UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 

x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended September 30, 2003March 31, 2004

or

¨    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. 0-5108

 

STATE STREET CORPORATION

(Exact name of registrant as specified in its charter)

 

MASSACHUSETTS 04-2456637

(State or other jurisdiction

of incorporation)

 

(I.R.S. Employer

Identification No.)

225 Franklin Street

Boston, Massachusetts

 

02110

(Zip Code)

(Address of principal

executive office)

  

 

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.

 

Yesx    No¨

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

 

Yesx    No¨

 

The number of shares of the Registrant’s Common Stock outstanding on October 31, 2003April 30, 2004 was 334,213,804.335,919,316.

 



STATE STREET CORPORATION

 

Table of Contents

 

      Page

PART I.    FINANCIAL INFORMATION   
Item 1.  Financial Statements   
Consolidated StatementsStatement of Income  1
Consolidated Statement of Condition  32
Consolidated Statement of Changes in Stockholders’ Equity  43
Consolidated Statement of Cash Flows  54
Notes to Consolidated Financial Statements  65
Independent Accountants’ Review Report  2116
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations  2217
Item 3.  Quantitative and Qualitative DisclosureDisclosures About Market Risk  5032
Item 4.  Controls and Procedures  5032
PART II.    OTHER INFORMATION   
Item 1.Legal Proceedings33
Item 2.Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities33
Item 4.Submission of Matters to a Vote of Security Holders34
Item 6.  Exhibits and Reports on Form 8-K  5134
SignaturesSignature  5235
Exhibits   


PART I.    ITEM 1.

FINANCIAL STATEMENTS

 

Consolidated Statement of Income—State Street Corporation (Unaudited)

 


(Dollars in millions, except per share data) Three months ended September 30,

   2003   2002

Fee Revenue:        
Servicing fees  $505  $390
Management fees   141   116
Global securities lending   61   45
Foreign exchange trading   101   78
Brokerage fees   28   32
Processing fees and other   92   41
   


 

Total fee revenue   928   702
Net Interest Revenue:        
Interest revenue   364   475
Interest expense   161   251
   


 

Net interest revenue   203   224
Provision for loan losses      1
   


 

Net interest revenue after provision for loan losses   203   223
(Losses) gains on the sales of available-for-sale investment securities, net   (5)  31
   


 

Total Revenue   1,126   956
Operating Expenses:        
Salaries and employee benefits   407   398
Information systems and communications   140   92
Transaction processing services   80   63
Occupancy   84   62
Merger and integration costs   26   
Restructuring costs   3   
Other   81   69
   


 

Total operating expenses   821   684
   


 

Income before income taxes   305   272
Income tax expense   103   90
   


 

Net Income  $202  $182
   


 

Earnings Per Share        
Basic  $.61  $.57
Diluted   .60   .56
Average Shares Outstanding(in thousands)        
Basic   332,246   323,023
Diluted   336,568   328,163
Cash Dividends Declared Per Share  $.14  $.12

The accompanying notes are an integral part of these financial statements.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Consolidated Statement of Income—State Street Corporation (Unaudited)



(Dollars in millions, except per share data) Nine months ended September 30,

   2003   2002


(Dollars in millions, except per share data) Three months ended March 31,

   2004   2003

Fee Revenue:            
Servicing fees  $1,425  $1,143  $555  $438
Management fees   396   369   147   125
Global securities lending   192   177

Securities lending

   64   55
Foreign exchange trading   276   238   118   72
Brokerage fees   85   86   45   30
Processing fees and other   225   131   84   70
  

  

  

 ��

Total fee revenue   2,599   2,144   1,013   790
Net Interest Revenue:            
Interest revenue   1,162   1,509   384   397
Interest expense   562   755   181   193
  

  

  

  

Net interest revenue   600   754   203   204
Provision for loan losses      3      
  

  

  

  

Net interest revenue after provision for loan losses   600   751   203   204
Gains on the sales of available-for-sale investment securities, net   29   45

Gains on the sales of available-for-sale investment securities

   3   26
  

  

  

  

Total Revenue   3,228   2,940   1,219   1,020
Operating Expenses:            
Salaries and employee benefits   1,294   1,243   462   443
Information systems and communications   410   279   139   130
Transaction processing services   231   181   96   72
Occupancy   231   182   90   71
Merger and integration costs   81      18   37
Restructuring costs   295   20
Other   252   232   103   81
  

  

  

  

Total operating expenses   2,794   2,137   908   834
  

  

  

  

Income before income taxes   434   803   311   186
Income tax expense   159   265   94   90
  

  

  

  

Net Income  $275  $538  $217  $96
  

  

  

  

Earnings Per Share            
Basic  $.83  $1.66  $.65  $.29
Diluted   .82   1.64   .63   .29
Average Shares Outstanding(in thousands)            
Basic   331,056   323,521   334,635   329,569
Diluted   334,160   327,713   342,129   332,054
Cash Dividends Declared Per Share  $.41  $.35  $.15  $.13

 

The accompanying notes are an integral part of these financial statements.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Consolidated Statement of Condition—State Street Corporation

 




 

(Dollars in millions)

  

 

 

September 30,

2003

 

 

 

 

 

December 31,

2002

 

 

   
 
March 31,
2004
 
 
  
 
December 31,
2003
 
 



 
  (Unaudited)  (Note 1)   (Unaudited) (Note 1) 
Assets        
Cash and due from banks  $1,691  $1,361   $2,379  $3,376 
Interest-bearing deposits with banks   22,333   28,143    27,228   21,738 
Securities purchased under resale agreements and securities borrowed   8,737   17,215 

Securities purchased under resale agreements

   13,968   9,447 

Federal funds sold

   1,000   104 
Trading account assets   1,059   984    347   405 
Investment securities (including securities pledged of $14,176 and $10,335)   32,364   28,071 
Loans (less allowance of $61 and $61)   6,168   4,113 

Investment securities (including securities pledged of $ and $13,278)

   34,605   38,215 

Loans (less allowance of $36 and $61)

   4,968   4,960 
Premises and equipment   1,154   887    1,238   1,212 
Accrued income receivable   1,010   823    1,014   1,015 
Goodwill   1,301   462    1,329   1,326 
Other intangible assets   508   127    542   525 
Other assets   5,451   3,608    4,278   5,211 
  


 


  


 


Total Assets  $81,776  $85,794   $92,896  $87,534 
  


 


  


 


Liabilities        
Deposits:        
Noninterest-bearing  $10,690  $7,279   $9,352  $7,893 
Interest-bearing—U.S.   3,746   9,005    6,826   5,062 
Interest-bearing—Non-U.S.   28,722   29,184    37,334   34,561 
  


 


  


 


Total deposits   43,158   45,468    53,512   47,516 
Securities sold under repurchase agreements   21,895   21,963    21,811   22,806 
Federal funds purchased   1,778   3,895    2,083   1,019 
Other short-term borrowings   1,842   3,440    1,434   1,437 
Accrued taxes and other expenses   2,199   1,967    2,386   2,424 
Other liabilities   3,509   3,004    3,484   4,363 
Long-term debt   2,151   1,270    2,244   2,222 
  


 


  


 


Total Liabilities   76,532   81,007    86,954   81,787 
Stockholders’ Equity        
Preferred stock, no par: authorized 3,500,000; issued none     

Common stock, $1 par: authorized 500,000,000, issued 337,135,000 and 329,992,000

   337   330 

Preferred stock, no par: authorized 3,500,000 shares; issued none

   

Common stock, $1 par: authorized 500,000,000 shares, issued 337,130,000 and 337,132,000

   337   337 
Surplus   336   104    298   329 
Retained earnings   4,610   4,472    5,174   5,007 
Accumulated other comprehensive income   126   106    207   192 
Treasury stock, at cost (3,738,000 and 5,065,000 shares)   (165)  (225)

Treasury stock, at cost (1,705,000 and 2,658,000 shares)

   (74)  (118)
  


 


  


 


Total Stockholders’ Equity   5,244   4,787    5,942   5,747 
  


 


  


 


Total Liabilities and Stockholders’ Equity  $81,776  $85,794   $92,896  $87,534 
  


 


  


 




   


 

 

The accompanying notes are an integral part of these financial statements.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Consolidated Statement of Changes in Stockholders’ Equity—State Street Corporation (Unaudited)

 


(Dollars in millions, shares in thousands) Common Stock

 

Surplus

  

Retained
Earnings

  Accumulated
Other
Comprehensive
Income
  Treasury Stock

    
  Shares  Amount    Shares  Amount  Total 

Balance at December 31, 2001 329,999  $330 $110  $3,612  $70  6,329  $(277) $3,845 
Comprehensive income:                             
Net income            538              538 

Change in net unrealized gains/losses on available-for sale securities, net of related taxes of $28

                41          41 

Foreign currency translation, net of related taxes of $15

                28          28 
Other, net of related tax benefit of $10                (14)         (14)
  

 

 


 


 


 

 


 


Total comprehensive income            538   55          593 
Cash dividends declared-$.35 per share            (113)             (113)
Common stock issued pursuant to:                             

Stock awards and options exercised, including tax benefit of $20

 (7)                (2,243)  99   99 
Debt conversion        (3)         (70)  3    
Common stock acquired                   1,636   (75)  (75)
  

 

 


 


 


 

 


 


Balance at September 30, 2002 329,992  $330 $107  $4,037  $125  5,652  $(250) $4,349 
  

 

 


 


 


 

 


 


Balance at December 31, 2002 329,992  $330 $104  $4,472  $106  5,065  $(225) $4,787 
Comprehensive income:                             
Net income            275              275 

Change in net unrealized gains/losses on available-for sale securities, net of related tax benefit of $30

                (39)         (39)

Foreign currency translation, net of related taxes of $29

                58          58 

Change in unrealized gains/losses on cash flow hedges, net of related taxes of $1

                1          1 
  

 

 


 


 


 

 


 


Total comprehensive income            275   20          295 
Cash dividends declared-$.41 per share            (137)             (137)
Common stock issued pursuant to:                             
January 14, 2003, Registration Statement 7,153   7  260                  267 

Present value of the estimated contract fees payable with respect to SPACES, pursuant to January 14, 2003 Registration Statement

        (57)                 (57)

Stock awards and options exercised, including tax benefit of $5

 (10)     6          (1,066)  48   54 
Debt conversion        (1)         (21)  1    
Shares divested from consolidated trust                   (54)  2   2 

Modified stock awards and options for restructuring

        24          (266)  12   36 
Common stock acquired                   80   (3)  (3)
  

 

 


 


 


 

 


 


Balance at September 30, 2003 337,135  $337 $336  $4,610  $126  3,738  $(165) $5,244 
  

 

 


 


 


 

 


 




 
  Common Stock

 Surplus  

Retained

Earnings

  

Accumulated

Other

Comprehensive

Income (Loss)

  Treasury Stock

    
(Dollars in millions, shares in thousands) Shares  Amount    Shares  Amount  Total 

 

Balance at December 31, 2002

 329,992  $330 $104  $4,472  $106  5,065  $(225) $4,787 

Comprehensive income:

                             

Net income

            96              96 

Change in net unrealized gains/losses on available-for sale securities, net of related taxes of $(16)

                (19)         (19)

Foreign currency translation, net of related taxes of $4

                8          8 

Change in unrealized gains/losses on cash flow hedges, net of related taxes of $(1)

                (1)         (1)
  

 

 


 


 


 

 


 


Total comprehensive income

            96   (12)         84 

Cash dividends declared-$.13 per share

            (43)             (43)

Common stock acquired

                   71   (2)  (2)

Common stock issued pursuant to:

                             

January 14, 2003, Registration Statement

 7,153   7  260                  267 

Present value of the estimated fees payable with respect to SPACES, pursuant to January 14, 2003 Registration Statement

        (57)                 (57)

Stock awards and options exercised, including tax benefit of $2

        (1)         (373)  16   15 

Debt conversion

        (1)         (14)  1    
  

 

 


 


 


 

 


 


Balance at March 31, 2003

 337,145  $337 $305  $4,525  $94  4,749  $(210) $5,051 
  

 

 


 


 


 

 


 


Balance at December 31, 2003

 337,132  $337 $329  $5,007  $192  2,658  $(118) $5,747 

Comprehensive income:

                             

Net income

            217              217 

Change in net unrealized gains/losses on available-for sale securities, net of related taxes of $21

                34          34 

Change in minimum pension liability

                (23)         (23)

Foreign currency translation, including tax benefit of $5

                8          8 

Change in unrealized gains/losses on cash flow hedges, net of related taxes of $(3)

                (4)         (4)
  

 

 


 


 


 

 


 


Total comprehensive income

            217   15          232 

Cash dividends declared-$.15 per share

            (50)             (50)

Impact of fixing the variable-share settlement rate of SPACES

        (26)                 (26)

Common stock issued pursuant to:

                             

Stock awards and options exercised, including tax benefit of $10

 (2)     (5)         (953)  44   39 
  

 

 


 


 


 

 


 


Balance at March 31, 2004

 337,130  $337 $298  $5,174  $207  1,705  $(74) $5,942 
  

 

 


 


 


 

 


 



 

 

The accompanying notes are an integral part of these financial statements.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Consolidated Statement of Cash Flows—State Street Corporation (Unaudited)

 


(Dollars in millions) Nine months ended September 30,

   2003   2002 

Operating Activities         
Net Income  $275  $538 

Non-cash charges for depreciation, amortization, provision for loan losses and deferred income taxes

   425   499 
Restructuring costs   295   20 
Write-down of real estate   13    
Securities gains, net   (29)  (45)
Change in trading account assets, net   (75)  (169)
Other, net   (432)  (273)
   


 


Net Cash Provided by Operating Activities   472   570 
   


 


