State Street Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011; balance-sheet comparisons are with December 31, 2010 unless otherwise noted. State Street provides institutional investment servicing and investment management. Amounts below are in U.S. dollars; income-statement and cash-flow amounts are in millions unless stated otherwise.
Business context and key metrics
- At quarter-end, State Street reported $208.80 billion in assets, $135.00 billion in deposits, $19.65 billion in shareholders’ equity and 29,685 employees.
- Assets under custody and administration were $21.51 trillion, up 6% year over year but essentially unchanged from year-end 2010. Assets under management were $1.88 trillion, down from $2.01 trillion at year-end, reflecting market depreciation and net outflows, partly offset by the BIAM acquisition.
Financial results
| Metric | Q3 2011 | Q3 2010 | First 9 months 2011 | First 9 months 2010 |
|---|---|---|---|---|
| Total revenue | $2,427 | $2,310 | $7,279 | $6,910 |
| Fee revenue | $1,844 | $1,569 | $5,527 | $4,805 |
| Net interest revenue | $578 | $724 | $1,727 | $2,043 |
| Total expenses | $1,798 | $1,527 | $5,274 | $5,050 |
| Income before taxes | $629 | $782 | $2,004 | $1,834 |
| Net income | $555 | $546 | $1,539 | $1,473 |
| Diluted EPS | $1.10 | $1.08 | $3.03 | $2.93 |
- Quarterly total revenue rose 5% as fee growth more than offset lower net interest revenue. Servicing fees increased 10%, management fees 17%, trading services 46% and securities finance 25%. FX trading benefited from higher volatility and client volumes.
- Quarterly net interest margin fell to 1.56% from 2.36%; excluding conduit-related discount accretion, it was 1.44% versus 1.77%. The company recorded $46 million of such accretion in Q3 2011 versus $189 million a year earlier. Nine-month net interest margin was 1.71% versus 2.30%.
- Quarterly expenses increased 18%, including higher compensation, acquired-business costs and transformation-program charges. The effective tax rate was 11.7% for Q3, including a $91 million discrete tax benefit; the nine-month rate was 23.2%.
- Q3 pre-tax margin was approximately 25.9%, compared with 33.9% in Q3 2010. Return on average common equity was 11.2% versus 12.9%.
- For the first nine months, net cash used in operating activities was $2.11 billion; investing activities used $29.32 billion; financing activities provided $37.61 billion. Cash and due from banks ended at $9.49 billion. These cash flows reflect substantial movements in deposits, securities, trading assets and collateral.
Balance sheet, capital and liquidity
- Total assets grew to $208.80 billion from $160.51 billion at year-end 2010, while deposits rose to $135.00 billion from $98.35 billion. Available-for-sale securities were $96.60 billion; loans and leases, net of allowance, were $11.72 billion.
- Long-term debt was $8.11 billion, down from $8.55 billion. The company issued $2 billion of senior notes in March and prefunded a 2012 parent-company debt maturity. It reported $2.36 billion of commercial paper outstanding.
- Consolidated net liquid assets were $115.20 billion, versus $83.41 billion at year-end. Management considered liquidity sufficient for current commitments and business needs. The quarter-end balance included unusually high client deposits and $33.62 billion of excess central-bank balances.
- At September 30, State Street’s Tier 1 and total risk-based capital ratios were 17.9% and 19.5%; State Street Bank’s were 16.5% and 18.4%. Both entities exceeded applicable minimum and well-capitalized thresholds. Ratios declined from year-end as risk-weighted assets increased.
- The company declared $0.18 per common share for Q3 and $0.54 per share year to date. It repurchased approximately 10.7 million shares for $450 million during April–September, with $225 million of 2011 authorization remaining at quarter-end.
Changes, outlook and risks
- Fee growth reflected new servicing business, higher average equity valuations, increased trading activity and the BIAM acquisition. Q3 awards included approximately $245 billion of new servicing assets and $88 billion of gross new assets to manage; installations were still in progress.
- The business and IT transformation program had incurred $231 million of cumulative pre-tax restructuring charges. Management expected a further $45–$65 million in Q4 2011 and approximately $80 million of annual pre-tax savings in 2011. It projected approximately $575–$625 million of annualized savings by the end of 2014, with full effect in 2015, excluding the estimated $400–$450 million total restructuring charges. These are estimates, not earnings guidance.
- Management cited continued uncertainty around interest rates, client deposit mix, conduit-security accretion, markets and regulatory requirements. Remaining conduit securities were expected to generate about $1.14 billion of future accretion if held to maturity, but timing and amount were uncertain.
- Investment-portfolio risk includes mortgage- and asset-backed securities and housing-price assumptions. Management estimated an additional $20–$60 million of impairment under a 37%–39% peak-to-trough housing-price decline, versus its 36% base expectation. It reported $56 million of credit-related impairment for the first nine months.
- European sovereign-market uncertainty remained a risk. Exposure to Portugal, Ireland, Italy, Greece and Spain totaled approximately $2.44 billion, with no sovereign-debt exposure reported; the company had recorded no impairment or loan-loss provision on these positions at quarter-end.
- Material legal and regulatory matters include investigations and claims concerning FX pricing, securities lending and SSgA funds, as well as Lehman-related disputes. Certain outcomes could materially affect results in the period resolved; the company said potential exposure in several matters could not be reasonably estimated. It reported $400 million of allowed U.S. Lehman deficiency claims and stated that realizable claims were believed to exceed potential return obligations, while acknowledging uncertainty.
- Management identified Basel III, Dodd-Frank implementation, market disruption, funding access, credit ratings, operational and technology risks, litigation and investment-security impairment as potential risks. No specific overall earnings or revenue guidance was provided.
Important facts for investors to verify
- Whether fee growth and awarded business convert to installed assets and recurring revenue, particularly as assets under management declined.
- How net interest revenue and margin evolve as conduit accretion diminishes and client deposits, rates and reinvestment yields change.
- Whether the restructuring savings targets are achieved and what costs remain to complete the transformation program.
- Whether housing-market deterioration, securities valuations or European exposures lead to further impairment or credit losses.
- Developments in FX-pricing, securities-lending and Lehman matters, including potential costs, reserves and effects on client relationships.
- Capital and liquidity levels as balance-sheet and off-balance-sheet exposures grow, including implementation of future regulatory requirements.