STT-2014.09.30_10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
(Mark One)
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x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2014
OR
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¨ | 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)
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Massachusetts | | 04-2456637 |
(State or other jurisdiction of incorporation) | | (I.R.S. Employer Identification No.) |
One Lincoln Street Boston, Massachusetts | | 02111 |
(Address of principal executive office) | | (Zip Code) |
617-786-3000 (Registrant’s telephone number, including area code) |
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 ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer x | | Accelerated filer ¨ | | Non-accelerated filer ¨ | | Smaller reporting company ¨ |
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The number of shares of the registrant’s common stock outstanding as of October 31, 2014 was 417,495,288.
STATE STREET CORPORATION
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED
September 30, 2014
TABLE OF CONTENTS
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PART I. FINANCIAL INFORMATION | |
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PART II. OTHER INFORMATION | |
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
TABLE OF CONTENTS
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
GENERAL
State Street Corporation, or the parent company, is a financial holding company headquartered in Boston, Massachusetts. Unless otherwise indicated or unless the context requires otherwise, all references in this Management's Discussion and Analysis to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. Our principal banking subsidiary is State Street Bank and Trust Company, or State Street Bank. As of September 30, 2014, we had consolidated total assets of $274.81 billion, consolidated total deposits of $207.97 billion, consolidated total shareholders' equity of $21.16 billion and 29,510 employees. With $28.47 trillion of assets under custody and administration and $2.42 trillion of assets under management as of September 30, 2014, we are a leading specialist in meeting the needs of institutional investors worldwide.
We have two lines of business:
Investment Servicing provides services for mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations and endowments worldwide. Products include custody; product- and participant-level accounting; daily pricing and administration; master trust and master custody; record-keeping; cash management; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and alternative investment manager operations outsourcing; and performance, risk and compliance analytics to support institutional investors.
Investment Management, through State Street Global Advisors, or SSgA, provides a broad array of investment management, investment research and investment advisory services to corporations, public funds and other sophisticated investors. SSgA offers active and passive asset management strategies across equity, fixed-income and cash asset classes. Products are distributed directly and through intermediaries using a variety of investment vehicles, including exchange-traded funds, or ETFs, such as the SPDR® ETF brand.
For financial and other information about our lines of business, refer to “Line of Business Information” included in this Management's Discussion and Analysis and note 17 to the consolidated financial statements included in this Form 10-Q.
This Management's Discussion and Analysis is part of our Quarterly Report on Form 10-Q for the
quarter ended September 30, 2014, and updates the Management's Discussion and Analysis in our Annual Report on Form 10-K for the year ended December 31, 2013, referred to as our 2013 Form 10-K, and in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2014 and June 30, 2014, all of which we previously filed with the SEC. You should read the financial information contained in this Management's Discussion and Analysis and elsewhere in this Form 10-Q in conjunction with the financial and other information contained in those reports. Certain previously reported amounts presented in this Form 10-Q have been reclassified to conform to current-period presentation.
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the U.S., referred to as GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in its application of certain accounting policies that materially affect the reported amounts of assets, liabilities, equity, revenue and expenses.
The significant accounting policies that require us to make judgments, estimates and assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods consist of accounting for fair value measurements; other-than-temporary impairment of investment securities; and impairment of goodwill and other intangible assets. These significant accounting policies require the most subjective or complex judgments, and underlying estimates and assumptions could be subject to revision as new information becomes available.
Additional information about these significant accounting policies is included under “Significant Accounting Estimates” in Management's Discussion and Analysis in our 2013 Form 10-K. We did not change these significant accounting policies in the first nine months of 2014.
Certain financial information provided in this Management's Discussion and Analysis is prepared on both a GAAP, or reported basis, and a non-GAAP, or operating basis, including certain non-GAAP measures used in the calculation of identified regulatory capital ratios. We measure and compare certain financial information on an operating basis, as we believe that this presentation supports meaningful comparisons from period to period and the analysis of comparable financial trends with respect to State Street's normal ongoing business operations. We believe that operating-basis financial information,
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
which reports non-taxable revenue, such as interest revenue associated with tax-exempt investment securities, on a fully taxable-equivalent basis, facilitates an investor's understanding and analysis of State Street's underlying financial performance and trends in addition to financial information prepared and reported in conformity with GAAP.
We also believe that the use of certain non-GAAP measures in the calculation of identified regulatory capital ratios is useful in understanding State Street's capital position and is of interest to investors. Operating-basis financial information should be considered in addition to, not as a substitute for or superior to, financial information prepared in conformity with GAAP. Any non-GAAP, or operating-basis, financial information presented in this Management’s Discussion and Analysis is reconciled to its most directly comparable GAAP-basis measure.
We provide additional disclosures required by applicable bank regulatory standards, including supplemental qualitative and quantitative information with respect to regulatory capital (including market risk associated with our trading activities), and summary results of semi-annual State Street-run stress tests which we conduct under the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act. These additional disclosures are accessible under "Filings and Reports" on the “Investor Relations” section of our corporate website at www.statestreet.com. We have included our website address in this report as an inactive textual reference only. Information on our website is not incorporated by reference into this Form 10-Q.
FORWARD-LOOKING STATEMENTS
This Form 10-Q, as well as other reports submitted by us under the Securities Exchange Act of 1934, registration statements filed by us under the Securities Act of 1933, our annual report to shareholders and other public statements we may make, contain statements (including statements in this Management's Discussion and Analysis) that are considered “forward-looking statements” within the meaning of U.S. securities laws, including statements about our goals and expectations regarding our business, financial and capital condition, results of operations, strategies, financial portfolio performance, dividend and stock purchase programs, market growth, acquisitions, joint ventures and divestitures, new technologies, services and opportunities, and expected outcomes of legal proceedings, as well as regarding industry, regulatory, economic and market trends, initiatives and developments, the business environment and other matters that do not relate strictly to historical facts.
Terminology such as “plan,” “expect,” “intend,” “objective,” “forecast,” “outlook,” “believe,” “anticipate,” “estimate,” “seek,” “may,” “will,” “trend,” “target,” “strategy” and “goal,” or similar statements or variations of such terms, are intended to identify forward-looking statements, although not all forward-looking statements contain such terms.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management's expectations and assumptions at the time the statements are made, and are not guarantees of future results. Management's expectations and assumptions, and the continued validity of the forward-looking statements, are subject to change due to a broad range of factors affecting the national and global economies, the equity, debt, currency and other financial markets, as well as factors specific to State Street and its subsidiaries, including State Street Bank. Factors that could cause changes in the expectations or assumptions on which forward-looking statements are based cannot be foreseen with certainty and include, but are not limited to:
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• | the financial strength and continuing viability of the counterparties with which we or our clients do business and to which we have investment, credit or financial exposure, including, for example, the direct and indirect effects on counterparties of the sovereign-debt risks in the U.S., Europe and other regions; |
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• | increases in the volatility of, or declines in the level of, our net interest revenue, changes in the composition or valuation of the assets recorded in our consolidated statement of condition (and our ability to measure the fair value of investment securities) and the possibility that we may change the manner in which we fund those assets; |
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• | the liquidity of the U.S. and international securities markets, particularly the markets for fixed-income securities and inter-bank credits, and the liquidity requirements of our clients; |
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• | the level and volatility of interest rates and the performance and volatility of securities, credit, currency and other markets in the U.S. and internationally; |
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• | the credit quality, credit-agency ratings and fair values of the securities in our investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the respective securities and the recognition of an impairment loss in our consolidated statement of income; |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
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• | our ability to attract deposits and other low-cost, short-term funding, and our ability to deploy deposits in a profitable manner consistent with our liquidity requirements and risk profile; |
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• | the manner and timing with which the Federal Reserve and other U.S. and non-U.S. regulators implement the Dodd-Frank Act, changes to the Basel III capital framework and European legislation, such as the Alternative Investment Fund Managers Directive and the Undertakings for Collective Investment in Transferable Securities Directives, with respect to the levels of regulatory capital we must maintain, our credit exposure to third parties, margin requirements applicable to derivatives, banking and financial activities and other regulatory initiatives in the U.S. and internationally, including regulatory developments that result in changes to our structure or operating model, increased costs or other changes to how we provide services; |
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• | the impact of evolving and increasing regulatory compliance requirements and expectations; |
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• | adverse changes in the regulatory capital ratios that we are required or will be required to meet, whether arising under the Dodd-Frank Act or the Basel III capital and liquidity standards, or due to changes in regulatory positions, practices or regulations in jurisdictions in which we engage in banking activities, including changes in internal or external data, formulae, models, assumptions or other advanced systems used in the calculation of our capital ratios that cause changes in those ratios as they are measured from period to period; |
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• | increasing requirements to obtain the prior approval of the Federal Reserve or our other U.S. and non-U.S. regulators for the use, allocation or distribution of our capital or other specific capital actions or programs, including acquisitions, dividends and equity purchases, without which our growth plans, distributions to shareholders, equity purchase programs or other capital initiatives may be restricted; |
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• | changes in law or regulation, or the enforcement of law or regulation, that may adversely affect our business activities or those of our clients or our counterparties, and the products or services that we sell, including additional or increased taxes or assessments thereon, capital adequacy requirements, margin requirements and changes that expose us to risks related to the |
adequacy of our controls or compliance programs;
