State Street Corporation — Q1 2012 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2012; comparisons are primarily with Q1 2011. State Street provides institutional investment servicing and investment management. At quarter-end, it reported $187.96 billion in assets, $130.18 billion in deposits, $20.16 billion in shareholders’ equity, 29,800 employees, $23.21 trillion in assets under custody and administration, and $1.99 trillion in assets under management. Interim financial statements are unaudited; the independent accountant performed a review, not an audit.
Financial results and condition
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Total revenue | $2.421 billion | $2.361 billion | Up 3% |
| Fee revenue | $1.785 billion | $1.791 billion | Approximately flat |
| Net interest revenue | $625 million | $577 million | Up 8% |
| Total expenses | $1.835 billion | $1.702 billion | Up 8% |
| Income before taxes | $586 million | $660 million | Down 11% |
| Net income | $427 million | $471 million | Down 9% |
| Net income available to common shareholders | $417 million | $466 million | Down 11% |
| Diluted EPS | $0.85 | $0.93 | Down 9% |
| Return on average common equity | 8.8% | 10.5% | Lower |
Net interest margin on a fully taxable-equivalent basis was 1.64%, down from 1.85%. The effective tax rate was 27.2%, versus 28.7%. No loan-loss provision was recorded in Q1 2012; Q1 2011 included a $1 million benefit.
Operating cash flow was $1.315 billion, compared with $153 million in Q1 2011. Investing activities provided $26.323 billion, largely reflecting a decline in interest-bearing deposits with banks; financing activities used $28.448 billion, including deposit outflows. Cash and due from banks declined by $810 million during the quarter to $1.383 billion.
At March 31, total assets were $187.96 billion, down from $216.83 billion at year-end 2011; deposits were $130.18 billion, down from $157.29 billion. Long-term debt was $8.12 billion. Consolidated net liquid assets, as defined by State Street, were $120.68 billion, down from $144.15 billion at year-end. Management considered liquidity sufficient for current commitments and business needs. Regulatory capital ratios exceeded minimum and “well capitalized” thresholds: State Street’s Tier 1 risk-based ratio was 19.1% and total risk-based ratio was 20.7%; State Street Bank’s were 17.3% and 19.2%, respectively.
Material changes versus the prior comparable period
- Net interest revenue rose on growth in investment securities and higher yields on U.S. floating-rate securities, partly offset by lower accretion from former conduit securities and a lower fixed-rate portfolio yield.
- Servicing fees fell 2%, reflecting non-U.S. market weakness and asset-mix changes. Trading services revenue declined 7%, including lower FX revenue amid reduced currency volatility. Securities finance revenue increased 47%, driven by higher spreads despite lower average lending volumes.
- Expenses increased 8%, principally from compensation and benefits, including equity-based compensation, salary increases, higher staffing and program-related costs. A $15 million restructuring charge was partly offset by a $7 million credit associated with the fixed-income trading exit; net restructuring charges were $8 million. The company also recorded $15 million of litigation settlement costs.
- Assets under custody and administration increased from $22.61 trillion at March 31, 2011, while assets under management declined from $2.12 trillion. Q1 2012 managed-asset net flows were $10 billion including $31 billion of U.S. Treasury-related redemptions, or $41 billion excluding them.
- Balance-sheet assets and deposits contracted materially from December 31, 2011, while loans and leases increased to $12.25 billion from $10.03 billion, mainly due to higher short-duration advances.
Guidance, management commentary, risks and unusual items
- Cost program: Management expected an additional $90–$100 million of annual pre-tax run-rate savings in 2012 versus the 2010 expense base. It projected total annualized savings of approximately $575–$625 million by the end of 2014, with the full effect in 2015, against expected aggregate restructuring charges of $400–$450 million through 2014. These are program estimates, not overall expense guidance.
- Capital returns: Following Federal Reserve non-objection to its 2012 capital plan, State Street declared a $0.24 quarterly common dividend, up from $0.18 a year earlier. The board authorized up to $1.8 billion of repurchases through March 31, 2013; none occurred under that program in Q1. In April, the company repurchased approximately 1.62 million shares for $74 million.
- Revenue drivers: Q1 servicing mandates totaled approximately $233 billion, of which $90 billion was installed by quarter-end; $143 billion remained to be installed. SSgA had another $25 billion of awarded business awaiting installation. These uninstalled assets were not yet contributing fee revenue.
- Investment portfolio and rates: Approximately 89% of investment securities were rated AAA or AA; about 83% of portfolio carrying value comprised mortgage- and asset-backed securities. Management estimated that a further housing-price decline to 37%–39% peak-to-trough, versus its 35.8% expectation, could increase impairment by approximately $5–$35 million. A 100-basis-point rate decline was estimated to reduce next-12-month net interest revenue by $322 million under an immediate shock; estimates depend on assumptions and exclude possible management actions.
- Europe and concentration: State Street reported no direct sovereign debt exposure to Spain, Italy, Ireland, Greece or Portugal, but approximately $1.28 billion of aggregate exposure, including $1.09 billion of mortgage- and asset-backed securities with about $100 million of pre-tax gross unrealized losses. It reported no Q1 impairment for expected credit losses on those securities. The filing also identifies sovereign-debt, counterparty, market, liquidity, credit, operational, regulatory and technology risks.
- Legal and contingent exposures: A court ruled that Prudential was entitled to $28.1 million, subject to possible interest and costs; State Street intended to appeal. Estimated exposure across three related lawsuits was approximately $0–$85 million, excluding unquantifiable potential punitive damages. Foreign-exchange pricing investigations and litigation remained pending, with no reserves recorded for those proceedings; outcomes could affect future results and reputation. A separate California action sought $56 million in asserted actual damages plus penalties, including treble damages.
- Off-balance-sheet activity: State Street indemnified $323.43 billion of securities on loan at quarter-end, against $334.66 billion of collateral held as agent. These arrangements are not recorded as ordinary balance-sheet assets and liabilities, but expose the firm to indemnification and collateral-investment risks.
- State Street settled an investigation by the Massachusetts Secretary of State concerning disclosures for the Carina CDO in February 2012; the settlement amount is not clear in the provided filing text. The filing also reported a $400 million allowed claim against Lehman estates, with an initial distribution received in April; ultimate recovery depends on estate assets.
- No specific earnings or revenue forecast was provided. Forward-looking statements are subject to market, regulatory, litigation, credit, liquidity, client-flow and execution risks.
Most important facts for investors to verify
- Whether expense growth moderates and whether projected transformation savings are achieved, including their costs and timing.
- Whether net interest revenue and margin remain resilient as rates, deposit mix and former-conduit discount accretion change.
- Progress installing servicing and management mandates, client retention, and the trajectory of assets under custody and management and related fees.
- Developments in foreign-exchange litigation and investigations, the Prudential appeal and other legal matters, including any new reserves or settlements.
- Credit performance, valuations and impairment sensitivity in mortgage- and asset-backed securities, including indirect European exposure.
- Liquidity and capital after deposit movements, regulatory changes, dividends and the authorized share-repurchase program.
- Risks associated with securities-lending indemnities, collateral reinvestment and other off-balance-sheet commitments.