DBRS Confirms State Street’s Senior Debt at AA (low); Trend Stable

DBRS, Inc. (DBRS) has today confirmed all ratings of State Street Corporation (State Street or the Company), including its Issuer & Senior Debt rating of AA (low) and the Deposits & Senior Debt rating of State Street Bank and Trust Company of AA. The trend for all ratings is Stable. The ratings action follows a detailed review of the Company’s operating results, financial fundamentals, and future prospects.

State Street’s ratings and Stable trend reflect its leading market positions and deep global product set providing financial services to institutional investors. Both of the Company’s lines of business, Investment Servicing and Investment Management, generated solid net new business in 2012, as well as in 1Q13, and remain well positioned for future growth. Moreover, a robust balance sheet that is underpinned by strong capital and ample liquidity helps support the rating. The ratings also consider the low interest rate environment and global economic uncertainty that have pressured profitability through client de-risking, net interest margin (NIM) pressure, and lower market driven revenues. Given the increasing complexity in servicing and managing assets globally, managing operational and reputational risks remain extremely important. Attesting to its asset gathering ability and recovering markets, assets under custody (AUC) increased 17.2% to $18.6 trillion over the past twelve months, while assets under management (AUM) increased 9.9% to $2.2 trillion.

In order create efficiencies, improve risk controls, speed the creation of new products and services, and improve the overall client experience, State Street launched its Business Operations and Information Technology Transformation program in 2010, which was launched prior to similar programs at the other two trust banks. Specifically, the program has targeted achieving a pre-tax benefit of between $575 million and $625 million by the end of 2014, and the Company is currently ahead of schedule. All else being equal, State Street’s operating pre-tax profit margin should improve by 400 basis points (bps) to 31.5%. Despite the challenging revenue environment, DBRS notes that
State Street was already at 29.1% for 2012.

After a difficult several years, the Company was able to generate positive operating leverage, albeit a very modest three bps, in 2012. Most recently in 1Q13, higher equity markets, stronger foreign exchange trading, and solid expense control (excluding seasonality related to equity incentive compensation for retirement-eligible employees and payroll taxes of $118 million) resulted in positive operating leverage of 145 bps sequentially. Moreover, management has publicly stated its intent to deliver positive operating leverage for 2013. DBRS notes that on a pre-tax margin basis, State Street has outperformed the other two trust banks in FY12 and 1Q13. On an operating basis, State Street reported net income available to common shareholders of $443 million for 1Q13, down from $521 million in 4Q12, but up from $410 million in 1Q12.

Fee revenues, which represented a high 76% of total revenues in 1Q13, increased both sequentially and year-over-year. However, market driven revenues remain pressured. Specifically, in 2012, securities finance revenues grew 7% to $405 million, which was more than offset by a 25% decline in foreign exchange revenue to $511 million reflecting lower volatility and the continued migration of clients away from indirect foreign exchange trading to lower spread execution methods. Positively, 1Q13 foreign-exchange trading revenue increased 24% to $146 million sequentially reflecting higher volumes and volatility. Meanwhile, securities finance revenue increased over 5% to $78 million driven by slightly higher volumes. The Company expects these market driven revenues to remain constrained in 2013.

The low interest rate environment remains a headwind, especially for net interest revenue. Indeed, 1Q13 net interest revenues decreased by 3.8% to $577 million sequentially, as average earning asset growth was more than offset by NIM compression of five bps to 1.31% and two fewer days in the quarter. The Company has guided towards a NIM of between 1.30% and 1.40% for 2013.

At present, DBRS believes the current litigation and reputational risks associated with foreign exchange trading, as well as other pending litigation, have had very little impact on State Street’s overall franchise strength. Moreover, the potential financial impact of the various cases appears to be manageable, especially considering the Company’s strong earnings power and capital base.

At March 31, 2013, the $116.4 billion investment portfolio’s unrealized after-tax mark-to-market gain was $817 million. Approximately 88% of the portfolio is rated AA or higher and the duration was a relatively conservative 1.7 years, although this is above the 1.5 years normally targeted by State Street.

Following the Federal Reserve’s non-objection to State Street’s capital plan, the Company announced a $2.1 billion share repurchase plan and a $0.02 increase in its dividend to $0.26 per share. DBRS notes that among CCAR participants, State Street’s capital plan returns the most capital to shareholders, yet capital remains strong. Indeed, the Company estimated its pro forma Basel III tier 1 common ratio under the most recent NPRs was 10.6% at March 31, 2013. State Street has been designated a systemically important financial institution (SIFI), and as such, currently plans to target a 10% tier 1 common ratio under Basel III (as they currently understand the rules).

State Street Corporation, a diversified financial services corporation headquartered in Boston, Massachusetts, reported $218.2 billion in consolidated assets as of March 31, 2013.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other applicable methodologies include the DBRS Criteria: Intrinsic and Support Assessments, DBRS Criteria: Bank and Bank Holding Company Trust Preferred Securities, DBRS Criteria: Rating Bank Subordinated Debt & Hybrid Instruments with Discretionary Payments, and DBRS Criteria: Rating Bank Preferred Shares & Equivalent Hybrids. These can be found can be found at: http://www.dbrs.com/about/methodologies

[Amended on June 17, 2014, to reflect actual methodologies used.]

The sources of information used for this rating include the company documents, the Federal Reserve, 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Driscoll
Approver: Alan G. Reid
Initial Rating Date: 11 November 2005
Most Recent Rating Update: 20 December 2011

For additional information on this rating, please refer to the linking document under Related Research.