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• | financial market disruptions or economic recession, whether in the U.S., Europe, Asia or other regions; |
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• | our ability to promote a strong culture of risk management, operating controls, compliance oversight and governance that meet our expectations and those of our clients and our regulators; |
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• | the results of, and costs associated with, governmental or regulatory inquiries and investigations, litigation and similar claims, disputes, or proceedings; |
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• | delays or difficulties in the execution of our previously announced Business Operations and Information Technology Transformation program, which could lead to changes in our estimates of the charges, expenses or savings associated with the planned program and may cause volatility of our earnings; |
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• | the potential for losses arising from our investments in sponsored investment funds; |
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• | the possibility that our clients will incur substantial losses in investment pools for which we act as agent, and the possibility of significant reductions in the liquidity or valuation of assets underlying those pools; |
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• | our ability to anticipate and manage the level and timing of redemptions and withdrawals from our collateral pools and other collective investment products; |
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• | the credit agency ratings of our debt and depository obligations and investor and client perceptions of our financial strength; |
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• | adverse publicity, whether specific to State Street or regarding other industry participants or industry-wide factors, or other reputational harm; |
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• | our ability to control operational risks, data security breach risks and outsourcing risks, our ability to protect our intellectual property rights, the possibility of errors in the quantitative models we use to manage our business and the possibility that our controls will prove insufficient, fail or be circumvented; |
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• | dependencies on information technology and our ability to control related risks, including cyber-crime and other threats to our information technology infrastructure and systems and their effective operation both independently and with external systems, and complexities and costs of protecting the security of our systems and data; |
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• | our ability to grow revenue, control expenses, attract and retain highly skilled people and raise the capital necessary to achieve our |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
business goals and comply with regulatory requirements;
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• | changes or potential changes to the competitive environment, including changes due to regulatory and technological changes, the effects of industry consolidation and perceptions of State Street as a suitable service provider or counterparty; |
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• | changes or potential changes in how and in what amounts clients compensate us for our services, and the mix of services provided by us that clients choose; |
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• | our ability to complete acquisitions, joint ventures and divestitures, including the ability to obtain regulatory approvals, the ability to arrange financing as required and the ability to satisfy closing conditions; |
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• | the risks that our acquired businesses and joint ventures will not achieve their anticipated financial and operational benefits or will not be integrated successfully, or that the integration will take longer than anticipated, that expected synergies will not be achieved or unexpected negative synergies will be experienced, that client and deposit retention goals will not be met, that other regulatory or operational challenges will be experienced, and that disruptions from the transaction will harm our relationships with our clients, our employees or regulators; |
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• | our ability to recognize emerging needs of our clients and to develop products that are responsive to such trends and profitable to us, the performance of and demand for the products and services we offer, and the potential for new products and services to impose additional costs on us and expose us to increased operational risk; |
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• | changes in accounting standards and practices; and |
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• | changes in tax legislation and in the interpretation of existing tax laws by U.S. and non-U.S. tax authorities that affect the amount of taxes due. |
Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed in this section and elsewhere in this Form 10-Q or disclosed in our other SEC filings, including the risk factors discussed in our 2013 Form 10-K. Forward-looking statements in this Form 10-Q should not be relied on as representing our expectations or beliefs as of any date subsequent to the time this Form 10-Q is filed with the SEC. We undertake no obligation to revise our forward-looking statements after the time they are made. The factors discussed above are not intended
to be a complete statement of all risks and uncertainties that may affect our businesses. We cannot anticipate all developments that may adversely affect our business or operations or our consolidated results of operations or financial condition.
Forward-looking statements should not be viewed as predictions, and should not be the primary basis on which investors evaluate State Street. Any investor in State Street should consider all risks and uncertainties disclosed in our SEC filings, including our filings under the Securities Exchange Act of 1934, in particular our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K, or registration statements filed under the Securities Act of 1933, all of which are accessible on the SEC's website at www.sec.gov or on the “Investor Relations” section of our corporate website at www.statestreet.com.
OVERVIEW OF FINANCIAL RESULTS
The following tables present our financial results for the quarters and nine months ended September 30, 2014 and 2013:
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| Quarters Ended September 30, | | |
(Dollars in millions, except per share amounts) | 2014 | | 2013 | | % Change |
Total fee revenue | $ | 2,012 |
| | $ | 1,883 |
| | 7 | % |
Net interest revenue | 570 |
| | 546 |
| | 4 |
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Gains (losses) related to investment securities, net | — |
| | (4 | ) | | |
Total revenue | 2,582 |
| | 2,425 |
| | 6 |
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Provision for loan losses | 2 |
| | — |
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Total expenses | 1,892 |
| | 1,722 |
| | 10 |
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Income before income tax expense | 688 |
| | 703 |
| | (2 | ) |
Income tax expense | 128 |
| | 163 |
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Net income | $ | 560 |
| | $ | 540 |
| | 4 |
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Adjustments to net income: | | | | | |
Dividends on preferred stock | (18 | ) | | (7 | ) | | |
Earnings allocated to participating securities | — |
| | (2 | ) | | |
Net income available to common shareholders | $ | 542 |
| | $ | 531 |
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Earnings per common share: | | | | | |
Basic | $ | 1.28 |
| | $ | 1.20 |
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Diluted | 1.26 |
| | 1.17 |
| | 8 |
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Average common shares outstanding (in thousands): | | | | | |
Basic | 421,974 |
| | 442,860 |
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Diluted | 429,736 |
| | 452,154 |
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Cash dividends declared per common share | $ | .30 |
| | $ | .26 |
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Return on average common equity | 10.6 | % | | 10.8 | % | | |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
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| Nine Months Ended September 30, | | |
(Dollars in millions, except per share amounts) | 2014 | | 2013 | | % Change |
Total fee revenue | $ | 5,975 |
| | $ | 5,711 |
| | 5 | % |
Net interest revenue | 1,686 |
| | 1,718 |
| | (2 | ) |
Gains (losses) related to investment securities, net | 4 |
| | (9 | ) | | |
Total revenue | 7,665 |
| | 7,420 |
| | 3 |
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Provision for loan losses | 6 |
| | — |
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Total expenses | 5,770 |
| | 5,346 |
| | 8 |
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Income before income tax expense | 1,889 |
| | 2,074 |
| | (9 | ) |
Income tax expense | 344 |
| | 491 |
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Net income | $ | 1,545 |
| | $ | 1,583 |
| | (2 | ) |
Adjustments to net income: | | | | | |
Dividends on preferred stock | (43 | ) | | (20 | ) | | |
Earnings allocated to participating securities | (2 | ) | | (6 | ) | | |
Net income available to common shareholders | $ | 1,500 |
| | $ | 1,557 |
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Earnings per common share: | | | | | |
Basic | $ | 3.52 |
| | $ | 3.46 |
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Diluted | 3.45 |
| | 3.40 |
| | 1 |
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Average common shares outstanding (in thousands): | | | | | |
Basic | 426,775 |
| | 449,742 |
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Diluted | 434,510 |
| | 458,392 |
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Cash dividends declared per common share | $ | .86 |
| | $ | .78 |
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Return on average common equity | 10.0 | % | | 10.4 | % | | |
The following “Highlights” and “Financial Results” sections provide information related to significant events, as well as highlights of our consolidated financial results for the third quarter of 2014. More detailed information about our consolidated financial results, including comparisons of our financial results for the third quarter of 2014 to those for the third quarter of 2013 and for the nine months ended September 30, 2014 to those for the nine months ended September 30, 2013, is provided under “Consolidated Results of Operations,” which follows these sections.
Highlights
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• | In the third quarter of 2014, we purchased approximately 5.8 million shares of our common stock at an average price of $70.61 per share and an aggregate cost of approximately $410 million. |
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• | In the third quarter of 2014, we declared a quarterly common stock dividend of $0.30 per share, totaling approximately $126 million, which was paid in October 2014. |
Additional information about our common stock purchase program, as well as our
common stock dividends, is provided under “Financial Condition – Capital” in this Management's Discussion and Analysis. Information about our common stock purchase program is also provided in Part II Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” included in this Form 10-Q.
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• | State Street is registered with the Federal Reserve as a bank holding company pursuant to the Bank Holding Company Act of 1956. The Bank Holding Company Act limits the activities in which we (and non-banking entities that we are deemed to control under that Act) may engage to activities the Federal Reserve considers to be closely related to banking or to managing or controlling banks. Financial holding company status expands the activities permissible for a bank holding company to those that are deemed to be “financial in nature” by the Federal Reserve. State Street elected to become a financial holding company under the Bank Holding Company Act. Financial holding company status requires State Street and its banking subsidiaries to remain well capitalized and well managed and to comply with Community Reinvestment Act obligations. Currently, under the Bank Holding Company Act, we may not be able to engage in new activities or acquire shares or control of other businesses. |
In addition, we meet the criteria for a systemically important financial institution under the Dodd-Frank Act and we are one of 29 banking organizations identified as a global systemically important bank, or G-SIB, by the Financial Stability Board.
Our compliance obligations have increased significantly due to new regulations in the U.S. and internationally that have been adopted or proposed in response to the financial crisis. As a systemically important financial institution, we are subject to enhanced supervision and prudential standards. In Europe, certain of our European banking subsidiaries are subject to the European Central Bank's new supervisory authority. Our status as a G-SIB has also resulted in heightened prudential and conduct expectations of our U.S., non-U.S. and international regulators with respect to our capital and liquidity management and our compliance and risk oversight programs. These heightened expectations have increased our regulatory compliance costs,
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
including personnel and systems, as well as significant additional implementation and related costs to enhance our programs.
