State Street Corporation — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless stated otherwise. State Street provides investment servicing and investment management services to institutional clients worldwide. At quarter-end, it reported $32.11 trillion of assets under custody and administration (AUCA), $2.67 trillion of assets under management (AUM), and 36,303 employees.
Financial results and condition
- Q3 revenue: $2.846 billion, up 9%; fee revenue was $2.242 billion, up 8%, and GAAP net interest income (NII) was $603 million, up 12%.
- Q3 earnings: Net income was $685 million, up 22%; diluted EPS was $1.66, up 29%. Return on average common equity was 13.0%, versus 10.6%, and pre-tax margin was 28.9%, versus 24.3%.
- First nine months: Revenue was $8.324 billion, up 8%; net income was $1.807 billion, up 17%; diluted EPS was $4.35, up 23%. Net income available to common shareholders was $1.659 billion.
- Margins and costs: Q3 fully taxable-equivalent net interest margin was 1.35%, versus 1.14%. Expenses rose 2% in Q3 to $2.021 billion and 4% for nine months to $6.138 billion. Q3 included $33 million of Beacon restructuring charges.
- Balance sheet at September 30: Total assets were $235.99 billion, deposits $179.26 billion, total liabilities $213.49 billion, shareholders’ equity $22.50 billion, and long-term debt $11.72 billion. Loans and leases were $23.64 billion, up from $19.76 billion at December 31, 2016.
- Cash flows, nine months: Operating cash flow was $1.857 billion, versus $2.276 billion. Investing activities provided $10.879 billion, while financing activities used $10.111 billion. Ending cash and due from banks was $3.939 billion. Investing cash flow included a $9.979 billion net decrease in interest-bearing bank deposits; these movements reflect balance-sheet activity and should not be read as operating cash generation alone.
- Capital and liquidity: CET1 ratio was 11.6% under the standardized approach; tier 1 leverage ratio was 7.4%. The company reported an LCR above 100%; average HQLA was $67.23 billion. Parent-company net liquid assets were $0.57 billion, down from $3.64 billion at year-end, primarily because assets were transferred to SSIF for its resolution strategy; the filing says those resources remain available absent specified financial-distress triggers.
Material changes and notable drivers
- Q3 servicing fees increased 4%, primarily reflecting higher equity markets, new business, and a weaker U.S. dollar; management fees rose 14%, aided by markets, new business, and higher-yielding ETF inflows. Trading services revenue declined 3% overall, including a 6% decline in foreign-exchange trading.
- NII growth reflected higher U.S. interest rates, loan growth, lower wholesale CD costs, and disciplined deposit pricing; lower average interest-earning assets partly offset those benefits.
- AUCA rose 10% year over year and AUM rose 9%, supported mainly by market appreciation. AUM nevertheless had net outflows of $64 billion for the first nine months, including $87 billion of net long-term institutional outflows, partly offset by ETF and cash-fund inflows.
- State Street secured approximately $105 billion of new servicing mandates in Q3; its won-but-not-installed AUCA pipeline was approximately $390 billion. Approximately $29 billion of awarded asset-management business was also not yet installed.
- A large client plans to move approximately $1 trillion of assets, largely common trust funds, to another provider, principally during 2018. State Street expects to remain a significant provider, but will no longer earn revenue on the transferred assets after transition.
- Nine-month investment-security results included a net loss of $39 million, primarily reflecting a $40 million pre-tax loss on the Q1 sale of $2.7 billion of available-for-sale securities. Q3 processing fees and other revenue benefited from an approximately $26 million pre-tax gain on an equity trading platform sale; first-quarter joint-venture dispositions generated an aggregate $30 million pre-tax gain.
Outlook, risks, and contingencies
- Beacon: Management expected total pre-tax restructuring charges of approximately $300–$400 million from 2016 through 2020 and annual pre-tax net run-rate savings of $550 million by the end of 2020, with full effect in 2021. It reported approximately $100 million of savings in the first nine months of 2017 against a 2017 target of $140 million. These are estimates, not guaranteed outcomes.
- Interest-rate exposure: The company estimated that a 100-basis-point instantaneous rate increase would benefit next-12-month NII by $515 million, while a 100-basis-point decrease would reduce it by $352 million, assuming no management action. It remains exposed to losses in economic value of equity from rising rates.
- Regulatory and funding risks: State Street is a G-SIB subject to evolving capital, liquidity, resolution-planning, compliance, and TLAC requirements. It projected approximately $2 billion of additional long-term debt by December 31, 2018, relative to TLAC-eligible debt outstanding at September 30, 2017. Failure to satisfy regulators’ resolution-plan expectations could lead to stricter requirements or activity restrictions.
- Legal and compliance matters: In 2017, the company paid a $32.3 million DOJ fine under a deferred prosecution agreement and a $32.3 million SEC penalty; an independent monitor/consultant is required. A Federal Reserve/Massachusetts banking-agency written agreement requires compliance-program improvements. The review of historical client invoicing errors remained ongoing; management expected cumulative client reimbursements of at least $340 million, including interest, and disclosed related litigation and government inquiries.
- At September 30, aggregate legal and regulatory loss-contingency accruals were approximately $15 million. The estimated reasonably possible loss range was $0–$15 million for matters that could be estimated, but excludes certain significant matters—including the invoicing matter and regulatory written agreement—for which a loss range was not currently feasible.
- Other key risks include market and foreign-exchange volatility, client fee pressure and outflows, credit and counterparty exposures, cyber and operational risks, and execution of transformation initiatives. Management provided no broad near-term earnings guidance in the supplied filing text.
Most important facts for investors to verify
- Progress and timing of the approximately $1 trillion client asset transition in 2018, and its expected effect on recurring servicing revenue.
- Whether Beacon delivers its $550 million annual run-rate savings goal by end-2020, and the remaining restructuring costs and cash outlays.
- Final client reimbursement totals and outcomes of the invoicing review, related class actions, and regulatory investigations; the filing says some potential exposures cannot yet be estimated.
- Sustainability of NII and fee growth if interest rates, markets, client flows, or deposit mix change; assess market sensitivity alongside reported growth.
- Capital and liquidity headroom as TLAC and other regulatory requirements phase in, including the projected debt issuance and the resources held by SSIF.
- Credit quality and concentrations as loans grew, particularly senior secured loans: approximately 90% were externally rated BB or B, and the company noted higher potential credit-loss exposure than for higher-rated loans.