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 global market positions within custody and investment management, a diversified business model that generates significant recurring fee-based revenues that is supported by sound capital, and a lower risk, highly liquid balance sheet. The ratings also consider State Street’s modest underperformance compared to its trust bank peers, and such operational missteps over the past year that include the misbilling of clients, a large operational loss that was incurred in 4Q15, as well other fines and settlements.

State Street’s 2Q16 results were improved after a relative underperformance in FY15 and 1Q16, which was primarily driven by a shrinking balance sheet that reduced net interest income, as well as a custody asset mix more heavily weighted towards emerging market equities, an asset class that has experienced declining valuations. Specifically, on an operating basis, State Street reported 2Q16 of $582 million, an increase from both 2Q15 and 1Q16. Moreover, State Street was able to report positive operating leverage year-over-year (YoY), primarily reflecting lower expenses, as State Street Beacon, the Company’s transformation program, is already delivering better than expected results. Specifically, State Street now expects at least $140 million in estimated annual pre-tax savings in 2016, and at least $550 million in pre-tax savings by the end of 2020.

Over the past year, State Street has made some operational missteps, including a large securities processing error and incorrectly billing clients for expenses they were not responsible for over a period of 18 years. While these missteps could potentially hurt the Company’s reputation and ability to attract or retain clients, there has been no indication of any franchise impairment. Indeed, State Street’s 2Q16 new asset servicing commitments of approximately $750 billion were robust with uninstalled new business totaling over $1 trillion. Overall, assets under custody and administration (AUC/A) increased 3.1% sequentially to $27.8 trillion, the second largest globally.

During the second quarter, assets under management (AUM) were up modestly with market appreciation and the impact of foreign exchange more than offsetting $35 billion of net outflows related to official institutional clients withdrawing funds, primarily lower fee funds, in response to economic conditions. While fees remain under pressure, State Street continues to innovate, adding 15 new ETFs with an average expense ratio of 37 bps in 2Q16.

The securities portfolio continues to dominate the balance sheet, representing approximately 40% of total assets. The portfolio is primarily comprised of very high quality and liquid securities, of which 93% are rated at least AA. Moreover, the duration remains relatively short at 2.0 years. The loan portfolio remains the smallest of the trust banks, but has been growing and now represents approximately 8% of assets. The Company’s higher risk $3.5 billion leveraged loan portfolio primarily consists of BB and B credits, but the size remains very manageable in DBRS’s view.

State Street has done a good job managing down non-operational deposits, reducing risk-weighted assets, while building capital and bolstering its Supplementary Leverage Ratio (SLR), which remains a binding restraint. Specifically, State Street’s fully phased-in SLR improved 100 basis points over the past year to 6.1%. Nonetheless, the balance sheet remains highly liquid and State Street is already in compliance with the fully phased-in Liquidity Coverage Ratio (LCR).

Capital remains sound and was further augmented through retained earnings and further preferred issuance. On a fully-phased in basis, the Company’s CET1 ratio under the advanced approach was 11.6%. The Fed did not object to State Street’s 2016 capital plan, which calls for the repurchase of up to approximately $1.4 billion shares and a dividend increase of approximately 12%. DBRS notes that under the CCAR stress test, State Street’s minimum CET1 Ratio under the severely adverse scenario was 6.6%, which was at the median of all the 33 participants.

State Street Corporation, a diversified financial services corporation headquartered in Boston, Massachusetts, reported $255.4 billion in consolidated assets as of June 30, 2016.

RATING DRIVERS
DBRS views State Street as comfortably placed within its rating category. Given the already high rating level, there is limited upside in the rating. Conversely, sustained negative operating leverage, continued missteps in managing operational and/or reputational risk that negatively impact franchise strength, or the inability to consistently win new business could have negative rating implications.

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

The applicable methodologies are the Global Methodology for Rating Banks and Banking Organisations (July 2016), DBRS Criteria – Support Assessments for Banks and Banking Organisations (March 2016), and DBRS Criteria - Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2016), which can be found on our website under 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: William Schwartz
Initial Rating Date: 11 November 2005
Most Recent Rating Update: 21 July 2015

The rated entity or its related entities did participate in the rating process. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities.