State Street Corporation: Q2 2008 10-Q Summary
Business Context and Reporting Period
This report covers the quarterly period ended June 30, 2008. State Street Corporation is a financial holding company providing investment servicing and investment management services to institutional investors. As of June 30, 2008, the company reported consolidated total assets of $146.22 billion, total deposits of $97.25 billion, and shareholders' equity of $14.04 billion. The company employed 28,700 people and managed $15.26 trillion in assets under custody and $1.89 trillion in assets under management.
Key Financial Metrics
| Metric | Q2 2008 | Q2 2007 | YTD 2008 | YTD 2007 |
|---|---|---|---|---|
| Total Revenue | $2,672 million | $1,921 million | $5,249 million | $3,617 million |
| Net Income | $548 million | $366 million | $1,078 million | $680 million |
| Diluted EPS | $1.35 | $1.07 | $2.70 | $2.00 |
| Return on Equity | 18.6% | 19.2% | 18.6% | 18.4% |
| Net Interest Margin (FTE) | 2.31% | 1.64% | 2.26% | 1.55% |
Liquidity and Capital: Liquid assets totaled $64.71 billion. The company completed a public offering of 40.5 million shares in June 2008, raising approximately $2.75 billion net of costs. Regulatory capital ratios exceeded "well-capitalized" thresholds, with a Tier 1 risk-based capital ratio of 17.1%.
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 39% in Q2 and 45% year-to-date compared to 2007. This was driven by the full-year impact of the Investors Financial acquisition (completed July 2007) and strong growth in organic businesses.
- Fee Revenue: Total fee revenue grew 31% in Q2. Key drivers included a 117% increase in securities finance revenue (due to wider credit spreads) and a 23% increase in trading services revenue (driven by currency volatility).
- Net Interest Revenue: Increased 71% in Q2 and 81% year-to-date, primarily due to wider spreads on fixed-rate investment securities and higher customer deposit volumes.
- Expenses: Total operating expenses rose 36% in Q2, largely due to the inclusion of Investors Financial expenses and increased staffing. Merger and integration costs totaled $32 million for the quarter.
- Assets Under Management (AUM): AUM decreased to $1.89 trillion from $1.98 trillion at year-end 2007, reflecting market declines in equity valuations.
Outlook, Risks, and Unusual Items
- Unusual Items: The company expects to record a pre-tax gain of approximately $345 million in Q3 2008 from the sale of its 50% interest in CitiStreet. In Q1 2008, the company purchased $850 million of conduit assets at prices exceeding fair value, resulting in a $12 million reduction in revenue.
- Market Risk: The company faces significant exposure to market volatility. Unrealized losses on the investment securities portfolio totaled $3.31 billion (pre-tax) at June 30, 2008, primarily due to illiquidity in fixed-income markets. Management considers these losses temporary.
- Conduit Risk: State Street administers four unconsolidated asset-backed commercial paper conduits with $28.36 billion in assets. The company has $28.05 billion in liquidity commitments. If consolidation were required, the company estimates a pre-tax loss of approximately $2.71 billion.
- Legal Contingencies: A reserve of approximately $296 million remains for legal exposure related to SSgA active fixed-income strategies involving sub-prime mortgages, following $329 million in settlements paid through June 30, 2008.
- Guidance: Management expects net interest margins to decline in the second half of 2008 compared to the first half. Securities finance revenue growth is also expected to moderate.
Investor Verification Checklist
- Verify the status of the $28.36 billion in unconsolidated conduit assets and the sufficiency of the $67 million in first-loss notes to prevent consolidation under FIN 46(R).
- Monitor the $3.31 billion in unrealized losses on investment securities for potential other-than-temporary impairment charges.
- Confirm the timing and final amount of the $345 million gain from the CitiStreet sale in Q3 2008.
- Review the impact of the $296 million legal reserve on future earnings as litigation regarding sub-prime strategies resolves.
- Assess the sustainability of securities finance revenue growth as credit spreads potentially normalize in the second half of the year.