Business context and reporting period
State Street Corporation’s Form 10-K covers the fiscal year ended December 31, 2010; it is an annual report, not a standalone fourth-quarter filing. The company provides investment servicing and investment management services to institutional investors. At year-end, it reported $21.53 trillion in assets under custody and administration and $2.01 trillion in assets under management.
During 2010, State Street acquired Mourant International Finance Administration (MIFA) and Intesa Sanpaolo’s securities-services business. The January 2011 acquisition of Bank of Ireland Asset Management occurred after the reporting period.
Key financial metrics
| Metric | FY 2010 | FY 2009 |
|---|---|---|
| Total revenue | $8.953 billion | $8.640 billion |
| Fee revenue | $6.540 billion | $5.935 billion |
| Net interest revenue | $2.699 billion | $2.564 billion |
| Income before tax | $2.086 billion | $2.525 billion |
| Net income from continuing operations | $1.556 billion | $1.803 billion |
| Net income available to common shareholders, before extraordinary loss | $1.540 billion | $1.640 billion |
| Diluted EPS, before extraordinary loss | $3.09 | $3.46 |
| Operating cash flow | $823 million | $(4.231) billion |
- Revenue rose 4% year over year. Servicing fees increased 18%, management fees 8%, and processing fees and other revenue 104%; securities finance revenue fell 44%.
- Expenses increased 15% to $6.842 billion, including a $414 million securities-lending charge, $156 million of restructuring charges and $89 million of merger and integration costs. The filing reports a 9.5% return on average common equity, down from 13.2% in 2009.
- Net interest margin, on a fully taxable-equivalent basis, improved to 2.24% from 2.19%. Net interest revenue included $712 million of discount accretion from securities consolidated with former asset-backed commercial paper conduits.
- At December 31, total assets were $160.505 billion, deposits $98.345 billion, shareholders’ equity $17.787 billion and long-term debt $8.550 billion. Total investment securities were $94.130 billion. Liquid assets, as defined by management, were $83.41 billion.
- Consolidated Tier 1 and total risk-based capital ratios were 20.5% and 22.0%, respectively; the Tier 1 leverage ratio was 8.2%. State Street Bank also exceeded applicable “well capitalized” thresholds.
- Cash and due from banks increased by $670 million during the year to $3.311 billion. Investing activities provided $3.192 billion and financing activities used $3.345 billion.
Material changes versus the prior comparable period
- Common-shareholder income before extraordinary loss declined 6%, and diluted EPS before extraordinary loss fell from $3.46 to $3.09, despite higher revenue. Higher expenses and investment-security losses were important offsets.
- In the fourth quarter, State Street recorded a $344 million pretax loss from selling approximately $11 billion of mortgage- and asset-backed securities to reposition its portfolio. The sale reduced exposure to certain asset classes and improved regulatory capital ratios; fourth-quarter net income was $83 million and diluted EPS was $0.16.
- The 2010 reported net loss on investment securities was $286 million, compared with a $141 million net gain in 2009. The 2010 figure included the portfolio-repositioning loss and $231 million of credit-related impairment losses.
- Year-end assets under custody and administration increased 15% to $21.53 trillion, while assets under management increased 3% to $2.01 trillion. The AUM increase reflected market appreciation; net new business was negative $68 billion.
- Shareholders’ equity rose to $17.787 billion from $14.491 billion. Deposits increased to $98.345 billion from $90.062 billion, while year-end short-term borrowings declined overall; the filing’s cash-flow statement shows net short-term borrowing reductions of $11.233 billion.
Outlook, commentary, risks and unusual items
- Management announced a multi-year operating-model program targeting service and technology improvements, efficiencies and cost reductions. It expects $400–$450 million of restructuring charges over four years and annualized operating-expense reductions of approximately $575–$625 million by the end of 2014. The 2010 plan included a reduction of about 1,400 positions, intended to be substantially completed by the end of 2011. No specific earnings guidance is provided in the filing text.
- Management said that the portfolio repositioning would reduce future discount accretion; assuming the remaining former-conduit securities are held to maturity, it estimated approximately $1.3 billion of future accretion. The timing and amount depend on cash flows, credit performance, prepayments and future portfolio actions.
- Securities lending remains a significant risk. State Street contributed $330 million to SSgA lending-fund collateral pools in 2010 and recorded a $75 million reserve for potential inconsistencies in agency-pool redemptions. Agency duration pools had a $319 million shortfall between participant return obligations and asset market value at year-end; the company cautioned that further losses or claims were possible.
- Pending matters include SEC inquiries and litigation concerning securities lending, foreign-exchange pricing claims, and Lehman-related proceedings. California authorities allege $56 million of actual damages for historical FX pricing and seek additional penalties; State Street separately settled a Washington matter for $12 million. The filing says some outcomes could materially affect results in the period resolved, though it does not consider pending matters likely to materially affect consolidated financial condition.
- Other principal risks include counterparty and liquidity exposure, European-market disruption, interest-rate and investment-portfolio risk, evolving Dodd-Frank and Basel capital requirements, regulatory compliance, acquisitions and integration, technology and operational failures, and litigation. The investment portfolio represented about 59% of total assets and included mortgage-backed, asset-backed and non-U.S. securities.
- Common dividends remained $0.01 per share quarterly; any increase required Federal Reserve approval. The company reported sufficient liquidity and capital at year-end. The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether the planned cost savings materialize, and how actual restructuring charges compare with the $400–$450 million estimate.
- How securities-lending pool values, participant redemptions, SEC inquiries and related litigation develop, including the $319 million duration-pool shortfall and $75 million reserve.
- Whether investment-security credit performance, impairment charges and former-conduit discount accretion differ materially from management’s assumptions.
- How new capital and liquidity rules affect required capital, dividend flexibility and returns; reported 2010 ratios predate full Basel III implementation.
- Whether acquired businesses retain clients and deliver expected benefits, and whether the $68 billion net AUM outflow reverses as awarded business is installed.
- The cash-flow statement’s composition and sustainability: operating cash flow was positive $823 million in 2010 after being negative $4.231 billion in 2009.