In addition, we and other large banking organizations are required under the Dodd-Frank Act to periodically submit a resolution plan to the Federal Reserve and the Federal Deposit Insurance Corporation, or FDIC, describing our strategy for rapid and orderly resolution in the event of material financial distress or failure. In August 2014, the Federal Reserve and the FDIC announced the completion of their reviews of resolution plans submitted in 2013 by 11 large, complex banking organizations, including State Street, under the requirements of the Dodd-Frank Act, and informed each of these organizations of specific shortcomings with their respective 2013 resolution plans. If we fail to meet regulatory expectations to the satisfaction of the Federal Reserve and the FDIC in the submission of our 2015 resolution plan, we could be subject to more stringent capital, leverage or liquidity requirements, restrictions on our growth, activities or operations, or be required to divest certain of our assets or operations.
Financial Results
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• | Total revenue in the third quarter of 2014 increased 6%, and total fee revenue increased 7%, compared to the third quarter of 2013. Increases in servicing fee and management fee revenue, trading services revenue, net interest revenue and securities finance revenue were partly offset by a decline in processing fees and other revenue. |
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• | Servicing fee revenue in the third quarter of 2014 increased 8% compared to the third quarter of 2013, mainly the result of stronger global equity markets and the positive revenue impact of net new business. Servicing fees generated outside the U.S. in both the third quarter of 2014 and the third quarter of 2013 were approximately 42% of total servicing fees for those periods. |
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• | Management fee revenue increased 14% in the third quarter of 2014 compared to the third quarter of 2013, primarily the result of stronger global equity markets, net inflows, higher performance fees and the positive revenue impact of net new business. Management fees generated outside the U.S. in the third quarter of 2014 and the third quarter of 2013 were approximately 38% and 37%, respectively, of total management fees for those periods. |
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• | In the third quarter of 2014, trading services revenue, composed of revenue generated by foreign exchange trading and revenue from brokerage and other trading services, increased 5% compared to the third quarter of 2013. Revenue from foreign exchange trading increased 10%, with direct sales and trading foreign exchange revenue up 39% and estimated indirect foreign exchange revenue down 21%, from the third quarter of 2013. Direct sales and trading foreign exchange revenue benefited from higher volumes, while indirect foreign exchange revenue declined mainly due to lower volatility and lower spreads. |
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• | Securities finance revenue increased 34% in the third quarter of 2014 compared to the third quarter of 2013, mainly reflective of growth in our enhanced custody business, where we participate in securities finance transactions as a principal, and the impact of higher lending volumes associated with our agency lending program. |
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• | Net interest revenue in the third quarter of 2014 increased 4% compared to the third quarter of 2013, primarily driven by the investment of a higher level of client deposits, an increase in the investment portfolio, and our continued investment in senior secured bank loans in the third quarter of 2014. |
Net interest margin, calculated on fully taxable-equivalent net interest revenue, declined 21 basis points to 1.12% in the third quarter of 2014 from 1.33% in the third quarter of 2013. Continued elevated levels of client deposits increased our average interest-earning assets, but negatively affected our net interest margin, as we placed a portion of these deposits with U.S. and non-U.S. central banks and earned the relatively low interest rates paid by the central banks on those balances.
Fully taxable-equivalent net interest revenue and net interest margin are discussed in more detail under “Consolidated Results of Operations - Net Interest Revenue” in this Management's Discussion and Analysis.
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• | Total expenses in the third quarter of 2014 increased 10% compared to the third quarter of 2013. Compensation and employee benefits expenses increased 6% in the quarterly comparison, primarily due to costs for additional staffing to support new business, the impact of merit increases and promotions, and higher regulatory compliance costs. These aggregate |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
increases were partly offset by savings generated from the implementation of our Business Operations and Information Technology Transformation program.
Other expenses increased 40% in the third quarter of 2014 compared to the third quarter of 2013, primarily due to a legal accrual (refer to "Consolidated Results of Operations - Trading Services Revenue" in this Management's Discussion and Analysis) and a charitable contribution to the State Street Foundation, as well as the impact of gains and recoveries associated with Lehman Brothers-related assets recorded in the third quarter of 2013.
We anticipate that evolving and increasing regulatory compliance requirements and expectations will continue to affect our expenses. Our employee compensation and benefits, information systems and other expenses could increase, as we further adjust our operations in response to new or proposed requirements and heightened expectations.
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• | With respect to our Business Operations and Information Technology Transformation program, we expect to achieve additional pre-tax expense savings for full-year 2014 of approximately $130 million. These pre-tax expense savings relate only to the Business Operations and Information Technology Transformation program and are based on projected improvement from our total 2010 expenses from operations, all else being equal. Our actual total expenses have increased since 2010, and may in the future increase or decrease, due to other factors. |
Additional information with respect to our expenses, including our Business Operations and Information Technology Transformation program, is provided under “Consolidated Results of Operations - Expenses” in this Management's Discussion and Analysis.
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• | In the third quarter of 2014, we secured an estimated $302 billion of new business in assets to be serviced; of that total, approximately $173 billion was installed prior to September 30, 2014, with the remaining $129 billion expected to be installed in the remainder of 2014 or later. In the third quarter of 2014, we also installed approximately $121 billion of new asset servicing business that we were awarded in prior periods. As of September 30, 2014, we had an estimated $250 billion of new business in assets to be serviced, including |
the $129 billion referenced above, which remained to be installed in future periods. New business in assets to be serviced includes assets from new servicing clients, as well as additional assets to be serviced for existing clients.
The new business not installed by September 30, 2014 was not included in our assets under custody and administration as of that date, and had no impact on our servicing fee revenue in the third quarter of 2014, as the assets are not included until their installation is complete and we begin to service them. Once installed, the assets generate servicing fee revenue in subsequent periods in which the assets are serviced.
With respect to these new assets, we will provide various services, including accounting, bank loan servicing, compliance reporting and monitoring, custody, depository banking services, foreign exchange, fund administration, hedge fund servicing, middle-office outsourcing, performance and analytics, private equity administration, real estate administration, securities finance, transfer agency, and wealth management services.
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• | In the third quarter of 2014, SSgA added approximately $3 billion of net new business in assets to be managed, composed primarily of approximately $8 billion of net inflows, substantially into ETFs and managed cash, partly offset by net outflows of approximately $5 billion from institutional products. |
In addition, approximately $1 billion of new business awarded to SSgA but not installed by September 30, 2014 was not included in our assets under management as of that date, and had no impact on our management fee revenue for the third quarter of 2014, as the assets are not included until their installation is complete and we begin to manage them. Once installed, the assets generate management fee revenue in subsequent periods in which the assets are managed.
CONSOLIDATED RESULTS OF OPERATIONS
This section discusses our consolidated results of operations for the third quarter and first nine months of 2014 compared to the same periods in 2013 in more detail, and should be read in conjunction with the consolidated financial statements and accompanying condensed notes included in this Form 10-Q.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Total Revenue
Additional information with respect to the sources of our revenue, the products and activities that generate it, and the factors that influence the levels of revenue generated during any period is provided under “Consolidated Results of Operations – Total Revenue” in Management’s Discussion and Analysis included in our 2013 Form 10-K.
The following tables present the components of total revenue for the periods indicated:
|
| | | | | | | | | | |
| Quarters Ended September 30, | | |
| 2014 | | 2013 | | % Change |
(Dollars in millions) | | | | | |
Fee revenue: | | | | | |
Servicing fees | $ | 1,302 |
| | $ | 1,211 |
| | 8 | % |
Management fees | 316 |
| | 276 |
| | 14 |
|
Trading services: | | | | | |
Foreign exchange trading | 161 |
| | 147 |
| | 10 |
|
Brokerage and other trading services | 117 |
| | 118 |
| | (1 | ) |
Total trading services | 278 |
| | 265 |
| | 5 |
|
Securities finance | 99 |
| | 74 |
| | 34 |
|
Processing fees and other | 17 |
| | 57 |
| | (70 | ) |
Total fee revenue | 2,012 |
| | 1,883 |
| | 7 |
|
Net interest revenue: | | | | | |
Interest revenue | 671 |
| | 643 |
| | 4 |
|
Interest expense | 101 |
| | 97 |
| | 4 |
|
Net interest revenue | 570 |
| | 546 |
| | 4 |
|
Gains (losses) related to investment securities, net | — |
| | (4 | ) | | |
Total revenue | $ | 2,582 |
| | $ | 2,425 |
| | 6 |
|
|
| | | | | | | | | | |
| Nine Months Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Fee revenue: | | | | | |
Servicing fees | $ | 3,828 |
| | $ | 3,587 |
| | 7 | % |
Management fees | 908 |
| | 816 |
| | 11 |
|
Trading services: | | | | |
|
|
Foreign exchange trading | 439 |
| | 464 |
| | (5 | ) |
Brokerage and other trading services | 352 |
| | 394 |
| | (11 | ) |
Total trading services | 791 |
| | 858 |
| | (8 | ) |
Securities finance | 331 |
| | 283 |
| | 17 |
|
Processing fees and other | 117 |
| | 167 |
| | (30 | ) |
Total fee revenue | 5,975 |
| | 5,711 |
| | 5 |
|
Net interest revenue: | | | | | |
Interest revenue | 1,976 |
| | 2,030 |
| | (3 | ) |
Interest expense | 290 |
| | 312 |
| | (7 | ) |
Net interest revenue | 1,686 |
| | 1,718 |
| | (2 | ) |
Gains (losses) related to investment securities, net | 4 |
| | (9 | ) | | |
Total revenue | $ | 7,665 |
| | $ | 7,420 |
| | 3 |
|
Fee Revenue
Servicing and management fees collectively composed approximately 80% and 79% of our total fee revenue in the third quarter and first nine months of 2014, respectively, compared to approximately 79% and 77%, respectively, for the corresponding periods in 2013. The level of these fees is influenced by several factors, including the mix and volume of our assets under custody and administration and our assets under management, the value and type of securities positions held (with respect to assets under custody) and the volume of portfolio transactions, and the types of products and services used by our clients, and is generally affected by changes in worldwide equity and fixed-income security valuations and trends in market asset class preferences.
