UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

x                              ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                 to                

Commission File No. 001-07511

STATE STREET CORPORATION

(Exact name of registrant as specified in its charter)

617-786-3000

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:
None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x  No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o  No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes o  No x

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2006) was approximately $19.18 billion.

The number of shares of the registrant’s Common Stock outstanding as of January 31, 2007 was 333,845,013.

Portions of the following documents are incorporated into the Parts of this Report on Form 10-K by reference as indicated below:

(1) The registrant’s definitive Proxy Statement for the 2007 Annual Meeting to be filed pursuant to Regulation 14A on or before April 30, 2007 (Part III).

STATE STREET CORPORATION
Table of Contents

 

PART I

ITEM 1.                BUSINESS

State Street Corporation is a financial holding company organized under the laws of the Commonwealth of Massachusetts, and through its subsidiaries, provides a full range of products and services for institutional investors worldwide. Unless otherwise indicated or unless the context requires otherwise, all references in this Form 10-K to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. The parent company is a legal entity separate and distinct from its subsidiaries, assisting those subsidiaries by providing financial resources and management. At December 31, 2006, we had total assets of $107.35 billion, total deposits of $65.65 billion, total shareholders’ equity of $7.25 billion and employed 21,700. Our executive offices are located at One Lincoln Street, Boston, Massachusetts 02111 (telephone (617) 786-3000).

We make available, without charge, on or through our Internet website at www.statestreet.com all reports we electronically file with, or furnish to, the Securities and Exchange Commission, or “SEC,” including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments to those reports, as soon as reasonably practicable after those documents have been filed with, or furnished to, the SEC. These documents are also accessible on the SEC’s website at www.sec.gov. We have included the web addresses of State Street and the SEC as inactive textual references only. Except as specifically incorporated by reference into this Form 10-K, information on those websites is not part of this Form 10-K.

We have adopted Corporate Governance Guidelines, as well as written charters for the Executive Committee, the Examining and Audit Committee, the Executive Compensation Committee, and the Nominating and Corporate Governance Committee of the Board of Directors, or “Board,” and a Code of Ethics for Senior Financial Officers, a Standard of Conduct for Directors, and a Standard of Conduct for our employees. Each of these documents is posted on our website, and each is available in print to any shareholder who requests it by writing to the Office of the Secretary, State Street Corporation, One Lincoln Street, Boston, Massachusetts 02111.

In February 2007, we announced a definitive agreement to acquire Investors Financial Services Corp., or “Investors Financial,” a $12 billion bank holding company based in Boston. Under the terms of the agreement, we will exchange .906 shares of our common stock for each share of Investors Financial common stock. The transaction is subject to customary conditions, including the approvals of Investors Financial shareholders and regulatory agencies, and we expect to close the acquisition in the third quarter of 2007. The acquisition will be accounted for as a purchase. Additional information about this acquisition is included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in this Form 10-K under Item 7.

GENERAL

We were organized under the laws of the Commonwealth of Massachusetts in 1970 and we conduct our business primarily through our principal bank subsidiary, State Street Bank and Trust Company, which we refer to in this Form 10-K as “State Street Bank” or “the Bank.” State Street Bank traces its beginnings to the founding of the Union Bank in 1792. The charter under which State Street Bank now operates was authorized by a special act of the Massachusetts Legislature in 1891, and its present name was adopted in 1960.

With $11.85 trillion of assets under custody and $1.75 trillion of assets under management at year-end 2006, we are a leading specialist in meeting the needs of institutional investors worldwide. Our customers include mutual funds and other collective investment funds, corporate and public retirement plans, insurance companies, foundations, endowments and other investment pools, and investment managers.

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Including the United States, we operate in 26 countries and more than 100 geographic markets worldwide. For a discussion of our business activities, refer to the “Lines of Business” section that follows. For information about our management of capital, liquidity, market risk, including interest-rate risk, and other risks inherent in our businesses, refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included under Item 7 of this Form 10-K. Financial information with respect to our non-U.S. activities is included in Note 23 of the “Notes to Consolidated Financial Statements” included in this Form 10-K under Item 8 .

LINES OF BUSINESS

We report two lines of business: Investment Servicing and Investment Management. These two lines of business provide services to support institutional investors, including custody, recordkeeping, daily pricing and administration, shareholder services, foreign exchange, brokerage and other trading services, securities finance, deposit and short-term investment facilities, loan and lease financing, investment manager and hedge fund manager operations outsourcing, performance, risk and compliance analytics, investment research and investment management, including passive and active U.S. and non-U.S. equity and fixed income strategies. For additional information about our lines of business, see the “Line of Business Information” section of Management’s Discussion and Analysis included under Item 7, and Note 22 of the “Notes to Consolidated Financial Statements” included under Item 8, of this Form 10-K.

COMPETITION

We operate in a highly competitive environment in all areas of our business worldwide. We face competition from other financial services institutions, deposit-taking institutions, investment management firms, insurance companies, mutual funds, broker/dealers, investment banking firms, benefits consultants, leasing companies, and business service and software companies. As we expand globally, we encounter additional sources of competition.

We believe that there are certain key competitive considerations in these markets. These considerations include, for investment servicing, quality of service, economies of scale, technological expertise, quality and scope of sales and marketing, and price; and for investment management, expertise, experience, the availability of related service offerings, and price.

Our competitive success will depend upon our ability to develop and market new and innovative services, to adopt or develop new technologies, to bring new services to market in a timely fashion at competitive prices, to continue and expand our relationships with existing customers and to attract new customers.

SUPERVISION AND REGULATION

We are registered with the Board of Governors of the Federal Reserve System, or “Federal Reserve Board,” as a bank holding company pursuant to the Bank Holding Company Act of 1956, as amended, or “the Act.” The Act, with certain exceptions, limits the activities in which we and our non-bank subsidiaries may engage, including non-bank companies for which we own or control more than 5% of a class of voting shares, to those that the Federal Reserve Board considers to be closely related to banking or managing or controlling banks. The Federal Reserve Board may order a bank holding company to terminate any activity or its ownership or control of a non-bank subsidiary if the Federal Reserve Board finds that such activity, ownership or control constitutes a serious risk to the financial safety, soundness or stability of a bank subsidiary or is inconsistent with sound banking principles or statutory purposes. In the opinion of management, all of our present subsidiaries operate within the statutory standard or are otherwise permissible. The Act also requires a bank holding company to obtain prior approval of the Federal

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Reserve Board before it may acquire substantially all the assets of any bank or ownership or control of more than 5% of the voting shares of any bank.

The parent company elected to become a financial holding company, which reduces to some extent the restrictions on our activities. A financial holding company and the companies under its control are permitted to engage in activities considered “financial in nature” as defined by the Gramm-Leach-Bliley Act and Federal Reserve Board interpretations, and therefore may engage in a broader range of activities than permitted for bank holding companies and their subsidiaries. Financial holding companies may engage directly or indirectly in activities considered financial in nature, either de novo or by acquisition, provided the financial holding company gives the Federal Reserve Board after-the-fact notice of the new activities. Activities defined to be financial in nature include, but are not limited to, the following: providing financial or investment advice; underwriting; dealing in or making markets in securities; merchant banking, subject to significant limitations; and any activities previously found by the Federal Reserve Board to be closely related to banking. In order to maintain status as a financial holding company, each of a bank holding company’s depository subsidiaries must be well capitalized and well managed, as judged by regulators, and must comply with Community Reinvestment Act obligations. Failure to maintain such standards may ultimately permit the Federal Reserve Board to take certain enforcement actions against such company.

Many aspects of our business are subject to regulation by other U.S. federal and state governmental and regulatory agencies and self-regulatory organizations (including securities exchanges), and by non-U.S. governmental and regulatory agencies and self-regulatory organizations. Aspects of our public disclosure, corporate governance principles and internal control systems are subject to the Sarbanes-Oxley Act of 2002 and related regulations and rules of the SEC and the New York Stock Exchange.

Capital Adequacy

Like other bank holding companies, we are subject to Federal Reserve Board minimum risk-based capital and leverage ratio guidelines. State Street Bank is subject to similar risk-based capital and leverage ratio guidelines. As of December 31, 2006, our capital levels on a consolidated basis, and the capital levels of the Bank, exceeded the applicable minimum capital requirements. Failure to meet capital requirements could subject us to a variety of enforcement actions, including the termination of deposit insurance of the Bank by the Federal Deposit Insurance Corporation, or “FDIC,” and to certain restrictions on our business that are described further in this “Supervision and Regulation” section.

For additional information about our capital position and capital adequacy, refer to the “Capital” section of Management’s Discussion and Analysis included under Item 7, and Note 14 of the “Notes to Consolidated Financial Statements” included under Item 8, of this Form 10-K.

