STT

Business Context and Reporting Period

Company: State Street Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2002
Business Overview: State Street is a financial holding company providing custody, accounting, investment management, trustee, foreign exchange, and information services to institutional investors worldwide. Operations are divided into two primary lines of business: Investment Servicing and Investment Management.

Key Financial Metrics

(Dollars in millions, except per share data)

Capital Ratios (State Street Bank): Tier 1 risk-based capital ratio was 15.9% and Total capital ratio was 16.1% as of September 30, 2002, significantly exceeding the "well capitalized" regulatory thresholds of 6% and 10%, respectively.

Material Changes vs. Prior Comparable Period

• Revenue: Total revenue for the three months ended September 30, 2002, decreased 1% to $956 million from $967 million in 2001. For the nine-month period, revenue increased 4% to $2.94 billion from $2.83 billion.
• Profitability: Net income increased 8% to $182 million for the quarter and 18% to $538 million for the nine-month period compared to the prior year.
• Fee Revenue: Servicing fees increased 6% in the quarter and 5% for the nine months, driven by new business and acquisitions, offsetting declines in equity market valuations. Management fees remained relatively flat for the quarter but increased 3% for the nine months.
• Net Interest Revenue: Decreased 12% in the quarter to $224 million due to lower yields on assets and an adverse interest-rate environment. For the nine months, it increased 2% to $754 million.
• Operating Expenses: Decreased 5% in the quarter and 1% for the nine months. The reduction is partially attributable to the adoption of SFAS No. 142, which eliminated goodwill amortization effective January 1, 2002.
• Accounting Changes: Results for 2001 have been restated to present client-reimbursed out-of-pocket expenses on a gross basis. Additionally, 2001 results included a $50 million write-off of the investment in Bridge Information Systems, Inc., and goodwill amortization expenses that are not present in 2002 results.

Guidance, Outlook, and Material Events

• Acquisitions:
  • International Fund Services (IFS): Completed in July 2002. IFS is a leading provider of fund accounting and administration for hedge funds, adding approximately 500 employees.
  • Deutsche Bank AG: In November 2002, State Street announced a definitive agreement to acquire substantial parts of Deutsche Bank's Global Securities Services business. The initial payment is approximately $1.2 billion, with potential subsequent payments up to EUR 300 million. The transaction is expected to be dilutive by $0.01 to $0.03 per share in 2003 and accretive in 2004.
• Divestiture: In August 2002, State Street agreed to sell its Corporate Trust services to U.S. Bank, N.A. for approximately $725 million. The transaction is expected to close by year-end 2002.
• Financial Goals: Management targets a long-term real compound annual revenue growth rate of 12.5% (approx. 15% nominal) and an annual return on stockholders' equity of 18%.
• Risks and Contingencies:
  • Market Volatility: Revenue is sensitive to worldwide equity and bond market valuations. A 10% change in equity values could impact total revenue by approximately 2%.
  • Interest Rates: Net interest revenue is constrained by lower interest rates and a flat yield curve.
  • Legal: Management believes pending legal actions will not have a material adverse effect on financial position.

Investor Verification Checklist

• Deutsche Bank Acquisition Impact: Verify the final purchase price, regulatory approval status, and the specific timeline for the expected dilution in 2003 and accretion in 2004.
• Corporate Trust Divestiture: Confirm the closing date and final valuation of the sale to U.S. Bank, N.A., and the impact on future servicing fee revenue (approx. 3% of total revenue).
• Goodwill Accounting: Review the impact of SFAS No. 142 on future earnings, specifically regarding potential impairment tests rather than amortization.
• Market Sensitivity: Assess current global equity market trends to gauge potential headwinds or tailwinds for fee revenue, given the stated 2% sensitivity to a 10% market move.
• Capital Adequacy: Monitor Tier 1 and Total risk-based capital ratios to ensure continued "well capitalized" status, which is required for financial holding company status.