Business Context and Reporting Period
Company: State Street Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2003
Business Overview: State Street is a financial holding company providing custody, accounting, investment management, and trading services. The company operates two primary lines of business: Investment Servicing and Investment Management. The reporting period is significantly impacted by the acquisition of the Global Securities Services (GSS) business from Deutsche Bank AG, completed in January 2003, and a major restructuring program initiated in the second quarter.
Key Financial Metrics
| Metric (Dollars in millions) | Three Months Ended Sep 30, 2003 | Nine Months Ended Sep 30, 2003 |
|---|---|---|
| Total Revenue | $1,126 | $3,228 |
| Net Income | $202 | $275 |
| Earnings Per Share (Diluted) | $0.60 | $0.82 |
| Operating Expenses | $821 | $2,794 |
| Net Interest Revenue | $203 | $600 |
| Total Assets | $81,776 | (N/A - Balance Sheet Item) |
| Total Liabilities | $76,532 | (N/A - Balance Sheet Item) |
| Stockholders' Equity | $5,244 | (N/A - Balance Sheet Item) |
| Cash and Due from Banks | $1,691 | (N/A - Balance Sheet Item) |
Liquidity and Capital: Defined liquid assets totaled $66.184 billion (81% of total assets). Tier 1 risk-based capital ratio was 12.8% and total risk-based capital ratio was 14.7% at September 30, 2003, exceeding regulatory "well-capitalized" thresholds.
Material Changes vs. Prior Comparable Period
- Revenue Growth: Total revenue increased 18% ($170 million) for the quarter and 10% ($288 million) for the nine months compared to the prior year. This growth was primarily driven by the GSS acquisition, which contributed $163 million in revenue for the quarter and $405 million for the nine months.
- Net Income Decline (YTD): While quarterly net income rose 11% to $202 million, nine-month net income fell 49% to $275 million compared to $538 million in 2002. The YTD decline is largely attributable to one-time charges.
- Restructuring and Merger Costs: The company incurred $295 million in restructuring costs and $81 million in merger and integration costs during the first nine months of 2003. In the prior year's comparable period, restructuring costs were only $20 million, and there were no merger costs.
- Net Interest Revenue: Net interest revenue declined 9% for the quarter and 20% for the nine months due to lower yields on assets resulting from the declining interest rate environment.
- Fee Revenue: Fee revenue increased 32% for the quarter and 21% for the nine months, driven by higher servicing fees ($505 million vs. $390 million in Q3) and management fees.
Guidance, Outlook, and Risks
Management Commentary:
- Baseline Performance: Excluding the GSS acquisition and one-time charges, "baseline" earnings were $211 million ($0.65 per share) for the quarter, up 19% from the prior year. Baseline earnings for the nine months were $523 million ($1.63 per share), slightly down 2% from the prior year due to lower net interest revenue.
- GSS Integration: The GSS business is expected to be dilutive to earnings per share by approximately $0.01 to $0.03 in the first year. Management expects to meet cost-saving targets through workforce reductions of approximately 1,000 employees related to GSS.
- Financial Goals: The company maintains a long-term revenue goal of 12.5% real compound annual growth and a return on common stockholders' equity (ROE) goal of 13%-15% for 2003 and 2004.
Risks and Contingencies:
- Market Sensitivity: Revenue is sensitive to worldwide equity and fixed income valuations. A 10% change in equity values could impact total revenue by approximately 2%.
- Interest Rates: Sustained lower interest rates and a flat yield curve constrain net interest revenue growth.
- Regulatory Capital: The company must maintain "well-capitalized" status to retain its financial holding company status. Capital ratios were impacted by goodwill from the GSS acquisition and restructuring charges.
- Subsequent Event: On October 31, 2003, the company completed the sale of its Private Asset Management business to U.S. Trust for approximately $365 million, expecting to record approximately $280 million in pretax income in the fourth quarter.
Investor Verification Checklist
- One-Time Charges: Verify the impact of the $295 million restructuring charge and $81 million merger cost on the reported nine-month net income decline.
- GSS Run-Rate: Assess the annualized revenue and expense run-rate of the GSS acquisition to determine long-term accretion/dilution to earnings.
- Net Interest Margin: Monitor the trend in net interest margin (1.17% in Q3 2003 vs. 1.36% in Q3 2002) given the low-interest-rate environment.
- Assets Under Management/Custody: Confirm growth in assets under management ($965 billion) and custody ($8.8 trillion) as key drivers for fee revenue.
- Capital Ratios: Review the impact of goodwill amortization and intangible assets on risk-weighted assets and regulatory capital ratios.