Subsidiaries

The Federal Reserve Board is the primary federal banking agency responsible for regulating us and our subsidiaries, including State Street Bank, for both our U.S. and non-U.S. operations.

Our bank subsidiaries are subject to supervision and examination by various regulatory authorities. State Street Bank is a member of the Federal Reserve System and the FDIC and is subject to applicable federal and state banking laws and to supervision and examination by the Federal Reserve Bank of Boston, as well as by the Massachusetts Commissioner of Banks, the FDIC, and the regulatory authorities of those countries in which a branch of the Bank is located. Other subsidiary trust companies are subject to supervision and examination by the Office of the Comptroller of the Currency, other offices of the Federal Reserve System or by the appropriate state banking regulatory authorities of the states in which they are located. Our non-U.S. bank subsidiaries are subject to regulation by the regulatory authorities of the

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countries in which they are located. As of December 31, 2006, the capital of each of these banking subsidiaries exceeded the minimum legal capital requirements as set by those authorities.

The parent company and its non-bank subsidiaries are affiliates of State Street Bank under federal banking laws, which impose certain restrictions on transfers of funds in the form of loans, extensions of credit, investments or asset purchases from the Bank to the parent and its non-bank subsidiaries. Transfers of this kind to affiliates by State Street Bank are limited with respect to each affiliate to 10% of the Bank’s capital and surplus, as defined, and to 20% in the aggregate for all affiliates, and are subject to certain collateral requirements. As a bank holding company, the parent company and its subsidiaries are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or lease or sale of property or furnishing of services. Federal law also provides that certain transactions with affiliates must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions involving other non-affiliated companies or, in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in good faith would be offered to, or would apply to, non-affiliated companies. The Federal Reserve Board has jurisdiction to regulate the terms of certain debt issues of bank holding companies. Federal law provides as well for a depositor preference on amounts realized from the liquidation or other resolution of any depository institution insured by the FDIC.

We are subject to the USA PATRIOT Act of 2001, which contains anti-money laundering and financial transparency laws and requires implementation of regulations applicable to financial services companies, including standards for verifying client identification and monitoring client transactions and detecting and reporting suspicious activities. Anti-money laundering laws outside the U.S. contain similar requirements.

Our investment management subsidiary is registered as an investment adviser with the SEC. Our U.S. broker/dealer subsidiary is registered as a broker/dealer with the SEC, is subject to regulation by the SEC (including the SEC’s net capital rule) and is a member of the National Association of Securities Dealers, a self-regulatory organization. Many aspects of our investment management activities are subject to federal and state laws and regulations primarily intended to benefit the investment holder. These laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict us from carrying on our investment management activities in the event that we fail to comply with such laws and regulations, and examination authority. Our business relating to investment management and trusteeship of collective trust funds and separate accounts offered to employee benefit plans subject to ERISA is regulated by the U.S. Department of Labor.

Our businesses, including our investment management and securities and futures businesses, are also regulated extensively by non-U.S. governments, securities exchanges, self-regulatory organizations, central banks and regulatory bodies, especially in those jurisdictions in which we maintain an office. For instance, the Financial Services Authority, the London Stock Exchange, and the Euronext.liffe regulate activities in the United Kingdom; the Deutsche Borse AG and the Federal Financial Supervisory Authority regulate activities in Germany; and the Financial Services Agency, the Bank of Japan, the Japanese Securities Dealers Association and several Japanese securities and futures exchanges, including the Tokyo Stock Exchange, regulate activities in Japan. We have established policies, procedures, and systems designed to comply with these requirements. However, as a global financial services institution, we face complexity and costs in our worldwide compliance efforts.

Most of our non-U.S. operations are conducted pursuant to Federal Reserve Board Regulation K through State Street Bank’s Edge Act corporation subsidiary or through international branches of the Bank. An Edge Act corporation is a corporation organized under federal law that, in general, conducts foreign business activities. With prior approval of the Federal Reserve Board, State Street Bank may invest up to 20% of its capital and surplus in Edge Act and Agreement corporation subsidiaries. An Agreement

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corporation subsidiary is a subsidiary organized under state law that operates as if it was organized under federal law and is subject to Regulation K. Agreement corporation subsidiaries are generally restricted to foreign banking operations. The Bank has applied to renew its approval to invest 18% of its capital and surplus, which is less than the maximum 20% permitted by law.

Historically, we generally have invested abroad through our Edge Act corporation subsidiaries. However, under Federal Reserve Board Regulation Y, we may continue to make new investments abroad directly (through the parent company or through direct, non-bank subsidiaries of the parent company) or through international bank branch expansion without being subject to the 20% investment limitation for Edge Act corporation subsidiaries. We cannot predict with certainty the impact of the Edge Act corporation subsidiary investment limitation on the pace of our future international expansion. Nonetheless, in light of available alternatives, we do not believe that the Edge Act corporation subsidiary investment limitation will materially limit our ability to expand internationally.

We are also subject to the Massachusetts bank holding company statute. The Massachusetts statute requires prior approval by the Massachusetts Board of Bank Incorporation for our acquisition of more than 5% of the voting shares of any additional bank and for other forms of bank acquisitions.

Support of Subsidiary Banks

Under Federal Reserve Board guidelines, a bank holding company is required to act as a source of financial and managerial strength to its bank subsidiaries. Under these guidelines, the parent company is expected to commit resources to the Bank and any other bank subsidiary in circumstances where it might not do so absent such guidelines. In the event of our bankruptcy, any commitment by the parent company to a federal bank regulatory agency to maintain the capital of a bank subsidiary will be assumed by the bankruptcy trustee and will be entitled to a priority payment.

ECONOMIC CONDITIONS AND GOVERNMENT POLICIES

Economic policies of the U.S. government and its agencies influence our operating environment. Monetary policy conducted by the Federal Reserve Board directly affects the level of interest rates, which may impact overall credit conditions of the economy. Policy is applied by the Federal Reserve Board through open market operations in U.S. government securities, changes in reserve requirements for depository institutions, and changes in the discount rate and availability of borrowing from the Federal Reserve. Government regulation of banks and bank holding companies is intended primarily for the protection of depositors of the banks, rather than for the shareholders of the institutions.

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STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES

The following information, provided under Items 6, 7 and 8 of this Form 10-K, is incorporated by reference herein:

“Selected Financial Data” table (Item 6)—presents return on average common equity, return on average assets, common dividend payout and equity-to-assets ratios.

“Distribution of Average Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential” table (Item 8)—presents average balance sheet amounts, related fully taxable-equivalent interest earned or paid, related average yields and rates paid and changes in fully taxable-equivalent interest revenue and expense for each major category of interest-earning assets and interest-bearing liabilities.

Note 3, “Investment Securities,” of the “Notes to Consolidated Financial Statements” (Item 8) and “Investment Securities” section included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7)—disclose information regarding book values, market values, maturities and weighted average yields of securities (by category).

Note 1, “Summary of Significant Accounting Policies—Loans and Lease Financing” of the “Notes to Consolidated Financial Statements” (Item 8)—discloses our policy for placing loans and leases on non-accrual status.

Note 4, “Loans and Lease Financing,” of the “Notes to Consolidated Financial Statements” (Item 8) and “Loans and Lease Financing” section included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7)—disclose distribution of loans, loan maturities and sensitivities of loans to changes in interest rates.

“Loans and Lease Financing” and “Cross-Border Outstandings” sections of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7)—disclose information regarding cross-border outstandings and other loan concentrations of State Street.

“Credit Risk” section of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (Item 7) and Note 4, “Loans and Lease Financing,” of the “Notes to Consolidated Financial Statements” (Item 8)—present the allocation of the allowance for loan losses, and a description of factors which influenced management’s judgment in determining amounts of additions or reductions to the allowance charged or credited to results of operations.

“Distribution of Average Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential” table (Item 8)—discloses deposit information.

Note 8, “Short-Term Borrowings,” of the “Notes to Consolidated Financial Statements” (Item 8)—discloses information regarding short-term borrowings of State Street.

ITEM 1A.        RISK FACTORS

This Form 10-K contains statements (including, without limitation, statements in “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included in this Form 10-K under Item 7) that are considered “forward-looking statements” within the meaning of U.S. federal securities laws. In addition, State Street and its management may make other written or oral communications from time to time that contain forward-looking statements. Forward-looking statements, including statements as to industry trends, future expectations of State Street and other matters that do not relate strictly to historical facts, are based on certain assumptions by management, and are often identified by such forward-looking terminology as “expect,” “look,” “believe,” “anticipate,” “estimate,” “seek,” “may,” “will,” “trend,” “target” and “goal,” or similar statements or variations of such terms. Forward-

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looking statements may include statements about State Street’s confidence in its strategies and its expectations about revenue and market growth, acquisitions and divestitures, new technologies, services and opportunities, and earnings.

