State Street Corporation — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; balance-sheet figures are as of March 31, 2014, compared with December 31, 2013 where stated. State Street provides institutional investment servicing and investment management through State Street Global Advisors (SSgA). It reported $27.48 trillion of assets under custody and administration and $2.38 trillion of assets under management.
Financial results and position
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Total revenue | $2.485 billion | $2.435 billion; up 2% |
| Fee revenue | $1.924 billion | $1.857 billion; up 4% |
| Net interest revenue (GAAP) | $555 million | $576 million; down 4% |
| Net interest margin | 1.30% | 1.38%; down 8 basis points |
| Expenses | $2.028 billion | $1.826 billion; up 11% |
| Income before tax | $455 million | $609 million; down 25% |
| Net income | $363 million | $464 million; down 22% |
| Net income available to common shareholders | $356 million | $455 million |
| Diluted EPS | $0.81 | $0.98; down 17% |
| Return on average common equity | 7.2% | 9.1% |
| Pre-tax margin | 18% | 25% |
- Fee trends were mixed: servicing fees rose 5%, management fees 11%, and securities finance revenue 9%; trading services revenue fell 15%, including declines in foreign exchange and brokerage/other trading.
- Higher global equity markets and installed new business supported servicing and management fees. Lower currency volatility and spreads, weaker electronic trading volumes, and lower SPDR Gold ETF distribution fees weighed on trading revenue.
- Expenses increased chiefly due to $72 million of severance, higher incentive compensation, staffing for new business and regulatory requirements, and higher professional services and securities-processing costs. The company also recorded $2 million of loan-loss provision.
- Operating cash flow was $1.947 billion, investing cash flow was negative $14.514 billion, and financing cash flow was positive $13.224 billion. Cash and due from banks ended at $3.877 billion. These banking cash-flow movements include substantial deposit and investment activity.
- Total assets were $256.663 billion, versus $243.291 billion at year-end; total deposits were $194.648 billion, versus $182.268 billion; and shareholders’ equity was $21.273 billion, versus $20.378 billion. Long-term debt was $9.503 billion, versus $9.699 billion.
- Asset liquidity was $97.408 billion, up from $86.579 billion at year-end. The parent company reported $4.76 billion of net liquid assets. Management considered overall liquidity sufficient for current commitments and business needs.
- State Street’s tier 1 risk-based, total risk-based, and tier 1 leverage ratios were 18.3%, 21.0%, and 7.4%, respectively, under the then-applicable measures. The company estimated Basel III tier 1 common ratios of 11.2% under the standardized approach and 13.2% under the advanced approach; these estimates were preliminary.
Material changes versus the prior comparable period
- Revenue growth did not offset faster expense growth, reducing pre-tax income, net income, EPS, and return on common equity.
- Global equity market appreciation and new business helped lift custody assets to $27.477 trillion from $25.422 trillion a year earlier. Assets under management rose to $2.381 trillion from $2.176 trillion.
- Net interest margin declined amid lower yields on interest-earning assets and elevated client deposits, some of which were held at central banks at low rates. Average interest-earning assets increased, while average investment securities declined and loans and leases grew.
- Common shares outstanding averaged less than in Q1 2013, reflecting repurchases, but diluted EPS still declined. The company completed its prior buyback program in Q1, purchasing about 6.1 million shares for approximately $420 million.
- Other comprehensive income was $283 million, compared with a $109 million loss in Q1 2013, mainly reflecting improved unrealized gains on available-for-sale securities and foreign currency translation.
Outlook, risks, contingencies, and unusual items
- Management expected approximately $130 million of additional 2014 pre-tax savings from its Business Operations and Information Technology Transformation program. It projected annualized program savings of approximately $575 million to $625 million by the end of 2014 versus 2010, with the full effect expected in 2015. These are program estimates, not a forecast of total company expense reductions.
- The Federal Reserve did not object to the 2014 capital plan. The board authorized up to $1.70 billion of common-stock repurchases through March 31, 2015; none was purchased under this new authorization in Q1. A proposed increase in the Q2 dividend to $0.30 per share remained subject to board approval; the Q1 dividend was $0.26 per share.
- The company issued Series D preferred stock in February, receiving approximately $742 million net proceeds. It began using Basel III capital rules for capital calculations in 2014 and expected to disclose advanced-approach risk-based ratios beginning in Q2. It also identified prospective G-SIB capital surcharges and evolving U.S. liquidity rules as matters to monitor.
- In January, State Street paid a £22.9 million (approximately $37.8 million) U.K. regulatory fine related to excess charges to six transition-management clients in 2010–2011. It recorded an additional approximately $13 million of Q1 transition-management costs, mainly securities-processing costs net of accrual adjustments.
- Legal and regulatory matters included indirect foreign-exchange pricing inquiries and litigation, securities-lending disputes, shareholder cases, and the transition-management investigations. Aggregate legal and regulatory accruals were approximately $111 million. Management said pending matters were not expected to materially affect consolidated financial condition, but some adverse outcomes could materially affect results or reputation.
- Investment risks include sensitivity of earnings to global rates, client deposits, market valuations and volatility; credit and counterparty exposures; mortgage- and asset-backed securities; and approximately $5.45 billion of collateralized loan obligation investments that might require divestiture if classified as Volcker-rule covered funds. Indemnified securities on loan totaled $346.79 billion, with collateral held as agent; these are off-balance-sheet arrangements and carry counterparty and collateral-management risks.
- Q1 included a $9 million other-than-temporary impairment charge associated with expected credit losses on U.S. non-agency commercial mortgage-backed securities. The filing also reported $1.24 billion of gross unrealized losses on available-for-sale securities, which management considered temporary, subject to its estimates and market conditions.
- The interim financial statements were reviewed, not audited, by the independent accounting firm, which reported no material modifications known to be necessary for GAAP conformity. Management concluded disclosure controls were effective as of March 31, 2014.
Most important facts for investors to verify
- Whether servicing and management fee growth and the awarded-but-not-yet-installed business convert into durable revenue, and whether asset outflows persist in passive equity products.
- Whether expense growth moderates as severance and transformation charges subside, and whether management achieves the stated transformation savings despite rising regulatory and compliance costs.
- How net interest revenue and margin respond to interest-rate changes, deposit levels, asset repricing, and the runoff of former conduit-related discount accretion.
- Developments and potential financial or reputational effects from foreign-exchange pricing matters, transition-management investigations, and other legal proceedings, including adequacy of recorded accruals.
- Final Basel III and liquidity-rule capital impacts, including advanced-approach ratios, G-SIB surcharges, and the company’s capacity to execute repurchases and dividend plans.
- Credit performance and valuation assumptions for structured securities and senior secured bank loans, plus risks arising from CLO treatment under the Volcker rule and large indemnified securities-lending exposures.