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STT > SEC Filings for STT > Form 10-Q on 2-Nov-2012All Recent SEC Filings

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Form 10-Q for STATE STREET CORP


2-Nov-2012

Quarterly Report


MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

GENERAL
State Street Corporation, the parent company, is a financial holding company headquartered in Boston, Massachusetts. Unless otherwise indicated or unless the context requires otherwise, all references in this Management's Discussion and Analysis to "State Street," "we," "us," "our" or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. Our principal banking subsidiary is State Street Bank and Trust Company, or State Street Bank. At September 30, 2012, we had total assets of $204.52 billion, total deposits of $146.29 billion, total shareholders' equity of $20.75 billion and 29,650 employees. With $23.44 trillion of assets under custody and administration and $2.07 trillion of assets under management at September 30, 2012, we are a leading specialist in meeting the needs of institutional investors worldwide. We have two lines of business:
Investment Servicing provides services for mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations and endowments worldwide. Products include custody, product- and participant-level accounting, daily pricing and administration; master trust and master custody; record-keeping; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and alternative investment manager operations outsourcing; and performance, risk and compliance analytics to support institutional investors.
Investment Management, through State Street Global Advisors, or SSgA, provides a broad range of investment management strategies, specialized investment management advisory services and other financial services, such as securities finance, for corporations, public funds, and other sophisticated investors. Management strategies offered by SSgA include passive and active, such as enhanced indexing and hedge fund strategies, using quantitative and fundamental methods for both U.S. and non-U.S. equity and fixed-income securities. SSgA also offers exchange-traded funds.
For financial and other information about our lines of business, refer to "Line of Business Information" in this Management's Discussion and Analysis and note 14 to the consolidated financial statements included in this Form 10-Q. This Management's Discussion and Analysis is part of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, and updates the Management's Discussion and Analysis in our Annual Report on Form 10-K for the year ended December 31, 2011, referred to as our 2011 Form 10-K, and in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2012 and June 30, 2012, all of which we previously filed with the SEC. You should read the financial information contained in this Management's Discussion and Analysis and elsewhere in this Form 10-Q in conjunction with the financial and other information contained in those reports. Certain previously reported amounts presented in this Form 10-Q have been reclassified to conform to current period classifications.
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the U.S., referred to as GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in its application of certain accounting policies that materially affect the reported amounts of assets, liabilities, equity, revenue and expenses. The significant accounting policies that require us to make estimates and assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods are accounting for fair value measurements; interest revenue recognition and other-than-temporary impairment; and impairment of goodwill and other intangible assets. These significant accounting policies require the most subjective or complex judgments, and underlying estimates and assumptions could be subject to revision as new information becomes available. An understanding of the judgments, estimates and assumptions underlying these significant accounting policies is essential in order to understand our reported consolidated results of operations and financial condition.
Additional information about these significant accounting policies is included under "Significant Accounting Estimates" in Management's Discussion and Analysis in our 2011 Form 10-K. We did not change these significant accounting policies during the first nine months of 2012.
Certain financial information presented in this Management's Discussion and Analysis is prepared on both a GAAP, or reported basis and a non-GAAP, or operating basis. We measure and compare certain financial information on an operating basis, as we believe that this presentation supports meaningful comparisons from period to period and the analysis of comparable financial trends with respect to State Street's normal ongoing business operations. We believe that operating-basis financial information, which reports revenue from non-taxable sources on a fully taxable-equivalent basis and excludes the impact of revenue and expenses outside of the normal course of our business, facilitates an investor's understanding and analysis of State Street's underlying financial performance and trends in addition to financial information prepared and reported in conformity with GAAP. Operating-basis financial information should be considered in addition to, not as a substitute for or superior to, financial information prepared in conformity with GAAP. Any non-GAAP, or operating-basis, financial information presented in this Management's Discussion and Analysis is reconciled to its nearest GAAP-basis measure.


Table of Contents
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

FORWARD-LOOKING STATEMENTS
This Form 10-Q, as well as other reports filed by us under the Securities Exchange Act of 1934, registration statements filed by us under the Securities Act of 1933, our annual report to shareholders and other public statements we may make, contain statements (including statements in this Management's Discussion and Analysis) that are considered "forward-looking statements" within the meaning of U.S. securities laws, including statements about industry, regulatory, economic and market trends, management's expectations about our financial performance, market growth, capital, acquisitions and divestitures, new technologies, services and opportunities and earnings, management's confidence in our strategies and other matters that do not relate strictly to historical facts. Terminology such as "expect," "look," "believe," "anticipate," "intend," "plan," "estimate," "forecast," "seek," "may," "will," "trend," "target" and "goal," or similar statements or variations of such terms, are intended to identify forward-looking statements, although not all forward-looking statements contain such terms.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management's expectations and assumptions at the time the statements are made, and are not guarantees of future results. Management's expectations and assumptions, and the continued validity of the forward-looking statements, are subject to change due to a broad range of factors affecting the national and global economies, the equity, debt, currency and other financial markets, as well as factors specific to State Street and its subsidiaries, including State Street Bank. Factors that could cause changes in the expectations or assumptions on which forward-looking statements are based cannot be foreseen with certainty and may include, but are not limited to:

• the financial strength and continuing viability of the counterparties with which we or our clients do business and to which we have investment, credit or financial exposure, including, for example, the direct and indirect effects on counterparties to the current sovereign debt risks in Europe and other regions;

• financial market disruptions or economic recession, whether in the U.S., Europe or other regions internationally;

• increases in the volatility of, or declines in the level of, our net interest revenue, changes in the composition of the assets recorded in our consolidated statement of condition and the possibility that we may be required to change the manner in which we fund those assets;

• the liquidity of the U.S. and international securities markets, particularly the markets for fixed-income securities and inter-bank credits, and the liquidity requirements of our clients;

• the level and volatility of interest rates and the performance and volatility of securities, credit, currency and other markets in the U.S. and internationally;

• the credit quality, credit agency ratings, and fair values of the securities in our investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the respective securities and the recognition of an impairment loss in our consolidated statement of income;

• our ability to attract deposits and other low-cost, short-term funding, and our ability to deploy deposits in a profitable manner consistent with our liquidity requirements and risk profile;

• the manner in which the Federal Reserve and other regulators implement the Dodd-Frank Act, Basel III, European legislation with respect to banking and financial activities and other regulatory initiatives in the U.S. and internationally, including regulatory developments that result in changes to our structure or operating model, increased costs or other changes to the provision of our services;

• adverse changes in required regulatory capital ratios, whether arising under the Dodd-Frank Act, Basel II or Basel III, or due to changes in regulatory positions or regulations in jurisdictions in which we engage in banking activities;

• increasing requirements to obtain necessary approvals of the Federal Reserve and our other regulators for the use, allocation or distribution of our capital or for other specific capital actions or programs, including acquisitions, dividends and equity repurchases, without which our growth plans, distributions to shareholders, equity purchase programs or other capital initiatives may be restricted;

• changes in law or regulation that may adversely affect our, our clients' or our counterparties' business activities and the products or services that we sell, including additional or increased taxes or assessments thereon, capital adequacy requirements and changes that expose us to risks related to compliance;

• the maintenance of credit agency ratings for our debt and depository obligations as well as the level of credibility of credit agency ratings;


Table of Contents
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

• delays or difficulties in the execution of our previously announced Business Operations and Information Technology Transformation program, which could lead to changes in our estimates of the charges, expenses or savings associated with the planned program, resulting in increased volatility of our earnings;

• the results of, and costs associated with, government investigations, litigation, and similar claims, disputes, or proceedings;

• the possibility that our clients will incur substantial losses in investment pools for which we act as agent, and the possibility of significant reductions in the valuation of assets;

• adverse publicity or other reputational harm;

• dependencies on information technology, complexities and costs of protecting the security of our systems and difficulties with protecting our intellectual property rights;

• our ability to grow revenue, attract and/or retain and compensate highly skilled people, control expenses and attract the capital necessary to achieve our business goals and comply with regulatory requirements;

• potential changes to the competitive environment, including changes due to regulatory and technological changes, the effects of consolidation, and perceptions of State Street as a suitable service provider or counterparty;

• potential changes in how clients compensate us for our services, and the mix of services that clients choose from us;

• the risks that acquired businesses and joint ventures will not achieve their anticipated financial and operational benefits or will not be integrated successfully, or that the integration will take longer than anticipated, that expected synergies will not be achieved or unexpected disynergies will be experienced, that client and deposit retention goals will not be met, that other regulatory or operational challenges will be experienced and that disruptions from the transaction will harm relationships with clients, employees or regulators;

• the ability to complete acquisitions, divestitures and joint ventures, including the ability to obtain regulatory approvals, the ability to arrange financing as required and the ability to satisfy closing conditions;

• our ability to recognize emerging needs of clients and to develop products that are responsive to such trends and profitable to the company; the performance of and demand for the products and services we offer, including the level and timing of redemptions and withdrawals from our collateral pools and other collective investment products; and the potential for new products and services to impose additional costs on us and expose us to increased operational risk;

• our ability to measure the fair value of the investment securities recorded in our consolidated statement of condition;

• our ability to control operating risks, data security breach risks, information technology systems risks and outsourcing risks, and our ability to protect our intellectual property rights, the possibility of errors in the quantitative models we use to manage our business and the possibility that our controls will prove insufficient, fail or be circumvented;

• changes in accounting standards and practices; and

• changes in tax legislation and in the interpretation of existing tax laws by U.S. and non-U.S. tax authorities that affect the amount of taxes due.

Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed in this section and elsewhere in this Form 10-Q or disclosed in our other SEC filings, including the risk factors discussed in our 2011 Form 10-K. Forward-looking statements should not be relied upon as representing our expectations or beliefs as of any date subsequent to the time this Form 10-Q is filed with the SEC. We undertake no obligation to revise our forward-looking statements after the time they are made. The factors discussed above are not intended to be a complete summary of all risks and uncertainties that may affect our businesses. We cannot anticipate all developments that may adversely affect our consolidated results of operations and financial condition.
Forward-looking statements should not be viewed as predictions, and should not be the primary basis upon which investors evaluate State Street. Any investor in State Street should consider all risks and uncertainties disclosed in our SEC filings, including our filings under the Securities Exchange Act of 1934, in particular our reports on Forms 10-K, 10-Q and 8-K, or registration statements filed under the Securities Act of 1933, all of which are accessible on the SEC's website at www.sec.gov or on our website at www.statestreet.com.


Table of Contents
          MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
                     AND RESULTS OF OPERATIONS (Continued)

OVERVIEW OF FINANCIAL RESULTS

                                      Quarters Ended September 30,                  Nine Months Ended September 30,
(Dollars in millions, except
per share amounts)                2012             2011         % Change          2012              2011         % Change
Total fee revenue             $    1,719       $    1,844          (7 )%     $     5,282       $     5,527          (4 )%
Net interest revenue                 619              578           7              1,916             1,727          11
Gains related to investment
securities, net                       18                5                              2                25
Total revenue                      2,356            2,427          (3 )            7,200             7,279          (1 )
Provision for loan losses              -                -                             (1 )               1
Expenses:
Expenses from operations           1,664            1,713          (3 )            5,191             5,153           1
Claims resolution(1)                (362 )              -                           (362 )               -
Provisions for litigation
exposure and other costs(2)           85                -                            107                 -
Acquisition costs                     13               19                             41                46
Restructuring charges                 15               66                             45                75
Total expenses                     1,415            1,798         (21 )            5,022             5,274          (5 )
Income before income tax             941              629          50              2,179             2,004           9
expense
Income tax expense                   267               74                            588               465
Net income                    $      674       $      555          21        $     1,591       $     1,539           3
Adjustments to net income:
Dividends on preferred
stock(3)                      $      (15 )     $       (6 )                  $       (29 )     $       (13 )
Earnings allocated to
participating securities(4)           (5 )             (6 )                          (11 )             (15 )
Net income available to
common shareholders           $      654       $      543                    $     1,551       $     1,511
Earnings per common share:
Basic                         $     1.39       $     1.11                    $      3.23       $      3.05
Diluted                             1.36             1.10          24               3.19              3.03           5
Average common shares
outstanding (in thousands):
Basic                            472,355          490,840                        479,536           495,015
Diluted                          480,010          494,780                        485,813           498,417
Cash dividends declared per
common share                  $      .24       $      .18                    $       .72       $       .54
Return on average common
equity                              13.3 %           11.2 %                         10.7 %            10.8 %

(1) Represented a benefit related to claims associated with the 2008 Lehman Brothers bankruptcy; refer to "Consolidated Results of Operations - Expenses" in this Management's Discussion and Analysis.
(2) Composed of provisions of $60 million and $82 million for the quarter and nine months, respectively, for exposure related to previously disclosed litigation associated with asset management and securities lending, and a special one-time additional charitable contribution of $25 million. Additional information about our litigation exposure is provided in note 6 to the consolidated financial statements included in this Form 10-Q.
(3) Quarter and nine months ended September 30, 2012 included $8 million related to Series C preferred stock, issued in August 2012, and $7 million and $21 million, respectively, related to Series A preferred stock, redeemed in October 2012; prior-period amounts related to Series A preferred stock.
(4) Refer to note 13 to the consolidated financial statements included in this Form 10-Q.


Table of Contents
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

The following "Highlights" and "Financial Results" sections provide information related to notable events, as well as highlights of our financial results for the third quarter of 2012 presented in the preceding table. More detailed information about our financial results is provided under "Consolidated Results of Operations," which follows these sections.