Generally, servicing fees are affected by changes in daily average valuations of assets under custody and administration. Additional factors, such as the relative mix of assets serviced, the level of transaction volumes, changes in service level, the nature of services provided, balance credits, client minimum balances, pricing concessions and other factors, may have a significant effect on our servicing fee revenue.
Generally, management fees are affected by changes in month-end valuations of assets under management. Management fees for certain components of managed assets, such as ETFs, are affected by daily average valuations of assets under management. Management fee revenue is more sensitive to market valuations than servicing fee revenue, since a higher proportion of the underlying services provided, and the associated management fees earned, are dependent on equity and fixed-income security valuations. Additional factors, such as the relative mix of assets managed, changes in service level and other factors, may have a significant effect on our management fee revenue. While certain management fees are directly determined by the values of assets under management and the investment strategies employed, management fees may reflect other factors as well, including performance fee arrangements, discussed later in this section, as well as our relationship pricing for clients using multiple services.
Asset-based management fees for actively-managed products are generally charged at a higher percentage of assets under management than for passive products. Actively-managed products may also include performance fee arrangements. Performance fees are generated when the performance of certain managed portfolios exceeds benchmarks specified in the management agreements. Generally, we experience more volatility with performance fees than with more traditional management fees.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
In light of the above, we estimate, using relevant information as of September 30, 2014 and assuming that all other factors remain constant, that: (1) a 10% increase or decrease, over the relevant periods on which our servicing and management fees are calculated, in worldwide equity valuations would result in a corresponding change in our total revenue of approximately 2%; and (2) a 10% increase or decrease, over the relevant periods for or on which our servicing and management fees are calculated, in worldwide fixed-income security valuations would result in a corresponding change in our total revenue of approximately 1%.
The following table presents selected equity market indices. While the specific indices presented
are indicative of general market trends, the asset types and classes relevant to individual client portfolios can and do differ, and the performance of associated relevant indices can therefore differ from the performance of the indices presented.
Daily averages and the averages of month-end indices demonstrate worldwide changes in equity markets that affect our servicing and management fee revenue. Quarter-end indices affect the values of assets under custody and administration and assets under management as of those dates. The index names listed in the table are service marks of their respective owners.
INDEX |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Daily Averages of Indices | | Averages of Month-End Indices | | Quarter-End Indices |
| Quarters Ended September 30, | | Quarters Ended September 30, | | As of September 30, |
| 2014 | | 2013 | | % Change | | 2014 | | 2013 | | % Change | | 2014 | | 2013 | | % Change |
S&P 500® | 1,976 |
| | 1,675 |
| | 18 | % | | 1,969 |
| | 1,667 |
| | 18 | % | | 1,972 |
| | 1,682 |
| | 17 | % |
NASDAQ® | 4,483 |
| | 3,641 |
| | 23 |
| | 4,481 |
| | 3,663 |
| | 22 |
| | 4,493 |
| | 3,771 |
| | 19 |
|
MSCI EAFE® | 1,924 |
| | 1,748 |
| | 10 |
| | 1,901 |
| | 1,747 |
| | 9 |
| | 1,846 |
| | 1,818 |
| | 2 |
|
| Daily Averages of Indices | | Averages of Month-End Indices | | |
| Nine Months Ended September 30, | | Nine Months Ended September 30, | | |
| 2014 | | 2013 | | % Change | | 2014 | | 2013 | | % Change | | | | | | |
S&P 500® | 1,905 |
| | 1,601 |
| | 19 | % | | 1,910 |
| | 1,602 |
| | 19 | % | | | | | |
|
|
NASDAQ® | 4,298 |
| | 3,400 |
| | 26 |
| | 4,313 |
| | 3,416 |
| | 26 |
| | | | | |
|
|
MSCI EAFE® | 1,920 |
| | 1,708 |
| | 12 |
| | 1,918 |
| | 1,707 |
| | 12 |
| | | | | |
|
|
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
The following tables present the components of fee revenue for the periods indicated:
FEE REVENUE |
| | | | | | | | | | |
| Quarters Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Servicing fees | $ | 1,302 |
| | $ | 1,211 |
| | 8 | % |
Management fees | 316 |
| | 276 |
| | 14 |
|
Trading services: | | | | | |
Foreign exchange trading | 161 |
| | 147 |
| | 10 |
|
Brokerage and other trading services | 117 |
| | 118 |
| | (1 | ) |
Total trading services | 278 |
| | 265 |
| | 5 |
|
Securities finance | 99 |
| | 74 |
| | 34 |
|
Processing fees and other | 17 |
| | 57 |
| | (70 | ) |
Total fee revenue | $ | 2,012 |
| | $ | 1,883 |
| | 7 |
|
|
| | | | | | | | | | |
| Nine Months Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Servicing fees | $ | 3,828 |
| | $ | 3,587 |
| | 7 | % |
Management fees | 908 |
| | 816 |
| | 11 |
|
Trading services: | | | | | |
Foreign exchange trading | 439 |
| | 464 |
| | (5 | ) |
Brokerage and other trading services | 352 |
| | 394 |
| | (11 | ) |
Total trading services | 791 |
| | 858 |
| | (8 | ) |
Securities finance | 331 |
| | 283 |
| | 17 |
|
Processing fees and other | 117 |
| | 167 |
| | (30 | ) |
Total fee revenue | $ | 5,975 |
| | $ | 5,711 |
| | 5 |
|
Servicing Fees
Increases in servicing fees in the third quarter and first nine months of 2014 compared to the third quarter and first nine months of 2013 resulted primarily from stronger global equity markets and the positive revenue impact of net new business (revenue added from new servicing business installed less revenue lost from the removal of assets serviced). The increase in the nine-month comparison also reflected the positive impact of foreign currency translation.
For both the third quarter and first nine months of 2014, servicing fees generated outside the U.S. were approximately 42% of total servicing fees, compared to approximately 42% and 41% for the third quarter and first nine months of 2013, respectively.
We are responding to subpoenas from the Department of Justice and the SEC for information regarding our solicitation of asset servicing business of public retirement plans. We have retained counsel to conduct a review of these matters, including our use of consultants and lobbyists in our solicitation of business of public retirement plans and, in at least one instance, political contributions by one of our consultants during and after a public bidding process. While we are
unable to predict the outcome of these matters, adverse outcomes could have a material adverse effect on our business and reputation.
The following tables present the components, financial instrument mix and geographic mix of assets under custody and administration, as of the dates indicated:
COMPONENTS OF ASSETS UNDER CUSTODY AND ADMINISTRATION |
| | | | | | | | | | | | |
(In billions) | | September 30, 2014 | | December 31, 2013 | | September 30, 2013 |
Mutual funds | | $ | 7,035 |
| | $ | 6,811 |
| | $ | 6,524 |
|
Collective funds | | 6,919 |
| | 6,428 |
| | 6,013 |
|
Pension products | | 5,780 |
| | 5,851 |
| | 5,446 |
|
Insurance and other products | | 8,731 |
| | 8,337 |
| | 8,050 |
|
Total | | $ | 28,465 |
| | $ | 27,427 |
| | $ | 26,033 |
|
FINANCIAL INSTRUMENT MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION |
| | | | | | | | | | | | |
(In billions) | | September 30, 2014 | | December 31, 2013 | | September 30, 2013 |
Equities | | $ | 15,616 |
| | $ | 15,050 |
| | $ | 13,849 |
|
Fixed-income | | 9,298 |
| | 9,072 |
| | 8,894 |
|
Short-term and other investments | | 3,551 |
| | 3,305 |
| | 3,290 |
|
Total | | $ | 28,465 |
| | $ | 27,427 |
| | $ | 26,033 |
|
GEOGRAPHIC MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION(1) |
| | | | | | | | | | | | |
(In billions) | | September 30, 2014 | | December 31, 2013 | | September 30, 2013 |
North America | | $ | 21,255 |
| | $ | 20,764 |
| | $ | 19,737 |
|
Europe/Middle East/Africa | | 5,869 |
| | 5,511 |
| | 5,219 |
|
Asia/Pacific | | 1,341 |
| | 1,152 |
| | 1,077 |
|
Total | | $ | 28,465 |
| | $ | 27,427 |
| | $ | 26,033 |
|
(1) Geographic mix is based on the location at which the assets are serviced.
The increases in total assets under custody and administration as of September 30, 2014 compared to both December 31, 2013 and September 30, 2013, resulted primarily from stronger global equity markets and net shareholder subscriptions experienced by our custody clients, partly offset by net losses of assets serviced. Asset levels as of September 30, 2014 did not reflect the estimated $250 billion of new business in assets to be serviced awarded to us in the third quarter of 2014 and prior periods but not installed prior to September 30, 2014. This new business will be reflected in assets under custody and administration in
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
future periods after installation and will generate servicing fee revenue in subsequent periods.
The value of assets under custody and administration is a broad measure of the relative size of various markets served. Changes in the values of assets under custody and administration from period to period do not necessarily result in proportional changes in our servicing fee revenue.
Management Fees
Increases in management fees in the third quarter and first nine months of 2014 compared to the same periods in 2013 resulted primarily from stronger global equity markets, net inflows, higher performance fees and, in the quarterly comparison, the positive revenue impact of the excess of revenue added from newly installed assets to be managed over the revenue lost from liquidations of managed assets. For the third quarter and first nine months of 2014, management fees generated outside the U.S. were approximately 38% and 37%, respectively, of total management fees, compared to approximately 37% and 36%, respectively, for the same periods in 2013.
