State Street Corporation: Q2 2006 10-Q Summary
Business Context and Reporting Period
This filing covers the quarterly period ended June 30, 2006. State Street Corporation is a financial holding company providing investment servicing and investment management services to institutional investors worldwide. As of the reporting date, the company had consolidated total assets of $102.54 billion, total deposits of $63.56 billion, and 21,675 employees.
Key Financial Metrics
| Metric | Q2 2006 | Q2 2005 | YTD 2006 | YTD 2005 |
|---|---|---|---|---|
| Total Revenue | $1,651 million | $1,361 million | $3,174 million | $2,669 million |
| Net Income | $227 million | $220 million | $519 million | $446 million |
| Diluted EPS | $0.68 | $0.66 | $1.55 | $1.33 |
| Operating Expenses | $1,176 million | $1,028 million | $2,272 million | $1,994 million |
| Effective Tax Rate | 52.1% | 34.0% | 43.6% | 33.9% |
| Return on Equity (YTD) | 16.1% | |||
| Assets Under Custody | $10.86 trillion | |||
| Assets Under Management | $1.53 trillion |
Material Changes vs. Prior Period
- Revenue Growth: Total revenue increased 21% in Q2 and 19% year-to-date (YTD) compared to 2005. Fee revenue grew 20% in Q2, driven by strong performance in management fees and trading services (specifically foreign exchange).
- Net Interest Revenue: Increased 21% in Q2 and 23% YTD due to a favorable deposit mix and balance sheet growth.
- Tax Charges: The effective tax rate spiked to 52.1% in Q2 2006 (vs. 34.0% in 2005) due to non-cash charges of $0.25 per share. This included $0.18 per share related to the Tax Increase Prevention and Reconciliation Act impacting leveraged leases and $0.07 per share for an additional provision regarding IRS issues with LILO/SILO transactions.
- Operating Leverage: The company achieved positive operating leverage of 7% in Q2, as revenue growth outpaced expense growth (14%).
- Discontinued Operations: YTD 2006 included $10 million of after-tax income from discontinued operations related to the divestiture of Bel Air Investment Advisors.
Guidance, Outlook, and Risks
Financial Goals: Management reaffirmed 2006 goals of 10-15% growth in operating-basis EPS, 8-12% growth in operating-basis revenue, and a 14-17% return on shareholders' equity. Management believes current performance supports achieving these goals, potentially at the high end of the ranges if first-half strength continues.
Outlook Challenges: Management noted potential headwinds for the remainder of the year, including seasonally reduced transaction volumes in Q3, a slowdown in capital markets activity, and a challenging short-term interest-rate environment.
Risks and Contingencies:
- Tax Legislation: Future income from affected leveraged leases is expected to increase, but a one-time after-tax reduction of $190-$240 million to retained earnings is expected upon the January 1, 2007, effective date of new FASB rules.
- IRS Matters: The company has accrued $24 million for potential resolution of IRS issues regarding LILO and SILO transactions but believes reserves are sufficient.
- Market Risk: The company holds $529.36 billion in notional derivative instruments. Value-at-risk for trading activities averaged $1.7 million for foreign exchange products over the six months ended June 30, 2006.
Investor Verification Checklist
- Tax Rate Volatility: Verify the sustainability of the effective tax rate, noting the one-time $83 million charge in Q2 2006 related to tax legislation and IRS provisions.
- Operating Basis Metrics: Review "operating-basis" earnings (excluding tax charges) to assess core business performance against the 10-15% EPS growth target.
- Interest Rate Sensitivity: Assess the impact of rising short-term rates on Net Interest Revenue (NIR), noting the company's exposure to rate shocks (NIR-at-risk of $84 million for a +100 bps shock).
- Asset Growth: Confirm the correlation between Assets Under Custody ($10.86T) and Assets Under Management ($1.53T) growth with fee revenue trends.
- Capital Adequacy: Verify Tier 1 risk-based capital ratio (11.0%) remains well above the 6% regulatory minimum for "well-capitalized" status.