State Street Corporation — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods unless otherwise stated. Interim financial statements are unaudited and were reviewed by the independent auditor. State Street provides investment servicing and investment management to institutional clients worldwide.
Key financial results
| Metric | Q3 2016 | Q3 2015 | First nine months 2016 | First nine months 2015 |
|---|---|---|---|---|
| Total revenue | $2.620 billion | $2.614 billion | $7.677 billion | $7.822 billion |
| Net interest revenue | $537 million | $513 million | $1.570 billion | $1.594 billion |
| Fee revenue | $2.079 billion | $2.103 billion | $6.102 billion | $6.234 billion |
| Income before tax | $636 million | $647 million | $1.775 billion | $1.618 billion |
| Net income | $563 million | $581 million | $1.550 billion | $1.404 billion |
| Net income available to common shareholders | $507 million | $539 million | $1.411 billion | $1.301 billion |
| Diluted EPS | $1.29 | $1.31 | $3.54 | $3.13 |
- Q3 total revenue was essentially flat; net income available to common shareholders fell 6%. Management cited higher management fees, including GE Asset Management (GEAM), offset by weaker processing fees and other revenue.
- For the first nine months, revenue declined 2%, while expenses fell 5% to $5.894 billion; net income rose 10% and diluted EPS rose 13%. Prior-year expenses included approximately $400 million of legal accruals tied to indirect FX activity.
- Q3 net interest margin was 1.14% on a fully taxable-equivalent basis, versus 1.00% a year earlier; nine-month margin was 1.14%, versus 1.02%. Q3 return on average common equity was 10.6%, versus 11.3%; nine-month return was 9.9%, versus 9.1%.
- Q3 pre-tax margin was 24%, versus 25%; nine-month pre-tax margin was 23%, versus 21%.
Balance sheet, cash flow, capital and liquidity
- At September 30, total assets were $256.14 billion, deposits were $198.77 billion, total liabilities were $233.96 billion, and shareholders’ equity was $22.15 billion. Long-term debt was $11.83 billion.
- For the first nine months, operating cash flow was $2.276 billion, compared with cash used of $4.782 billion in 2015. Investing activities used $5.552 billion, versus providing $29.793 billion; financing activities provided $5.559 billion, versus using $23.206 billion. Cash and due from banks ended at $3.490 billion.
- State Street’s September 30 regulatory capital ratios included common equity tier 1 of 12.3% under the advanced approach and 12.5% under the standardized approach; tier 1 leverage was 6.8%. Transitional supplementary leverage ratio was 6.1%, with a fully phased-in pro forma estimate of 6.0%. The filing says State Street and State Street Bank exceeded applicable regulatory capital requirements.
- Liquidity coverage ratio was above 100%. Estimated high-quality liquid assets were $109.47 billion. Parent-company net liquid assets were $4.47 billion, down from $5.73 billion at December 31, 2015.
- Investment securities totaled $99.89 billion at carrying value; approximately 92% were rated AAA or AA. The allowance for loan and lease losses was $51 million against $21.50 billion of loans and leases.
Material changes and business developments
- AUCA was $29.18 trillion and AUM was $2.446 trillion at quarter-end. AUCA increased from $27.27 trillion at September 30, 2015; AUM increased from $2.203 trillion, including $112 billion acquired with GEAM.
- State Street completed the GEAM acquisition on July 1 for an initial purchase price of approximately $437 million, with up to approximately $46 million of additional potential consideration. GEAM contributed to the rise in management fees; State Street recorded about $29 million of related acquisition costs in Q3 and expects total merger and integration costs of about $80 million through 2018.
- Net AUM outflows, excluding GEAM, were $36 billion in Q3 and $58 billion year to date. Asset servicing mandates secured were $212 billion in Q3 and $1.225 trillion year to date; approximately $95 billion and $886 billion, respectively, had been installed.
- Q3 management fees rose 28%, helped by GEAM, lower money-market fee waivers and higher global equity markets. Q3 servicing fees rose 1%; trading services fell 9%, primarily reflecting lower FX and brokerage activity. Securities finance revenue rose 20%.
- The company repurchased 4.7 million shares for $325 million in Q3 under its $1.4 billion 2016 program. Nine-month repurchases totaled $1.040 billion. Common dividends declared were $0.38 per share in Q3 and $1.06 year to date.
Outlook, risks and unusual items
- State Street Beacon: management said it was on track to generate at least $165 million of estimated annual year-over-year pre-tax savings in 2016, with the full effect expected in 2017. The company expects $300 million to $400 million of aggregate pre-tax restructuring charges from 2016 through 2020; $120 million had been recorded in the first nine months of 2016.
- Interest-rate and deposit trends remain important: elevated client deposits invested at central banks generate low returns and weigh on net interest margin. Management noted that lower global rates, a strong U.S. dollar and reinvestment yields may pressure net interest revenue. Its modeled 12-month net interest revenue sensitivity showed a $546 million benefit from an instantaneous 100-basis-point rate increase and a $232 million reduction from a 100-basis-point decrease, assuming no mitigating management action.
- Legal and regulatory matters include indirect FX, transition management, GovEx, BSA/AML and sanctions compliance, and client invoicing. The company recorded a $42 million Q3 legal reserve related to U.S. investigations of transition-management activities. Aggregate legal and regulatory accruals were approximately $622 million, excluding the invoicing matter.
- For indirect FX matters, State Street had accrued $565 million. A settlement class was approved by the court on November 2, 2016, subject to the appeal period and finalization of related agency settlements. State Street said the existing accrual was sufficient for those settlements if they became final, but additional claims remain possible.
- In the invoicing review, State Street identified approximately $292 million of expenses incorrectly charged to certain clients, excluding interest, and said it was reimbursing affected clients. The review also covers other billing practices; further reimbursements, claims or regulatory action could have a material effect.
- Regulators found State Street’s 2015 resolution plan not credible or insufficient to facilitate orderly resolution. The company submitted a response on October 1, 2016; failure to satisfy regulatory expectations could lead to more stringent capital, leverage or liquidity requirements, or restrictions on growth or activities.
- Other risks include market and FX volatility, securities-lending and counterparty exposures, operational and cybersecurity risks, regulatory cost, and possible Volcker Rule implications for CLO holdings. The company held approximately $1.39 billion of CLO investments at quarter-end.
Important facts for investors to verify
- Whether GEAM integration delivers expected growth and whether related costs remain within the approximately $80 million estimate.
- Progress on Beacon savings versus restructuring costs, and whether the expected savings materialize in 2017.
- Final status and sufficiency of indirect FX settlements, and the ultimate cost and scope of the invoicing review and transition-management investigations.
- Whether AUM outflows persist and whether awarded servicing mandates are installed on schedule and contribute to fees.
- Effects of interest rates, deposit levels, currencies and securities reinvestment on net interest revenue and margins.
- Capital and liquidity headroom under fully phased-in requirements, and the regulatory response to the resolution plan.
- Credit quality and loss experience in senior secured loans, CLOs and other investment holdings, as well as the scale and collateral coverage of off-balance-sheet indemnities.