The following tables present assets under management by asset class and investment approach, ETFs by asset class, and the geographic mix of assets under management, as of the dates indicated:
ASSETS UNDER MANAGEMENT BY ASSET CLASS AND INVESTMENT APPROACH(1) |
| | | | | | | | | | | | |
(In billions) | | September 30, 2014 | | December 31, 2013 | | September 30, 2013 |
Equity: | | | | | | |
Active | | $ | 40 |
| | $ | 42 |
| | $ | 41 |
|
Passive | | 1,371 |
| | 1,334 |
| | 1,228 |
|
Total Equity | | 1,411 |
| | 1,376 |
| | 1,269 |
|
Fixed-Income: | | | | | | |
Active | | 16 |
| | 16 |
| | 17 |
|
Passive | | 322 |
| | 311 |
| | 314 |
|
Total Fixed-Income | | 338 |
| | 327 |
| | 331 |
|
Cash(2) | | 410 |
| | 385 |
| | 386 |
|
Multi-Asset-Class Solutions: | | | | | | |
Active | | 34 |
| | 23 |
| | 23 |
|
Passive | | 104 |
| | 110 |
| | 105 |
|
Total Multi-Asset-Class Solutions | | 138 |
| | 133 |
| | 128 |
|
Alternative Investments(3): | | | | | | |
Active | | 17 |
| | 14 |
| | 14 |
|
Passive | | 107 |
| | 110 |
| | 113 |
|
Total Alternative Investments | | 124 |
| | 124 |
| | 127 |
|
Total | | $ | 2,421 |
| | $ | 2,345 |
| | $ | 2,241 |
|
(1) As of December 31, 2013, the presentation was changed to align with the reporting of core businesses. Amounts reported as of September 30, 2013 have been adjusted for comparative purposes.
(2) Includes both floating- and constant-net-asset-value portfolios held in commingled structures or separate accounts.
(3) Includes real estate investment trusts, currency and commodities, including SPDR® Gold Fund, for which State Street is not the investment manager, but acts as distribution agent.
EXCHANGE-TRADED FUNDS BY ASSET CLASS(1)(2) |
| | | | | | | | | | | | |
(In billions) | | September 30, 2014 | | December 31, 2013 | | September 30, 2013 |
Alternative investments | | $ | 40 |
| | $ | 39 |
| | $ | 46 |
|
Cash | | 1 |
| | 1 |
| | 2 |
|
Equity | | 338 |
| | 325 |
| | 280 |
|
Fixed-income | | 37 |
| | 34 |
| | 33 |
|
Total Exchange-Traded Funds | | $ | 416 |
| | $ | 399 |
| | $ | 361 |
|
(1) Exchange-traded funds are a component of assets under management presented in the preceding table.
(2) Includes SPDR® Gold Fund, for which State Street is not the investment manager, but acts as distribution agent.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1) |
| | | | | | | | | | | | |
(In billions) | | September 30, 2014 | | December 31, 2013 | | September 30, 2013 |
North America | | $ | 1,502 |
| | $ | 1,456 |
| | $ | 1,388 |
|
Europe/Middle East/Africa | | 565 |
| | 560 |
| | 537 |
|
Asia/Pacific | | 354 |
| | 329 |
| | 316 |
|
Total | | $ | 2,421 |
| | $ | 2,345 |
| | $ | 2,241 |
|
(1) Geographic mix is based on client location or fund management location. Amounts reported as of September 30, 2013 were adjusted for comparative purposes to reflect realignment of reporting.
The increase in total assets under management as of September 30, 2014 compared to December 31, 2013 resulted primarily from net market appreciation during the first nine months of 2014 in the values of the assets managed and net new business of approximately $21 billion, partly offset by the impact of the stronger U.S. dollar. The net new business of approximately $21 billion was primarily composed of approximately $28 billion of net inflows into money market funds, partly offset by net outflows of approximately $5 billion from long-term institutional portfolios and approximately $2 billion from ETFs.
The following table presents activity in assets under management, by product category, for the twelve months ended September 30, 2014:
ASSETS UNDER MANAGEMENT |
| | | | | | | | | | | | | | | | | | | | | | | |
(In billions) | Equity | | Fixed-Income | | Cash | | Multi-Asset-Class Solutions | | Alternative Investments | | Total |
Balance as of September 30, 2013 | $ | 1,269 |
| | $ | 331 |
| | $ | 386 |
| | $ | 128 |
| | $ | 127 |
| | $ | 2,241 |
|
Long-term institutional inflows(1) | 66 |
| | 15 |
| | — |
| | 11 |
| | 6 |
| | 98 |
|
Long-term institutional outflows(1) | (79 | ) | | (17 | ) | | — |
| | (9 | ) | | (6 | ) | | (111 | ) |
Long-term institutional flows, net | (13 | ) | | (2 | ) | | — |
| | 2 |
| | — |
| | (13 | ) |
ETF flows, net | 22 |
| | 1 |
| | — |
| | — |
| | (4 | ) | | 19 |
|
Cash fund flows, net | — |
| | — |
| | (1 | ) | | — |
| | — |
| | (1 | ) |
Total flows, net | 9 |
| | (1 | ) | | (1 | ) | | 2 |
| | (4 | ) | | 5 |
|
Market appreciation(2) | 102 |
| | 1 |
| | — |
| | 2 |
| | 2 |
| | 107 |
|
Foreign exchange impact(2) | (4 | ) | | (4 | ) | | — |
| | 1 |
| | (1 | ) | | (8 | ) |
Total market/foreign exchange impact | 98 |
| | (3 | ) | | — |
| | 3 |
| | 1 |
| | 99 |
|
Balance as of December 31, 2013 | 1,376 |
| | 327 |
| | 385 |
| | 133 |
| | 124 |
| | 2,345 |
|
Long-term institutional inflows(1) | 199 |
| | 60 |
| | — |
| | 36 |
| | 9 |
| | 304 |
|
Long-term institutional outflows(1) | (216 | ) | | (58 | ) | | — |
| | (27 | ) | | (8 | ) | | (309 | ) |
Long-term institutional flows, net | (17 | ) | | 2 |
| | — |
| | 9 |
| | 1 |
| | (5 | ) |
ETF flows, net | (6 | ) | | 4 |
| | — |
| | — |
| | — |
| | (2 | ) |
Cash fund flows, net | — |
| | — |
| | 28 |
| | — |
| | — |
| | 28 |
|
Total flows, net | (23 | ) | | 6 |
| | 28 |
| | 9 |
| | 1 |
| | 21 |
|
Market appreciation(2) | 74 |
| | 13 |
| | — |
| | (1 | ) | | 2 |
| | 88 |
|
Foreign exchange impact(2) | (16 | ) | | (8 | ) | | (3 | ) | | (3 | ) | | (3 | ) | | (33 | ) |
Total market/foreign exchange impact | 58 |
| | 5 |
| | (3 | ) | | (4 | ) | | (1 | ) | | 55 |
|
Balance as of September 30, 2014 | $ | 1,411 |
| | $ | 338 |
| | $ | 410 |
| | $ | 138 |
| | $ | 124 |
| | $ | 2,421 |
|
(1) Amounts represent long-term portfolios, excluding ETFs.
(2) Amounts represent aggregate impact on each product category for the period.
The net new business of approximately $21 billion in the first nine months of 2014 presented in the preceding table did not include approximately $1 billion of new asset management business, substantially all of which was awarded to SSgA in the third quarter of 2014 but not installed prior to September 30, 2014. This new business will be reflected in assets under management in future periods after installation, and will
generate management fee revenue in subsequent periods.
Total assets under management as of September 30, 2014 included managed assets lost but not yet liquidated. Lost business occurs from time to time and it is difficult to predict the timing of client behavior in transitioning these assets. This timing can vary significantly.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Trading Services
The following tables summarize the components of trading services revenue for the periods indicated:
|
| | | | | | | | | | |
| Quarters Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Foreign exchange trading: | | | | | |
Direct sales and trading | $ | 103 |
| | $ | 74 |
| | 39 | % |
Indirect foreign exchange trading | 58 |
| | 73 |
| | (21 | ) |
Total foreign exchange trading | 161 |
| | 147 |
| | 10 |
|
Brokerage and other trading services: | | | | | |
Electronic foreign exchange trading | 52 |
| | 57 |
| | (9 | ) |
Other trading, transition management and brokerage | 65 |
| | 61 |
| | 7 |
|
Total brokerage and other trading services | 117 |
| | 118 |
| | (1 | ) |
Total trading services revenue | $ | 278 |
| | $ | 265 |
| | 5 |
|
|
| | | | | | | | | | |
| Nine Months Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Foreign exchange trading: | | | | | |
Direct sales and trading | $ | 253 |
| | $ | 241 |
| | 5 | % |
Indirect foreign exchange trading | 186 |
| | 223 |
| | (17 | ) |
Total foreign exchange trading | 439 |
| | 464 |
| | (5 | ) |
Brokerage and other trading services: | | | | | |
Electronic foreign exchange trading | 160 |
| | 199 |
| | (20 | ) |
Other trading, transition management and brokerage | 192 |
| | 195 |
| | (2 | ) |
Total brokerage and other trading services | 352 |
| | 394 |
| | (11 | ) |
Total trading services revenue | $ | 791 |
| | $ | 858 |
| | (8 | ) |
Trading services revenue is composed of revenue generated by foreign exchange, or FX, trading, as well as revenue generated by brokerage and other trading services. We earn FX trading revenue by acting as a principal market maker. We offer a range of FX products, services and execution models. Most of our FX products and execution services can be grouped into three broad categories, which are further explained below: “direct sales and trading FX,” “indirect FX” and “electronic FX trading.” With respect to electronic FX trading, we provide an execution venue but do not act as agent or principal.