Forward-looking statements are subject to various risks and uncertainties, which change over time, and are based on management’s expectations and assumptions at the time the statements are made. These 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, and factors specific to the parent company and to the Bank. Factors that could cause changes in the expectations or assumptions on which forward-looking statements are based include, but are not limited to:

·       Economic conditions and monetary and other governmental actions designed to address those conditions;

·       The performance and volatility of securities, currency and other markets in the U.S. and internationally;

·       The level and volatility of interest rates, particularly in the U.S. and Europe;

·       Our ability to attract non-interest bearing deposits and other low-cost funds;

·       The enactment of legislation, including tax legislation, and changes in regulation and enforcement that impact State Street and its customers;

·       The competitive environment in which we operate, including the willingness of our competitors to reduce fees or add to their products and services to seek to attract our customers, as well as our ability to cross-sell services to our customers and to maintain service levels, technology and product offerings that are sufficient to attract new customers and retain current customers;

·       Our ability to continue to grow revenue, control expenses and attract the capital necessary to achieve our business goals and comply with regulatory requirements;

·       Our ability to control systemic and operating risks;

·       Trends in the globalization of investment activity and the growth on a worldwide basis in financial assets;

·       Trends in governmental and corporate pension plans and savings rates;

·       Changes in accounting standards and practices, including changes in the interpretation of existing standards, that impact our consolidated financial statements; and

·       Changes in tax legislation and in the interpretation of existing tax laws by U.S. and non-U.S. tax authorities that impact the amount of taxes due.

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 this Form 10-K and in our other SEC filings, including our reports on Form 10-Q and Form 8-K, which are accessible on the SEC’s website at www.sec.gov or on our website at www.statestreet.com.

In addition to factors discussed above and elsewhere in this Form 10-K or previously disclosed in our other SEC filings, the factors discussed below could cause actual future results to differ materially from those contemplated by forward-looking statements and from our historical financial results. State Street undertakes no obligation to revise the forward-looking statements contained in this Form 10-K to reflect events after the date it is filed with the SEC. These factors are not intended to be a complete summary of

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all risks and uncertainties that may affect our businesses. Though we strive to monitor and mitigate risk, we cannot anticipate all potential economic, operational and financial developments that may adversely impact our operations and our financial results.

Business Conditions/Economic Risk

Our businesses are affected by global economic conditions, political uncertainties and volatility and other developments in the financial markets. Factors such as interest rates and commodities prices, regional and international rates of economic growth, inflation, political instability, the liquidity and volatility of equity, credit, currency, derivative and other financial markets, and investor confidence can significantly affect the financial markets in which we and our customers are engaged. Such factors have affected, and may further unfavorably affect, both regional and worldwide economic growth, creating adverse effects on many companies, including us, in ways that are not predictable.

A significant market downturn may lead to a decline in the value of assets under management and custody, which would reduce our asset-based fee revenue and the value of securities we hold in our investment portfolio, and may adversely impact transaction revenue and the volume of transactions that we execute for our customers. In addition, lower market volatility, even in a generally rising market environment, may reduce trading volumes of our customers, and our ability to achieve attractive spreads, which could lead to lower trading revenues. Our revenues, particularly our trading revenues, may increase or decrease depending upon the extent of increases or decreases in cross-border investments made by our customers. The level of cross-border activity can be influenced by a number of factors, including geopolitical instabilities and customer mix. General market downturns would also likely lead to a decline in the volume of transactions we execute on behalf of our customers, decreasing our fee and revenue opportunities and reducing the level of assets under management and custody.

In addition, revenues during a calendar year, driven by the products and services we provide, can fluctuate commensurate with normal course business activity of our customers, typically resulting in stronger revenues in the second and fourth quarters and relatively weaker revenues in the first and third quarters.

In recent years, investment manager and hedge fund manager operations outsourcing and non-U.S. asset servicing have been areas of rapid growth in our business. If the demand for these types of services were to decline, we could see a slowing in the growth rate of our revenue.

Strategic/Competition Risk

We expect the markets in which we operate to remain both highly competitive and global across all facets of our business, resulting in increases in both regional and global competitive risks. We have experienced, and anticipate that we will continue to experience, pricing pressure in many of our core businesses. Many of our businesses compete with other domestic and international banks and financial services companies, such as custody banks, investment advisors, broker/dealers, outsourcing companies and data processing companies. Many of our competitors, including our competitors in core services, have substantially greater capital resources. In some of our businesses, we are service providers to significant competitors. The ability of a competitor to offer comparable or improved products or services at a lower price would likely negatively affect our ability to maintain or increase our profitability.  In addition, pricing pressures as a result of the activities of competitors, customer pricing reviews and rebids, as well as the introduction of new products, may result in a reduction in the prices we can charge for our products and services.

Acquisitions of complementary businesses and technologies, development of strategic alliances and divestitures of portions of our business, in addition to fostering organic growth opportunities, are an active part of our overall business strategy to remain competitive. We may not be able to effectively assimilate

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services, technologies, key personnel or businesses of acquired companies into our business or service offerings, alliances may not be successful, and related revenue growth or cost savings may not be achieved. In addition, we may not be able to successfully manage the divestiture of identified businesses on satisfactory terms, if at all, which would reduce anticipated benefits to earnings. Ongoing consolidation within the financial services industry could provide opportunities and pose challenges in the markets we serve.

Acquisitions present risks that differ from the risks associated with our ongoing operations. In January 2007, we announced a definitive agreement to acquire Currenex, Inc., an independently owned electronic foreign exchange trading platform. In addition, in February 2007, we announced a definitive agreement to acquire Investors Financial. Our financial results for 2007 and for the next few years may be significantly impacted by our ability to achieve the cost savings and other benefits that we anticipate as a result of the acquisition of Investors Financial, as well as our ability to retain its customer base and to successfully cross-sell our products and services to its customers.

Intellectual property of an acquired business such as Currenex may be an important component of the value that we agree to pay for such a business; however, these types of acquisitions entail the risk that the acquired business does not own the intellectual property that we believe we are acquiring, that the intellectual property is dependent upon licenses from third parties, or that the acquired business infringes upon the intellectual property rights of others. Acquisitions of investment servicing businesses such as Investors Financial normally entail information technology systems conversions, which involve operational risks and may result in customer dissatisfaction and defection. Customers of businesses that we acquire, including, in the case of Investors Financial, its largest customer, are competitors of our non-custody businesses. The loss of some of these customers or a significant reduction in revenues generated from them, for competitive or other reasons, would adversely affect the benefits that we expect to achieve from the acquisition.

In connection with most acquisitions, before the acquisition can be completed, we must obtain various regulatory approvals or consents, which approvals may include the Federal Reserve Board, the Massachusetts Commissioner of Banking and other domestic and foreign regulatory authorities. These regulatory authorities may impose conditions on the completion of the acquisition or require changes to its terms. Although we would not enter into a transaction anticipating materially adverse regulatory conditions, such conditions may be imposed, or we may experience regulatory delays that limit the benefits of the transaction.

With any acquisition, the integration of the operations and resources of the two businesses could result in the loss of key employees, the disruption of our and the acquired company’s ongoing businesses, or inconsistencies in standards, controls, procedures and policies that could adversely affect our ability to maintain relationships with clients, customers, and employees or to achieve the anticipated benefits of the acquisition. Integration efforts may also divert management attention and resources. Where we acquire a business and combine it with our operations, we are also exposed to risks of unknown or contingent liabilities as to which we may have no recourse against the seller. While we normally seek to mitigate that risk through pre-acquisition due diligence, increasingly acquisition transactions are competitive auctions in which we have limited time and access to information to evaluate the risks inherent in the business being acquired, and no or limited recourse against the seller if undisclosed liabilities are discovered after we enter into a definitive agreement.

Our financial results may be adversely affected by the accounting treatment for an acquisition.  We may not achieve the benefits we sought in an acquisition, or, if achieved, those benefits may come later than we anticipated. Failure to achieve anticipated benefits from an acquisition, such as our acquisitions of Investors Financial and Currenex, could result in increased costs and lower revenues than expected of the combined company.

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We actively strive to achieve significant cost savings by shifting certain business processes to lower-cost geographic locations, while continuing to maintain service quality, control and effective management of risks within these business operations. This transition to a true “shared services” operational model focuses on certain core service offerings, including middle- and back-office reconciliations, securities processing and transfer agency activities. The increased elements of risk that arise from conducting certain operating processes in some jurisdictions could lead to an increase in reputation risk. Reputation risk is inherent in our current operating model; shifting business processes merely accentuates these risks through the transition process, until such time as technology, training and infrastructure changes are in place to mitigate the risk. The extent and pace at which we are able to move functions to lower-cost locations may also be impacted by regulatory and customer acceptance issues. Such relocation of functions also entails costs, such as technology and real estate expenses, that partially offset the financial benefits of the lower-cost locations.

