, so it may not track earnings closely.
- Year-end balance sheet: Total assets were $244.626 billion; deposits $180.360 billion; shareholders’ equity $24.790 billion; long-term debt $11.093 billion. Deposits declined from $184.896 billion and long-term debt from $11.620 billion in 2017.
- Capital and liquidity: Advanced-approaches CET1 ratio was 12.1% and standardized CET1 was 11.7% at year-end; the standardized ratio was 11.9% in 2017. Supplementary leverage ratio was 6.3%, versus 6.5%. Fourth-quarter average parent-company LCR was 108%, versus 112% a year earlier; average HQLA was $91.67 billion, versus $65.35 billion.
- Dividends and repurchases: Common dividends declared were $1.78 per share, up from $1.60. State Street repurchased $350 million of stock in 2018, but paused repurchases during much of the year to help fund its acquisition. It said it could repurchase up to $600 million through June 30, 2019, subject to the capital plan and other considerations.
Material changes versus the prior year
- NII benefited from higher U.S. interest rates and disciplined deposit pricing, partly offset by a shift toward lower-yielding high-quality liquid assets (HQLA). Interest expense rose 64%, faster than interest income, which rose 26%.
- Management fees increased 15%, reflecting higher average equity markets and the adoption of the new revenue standard. Servicing fees rose 1%, with market appreciation and new business largely offset by fee pressure. Securities finance revenue fell 10% amid balance-sheet repositioning.
- AUC/A fell 5% to $31.62 trillion, primarily due to lower year-end market levels. AUM fell 10% to $2.51 trillion, reflecting weaker markets and institutional and cash outflows, partly offset by ETF inflows.
- A large client’s provider-diversification decision moved approximately $1 trillion of assets, largely common trust funds, to another provider; State Street said the transition was largely complete and it remained a significant provider to the client.
- Charles River Development was acquired on October 1, 2018, for approximately $2.6 billion in cash. It contributed about $121 million of revenue and $57 million of expenses in the fourth quarter. The acquisition added approximately $1.5 billion of goodwill and $1.0 billion of identifiable intangible assets.
Outlook, commentary and risks
- Management launched a new expense program and expects $350 million of gross expense savings by the end of 2019. It recorded $300 million of 2018 repositioning charges. Separately, it expects total Charles River acquisition and integration costs of approximately $200 million through 2021, including $31 million recorded in 2018.
- The Charles River acquisition is intended to support a front-to-back investment platform. Integration, client retention, technology development and realization of expected benefits remain execution risks. The filing does not provide a specific full-year 2019 earnings or revenue forecast.
- Revenue growth remained exposed to market levels, transaction activity, client asset flows and fee compression. Management noted challenging market and industry conditions and negative operating leverage of 1.2% for 2018.
- Legal and compliance matters include historical client-billing errors. State Street said cumulative customer reimbursements for identified errors were expected to be at least $380 million, all paid or accrued, but further remediation may be identified. Legal and regulatory accruals totaled approximately $38 million; estimated reasonably possible losses beyond accruals ranged up to approximately $300 million, excluding matters for which a range could not be estimated. Investigations and potential penalties could exceed current accruals.
- Other significant risks include counterparty and market exposures, interest-rate and liquidity sensitivity, cyber and operational risk, extensive G-SIB regulation, Brexit-related operating changes, and reputational risk. The company reported a 2015 regulatory agreement concerning anti-money-laundering and sanctions compliance, as well as a DOJ deferred prosecution agreement and SEC settlement related to transition-management conduct.
- CEO Ronald O’Hanley succeeded Joseph Hooley on January 1, 2019. The 2018 CCAR capital plan received no objection, subject to enhancements to counterparty-stress analysis. Ernst & Young gave unqualified opinions on the financial statements and internal control over financial reporting; the acquired Charles River business was excluded from management’s internal-control assessment for 2018.
Important facts for investors to verify
- How much of 2018 revenue and EPS growth reflects underlying business performance versus accounting presentation changes and market effects? The new revenue standard increased both revenue and expenses by approximately $272 million without affecting cash flows.
- Whether the $350 million savings target is achieved, and what implementation costs, service effects or further restructuring charges accompany it.
- Retention and revenue contribution from the Charles River business, integration progress, and whether goodwill or intangible assets face impairment risk.
- The ongoing effect of the approximately $1 trillion client transition on servicing fees, and whether new mandates are installed as expected.
- Potential additional billing remediation, litigation outcomes and regulatory penalties relative to the $38 million accrual and the stated reasonably possible loss range.
- Capital and liquidity headroom as Basel III and G-SIB requirements become fully effective, including the effect of market movements, deposit behavior and planned repurchases.