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 and commission recapture. In addition, we act as distribution agent for the SPDR® Gold ETF. These products and services are generally differentiated by our role as an agent of the institutional investor. Revenue earned from these
services is recorded in other trading, transition management and brokerage revenue within brokerage and other trading services revenue.
FX trading revenue is influenced by three principal factors: the volume and type of client FX transactions and related spreads; currency volatility; and the management of market risk associated with currencies and interest rates. Revenue earned from direct sales and trading FX and indirect FX is recorded in FX trading revenue. Revenue earned from electronic FX trading is recorded in brokerage and other trading services revenue.
The changes in total trading services revenue in the third quarter and first nine months of 2014 compared to the same periods in 2013, composed of changes related to FX trading and brokerage and other trading services, are explained below.
Total FX trading revenue increased 10% in the third quarter of 2014 compared to the third quarter of 2013, primarily the result of higher client volumes. The 5% decrease in the first nine months of 2014 compared to the first nine months of 2013 was primarily the result of lower currency volatility and spreads, partly offset by higher client volumes in direct sales and trading.
We enter into FX transactions with clients and investment managers that contact our trading desk directly. These trades are all executed at negotiated rates. We refer to this activity, and our principal market-making activities, as “direct sales and trading FX.” Alternatively, clients or their investment managers may elect to route FX transactions to our FX desk through our asset-servicing operation; we refer to this activity as “indirect FX.” We execute indirect FX trades as a principal at rates disclosed to our clients. We calculate revenue for indirect FX using an attribution methodology based on estimated effective mark-ups/downs and observed client volumes. All other FX trading revenue, other than this indirect FX revenue estimate, is considered by us to be direct sales and trading FX revenue.
Our clients that utilize indirect FX can, in addition to executing their FX transactions through dealers not affiliated with us, transition from indirect FX to either direct sales and trading FX execution, including our “Street FX” service, or to one of our electronic trading platforms. Street FX, in which State Street continues to act as a principal market maker, enables our clients to define their FX execution strategy and automate the FX trade execution process.
For the third quarter and first nine months of 2014, our estimated indirect FX revenue decreased 21% and 17%, respectively, compared to the same periods in 2013. The declines mainly resulted from
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
lower currency volatility and spreads. For the third quarter and first nine months of 2014 compared to the same periods in 2013, our direct sales and trading FX revenue increased 39% and 5%, respectively. The increases primarily resulted from higher client volumes, partly offset by lower currency volatility and spreads.
In the third quarter of 2014, we recorded a pre-tax legal accrual of approximately $70 million, or $53 million after-tax, in connection with management’s intention to seek to resolve some, but not all, of the outstanding and potential claims arising out of our indirect FX client activities. This accrual is more fully discussed under "Legal and Regulatory Matters" in note 8 to the consolidated financial statements included in this Form 10-Q.
We continue to expect that some clients may choose, over time, to reduce their level of indirect FX transactions in favor of other execution methods, including either direct FX transactions or electronic FX trading which we provide. To the extent that clients shift to other execution methods that we provide, our FX trading revenue may decrease, even if volumes remain consistent.
Participants in the foreign exchange industry are reported to be experiencing governmental scrutiny and litigation concerning alleged manipulation in foreign exchange markets, particularly with respect to published benchmarks. We are enhancing our monitoring with respect to foreign exchange transactions and communications by foreign exchange traders. We have also commenced, but have not completed, an internal review of communications in the inter-bank market and have been advising certain U.S. and non-U.S. government agencies of the results of such review. Our business may become subject to material governmental review or proceedings or the assertion of material claims.
Total brokerage and other trading services revenue in the third quarter of 2014 decreased 1% compared to the third quarter of 2013, and in the first nine months of 2014 declined 11% compared to the first nine months of 2013. Our clients may choose to execute FX transactions through one of our electronic trading platforms. These transactions generate revenue through a “click” fee. Revenue from such electronic FX trading declined 9% and 20% in the third quarter and first nine months of 2014, respectively, compared to the same periods in 2013, mainly due to declines in client volumes.
In the third quarter of 2014, other trading, transition management and brokerage revenue increased 7% compared to the third quarter of 2013 primarily due to an increase in currency management revenue, partly offset by declines in distribution fees associated with the SPDR® Gold ETF, which resulted
from outflows as average gold prices declined during the period. In the first nine months of 2014, other trading, transition management and brokerage revenue declined 2% compared to the same period in 2013. The decrease was primarily due to declines in distribution fees associated with the SPDR® Gold ETF, which resulted from outflows as average gold prices declined during the period, partly offset by an increase in currency management revenue. With respect to the SPDR® Gold ETF, fees earned by us as distribution agent are recorded in other trading, transition management and brokerage revenue within brokerage and other trading services revenue, and not in management fee revenue.
Our revenue from transition management and related expenses in the first nine months of 2014, as well as in full years 2013, 2012 and 2011, were adversely affected by compliance issues in our U.K. business, the reputational and regulatory impact of which may continue to adversely affect our transition management revenue in future periods.
Securities Finance
Our agency securities finance business consists of two components: an agency lending program for SSgA-managed investment funds with a broad range of investment objectives, which we refer to as the SSgA lending funds, and an agency lending program for third-party investment managers and asset owners, which we refer to as the agency lending funds.
Securities finance revenue earned from our agency lending activities, which is composed of our split of both the spreads related to cash collateral and the fees related to non-cash collateral, is principally a function of the volume of securities on loan, the interest-rate spreads and fees earned on the underlying collateral, and our share of the fee split.
We also participate in securities lending transactions as a principal, which we refer to as our enhanced custody business. As principal, we borrow securities from the lending client and then lend such securities to the subsequent borrower, either a State Street client or a broker/dealer. Our involvement as principal is utilized when the lending client is unable to, or elects not to, transact directly with the market and requires us to execute the transaction and furnish the securities. In our role as principal, we provide support to the transaction through our credit rating. While we source a significant proportion of the securities furnished by us in our role as principal from third parties, we have the ability to source securities through our assets under custody and administration, from clients who have designated State Street as an eligible borrower.
Securities finance revenue in the third quarter and first nine months of 2014 increased 34% and 17%, respectively, compared to the same periods in 2013.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
The quarter-over-quarter increase was mainly the result of growth in our enhanced custody business and the impact of higher lending volumes associated with our agency lending program. The increase in the nine-month comparison was mainly the result of growth in our enhanced custody business.
Market influences may continue to affect client demand for securities finance, and as a result our revenue from, and the profitability of, our securities lending activities in future periods. In addition, proposed or anticipated regulatory changes may affect the volume of our securities lending activity and related revenue and profitability in future periods.
Processing Fees and Other
Processing fees and other revenue declined 70% and 30% in the third quarter and first nine months of 2014, respectively, compared to the same periods in 2013. The decrease was mainly due to higher amortization of tax-advantaged investments, partly offset by higher revenue from our investment in bank-owned life insurance.
Net Interest Revenue
Net interest revenue is defined as interest revenue earned on interest-earning assets less interest expense incurred on interest-bearing liabilities. Interest-earning assets, which principally consist of investment securities, interest-bearing deposits with banks, repurchase agreements, loans and leases and other liquid assets, are financed primarily by client deposits, short-term borrowings and long-term debt. Net interest margin represents the relationship between annualized fully taxable-equivalent net interest revenue and average total interest-earning assets for the period. Revenue that is exempt from income taxes, mainly that earned from certain investment securities (state and political subdivisions), is adjusted to a fully taxable-equivalent basis using a federal statutory income tax rate of 35%, adjusted for applicable state income taxes, net of the related federal tax benefit.
