State Street Corporation — Q2 2010 Form 10-Q
Reporting period: Three and six months ended June 30, 2010; figures are unaudited. State Street provides investment servicing and investment management services to institutional investors. At quarter-end it reported $162.08 billion in assets, $95.74 billion in deposits, $16.06 billion in shareholders’ equity, $19.03 trillion in assets under custody and administration, and $1.78 trillion in assets under management.
Key financial results
| Metric ($ millions, except per-share data and percentages) | Q2 2010 | Q2 2009 | H1 2010 | H1 2009 |
|---|---|---|---|---|
| Total revenue | 2,304 | 2,122 | 4,600 | 4,124 |
| Fee revenue | 1,696 | 1,516 | 3,236 | 2,938 |
| Net interest revenue (GAAP) | 658 | 580 | 1,319 | 1,144 |
| Provision for loan losses | 10 | 14 | 25 | 98 |
| Total expenses | 1,944 | 1,364 | 3,523 | 2,668 |
| Income before tax and extraordinary loss | 350 | 744 | 1,052 | 1,358 |
| Net income before extraordinary loss | 432 | 502 | 927 | 978 |
| Diluted EPS before extraordinary loss | $0.87 | $0.79 | $1.86 | $1.81 |
| Fully taxable-equivalent net interest margin | 2.21% | 1.93% | 2.27% | 1.96% |
In Q2 2010, GAAP net income was $432 million. The comparable 2009 GAAP net loss of $3.18 billion included a $3.68 billion after-tax extraordinary loss related to consolidating asset-backed commercial paper conduits. For H1 2010, net income was $927 million versus a $2.71 billion loss in 2009, which also included that extraordinary loss. Q2 2010 return on average common equity was 11.0%, compared with 13.0% in Q2 2009 before the extraordinary loss.
Cash flows for H1 2010 were $3.38 billion provided by operating activities, $1.07 billion used in investing activities, and $357 million provided by financing activities; cash and due from banks increased $2.67 billion to $5.31 billion. At June 30, long-term debt was $8.55 billion and other short-term borrowings were $15.75 billion. Management reported $79.75 billion of liquid assets, up from $75.98 billion at year-end 2009, and considered liquidity sufficient for current commitments and business needs.
Changes versus comparable periods
- Q2 revenue grew 9% year over year, led by servicing fees (+20%) and management fees (+12%). H1 revenue rose 12%.
- Q2 net interest revenue rose 13%; management attributed much of the increase to discount accretion on securities added in the 2009 conduit consolidation. Q2 accretion was $172 million versus $112 million a year earlier; excluding accretion, fully taxable-equivalent net interest revenue increased 4%.
- Securities finance revenue fell 46% in Q2 and 53% in H1, primarily because of lower lending spreads. Trading services rose 5% in Q2, while foreign-exchange revenue declined 3% amid lower currency volatility.
- Q2 expenses increased 43%, principally reflecting a $414 million securities-lending charge, higher compensation and acquisition-related costs. The 2010 charge comprised a $330 million contribution to SSgA lending-fund collateral pools, a $75 million reserve related to agency-lending redemption restrictions, and $9 million of legal costs.
- Q2 net income before extraordinary loss declined 14% despite higher revenue. A discrete $180 million tax benefit from restructuring former non-U.S. conduit assets produced an $82 million tax benefit for the quarter; excluding that benefit, management reported a 28% effective tax rate.
Business, balance sheet and capital developments
- State Street completed acquisitions of MIFA on April 1 and Intesa Sanpaolo’s securities services business on May 17. Together they contributed approximately $60 million of Q2 revenue and $50 million of expenses, excluding integration costs. The acquisitions added $686 billion of servicing assets; State Street also won approximately $427 billion of additional servicing mandates during Q2, which were not yet fully reflected in reported assets.
- Assets under custody and administration rose 16% year over year to $19.03 trillion. Assets under management were down 7% from year-end 2009 to $1.78 trillion, reflecting market depreciation and net lost business, but up 14% year over year.
- Shareholders’ equity increased to $16.06 billion from $14.49 billion at year-end. Regulatory capital ratios remained above minimum and “well-capitalized” thresholds, though they declined from year-end: State Street’s Tier 1 risk-based ratio was 15.1% and total risk-based ratio 16.4% at June 30.
- Available-for-sale securities had a $749 million pretax net unrealized loss, improved from $2.14 billion at year-end. The portfolio was approximately 82% rated AAA or AA; management recorded $53 million of Q2 other-than-temporary impairment, mainly associated with non-agency mortgage-backed securities.
Outlook, risks and contingencies
- No specific full-year earnings or revenue guidance is provided in the supplied filing text. Management expected conduit-related discount accretion to remain a material component of net interest revenue in 2010 and later periods, while warning that its timing and amount depend on credit conditions and prepayments.
- Management expected weak securities-lending spreads to continue to weigh on revenue versus pre-crisis levels. SSgA planned to lift redemption restrictions from its lending funds in August 2010; State Street anticipated giving agency-lending participants greater liquidity control by year-end. The effects could include reduced lending volumes, particularly in the short term.
- Agency-lending collateral-pool NAVs remained below $1.00 per unit at June 30, ranging from $0.94 to $1.00, with a weighted average of $0.991. State Street continued transactions at $1.00; the aggregate market value was approximately $633 million below the value at $1.00 per unit. The filing states that no pool securities were then in default or considered materially impaired.
- Litigation and investigations include claims involving SSgA and agency securities-lending funds, SEC inquiries, foreign-exchange pricing matters, and customer claims relating to Lehman prime-brokerage arrangements. The California Attorney General asserted $56 million in actual damages for alleged FX-pricing issues, plus penalties. The filing says outcomes of some matters could materially affect results in the period resolved, while ultimate exposures are generally not reasonably estimable.
- Other risks include securities impairment and valuation uncertainty, credit and counterparty exposures, market and interest-rate movements, client deposit withdrawals, regulatory changes, and operational and reputational risks. A 100-basis-point rate decline was estimated to reduce next-12-month net interest revenue by $407 million under the stated shock scenario.
- Management said disclosure controls were effective at June 30, 2010, and reported no material change in internal control over financial reporting during the quarter. The independent accountant performed an interim review, not an audit, and reported no material modifications needed for GAAP conformity.
Most important facts for investors to verify
- Whether servicing and management fee growth persists when market valuations and acquisition contributions are separated from organic business growth.
- How much future net interest revenue depends on conduit discount accretion, and whether expected cash flows and impairment assumptions change.
- Progress on the SSgA and agency-lending pool restrictions, actual collateral-pool values, client withdrawals, and any further support or legal costs.
- Integration, retention and financial contribution from the Intesa and MIFA acquisitions, including the conversion of won mandates into serviced assets and revenue.
- Developments in securities impairments, commercial real estate loan recoveries, litigation and regulatory inquiries, and any resulting additional charges or reserves.
- Liquidity and capital trends, including the effect of client deposit movements, regulatory changes and risk-weighted-asset growth.