State Street Corporation — Q1 2013 Form 10-Q
Reporting period: Three months ended March 31, 2013; balance-sheet comparisons are with December 31, 2012. State Street is a global institutional financial services company operating Investment Servicing and Investment Management. At quarter-end, it reported $25.42 trillion of assets under custody and administration and $2.18 trillion of assets under management.
Financial results
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Total revenue | $2.435 billion | $2.421 billion | +1% |
| Fee revenue | $1.857 billion | $1.785 billion | +4% |
| Net interest revenue | $576 million | $625 million | -8% |
| Total expenses | $1.826 billion | $1.835 billion | Approximately flat |
| Income before tax | $609 million | $586 million | +4% |
| Net income | $464 million | $427 million | +9% |
| Net income available to common shareholders | $455 million | $417 million | — |
| Diluted EPS | $0.98 | $0.85 | +15% |
| Net interest margin, fully taxable-equivalent | 1.38% | 1.64% | -26 basis points |
| Return on average common equity | 9.1% | 8.8% | — |
Fee growth was led by servicing fees (+9%) and management fees (+11%), reflecting stronger equity markets, installed new business, and the GSAS acquisition. Securities finance revenue fell 20% on lower spreads and lending volumes; processing fees and other fell 36%, partly because Q1 2012 included a $24 million favorable fair-value adjustment. Net interest revenue declined as lower market rates, floating-rate asset repricing, and reinvestment at lower yields outweighed lower funding costs and growth in the investment portfolio.
Cash flow: Operating activities provided $113 million, versus $623 million in Q1 2012. Investing activities provided $8.116 billion, versus $26.783 billion, and financing activities used $6.111 billion, versus $28.216 billion. Cash and due from banks increased $2.118 billion during the quarter to $4.708 billion.
Financial position, capital and liquidity
- At March 31, total assets were $218.19 billion, down from $222.58 billion at year-end; total deposits were $154.78 billion, down from $164.18 billion; and shareholders’ equity was $20.87 billion, essentially unchanged.
- Loans and leases, net of allowance, were $13.96 billion, up from $12.29 billion. The allowance for loan losses remained $22 million; the quarter included a $1 million provision and $1 million in recoveries.
- Long-term debt was $7.44 billion, versus $7.43 billion at year-end. Average long-term debt was lower year over year, mainly reflecting prior maturities, partly offset by a $1 billion extendible-note issuance in December 2012.
- Management reported $133.2 billion in consolidated net liquid assets, down from $149.02 billion at year-end, and considered liquidity sufficient for commitments and business needs. Excess cash held at central banks was approximately $31.52 billion, compared with $41.11 billion at year-end.
- Regulatory capital ratios exceeded minimum and “well capitalized” thresholds. State Street’s Tier 1 risk-based capital ratio was 18.0%, total risk-based capital was 19.2%, and Tier 1 leverage was 6.9%; each was lower than at year-end.
- Assets under custody and administration rose to $25.42 trillion from $24.37 trillion at year-end; assets under management rose to $2.176 trillion from $2.086 trillion.
Material changes, outlook and risks
- The Federal Reserve did not object to State Street’s 2013 capital plan. The Board authorized a new common-stock repurchase program of up to $2.10 billion through March 31, 2014. No repurchases were made under the new program in Q1; approximately $360 million was spent completing the prior program. The quarterly common dividend was raised to $0.26 per share from $0.24.
- Management forecast approximately $220 million of additional 2013 pre-tax expense savings from its Business Operations and IT Transformation program, measured against its 2010 expense base, all else equal. It estimated annualized savings of $575–$625 million by the end of 2014, with the full effect expected in 2015; aggregate program restructuring charges were expected to total $400–$450 million through 2014. These are program-specific estimates, not a forecast that total expenses will decline.
- Q1 generated approximately $223 billion in servicing mandates, of which $180 billion was installed by quarter-end; $43 billion remained to be installed. SSgA reported $5 billion of net new business, while $34 billion awarded but not installed was excluded from quarter-end AUM and current-period fees.
- Management identified low global interest rates, deposit mix, future reinvestment yields and investment-portfolio runoff as important pressures on net interest revenue and margin. Remaining discount accretion from securities associated with the 2009 conduit consolidation was estimated at approximately $684 million over their remaining terms, assuming the securities are held to maturity; approximately half was expected over the next four years.
- Basel III proposals, including the proposed treatment of securitization exposures, could materially increase risk-weighted assets, reduce capital ratios and affect profitability. State Street was also designated a global systemically important bank, with a then-current 1% capital surcharge designation subject to change and phased implementation expected from 2016.
- Key exposures include mortgage- and asset-backed securities, changing housing and credit conditions, European sovereign and counterparty risks, market and interest-rate risk, client deposit withdrawals, and potential regulatory changes. Management reported no direct sovereign-debt exposure to Spain, Italy, Ireland or Portugal, but approximately $717 million of indirect exposure across the portfolio and other cross-border exposures.
- Legal and regulatory matters include FX-pricing litigation and investigations, securities-lending disputes, ERISA-related cases, shareholder litigation and a U.K. transition-management matter. The company had recorded $10 million reserves for the securities-finance withdrawal dispute and $10 million for transition-management indemnification costs and potential penalty; it had not reserved for the pending indirect-FX matters. Adverse outcomes could affect earnings, financial condition or reputation.
- Off-balance-sheet obligations include $18.28 billion of unfunded credit commitments and $314.94 billion of indemnified securities on loan, generally collateralized at or above the value of securities lent. Stable-value protection guarantees had a gross contractual amount of $32.17 billion; management considered the likelihood of a materially significant payment remote.
- Management concluded disclosure controls were effective as of March 31, 2013, and reported no material change in internal control over financial reporting during the quarter. The independent accountant performed an interim review, not a full audit.
Most important facts for investors to verify
- Whether fee growth, installed new business and market appreciation can offset continued net-interest-margin pressure and weaker securities-finance revenue.
- Progress against transformation savings targets, remaining restructuring costs, and whether technology-outsourcing costs undermine expected savings.
- Current liquidity and capital ratios, the pace and regulatory approval of repurchases, and the effects of evolving Basel III and G-SIB requirements.
- Developments in indirect-FX investigations and litigation, securities-lending disputes, and the adequacy of recorded legal reserves.
- Credit performance, fair-value assumptions and impairment sensitivity in the large mortgage- and asset-backed securities portfolio, as well as the extent of contingent exposure from securities lending and stable-value guarantees.