Investing Activities         
Payments for purchases of:         
Available-for-sale securities   (35,575)  (14,770)
Held-to-maturity securities   (1,054)  (750)
Premises and equipment   (229)  (213)
Equity investments and other long-term assets   (23)  (27)
Business acquisitions, net of cash acquired   (1,213)  (79)
Proceeds from:         
Maturities of available-for-sale securities   21,754   10,249 
Maturities of held-to-maturity securities   1,047   636 
Sales of available-for-sale securities   8,139   4,759 
Principal collected from lease financing   48   21 
Net proceeds from (payments for):         
Interest-bearing deposits with banks   5,810   (3,859)
Federal funds sold, resale agreements and securities borrowed   8,478   (3,764)
Loans   (1,995)  669 
   


 


Net Cash Provided by (Used by) Investing Activities   5,187   (7,128)
   


 


Financing Activities         
Proceeds from issuance of:         
Treasury stock   87   79 
Common Stock/SPACES, net of issuance costs   257    
Long term debt, net of issuance costs   742    
Payments for:         
Non-recourse debt for lease financing   (66)  (37)
Long-term debt   (101)  (1)
Cash dividends   (132)  (110)
Purchase of common stock   (3)  (75)
Net (payments for) proceeds from:         
Deposits   (2,330)  4,635 
Short-term borrowings   (3,783)  2,044 
   


 


Net Cash (Used by) Provided by Financing Activities   (5,329)  6,535 
   


 


Net Increase (Decrease)   330   (23)
Cash and due from banks at beginning of period   1,361   1,651 
   


 


Cash and Due From Banks at End of Period  $1,691  $1,628 
   


 




 

(Dollars in millions) Three months ended March 31,

   2004   2003 

 

Operating Activities

         

Net Income

  $217  $96 

Adjustments to reconcile net income to net cash provided (used) by operating activities:

         

Non-cash charges for depreciation, amortization, provision for loan losses and deferred income taxes

   195   190 

Securities gains, net

   (3)  (26)

Change in trading account assets, net

   58   (332)

Other, net

   (106)  (440)
   


 


Net Cash Provided (Used) by Operating Activities

   361   (512)

Investing Activities

         

Net (increase) decrease in interest-bearing deposits with banks

   (5,490)  7,136 

Net (increase) decrease in federal funds sold and securities purchased under resale agreements

   (5,417)  1,544 

Proceeds from sales of available-for-sale securities

   3,586   3,862 

Proceeds from maturities of available-for-sale securities

   2,872   9,323 

Purchases of available-for-sale securities

   (2,812)  (13,774)

Proceeds from maturities of held-to-maturity securities

   579   293 

Purchases of held-to-maturity securities

   (587)  (289)

Net decrease (increase) in loans

   32   (489)

Principal collected from lease financing

   61   41 

Business acquisitions, net of cash acquired

   (10)  (1,078)

Purchases of equity investments and other long-term assets

   (23)  (10)

Purchases of premises and equipment

   (101)  (98)
   


 


Net Cash (Used) Provided by Investing Activities

   (7,310)  6,461 

Financing Activities

         

Net increase (decrease) in deposits

   5,995   (7,063)

Net increase in short-term borrowings

   66   831 

Payments for non-recourse debt for lease financing

   (83)  (65)

Proceeds from issuance of long-term debt, net of issuance costs

      343 

Payments for long-term debt and obligations under capital leases

   (5)   

Proceeds from issuance of common stock/SPACES, net of issuance costs

      257 

Proceeds from issuance of treasury stock

   29   11 

Payments for cash dividends

   (50)  (43)
   


 


Net Cash Provided (Used) by Financing Activities

   5,952   (5,729)
   


 


Net (Decrease) Increase

   (997)  220 

Cash and due from banks at beginning of period

   3,376   1,361 
   


 


Cash and Due From Banks at End of Period

  $2,379  $1,581 
   


 



 

 

The accompanying notes are an integral part of these financial statements.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 1—Basis of Presentation

 

Organization and Nature of Operations

State Street Corporation (“State Street” or the “Corporation”) is a financial holding company thatand reports two lines of business. Investment Servicing provides services for U.S. mutual funds, collective funds worldwide, corporate and public retirement plans, insurance companies, foundations, endowments, and other investment pools. Products include custody, accounting, daily pricing and administration; master trust and master custody; investment management; trusteeship and recordkeeping; foreign exchange; securities lending; cash management; trading; and information services to clients worldwide. State Street reports two lines of business. Investment Servicing includes custody, accounting, daily pricing and administration; master trust and master custody; trusteeship and recordkeeping; foreign exchange and trading services; securities lending; deposit and short-term investment facilities; loans and lease financing; investmentwealth manager and hedge fund manager operations outsourcing;services; and performance, risk and compliance analytics to support institutional investors. Investment Management offers a broad array of services for managing financial assets, including investment management and investment research services, primarily for both institutions and individualinstitutional investors worldwide; these services include activepassive and passiveactive U.S. and non-U.S. equity and fixed income strategies, and other related services, such as securities lending.

 

The consolidated financial statements include the accountsBasis of State Street and its subsidiaries, including its principal subsidiary, State Street Bank and Trust Company (“State Street Bank”).

All significant intercompany balances and transactions have been eliminated upon consolidation. The results of operations of businesses purchased are included from the date of acquisition. Investments in affiliates in which the Corporation has the ability to exercise significant influence, but not control, are accounted for using the equity method.Presentation

 

In the opinion of management, all adjustments, consisting of normal recurring accruals, which are necessary for a fair presentation of the financial position of State Street and subsidiaries at September 30, 2003March 31, 2004 and December 31, 2002,2003, its cash flows for the ninethree months ended September 30,March 31, 2004 and 2003, and 2002, and consolidated results of its operations for the three-three months ended March 31, 2004 and nine-months ended September 30, 2003, and 2002, have been made. Operating results for the three- and nine-month periodsthree months ended September 30, 2003,March 31, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.2004. These statements should be read in conjunction with the financial statements and other information included in State Street’s latest annual report on Form 10-K.

 

The Statement of Condition at December 31, 2002,2003, has been developed from the audited financial statements at that date, but does not include all footnotes required by generally accepted accounting principles for complete financial statements.

 

Principles of Consolidation

The consolidated financial statements include the accounts of State Street and its subsidiaries, including its principal subsidiary, State Street Bank and Trust Company (“State Street Bank”). All significant intercompany balances and transactions have been eliminated upon consolidation.

The assets and liabilities of non-U.S. operations are translated at month-end exchange rates, and revenue and expenses are translated at rates that approximate average monthly exchange rates. Gains or losses from the translation of the net assets of non-U.S. subsidiaries and branches, net of related taxes, are reported in accumulated other comprehensive income.

Use of Estimates

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

 

Certain previously reported amounts have been reclassified to conform to the current method of presentation.Investments in Affiliates

 

Investments in affiliates in which the Corporation has the ability to exercise significant influence, but not control, are accounted for using the equity method, unless the affiliate is determined to be a variable interest entity (“VIE”) of which State Street absorbs the majority of expected losses, in which case State Street consolidates the VIE.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

Note 1—Basis of Presentation (continued)

Revenue Recognition

 

Revenues from investmentRevenue recorded as servicing fees, management fees, securities lending fees, foreign exchange trading, brokerage fees and certain types of revenue recorded in processing arefees and other is recognized when earned based on contractual terms and areis accrued based on estimates, or areis recognized as transactions occur or services are provided and collectibility is reasonably assured. Revenue on interest-earning assets is recognized based on the effective yield of the financial instrument.

Stock-Based Compensation

State Street expenses stock options using the fair value method in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation” using the prospective transition method afforded under SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” an amendment to SFAS No. 123. The following table illustrates thepro forma effect on net income and earnings per share as if the fair value method had been applied to all outstanding and unvested stock options in each period:


   

Three Months

Ended

March 31,


 
(Dollars in millions, except per share data)      2004          2003     

 

Net income, as reported

  $217  $96 

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects at the effective tax rate

   3    

Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects at the effective tax rate

   (10)  (15)
   


 


Pro forma net income

  $210  $81 
   


 


Earnings per share:

         

Basic—as reported

  $.65  $.29 

Basic—pro forma

   .63   .25 

Diluted—as reported

   .63   .29 
Diluted—pro forma   .61   .24 

 

A total of 768,000 options were exercised during the three months ended March 31, 2004, with a weighted average option price of $29.26 per share. During the three months ended March 31, 2004, 2,200,000 options were granted with a weighted average option price of $52.78 per share.

Reclassification

Certain previously reported amounts have been reclassified to conform to the current method of presentation.

Accounting Changes and Recent Accounting Pronouncements

In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). As a result of this Interpretation, State Street deconsolidated the trusts that issued trust preferred capital securities in the fourth quarter of 2003. In December 2003, the FASB issued a revised version of FIN 46 (“FIN 46-R”) that deferred the effective date of

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 1—Basis of Presentation (continued)

 

Impact of Recent Accounting Announcements

In November 2002, the FASB issued FASB Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements of Guarantees, Including Guarantees of Indebtedness of Others.” Accounting requirements became effective January 1, 2003, and require all guarantees and indemnifications within its scope to be recorded at fair value as liabilities, and the maximum possible loss to the Corporation under these guarantees and indemnifications to be disclosed. State Street has indemnificationsit related to securities lending clients, certain investment guarantee products, credit enhancements and liquidity facilities, and parent company guaranteestypes of subsidiary’s obligations that fall within the scope of this Interpretation. Each of these guarantees, except the parent company guarantees, is collateralized to some extent, which reduces loss exposure to the Corporation. The liabilities associated with these products are not material to the Corporation.

On January 1, 2003, State Street began expensing stock options using the fair value method in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation.” State Street used the prospective transition method afforded under SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure,” an amendment to SFAS No. 123. The following table illustrates the effect on net income and earnings per share if the fair value method had been applied to all outstanding and unvested stock options in each period:


   

Three Months

Ended

September 30,


  

Nine Months

Ended

September 30,


 
(Dollars in millions, except per share data)  2003  2002  2003  2002 

Net income, as reported  $202  $182  $275  $538 

Add: Stock-based employee compensation expense included in reported net income, net of related tax effects

         19(a)   

Deduct: Total stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects

   (6)  (13)  (47)  (40)
   


 


 


 


Pro forma net income  $196  $169  $247  $498 
   


 


 


 


Earnings per share:                 
Basic—as reported  $.61  $.57  $.83  $1.66 
Basic—pro forma   .58   .52   .74   1.54 
Diluted—as reported   .60   .56   .82   1.64 
Diluted—pro forma   .58   .52   .73   1.52 

(a)State Street accelerated recognition of $29 million of pre-tax stock option ($19 million post-tax) expense in the second quarter of 2003 in connection with its restructuring. See Note 12 for further details.

A total of 394,000 and 873,000 options were exercised during the three- and nine-months ended September 30, 2003, respectively, with a weighted average option price of $31.70 and $24.26 per share, respectively. During the three- and nine-months ended September 30, 2003, 4,211,000 and 4,271,000 options were granted, with a weighted average option price of $45.12 and $45.01 per share, respectively.

On January 17, 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities.” On October 8, 2003, the FASB issued a statement that deferred application of FIN 46 until December 31, 2003. For companies that had consolidated variable interest entities under FIN 46 prior to October 8, 2003, early adoption is

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

Note 1—Basis of Presentation (continued)

allowed. State Street applied the rules of the interpretation to certain variable interest entities effective July 1, 2003. It was determined that two investments, previously accounted for under the equity method, needed to be consolidated.until March 31, 2004. The impact of consolidating these entities was not material to the financial statements of the Corporation. State Street is still evaluating other off-balance sheet entities. After restructuring of certain contractual obligations in the asset-backed commercial paper program, which is not reflected in the financial statements of State Street, consolidation of these entities is not required under existing guidance. Upon adoption of FIN 46, the Corporation will have to deconsolidate the trusts which issue these Trust Preferred Capital Securities. The impact46-R as of deconsolidating the trusts will be an increase in other assets and long-term debt of $31 million. State Street will continue to monitor the application of FIN 46, and additional actions may be taken.

On April 30, 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 provides criteria for when a contract with an initial net investment should be classified as a derivative, as discussed in SFAS No. 133. In addition, SFAS No. 149 clarifies circumstances requiring special reporting in the statement of cash flows for a derivative with a financing component. SFAS No. 149 is effective on a prospective basis for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. Application of this standardMarch 31, 2004, did not have a materialmaterially impact oneither the financial conditionposition or results of operations of the Corporation.

On May 15, 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” This statement requires certain freestanding financial instruments be classified as liabilities in the Consolidated Statement of Condition that were classified as equity under previous guidance. This statement does not apply to features embedded in a financial instrument that is not a derivative in its entirety. The majority of the statement is effective for all financial instruments entered into or modified after May 31, 2003, with the remainder effective at the first day of the interim period beginning after June 15, 2003. Application of this standard did not have a material impact on the financial condition or results of operations of the Corporation. The FASB has decided to defer certain provisions of the statement as they apply to mandatorily redeemable non-controlling interests. These provisions include the requirement that ownership interests in finite-lived entities, such as trusts which issue Trust Preferred Securities, be classified as liabilities. State Street currently has Trust Preferred Securities of approximately $1 billion and ownership interests in the trusts of approximately $31 million.

 

Note 2—Acquisitions and Divestitures

 

In JuneOn October 31, 2003, State Street entered into a definitive agreement to sellcompleted the sale of its Private Asset Management business to U.S. Trust for approximately $365 million. ThisTrust. Under the terms of the agreement, the transaction was completed on October 31, 2003. See Note 20 for further details.valued at $365 million, about five percent of which is subject to the successful transition of the business over the subsequent 16 months.