Our financial performance depends, in part, on our ability to develop and market new and innovative services and to adopt or develop new technologies that differentiate our products or provide cost efficiencies, while avoiding increased related expenses. The risks we face include rapid technological change in the industry, our ability to access technical and other information from our customers, and the significant and ongoing investments required to bring new products and services to market in a timely fashion at competitive prices. We proactively cross-sell multiple products and services to our customers, which can exacerbate the negative financial effects associated with the risk of loss of any one customer. Developments in the securities processing industry, including shortened settlement cycles and straight-through processing, have required continued internal procedural enhancements and further technology investment.

Our growth strategy depends upon both attracting new customers and cross-selling additional products and services to our existing customer base. To the extent that we are not able to achieve these goals, we may not be able to achieve our financial goals. There are substantial risks and uncertainties associated with the introduction of new products and services, including technical and control requirements that may need to be developed and implemented to offer such products while also managing associated risks. The introduction of new products and services can also entail significant time and resources. Regulatory and internal control requirements, capital requirements, competitive alternatives and shifting market preferences may also determine if such initiatives can be brought to market in a manner that is timely and attractive to our customers. Failure to successfully manage these risks in the development and implementation of new products or services could have a material adverse effect on our business, as well as our results of operations and financial condition.

Credit Risk

Our focus on large institutional investors and their businesses requires that we assume credit and counterparty risk, both on- and off-balance sheet, in a variety of forms. We may experience significant intra- and inter-day credit exposure through settlement-related extensions of credit. From time to time, we may assume concentrated credit risk at the individual counterparty, industry and/or country level, thereby potentially exposing us to a single market or political event or a correlated set of events. The credit quality of our on- and off-balance sheet exposures may be affected by many factors, such as economic and business conditions or deterioration in the financial condition of an individual counterparty or group of counterparties. If there is a significant economic downturn in either a country or a region, or we experience the failure of a significant individual counterparty, we could incur financial losses that could adversely affect our earnings.

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Financial Markets Risk

As asset values in worldwide financial markets increase or decrease, our opportunities to invest in and service financial assets change. Given that a portion of our fees is based on the value of assets under custody and management, fluctuations in the valuation of worldwide securities markets will affect revenue. Many of the costs of providing our services are relatively fixed; therefore, a decline in revenue could have a disproportionate effect on our earnings. In addition, if investment performance in our asset management business fails to meet either benchmarks or the performance of our competitors, we could experience a decline in assets under management and a reduction in the fees we earn, irrespective of economic or market conditions.

We have increased the portion of our management fee revenue that is generated from enhanced index and actively managed products, with respect to which we receive higher fees compared to passive products. We may not be able to continue to increase this segment of our business at the same rate that we have achieved in the past few years. In addition, with respect to certain of these products, we have entered into performance fee arrangements, where the management fee revenue we earn is based on the performance of managed funds against specified benchmarks. The reliance on performance fees increases the potential volatility of our management fee revenue.

The degree of volatility in foreign exchange rates can affect our foreign exchange trading revenue. In general, we benefit from currency volatility, although it can increase risk, and foreign exchange revenue, all other things being equal, is likely to decrease during times of decreased currency volatility. In addition, as our business grows globally, our exposure to changes in foreign currency exchange rates could affect our levels of revenue, expense and earnings, as well as the value of our investment in our non-U.S. operations. Our other financial markets trading businesses, as well as our asset and liability management activities, are also subject to market risks. Adverse movements in levels and volatilities of financial markets could cause losses that may affect our consolidated results of operations and financial condition.

Liquidity Risk

We depend on access to global capital markets to provide us with sufficient capital resources and liquidity to meet our commitments and business needs, and to accommodate the transaction and cash management needs of our customers. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors or counterparties participating in the capital markets with us in particular, or a downgrade of our debt rating, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. General market disruptions, natural disasters or operational problems may affect either third parties or us, and can also have an adverse affect on our liquidity.

Interest Rate Risk

State Street’s financial performance could be unfavorably affected by changes in interest rates as they impact our asset and liability management process. The levels of global market interest rates, the shape of these yield curves (changes in the relationship between short- and long-term interest rates), the direction and speed of interest rate changes, and the asset and liability spreads relative to the currency and geographic mix of our interest-bearing assets and interest-bearing liabilities, affect our net interest revenue. Our ability to anticipate these changes and/or to hedge the related exposures on and off our balance sheet can significantly influence the success of our asset and liability management process and the resulting level of our net interest revenue. The impact of changes in interest rates will depend on the relative durations of assets and liabilities in accordance with their relevant currencies. In general, sustained lower interest rates, a flat or inverted yield curve and narrow interest-rate spreads have a constraining effect on our net interest revenue.

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Operational Risk

Operational risk is inherent in all of State Street’s activities. Our customers have a broad array of complex and specialized servicing, confidentiality and fiduciary requirements. We have established policies, procedures and systems designed to comply with these regulatory and operational risk requirements. We also face the potential for loss resulting from inadequate or failed internal processes, employee supervisory or monitoring mechanisms, or other systems or controls, and from external events, which could materially affect our future results of operations. We may also be subject to disruptions from events that are wholly or partially beyond our control, which could cause delays or disruptions to operational functions, including functions such as information processing and financial market settlement. In addition, our customers, vendors and counterparties could suffer from such events. Should these events affect us, or the customers, vendors or counterparties with which we conduct business, our results of operations could be negatively affected. We use various strategies and processes to monitor and mitigate operational and other risks. These risk management measures entail many assumptions regarding events that are not possible to predict. As a result, our risk management framework may not always be successful.

Our success depends, in large part, on our ability to attract and retain key people. Competition for the best people in most activities in which we engage can be intense, and we may not be able to hire people or retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, their knowledge of our markets, their years of industry experience, in some cases, and the difficulty of promptly finding qualified replacement personnel.  In some of our businesses, we have experienced significant employee turnover, which increases costs, requires additional training and increases the potential for operational risks.

We enter into long-term fixed price contracts to provide middle office or investment manager and hedge fund manager operations outsourcing services to customers, services related but not limited to certain trading activities, cash reporting, settlement and reconciliation activities, collateral management and information technology development. These long-term contracts require considerable up-front investment by us, including technology and conversion costs, and carry the risk that pricing for the products and services we provide might not prove adequate to generate expected operating margins over the term of the contracts. Profitability of these contracts is largely a function of our ability to accurately calculate pricing for our services and our ability to control our costs and maintain the relationship with the customer for an adequate period of time to recover our up-front investment. Performance risk exists in each contract, given our dependence on successful conversion and implementation onto our own operating platforms of the service activities provided. In addition, our failure to meet specified service levels may adversely affect our revenue from such arrangements, or permit early termination of the contracts by the customer.

Our businesses depend on an information technology infrastructure to record and process a large volume of increasingly complex transactions, in many currencies, on a daily basis, across numerous and diverse markets. Any interruptions, delays and/or breakdowns of this infrastructure can result in significant costs. As a result, we continue to invest significantly in this infrastructure.

Regulatory/Legal/Accounting/Tax Risk

Most of our businesses are subject to extensive regulation, and many of the customers to which we provide services are themselves subject to a broad range of regulatory requirements. These regulations may affect the manner and terms of delivery of our services. As a financial institution with substantial international operations, we are subject to extensive regulatory and supervisory oversight, both in the U.S. and overseas in connection with our global operations. Our businesses are subject to stringent regulation and examination by U.S. federal and state governmental and regulatory agencies, including the Federal Reserve, the SEC and the Massachusetts Commissioner of Banking,  and self-regulatory organizations (including securities exchanges), and by non-U.S. governmental and regulatory agencies and self-

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regulatory organizations. The regulations affect, among other things, the scope of our activities and customer services, our capital structure and our ability to fund the operations of our subsidiaries, our lending practices, our dividend policy and the manner in which we market our services. Evolving regulations, such as the new Basel II capital framework and anti-money laundering regulations, can require significant effort on our part to ensure compliance. New or modified regulations and related regulatory guidance may have unforeseen or unintended adverse effects on the financial services industry.

If we do not comply with governmental regulations, we may be subject to fines, penalties or material restrictions on our businesses in the jurisdiction where the violation occurred, which can adversely affect our business operations and, in turn, our financial results. Similarly, many of our customers are subject to significant regulatory requirements, and retain our services in order for us to assist them in complying with those legal requirements. Changes in these regulations can significantly affect the services that we are asked to provide, as well as our costs. If we cause a customer to fail to comply with these regulatory requirements, we may be liable to them for losses and expenses that they incur. In addition, adverse publicity and damage to our reputation arising from the failure or perceived failure to comply with legal, regulatory or contractual requirements could affect our ability to attract and retain customers or to maintain access to capital markets, or could result in enforcement actions, fines, penalties and lawsuits. In recent years, regulatory oversight and enforcement has increased substantially, imposing additional costs and increasing the potential risks associated with our operations. If this regulatory trend continues, it could adversely affect our operations and, in turn, our financial results.

