State Street Corporation — Q3 2013 Form 10-Q
Business context and reporting period. The filing covers the quarter and nine months ended September 30, 2013, compared with the same periods in 2012. State Street provides institutional investment servicing and investment management through State Street Global Advisors. At quarter-end, it reported $26.03 trillion of assets under custody and administration, $2.24 trillion of assets under management, 29,230 employees and $217.18 billion of consolidated assets.
Financial results and condition
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $2.425 billion (+3%) | $2.356 billion | $7.420 billion (+3%) | $7.200 billion |
| Fee revenue | $1.883 billion (+10%) | $1.719 billion | $5.711 billion (+8%) | $5.282 billion |
| Net interest revenue | $546 million (-12%) | $619 million | $1.718 billion (-10%) | $1.916 billion |
| Income before tax | $703 million (-25%) | $941 million | $2.074 billion (-5%) | $2.179 billion |
| Net income | $540 million (-20%) | $674 million | $1.583 billion (-1%) | $1.591 billion |
| Diluted EPS | $1.17 (-14%) | $1.36 | $3.40 (+7%) | $3.19 |
- Revenue mix and margins: Servicing fees rose 10% in both comparison periods, helped by stronger equity markets, net new business and the October 2012 GSAS acquisition. Management fees increased 10% in Q3 and 11% year to date. Foreign exchange trading revenue increased 28% in Q3; securities finance revenue fell 19%. Fully taxable-equivalent net interest margin decreased to 1.33% from 1.53% in Q3 and to 1.38% from 1.63% year to date. Q3 return on average common equity was 10.8%, versus 13.3%.
- Expenses and unusual comparisons: Reported expenses increased 22% in Q3 and 6% year to date. Q3 2013 included $30 million of Lehman-related credits; Q3 2012 included a $277 million net credit from Lehman recoveries, partly offset by litigation provisions and other costs. Excluding these credits, expenses increased 4% in Q3; excluding the related credits, year-to-date expenses increased 2%. Information systems and communications costs rose 11% in Q3 and 16% year to date.
- Cash flow: For the first nine months, operating activities used $1.05 billion, versus providing $1.40 billion in 2012; investing activities provided $11.43 billion, versus $17.28 billion; financing activities used $9.07 billion, versus $14.44 billion. Reported cash and due from banks rose $1.31 billion to $3.90 billion. The filing attributes substantial cash-flow movements to balance-sheet and collateral activity.
- Balance sheet, debt and liquidity: At September 30, assets were $217.18 billion, deposits $154.20 billion, shareholders’ equity $20.43 billion and loans and leases, net, $15.56 billion. Long-term debt was $8.75 billion; commercial paper outstanding was $1.26 billion. Defined consolidated net liquid assets were $127.81 billion, down from $149.02 billion at December 31, 2012. Management considered liquidity sufficient to meet commitments and business needs.
- Capital: State Street’s Tier 1 and total risk-based capital ratios were 17.3% and 19.8%; State Street Bank’s were 16.1% and 18.8%. Both exceeded then-applicable minimum and “well capitalized” thresholds. Preliminary estimated Basel III Tier 1 common ratios were 10.2% under the standardized approach and 11.3% under the advanced approach.
Material changes, outlook and risks
- Fee growth and higher trading revenue were partly offset by declining net interest revenue, reflecting lower global rates, reinvestment of securities paydowns at lower yields and deposits held at central banks. Management expected former conduit securities to generate approximately $603 million of aggregate future discount accretion, about half over the next four years, assuming the securities are held to maturity.
- In Q3, State Street secured approximately $200 billion of new servicing mandates; $57 billion was installed by quarter-end and $143 billion was expected to be installed in the remainder of 2013 and later periods. SSgA had approximately $15 billion of net lost business in Q3, while $25 billion of awarded but uninstalled mandates were not yet reflected in assets under management.
- Management forecast approximately $220 million of incremental 2013 pre-tax savings from its transformation program versus the 2010 expense base, or approximately $418 million in total savings since inception. It projected annualized savings of approximately $575–$625 million by the end of 2014, with the full effect expected in 2015; these are program estimates, not forecasts of total company expense.
- Regulatory changes are a significant uncertainty. Management said Basel III could materially increase risk-weighted assets and reduce capital ratios, particularly because of the treatment of securitization exposures, and could affect portfolio composition and net interest revenue. Proposed supplementary leverage and liquidity standards, and a potential G-SIB capital surcharge, could also affect operations and capital distributions.
- Key exposures include interest-rate and investment-portfolio valuation risk; mortgage- and asset-backed securities and related impairment estimates; client deposit withdrawals and liquidity demands; securities-lending indemnities; and counterparty, operational and regulatory risks. Moody’s placed long-term ratings of State Street and its bank subsidiary under review for possible downgrade.
- Legal matters include foreign-exchange pricing claims and investigations, securities-lending-related ERISA cases, and other proceedings. State Street had a $15 million reserve for specified SSgA matters, a $10 million reserve for a securities-finance dispute, and a $13.4 million reserve for a U.K. transition-management matter. It had not established reserves for the pending indirect FX proceedings; outcomes and potential exposure were uncertain.
Investor verification priorities
- Track whether fee growth, servicing mandate installations and assets under management translate into recurring revenue, and whether SSgA net outflows persist.
- Assess the trajectory of net interest revenue and margin under changing rates, deposit levels and securities reinvestment yields.
- Reconcile reported expense growth with prior-period Lehman credits and monitor transformation savings against continuing technology, staffing and business-support costs.
- Review Basel III and other regulatory capital and liquidity implementation, including the potential effects on the investment portfolio, capital ratios and distributions.
- Follow securities-portfolio marks and impairment assumptions, liquidity and operating cash flows, and developments in material FX, securities-lending and other legal matters.