 

On January 31, 2003, State Street completed the primary closing of its acquisition of a substantial part of the Global Securities Services (“GSS”) business of Deutsche Bank AG for approximatelya premium of $1.1 billion. Separate closings for the acquisitions of business units in Italy and Austria were held upon receipt of applicable regulatory approvals. On July 1, 2003, State Street completed the acquisition of the Italian business units of GSS, and on July 31, 2003, completed the acquisition of the Austrian units of the business. The purchase price is subject to adjustments based upon performance of the acquired businesses onbusiness for the one-year anniversary ofyear following the closing. State Street couldmay make additional payments of up to an estimated €360 millionmillion; however, State Street anticipates that the actual payment will be recorded as an adjustment tomuch less.

In connection with the goodwill acquired. Duringacquisition, approximately 2,800 employees of Deutsche Bank became employees of State Street. For the second quarter of 2003,three months ended March 31, 2004, State Street reducedpaid $2.1 million of severance costs related to an overall workforce reduction, primarily in the original purchase price

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)U.S., and the severance liability outstanding as of March 31, 2004, was $16.9 million.

 

Notes to Consolidated Financial Statements—State StreetIn January 2003, the Corporation (Unaudited)

Note 2—Acquisitions and Divestitures (continued)

goodwill by $48 million for a purchase price adjustment related to revenue estimates made for the period prior to closing.

State Street financed $595 million of the initial purchase price through issuance to the public ofissued equity, equity-related and capital securities to the public under an existing shelf registration statement. In January 2003, State Street issued $345$283 million, or 7.2 million7,153,000 shares of common stock, $345 million, or 1.7 million1,725,000 units of SPACES (see Note 19)SM, and $345 million of floating-rate, medium-term capital securities due 2008 (see Note 8), a portion2008. Proceeds, net of which wasissuance costs, of $595 million from these security issuances were used to partially finance the acquisition.acquisition of the GSS business. The remainder of the purchase price was financed using existing resources.

 

The acquisition was accounted for under the purchase method of accounting, in accordance with SFAS No. 141, “Business Combinations.” The purchase price of $1.1 billion was allocated as follows: goodwill $724 million, customer relationship intangible $363 million, capitalized software $28 millionNote 3—Investment Securities

Available-for-sale securities and other tangible assets $14 million. The customer relationship intangible asset is being amortized on a straight-line basis over fifteen years. The software is being amortized on a straight-line basis over five years. The resultsheld-to-maturity securities consisted of the GSS acquisition were included infollowing as of the accompanying statement of income for the period from February 1, 2003, through September 30, 2003.dates indicated:

 

In connection with the acquisition, State Street expects to reduce its overall workforce, primarily in the United States, over a 12- to 18-month period beginning in June 2003, by approximately 1,000 employees. Severance costs of $22 million and transaction costs of $22 million related to these activities were initially recorded as a liability in conjunction with recording the initial purchase of GSS, and were capitalized as part of the goodwill allocated with the GSS business. During the second quarter of 2003, an additional $12 million was recorded for the severance liability and capitalized as goodwill. As of September 30, 2003, $4 million in accrued severance costs and $22 million of transaction costs had been paid. Additionally, State Street incurred $26 million and $81 million of merger and integration costs for the three- and nine-month periods ended September 30, 2003, respectively. These one-time expenses consisted primarily of costs for employee retention, systems conversion and consulting services.

On December 31, 2002, State Street completed the sale of its Corporate Trust business to U.S. Bank, N.A., the lead bank of U.S. Bancorp. The premium received on the sale was $725 million, $75 million of which was placed in escrow pending the successful transition of the business. The Corporate Trust business consisted of $689 billion in bonds under trusteeship, $187 billion in assets under custody and $2.3 billion in client deposits. The bonds under trusteeship transferred to U.S. Bank, N.A. on December 31, 2002. The assets under custody and deposits have transferred in 2003.

In July 2002, State Street completed the cash purchase of International Fund Services (“IFS”), a leading provider of fund accounting and administration as well as securities trade support and operational services for hedge funds, for $80 million. As one of the largest providers of hedge funds services, IFS services over 100 large asset management firms and private equity fund managers, representing more than 350 funds globally. IFS is headquartered in New York City, and has operations centers in New York City and Dublin, Ireland with approximately 500 employees. In connection with this transaction, during the second quarter of 2003 an additional $47 million of the purchase price was paid and recorded based upon certain performance measures.


   March 31, 2004

  December 31, 2003

   

Amortized

Cost

  Unrealized

  

Fair

Value

  

Amortized

Cost

  Unrealized

  

Fair

Value

(Dollars in millions)    Gains  Losses      Gains  Losses  

Available for sale:

                                

U.S. Treasury and federal agencies

  $19,380  $110  $9  $19,481  $22,695  $73  $20  $22,748

Asset-backed securities

   9,564   46   4   9,606   9,852   46   13   9,885

State and political subdivisions

   1,958   30      1,988   1,961   38      1,999

Collateralized mortgage obligations

   1,242   6   1   1,247   1,338   2   7   1,333

Other debt investments

   284   8      292   304   6      310

Money market mutual funds

   123         123   85         85

Other equity securities

   247   9   12   244   238   6   6   238
   

  

  

  

  

  

  

  

Total

  $32,798  $209  $26  $32,981  $36,473  $171  $46  $36,598
   

  

  

  

  

  

  

  

Held to maturity:

                                

U.S. Treasury and federal agencies

  $1,353  $5      $1,358  $1,345  $3      $1,348

Other investments

   271          271   272          272
   

  

      

  

  

      

Total

  $1,624  $5      $1,629  $1,617  $3      $1,620
   

  

      

  

  

      


PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 3—Investment Securities (continued)

Available-for-sale securities and held-to-maturity securities consisted of the following:


   September 30, 2003

  December 31, 2002

   

Amortized

Cost

  Unrealized

  

Fair

Value

  

Amortized

Cost

  Unrealized

  

Fair

Value

(Dollars in millions)    Gains  Losses      Gains  Losses  

Available for sale:                                

U.S. Treasury and federal agencies

  $19,272  $86  $20  $19,338  $15,665  $97  $2  $15,760

State and political subdivisions

   1,793   35      1,828   1,992   35   9   2,018
Asset-backed securities   7,694   59   40   7,713   4,205   88   17   4,276

Collateralized mortgage obligations

   1,365   2   10   1,357   546   3   1   548
Other debt investments   300   6      306   695   8      703
Money market mutual funds   67         67   3,057         3,057
Other equity securities   224   3   19   208   197      31   166
   

  

  

  

  

  

  

  

Total  $30,715  $191  $89  $30,817  $26,357  $231  $60  $26,528
   

  

  

  

  

  

  

  

Held to maturity:                                

U.S. Treasury and federal agencies

  $1,303  $4      $1,307  $1,327  $13      $1,340
Other investments   244          244   216          216
   

  

  

  

  

  

  

  

Total  $1,547  $4      $1,551  $1,543  $13      $1,556
   

  

  

  

  

  

  

  


 

During the ninethree months ended September 30, 2003, there wereMarch 31, 2004, gross gains of $44$20 million and gross losses of $15$17 million were realized on the sales of available-for-sale securities. During the ninethree months ended September 30, 2002, there wereMarch 31, 2003, gross gains of $49$26 million and gross losses of $4less than $1 million were realized on the sales of available-for-sale securities.

 

Note 4—Allowance for Loan Losses

 

State Street establishes an allowance for loan losses to absorb probable credit losses. Changes in the allowance for loan losses were as follows:

 


   Three Months Ended September 30,

  Nine Months Ended September 30,

 
(Dollars in millions)  2003  2002  2003  2002 

Balance at beginning of period  $61  $63  $61  $58 
Provision for loan losses      1      3 
Loan charge-offs      (3)     (3)
Recoveries            3 
   

  


 

  


Balance at end of period  $61  $61  $61  $61 
   

  


 

  



PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)


   

Three Months

Ended

March 31,


(Dollars in millions)  2004  2003

Balance at beginning of period  $61  $61
Reclassification   (25)  
   


 

Balance at end of period  $36  $61
   


 


 

Notes to Consolidated Financial Statements—During the first quarter of 2004, State Street Corporation (Unaudited)reclassified $25 million of the allowance for loan losses to other liabilities for off-balance sheet commitments. Subsequent to the reclassification, the reserve for off-balance sheet commitments was reduced by $10 million, and recorded as an offset to other operating expenses.

 

Note 5—PremisesOther Assets and EquipmentOther Liabilities

 

The Corporation leasesOther assets included $2.7 billion and $3.8 billion of unrealized gains on foreign exchange contracts at March 31, 2004, and December 31, 2003, respectively.

Other liabilities included $2.7 billion and $3.6 billion of unrealized losses on foreign exchange contracts at March 31, 2004, and December 31, 2003, respectively. Other liabilities also included a restructuring accrual related to a voluntary separation program initiated in the entire 1,045,000 square feetsecond quarter of One Lincoln Street, a new office building located in Boston, Massachusetts, under a 20-year, non-cancelable capital lease expiring in September 2023. State Street began occupying the first 100,000 square feet of the building in June 2003 and occupies 370,000 square feet at September 30, 2003. As of September 30, 2003, a net book value of $220 million for the capital lease was included in premises and equipment in the Consolidated Statement of Condition. The liability related to the lease is included in long-term debt. The amount capitalized represents the appraised value of the footage occupied by State Street as of September 30, 2003. When the building is fully occupied, expected by the end ofMarch 31, 2004, the total appraised value to be capitalized will be $462 million. Asliability was $32 million, reflecting payments of $52 million and reclassifications of $92 million during the lease is amortized, the cost will be included in occupancy expense. The scheduled lease payments for the next five years are $6 million in 2004, $31 million in 2005, and $41 million in each of 2006, 2007 and 2008, and $810 million over the remaining term of the lease; total minimum lease payments are $970 million over the term of the lease with $508 million representing interest.three months ended March 31, 2004.

 

Note 6—Goodwill and Other Intangible AssetsStockholders’ Equity

 

The changesSPACES

In January 2003, in connection with its acquisition of the carryingGSS business (see Note 2), State Street issued $345 million, or 1.7 million units, of SPACES. SPACES are collateralized, forward purchase contract units for additional shares of common stock of State Street. Each of the SPACES has a stated amount of goodwill for$200 and consists of PACES, a fixed-share purchase contract and treasury securities, and COVERS, a variable-share repurchase contract. The SPACES investors will receive total annual payments of 6.75% on the three-units, payable quarterly, consisting of an annual 4.00% contract payment on the COVERS, an annual 0.75% contract payment on the PACES and nine-months ended September 30, 2003, area 2.00% annual return on the underlying treasury securities. The present value of the contract payments totaled $45 million, and were treated as follows:a cost of capital and charged to surplus upon issuance. State Street will receive the proceeds of $345 million and issue common stock upon settlement of the fixed-share purchase contracts underlying the SPACES units on November 15, 2005.


   

For the Three Months

Ended September 30,


  

For the Nine Months

Ended September 30,


 
(Dollars in millions)  

Investment

Servicing

  

Investment

Management

 Total  

Investment

Servicing

  

Investment

Management

 Total 

Balance at beginning of period  $1,003  $210 $1,213  $252  $210 $462 
Goodwill acquired   99     99   823 (a)    823 
Purchase price adjustment           (1)(b)    (1)
Translation adjustments   (11)    (11)  (1)    (1)
Other adjustments           18     18 
   


 

 


 


 

 


Balance at end of period  $1,091  $210 $1,301  $1,091  $210 $1,301 
   


 

 


 


 

 



(a)Approximately $724 million of goodwill was recorded in January 2003, related to the acquisition of GSS. An additional $65 million was recorded in the third quarter of 2003 related to the closing of the Italy and Austria portions of the GSS acquisition. See Note 2 for further details. In addition, $34 million of goodwill related to the acquisition of an alliance was recorded in the third quarter of 2003.
(b)During the second quarter of 2003, goodwill related to GSS was reduced by $48 million due to a change-in-estimate purchase price adjustment, offset by a $47 million increase in goodwill attributable to a performance-based purchase price adjustment for the acquisition of IFS in 2002. See Note 2 for further details.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 6—Goodwill and Other Intangible AssetsStockholders’ Equity (continued)

 

Effective March 22, 2004, State Street exercised its right to fix the variable-share settlement rate of the variable-share repurchase contracts constituting part of the SPACES or existing separately as Separate COVERS, in accordance with the terms of the contracts. The gross carrying amount andvariable-share settlement rate has been fixed at 0.6949 shares per contract in accordance with a formula specified in the contracts.

After the effective date, a holder of a variable-share repurchase contract (whether held as a component of a SPACES or as a Separate COVERS) may settle the variable-share repurchase contract by delivery to the Purchase Contract Agent of that number of shares of common stock of State Street equal to the variable-share settlement rate, as fixed.

The impact of fixing the rate for the COVERS was a reclassification of the recognized gains of $26 million associated with the mark-to-market of the variable-share contracts from other assets to a reduction of surplus in stockholders’ equity.

Accumulated Other Comprehensive Income

At March 31, the components of accumulated amortizationother comprehensive income, net of other intangible assets as of September 30, 2003, isrelated taxes, were as follows:

 


(Dollars in millions) 

Gross

Carrying

Amount

 

Accumulated

Amortization

  

Net

Carrying

Amount


Customer lists (a) $544 $(37) $507
Other  2  (1)  1
  

 


 

Total $546 $(38) $508
  

 


 


(a)Approximately $363 million of customer list intangibles with an amortization period of 15 years were recorded in January 2003 related to the acquisition of GSS. See Note 2 for further details.

Amortization expense related to other intangible assets was $9 million and $23 million for the three- and nine-months ended September 30, 2003, respectively. State Street expects to amortize approximately $28 million per year through the year 2007 related to intangible assets currently held.