From time to time, our customers may make claims and take legal action pertaining to our performance of fiduciary or contractual responsibilities. If such claims and legal actions are not resolved in a manner favorable to us, such claims may result in financial liability to us and/or adversely affect the market perception of State Street and its products and services, and could impact customer demand for our products and services.  We record balance sheet reserves for such known and unknown loss contingencies, including litigation and operational losses; however, we cannot always estimate the ultimate outcome, and as a result the adequacy of these reserves to cover any settlements or judgments into which State Street ultimately enters or to which we are subject.

New accounting requirements, or changes in the interpretation of existing accounting requirements, by the Financial Accounting Standards Board, the SEC, and bank regulators can potentially affect our consolidated financial condition and results of operations, as accounting rules in the U.S. and other jurisdictions consistently evolve to reflect the increasing complexities of business. These changes are very difficult to predict, and can materially impact how we record and report our financial condition and results of operations and other financial information. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the revised treatment of certain transactions or activities, and, in some cases, the restatement of prior period financial statements.

Our businesses are subject to changes in tax legislation, and the interpretation of existing tax laws worldwide. These legislative actions may impact our business directly or indirectly through their impact on the financial markets. In the normal course of business, we are subject to reviews by U.S. and non-U.S. tax authorities regarding the amount of taxes due. These reviews may result in adjustments to the timing or amount of taxes due and the allocation of taxable income among tax jurisdictions. While such changes may or may not have an economic impact on our business, these changes could affect the attainment of our current financial goals.

ITEM 1B.       UNRESOLVED STAFF COMMENTS

None.

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ITEM 2.                PROPERTIES

Our headquarters is located at State Street Financial Center, One Lincoln Street, Boston, Massachusetts, a 36-story office building. We have leased the entire 1,025,000 square feet of this building, as well as the entire 366,000-square-foot parking garage at One Lincoln Street, under 20-year non-cancelable capital leases. A portion of the lease payments is offset by a sublease for 160,000 square feet of the building.

We occupy two buildings located in Quincy, Massachusetts, one of which we own and the other we lease. The buildings, containing a total of approximately 822,000 square feet, function as State Street Bank’s principal operations facilities. Additionally, we own a 92,000-square-foot building in Westborough, Massachusetts, and a 138,000-square-foot building in Grafton, Massachusetts, each of which is used as a data center. Our remaining offices and facilities around the world are leased. We enter into operating leases to meet the needs of our operations and to expand our geographic reach.

Additional information about our occupancy costs, including commitments under non-cancelable leases, is in Note 18 of the “Notes to Consolidated Financial Statements” included in this Form 10-K under Item 8.

ITEM 3.                LEGAL PROCEEDINGS

We are broadly involved with the securities industry worldwide, including the mutual fund industry. Securities industry practices and the mutual fund industry in the U.S. continue to be the subject of intense regulatory, governmental and public scrutiny. In that regard, we have received various industry-related regulatory, governmental and law enforcement inquiries and subpoenas relating to our activities and the activities of our mutual fund customers. We continue to respond to these regulatory, governmental and law enforcement inquiries and subpoenas in the normal course of business. We are also involved in various legal proceedings that arise in the normal course of business. In the opinion of management, after discussion with counsel, these regulatory, governmental and law enforcement inquiries and subpoenas, and legal proceedings can be successfully defended or resolved without a material adverse effect on our consolidated financial position or results of operations.

ITEM 4.                SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

None.

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ITEM 4A.        EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information with regard to each of our executive officers. As used in this section, the term “executive officer” corresponds to those positions designated as such for SEC purposes.

 

All executive officers are elected by the Board. The Chairman, President, Treasurer and Secretary hold office until the first meeting of the Board following the next annual meeting of shareholders and until their successors are chosen and qualified. All executive officers hold office at the discretion of the Board. There are no family relationships among any of our directors and executive officers.

Mr. Logue joined State Street in 1990. Since prior to 2002, he has served as President and Chief Operating Officer. In June 2004, he was appointed Chairman and Chief Executive Officer.

Mr. Antonellis joined State Street in 1991. As of 2002, he served as Executive Vice President and head of Institutional Investor Services. In 2003, he was named head of Information Technology and Global Securities Services. In 2006, he was appointed Vice Chairman with additional responsibility as head of Investor Services in North America and Global Investment Manager Outsourcing Services.

Mr. Hooley joined State Street in 1986. Since 2002, he has served as Executive Vice President and head of Investor Services. In 2006, he was appointed Vice Chairman and global head of Investment Servicing and Investment Research and Trading.

Mr. Hunt joined State Street in 1994.  As of 2002, he served as Executive Vice President of State Street and head of State Street Global Advisors’ international business. In January 2005, he was appointed President and Chief Executive Officer of SSgA. In 2006, he was appointed Vice Chairman of State Street.

Mr. Carp joined State Street in January 2006 as Executive Vice President and Chief Legal Officer. In 2006, he was also appointed Secretary. From April 2004 until December 2005, Mr. Carp served as executive vice president and general counsel of Massachusetts Financial Services, an investment management and research company. From 1989 until 2004, Mr. Carp was a senior partner at the law firm of Hale and Dorr LLP, where he was an attorney since 1982.

Mr. Chow first joined State Street in 1990, left in 2003, and returned in 2004. When he left in 2003, he was Executive Vice President and head of Credit and Risk Policy. Since 2004, he has served as Executive Vice President, Risk and Corporate Administration.

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Mr. Malerba joined State Street in November 2004 as Deputy Corporate Controller. Prior to joining State Street, he served as Deputy Controller at FleetBoston Financial Corporation and continued  in that role after the merger with Bank of America Corporation. In 2006, he was appointed Corporate Controller.

Mr. O’Leary joined State Street in 2005 as Executive Vice President and head of Global Human Resources. Prior to joining State Street, he served as a senior advisor to Credit Suisse First Boston Corporation after serving as Managing Director and Global Head of Human Resources with that organization for more than 18 years.

Mr. James Phalen joined State Street in 1992. As of 2002, he served as Executive Vice President of State Street and Chairman and Chief Executive Officer of CitiStreet, a joint venture. In February 2005, he was appointed head of Investor Services in North America. In 2006, he was appointed head of international operations for Investment Servicing and Investment Research and Trading, based in Europe.

Mr. David Phelan joined State Street in 2006 as Executive Vice President and General Counsel. From 1995 until 2006, he was a senior partner at the law firm of WilmerHale, where he was an attorney since 1993.

Mr. Resch joined State Street in 2002 as Executive Vice President and Chief Financial Officer. In 2006, he was also appointed Treasurer. Prior to joining State Street, he was managing director and chief financial officer of Pershing, LLC, a subsidiary of Credit Suisse First Boston Corporation, which provides brokerage processing and investment services. Prior to that, he served as managing director and chief accounting officer at Donaldson, Lufkin & Jenrette, Inc.

Mr. Shelton joined State Street in 1984. Since prior to 2002, he has served as Executive Vice President and head of State Street Global Markets.

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PART II

ITEM 5.                MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS

MARKET FOR REGISTRANT’S COMMON EQUITY

Our Common Stock is listed on the New York and Boston Stock Exchanges under the ticker symbol STT. There were 4,586 shareholders of record at December 31, 2006. Information concerning the market prices of, and dividends on, our common stock during the past two years is included in this Form 10-K under Item 8, under the caption “Quarterly Summarized Financial Information.”

In February 2005, our Board authorized the purchase of up to 15 million shares of our common stock for general corporate purposes, including mitigation of the dilutive impact of shares issued under employee benefit programs, and canceled a program authorized in 1995. In March 2006, the Board cancelled the remaining 2005 authorization and authorized a new program for the purchase of up to 15 million of our common shares for the same purposes.

During the first quarter of 2006, we purchased 3 million shares of our common stock under the 2005 program. Under the 2006 program, we purchased 2.8 million shares of our common stock during the first six months of 2006, and no common shares were purchased by us during the third and fourth quarters of 2006. As of December 31, 2006, 12.2 million shares remained available for purchase under the 2006 program. We employ third-party broker-dealers to acquire shares on the open market for our publicly announced stock purchase program.

RELATED STOCKHOLDER MATTERS

As a bank holding company, the parent company is a legal entity separate and distinct from its principal banking subsidiary, State Street Bank, and its non-bank subsidiaries. The right of the parent company to participate as a shareholder in any distribution of assets of State Street Bank upon its liquidation, reorganization or otherwise is subject to the prior claims by creditors of State Street Bank, including obligations for federal funds purchased and securities sold under repurchase agreements and deposit liabilities. Payment of dividends by State Street Bank is subject to the provisions of Massachusetts banking law, which provide that dividends may be paid out of net profits provided (i) capital stock and surplus remain unimpaired, (ii) dividend and retirement fund requirements of any preferred stock have been met, (iii) surplus equals or exceeds capital stock, and (iv) losses and bad debts, as defined, in excess of reserves specifically established for such losses and bad debts, have been deducted from net profits.

