DBRS Comments on State Street Corporation’s 3Q13 Earnings - Sr. at AA (low)

DBRS, Inc. (DBRS) has today commented on the 3Q13 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 $531 million for the third quarter, down from both $571 million in 2Q13 and $654 million a year ago. On an operating basis, State Street reported net income available to common shareholders of $537 million for the quarter, down from $571 million in 2Q13, but up from $473 million in 3Q12.

The Company reported $200 billion in new servicing mandates in its custody business, but experienced approximately $15 billion of net outflows within its asset management business primarily within institutional passive funds and securities finance pools. Positively, State Street noted that the business pipeline remains strong and is well-diversified. Moreover, since the end of the quarter, the Company has already won a major commitment from a new client to service approximately $137 billion of assets. Overall, total assets under custody grew 1.7% during the quarter to $19.2 trillion, while assets under management increased by 4.4% to $2.2 trillion. While both percentage increases trailed State Street’s primary trust bank competitors, the Company’s pre-tax profit margin remains the highest at 31.7% on an operating basis.

On an operating basis, total revenues declined 4.3% to $2.47 billion sequentially. Specifically, net interest revenue excluding discount accretion was $553 million, which declined 5% million during the quarter reflecting further compression in the net interest margin of four bps to 1.27% and a $5 billion decline in average earning assets. Meanwhile, total fee revenues decreased 4.2% to $1.92 billion driven by declines in most line items with the exception of modest growth in servicing fees. Market-driven revenues remained weak in the quarter. Indeed, foreign exchange trading was down 14% to $147 million reflecting lower volatility and volumes. Securities finance revenues declined 43.5% to $74 million following the seasonally stronger 2Q13, as well as lower volumes and spreads. Compared to 3Q12, which eliminates seasonality, securities finance revenues were still down 18.7% on lower spreads highlighting the difficulty of the low interest rate environment exacerbated by the FOMC’s restraint from tapering.

Operating expenses were well managed declining 3.8% to $1.69 billion. While most items were relatively stable to modestly down, the big improvement came in other expenses; which declined by $50 million, or 16.6%, to $251 million. During the quarter, the Company benefitted from a $19 million gain from the sale of a Lehman Brothers-related asset, lower litigation costs including a Lehman Brothers-related recovery of $11 million, and lower professional services fees and sales promotion costs. State Street’s Business Operations and Information Technology Transformation program remains on track to achieve total incremental estimated pre-tax expense savings in 2013 of approximately $220 million.

At $117 billion, the Company’s investment portfolio is comprised of high quality securities with 88% of the portfolio rated AA (low) or higher. The duration was a relatively conservative 1.9 years and was in an unrealized after-tax mark-to-market loss position of $79 million. State Street noted that under a hypothetical 100 bp interest rate shock increase, the loss would be approximately $1.3 billion. 3Q13 results included $10 million of other-than-temporary impairment charges.

During the quarter, State Street began investing in senior secured bank loans targeting BB and B-rated issuers to achieve higher risk-adjusted returns, which are all subject to internal underwriting standards. While current exposures total less than $1 billion and the overall portfolio is expected to remain small, these leveraged loans are riskier assets than what the Company has historically put on its balance sheet.

State Street estimated its pro forma Basel III tier 1 common ratio to be 10.2% under the standardized approach and 11.3% under the advanced approach. During the quarter, the Company repurchased approximately $560 million of common stock leaving approximately $1 billion remaining to be repurchased under its capital program ending March 31, 2014. Despite the repurchase, State Street’s tangible common equity ratio remained very sound at 6.8%. Lastly, the Company estimated its pro forma supplementary leverage ratio at 5.4% for the holding company and 5.0% for the Bank.

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

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