 
(Dollars in millions)  2004  2003 

 
Unrealized gain on available-for-sale securities  $108  $80 
Minimum pension liability   (23)   
Foreign currency translation   136   27 
Unrealized loss on cash flow hedges   (14)  (13)
   


 


Total  $207  $94 
   


 



 

 

Note 7—Other AssetsNet Interest Revenue

 

Other assets includes revaluation gains on foreign exchange contracts, investments in partnerships, joint ventures, and tax-advantaged financings, and trade receivables. At September 30, 2003, and December 31, 2002, revaluation gains on foreign exchange contracts were $2.769 billion and $2.451 billion, respectively, and trade receivables related to contractual settlements were $1.269 billion and $56 million, respectively.Net interest revenue consisted of the following:

 

Note 8—Long-term Debt

In January 2003, in connection with its acquisition of the GSS business, State Street issued $345 million of floating-rate, medium-term capital securities due 2008. The floating rate capital securities were issued at LIBOR plus 50 basis points, and are subject to mandatory redemption on December 15, 2005, provided certain regulatory requirements are met, and otherwise are due on February 15, 2008. These notes qualify as Tier 1 capital for bank regulatory purposes. See Note 2 for further details.

In September 2003, State Street Bank authorized $1 billion and issued $400 million of 5.25% Subordinated Bank Notes due 2018 (the “Notes”). The Notes bear an interest rate of 5.25% per annum, and State Street Bank is required to make semi-annual interest payments on the outstanding principal balance of the Notes on April 15 and October 15 of each year. The Notes qualify as Tier 2 capital for bank regulatory purposes. In connection with this offering, State Street Bank executed fair value swaps with a notional value of $400 million to, in effect, convert the Notes from fixed rate to variable rate. See Note 19 for further details.

At September 30, 2003, $227 million was included in long-term debt that related to the capital lease for One Lincoln Street. See Note 5 for further details.


   

Three Months Ended

March 31,


(Dollars in millions)      2004          2003    

Interest Revenue:        
Deposits with banks  $125  $125
Investment securities:        
U.S. Treasury and federal agencies   116   96
State and political subdivisions (exempt from federal tax)   15   17
Other investments   69   66
Securities purchased under resale agreements and federal funds sold   40   51
Commercial and financial loans   14   14
Lease financing   2   23
Trading account assets   3   5
   

  

Total interest revenue   384   397
Interest Expense:        
Deposits   104   100
Other borrowings   56   76
Long-term debt   21   17
   

  

Total interest expense   181   193
   

  

Net interest revenue  $203  $204
   

  


PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 8—Long-term Debt (continued)Operating Expenses—Other

 

Long-term debtThe other category of operating expenses consisted of the following:

 


(Dollars in millions) 

September 30

2003,

 

December 31,

2002


Capital Securities:      
8.035% Capital Securities B due 2027 $321 $329
7.94% Capital Securities A due 2026  217  217
Floating Rate Capital Trust I due 2028  150  150
Floating Rate Capital Trust II due 2008  345  
Other Securities:      
5.25% Subordinated notes due 2018  415  
7.65% Subordinated notes due 2010  312  309
7.35% Notes due 2026  150  150
5.95% Notes due 2003    100
Long-term capital lease  227  
9.50% Mortgage note due 2009  14  15
  

 

Total long-term debt 

$

2,151

 

$

1,270

  

 



   Three Months Ended
March 31,


(Dollars in millions)    2004      2003  

Professional services  $33  $20
Advertising and sales promotion   11   11
Other(1)   59   50
   

  

Total operating expenses–other  $103  $81
   

  


(1)Includes $17 million and $2 million of provisions for securities processing losses, respectively

 

Note 9—Stockholders’ EquityIncome Taxes

 

State Street recorded tax expense of $94 million for the first quarter of 2004, compared to $90 million in the first quarter of 2003. Tax expense for the first quarter of 2004 included a cumulative benefit of $18 million resulting from a change in the effective state tax rate applied to leasing transactions. The reduction in effective state tax rate reflects the relative increase in non-U.S. activity resulting from State Street’s recent acquisitions and divestitures. Tax expense for the first quarter of 2003 included a one-time $25 million after-tax charge for a REIT-related tax matter later settled with the Massachusetts Department of Revenue.

The effective rate for the first quarter of 2004 was 30%, including the impact of the leveraged lease adjustment. The expected tax rate for the full year 2004 is 33.0%, compared with an effective tax rate of 35.1% in 2003.

Accumulated Other Comprehensive Income (Loss)Note 10—Employee Benefit Plans

 

At September 30, theThe components of accumulated other comprehensive income, net of related taxes,periodic benefit cost for the three months ended March 31, were as follows:

 


(Dollars in millions)  2003  2002 

Unrealized gain on available-for-sale securities  $61  $137 
Foreign currency translation   77   2 
Unrealized loss on cash flow hedges   (12)  (14)
   


 


Total  $126  $125 
   


 




   Pension Benefits

   Other Benefits

   2004   2003   2004  2003

Service cost  $11   $11   $1  $1
Interest cost   9    9    1   1
Expected return on plan assets   (10)   (9)      
Transition (asset)/obligation       (1)      
Amortization of prior service cost   (1)          
Amortization of net loss   5    4       
   


  


  

  

Net periodic benefit cost  $14   $14   $2  $2
   


  


  

  


 

Note 10—Processing Fees and OtherEmployer Contributions

 

Processing feesAs previously disclosed in its financial statements for the year ended December 31, 2003, expected employer contributions to the tax-qualified U.S. defined benefit pension plans, non-qualified supplemental employee retirement plans (“SERPs”) and other revenue includes fees received from Deutsche Bank representing amounts earned on client deposits ofpost-retirement plan for the GSS business that have not yet moved to State Street. In addition, processing feesyear ending December 31, 2004 are $55 million, $6 million and other revenue includes fees from software licensing and maintenance, loans, investment banking, structured products, profits and losses from joint ventures, gains and losses on sales of leased equipment and other assets, other trading profits and losses, amortization of investments in tax-advantaged financings, and the residual interest from variable interest entities not consolidated in State Street’s statement of income.$3 million, respectively.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 11—Net Interest Revenue

Net interest revenue consisted of the following:


   

Three Months

Ended

September 30,


  

Nine Months

Ended

September 30,


(Dollars in millions)  2003  2002  2003  2002

Interest Revenue:                
Deposits with banks  $114  $154  $362  $475
Investment securities:                
U.S. Treasury and federal agencies   99   93   295   311
State and political subdivisions (exempt from federal tax)   15   17   48   49
Other investments   64   69   195   219

Securities purchased under resale agreements, securities borrowed and federal funds sold

   32   89   136   287
Commercial and financial loans   15   19   44   65
Lease financing   21   26   67   80
Trading account assets   4   8   15   23
   

  

  

  

Total interest revenue   364   475   1,162   1,509
   

  

  

  

Interest Expense:                
Deposits   81   137   289   381
Other borrowings   58   97   217   319
Long-term debt   22   17   56   55
   

  

  

  

Total interest expense   161   251   562   755
   

  

  

  

Net interest revenue  $203  $224  $600  $754
   

  

  

  


Note 12—Restructuring Expenses

During the second quarter of 2003, State Street announced a program to decrease operating expenses. The expense reductions are being achieved through a decrease in direct controllable expenses and by a voluntary separation and enhanced severance program (“VSP”) primarily in the United States. Approximately 3,000 individuals have accepted the VSP.

During the three- and nine-month periods ended September 30, 2003, State Street incurred $3 million and $295 million of restructuring costs, respectively. Details of the restructuring costs are as follows:


(Dollars in millions)  

Amount Incurred

Through

June 30, 2003

  

Amount

Incurred in

Three Months

Ended

September 30, 2003

  

Expected Future

Amount to be

Incurred

  

Total

Amount

Expected to be

Incurred


Severance  $154  $3  $1  $158
Pension   80         80
Stock compensation   36         36
Other   22         22
   

  

  

  

Total  $292  $3  $1  $296
   

  

  

  

Costs by Line of Business:                
Investment Servicing  $258  $3  $1  $262
Investment Management   34         34
   

  

  

  

Total  $292  $3  $1  $296
   

  

  

  


PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

Note 12—Restructuring Expenses (continued)


(Dollars in millions)  

Restructuring

Accrual

 

Balance as of June 30, 2003  $292 
Additional restructuring costs   3 
Cash payments made to date   (126)
   


Balance as of September 30, 2003  $169 
   



The restructuring costs were recorded during the second quarter at the time the accounting events and measurement date occurred. As of September 30, 2003, $126 million in payments had been made related to the restructuring liability. Severance costs included salaries and related benefits to be paid out over a defined period of up to two years. Pension costs will be paid out primarily in equal annual installments over a five-year period. Stock compensation expense was attributable to the modification of various stock options and restricted and deferred stock awards for individuals who accepted the VSP. See Note 1 for further details on the VSP. Other restructuring costs include outplacement services associated with the termination of employees and professional and actuarial fees incurred. It is expected that an additional $1 million of restructuring costs will be recorded through the first six months of 2004, as full-time employees continue to depart State Street, and a majority of accrued costs will be paid by June 30, 2004.

In April 2002, State Street incurred $20 million of expenses related to cost control efforts through the elimination of positions. These expenses have been reclassified as restructuring costs in the Consolidated Statements of Income for the nine-months ended September 30, 2002 included herein.

Note 13—Operating Expenses—Other

The other category of operating expenses consisted of the following:


   

Three Months Ended

September 30,


  

Nine Months Ended

September 30,


(Dollars in millions)  2003  2002  2003  2002

Professional services  $24  $20  $67  $71
Advertising and sales promotion   9   11   30   37
Other   48   38   155   124
   

  

  

  

Total operating expenses–other  $81  $69  $252  $232
   

  

  

  


Note 14—Income Taxes

State Street recorded tax expense of $103 million and $90 million for the three months ended  September 30, 2003 and 2002, respectively, with effective tax rates of 34.0% and 33.0%, respectively. For the nine months ended September 30, 2003, and 2002, State Street recorded tax expense of $159 million and $265 million, respectively, with effective rates of 36.7% and 33.0%, respectively.

In 2003, State Street recorded a one-time, after tax charge of $12 million representing settlement of a REIT-related tax matter with the Massachusetts Department of Revenue. Excluding the REIT matter, the effective rate for the nine months ended September 30, 2003, was 34.0%. The estimated full-year tax rate for 2003 is 34% excluding the impact of the REIT settlement and 35% if the REIT settlement is included.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

Note 15—Regulatory Capital

 

The regulatory capital amounts and ratios were the following at September 30, 2003,March 31, 2004, and December 31, 2002:2003:

 


  Regulatory Guidelines(a)

  State Street

  State Street Bank

   Regulatory Guidelines(a)

 State Street

 State Street Bank

 
(Dollars in millions)  Minimum  

Well

Capitalized

  2003  2002  2003  2002   Minimum Well
Capitalized
 2004 2003 2004 2003 



 
Risk-based ratios:                
Tier 1 capital  4% 6%  12.8%  17.1%  11.5%  16.4%  4% 6%  13.9%  14.0%  12.3%  12.4%
Total capital  8  10   14.7   18.0   12.8   16.5   8  10   15.6   15.8   13.4   13.7 
Tier 1 leverage ratio  3  5   5.5   5.6   5.3   5.7   3  5   5.5   5.6   5.3   5.4 
Tier 1 capital      $4,362  $4,727  $3,825  $4,449    $4,960  $4,822  $4,268  $4,185 
Total capital       4,998   4,975   4,246   4,476     5,558   5,450   4,657   4,601 

Adjusted risk-weighted assets and market-risk equivalents:

                
On-balance sheet      $20,821  $19,382  $20,074  $18,857    $21,501  $19,681  $20,618  $18,814 
Off-balance sheet       12,884   7,925   12,890   7,930     13,837   14,385   13,842   14,391 
Market-risk equivalents       310   342   272   317     399   436   383   421 
      


 


 


 


   


 


 


 


Total      $34,015  $27,649  $33,236  $27,104    $35,737  $34,502  $34,843  $33,626 
      


 


 


 


   


 


 


 


Quarterly average adjusted assets      $79,931  $84,031  $71,489  $77,563    $90,898  $85,562  $80,744  $76,888 
      


 


 


 


   


 


 


 





 
(a) State Street Bank must meet the regulatory designation of “well capitalized” in order to maintain State Street’s status as a financial holding company, including maintaining a minimum Tier 1 risk-based capital ratio (Tier 1 capital divided by adjusted risk-weighted assets and market-risk equivalents) of 6%, a minimum total risk-based capital ratio (total capital divided by adjusted risk-weighted assets and market-risk equivalents) of 10%, and a Tier 1 leverage ratio (Tier 1 capital divided by quarterly average adjusted assets) of 5%. In addition, Regulation Y defines “well capitalized” for a bank holding company such as State Street for the purpose of determining eligibility for a streamlined review process for acquisition proposals. For such Regulation Y purposes, “well capitalized” requires State Street to maintain a minimum Tier 1 risk-based capital ratio of 6% and a minimum total risk-based capital ratio of 10%.

Note 12—Lines of Business

State Street has two primary lines of business - - Investment Servicing and Investment Management.

Investment Servicing includes custody, accounting, daily pricing and administration; master trust and master custody; recordkeeping; foreign exchange and trading services; securities lending; deposit and short-term investment facilities; loans and lease financing; wealth manager and hedge fund manager services; and performance, risk and compliance analytics to support institutional investors. State Street’s 50%-owned affiliates, Boston Financial Data Services, Inc. and the International Financial Data Services group of companies, provide shareholder services, including mutual fund and collective fund shareholder accounting. Revenue from Investment Servicing comprised 85% of State Street’s total revenue for the three months ended March 31, 2004.

Investment Management offers a broad array of services for managing financial assets, including investment management and investment research, primarily for institutional investors worldwide. These services included

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 16—12—Lines of Business (continued)

passive and active U.S. and non-U.S. equity and fixed income strategies, and other related services, such as securities lending. Retirement benefit services are provided through State Street’s 50%-owned affiliate, CitiStreet, LLC. Revenue from the Investment Management line of business comprised 15% of State Street’s total revenue for the three months ended March 31, 2004.

Business Divesture included the revenue and expenses related to the Private Asset Management operations sold in October 2003.

