State Street Corporation — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods unless stated otherwise. State Street provides investment servicing and investment management to institutional investors. At quarter-end it reported $32.90 trillion in assets under custody and/or administration (AUC/A), $2.95 trillion in assets under management (AUM), 39,407 employees, and operations in more than 100 markets.
Financial performance
| Metric | Q3 2019 | Change | Nine months 2019 | Change |
|---|---|---|---|---|
| Total revenue | $2.903 billion | (3%) | $8.708 billion | (4%) |
| Fee revenue | $2.259 billion | (3%) | $6.779 billion | (5%) |
| Net interest income (NII) | $644 million | (4%) | $1.930 billion | (2%) |
| Total expenses | $2.180 billion | +4% | $6.627 billion | +2% |
| Income before tax | $721 million | (19%) | $2.074 billion | (19%) |
| Net income | $583 million | (24%) | $1.678 billion | (22%) |
| Diluted EPS | $1.42 | (24%) | $4.03 | (25%) |
| Pre-tax margin | 24.8% | 29.9% prior year | 23.8% | 28.2% prior year |
Q3 return on average common equity was 9.7%, versus 14.0% a year earlier. The FTE net interest margin was 1.42%, versus 1.48%. Q3 dividends declared were $0.52 per common share, compared with $0.47.
Revenue, expenses and business trends
- Q3 servicing fees fell 5% to $1.272 billion, management fees fell 6% to $445 million, foreign exchange trading services fell 1% to $284 million, and securities finance fell 9% to $116 million. Management cited fee pressure, prior client outflows and product mix, lower market volatility, and balance-sheet optimization.
- Processing fees and other revenue rose 49% to $142 million, including $77 million from Charles River Development (CRD), acquired in October 2018. CRD contributed approximately $81 million of Q3 revenue and $56 million of expenses.
- NII was pressured by lower long-end rates, mortgage-backed securities premium amortization, and a shift away from non-interest-bearing deposits. Q3 net premium amortization was $116 million, up from $96 million a year earlier.
- Expenses reflected CRD, technology investment and notable items, partly offset by the savings program. Q3 included $27 million of acquisition costs and approximately $18 million of legal and related expenses. Information systems and communications expense rose 13% to $376 million.
- Servicing assets remaining to be installed totaled approximately $1.17 trillion at quarter-end, including $1.03 trillion of mandates announced in Q3; timing, approvals, client transitions and service mix affect when these assets generate revenue. AUC/A was down 3% year over year, partly due to a client transition of approximately $1 trillion in assets that was nearing completion. AUM was up 5%, supported by market levels and net inflows.
Cash flow, financial condition and capital
- Operating cash flow for the first nine months was $4.637 billion, versus $9.061 billion in 2018; investing cash flow was $2.897 billion versus $11.431 billion, and financing cash outflow was $7.148 billion versus $18.217 billion. Cash and due from banks ended at $3.598 billion, up from $3.212 billion at year-end 2018. The filing’s cash-flow detail includes significant movements in collateral, deposits and investment securities.
- Total assets were $244.61 billion, essentially unchanged from year-end 2018. Deposits were $170.89 billion, down from $180.36 billion; shareholders’ equity was $25.21 billion, up from $24.74 billion.
- Long-term debt was $11.46 billion and other short-term borrowings were $7.07 billion at quarter-end. State Street reported approximately $6 billion of FHLB borrowings, compared with $2 billion at December 31, 2018. Approximately $1.70 billion of Parent Company and bank senior notes or subordinated debentures mature within the next 12 months.
- The standardized CET1 ratio was 11.3%, down from 11.7% at December 31, 2018; the Tier 1 leverage ratio was 7.4%, up from 7.2%, and the supplementary leverage ratio was 6.6%, up from 6.3%. The company and bank exceeded applicable capital requirements.
- Average daily Parent Company liquidity coverage ratio (LCR) was 110% for Q3, with average high-quality liquid assets of $94.70 billion. The filing states the minimum LCR requirement is 100%.
- State Street repurchased $500 million of common stock in Q3 under a $2.0 billion program running through June 30, 2020, and declared $189 million in common dividends. It returned approximately $690 million to shareholders through Q3 dividends and repurchases.
Outlook, risks and unusual items
- Management reported $275 million of gross savings in the first nine months of 2019 and $100 million in Q3, and expected the expense program to deliver $400 million of gross savings in 2019. CRD integration costs were expected to total approximately $200 million through 2021; $81 million had been incurred since the acquisition as of September 30, 2019.
- The interest-rate baseline incorporated an expectation of three Federal Reserve rate cuts over the following 12 months. Management said NII sensitivity remained positioned to benefit from rising rates, while acknowledging that lower rates, deposit pricing, market movements and reinvestment conditions could affect NII and margin.
- On October 21, 2019, State Street Bank announced a tender offer for up to $800 million of floating-rate junior subordinated debentures due 2047 and plans to redeem $50.1 million of Series A debentures due 2028.
- Legal and regulatory matters include investigations and claims concerning historical client invoicing. The company reported approximately $7 million of accrued legal and regulatory loss contingencies and estimated reasonably possible losses of up to approximately $300 million in excess of accruals; some matters could not be reasonably estimated. It expected cumulative customer reimbursements for invoicing errors to be at least $380 million, paid or accrued. In 2019 it agreed to SEC and Massachusetts settlements involving penalties of $40 million and $5.5 million, respectively; potential DOJ or Department of Labor actions remained a risk.
- Other material risks include fee and client concentration pressure, interest-rate and market volatility, deposit and liquidity conditions, credit exposure, regulatory capital and liquidity requirements, operational and cyber risk, technology execution, litigation and reputational risk. Indemnified securities on loan totaled $386.98 billion, supported by $406.20 billion of collateral held as agent; these are large off-balance-sheet arrangements and expose State Street to counterparty and indemnification risks.
- The 10-Q reports effective disclosure controls and no material change in internal control over financial reporting during the quarter. The independent accountant’s interim review is not an audit opinion.
Important facts for investors to verify
- Whether fee pressure, client transitions and outflows continue to offset the benefit of higher AUM, new mandates and CRD revenue.
- Progress toward the $400 million 2019 savings target, and the realized economics and integration costs of CRD.
- Deposit trends, funding costs, NII and margin sensitivity as rates and client deposit mix change.
- Capital and liquidity buffers, upcoming debt maturities, and the effect of repurchases and dividends on capital.
- Developments in invoicing-related investigations, any further remediation or penalties, and other legal matters whose potential losses are not currently estimable.
- Credit quality and valuation of investment securities and loans, alongside the scale and collateral coverage of securities-lending and other contingent exposures.