DBRS Comments on State Street’s 2Q11 Earnings; Sr. at AA (low) Unchanged; Trend Stable

DBRS Inc. (DBRS) has today commented that the ratings for State Street Corporation (State Street or the Company), including its Issuer & Senior Debt Rating of AA (low), remain unchanged, following the release of its 2Q11 financial results. The trend on its ratings remains at Stable. On an operating basis, State Street reported net income available to common shareholders of $483 million for the quarter, up 10% from 1Q11 and up 5% from the year ago quarter.

DBRS sees State Street’s second quarter results as reflective of good momentum in its core businesses in what remains a challenging operating environment. The Company reported new business wins of around $280 billion that highlighted the diversity of the franchise, in terms of both product and geography. In addition, the new business pipeline remains strong, and DBRS sees the Company as well-positioned to meet the ongoing demand and competition for ETFs as well as increasing demand for alternative asset servicing and outsourcing of investment management operations.

In the quarter, total revenues, on an operating basis, increased $143 million, or 6% from 1Q11 to $2.5 billion. Fee revenues were $1.9 billion, up 5.6% q-o-q and represented 76.5% of total 2Q11 revenues. Asset Servicing fees benefited from new business and slightly higher average equity valuations, increasing 2.6% from 1Q11 to $1.1 billion. AUC/A grew a modest 0.7% sequentially to $22.8 trillion. Investment Management revenue increased 5.9% from 1Q11 to $250 million due to acquisitions, new business and slightly higher markets. SSgA reported net outflows of $27 billion in the quarter, though DBRS notes that the outflows were driven by the U.S. Treasury (UST), a customer, redeeming investments. Excluding UST, net inflows would have been $10 billion in 2Q11, and AUM declined just 0.2% to $2.1 trillion. Meanwhile, Trading Services revenue increased 3.0% sequentially to $311 million, driven by higher foreign exchange revenues. Reflecting typical second quarter seasonality, Securities Finance revenues more than doubled from 1Q11 to $137 million.

Net interest revenue (on an FTE basis and excluding discount accretion) was $554 million in 2Q11, up $8 million from 1Q11. The modest improvement was driven by higher levels of earning assets and benefited from the ECB rate increase early in the quarter. NIM, excluding discount accretion, was 1.61%, down 5 bps from the prior quarter. Client deposits continued to grow in the quarter in part reflecting the considerable uncertainty surrounding sovereign risk as well as State Street’s status as a safe haven for clients globally. Average deposit balances (including non-interest bearing balances) increased 2.3% from 1Q11 to $103 billion.

Operating-basis expenses increased 4.4% from 1Q11 to $1.8 billion for 2Q11, resulting in modest positive operating leverage in the quarter. Higher volumes, annual merit increases and higher regulatory costs drove the linked quarter increase. State Street noted that its IT transformation program remains on track to deliver further savings in 2H11, offsetting some of the charges taken previously and resulting in modest cost savings for 2011.

State Street’s investment securities portfolio grew about $2.5 billion from the prior quarter end to $106.4 billion. The portfolio remains sound, in DBRS’s view, with 90% of the securities in the portfolio rated AA-rated or above at June 30, 2011, the same as last quarter. In addition, the Company reported further improvement in the net unrealized after-tax loss position on the portfolio in the quarter. At quarter-end the unrealized loss was $94 million, down from $352 million last quarter and $994 million a year earlier.

Capital levels remains solid and DBRS sees State Street as well-positioned to meet Basel III capital requirements. Though down from 1Q11 levels due primarily to growth in risk-weighted assets, the Company reported still quite strong capital ratios including an estimated Basel I Tier 1 Common ratio of 16.8% at quarter end. Under Basel III, State Street estimates its Tier 1 Common ratio would have been 11.8% at June 30, 2011.

Note:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, Rating Bank Subordinated Debt and Hybrid Instruments with Discretionary Payments, and Rating Bank Preferred Shares and Equivalent Hybrids, all of which can be found on the DBRS website under Methodologies.

The sources of information used for this rating include the company documents, the Federal Deposit Insurance Corporation and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: William Schwartz
Approver: Roger Lister
Initial Rating Date: 11 November 2005
Most Recent Rating Update: 11 March 2011

For additional information on this rating, please refer to the linking document below.