The following tables present the components of average interest-earning assets and average interest-bearing liabilities, related interest revenue and interest expense, and rates earned and paid, for the periods indicated:
|
| | | | | | | | | | | | | | | | | | | | | |
| Quarters Ended September 30, |
| 2014 | | 2013 |
(Dollars in millions; fully taxable-equivalent basis) | Average Balance | | Interest Revenue/ Expense | | Rate | | Average Balance | | Interest Revenue/ Expense | | Rate |
Interest-bearing deposits with banks | $ | 63,160 |
| | $ | 53 |
| | .33 | % | | $ | 25,270 |
| | $ | 29 |
| | .46 | % |
Securities purchased under resale agreements | 3,249 |
| | 9 |
| | 1.05 |
| | 5,895 |
| | 8 |
| | .54 |
|
Trading account assets | 985 |
| | — |
| | — |
| | 802 |
| | — |
| | — |
|
Investment securities | 117,618 |
| | 586 |
| | 1.99 |
| | 115,552 |
| | 582 |
| | 2.02 |
|
Loans and leases | 16,002 |
| | 64 |
| | 1.59 |
| | 13,859 |
| | 58 |
| | 1.66 |
|
Other interest-earning assets | 17,003 |
| | 2 |
| | .05 |
| | 11,927 |
| | 1 |
| | .02 |
|
Average total interest-earning assets | $ | 218,017 |
| | $ | 714 |
| | 1.30 |
| | $ | 173,305 |
| | $ | 678 |
| | 1.56 |
|
Interest-bearing deposits: | | | | | | | | | | | |
U.S. | $ | 24,144 |
| | $ | 7 |
| | 0.11 | % | | $ | 5,735 |
| | $ | 1 |
| | .06 | % |
Non-U.S. | 114,756 |
| | 26 |
| | 0.09 |
| | 99,253 |
| | 16 |
| | .06 |
|
Securities sold under repurchase agreements | 9,111 |
| | — |
| | — |
| | 8,757 |
| | — |
| | — |
|
Federal funds purchased | 18 |
| | — |
| | — |
| | 247 |
| | — |
| | — |
|
Other short-term borrowings | 4,376 |
| | — |
| | — |
| | 3,413 |
| | 15 |
| | 1.63 |
|
Long-term debt | 9,020 |
| | 60 |
| | 2.64 |
| | 8,824 |
| | 59 |
| | 2.67 |
|
Other interest-bearing liabilities | 7,386 |
| | 8 |
| | 0.42 |
| | 6,777 |
| | 6 |
| | .35 |
|
Average total interest-bearing liabilities | $ | 168,811 |
| | $ | 101 |
| | 0.24 |
| | $ | 133,006 |
| | $ | 97 |
| | .29 |
|
Interest-rate spread | | | | | 1.06 | % | | | | | | 1.27 | % |
Net interest revenue—fully taxable-equivalent basis |
| | $ | 613 |
| | | | | | $ | 581 |
| | |
Net interest margin—fully taxable-equivalent basis | | | | | 1.12 | % | | | | | | 1.33 | % |
Tax-equivalent adjustment | | | (43 | ) | | | | | | (35 | ) | | |
Net interest revenue—GAAP basis | | | $ | 570 |
| | | | | | $ | 546 |
| | |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
|
| | | | | | | | | | | | | | | | | | | | | |
| Nine Months Ended September 30, |
| 2014 | | 2013 |
(Dollars in millions; fully taxable-equivalent basis) | Average Balance | | Interest Revenue/ Expense | | Rate | | Average Balance | | Interest Revenue/ Expense | | Rate |
Interest-bearing deposits with banks | $ | 50,153 |
| | $ | 138 |
| | .37 | % | | $ | 28,014 |
| | $ | 91 |
| | .43 | % |
Securities purchased under resale agreements | 4,717 |
| | 27 |
| | .78 |
| | 5,799 |
| | 33 |
| | .76 |
|
Trading account assets | 947 |
| | 1 |
| | .12 |
| | 723 |
| | — |
| | — |
|
Investment securities | 117,681 |
| | 1,752 |
| | 1.98 |
| | 117,877 |
| | 1,809 |
| | 2.05 |
|
Loans and leases | 15,227 |
| | 183 |
| | 1.61 |
| | 13,537 |
| | 193 |
| | 1.91 |
|
Other interest-earning assets | 15,138 |
| | 5 |
| | .04 |
| | 10,666 |
| | 4 |
| | .04 |
|
Average total interest-earning assets | $ | 203,863 |
| | $ | 2,106 |
| | 1.38 |
| | $ | 176,616 |
| | $ | 2,130 |
| | 1.61 |
|
Interest-bearing deposits: | | | | | | | | | | | |
U.S. | $ | 19,016 |
| | $ | 12 |
| | .09 | % | | $ | 9,006 |
| | $ | 10 |
| | .14 | % |
Non-U.S. | 108,492 |
| | 54 |
| | .07 |
| | 100,365 |
| | 68 |
| | .09 |
|
Securities sold under repurchase agreements | 8,763 |
| | — |
| | — |
| | 8,358 |
| | — |
| | — |
|
Federal funds purchased | 19 |
| | — |
| | — |
| | 303 |
| | — |
| | — |
|
Other short-term borrowings | 4,096 |
| | 4 |
| | .12 |
| | 3,894 |
| | 46 |
| | 1.55 |
|
Long-term debt | 9,340 |
| | 186 |
| | 2.66 |
| | 8,146 |
| | 169 |
| | 2.77 |
|
Other interest-bearing liabilities | 7,237 |
| | 34 |
| | .62 |
| | 6,517 |
| | 19 |
| | .39 |
|
Average total interest-bearing liabilities | $ | 156,963 |
| | $ | 290 |
| | .25 |
| | $ | 136,589 |
| | $ | 312 |
| | .30 |
|
Interest-rate spread | | | | | 1.13 | % | | | | | | 1.31 | % |
Net interest revenue—fully taxable-equivalent basis | | | $ | 1,816 |
| | | | | | $ | 1,818 |
| | |
Net interest margin—fully taxable-equivalent basis | | | | | 1.19 | % | | | | | | 1.38 | % |
Tax-equivalent adjustment | | | (130 | ) | | | | | | (100 | ) | | |
Net interest revenue—GAAP basis | | | $ | 1,686 |
| | | | | | $ | 1,718 |
| | |
Average total interest-earning assets for the first nine months of 2014 were higher compared to the first nine months of 2013, the result of our investment of elevated levels of client deposits in interest-bearing deposits with banks, higher levels of cash collateral (included in other interest-earning assets in the preceding tables) provided in connection with our enhanced custody business, and higher average loans and leases.
Our average other interest-earning assets, largely associated with the enhanced custody business, composed approximately 8% of our total average interest-earning assets for the third quarter of 2014 and approximately 7% for the first nine months of 2014, compared to approximately 7% for the third quarter of 2013 and approximately 6% for the first nine months of 2013, as this business continued to grow. While the enhanced custody business supports our overall profitability by generating securities finance revenue, it puts downward pressure on our net interest margin, as interest on the cash collateral provided is earned at a lower rate compared to our investment securities portfolio.
The higher level of investment in interest-bearing deposits with banks resulted from continued
higher levels of client deposits, discussed further below, while the increase in average loans and leases resulted from growth in mutual fund lending and our continued investment in senior secured bank loans.
During the past year, our clients have continued to place elevated levels of deposits with us, as low global interest rates have made deposits attractive relative to other investment options. The portion of these client deposits characterized as transient in nature has been generally placed with various central banks globally, while deposits characterized as more stable have been invested in our investment securities portfolio and used to support growth in other client-related activities.
A portion of the increase in client deposits in the third quarter of 2014 was driven by higher levels of Euro denominated deposits, as clients placed these deposits with us due to the negative interest rate environment in Europe. We have characterized these additional deposits as transient in nature and, accordingly, have invested these deposits in central banks.
Net interest revenue increased 4% in the third quarter of 2014, and on a fully taxable-equivalent basis increased 6%, compared to the third quarter of 2013. The quarter-over-quarter increase was primarily driven by the investment of a higher level of
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
client deposits, an increase in the investment portfolio, and our continued investment in senior secured bank loans in the third quarter of 2014.
In the first nine months of 2014, net interest revenue decreased 2%, and on a fully taxable-equivalent basis was relatively flat, compared to the first nine months of 2013. The comparisons were generally the result of lower yields on interest-earning assets, as lower global interest rates affected our revenue from floating-rate assets, partly offset by the benefit of higher levels of interest-earning assets and lower rates on interest paid.
Subsequent to the commercial paper conduit consolidation in 2009, we have recorded aggregate discount accretion in interest revenue of $1.99 billion ($621 million in 2009, $712 million in 2010, $220 million in 2011, $215 million in 2012, $137 million in 2013 and $88 million in the first nine months of 2014). The timing and ultimate recognition of any applicable discount accretion depends, in part, on factors that are outside of our control, including anticipated prepayment speeds and credit quality. The impact of these factors is uncertain and can be significantly influenced by general economic and financial market conditions. The timing and recognition of any applicable discount accretion can also be influenced by our ongoing management of the risks and other characteristics associated with our investment securities portfolio, including sales of securities which would otherwise generate interest revenue through accretion.
Depending on the factors discussed above, among others, we anticipate that, until the former conduit securities remaining in our investment portfolio mature or are sold, discount accretion will continue to contribute, though generally in declining amounts, to our net interest revenue. Assuming that we hold the remaining former conduit securities to maturity, all else being equal, we expect the remaining former conduit securities carried in our investment portfolio as of September 30, 2014 to generate aggregate discount accretion in future periods of approximately $427 million over their remaining terms, with approximately half of this aggregate discount accretion to be recorded over the next four years.
Changes in the components of interest-earning assets and interest-bearing liabilities are discussed in more detail below. Additional detail about the components of interest revenue and interest expense is provided in note 14 to the consolidated financial statements included in this Form 10-Q.
Interest-bearing deposits with banks averaged $63.16 billion for the quarter ended September 30, 2014, compared to $25.27 billion for the quarter ended September 30, 2013. For the first nine months
of 2014, such deposits averaged $50.15 billion, compared to $28.01 billion for the first nine months of 2013. While these deposits reflected our maintenance of cash balances at the Federal Reserve, the European Central Bank, or ECB, and other non-U.S. central banks to satisfy regulatory reserve requirements, the above-described amounts also reflect the additional impact of continued elevated levels of client deposits and our investment of the excess deposits with these banks.
Certain client deposits were characterized as transient in nature and were placed with various central banks globally. If client deposits remain at or close to current elevated levels, we expect to continue to invest them in either money market assets, including central bank deposits, or in investment securities, depending on our assessment of the underlying characteristics of the deposits.
Average investment securities increased to $117.62 billion for the quarter ended September 30, 2014 from $115.55 billion for the quarter ended September 30, 2013, and in the nine-month comparison were relatively flat, $117.68 billion compared to $117.88 billion. The quarter-over-quarter growth was primarily driven by investments in U.S. Treasury securities. Detail with respect to our investment portfolio as of September 30, 2014 and December 31, 2013 is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
Loans and leases averaged $16.00 billion for the third quarter of 2014, compared to $13.86 billion for the third quarter of 2013, and $15.23 billion for the first nine months of 2014, up from $13.54 billion for the same period in 2013. The increases were mainly related to mutual fund lending and our continued investment in senior secured bank loans, which in the aggregate averaged $10.62 billion for the quarter ended September 30, 2014 compared to $8.75 billion, the latter of which was primarily composed of mutual fund lending, for the quarter ended September 30, 2013.
