State Street Corporation — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; balance-sheet figures are as of March 31, 2015, compared with December 31, 2014 where indicated. State Street provides investment servicing and investment management to institutional clients. It reported $28.49 trillion in assets under custody and administration and $2.44 trillion in assets under management.
Financial results
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Total revenue | $2.605 billion | $2.485 billion | +5% |
| Fee revenue | $2.060 billion | $1.924 billion | +7% |
| Net interest revenue, GAAP | $546 million | $555 million | -2% |
| Net interest margin, fully taxable-equivalent | 1.06% | 1.30% | Down 24 bps |
| Expenses | $2.097 billion | $2.028 billion | +3% |
| Net income | $409 million | $363 million | +13% |
| Net income available to common shareholders | $377 million | $356 million | +6% |
| Diluted EPS | $0.90 | $0.81 | +11% |
| Return on average common equity | 7.9% | 7.2% | Up 0.7 percentage points |
Foreign exchange trading revenue rose 51% to $203 million, principally on higher volatility and client volumes. Securities finance revenue increased 19% to $101 million. A stronger U.S. dollar reduced year-over-year revenue by an estimated $97 million and expenses by about $77 million.
Balance sheet, cash flow and capital
- Total assets were $279.48 billion, deposits $211.35 billion, and shareholders’ equity $20.82 billion. Long-term debt was $9.17 billion, down from $10.04 billion at year-end.
- Cash and due from banks were $3.15 billion. Operating cash flow was $397 million, versus $1.906 billion in Q1 2014; investing activities used $991 million, while financing activities provided $1.888 billion. Net cash increased $1.294 billion.
- High-quality liquid assets were estimated at $113.75 billion, compared with $115.58 billion at year-end. The company said its liquidity coverage ratio exceeded the then-applicable 100% minimum; it did not provide a specific LCR value in the supplied filing text.
- State Street’s Basel III common equity tier 1 ratio was 12.2% under the advanced approaches and 10.4% under the standardized approach; its tier 1 leverage ratio was 5.8%. State Street Bank’s corresponding CET1 ratios were 14.5% and 12.1%. The filing cautions that regulatory approaches and transition rules affect comparability.
- State Street’s supplementary leverage ratio was 5.2% on a transitional basis; its estimated fully phased-in ratio was 4.9%. The fully phased-in figure was a preliminary company estimate.
Material changes and management commentary
- Servicing and management fees each increased 3%, supported by net new business and stronger U.S. equity markets, partly offset by currency effects. Assets under custody and administration rose to $28.49 trillion from $27.48 trillion a year earlier.
- Assets under management were $2.443 trillion, slightly below $2.448 trillion at year-end. Net outflows were approximately $38 billion in the quarter, primarily seasonal outflows from the SPY ETF; about $4 billion of awarded asset-management business had not yet been installed.
- Net interest revenue and margin declined amid low global rates, lower yields on floating-rate assets, elevated client deposits invested partly at central banks, and a stronger U.S. dollar. Management noted that further downward pressure on European rates or additional dollar strength could worsen the effect.
- Investment Servicing pre-tax income fell to $452 million from $502 million, and its pre-tax margin declined to 20% from 23%, reflecting higher expenses, including the FX-related legal accrual. Investment Management pre-tax income declined to $57 million from $64 million.
- The Q1 2015 effective tax rate was 18.9%, compared with 20.3% a year earlier.
Outlook, risks and unusual items
- State Street recorded a $150 million Q1 charge to increase its accrual for claims and inquiries concerning indirect foreign-exchange client activities. The associated accrual was $335 million at filing; aggregate legal and regulatory accruals were about $358 million. Settlement demands received in negotiations aggregated up to $925 million. The company warned that resolution costs could materially exceed its accrual and that further claims may arise.
- The company completed its prior $1.7 billion share repurchase authorization, purchasing about 6.3 million shares in Q1 for $470 million at an average $74.88 per share. A new authorization permits up to $1.8 billion of repurchases through June 30, 2016. The capital plan proposed a Q2 common dividend of $0.34 per share, subject to Board approval.
- Q1 operating results included $25 million of discount accretion from securities consolidated from former asset-backed commercial-paper conduits. Assuming the remaining securities are held to maturity, management estimated about $343 million of future accretion, roughly half over the next four years; realization depends on factors including prepayments, credit quality and portfolio decisions.
- Other risks include interest-rate and currency movements, client deposit changes, credit and counterparty exposures, securities valuations, regulatory capital and liquidity requirements, operational and cyber risks, and litigation. The filing also identifies potential Volcker Rule-related costs and lost business; State Street held about $4.30 billion in CLO investments that could be affected by regulatory interpretation.
- Indemnified securities on loan totaled $348.96 billion, supported by $364.21 billion of collateral held as agent. These are large off-balance-sheet arrangements and involve indemnification and collateral-investment risks.
Important facts for investors to verify
- How the indirect FX matters are resolved, whether additional claims arise, and whether the $335 million accrual is adequate relative to demands and potential exposure.
- Whether fee growth and new business installations offset asset-management outflows, currency headwinds and changes in client pricing or service mix.
- Net interest revenue sensitivity to rates, client-deposit levels and deposit mix, including the costs of holding liquidity assets.
- Capital and leverage headroom under evolving Basel III, G-SIB and supplementary leverage requirements, and the assumptions behind fully phased-in estimates and planned capital distributions.
- The sustainability of reported operating cash flow and the risks associated with securities lending indemnities, collateral reinvestment, and the loan portfolio’s speculative senior secured bank loans.
The interim financial statements were reviewed by Ernst & Young LLP; the review is substantially narrower in scope than an audit.