State Street Corporation — Q1 2016 Form 10-Q
Business context and period. This unaudited quarterly report covers the three months ended March 31, 2016, compared with Q1 2015; balance-sheet comparisons are generally with December 31, 2015. State Street provides institutional investment servicing and investment management. At quarter-end, it reported $26.94 trillion in assets under custody and administration (AUCA), $2.30 trillion in assets under management (AUM), and 32,527 employees. The independent accountant performed an interim review, not a full audit.
Financial results and position
| Metric | Q1 2016 | Q1 2015 / comparison |
|---|---|---|
| Total revenue | $2.484 billion | $2.600 billion; down 4% |
| Fee revenue | $1.970 billion | $2.055 billion; down 4% |
| Net interest revenue | $512 million | $546 million; down 6% |
| Expenses | $2.050 billion | $2.097 billion; down 2% |
| Income before tax | $430 million | $499 million; down 14% |
| Net income | $368 million | $405 million; down 9% |
| Net income available to common shareholders | $319 million | $373 million; down 14% |
| Diluted EPS | $0.79 | $0.89; down 11% |
| Return on average common equity | 6.8% | 7.9% |
| Net interest margin, fully taxable-equivalent | 1.15% | 1.06% |
The effective tax rate was 14.4%, versus 18.8% a year earlier. The filing attributes the lower rate primarily to alternative-energy investments, foreign tax credits, and the prior-year non-deductible legal accrual. Common dividends declared were $0.34 per share, versus $0.30.
Revenue drivers. Servicing fees fell 2% to $1.242 billion, mainly reflecting lower equity markets and currency translation, partly offset by new business. Management fees fell 10% to $270 million, reflecting lower markets and AUM and net outflows, partly offset by reduced money-market fee waivers. Foreign-exchange trading revenue declined 23% to $156 million, primarily on lower volumes and volatility. Securities-finance revenue rose 33% to $134 million, primarily from enhanced custody growth and higher agency lending.
Cash flow and balance sheet. Total assets were $243.69 billion, deposits $185.52 billion, total liabilities $222.16 billion, and shareholders’ equity $21.50 billion at March 31, 2016. Long-term debt was $10.32 billion, down from $11.50 billion at year-end. The cash-flow statement reports a $2.852 billion line labeled “net cash used in operating activities,” $8.027 billion provided by investing activities, and $8.351 billion used in financing activities; cash and due from banks increased by $2.528 billion to $3.735 billion. Because the extracted statement’s operating-cash-flow label and sign are not readily reconcilable, verify the original statement presentation.
High-quality liquid assets were $102.62 billion, down from $109.39 billion at year-end; the company reported an LCR above 100%. Parent-company net liquid assets were $4.51 billion, compared with $5.73 billion at year-end. State Street’s Basel III common-equity tier 1 ratio was 12.3% under the advanced approach and 12.5% under the standardized approach; reported tier 1 leverage was 6.9%. These ratios are subject to evolving regulatory calculations.
Material changes and notable items
- Average interest-earning assets were $194.08 billion, versus $226.36 billion a year earlier. Management said balance-sheet actions to reduce elevated client deposits and optimize capital and liquidity lowered net interest revenue; the stronger U.S. dollar and lower global rates were additional headwinds. Average client deposits fell to $170.56 billion from $193.13 billion.
- Q1 2016 included $97 million of restructuring charges, mainly employee-related, for State Street Beacon. Expenses also benefited from the absence of a $150 million legal accrual recorded in Q1 2015.
- Investment Servicing revenue declined 4%, but pretax income increased 13% to $505 million, supported by lower expenses. Investment Management revenue declined 8% to $288 million and pretax income fell 44% to $32 million.
- AUCA was $26.94 trillion, down from $28.49 trillion a year earlier. AUM was $2.296 trillion, down from $2.443 trillion; Q1 net AUM inflows were $13 billion, excluding $8 billion of awarded but not yet installed business.
- Investment securities totaled $102.64 billion at fair value, including $71.09 billion available-for-sale and $31.21 billion held-to-maturity. Management reported that 93% of the portfolio was rated AAA or AA and considered unrealized losses temporary; Q1 other-than-temporary impairment was less than $1 million.
Outlook, risks, contingencies, and subsequent events
- Transformation: Management expected at least $100 million of annualized pretax net run-rate savings in 2016 versus 2015 operating-basis expenses, with the full effect expected in 2017. It forecast total Beacon restructuring charges of approximately $300–$400 million through 2020.
- Acquisition: State Street agreed to buy GE Asset Management for $435 million, subject to adjustments, with up to $50 million more tied to incremental opportunities. It expected closing early in Q3 2016, subject to approvals and closing conditions, and estimated $70–$80 million of integration costs through 2018.
- Resolution plan: In April 2016, the Federal Reserve and FDIC found the company’s 2015 resolution plan not credible or insufficient to facilitate orderly resolution and required remediation by October 1, 2016. Failure to satisfy regulators could bring stricter capital, leverage, or liquidity requirements, or restrictions on growth and activities.
- Legal and billing matters: Aggregate legal and regulatory accruals were approximately $575 million, excluding a separate $240 million accrual for client invoice errors. The company said it would reimburse affected clients for incorrectly invoiced expenses plus interest and was reviewing other billing practices. It had accrued $565 million for indirect FX matters; outcomes, additional claims, and non-financial settlement terms remained uncertain. A Massachusetts administrative proceeding concerning invoicing was commenced in April 2016.
- Other regulatory exposure: A 2015 written agreement with banking regulators required improvements to Bank Secrecy Act, anti-money-laundering, and sanctions compliance. Separate U.S. investigations into U.K. transition-management conduct continued; two former employees were charged in April 2016. The filing said potential regulatory actions could include fines or other sanctions.
- Interest-rate, liquidity, and credit risks: Management expected elevated client deposits to persist versus longer-term historical levels and noted that low global rates, a stronger dollar, deposit behavior, and reinvestment yields could pressure net interest revenue. The company also highlighted potential withdrawals, commitment drawdowns, rating downgrades, and collateral calls under stress.
- Capital and portfolio matters: The estimated fully phased-in SLR was 6.0% for State Street and 6.2% for State Street Bank; these were preliminary estimates. Potential Volcker Rule treatment of approximately $2.10 billion of CLO investments could require divestiture, potentially at a discount. Indemnified client securities on loan were $337.94 billion; collateral and daily monitoring mitigate, but do not eliminate, exposure.
- Subsequent transactions: In April 2016, State Street sold the WM/Reuters branded FX benchmark business; it expected a $53 million pretax gain ($40 million after tax) in Q2. It also issued Series G preferred depositary shares, receiving approximately $494 million net proceeds.
Most important facts for investors to verify
- Reconcile the cash-flow statement’s reported operating-cash-flow label and amount against the filed financial statements.
- Track the October 1, 2016 resolution-plan remediation deadline and any regulatory consequences.
- Assess the ultimate cost and scope of indirect-FX claims, invoice reimbursements, related investigations, and other legal contingencies.
- Test whether Beacon delivers the targeted savings and whether restructuring charges remain within the $300–$400 million estimate.
- Monitor client deposits, interest rates, currency effects, net interest revenue, and installation of awarded AUCA and AUM mandates.
- Confirm GE Asset Management closing terms, timing, and integration costs, and verify recognition of the FX benchmark sale gain.
- Review capital and liquidity ratios as regulatory rules phase in, including the company’s progress toward fully phased-in leverage requirements.