Average loans and leases also include short-duration advances. The proportion of the daily average of short-duration advances to average loans and leases declined to approximately 24% for the third quarter of 2014 from approximately 25% for the third quarter of 2013, and declined to approximately 24% for the first nine months of 2014 from approximately 28% for the first nine months of 2013, mainly because of growth in the other segments of the loan and lease portfolio. Short-duration advances provide liquidity to clients in support of their investment activities.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
The following tables present average U.S. and non-U.S. short-duration advances for the periods indicated:
|
| | | | | | | |
| Quarters Ended September 30, |
(In millions) | 2014 | | 2013 |
Average U.S. short-duration advances | $ | 2,372 |
| | $ | 2,292 |
|
Average non-U.S. short-duration advances | 1,468 |
| | 1,219 |
|
Average total short-duration advances | $ | 3,840 |
| | $ | 3,511 |
|
|
| | | | | | | |
| Nine Months Ended September 30, |
(In millions) | 2014 | | 2013 |
Average U.S. short-duration advances | $ | 2,264 |
| | $ | 2,343 |
|
Average non-U.S. short-duration advances | 1,463 |
| | 1,409 |
|
Average total short-duration advances | $ | 3,727 |
| | $ | 3,752 |
|
Although average short-duration advances for the third quarter of 2014 increased compared to the third quarter of 2013, such average advances remained low relative to historical levels, mainly the result of clients continuing to hold higher levels of liquidity.
Average other interest-earning assets increased to $17.00 billion for the third quarter of 2014 from $11.93 billion for the third quarter of 2013, and increased to $15.14 billion from $10.67 billion in the nine-month comparison. The increased levels were primarily the result of higher levels of cash collateral provided in connection with our enhanced custody business.
Aggregate average interest-bearing deposits increased to $138.90 billion for the third quarter of 2014 from $104.99 billion for third quarter of 2013, and increased to $127.51 billion from $109.37 billion in the nine-month comparison. The higher levels were primarily the result of increases in both U.S. and non-U.S. transaction accounts and time deposits. Future transaction account levels will be influenced by the underlying asset servicing business, as well as market conditions, including the general levels of U.S. and non-U.S. interest rates.
Average other short-term borrowings increased to $4.38 billion for the third quarter of 2014 from $3.41 billion for the third quarter of 2013. In the nine-month comparison, average other short-term borrowings increased to $4.10 billion from $3.89 billion, with both increases the result of a higher level of client demand of our commercial paper. The declines in the rates paid in the third quarter and first nine months of 2014 compared to the third quarter and first nine months of 2013 resulted from a reclassification of certain derivative contracts that hedge our interest-rate risk on certain assets and liabilities, which reduced interest revenue and interest expense.
Average long-term debt increased to $9.02 billion for the third quarter of 2014 from $8.82 billion for the third quarter of 2013, and increased to $9.34 billion from $8.15 billion in the nine-month comparison. The increase primarily reflected the issuance of $1.5 billion of senior and subordinated debt in May 2013 and the issuance of $1.0 billion of senior debt in November 2013, partly offset by the maturity of $500 million of senior debt in May 2014 and $250 million of senior debt in March 2014.
Average other interest-bearing liabilities increased to $7.39 billion for the third quarter of 2014 from $6.78 billion for the third quarter of 2013 and increased to $7.24 billion from $6.52 billion in the nine-month comparison, primarily the result of higher levels of cash collateral received from clients in connection with our enhanced custody business.
Several factors could affect future levels of our net interest revenue and margin, including the mix of client liabilities; actions of various central banks; changes in U.S. and non-U.S. interest rates; changes in the various yield curves around the world; revised or proposed regulatory capital or liquidity standards, or interpretations of those standards; the amount of discount accretion generated by the former conduit securities that remain in our investment securities portfolio; and the yields earned on securities purchased compared to the yields earned on securities sold or matured.
Based on market conditions and other factors, we continue to reinvest the majority of the proceeds from pay-downs and maturities of investment securities in highly-rated securities, such as U.S. Treasury and agency securities, federal agency mortgage-backed securities and U.S. and non-U.S. mortgage- and asset-backed securities. The pace at which we continue to reinvest and the types of investment securities purchased will depend on the impact of market conditions and other factors over time. We expect these factors and the levels of global interest rates to influence what effect our reinvestment program will have on future levels of our net interest revenue and net interest margin.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
Gains (Losses) Related to Investment Securities, Net
The following tables present net realized gains from sales of available-for-sale securities, and the components of net impairment losses included in net gains and losses related to investment securities, for the periods indicated:
|
| | | | | | | |
| Quarters Ended September 30, |
(In millions) | 2014 | | 2013 |
Net realized gains from sales of available-for-sale securities | $ | — |
| | $ | 6 |
|
Net impairment losses: | | | |
Gross losses from other-than-temporary impairment | — |
| | (13 | ) |
Losses reclassified (from) to other comprehensive income | — |
| | 3 |
|
Net impairment losses(1) | — |
| | (10 | ) |
Gains (losses) related to investment securities, net | $ | — |
| | $ | (4 | ) |
| | | |
(1) Net impairment losses, recognized in our consolidated statement of income, were composed of the following: | | | |
Impairment associated with expected credit losses | $ | — |
| | $ | (8 | ) |
Impairment associated with management’s intent to sell impaired securities prior to recovery in value | — |
| | — |
|
Impairment associated with adverse changes in timing of expected future cash flows | — |
| | (2 | ) |
Net impairment losses | $ | — |
| | $ | (10 | ) |
|
| | | | | | | |
| Nine Months Ended September 30, |
(In millions) | 2014 | | 2013 |
Net realized gains from sales of available-for-sale securities | $ | 15 |
| | $ | 11 |
|
Net impairment losses: | | | |
Gross losses from other-than-temporary impairment | (1 | ) | | (19 | ) |
Losses reclassified (from) to other comprehensive income | (10 | ) | | (1 | ) |
Net impairment losses(1) | (11 | ) | | (20 | ) |
Gains (losses) related to investment securities, net | $ | 4 |
| | $ | (9 | ) |
| | | |
(1) Net impairment losses, recognized in our consolidated statement of income, were composed of the following: | | | |
Impairment associated with expected credit losses | $ | (10 | ) | | $ | (8 | ) |
Impairment associated with management’s intent to sell impaired securities prior to recovery in value | — |
| | (6 | ) |
Impairment associated with adverse changes in timing of expected future cash flows | (1 | ) | | (6 | ) |
Net impairment losses | $ | (11 | ) | | $ | (20 | ) |
From time to time, in connection with our ongoing management of our investment securities portfolio, we sell available-for-sale securities to
manage risk, to take advantage of favorable market conditions, or for other reasons. In the first nine months of 2014, we sold approximately $8.20 billion of such investment securities, compared to approximately $8.09 billion in the first nine months of 2013, and recorded net realized gains of $15 million and $11 million, respectively, as presented in the preceding table.
We regularly review our investment securities portfolio to identify other-than-temporary impairment of individual securities. Additional information about investment securities, the gross gains and losses that compose the net gains from sales of securities and other-than-temporary impairment is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
Expenses
The following tables present the components of expenses for the periods indicated:
|
| | | | | | | | | | |
| Quarters Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Compensation and employee benefits | $ | 953 |
| | $ | 903 |
| | 6 | % |
Information systems and communications | 242 |
| | 235 |
| | 3 |
|
Transaction processing services | 199 |
| | 185 |
| | 8 |
|
Occupancy | 119 |
| | 113 |
| | 5 |
|
Acquisition costs | 12 |
| | 18 |
| | |
Restructuring charges, net | 8 |
| | 12 |
| | |
Other: | | | | | |
Professional services | 97 |
| | 98 |
| | (1 | ) |
Amortization of other intangible assets | 54 |
| | 53 |
| | 2 |
|
Securities processing costs | 8 |
| | 14 |
| | |
Regulatory fees and assessments | 17 |
| | 23 |
| | |
Other | 183 |
| | 68 |
| | 169 |
|
Total other | 359 |
| | 256 |
| | 40 |
|
Total expenses | $ | 1,892 |
| | $ | 1,722 |
| | 10 |
|
Number of employees as of quarter-end | 29,510 |
| | 29,230 |
| | |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)
|
| | | | | | | | | | |
| Nine Months Ended September 30, | | |
(Dollars in millions) | 2014 | | 2013 | | % Change |
Compensation and employee benefits | $ | 3,088 |
| | $ | 2,855 |
| | 8 | % |
Information systems and communications | 730 |
| | 707 |
| | 3 |
|
Transaction processing services | 583 |
| | 551 |
| | 6 |
|
Occupancy | 348 |
| | 343 |
| | 1 |
|
Acquisition costs | 48 |
| | 52 |
| |
|
|
Restructuring charges, net | 33 |
| | 22 |
| |
|
|
Other: | | | | |
|
Professional services | 318 |
| | 280 |
| | 14 |
|
Amortization of other intangible assets | 162 |
| | 160 |
| | 1 |
|
Securities processing costs | 39 |
| | 24 |
| |
|
|
Regulatory fees and assessments | 55 |
| | 55 |
| |
|
|
Other | 366 |
| | 297 |
| | 23 |
|
Total other | 940 |
| |