State Street Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. State Street provides custody, investment servicing and investment management to institutional investors. At quarter-end it reported $27.79 trillion in assets under custody and administration (AUCA), $2.30 trillion in assets under management (AUM), and 32,636 employees. Financial statements are unaudited; the independent accountant performed an interim review, not an audit.
Key financial results
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $2.573B | $2.608B | $5.057B | $5.208B |
| Net interest revenue | $521M | $535M | $1.033B | $1.081B |
| Net income | $619M | $418M | $987M | $823M |
| Net income available to common shareholders | $585M | $389M | $904M | $762M |
| Diluted EPS | $1.47 | $0.93 | $2.25 | $1.83 |
| Total expenses | $1.860B | $2.134B | $3.910B | $4.231B |
| Return on average common equity | 12.4% | 8.2% | 9.6% | 8.0% |
Q2 pre-tax margin was 28%, versus 18% a year earlier. Six-month consolidated pre-tax margin was 23%, versus 19%. Six-month effective tax rate was 13.5%, down from 15.2%.
Six-month operating cash flow was $5.012B, compared with cash used of $4.527B in 2015; investing cash use was $2.286B versus $16.837B, and financing cash provided was $740M versus $22.593B. The operating-cash-flow swing included significant collateral-deposit movements, so it should not be viewed as a simple measure of recurring earnings conversion.
Financial position and liquidity
- At June 30, total assets were $255.39B, deposits $193.13B, total liabilities $233.28B and shareholders’ equity $22.07B. Long-term debt was $11.92B, compared with $11.50B at December 31, 2015.
- Cash and due from banks totaled $4.67B; interest-bearing deposits with banks were $75.17B. The investment securities portfolio had $103.12B carrying value: $72.74B available-for-sale and $30.39B held-to-maturity. Approximately 93% was rated AAA or AA.
- High-quality liquid assets were $113.67B, up from $109.39B at year-end; the liquidity coverage ratio exceeded 100%. Parent-company net liquid assets were $5.99B. Approximately $450M of senior notes matured within the following 12 months.
- Regulatory capital remained above requirements. State Street’s common equity tier 1 ratio was 12.0% under both advanced and standardized approaches; its supplementary leverage ratio was 6.3% (6.1% fully phased-in pro forma). State Street Bank’s CET1 ratios were 15.9% advanced and 15.8% standardized.
- Loans and leases were $19.84B, with a $51M allowance for loan losses. Six-month provision was $8M, primarily related to non-investment-grade senior secured loans.
Changes versus comparable periods
- Q2 revenue declined 1%; six-month revenue declined 3%. Servicing fees fell 6% in Q2 and 4% year to date, reflecting the client-invoicing reserve increase, weaker global equity markets and currency effects. Management fees fell 4% and 7%, respectively, due to lower markets and AUM, partly offset by lower money-market fee waivers.
- Q2 net interest revenue fell 3%; six-month net interest revenue fell 4% on a GAAP basis. Balance-sheet reductions, lower global rates and a stronger dollar weighed on results; the December 2015 U.S. rate increase provided a partial offset. Average interest-earning assets and client deposits were substantially lower than a year earlier.
- Expenses fell 13% in Q2 and 8% year to date, mainly because 2015 included substantial legal accruals—$250M in Q2 and $400M in the first half. This comparison partly explains the increase in profit. Compensation and technology costs rose, and 2016 included Beacon restructuring charges.
- Trading services revenue declined 5% in Q2 and 11% year to date, principally due to lower FX activity and volatility; prior-year European market events supported activity. Securities-finance revenue increased 1% in Q2 and 13% year to date. Processing fees and other revenue benefited from a $53M pre-tax gain on the WM/Reuters sale.
- AUCA was $27.79T versus $28.65T a year earlier; AUM was $2.30T versus $2.37T. AUM had net outflows of $21B in the first half, while market and foreign-exchange movements added $77B. These ending balances exclude awarded but not yet installed mandates.
Outlook, notable items and risks
- State Street reported $750B in new asset-servicing mandates awarded in Q2, including $583B from two European asset managers; about $90.7B had been installed by June 30. Separately, the filing cited an estimated $1.038T of awarded but uninstalled servicing mandates across Q2 and prior periods. Installation timing and future fee contribution are not assured.
- In July 2016, State Street completed its $435M cash acquisition of GE Asset Management, with up to $50M additional consideration tied to opportunities. The acquired business had approximately $110B of AUM; expected merger and integration costs were $70M–$80M through 2018. Results were to be reflected beginning in Q3.
- For State Street Beacon, management expected at least $140M of annual year-over-year pre-tax savings in 2016, with the full effect expected in 2017. It projected $300M–$400M of aggregate pre-tax restructuring charges through 2020; $110M had been recorded in the first half of 2016.
- The company increased its reserve for incorrectly invoiced client expenses by approximately $58M in Q2. It had identified about $283M of expenses, excluding interest, for reimbursement and was reviewing other billing practices, including asset-based fees. Additional reimbursements, claims or regulatory actions could follow.
- As of June 30, accrued indirect-FX-related amounts totaled $565M. On July 26, State Street announced negotiated settlements with the DOJ, DOL, Massachusetts Attorney General and, subject to approval, a U.S. custody-client class; it also reported an agreement in principle with the SEC. Settlements required class certification and court approval, and further claims remained possible.
- Regulators found the 2015 resolution plan not credible or insufficient to facilitate orderly resolution and required remediation by October 1, 2016. Failure to satisfy regulators could lead to higher capital, leverage or liquidity requirements, or restrictions on growth and activities.
- Other risks include regulatory and compliance obligations, transition-management investigations, interest-rate and foreign-exchange movements, client deposit and asset flows, market and counterparty exposures, cybersecurity and operational risks, and potential Volcker Rule-related restrictions or divestitures. Management said the filing-date LCR was above 100%; it also estimated remaining discount accretion from former conduit securities at about $204M over their remaining terms.
Most important facts for investors to verify
- Whether the invoicing review identifies further client reimbursements or affects fee revenue, and whether the announced FX settlements receive final approval and resolve the relevant claims.
- How quickly the large servicing mandates are installed, their retained value, and whether AUM flows improve after first-half net outflows.
- Whether revenue and margins can withstand subdued markets, lower interest rates, deposit changes and continued FX volume pressure.
- Actual Beacon savings versus restructuring costs, and GE Asset Management’s integration costs, acquired AUM retention and contribution to earnings.
- Progress on the October 1 resolution-plan remediation deadline and the resulting implications for capital, liquidity and permissible capital distributions.
- Capital and liquidity trends, including the effects of share repurchases, dividends, deposit volatility and regulatory methodology changes on reported ratios.