DBRS: State Street Reports Negative 1Q14 Operating Leverage Both QoQ & YoY on Higher Expenses

Summary:
• Net income available to common shareholders was down 22% YoY to $356 million, driven by higher expenses, including a $72 million pre-tax severance charge.
• Despite improved operating revenues, operating expenses increased at higher rate resulting in negative operating leverage both QoQ and YoY.
• DBRS rates State Street Corporation Issuer & Senior Debt at AA (low) with a Stable trend.

DBRS, Inc. (DBRS) views State Street Corporation’s (State Street or the Company) 4Q13 results as weaker than expected given the decline in operating income before provisions and taxes both quarter-over-quarter (QoQ) and year-over-year (YoY). As a result of tepid revenue growth and higher expenses, the Company announced a headcount reduction to better align expenses with revenues. Management emphasized that they remain focused on achieving positive operating leverage for FY14 and will look harder at expenses if the revenue environment remains challenging. Despite the negative operating leverage, the rating remains supported by a strong, highly liquid balance sheet.

For the quarter, operating revenues increased by 1.2% QoQ and 3.6% YoY with fee income growth offsetting declines in net interest revenue (NIR). DBRS notes that excluding the $19 million benefit from a previously impaired municipal security in 4Q13, NIR would have increased sequentially reflecting higher average earning assets and a relatively stable net interest margin. Meanwhile, fee income improved including higher sequential securities lending and foreign exchange trading revenues. Overall, the Company’s diversified fee-based business model accounted for 77% of total operating revenues.

While first quarter expenses typically spike from seasonal deferred incentive compensation expense for retirement-eligible employees and payroll taxes, operating expenses were 5.8% higher compared to 1Q13. The higher YoY expenses were primarily driven by higher incentive compensation, increased costs associated with installing new business, additional regulatory and compliance burdens, and continued investments in the businesses. The aforementioned headcount reduction is expected to save $22 million in FY14 and approximately $40 million annually thereafter.

During the quarter, the Company won new asset servicing mandates of $189 billion, while attracting $4 billion of net new assets under management (AUM). Overall, State Street’s assets under custody (AUC) reached a record $21.0 trillion, while AUM was also a record at $2.4 trillion.

The Company’s ratings remain supported by a strong, low risk balance sheet that is highly liquid. State Street’s Basel III ratios and supplementary leverage ratios both improved significantly during the quarter, but a portion of the increase was related to short-lived benefits from the way intangibles are currently being treated. Nonetheless, capital remains strong and DBRS continues to view State Street as well positioned to meet evolving regulatory demands. Following the Federal Reserve’s non-objection to its 2014 Capital Plan, State Street expects to repurchase up to $1.7 billion of common stock and is expected to raise the dividend to $0.30 cents per share from $0.26 cents per share, subject to Board approval.

DBRS rates State Street Corporation Issuer & Senior Debt at AA (low) with a Stable trend.

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