DBRS Morningstar Upgrades State Street Corporation to AA; Trend Revised to Stable

DBRS, Inc. (DBRS Morningstar) upgraded most of the ratings of State Street Corporation (State Street or the Company), including the Company’s Long-Term Issuer Rating to AA from AA (low). At the same time, DBRS Morningstar upgraded the ratings of its primary banking subsidiary, State Street Bank and Trust Company (the Bank) to AA (high) from AA. The trend for all ratings is Stable. The Intrinsic Assessment (IA) for the Bank was raised to AA (high), while its Support Assessment remains SA1. The Company’s Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA.

KEY RATING CONSIDERATIONS
The upgrade reflects State Street’s very strong, low risk balance sheet that is supported by a globally diversified, resilient business model. Indeed, State Street’s DFAST / CCAR results were among the best in the peer group and the Company typically benefits from a deposit flight to quality, which augments an already very liquid balance sheet. While State Street’s 9M19 financial results underperformed our expectations, DBRS Morningstar believes the Company is taking the necessary steps in order to achieve their medium-term financial targets.

The ratings and Stable trend reflect State Street’s powerful franchise, with dominant or top-tier global positions in highly defensible businesses that generate a considerable amount of stable and recurring fee-based revenues, as well as its very strong balance sheet. Consistent with all trust banks, the ratings also consider the operational and reputational risks associated with the important role State Street plays in the global financial markets that are growing increasingly complex. Given the headwinds impacting State Street, including fee pressures within the Company’s businesses, expectations of a slower growing economy and a lower interest rate environment, State Street’s ongoing efficiency and simplification initiatives are an important lever in improving overall performance.

RATING DRIVERS
Given the recent ratings action and State Street’s very high rating level, upward ratings momentum is unlikely. Conversely, sustained negative operating leverage, missteps in managing operational and/or reputational risk that negatively impacts franchise strength, or the inability to consistently win new business could have negative ratings implications.

RATING RATIONALE
DBRS Morningstar considers State Street’s franchise as very strong. The Company is the second largest custodian in the world, servicing approximately 10% of the world’s financial assets. In addition, State Street is the market leader in providing middle office services, the number-one servicer of ETFs, the number-one FX liquidity provider to asset managers, as well as the third-largest asset manager globally and third-largest ETF provider globally. DBRS Morningstar views these businesses as defensible and sustainable, considering their significant barriers to entry and that many of the related activities are critical to the functioning of financial markets, regardless of the business cycle stage.

In 9M19, State Street generated a 9.5% return on equity, down from 13.8% in the prior year period, but this was largely a function of a more challenging operating environment, including fee pressure, lower interest rates, lower client activity and lower market volatility. Positively, the Company’s expense initiatives are on track to achieve an underlying cost reduction for the full year 2019 of 1.5%, despite ongoing significant technology infrastructure investments. Separately, assets under custody and/or administration (AUC/A) declined 3% from the prior year (to $32.9 trillion) due to a previously announced client transition, partially offset by higher end of period fixed income levels. Assets under management (AUM) increased 5% (to $3.0 trillion), benefiting from higher market values and net inflows.

DBRS Morningstar views State Street’s risk profile as very strong, considering that its balance sheet is generally less risky than most financial institutions, but recognizes the significant operational and reputational risks the Company faces given its important role in global financial markets. Credit risk remains very low, as the Company’s loan portfolio represents just 11% of total assets and is still the smallest of the trust banks. While State Street does have a riskier $4.3 billion leveraged loan portfolio, DBRS Morningstar views the risk as modest as this portfolio comprises only 1.7% of total assets.

DBRS Morningstar considers the Company’s funding profile to be very strong, as deposits generated by its asset servicing business provide a substantial and stable source of funds. Additionally, State Street has typically attracted significant client funds during times of stress, indicative of a “flight to quality”. The Company’s deposits at the end of 3Q19 were essentially flat versus the prior year, but reflected a continued mix shift from noninterest-bearing to interest-bearing balances. On the asset side, State Street had $160 billion of cash and securities, representing about two-thirds of total assets, with 90% of the securities portfolio rated at least AA at September 30, 2019. Capitalization remains very strong, particularly given State Street’s risk profile.

State Street Corporation, a diversified financial services corporation headquartered in Boston, Massachusetts, reported $245 billion in consolidated assets as of September 30, 2019.

The Grid Summary Grades for State Street are as follows: Franchise Strength – Very Strong; Earnings Power – Very Strong/Strong; Risk Profile – Very Strong/Strong; Funding & Liquidity – Very Strong; Capitalisation – Very Strong/Strong.

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

The applicable methodology is Global Methodology for Rating Banks and Banking Organisations (June 2019), which can be found on our website under Methodologies & Criteria.

The primary sources of information used for this rating include Company Documents and S&P Global Market Intelligence. DBRS Morningstar considers the information available to it for the purposes of providing this rating was of satisfactory quality.

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

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