DBRS Confirms State Street Corporation’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), and its related bank subsidiary, including its Issuer & Senior Debt rating of AA (low). The trend for all ratings is Stable. The rating action follows a detailed review of the Company’s operating results, financial fundamentals, and future prospects.

State Street’s ratings reflect its leading market positions and deep global product set, providing financial services primarily to institutional investors that help generate a high component of predictable and recurring fee revenue. The Company’s ratings remain supported by a strong, low risk, and highly liquid balance sheet. The ratings also consider the low interest rate environment that is pressuring revenues and the evolving regulatory and compliance burdens facing the trust banks that are elevating expenses, both of which constrain profitability. Given the increasing complexity in servicing and managing assets globally, managing operational and reputational risks also remain extremely important for the rating.

The Stable trend reflects DBRS’s view that State Street is comfortably placed within its rating category. Given the already high rating level, there is limited upside in the rating. Nonetheless, generating sustained positive operating leverage and improving profitability, while maintaining a sound risk profile, and strong balance sheet could have positive rating implications. Conversely, sustained negative operating leverage or unexpected capital erosion could carry negative rating implications.

While the low interest rate environment, heightened regulatory and compliance costs, and lower volatility remain headwinds, buoyant equity markets, net new business wins, and continued success in generating efficiencies through the Company’s Business Operations and Information Technology Transformation program have led to improving results the past several years. Indeed, State Street’s pre-tax profit margin (operating basis) was the highest among the trust banks in 2013 at 30.1% and the Company was able to generate positive operating leverage of 171 basis points.

Most recently, State Street’s 1Q14 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 a higher rate resulting in negative operating leverage both quarter-over-quarter and year-over-year. As a result of tepid revenue growth and higher expenses, State Street announced a headcount reduction to better align expenses with revenues. DBRS notes that this was the second headcount reduction outside of its efficiency program, which shows the Company remains focused on achieving positive operating leverage for FY14 and is not hesitant to make difficult decisions.

During 1Q14, 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. These assets help generate relatively consistent fee revenues including servicing fees, management fees, and more volatile performance fees. For 1Q14, fee revenues comprised a high 78% of total revenues.

At March 31, 2014, the $117 billion investment portfolio is comprised of mostly high quality securities with approximately 89% of the securities rated AA (low) or higher (70% AAA and 19% AA). Approximately 55% of these securities were floating rate in nature and the overall portfolio had a duration of 1.9 years. Meanwhile, loans have increased, but still only comprised approximately 6% of total assets. DBRS notes that State Street began building a more risky leveraged loan portfolio in 2013, but this portfolio totalled just $1.3 billion at quarter-end and is not expected to become material in size.

Capital remains strong and DBRS continues to view State Street as well positioned to meet evolving regulatory demands. Indeed, State Street’s Basel III ratios and supplementary leverage ratios both improved significantly during the first quarter, but a portion of the increase was related to short-lived benefits from the current treatment of intangibles. Specifically, the Company’s estimated pro-forma Tier 1 Common ratio under the standardized approach was 11.1%. Meanwhile, State Street’s estimated supplementary leverage ratio was 6.4% at the Company and 6.0% at the Bank. 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 through 1Q15 and recently raised the dividend to $0.30 cents per share from $0.26 cents per share.

State Street Corporation, a diversified financial services corporation headquartered in Boston, Massachusetts, reported $256.7 billion in consolidated assets as of March 31, 2014.

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 (June 2014). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (January 2014) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (December 2013). These can be found at: http://www.dbrs.com/about/methodologies.

The primary sources of information used for this rating include company documents 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
Rating Committee Chair: Roger Lister
Initial Rating Date: 11 November 2005
Most Recent Rating Update: 13 May 2013

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