Other/One-Time charges for the first three months of 2004 and 2003 included merger and integration costs related to the acquisition of GSS of $18 million and $37 million, respectively.

 

The following is a summarytotal columns represent consolidated results in accordance with accounting principles generally accepted in the United States as they appear in the Consolidated Statements of Income included in the lines of business financial results:statements.

 


   For the Three Months Ended September 30,

   

Investment

Servicing


  

Investment

Management


  

Business

Divestiture(a)


  

Other/

One-Time


  Total

(Dollars in millions, except where

otherwise noted; taxable equivalent)

  2003  2002  2003  2002  2003  2002  2003  2002  2003  2002

Total revenue  $958  $788  $168  $145     $23         $1,126  $956

Income before income taxes

   293   238   41   25      9  $(29)(b)     305   272
Average assets (billions)   79.6   73.8   2.2   1.8      .5          81.8   76.1

(a)Results of operations of the Corporate Trust operations divestiture
(b)Restructuring costs related to an expense control program of $3 million (all Investment Servicing); merger and integration expenses related to the acquisition of GSS of $26 million


   For the Nine Months Ended September 30,

   

Investment

Servicing


  

Investment

Management


  

Business

Divestiture(a)


  

Other/

One-Time


  Total

(Dollars in millions, except where

otherwise noted; taxable equivalent)

  2003  2002  2003  2002  2003  2002  2003  2002  2003  2002

Total revenue  $2,764  $2,409  $477  $461     $70  $(13)(b)     $3,228  $2,940

Income before income taxes

   735   723   88   73      27   (389)(c) $(20)(d)  434   803
Average assets (billions)   79.0   74.8   2.0   1.8      .5           81.0   77.1

(a)Results of operations of the Corporate Trust operations divestiture
(b)Represents the loss on sale of real estate sold
(c)Restructuring costs related to an expense control program of $295 million ($261 million incurred in Investment Servicing and $34 million incurred in Investment Management), merger and integration expenses related to the acquisition of GSS of $81 million; and the loss on sale of real estate sold of $13 million
(d)Restructuring costs related to an expense control program of $20 million ($17 million incurred in Investment Servicing and $3 million incurred in Investment Management)

Note 17—Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share:


   

Three Months Ended

September 30,


  

Nine Months Ended

September 30,


(Dollars in millions, except per share data; shares in thousands)  2003  2002  2003  2002

Net income  $202  $182  $275  $538
Earnings per share:                
Basic  $.61  $.57  $.83  $1.66
Diluted   .60   .56   .82   1.64
Basic average shares   332,246   323,023   331,056   323,521
Stock options and stock awards   4,184   2,808   2,961   3,829
7.75% convertible subordinated debentures   138   332   143   363
   

  

  

  

Dilutive average shares   336,568   326,163   334,160   327,713
   

  

  

  



   For the Three Months Ended March 31,

   Investment
Servicing


  

Investment

Management


  

Business

Divestiture(1)


  Other/
One-Time


  Total

(Dollars in millions, except

where otherwise noted)

  2004  2003  2004  2003  2004  2003  2004  2003  2004  2003

Fee Revenue:

                                       

Servicing fees

  $555  $438                         $555  $438

Management fees

        $147  $108     $17           147   125

Securities lending

   53   47   11   8                 64   55

Foreign exchange trading

   118   72                       118   72

Brokerage fees

   45   30                       45   30

Processing fees and other

   70   64   14   5      1           84   70
   


 


 


 


    

          

  

Total fee revenue

   841   651   172   121      18           1,013   790

Net interest revenue after provision for loan losses

   194   194   9   10                 203   204

Gains on sale of available-for-sale securities, net

   3   26                       3   26
   


 


 


 


    

          

  

Total Revenue

   1,038   871   181   131      18           1,219   1,020

Operating Expenses

   755   669   135   116      12  $18  $37   908   834
   


 


 


 


 
  

  


 


 

  

Income (Loss) Before Income Taxes

  $283  $202  $46  $15     $6  $(18) $(37) $311  $186
   


 


 


 


 
  

  


 


 

  

Pre-tax margin

   27%  23%  25%  12%                      

Average assets (billions)

  $90.6  $75.8  $2.4  $1.8     $.1          $93.0  $77.7
   


 


 


 


 
  

  


 


 

  


PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 17—13—Earnings Per Share (continued)

The following table sets forth the computation of basic and diluted earnings per share:


   Three Months Ended
March 31,


(Dollars in millions, except per share data; shares in thousands)  2004  2003

Net income  $217  $96
Earnings per share:        
Basic  $.65  $.29
Diluted   .63   .29
Basic average shares   334,635   329,569
Effect of dilutive securities:        
Stock options and stock awards   7,356   2,336
Equity-related financial instruments   138   149
   

  

Dilutive average shares   342,129   332,054
   

  


 

For the three months ended September 30,March 31, 2004 and 2003, and 2002, the following potentially dilutive financial instruments were outstanding, but not included in the computation of diluted average shares because the exercise prices of the instruments were greater than the average fair value of State Street’s common stock during those periods: 2003—2004—stock options of 11,898,000; 2002—stock1.8 million; 2003 —stock options of 8,140,000.

For the nine months ended September 30, 2003 and 2002, the following potentially dilutive financial instruments were outstanding, but not included in the computation of diluted average shares because of contractual obligations or the exercise prices of the instruments were greater than the average fair value of State Street’s common stock during those periods: 2003—stock options of 11,898,000 and SPACES of 8,712,000; 2002—stock options of 8,140,000.19.3 million.

 

Note 18—14—Contingent Liabilities

 

State Street provides custody, accounting, daily pricing and administration; master trust and master custody; investment management; trustee and recordkeeping; foreign exchange;exchange and trading services; securities lending; cash management; trading;wealth manager and hedge fund manager services; and information services to clients worldwide. Assets under custody and assets under management are held by State Street in a fiduciary or custodial capacity and are not included in the Consolidated Statement of Condition because such items are not assets of State Street. Management conducts regular reviews of its responsibilities for these services and considers the results in preparing its financial statements. In the opinion of management, there are no contingent liabilities exist at September 30, 2003,March 31, 2004, that would have a material adverse effect on State Street’s financial position or results of operations.

 

In the normal course of business, State Street is subject to pendingchallenges from U.S. and threatened legal actions that arisenon-U.S. tax authorities regarding the amount of taxes due. These challenges may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions. Management believes State Street is appropriately accrued for tax exposures. If State Street prevails in a matter for which an accrual has been established, or is required to pay an amount exceeding its reserve, the financial impact will be reflected in the normal course of business. Inperiod that the opinion of management, after discussion with counsel, these actions can be successfully defended or resolved without a material adverse effect on State Street’s financial position or results of operations.matter is resolved.

Note 19—Off-Balance Sheet Financial Instruments, Including Derivatives

State Street uses various off-balance sheet financial instruments, including derivatives. The following table summarizes the contractual or notional amounts of derivative financial instruments held or issued by State Street for trading and balance sheet management purposes:


(Dollars in millions)  

September 30,

2003

  

December 31,

2002


Trading:        
Interest rate contracts:        
Swap agreements  $5,577  $3,847
Options and caps purchased   337   351
Options and caps written   564   483
Futures—short position   32,415   15,078
Foreign exchange contracts:        
Forward, swap and spot   316,521   227,782
Options purchased   1,408   350
Options written   1,220   136
Futures      409
Balance Sheet Management:        
Interest rate contracts:        
Swap agreements   3,472   2,020

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

 

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

 

Note 19—Off-Balance Sheet15—Derivative Financial Instruments Including Derivatives (continued)

State Street uses various derivatives to support clients’ needs, conduct trading activities and manage its interest rate and currency risk. The following table summarizes the contractual or notional amounts of derivative financial instruments held or issued for trading and balance sheet management:


(Dollars in millions)  March 31,
2004
  December 31,
2003

Trading:

        
Interest rate contracts:        
Swap agreements  $2,873  $3,154
Options and caps purchased   331   332
Options and caps written   650   656
Futures   38,693   40,003
Foreign exchange contracts:        
Forward, swap and spot   401,034   322,051
Options purchased   4,713   2,243
Options written   4,326   2,064

Balance Sheet Management:

        
Interest rate contracts:        
Swap agreements   3,431   3,964

 

In connection with its interest rateinterest-rate risk management strategies, State Street has executed interest rateinterest-rate swap agreements with a notional value of $2.322$2.1 billion at September 30, 2003,March 31, 2004, designated as fair value hedges to hedge the changes in the fair value of certain securities. For the ninethree months ended September 30, 2003,March 31, 2004, State Street recognized net pre-tax losses of $3 million, which represented the ineffective portion of the hedge.

 

State Street has designated interest rate swaps with a notional value of $150 million as cash flow hedges to its floating rate debt. These interest rate swaps constitute a fully effective hedge. In addition, State Street entered into interest rate swaps with a notional value of $500 million effective February 20, 2002, a notional value of $50 million effective June 11, 2002, and a notional value of $50 million effective July 9, 2002,$1.2 billion was designated as fair value hedges to hedge certain of its fixed rate debt issuances. On September 24, 2003, State Street Bank entered into interest rate swaps with a notional value of $400 million, designated as a fair value hedge for the subordinated notes issued on that date.debt. The fair value hedge swaps increased the value of long-term debt presented in the Statement of Condition by $66 million.$72 million at March 31, 2004. For the ninethree months ended September 30, 2003,March 31, 2004, the Corporation’s overall weighted average interest rate for long-term debt was 5.76%5.80% on a contractual basis and 4.42%3.76% including the effects of derivative contracts.

 

In January 2003, in connection with its acquisition of the GSS business (see Note 2), State Street issued $345 million, or 1.7 million units, of SPACES. SPACES are collateralized, forward purchase contract units for additional shares of common stock of State Street. Each of the SPACES has a stated amount of $20016—Commitments and consists of PACES, a fixed-share purchase contract and treasury securities, and COVERS, a variable-share repurchase contract. The SPACES investors will receive total annual payments of 6.75% on the units, payable quarterly, consisting of an annual 4.00% contract payment on the COVERS, an annual 0.75% contract payment on the PACES and a 2.00% annual return on the underlying treasury securities. These payments, the present value of which totaled $45 million, were treated as a cost of capital and charged to surplus upon issuance. State Street will receive the proceeds of $345 million and issue common stock upon settlement of the fixed share purchase contracts underlying the SPACES units on November 15, 2005.Off-Balance Sheet Activities

 

The following is a summary of the contractual amount of State Street’s credit-related, off-balance sheet financial instruments:

 


(Dollars in millions)  

September 30,

2003

  

December 31,

2002

  March 31,
2004
  December 31,
2003

Indemnified securities on loan  $204,372  $131,991  $348,778  $266,055
Asset purchase agreements   17,181   14,044
Liquidity asset purchase agreements   16,824   16,540
Loan commitments   12,441   12,499   12,599   12,270
Standby letters of credit   4,029   3,252   5,126   4,545
Letters of credit      106

 

On behalf of its clients, State Street lends their securities to creditworthy broker-dealersbrokers and other institutions. In certain circumstances, State Street may indemnify its clients for the fair market value of those securities against a failure

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

Note 16—Commitments and Off-Balance Sheet Activities (continued)

of the borrower to return such securities. State Street requires the borrowers to provide collateral in an amount equal to or in excess of 102% of the fair market value of the securities borrowed. The borrowed securities are revalued daily to determine if additional collateral is necessary. State Street held, as collateral, cash and U.S. government securities and other securities totaling $210.8$378.9 billion and $134.6$271.3 billion for indemnified securities on loan at September 30, 2003,March 31, 2004, and December 31, 2002,2003, respectively.

PART I.    ITEM 1.

FINANCIAL STATEMENTS (continued)

Notes to Consolidated Financial Statements—State Street Corporation (Unaudited)

Note 19—Off-Balance Sheet Financial Instruments, Including Derivatives (continued)

 

Loan commitments (unfunded loans and unused lines of credit), liquidity asset purchase agreements and standby letters of credit and letters of credit are issued to accommodate the financing needs of State Street’s clients and to provide liquidity and credit enhancements to variable interest entities. Loan commitments are agreements by State Street to lend monies at a future date. AssetLiquidity asset purchase agreements are commitments to purchase receivables or securities, subject to conditions established in the agreements.

 

Approximately 88%87% of the loan commitments and liquidity asset purchase agreements will expire inwithin one year or less from the date of issue. Since many of the commitments are expected to expire or renew without being drawn, the total commitment amounts do not necessarily represent future cash requirements.

 

State Street provides liquidity and credit enhancement facilities in the formsform of liquidity asset purchase agreements, lines of credit, and standby letters of credit to two types of variable interestoff-balance sheet entities. One type, special purpose entities (“VIEs”SPEs”). One type,, as defined by FIN 46-R (revised), which are administered by State Street, administers, issues asset-backed commercial paper (“ABCP”). At September 30,March 31, 2004 and December 31, 2003, and 2002, State Street’s commitments under liquidity asset purchase agreements and lines of credit to this type of VIEsthese SPEs were $12.6$12.0 billion and $9.9$11.9 billion, respectively, and standby letters of credit were $644$653 million and $590$644 million, respectively. Amounts committed, but unused, under the liquidity asset purchase agreements, lines of credit and standby letters of credit that State Street provides to these VIEsSPEs are included in the table above. During the three-months ended September 30, 2003, $50 million was drawn under a liquidity asset purchase agreement.preceding table. Asset performance deterioration or certain other factors may cause the asset risk to shift from the ABCP investors to State Street as the liquidity provider for the liquidity asset purchase agreements, as the VIESPE may need to repay maturing commercial paper by drawing the liquidity facilities. State Street would acquire the assets at fair market value at the date of transfer. Potential losses, if any, from these VIEsSPEs are not expected to materially affect the financial condition or results of operations of the Corporation.