Highlights
On October 15, 2012, we completed our acquisition of Goldman Sachs Administration Services, or GSAS, a global hedge fund administrator with approximately $200 billion of hedge fund assets under administration, in a cash transaction with a total purchase price of approximately $550 million, subject to certain adjustments. As of September 30, 2012, we had aggregate alternative assets under administration of approximately $900 billion, including hedge fund assets under administration of approximately $500 billion, which amounts did not include GSAS hedge fund assets under administration.
During the third quarter, we reached an agreement to settle our claims against the Lehman Brothers estate in the U.K., resolving the remainder of our indemnified repurchase and securities lending claims in the U.S. and the U.K. associated with the 2008 Lehman Brothers bankruptcy. In connection with the final resolution of these claims in the U.S. and the U.K., we recognized a benefit of approximately $362 million in our consolidated statement of income. Additional information about the settlement and related benefit is provided under "Consolidated Results of Operations - Expenses" in this Management's Discussion and Analysis.
On August 21, 2012, we issued and sold 20,000,000 depositary shares, each representing a 1/4,000th ownership interest in a share of State Street's non-cumulative perpetual preferred stock, Series C, without par value, with a liquidation preference of $100,000 per share (equivalent to $25 per depositary share), in a public offering. We issued 5,000 shares of Series C preferred stock in connection with the depositary share offering. The aggregate proceeds from the offering, net of underwriting discounts, commissions and other issuance costs, were approximately $488 million.
On October 4, 2012, we used the proceeds from the offering, together with cash on hand, to redeem all 5,001 outstanding shares of our floating-rate non-cumulative perpetual preferred stock, Series A, liquidation preference per share of $100,000, for an aggregate of approximately $500 million. The Series A preferred stock, issued in March 2011, was held by State Street Capital Trust III, and constituted the principal asset of the trust. Additional information about the Series C offering and the Series A redemption is provided under "Financial Condition - Capital" in this Management's Discussion and Analysis and in note 8 to the consolidated financial statements included in this Form 10-Q. During the third quarter, we declared a quarterly common stock dividend of $0.24 per share, or approximately $113 million, which was paid in October 2012. This dividend compares to a quarterly common stock dividend of $0.18 per share, or approximately $90 million, which was declared during the third quarter of 2011 and paid in October 2011. In addition, we declared aggregate preferred stock dividends of approximately $15 million, with $8 million related to the Series C preferred stock and $7 million related to the Series A preferred stock. The dividends on the Series A preferred stock included dividends paid in connection with the above-described redemption.
During the third quarter, we purchased approximately 11.4 million shares of our common stock under the program approved by the Board of Directors in March 2012, under which we are authorized to purchase up to $1.8 billion of our common stock through March 31, 2013. The shares were purchased at an average and aggregate cost of $42.11 and $480 million, respectively. Additional information about dividends and the common stock purchase program is provided under "Financial Condition - Capital" in this Management's Discussion and Analysis. During the third quarter, we continued the implementation of our Business Operations and Information Technology Transformation program. With respect to this program, in 2011 we achieved approximately $86 million of annual pre-tax run-rate expense savings. In addition to the $86 million of annual pre-tax run-rate expense savings achieved in 2011, we expect to achieve incremental annual pre-tax run-rate expense savings in 2012 in the range of approximately $90 million to $100 million. These expected pre-tax expense savings relate only to the Business Operations and Information Technology Transformation program and are based on projected incremental improvement in 2012 from our total 2010 expenses from operations of $6.18 billion, all else being equal; our actual expenses from operations may increase or decrease due to other factors. Additional information about our Business Operations and Information Technology Transformation program is provided under "Consolidated Results of Operations - Expenses" in this Management's Discussion and Analysis. Financial Results
Total revenue for the third quarter of 2012 decreased 3% compared to the same period in 2011, the result of a decline in fee revenue, partly offset by higher levels of net interest revenue and net gains related to investment securities. Servicing fees declined 1% from last year's third quarter, generally reflective of the impact of the weaker Euro, as well as


Table of Contents
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

changes in asset mix, partly offset by the impact of improvement in equity market valuations and net new business installed. Servicing fees generated outside the U.S. during both the third quarter of 2012 and the third quarter of 2011 were approximately 42% of total servicing fees. Management fees increased 10% in the same comparison, primarily due to the impact of stronger equity market valuations and net new business. Average month-end equity valuations for the S&P 500 index were up 16%, and for the MSCI® EAFE Indexes were down approximately 3%, from the third quarter of 2011. Management fees generated outside the U.S. during the third quarter of 2012 and the third quarter of 2011 were approximately 35% and 41%, respectively, of total management fees. Trading services revenue declined 31% from last year's third quarter, mainly the result of lower currency volatility in foreign exchange trading partly offset by higher foreign exchange trading volumes (foreign exchange trading revenue), as well as lower levels of revenue from electronic foreign exchange trading (brokerage and other trading services revenue). Securities finance revenue increased 7% from last year's third quarter as a result of higher spreads, partly offset by lower lending volumes associated with lower overall demand. For the third quarter of 2012, net interest revenue increased 7% compared to the third quarter of 2011. Both periods included discount accretion related to investment securities added to our consolidated statement of condition in connection with the 2009 asset-backed commercial paper conduit consolidation. . . .

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