DBRS: STT 3Q14 FX Charge Masks Core Positive Operating Leverage Resulting in Lower Net Income

Summary:
• Operating net income available to common shareholders was up 8% YoY to $581 million, reflecting continued growth in core servicing and management fees, improved market-driven revenues and higher net interest revenue.
• The Company recorded a $70 million pre-tax ($53 million after-tax) charge in hopes of resolving some, but not all, claims related to certain previously disclosed indirect FX matters.
• 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) 3Q14 results as solid with continued growth in core servicing and management fees, improved market-driven revenues and higher net interest revenue. However, the Company took a $70 million pre-tax charge related to some previously disclosed indirect foreign exchange (FX) issues, that appears to address only a portion of outstanding claims, which in DBRS’s view, likely means additional large charges remain before the issues are fully settled. The balance sheet remains strong, but continued growth pressured capital metrics.

New servicing mandates totaled $302 billion, the highest level seen in 2014, and the pipeline remains strong. With modest assets under custody growth during the quarter, DBRS notes that State Street is now the largest global custodian. On the asset management side, net new assets totaled $3 billion. Overall, assets under management declined by 2.4% during the quarter to $2.4 trillion.

Operating revenues were relatively stable even with seasonally stronger securities finance revenues in 2Q14. Indeed, net interest revenue, servicing fees, management fees and FX trading offset a 33% decline in securities finance revenue. DBRS notes that market-driven revenues performed well relative to the other trust banks. Meanwhile, operating expenses actually declined benefitting from a stronger dollar, as well as some delayed regulatory compliance spending that will be incurred during 4Q14. Following positive operating leverage in 3Q14, State Street’s YTD negative operating leverage narrowed to 30 basis points, and management remains highly focused on achieving its goal of generating positive operating leverage for FY14.

The Company estimated that its liquidity coverage ratio was already in excess of 80%, as State Street has been increasing its holdings of U.S. Treasuries and central bank deposits. State Street noted that it will continue to add to these assets, which will pressure the net interest margin and net interest revenue.

Balance sheet growth and a currency translation adjustment negatively impacted capital metrics, which remain strong. Specifically, the Company’s supplementary leverage ratio declined 40 bps sequentially to 5.7% at the holding company. Meanwhile, State Street estimated that its pro forma Tier 1 common ratio was approximately 10.9% under the Basel III standardized approach that goes into effect January 1, 2015.

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.