DBRS Comments on State Street Corporation’s 2Q13 Earnings - Sr. at AA (low)

DBRS, Inc. (DBRS) has today commented on the 2Q13 earnings of State Street Corporation (State Street or the Company). DBRS rates the Company’s Issuer & Senior Debt at AA (low) with a Stable trend.

State Street reported net income available to common shareholders of $571 million for the second quarter, up from $455 million in 1Q13, and from $480 million a year ago. On an operating basis, State Street reported net income available to common shareholders of $571 million for the quarter, up from $443 million in 1Q13, and from $494 million in 2Q12.

Highlights of the quarter include generating positive operating leverage, as well as solid net new business. Revenue growth reflected new business, improved equity markets, and higher market-driven revenues that benefitted from seasonality (securities lending) and higher volatility (foreign exchange trading). During the quarter, State Street had $201 billion of new business on the servicing side of the business, and had net inflows of $11 billion (excluding the $12 billion of SPDR Gold ETF outflows) on the investment management side. Included in the servicing wins were 30 new alternative asset servicing mandates, a faster growing segment in the industry where State Street is the industry leader.

Overall, total assets under custody (AUC) grew 1.6% during the quarter to $18.9 trillion, while assets under management (AUM) declined by 1.4% to $2.1 trillion. DBRS notes that the modest AUC increase was the highest among the three primary trust banks, while the AUM decline was the largest. Management noted that the new business pipeline remains strong and is nicely diversified.

State Street announced the hiring of a new CFO, Mike Bell, who will replace a retiring Ed Resch. Prior to joining State Street, Mike Bell was the CFO at both Manulife and Cigna.

Operating revenue was $2.58 billion, a $110 million increase from 1Q13. Specifically, net interest revenue excluding discount accretion was $582 million, up $5 million sequentially. State Street’s net interest margin remained stable at 1.31% in 2Q13. Meanwhile, with the exception of brokerage and other fees, which were impacted by the outflow in the Gold ETF, noninterest revenue growth was broad-based. Importantly, foreign exchange revenue increased 17.1% to $171 million reflecting higher volatility and increased volumes. Meanwhile, securities finance revenue increased 67.9% to $131 million benefitting from seasonality, but was down 8.4% from 2Q12 on lower volumes.

Coming off of seasonally higher expenses related to equity incentive compensation expense for retirement-eligible employees and payroll taxes incurred in 1Q13, operating expenses declined 3.3% to $1.75 billion. Even excluding the impact of these items for 1Q13, the Company would still have reported positive operating leverage of 97 basis points sequentially.

The Company’s Business Operations and Information Technology Transformation program remains on track to achieve incremental estimated pre-tax expense savings of approximately $220 million in 2013.

State Street’s $116 billion investment portfolio was negatively impacted by rising rates with the portfolio now in an unrealized after-tax loss position of $123 million. Nonetheless, the portfolio remains comprised of high quality securities with approximately 88% of the portfolio rated at least AA (low) or higher. Moreover, the duration is short at 1.9 years, but remains higher than the Company’s 1.5 target portfolio duration.

The Company’s estimated pro forma Basel III tier 1 common ratio was 10.0% under the standardized approach and 10.9% under the advanced approach. State Street noted that it expects to manage its capital to the lower of the two ratios. Under the proposed supplementary leverage rules, State Street estimated that its supplementary leverage ratio at the holding company was 5.4% and 4.9% at the Bank. While already compliant at the holding company, the Bank is currently below the 6% requirement. Positively, State Street does not expect the new leverage ratio to negatively impact its business, nor does it expect any problems in complying with the proposal phasing in to be fully effective on January 1, 2018. During the quarter, State Street repurchased $560 million of common stock during the quarter and returning capital to shareholders remains a priority.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]