 

For a second type of VIE,off-balance sheet entity, structured as a qualified special purpose entityspecial-purpose entities (“QSPEs”) in accordance with accounting principles generally accepted in the United States, State Street distributes and sells equity interests in tax-exempt investment-grade assets that are primarily sold to mutual fund clients. For these QSPEs, State Street transfers the assets from its investment portfolio at fair market value. Such transfers are treated as sales. The QSPEs finance the acquisition of these assets by selling equity interests to third-party investors. State Street owns a minority residual interest in these QSPEs of less than 6%, or $72 million at March 31, 2004. These trusts have a weighted average life of approximately 5.1 years. In a separate agreement, State Street provides liquidity asset purchase agreements to these entities. These liquidity asset purchase agreements obligate State Street to buy the equity interests in the underlying portfolio at par, which approximates market value, in the event that the re-marketing agent is unable to place the equity interests of the VIEoff-balance sheet entity with investors. The liquidity asset purchase agreements are subject to early termination by State Street in the event of payment default, bankruptcy of the issuer or credit enhancement provider, taxability, or downgrade of an asset below investment grade. State Street’s liquidity asset purchase agreements to these VIEsoff-balance sheet entities were $1.4 billion and $1.3$1.2 billion at September 30,March 31, 2004, and December 31, 2003, and 2002, respectively, none of which were utilized.

Note 20—Subsequent Event

On October 31, 2003, State Street completed the sale of its Private Asset Management business to U.S. Trust. Under the terms of the agreement, the transaction is valued at $365 million, about five percent of which is subject to the successful transition of the business over the next 16 months. The company expects to record approximately $280 million in pretax income from the transaction after providing for about $65 million in exitutilized and closing costsare included in the fourth quarter.preceding table.

Independent Accountants’ Review Report

 

The Stockholders and Board of Directors

State Street Corporation

 

We have reviewed the accompanying consolidated statement of condition of State Street Corporation as of September 30, 2003,March 31, 2004, and the related consolidated statements of income, for the three-month and nine-month periods ended September 30, 2003 and 2002, and the consolidated statements of changes in stockholders’ equity and cash flows for the nine-month periodsthree months ended September 30, 2003March 31, 2004 and 2002.2003. These financial statements are the responsibility of the Corporation’s management.

 

We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

 

Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.

 

We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated statement of condition of State Street Corporation as of December 31, 2002,2003, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the year then ended (not presented herein) and in our report dated January 10, 2003, except for Note 25, as to which the date is January 31, 2003,12, 2004, we expressed an unqualified opinion on those consolidated financial statements.

 

ERNST & YOUNG LLP

 

Boston, Massachusetts

October 13, 2003April 12, 2004

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS

 

RESULTS OF OPERATIONS

 

State Street prepares and reports its financial information in accordance with accounting principles generally accepted in the United States (“reported” results). ReportedUnless otherwise indicated, results for 2003 include the impact of the newly acquired Global Securities Services (“GSS”) business, the financing costs attributablediscussed in this Form 10-Q refer to the acquisition and amortization of intangibles related to the acquisition, and various other one-time charges. The 2002 reported results include the operating results of the divested Corporate Trust business and restructuring charges.results.

 

RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30,MARCH 31, 2004 AND 2003 AND 2002

 

Condensed Income Statement—Reported Results

 


  Three Months Ended September 30,

   Three Months Ended March 31,

 
(Dollars in millions, except per share data)  2003  2002  $ Change  % Change   2004  2003  $ Change % Change 



 
Fee Revenue:                   
Servicing fees  $505  $390  $115  30%  $555  $438  $117  27%
Management fees   141   116   25  21    147   125   22  17 
Global securities lending   61   45   16  36 
Securities lending   64   55   9  16 
Foreign exchange trading   101   78   23  27    118   72   46  63 
Brokerage fees   28   32   (4) (10)   45   30   15  51 
Processing fees and other   92   41   51      84   70   14  21 
  


 

  


    

  

  


 
Total fee revenue   928   702   226  32    1,013   790   223  28 
Net Interest Revenue:                   
Net interest revenue   203   224   (21) (10)   203   204   (1)  
Provision for loan losses      1   (1)              
  


 

  


    

  

  


 
Net interest revenue after provision for loan losses   203   223   (20) (9)   203   204   (1)  
(Losses) gains on sales of available-for-sale investment securities, net   (5)  31   (36)  
Gains on the sales of available-for-sale investment securities, net   3   26   (23) (89)
  


 

  


    

  

  


 
Total Revenue   1,126   956   170  18    1,219   1,020   199  19 
Operating Expenses:                   
Salaries and employee benefits   407   398   9  2    462   443   19  4 
Information systems and communications   140   92   48  53    139   130   9  7 
Transaction processing services   80   63   17  25    96   72   24  33 
Occupancy   84   62   22  37    90   71   19  26 
Merger and integration costs   26      26      18   37   (19) (51)
Restructuring   3      3   
Other   81   69   12  17    103   81   22  28 
  


 

  


    

  

  


 
Total operating expenses   821   684   137  20    908   834   74  9 
  


 

  


    

  

  


 
Income before income taxes   305   272   33  12    311   186   125  68 
Income tax expense   103   90   13  15    94   90   4  6 
  


 

  


    

  

  


 
Net Income  $202  $182  $20  10   $217  $96  $121  125 
  


 

  


    

  

  


 
Earnings Per Share:                   
Basic  $.61  $.57  $.04  7   $.65  $.29  $.36  124 
Diluted   .60   .56   .04  7    .63   .29   .34  117 



 

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

SUPPLEMENTAL FINANCIAL INFORMATION

 

In order to provide information on a comparable basis from period to period and to assist stockholders, analysts, other external parties and management in analyzing the financial results and trends of its ongoing businesses and operations, supplemental financial results on a “baseline”an “operating” basis are presented below. In this Management’s Discussion and Analysis of Financial Condition and Results of Operations section, the discussion will reference reported results, as previously defined, and “baseline” results, “GSS contribution” results, and “operating” results. These additional termsOperating results are defined as follows:

“Operating” results are reported results on a taxable equivalent basis, excluding significant chargesmerger and results of a divested business. For the third quarter ofintegration costs and for 2003, operating results exclude merger, integration and restructuring costs. For 2002, third quarter operating results exclude the results of the divested Corporate Trust business.

“GSS contribution”Private Asset Management (“PAM”) business and the impact of a state tax matter. Operating results areinclude the revenue and expensesresults of the Global Securities Services (“GSS”) business for a full three months in the thirdfirst quarter of 2003, including financing costs2004 and amortizationfrom the date of intangibles, attributable to the GSS business acquiredacquisition, January 31, 2003, as well as revenue and expenses from “out-of-scope” GSS business that were not part of the acquisition, but commenced in the secondfirst quarter of 2003 with GSS clients. Per share amounts reflect the effect on outstanding shares due to the acquisition.

“Baseline” results are operating results excluding GSS contribution, and are presented on a taxable-equivalent basis.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)2003.

 

Supplemental Financial Information—BaselineOperating Basis Reconciliation—Three Months Ended September 30,March 31, 2004 and 2003

 





  Three Months Ended March 31,

  Three Months Ended September 30, 2003

   2004

  2003

(Dollars in millions, except per share data)  

Baseline

Results

  

GSS (a)

Contribution

  

Operating

Results

  Other  

Reported

Results

   

Operating

Results

  Other 

Reported

Results

  

Operating

Results

  PAM(4)  Other 

Reported

Results


Fee Revenue:                          
Servicing fees  $400  $105  $505    $505   $555   $555  $438      $438
Management fees   137   4   141     141    147    147   108  $17    125
Global securities lending   48   13   61     61 

Securities lending

   64    64   55       55
Foreign exchange trading   89   12   101     101    118    118   72       72
Brokerage fees   28      28     28    45    45   30       30
Processing fees and other   61   31   92     92    84    84   69   1    70
  


 


 


   


  

   

  

  

   

Total fee revenue   763   165   928     928    1,013    1,013   772   18    790
Net Interest Revenue:                          
Net interest revenue   218   (2)(b)  216  $(13)(d)  203    214  $(11)(1)  203   217     $(13)(1)  204
Provision for loan losses                                     
  


 


 


 


 


  

  


 

  

  

  


 

Net interest revenue after provision for loan losses   218   (2)  216   (13)  203    214   (11)  203   217      (13)  204

Losses on sales of available-for-sale investment securities, net

   (5)     (5)     (5)

Gains on the sales of available-for-sale investment securities, net

   3      3   26         26
  


 


 


 


 


  

  


 

  

  

  


 

Total Revenue   976   163   1,139   (13)  1,126    1,230   (11)  1,219   1,015   18   (13)  1,020
Operating Expenses:                          
Salaries and employee benefits   354   53   407      407    462      462   436   7      443
Information systems and communications   94   46   140      140    139      139   130         130
Transaction processing services   66   14   80      80    96      96   72         72
Occupancy   74   10   84      84    90      90   70   1      71
Merger and integration costs            26   26       18(2)  18         37(2)  37
Restructuring            3   3 
Other   62   19(e)  81      81    103      103   77   4      81
  


 


 


 


 


  

  


 

  

  

  


 

Total operating expenses   650   142   792   29   821    890   18   908   785   12   37   834
  


 


 


 


 


  

  


 

  

  

  


 

Income (loss) before income taxes   326   21   347   (42)  305    340   (29)  311   230   6   (50)  186
Income tax expense (benefit)   102   7   109   (6)  103    101   (7)(3)  94   76   2   12(5)  90
Taxable-equivalent adjustment   13      13   (13)(d)      11   (11)(1)     13      (13)(1)  
  


 


 


 


 


  

  


 

  

  

  


 

Net Income  $211  $14  $225  $(23) $202   $228  $(11) $217  $141  $4  $(49) $96
  


 


 


 


 


  

  


 

  

  

  


 

Earnings Per Share—Diluted  $.65  $.01(c) $.66  $(.06) $.60   $.67  $(.04) $.63  $.43  $.01  $(.15) $.29

Reported results agree with the Corporation’s Consolidated Statement of Income

(a)Includes $10 million of revenue and $12 million of expenses related to out-of-scope client relationships
(b)Includes $5 million of net interests costs attributable to the GSS acquisition financing
(c)Includes ($.03) impact due to changes in shares outstanding attributable to the acquisition
(d)(1) Taxable-equivalent adjustment was not included in reported results
(e)(2) Includes amortizationMerger and integration costs associated with the acquisition of intangibles expensethe GSS business on January 31, 2003
(3)Tax benefit associated with the merger and integration costs
(4)Revenue and expenses of $7the Private Asset Management business divested October 31, 2003
(5)Impact of a state tax matter ($25 million of expense), net of the tax benefit associated with merger and integration costs of $13 million

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

SupplementalSupplement Financial Information—Baseline Reconciliation—Three Months Ended September 30, 2002


   Three Months Ended September 30, 2002

(Dollars in millions, except per share data)  

Baseline

Results

  

Corporate

Trust

Business

  Other  

Reported

Results


Fee Revenue:                
Servicing fees  $371  $19      $390
Management fees   116          116
Global securities lending   45          45
Foreign exchange trading   78          78
Brokerage fees   32          32
Processing fees and other   40   1       41
   

  

  


 

Total fee revenue   682   20       702
Net Interest Revenue:                
Net interest revenue   237   3  $(16)(a)  224
Provision for loan losses   1         1
   

  

  


 

Net interest revenue after provision for loan losses   236   3   (16)  223
Gains on sales of available-for-sale investment securities, net   31         31
   

  

  


 

Total Revenue   949   23   (16)  956
Operating Expenses:                
Salaries and employee benefits   390   8      398
Information systems and communications   90   2      92
Transaction processing services   62   1      63
Occupancy   60   2      62
Restructuring            
Other   67   2      69
   

  

  


 

Total operating expenses   669   15      684
   

  

  


 

Income (loss) before income taxes   280   8   (16)  272
Income tax expense   87   3      90
Taxable-equivalent adjustment   16      (16)(a)  
   

  

  


 

Net Income  $177  $5  $  $182
   

  

  


 

Earnings Per Share—Diluted  $.54  $.02     $.56

Reported results agree with the Corporation’s Consolidated Statement of Income

(a)Taxable-equivalent adjustment

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Supplemental Financial Information—BaselineOperating(a)(1) —Consolidated Statement of Income

 


  Three Months Ended September 30,

   Three Months Ended March 31,

 
(Dollars in millions, except per share data)  2003  2002  $ Change  % Change   2004  2003  $ Change % Change 



 
Fee Revenue:          

Operating Fee Revenue:

         
Servicing fees  $400  $371  $29  8%  $555  $438  $117  27%
Management fees   137   116   21  17    147   108   39  36 
Global securities lending   48   45   3  8 
Securities lending   64   55   9  16 
Foreign exchange trading   89   78   11  13    118   72   46  63 
Brokerage fees   28   32   (4) (10)   45   30   15  51 
Processing fees and other   61   40   21  58    84   69   15  21 
  


 

  


    

  

  


 
Total fee revenue   763   682   81  12 
Total operating fee revenue   1,013   772   241  31 

Net Interest Revenue:

          

Operating Net Interest Revenue:

         
Net interest revenue   218   237   (19) (8)   214   217   (3) 
Provision for loan losses      1   (1)             
  


 

  


    

  

  


 
Net interest revenue after provision for loan losses   218   236   (18) (8)   214   217   (3) (1)
(Losses) gains on sales of available-for-sale investment securities, net   (5)  31   (36)  
Gains on the sales of available-for-sale investment securities, net   3   26   (23) (89)
  


 

  


    

  

  


 
Total Revenue   976   949   27  3 
Total Operating Revenue   1,230   1,015   215  21 
Operating Expenses:          

Operating-Basis Operating Expenses:

         
Salaries and employee benefits   354   390   (36) (9)   462   436   26  6 
Information systems and communications   94   90   4  5    139   130   9  7 
Transaction processing services   66   62   4  5    96   72   24  33 
Occupancy   74   60   14  23    90   70   20  29 
Other   62   67   (5) (7)   103   77   26  34 
  


 

  


    

  

  


 
Total operating expenses   650   669   (19) (3)
Total operating-basis operating expenses   890   785   105  13 
  


 

  


    

  

  


 
Income before income taxes   326   280   46  17    340   230   110  48 
Income tax expense   102   87   15  18    101   76   25  
Taxable-equivalent adjustment   13   16   (3) (20)   11   13   (2) 
  


 

  


    

  

  


 
Net Income  $211  $177  $34  19 
Net Operating Income  $228  $141  $87  63 
  


 

  


    

  

  


 
Earnings Per Share—Diluted  $.65  $.54  $.11  20 
Operating Diluted Earnings Per Share  $.67  $.43  $.24  56 



 
(a)(1) As defined and reconciled to reported results on an earlier schedulesschedule

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

Summary

 

State Street reported net income for the thirdfirst quarter of 20032004 of $.60$.63 per share, reflecting net income of $202$217 million and total revenue of $1.126$1.2 billion. In the thirdfirst quarter of 2002,2003, State Street earned $.29 per share, reflecting net income of $182$96 million and total revenue of $1.0 billion. Total expenses in the first quarter of 2004 of $908 million are up $74 million compared to the year-ago quarter.

