Business context and reporting period
State Street Corporation’s Form 10-K covers the fiscal year ended December 31, 2016; the filing also reports fourth-quarter results. The company provides investment servicing and investment management to institutional investors worldwide. At year-end, it reported $28.77 trillion of assets under custody and administration (AUCA) and $2.47 trillion of assets under management (AUM).
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Total revenue | $10.207 billion | $10.360 billion |
| Fee revenue | $8.116 billion | $8.278 billion |
| Net interest revenue | $2.084 billion | $2.088 billion |
| Total expenses | $8.077 billion | $8.050 billion |
| Net income | $2.143 billion | $1.980 billion |
| Net income available to common shareholders | $1.968 billion | $1.848 billion |
| Diluted earnings per share | $4.97 | $4.47 |
| Net cash from operating activities | $2.290 billion | $(1.403) billion |
Net interest margin was 1.13% on a fully taxable-equivalent basis, versus 1.03% in 2015. Return on average common equity was 10.5%, up from 9.8%. The effective tax rate was negative 1.0%, reflecting tax benefits, including effects related to foreign earnings and overseas capital actions.
At December 31, 2016, total assets were $242.70 billion, deposits $187.16 billion, long-term debt $11.43 billion and shareholders’ equity $21.22 billion. Regulatory capital ratios included a 11.7% common equity tier 1 ratio, 14.8% tier 1 ratio, 16.0% total capital ratio and 5.9% supplementary leverage ratio (SLR). State Street reported an LCR above 100%; high-quality liquid assets were approximately $100.93 billion.
Common dividends declared were $1.44 per share for 2016. The company repurchased 21.1 million shares for approximately $1.365 billion. The cash-flow statement reports investing cash inflow of $4.230 billion and financing cash outflow of $6.413 billion.
Material changes versus the prior comparable period
- Revenue declined about 1%, primarily due to lower processing fees and other revenue. Servicing fees fell 2%; management fees rose 10%, partly reflecting the GE Asset Management (GEAM) acquisition and reduced money-market fee waivers; securities finance revenue increased 13%.
- Net income rose to $2.143 billion from $1.980 billion, despite slightly lower revenue and largely flat expenses. The 2016 tax benefit was a significant contributor to reported earnings.
- Investment Management pre-tax income fell to $109 million from $236 million, and its pre-tax margin declined to 8% from 20%, amid higher acquisition and compensation costs.
- Year-end AUCA increased 5% to $28.77 trillion; AUM rose to $2.47 trillion from $2.25 trillion, including $118 billion of GEAM AUM. Excluding acquired GEAM assets, AUM had net outflows of $42 billion.
- Total assets fell to $242.70 billion from $245.16 billion, deposits to $187.16 billion from $191.63 billion, and investment securities to $97.17 billion from $100.02 billion. The company cited balance-sheet management and portfolio repositioning.
- Common equity tier 1 declined to 11.7% from 12.5% under the advanced approaches; the filing attributes capital reduction chiefly to share repurchases, dividends, foreign currency translation, regulatory phase-ins and GEAM-related goodwill and intangible deductions.
Fourth-quarter highlights
Fourth-quarter 2016 revenue was $2.530 billion, versus $2.538 billion in fourth-quarter 2015. Net income was $593 million and diluted EPS was $1.43, compared with $576 million and $1.34. The quarter included a $248 million income tax benefit and a $249 million pre-tax charge from accelerating expense on certain deferred cash incentive awards; the charge reduced after-tax income by $161 million, or $0.41 per share.
Outlook, management commentary, risks and unusual items
- Transformation: State Street Beacon generated estimated annual pre-tax savings of $175 million in 2016. Management targeted at least $140 million of additional annual savings in 2017 and estimated $550 million of annual net run-rate savings by the end of 2020, relative to 2015, with full effect in 2021. The program was expected to incur $300 million to $400 million of restructuring charges through 2020.
- Client and revenue exposure: A large client plans to move approximately $1 trillion of assets to another provider, with transition expected to finish in 2018. State Street said it expects to remain a significant provider to the client. Fee revenue is sensitive to market values, client flows, product mix and pricing pressure.
- Acquisition: GEAM was acquired July 1, 2016 for approximately $485 million. State Street reported $53 million of acquisition and restructuring costs in 2016 and expected approximately $80 million of such costs through 2018, including costs already incurred.
- Legal and compliance matters: The ongoing client-invoicing review covered practices dating to 1998; the company expected to pay at least $340 million, including interest, in client reimbursements. Related government inquiries and potential claims or sanctions remained unresolved. For transition-management conduct, State Street entered a DOJ deferred prosecution agreement in January 2017 and agreed to a $32.3 million penalty and a three-year independent compliance monitor; an SEC settlement for an equal penalty was agreed in principle but remained subject to final terms and SEC review. Settlements relating to indirect foreign exchange totaled $575 million and became final in fourth-quarter 2016.
- Regulatory and market risks: State Street is a U.S. G-SIB subject to increasing capital, liquidity, resolution-planning and compliance requirements. The filing identifies counterparty concentration, interest rates and foreign exchange, European economic conditions, cyber and operational risk, and possible client deposit or mandate outflows as material risks. The company reported a 2016 written agreement with regulators concerning anti-money-laundering and sanctions compliance.
- Capital and liquidity constraints: A 2019 TLAC regime and higher SLR requirements were approaching. Future dividends and buybacks remain subject to regulatory capital planning and Federal Reserve review. Management considered consolidated liquidity sufficient at year-end; parent-company net liquid assets were $3.64 billion, down from $5.73 billion in 2015.
The independent auditor issued an unqualified opinion on the financial statements and internal control over financial reporting. Management and the auditor reported effective controls and no material weaknesses as of December 31, 2016.
Important facts for investors to verify
- How much of 2016 earnings growth reflects the unusually low effective tax rate, and what tax rate is sustainable?
- Actual cash paid for invoicing reimbursements, final resolution of related investigations and any additional legal or regulatory exposure.
- Final SEC terms for the transition-management matter, monitor requirements and any effects on client relationships or operating costs.
- Timing and revenue impact of the approximately $1 trillion client mandate transfer, alongside installation and retention of new servicing mandates.
- Progress toward Beacon savings targets, remaining restructuring costs and whether expense growth offsets savings.
- Capital headroom under fully phased-in Basel III, SLR and TLAC requirements, and the resulting capacity for dividends and repurchases.
- Whether investment-management flows, fee mix and the reduced investment portfolio sustain revenue and net interest margin amid changing rates and markets.