Under the Federal Reserve Act, the approval of the Federal Reserve Board would be required if dividends declared by State Street Bank in any year exceeded the total of its net profits for that year combined with retained net profits for the preceding two years, less any required transfers to surplus. Information about dividends from our subsidiary banks is in Note 14 of the “Notes to Consolidated Financial Statements” included in this Form 10-K under Item 8. Future dividend payments of State Street Bank and other non-bank subsidiaries cannot be determined at this time.

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SHAREHOLDER RETURN PERFORMANCE PRESENTATION

The graph presented below compares the cumulative total shareholder return on State Street’s common stock to the cumulative total return of the S&P 500 Index and the S&P Financial Index for the five fiscal years, which commenced January 1, 2002 and ended December 31, 2006. The cumulative total shareholder return assumes the investment of $100 in State Street’s common stock and in each index on December 31, 2001 and assumes reinvestment of dividends. The S&P Financial Index is a publicly available measure of 88 of the Standard & Poor’s 500 companies, representing 25 banking companies, 23 insurance companies, 26 diversified financial services companies, and 14 real estate companies.

 Comparison of Five-Year Cumulative Total Shareholder Return

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ITEM 6.   SELECTED FINANCIAL DATA

 

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ITEM 7.                MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF  OPERATIONS

GENERAL

State Street Corporation is a financial holding company organized under the laws of the Commonwealth of Massachusetts. Unless otherwise indicated or unless the context requires otherwise, all references in this Management’s Discussion to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. At December 31, 2006, we had total assets of $107.35 billion, total deposits of $65.65 billion, total shareholders’ equity of $7.25 billion and employed 21,700. With $11.85 trillion of assets under custody and $1.75 trillion of assets under management at year-end 2006, we are a leading specialist in meeting the needs of institutional investors worldwide.

In February 2007, we announced a definitive agreement to acquire Investors Financial Services Corp., or “Investors Financial,” a $12 billion bank holding company based in Boston. Under the terms of the agreement, we will exchange .906 shares of our common stock for each share of Investors Financial common stock. The transaction is subject to customary conditions, including the approvals of Investors Financial shareholders and regulatory agencies, and we expect to close the acquisition in the third quarter of 2007. We cannot be certain that approvals of Investors Financial shareholders or the regulators will be obtained.

The acquisition will be accounted for as a purchase. The acquisition agreement contains certain termination rights for both State Street and Investors Financial, and further provides that, if the agreement is terminated under specified circumstances, Investors Financial will be required to pay State Street a termination fee of up to $165 million.

We report two lines of business: Investment Servicing and Investment Management. These lines of business provide a full range of products and services for our customers, which include mutual funds and other collective investment funds, corporate and public retirement plans, insurance companies, foundations, endowments and other investment pools, and investment managers. Investment Servicing provides services to support institutional investors, such as custody, product- and participant-level accounting, daily pricing and administration; master trust and master custody; recordkeeping; shareholder services, including mutual fund and collective investment fund shareholder accounting; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and hedge fund manager operations outsourcing; and performance, risk and compliance analytics. Investment Management provides a broad array of services for managing financial assets, such as investment research services and investment management, including passive and active U.S. and non-U.S. equity and fixed income strategies. For additional information about our lines of business, see the “Line of Business Information” section of this Management’s Discussion and Note 22 of the “Notes to Consolidated Financial Statements” included in this Form 10-K under Item 8.

This Management’s Discussion and Analysis is part of our Annual Report on Form 10-K to the SEC, and should be read in conjunction with the “Consolidated Financial Statements” and the related “Notes to Consolidated Financial Statements,” included in this Form 10-K under Item 8. Certain previously reported amounts presented have been reclassified to conform to current period classifications. We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S. or “GAAP.” The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions in the application of certain accounting policies that materially affect the reported amounts of assets, liabilities, revenue and expenses. Estimates that require management to make assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods are discussed in more depth in the “Significant Accounting Estimates” section of this Management’s Discussion and Analysis.

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This Management’s Discussion and Analysis contains statements that are considered “forward-looking statements” within the meaning of U.S. federal securities laws. Forward-looking statements are based on our current expectations about revenue and market growth, acquisitions and divestitures, new technologies, services and opportunities, earnings and other factors. These forward-looking statements involve certain risks and uncertainties which could cause actual results to differ materially. We undertake no obligation to revise the forward-looking statements contained in this Management’s Discussion and Analysis to reflect events after the date we file this Form 10-K with the SEC. Additional information about forward-looking statements and related risks and uncertainties is included in this Form 10-K under Item 1A.

OVERVIEW OF FINANCIAL RESULTS

Years ended December 31,				2006			2005			2004
(Dollars in millions, except per share amounts)
Total fee revenue				$	5,186		$	4,551		$	4,048
Net interest revenue				1,110			907			859
Provision for loan losses				—			—			(18		)
Gains (Losses) on sales of available-for-sale investment securities, net				15			(1		)	26
Gain on sale of divested business				—			16			—
Total revenue				6,311			5,473			4,951
Total operating expenses				4,540			4,041			3,759
Income from continuing operations before income tax expense				1,771			1,432			1,192
Income tax expense from continuing operations				675			487			394
Income from continuing operations				1,096			945			798
Net income (loss) from discontinued operations				10			(107		)	—
Net income				$	1,106		$	838		$	798
Earnings Per Share From Continuing Operations:
Basic				$	3.31		$	2.86		$	2.38
Diluted				3.26			2.82			2.35
Earnings Per Share:
Basic				$	3.34		$	2.53		$	2.38
Diluted				3.29			2.50			2.35
Return on shareholders’ equity from continuing operations				16.2		%	15.3		%	13.3		%
Return on shareholders’ equity				16.4			13.6			13.3

 

Summary

Our financial results for 2006 reflect our overall objectives of consistent revenue growth, balancing expense growth with growth in revenue and continuing to expand our business overseas. The highlights are as follows:

·       Each category of revenue, as reported in our consolidated statement of income, increased in double digits compared to 2005, with the exception of processing fees and other revenue.

·       We achieved positive operating leverage for 2006 compared to 2005.

·       Our Investment Management business, State Street Global Advisors, or “SSgA,” increased its contribution to our consolidated results of operations to approximately 19% of consolidated total revenue and approximately 24% of consolidated income from continuing operations before income taxes for 2006, compared to 18% and 21%, respectively, for 2005.

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·       We grew the proportion of our non-U.S. revenue to approximately 43% of consolidated total revenue, from approximately 39% for 2005.

·       We ended 2006 with record levels of assets under custody and assets under management.

·       We exceeded our operating-basis financial goals for 2006 concerning growth in total revenue, growth in earnings per share from continuing operations and return on shareholders’ equity from continuing operations, all compared to 2005.

Our financial results for 2006 are summarized in the following “Financial Highlights” section, followed by a more detailed discussion in the “Consolidated Results of Operations” section of this Management’s Discussion and Analysis.

Financial Highlights

For 2006, we recorded income from continuing operations of $1.1 billion, or $3.26 per diluted share, a 16% increase from $945 million, or $2.82 per diluted share, for 2005. Total revenue increased 15% from 2005, and return on equity from continuing operations was 16.2%.

Overall results for 2006 included net income from discontinued operations of $10 million (pre-tax income of $16 million reduced by related tax expense of $6 million), or $.03 per share, the result of the finalization of certain legal, selling and other costs recorded in connection with our divestiture of Bel Air Investment Advisors LLC. Our results for 2005 included a net loss from discontinued operations of $107 million ($165 million charge reduced by related tax benefit of $58 million), related to our commitment to divest Bel Air.

Total revenue for 2006 grew 15% from 2005, with about three-quarters of the growth generated from existing customers. Total fee revenue for 2006, which grew 14%, reflected consistent growth throughout the year in servicing and management fees, up 10% and 26%, respectively, compared to 2005. Generally, servicing fees benefited from our continued expansion overseas and our cross-selling of services to our broad customer base, while management fees benefited from the strategic introduction of quantitative active products, which provide higher-margin revenue. Trading services revenue, which benefited from strong capital markets in the first half of 2006, grew 24% year over year. Securities finance revenue, which peaked in the second quarter and declined in the third quarter as a result of seasonality, benefited from increases in volumes of securities loaned, and for the full year increased 17% from 2005. We continued to cross-sell our existing customer relationships and to introduce new products and services to existing and new customers.