Results for the first quarter of 2004 include pre-tax merger and integration costs of $18 million, or $.56$0.03 per diluted share on $956 milliondue to the continuing integration of revenue. Reported resultsthe Deutsche Bank Global Securities Services business (GSS), acquired in January of 2003. Results for the thirdfirst quarter 2003 included net income of $14 million from the GSS business, or $.01 per share. In addition, reported results2003 included pre-tax merger and integration costs of $26$37 million, or $0.07 per diluted share, related to the GSS acquisition of the GSS business and a pre-tax restructuringan after-tax charge of $3$25 million, or $0.08 per diluted share, related to a tax matter with the Corporation’s expense-reduction program for a combined after-tax per share chargeCommonwealth of $.06. ReportedMassachusetts. First quarter 2003 results for 2002 includedalso include the operating results of the divested Corporate Trust business that added $5 million to net income, or $.02 per share.Private Asset Management (PAM) business.

 

ExcludingOperating earnings per share for the first quarter of 2004 were $0.67, up 56% compared to operating earnings per share of $0.43 for the first quarter of 2003. Operating results for 2003 have been reduced from the previously reported $0.44 per share reflecting the impact of GSS,the divested Private Asset Management business. Operating revenue of $1.2 billion in the first quarter of 2004 was up 21% from the first quarter of 2003, primarily due to increases in servicing and management fees, foreign exchange, brokerage fees, and processing fees and other, slightly offset by lower securities gains. Operating expenses of $890 million in the significant charges listed above, baseline earningsfirst quarter of 2004 were $211up $105 million, or $.65 per share in13%, from the thirdfirst quarter of 2003. This comparison reflects two months of recorded operating activity for the GSS business acquired on January 31, 2003, compared with baseline earningsthree full months in 2004.Return on stockholders’ equity on an operating basis was 15.6% for the third quarter of 2002 of $177 million, or $.54 per share, which excluded the impact of the operating results of the Corporate Trust business. Higher fee revenue, as well as lower operating expenses drove the increase in baseline earnings. A decline in net interest revenue somewhat offset some of the growth in baseline earnings.

 

Total Revenue

 

In the thirdfirst quarter of 2003,2004, total reported revenue was $1.126$1.2 billion, up $170$199 million, compared to $956 million$1.0 billion a year ago and included revenue from the GSS business of $163 million.ago. On a baselinean operating basis, total revenue was $976 million$1.2 billion compared to $949 million$1.0 billion in 2002,2003, an increase of $27$215 million, primarily fromreflecting an increase of $241 million in fee revenue, including higher servicing and management fees and processing fees and other revenue, offset somewhat by lower net interest revenue. Losses on thea $23 million decline in sales of available-for-sale securities in 2003 totaled $5 million, compared with gains of $31 million in 2002.securities.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

Fee Revenue

 

Fee revenue for the first quarter of 2004 was $1.0 billion on both a reported basis for the third quarter of 2003 was $928 million, up $226 million, from 2002.and operating basis. Reported fee revenue for 2003 was $790 million and included $165 million of revenue from the GSS business. Reported fee revenue for the third quarter of 2002 included $20$18 million from the divested Corporate TrustPAM business. On a baselinean operating basis, fee revenue was $763increased $241 million up $81from $772 million, compared to $682 million for the third quarter of 2002.

Servicingreflecting increases in servicing, management, foreign exchange, brokerage and managementprocessing fees were the largest components of fee revenue. Combined, they comprise approximately 70% of State Street’s total reported fee revenue. Servicing and management fees are affected by changes in worldwide equity and fixed income valuations. In general, servicing fees are affected by changes in daily average valuations of assets under custody, and management fees are affected by changes in month-end valuations of assets under management. Management fee revenue is significantly more sensitive to market valuations than servicing fee revenue.

State Street estimates that a 10% increase or decrease in worldwide equity values would cause a corresponding change in State Street’s total revenue of approximately 2%. Similarly, as bond values worldwide increase or decrease by 10%, State Street would anticipate a corresponding change of approximately 1% in its totalother revenue.

 

Servicing fees are derived from custody, product- and participant-level accounting, daily pricing and administration; master trust and master custody; trustee and recordkeeping; performance, risk and compliance analytics; and investmentwealth manager operations outsourcing.and hedge fund manager services. Servicing fees for the thirdfirst quarter of 20032004 were $505$555 million, up $115$117 million, or 27%, from the reported $390servicing fees of $438 million in the third quarter of 2002.a year earlier. The increase was primarily attributable to the extra month of servicing fee revenue generated by the GSS business, acquisition of $105 million offset somewhat by the $19 million of servicing fees in 2002 attributable to the divested Corporate Trust business. On a baseline basis, servicing fees were $400 million, up 8% from $371 million for the third quarter of 2002. The increase in baseline servicing fee revenue was attributable to improvement inhigher equity market valuations and new business from existing and new clients. The following table provides selected equity market indices, which demonstrate worldwide equity market valuation changes for the nine months ended September 30, 2003:clients in 2004.


  Daily Averages of Indices

 
  For the three months ended September 30, 
Index 2003  2002  Change 

S&P 500® 1,000.4  895.5  12%
NASDAQ® 1,765.2  1,310.0  35 
MSCI® EAFE 1,072.4  1,001.4  7 

 

At September 30, 2003,March 31, 2004, total assets under custody were $8.8$9.4 trillion, including $2.0up 19% from $7.9 trillion attributable to the GSS business.a year earlier. The value of assets under custody is a broad measure of the relative size of various markets served. Changes to the value of assets under custody do not result in proportional changes in revenue. Many services are priced on factors other than asset values, including the mix of assets under custody, securities positions held, portfolio transactions, and types of products and services. State Street uses relationship pricing for clients who take advantage of multiple services.


Mix of Assets Under Custody  March 31, 2004

  December 31, 2003

  March 31, 2003

 
(Dollars in trillions)  Assets  

Percentage

of Total

  Assets  Percentage
of Total
  Assets  Percentage
of Total
 

 
Equities  $3,681  39% $3,479  37% $2,647  33%
Fixed income   2,749  29   2,636  28   2,292  29 
Short-term investments   1,226  13   1,176  13   1,032  13 
Acquired GSS   1,766  19   2,079  22   1,939  25 
   

     

     

    
Total  $9,422     $9,370     $7,910    
   

     

     

    

 

Management fees from investment management services, primarily delivered through State Street Global Advisors®, were $147 million, compared to $125 million a year ago. Fees from the PAM business added $17 million to 2003 management fees. On an operating basis, management fees were up $39 million, or 36%, from $108 million in 2003, reflecting an increase in average month-end equity valuations and continued new business success. Total assets under management were $1.2 trillion, up 58%, compared to $788 billion the previous year.

Securities lending revenue was $64 million in the first quarter of 2004, compared to $55 million in the first quarter of the previous year, an increase of 16%. The increase in securities lending revenue reflected a 35% increase in the volume of securities lent, partially offset by significantly narrower interest rate spreads.

Foreign exchange trading revenue was $118 million for the first quarter of 2004 compared to $72 million a year ago. The increase was attributable to significantly higher currency volatility, and higher volumes reflecting increased cross-border investment activities of State Street’s clients.

Brokerage fee revenue was $45 million in the first quarter, up 51% from $30 million in 2003 due to an increase in transition management for State Street’s clients and growth in electronic trade execution.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

Management fees from investment management services, primarily delivered through State Street Global Advisors®, were $141 million, compared to $116 million a year ago. Fees from the GSS business added $4 million to management fees. On a baseline basis, management fees were $137 million, up $21 million from 2002, reflecting the effects of continued new business success, and an increase in average month-end equity valuations. Total assets under management were $965 billion, compared to $707 billion a year previously.

The following table shows the change in assets under management during the quarter:


(Dollars in billions)  Assets Under Management   

June 30, 2003  $901
Net inflows from clients   33
Market appreciation   31
      

September 30, 2003  $965
      


Commencing with the first quarter of 2003, securities lending revenue, previously included in both servicing fees and management fees, is presented as a separate revenue item. Prior period results have been adjusted to reflect this presentation. Reported securities lending revenue was $61 million in the quarter, compared to $45 million in the third quarter of the previous year. Reported results included securities lending fees from the GSS business of $13 million. On a baseline basis, securities lending revenue was up $3 million. Volume of securities on loan more than offset narrower interest-rate spreads.

Foreign exchange trading revenue was $101 million for the quarter compared to $78 million a year ago, including fees from the GSS business of $12 million in reported results in 2003. Baseline foreign exchange trading revenue increased $11 million from the third quarter of 2002. Brokerage fee revenue was $28 million compared to $32 million a year ago.

Reported processingProcessing fees and other revenue, which includes certain fees from Deutsche Bank related to the GSS business, profits and losses from joint ventures and other items, were $92was $84 million in the quarter compared to $41$70 million a year ago. Thisago, or $69 million on an operating basis. The increase was largelyprimarily due to $31 millionimproved performance of fee revenue from the GSS business. Until customers and their related deposits are converted to State Street systems, Deutsche Bank is making payments in consideration of revenue earned from GSS client deposits. These deposits will transfer to State Street when the custody business is converted, over the next several quarters. On a baseline basis, processing fees and other revenue were $61 million, up $21 million from 2002, and reflected improvement in earnings fromCorporation’s joint ventures, structured products and tax-advantaged financings.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)ventures.

 

Net Interest Revenue

 

In serving sophisticated global investors, State Street provides short-term funds management, deposit services and repurchase agreements for cash positions associated with clients’ investment activities. These activities, along with State Street’s investment and lending portfolios, generate net interest revenue.

Reported netNet interest revenue for the thirdfirst quarter of 20032004 was $203 million, down from $224 million inflat to the thirdfirst quarter of 2002. Operating2003. On an operating, tax-equivalent basis, net interest revenue was $216$214 million, down $3 million, or 1%, from $240 million. The GSS contribution$217 million in the first quarter of 2003. State Street’s loan portfolio includes leveraged leases, the income from which is included in interest income. Net interest revenue for the first quarter was reduced due to reportedthe recording of a cumulative charge of $19 million resulting from a change in assumptions used for recognition of income from leveraged lease transactions due to a change in the effective state tax rate. This charge was partially offset by increased earnings resulting from an increase in the average balance sheet during the quarter. Excluding the reduction related to leveraged leases, net interest revenue included $3 million of interest revenue and $5 million of interest expense attributable to financing forwould have increased by 8% from the acquisition of the GSS business. In the third quarter of 2002, the divested Corporate Trust business added $3 million to net interest revenue. Baseline net interest revenue was $218 million, a decline of $19 million, or 8%, from $237 million a year ago.prior year.

 


  Three Months Ended September 30,

   Three Months Ended March 31,

 
  2003

  2002

   2004

 2003

 
(Dollars in millions)  

Average

Balance

  Rate (a)  

Average

Balance

  Rate (a)   

Average

Balance

  Rate(a) 

Average

Balance

  Rate(a) 



 
Interest-earning assets  $73,064  2.04% $70,188  2.78%  $81,748  1.95% $69,705  2.39%
Interest-bearing liabilities   62,700  1.02   62,866  1.59    72,948  1.00   61,456  1.27 
     

    

     

   

Excess of rate earned over rate paid     1.02%    1.19%     .95%   1.12%
     

    

     

   

Net interest margin     1.17%    1.36%     1.06%   1.27%
     

    

         
Operating basis net interest revenue  $216    $240   



 
(a) Rates were calculated on a taxable-equivalent basis where the tax savings generated by tax-exempt investments was recorded as net interest revenue with a corresponding charge to income tax expense. Tax savings were computed using a federal income tax rate of 35%, adjusted for applicable state income taxes, net of the related federal tax benefit.

 

Lower yields on assets in 2003 reflected the continued decline in interest rates. Net interest margin for the three months ended September 30, 2003,March 31, 2004 was 1.17%1.06%, compared to 1.36% fora decline of 21 basis points from the comparable period in 2002.first quarter of 2003. Rates earned in excess of rates paid decreased by 17 basis points year-over-year. These declines are primarily the result of a $19 million lease rebooking charge in the first quarter of 2004. Without this one-time charge, margin would have narrowed by 12 basis points to 1.15% and excess of rates earned over rates paid would have narrowed 8 basis points to 1.04%. Lower asset yields, on assets, as maturing assets were reinvested at the lower market rates, were responsible for the remainder of the change.

 

(Losses) Gains on the Sales of Available-for-Sale Securities

 

State Street realized securities lossesgains of $5$3 million in the thirdfirst quarter of 2003,2004, compared with gains of $31$26 million in the thirdfirst quarter of lastthe prior year.

