STT

Business Context and Reporting Period

Company: State Street Corporation
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2006
Business Overview: State Street is a financial holding company and a leading specialist in providing investment servicing and investment management services to institutional investors worldwide. Its primary subsidiary is State Street Bank and Trust Company. The company operates in 26 countries and reports two main lines of business: Investment Servicing and Investment Management.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenue increased 15% year-over-year, driven by double-digit growth in fee revenue (14%) and net interest revenue (22%).
• Profitability: Net income rose 32% to $1.106 billion. Diluted earnings per share from continuing operations increased 16% to $3.26.
• Operating Leverage: The company achieved positive operating leverage of approximately 300 basis points, as revenue growth outpaced the 12% increase in operating expenses.
• Asset Growth: Assets under custody grew 17% and assets under management grew 21%, reaching record levels.
• Geographic Mix: Non-U.S. revenue increased to approximately 43% of total consolidated revenue, up from 39% in 2005.
• Discontinued Operations: 2006 included a net income of $10 million from discontinued operations (finalization of Bel Air divestiture costs), compared to a net loss of $107 million in 2005 related to the commitment to divest Bel Air.

Guidance, Outlook, and Risks

Acquisitions and Strategic Moves

In February 2007, the company announced a definitive agreement to acquire Investors Financial Services Corp. (a $12 billion bank holding company) and Currenex, Inc. (an electronic foreign exchange trading platform). The Investors Financial acquisition is expected to close in Q3 2007 and will be accounted for as a purchase.

2007 Financial Guidance (Operating Basis)

Assuming the Investors Financial acquisition closes in July 2007, management provided the following guidance for 2007:

• Revenue Growth: 16% to 18%.
• Diluted EPS Growth (Continuing Ops): 8% to 10%.
• Return on Equity (Continuing Ops): 12% to 15%.

Note: Operating basis results exclude merger, integration, and restructuring charges related to the acquisition.

Key Risks and Contingencies

• Market Risk: Revenue is sensitive to global equity and fixed income market valuations. A 10% decline in worldwide equity values could reduce total revenue by approximately 2%.
• Interest Rate Risk: Net interest revenue is exposed to changes in interest rates. Rising rates could constrain net interest revenue if spreads narrow.
• Acquisition Integration: Risks include failure to achieve anticipated cost savings, customer attrition, and integration challenges with Investors Financial and Currenex.
• Tax Contingencies: The company faces ongoing IRS reviews regarding Leveraged Lease (LILO) and Sale-in-Lease-Out (SILO) transactions. An additional tax provision of $46 million was recorded in 2006 related to these issues.
• Regulatory/Legal: The company is subject to extensive regulation globally and faces inquiries related to mutual fund industry practices.

Investor Verification Checklist

• Acquisition Closing: Verify the regulatory approval status and closing timeline for the Investors Financial and Currenex acquisitions.
• Tax Resolution: Monitor the status of IRS examinations regarding LILO and SILO transactions and potential future tax provisions.
• Operating Leverage: Assess whether the company can maintain positive operating leverage in 2007 given the integration costs of new acquisitions.
• Non-U.S. Growth: Track the progress toward the long-term goal of generating 50% of revenue from non-U.S. sources.
• Interest Rate Sensitivity: Review the impact of Federal Reserve rate changes on the company's net interest margin and asset/liability management strategy.