Net interest revenue increased 22% compared to 2005, and net interest margin increased to 1.25% from 1.08%. This growth was the result of several favorable trends—(1) the balance sheet repositioning we began to execute in late 2004; (2) higher yields on the re-investment of securities as they matured; (3) growth in our average balance sheet due to increased customer activity; (4) a more favorable mix of customer deposits, particularly non-U.S. deposits; and (5) the absence of increases in short-term interest rates by the Federal Reserve during the second half of the year. We accomplished the repositioning of the balance sheet without adversely affecting the credit profile of our investment portfolio, and at year-end 2006 had about 94% of the portfolio invested in “AAA” or “AA” rated securities, with 88% invested in “AAA” rated securities, compared to 95% and 90%, respectively, at year-end 2005.

Total operating expenses increased 12% from 2005, as we continued to carefully balance consistent expense management with revenue growth. Most of the increase was the result of increased incentive compensation due to our improved performance and increased headcount to support new business, particularly internationally. As a result, we generated positive operating leverage of almost 300 basis points on an annual basis, which we define as a rate of total revenue growth that exceeds the rate of growth of total operating expenses.

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SSgA is increasingly becoming a more significant contributor to our overall results, as that business comprised about 19% of our total consolidated revenue and about 24% of our total income from continuing operations before income taxes for 2006, compared to 18% and 21%, respectively, for 2005, and achieved a pre-tax operating margin of 35%, up from 31% for 2005. Net new business at SSgA was about $86 billion, with about two-thirds in active management products, such as enhanced indexing, hedge fund strategies and active quantitative management.

We continue to expand our business outside of the U.S., particularly in Europe and the Asia-Pacific region. For 2006, approximately 43% of our consolidated total revenue was generated from non-U.S. activities, up from approximately 39% for 2005, and at year-end 2006 we employed 8,630 outside the U.S. Our goal is to eventually generate 50% of our consolidated total revenue from outside the United States.

Assets under custody and assets under management both increased to record levels at year-end 2006, with assets under custody at $11.85 trillion, up 17% from $10.12 trillion a year ago, and assets under management at $1.75 trillion, up 21% from $1.44 trillion a year ago. Assets under custody have grown at a compound annual rate of 18% since year-end 2002, with U.S. assets growing by 14% and non-U.S. assets growing by 36%, while assets under management have grown at a compound annual rate of 23% over the same period.

Financial Goals

In early 2006, we reaffirmed our financial goals for State Street for 2006. These financial goals were:

·       Growth in operating-basis revenue of between 8% and 12%;

·       Growth in operating-basis earnings per share from continuing operations of between 10% and 15%; and

·       Operating-basis return on shareholders’ equity from continuing operations of between 14% and 17%.

Operating-basis results, as defined by management, include fully taxable-equivalent net interest revenue, reflecting tax-equivalent adjustments of $45 million and $42 million for 2006 and 2005, respectively, and a corresponding charge to income tax expense, and for 2006, exclude aggregate tax-related adjustments of $65 million, or $.20 per share. The tax adjustments related to additional provisions that resulted from the impact of the Tax Increase Prevention and Reconciliation Act and issues with respect to certain of our leveraged leases.

Management measures our financial goals and related results on an operating basis to provide financial information that is comparable from period to period, and to present comparable financial trends with respect to our ongoing business operations. The use of fully taxable-equivalent net interest revenue facilitates the comparison of revenues from both taxable and non-taxable sources. The previously described tax-related adjustments are not part of our normal ongoing business operations, and as a result prevent a meaningful comparison of earnings per share and return on shareholders’ equity with that of other periods. Management believes that operating-basis financial information facilitates an investor’s understanding and analysis of State Street’s underlying performance and trends in addition to financial information prepared in accordance with GAAP.

For 2006, we exceeded our financial goals. We increased our operating-basis earnings per share from continuing operations by 23%, from $2.82 to $3.46 (up 16% from $2.82 to $3.26 on a GAAP basis, including the tax-related adjustments). Our operating-basis revenue increased 15% from $5.52 billion to $6.36 billion (including taxable-equivalent adjustments of $45 million for 2006 and $42 million for 2005); and we recorded operating basis return on shareholders’ equity from continuing operations of 17.1% (16.2% on a GAAP basis, including the tax-related adjustments).

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Outlook

Our long term financial goals remain the same, but based on our recently announced agreement to acquire Investors Financial, we have adjusted our financial goals for 2007 to the following, assuming the acquisition closes in July 2007:

·       Growth in operating-basis revenue of between 16% and 18%;

·       Growth in operating-basis earnings per share from continuing operations of between 8% and 10%; and

·       Operating-basis return on shareholders’ equity from continuing operations of between 12% and 15%.

Operating-basis results for 2007 will exclude merger, integration and restructuring charges related to the above-mentioned acquisition, and for 2006 will exclude the previously discussed tax-related adjustments. Some of the factors and assumptions that we considered in determining this outlook for 2007 were as follows:

·       Expected equity market growth, based on S&P 500 and/or MSCI® EAFE indices, of about 7%;

·       Growth in revenue generated from active quantitative asset management products;

·       Relatively stable domestic interest rates;

·       The expected flattening of the U.S. dollar yield curve;

·       The continuation of beneficial trends in non-U.S. interest rates;

·       Modest growth in non-U.S. deposits, as well as the maintenance of a favorable mix of customer deposits, including demand deposits;

·       A stable income tax and regulatory environment;

·       Shareholder and regulatory approvals of the Investors Financial acquisition;

·       Achievement of expected cost savings from the acquisition; and

·       Retention of, and success in cross-selling to, Investors Financial’s customer base.

Information about other risks and uncertainties which could cause actual results to differ materially from those expected is included in this Form 10-K under Item 1A.

CONSOLIDATED RESULTS OF OPERATIONS

This section discusses our consolidated results of operations for 2006 compared to 2005, and should be read in conjunction with the consolidated financial statements and related notes included in this Form 10-K under Item 8.

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TOTAL REVENUE

													Change
Years ended December 31,				2006			2005			2004			2005-2006
(Dollars in millions)
Fee Revenue:
Servicing fees				$	2,723		$	2,474		$	2,263			10	%
Management fees				943			751			623				26
Trading services				862			694			595				24
Securities finance				386			330			259				17
Processing fees and other				272			302			308				(10	)
Total fee revenue				5,186			4,551			4,048				14
Net Interest Revenue:
Interest revenue				4,324			2,930			1,787				48
Interest expense				3,214			2,023			928				59
Net interest revenue				1,110			907			859				22
Provision for loan losses				—			—			(18		)
Net interest revenue after provision for loan losses				1,110			907			877				22
Gains (Losses) on sales of available-for-sale investment securities, net				15			(1		)	26
Gain on sale of Private Asset Management business				—			16			—
Total revenue				$	6,311		$	5,473		$	4,951			15

 

We are one of the world’s leading specialists in servicing mutual funds, other collective investment funds and pension plans. We are consistently gaining business globally, and for 2006, our non-U.S. revenue was approximately 43% of our total revenue, compared to 26% for 2000. We provide a broad range of reliable, easy-to-integrate investment services that are global and enable our customers to develop and launch competitive new investment products. We also provide active management products, including enhanced indexing, hedge fund strategies and quantitative management, and passive investment management products and strategies.

We provide fund accounting, custody, investment management, securities finance, transfer agency services, and operations outsourcing for investment managers and hedge fund managers. These services support the complex financial strategies and transactions of our customers worldwide, in any time zone across multiple currencies. Our focus on the total needs of the customer allows us to develop active, long-term relationships that result in high customer retention, cross-selling opportunities and recurring revenue. The servicing markets in which we compete are very price-competitive, and we consistently focus on winning and retaining customer business. This focus requires a strong commitment to customers while constantly working toward providing services at lower costs.

Our broad range of services generates fee revenue and net interest revenue. Fee revenue generated by investment servicing and investment management is augmented by securities finance, trading services and other processing fee revenue. We earn net interest revenue from customers’ deposits and short-term investment activities, by providing deposit services and short-term investment vehicles, such as repurchase agreements and commercial paper, to meet customers’ needs for high-grade liquid investments, and investing these sources of funds and additional borrowings in assets yielding a higher rate.

Fee Revenue

Servicing and management fees are the largest components of fee revenue, and collectively comprised approximately 71% of total fee revenue for 2006 and 2005. These fees are a function of several factors, including the mix and volume of assets under custody and assets under management, securities positions held and the volume of portfolio transactions, and the types of products and services used by customers, and are affected by changes in worldwide equity and fixed income valuations.

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Generally, servicing fees are impacted, in part, by changes in daily average valuations of assets under custody, while management fees are impacted by changes in month-end valuations of assets under management. Additional factors, such as transaction volumes, balance credits, customer minimum balances and other factors may have a significant impact on servicing fee revenue. Generally, management fee revenue is more sensitive to market valuations than servicing fee revenue. In addition, performance fees have become a larger component of management fee revenue over the past two years, and amounted to about 9% of management fees for 2006. Performance fees are generated when the performance of managed funds exceeds benchmarks specified in the management agreements.

