STT

State Street Corporation 10-Q Summary

Business Context and Reporting Period

This filing is a Quarterly Report (Form 10-Q) for State Street Corporation for the period ended June 30, 2004. State Street is a financial holding company operating primarily through two lines of business: Investment Servicing (custody, accounting, recordkeeping) and Investment Management (asset management). The company is in the process of integrating the Global Securities Services (GSS) business acquired from Deutsche Bank in January 2003.

Key Financial Metrics

Three Months Ended June 30, 2004 (vs. 2003):

• Total Revenue: $1.287 billion (up 19% from $1.082 billion).
• Net Income: $220 million ($0.65 diluted EPS) vs. a net loss of $23 million ($0.07 diluted EPS) in 2003.
• Operating Expenses: $953 million (down 16% from $1.139 billion, primarily due to the absence of $292 million in 2003 restructuring costs).
• Fee Revenue: $1.045 billion (up 19%).
• Net Interest Revenue: $226 million (up 17%).

Six Months Ended June 30, 2004 (vs. 2003):

• Total Revenue: $2.506 billion (up 19% from $2.102 billion).
• Net Income: $437 million ($1.28 diluted EPS) vs. $73 million ($0.22 diluted EPS) in 2003.
• Operating Expenses: $1.861 billion (down 6% from $1.973 billion).
• Fee Revenue: $2.058 billion (up 23%).
• Net Interest Revenue: $429 million (up 8%).

Balance Sheet and Liquidity (as of June 30, 2004):

• Total Assets: $94.14 billion (up from $87.53 billion at year-end 2003).
• Total Liabilities: $88.23 billion.
• Stockholders' Equity: $5.91 billion.
• Defined Liquid Assets: $81.25 billion (86% of total assets).
• Long-term Debt: $2.347 billion.
• Allowance for Loan Losses: $36 million.

Material Changes vs. Prior Period

The significant improvement in profitability compared to the prior year is largely attributable to the absence of $292 million in restructuring costs incurred in the second quarter of 2003 related to a voluntary separation program. Additionally, 2004 results reflect a full six months of revenue and expenses from the GSS acquisition, whereas 2003 included only five months.

Revenue growth was driven by:

• Servicing Fees: Increased 18% (Q3) and 22% (YTD) due to new business and higher equity market valuations. Assets under custody reached $9.15 trillion.
• Management Fees: Increased 18% (Q3) and 18% (YTD) on a reported basis, driven by new business and market appreciation. Assets under management reached $1.22 trillion.
• Foreign Exchange Trading: Increased 13% (Q3) and 34% (YTD) due to higher currency volatility.

Operating expenses on an "operating basis" (excluding restructuring and merger costs) increased 15% in the quarter and 14% YTD, primarily due to higher incentive compensation and transaction processing costs.

Guidance, Outlook, and Risks

Management Commentary: Management expects market conditions to be less favorable in the second half of 2004. They anticipate incurring implementation expenses related to converting new large investment operations outsourcing clients. Merger and integration costs for the full year 2004 are estimated at $50 million to $60 million.

Financial Goals: The company targets a 12.5% real compound annual growth rate in revenue (approx. 15% nominal) and an operating return on stockholders' equity of 13%-15% for 2004.

Risks and Contingencies:

• Regulatory: Implementation of Basel II capital adequacy rules (expected effective 2007-2008) may impact capital ratios.
• Market Risk: Revenue is sensitive to asset values, cross-border investment flows, and currency volatility. A 10% change in worldwide equity values could impact total revenue by approximately 2%.
• Legal: The company is responding to subpoenas and inquiries from the SEC and Department of Labor regarding mutual fund-related matters.
• Off-Balance Sheet: Significant commitments exist for securities lending indemnifications ($326.7 billion) and liquidity asset purchase agreements ($17.8 billion).

Investor Verification Checklist

• Verify the sustainability of revenue growth excluding the one-time impact of the GSS acquisition integration.
• Monitor the trajectory of merger and integration costs against the $50-$60 million full-year estimate.
• Assess the impact of potential market volatility on fee revenue, given the sensitivity to asset values under custody and management.
• Review the status of ongoing regulatory inquiries regarding mutual fund practices.
• Track the company's progress in meeting Basel II capital requirements and the potential impact on capital ratios.