In light of the above, we estimate, assuming all other factors remain constant, that a 10% increase or decrease in worldwide equity values would result in a corresponding change in our total revenue of approximately 2%. If fixed income security values were to increase or decrease by 10%, we would anticipate a corresponding change of approximately 1% in our total revenue.

The following table presents selected equity market indices. Daily averages and the averages of month-end indices demonstrate worldwide equity market valuation changes that impact servicing and management fee revenue, respectively. Year-end indices impact the value of assets under custody and management at those dates. The index names listed in the table and elsewhere in this Management’s Discussion and Analysis are service marks of their respective owners.

INDEX

 

FEE REVENUE

(1)          Includes performance fees of $84 million, $41 million and $29 million for 2006, 2005 and 2004, respectively.

Almost 70% of the $635 million increase in total fee revenue over 2005 came from servicing and management fees.

Servicing Fees:

Servicing fees include fee revenue from U.S. mutual funds, collective investment funds worldwide, corporate and public retirement plans, insurance companies, foundations, endowments, and other investment pools. Products and services include custody; product- and participant-level accounting; daily pricing and administration; recordkeeping; investment manager and hedge fund manager operations outsourcing services; master trust and master custody; and performance, risk and compliance analytics.

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The increase in servicing fees of $249 million from 2005 primarily resulted from net new business from existing and new customers, higher average equity market valuations, and higher customer transaction volumes. Net new business is defined as new business net of lost business. For 2006, servicing fees generated from customers outside the U.S. were approximately 44% of total servicing fees, up from 40% in  2005.

We are the largest provider of mutual fund custody and accounting services in the United States. We distinguish ourselves from other mutual fund service providers by offering customers a broad array of integrated products and services, including accounting, daily pricing and fund administration. We calculate more than 31% of the U.S. mutual fund prices provided to NASDAQ that appear daily in The Wall Street Journal and other publications with an accuracy rate of 99.9%.

We have a leading position for servicing U.S. tax-exempt assets for corporate and public pension funds. We provide trust and valuation services for more than 4,300 daily-priced portfolios, making us a leader for both monthly and daily valuation services.

We are a leading service provider outside of the U.S. as well. In Germany, we provide Depotbank services for approximately 17% of retail and institutional fund assets. In the United Kingdom, we provide custody services for 19% of pension fund assets and provide administration services to more than 23% of mutual fund assets. We service approximately 13% of the hedge fund market and more than $500 billion of offshore assets, primarily domiciled in the Cayman Islands, Ireland, Luxembourg, and the Channel Islands. We have more than $800 billion in assets under administration in the Asia-Pacific region, and are a leader in Japan with more than 36% of the trust assets held by non-domestic trust banks.

At year-end 2006, our total assets under custody were $11.85 trillion, compared to $10.12 trillion a year earlier. The value of assets under custody is a broad measure of the relative size of various markets served. Changes in the value of assets under custody do not necessarily result in proportional changes in revenue. Assets under custody consisted of the following at December 31:

ASSETS UNDER CUSTODY

 

MIX OF ASSETS UNDER CUSTODY

 

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GEOGRAPHIC MIX OF ASSETS UNDER CUSTODY

 

Management Fees:

We provide a broad range of investment management strategies, specialized investment management advisory services and other financial services for corporations, public funds, and other sophisticated investors. These services are offered through State Street Global Advisors®, or “SSgA®,” a division of State Street. Based upon assets under management, SSgA is the largest manager of institutional assets worldwide, the largest manager of assets for tax-exempt organizations (primarily pension plans) in the United States, and the fourth largest investment manager overall in the world. SSgA offers a broad array of investment management strategies, including passive and active, such as enhanced indexing and hedge fund strategies, using quantitative and fundamental methods for both U.S. and global equities and fixed income securities. SSgA also offers exchange traded funds, or “ETFs,” such as the SPDR® Dividend ETFs.

The $192 million increase in management fees from 2005 primarily resulted from higher equity market valuations and net new business. In addition, performance fees increased from $41 million in 2005 to $84 million in 2006. Management fees generated from customers outside the United States were approximately 32% of total management fees, up from 30% for 2005.

At year-end 2006, assets under management were $1.75 trillion, compared to $1.44 trillion at year-end 2005. While certain management fees are directly determined by the value of assets under management and the investment strategy employed, management fees reflect other factors as well, including our relationship pricing for customers who use multiple services, and the benchmarks specified in the respective management agreements related to performance fees. Accordingly, there is not necessarily a direct correlation between the value of assets under management, market indices and management fee revenue. Assets under management consisted of the following at December 31.

ASSETS UNDER MANAGEMENT

 

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GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT

 

The following table presents a roll-forward of assets under management for the three years ended December 31, 2006:

ASSETS UNDER MANAGEMENT

 

Trading Services:

Trading services revenue includes revenue from foreign exchange trading and brokerage and other trading services. We offer a complete range of foreign exchange services under an account model that focuses on the global requirements of our customers to execute trades and receive market insights in any time zone. We have exclusive ownership of FX Connect®, the world’s first and leading foreign exchange trading platform, and we provide quantitatively-based research into investor behavior, as well as consultative services that use quantitative tools designed to optimize our customers’ returns. Foreign exchange trading revenue is influenced by three principal factors: the volume and type of customer foreign exchange transactions; currency volatility and trend; and the management of currency market risks.

For 2006, foreign exchange trading revenue increased 31%, to $611 million from $468 million in 2005, and benefited from a strong first half of the year. The increase from 2005 resulted from increased transaction volumes, a favorable transaction mix related to custody FX services, and an increase in FX trading profits, partially offset by a decline in customer volume-weighted currency volatility.

We also offer a range of brokerage and other trading products tailored specifically to meet the needs of the global pension community, including transition management, commission recapture and self-directed brokerage. These products are differentiated by our position as an agent of the institutional investor. Brokerage and other trading fees were $251 million in 2006, up 11% compared to 2005. Growth was attributable to a significant increase in other trading services and trading profits, offset by a slight decrease in brokerage revenue, the result of a decline in commission recapture revenue.

Securities Finance:

Securities finance provides liquidity to the financial markets and an effective means for customers to earn revenue on their existing portfolios. By acting as a lending agent and coordinating loans between lenders and borrowers, we lend securities and provide liquidity in more than 35 markets around the world. Borrowers provide collateral in the form of cash or securities to State Street in return for loaned securities. For cash collateral, we pay a usage fee to the provider of the cash collateral, and invest the cash collateral in certain investment vehicles. The spread between the yield on the investment vehicle and the usage fee

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paid to the provider of the collateral is split between the lender of the securities and State Street as agent. For non-cash collateral, the borrower pays a fee for the loaned securities, and the fee is split between the lender of the securities and State Street.

Securities finance revenue has historically been affected by seasonality during the year, and is principally a function of the volume of securities loaned and the interest-rate spreads earned on the collateral. During 2006, securities finance revenue peaked in the second quarter, as a result of heavy borrowing demand from customers, declined in the third quarter, and rebounded slightly in the fourth quarter. Overall, securities finance revenue increased 17% from a year earlier. Growth in this revenue over 2005 resulted from a 22% increase in securities lending volumes. Consolidated spread was essentially unchanged from the prior year.

Processing Fees and Other:

Processing fees and other revenue includes diverse types of fees and other revenue, including fees from our structured products business, fees from software licensing and maintenance, profits and losses from unconsolidated subsidiaries, gains and losses on sales of leased equipment and other assets, and amortization of investments in tax-advantaged financings. Processing fees and other revenue decreased 10% from 2005, with the decline partially due to the absence of fees from Deutsche Bank AG related to customer deposits of the acquired Global Securities Services, or “GSS,” business, which were converted to our systems in prior years.

Net Interest Revenue

In servicing sophisticated global investors, we provide short-term funds management, deposit services and repurchase agreements for cash positions associated with our customers’ investing activities.

NET INTEREST REVENUE

 

Additional detail about the components of interest revenue and interest expense is in Note 16 of the “Notes to Consolidated Financial Statements” included in this Form 10-K under Item 8.

The increase in net interest revenue for 2006 compared to 2005 was due to several factors. On the asset side, there was an increase in average interest-earning assets as well as higher yields on our investment securities portfolio. The higher yields were the result of a higher interest rate environment as well as a repositioning program begun in late 2004 and substantially completed in the second half of 2006. On the liability side, a higher level of customer deposits, primarily resulting from the growth of our non-U.S. operations, as well as a more favorable mix of deposits, also contributed to the growth in net interest revenue. These benefits were partially offset by the impact of higher funding costs, as the Federal Reserve raised short-term interest rates during the first half of the year.

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