 

Operating Expenses

 

Reported operatingOperating expenses for the thirdfirst quarter of 20032004 were $821$908 million, up $137$74 million from $684$834 million a year ago. ThisIn 2003, the divested PAM business added $12 million to operating expenses. Excluding PAM and merger and integration costs, operating-basis operating expenses were $890 million, up $105 million, or 13%, from 2003. Approximately half of this increase was attributable to $142 millionan extra, full month of expenses fromrelated to the GSS business offset by a $15 million decrease inbusiness. Higher incentive compensation and transaction processing expenses from the divestiture of the Corporate Trust business in 2002. On a baseline basis, expenses decreased $19 million, or 3%. Lower salaries and benefits expense and direct controllable expenses more than offsetcontributed to the increase, in occupancy expense.as well.

 

Reported salaries and employee benefits expense increased $9 million to $407 million, including $53 million of costs from the addition of approximately 2,800 employees in January 2003 from the acquisition of GSS, partially offset by a reduction in expense of $8 million from the divestiture of the Corporate Trust business in 2002. Baseline-basis salariesSalaries and employee benefits expense was down $36$462 million as a result of the previously disclosed cost-reduction plans that included a reduction in the Corporation’s total workforce.first quarter of 2004, compared with $443 million in 2003 on a reported basis, or $436 million excluding PAM. The increase in salaries and employee

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

Reported information systems and communicationsbenefits expense increased $48 million to $140 million, including $46 millionis primarily attributable to GSS operating costs. On a baseline basis, information systemsthe extra month of GSS-related expenses and communication expenses increased by $4 millionhigher incentive compensation expense due to continued investmentimproved performance in technology.2004. These increases were significantly offset by lower headcount, which declined from 21,900 at March 31, 2003, to 19,800 at the end of the first quarter of 2004.

 

Reported transactionTransaction processing services expense increased $17$24 million to $80$96 million including $14 million in GSS transaction processing costs. On a baseline basis, transaction processing services expense was up $4 million, driven by sub-custodian fees and other external contract services.due to substantially higher brokerage volumes.

 

Occupancy expense increased $22for the first quarter of 2004 was $90 million, to $84up $19 million including $10on a reported basis, or $20 million in facilities costson an operating basis from the GSS acquisition. On a baseline basis,first quarter of 2003. The increase in occupancy expense was up $14 millionis primarily reflectingattributable to additional occupancy costs related tospace at State Street’s new office buildingStreet Financial Center, located in Boston, Massachusetts.Massachusetts, and new office space in Luxembourg.

 

Merger and integration costs totaled $26$18 million for the quarter.quarter, down from $37 million a year earlier. These expenses consisted primarily of professional fees and systems integration costs incurred in the third quarter related to the GSS acquisition.

 

Reported restructuring charges were $3 million in the third quarter of 2003. During the second quarter of 2003, State Street implemented a voluntary separation program (“VSP”). Third quarter 2003 expense consisted of additional severance liabilities.

Reported otherOther operating expenses in the thirdfirst quarter of 2003 increased $122004 were $103 million, tocompared with $81 million. The increase included $19 million of costs from GSS operations, including $7a year earlier on a reported basis and $77 million of amortization costs related to intangible assets acquired. On a baseline basis, other expenses decreased $5 million to $62 million due to continued cost control measures.

In the second quarter of 2003,year earlier on an operating basis. State Street initiated expense reduction programs that will reduce State Street’s operating expenses by approximately $125recorded a provision for securities processing losses of $17 million in the aggregate for the second, third and fourth quarters of 2003 compared to its first-quarter baseline run rate, all else being equal. The two components of this program include bringing down directly controllable expenses and the VSP. Baseline operating expenses for the thirdfirst quarter of 2003 were $552004, resulting from unusually high losses during the quarter. This compares to $2 million belowin the first quarter baseline run rate.

of 2003. Increases in the costs of professional services and an additional month of GSS-related expenses also contributed to the increase. During the first quarter of 2004, State Street also expectsreclassified $25 million of reserves for off-balance sheet commitments from the allowance for loan losses to generate cost savings in 2003 through its GSS integration plan, which includes reducing overall workforce relatingother liabilities. Subsequent to the GSS businessreclassification, State Street reduced its reserve for off-balance sheet commitments, reducing other expenses by approximately 1,000 employees, primarily in the U.S., over a 12-18 month period beginning in June 2003. In addition, GSS operations will be transitioned to State Street’s U.S. servicing platforms in Quincy, Massachusetts and Kansas City, Missouri from facilities in Jersey City, New Jersey and Nashville, Tennessee under the integration plan.$10 million.

 

Income Taxes

 

On a reported basis, State Street recorded tax expense of $103$94 million for the thirdfirst quarter of 2003,2004, compared to $90 million in the thirdfirst quarter of 2002. The effective rate2003. Tax expense for the thirdfirst quarter was 34% compared with 33%of 2004 included a year ago. Incumulative benefit of $18 million resulting from a change in the secondeffective state tax rate applied to leasing transactions. The reduction in effective state tax rate reflects the relative increase in non-U.S. activity resulting from State Street’s recent acquisitions and divestitures. Tax expense for the first quarter of 2003 State Street settledincluded a one-time $25 million after tax charge for a REIT-related tax matter later settled with the Massachusetts Department of Revenue. State Street’s estimated full-year tax rate for 2003 is 34% excluding the impact of the REIT settlement and 35% if the REIT settlement is included.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002

Condensed Income Statement—Reported Results


   Nine Months Ended September 30,

 
(Dollars in millions, except per share data)  2003  2002  $ Change  % Change 

Fee Revenue:                
Servicing fees  $1,425  $1,143  $282  25%
Management fees   396   369   27  7 
Global securities lending   192   177   15  9 
Foreign exchange trading   276   238   38  16 
Brokerage fees   85   86   (1) (1)
Processing fees and other   225   131   94  72 
   

  

  


   
Total fee revenue   2,599   2,144   455  21 
Net Interest Revenue:                
Net interest revenue   600   754   (154) (21)
Provision for loan losses      3   (3)  
   

  

  


   
Net interest revenue after provision for loan losses   600   751   (151) (20)
Gains on sales of available-for-sale investment securities, net   29   45   (16) (35)
   

  

  


   
Total Revenue   3,228   2,940   288  10 
Operating Expenses:                
Salaries and employee benefits   1,294   1,243   51  4 
Information systems and communications   410   279   131  47 
Transaction processing services   231   181   50  27 
Occupancy   231   182   49  27 
Merger and integration costs   81      81   
Restructuring   295   20   275   
Other   252   232   20  9 
   

  

  


   
Total operating expenses   2,794   2,137   657  31 
   

  

  


   
Income before income taxes   434   803   (369) (46)
Income tax expense   159   265   (106) (40)
   

  

  


   
Net Income  $275  $538  $(263) (49)
   

  

  


   
Earnings Per Share:                
Basic  $.83  $1.66  $(.83) (.50)
Diluted   .82   1.64   (.82) (.50)

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

SUPPLEMENTAL FINANCIAL INFORMATION

In order to provide information on a comparable basis from period to period and to assist stockholders, analysts, other external parties and management in analyzing the financial results and trends of its ongoing businesses and operations, supplemental financial results on a “baseline” basis are presented below. In this Management’s Discussion and Analysis of Financial Condition and Results of Operations section, the discussion will reference reported results, as previously defined, and “baseline” results, “GSS contribution” results, and “operating” results. These additional terms are defined as follows:

“Operating” results are reported results on a taxable equivalent basis, excluding significant charges and results of a divested business. For the first nine months of 2003, operating results exclude merger, integration and restructuring costs, the write-down associated with the sale of certain real estate, and the settlement of a real estate investment trust tax matter. For 2002, year-to-date operating results exclude the results of the divested Corporate Trust business and restructuring costs.

“GSS contribution” results are the revenue and expenses recorded to date, including financing costs and amortization of intangibles, attributable to the GSS business acquired January 31, 2003, as well as revenue and expenses from “out-of-scope” GSS business that were not part of the acquisition, but commenced in the second quarter of 2003 with GSS clients. Per share amounts reflect the effect on outstanding shares due to the acquisition.

“Baseline” results are operating results excluding GSS contribution, and are presented on a taxable-equivalent basis.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Income Statement—Baseline Reconciliation—Nine Months Ended September 30, 2003


   Nine Months Ended September 30, 2003

(Dollars in millions, except per share data)  

Baseline

Results

  

GSS

Contribution(a)

  

Operating

Results

  Other  

Reported

Results


Fee Revenue:                    
Servicing fees  $1,170  $255  $1,425      $1,425
Management fees   384   12   396       396
Global securities lending   150   42   192       192
Foreign exchange trading   249   27   276       276
Brokerage fees   85      85       85
Processing fees and other   160   78   238  $(13)(e)  225
   

  


 

  


 

Total fee revenue   2,198   414   2,612   (13)  2,599
Net Interest Revenue:                    
Net interest revenue   648   (9)(b)  639   (39)(f)  600
Provision for loan losses               
   

  


 

  


 

Net interest revenue after provision for loan losses

   648   (9)  639   (39)  600

Gains on sales of available-for-sale investment securities, net

   29      29      29
   

  


 

  


 

Total Revenue   2,875   405   3,280   (52)  3,228
Operating Expenses:                    
Salaries and employee benefits   1,153   141   1,294      1,294
Information systems and communications   294   116   410      410
Transaction processing services   194   37   231      231
Occupancy   203   28   231      231
Merger and integration costs            81   81
Restructuring            295   295
Other   200   52(c)  252      252
   

  


 

  


 

Total operating expenses   2,044   374   2,418   376   2,794
   

  


 

  


 

Income before income taxes   831   31   862   (428)  434
Income tax expense (benefit)   269   10   279   (120)(g)  159
Taxable-equivalent adjustment   39      39   (39)(f)  
   

  


 

  


 

Net Income  $523  $21  $544  $(269) $275
   

  


 

  


 

Earnings Per Share—Diluted  $1.63  $(.01)(d) $1.62  $(.80) $.82

Reported results agree with the Corporation’s Consolidated Statement of Income

(a)Includes $15 million of revenue and $19 million of expenses related to out-of-scope client relationships
(b)Includes $15 million of net interests costs attributable to the GSS acquisition financing
(c)Includes amortization of intangibles expense of $19 million
(d)Includes ($.07) impact due to changes in shares outstanding attributable to the acquisition
(e)Represents the loss on sale of certain real estate
(f)Taxable-equivalent adjustment was not included in reported results
(g)Reflects the impact of a certain Massachusetts REIT tax legislation issue ($12 million tax expense) as well as the tax benefit related to the valuation reserve and restructuring, merger and integration costs

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Income Statement—Baseline Reconciliation—Nine Months Ended September 30, 2002


   Nine Months Ended September 30, 2002

(Dollars in millions, except per share data)  

Baseline

Results

  

Corporate

Trust

Business

  Other  

Reported

Results


Fee Revenue:                
Servicing fees  $1,085  $58      $1,143
Management fees   369          369
Global securities lending   177          177
Foreign exchange trading   238          238
Brokerage fees   86          86
Processing fees and other   128   3       131
   

  

  


 

Total fee revenue   2,083   61       2,144
Net Interest Revenue:                
Net interest revenue   791   9  $(46)(a)  754
Provision for loan losses   3         3
   

  

  


 

Net interest revenue after provision for loan losses   788   9   (46)  751
Gains on sales of available-for-sale investment securities, net   45         45
   

  

  


 

Total Revenue   2,916   70   (46)  2,940
Operating Expenses:                
Salaries and employee benefits   1,218   25      1,243
Information systems and communications   274   5      279
Transaction processing services   178   3      181
Occupancy   178   4      182
Restructuring         20(b)  20
Other   225   7      232
   

  

  


 

Total operating expenses   2,073   44   20   2,137
   

  

  


 

Income before income taxes   843   26   (66)  803
Income tax expense (benefit)   263   9   (7)  265
Taxable-equivalent adjustment   46      (46)(a)  
   

  

  


 

Net Income (Loss)  $534  $17  $(13) $538
   

  

  


 

Earnings (Loss) Per Share—Diluted  $1.62  $.06  $(.04) $1.64

Reported results agree with the Corporation’s Consolidated Statement of Income

(a)Taxable-equivalent adjustment
(b)Other includes $20 million of costs associated with the April 2002 reduction in force included in reported results as restructuring costs

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Supplemental Financial Information—Baseline(a) —Consolidated Statement of Income


   Nine Months Ended September 30,

 
(Dollars in millions, except per share data)  2003  2002  $ Change  % Change 

Fee Revenue:                
Servicing fees  $1,170  $1,085  $85  8%
Management fees   384   369   15  4 
Global securities lending   150   177   (27) (15)
Foreign exchange trading   249   238   11  5 
Brokerage fees   85   86   (1) (1)
Processing fees and other   160   128   32  25 
   

  

  


   
Total fee revenue   2,198   2,083   115  6 
Net Interest Revenue:                
Net interest revenue   648   791   (143) (18)
Provision for loan losses      3   (3)  
   

  

  


   
Net interest revenue after provision for loan losses   648   788   (140) (18)
Gains on sales of available-for-sale investment securities, net   29   45   (16) (35)
   

  

  


   
Total Revenue   2,875   2,916   (41) (1)
Operating Expenses:                
Salaries and employee benefits   1,153   1,218   (65) (5)
Information systems and communications   294   274   20  7 
Transaction processing services   194   178   16  8 
Occupancy   203   178   25  15 
Other   200   225   (25) (11)
   

  

  


   
Total operating expenses   2,044   2,073   (29) (1)
   

  

  


   
Income before income taxes   831   843   (12) (1)
Income tax expense   269   263   6  2 
Taxable-equivalent adjustment   39   46   (7) (15)
   

  

  


   
Net Income  $523  $534  $(11) (2)
   

  

  


   
Earnings Per Share—Diluted  $1.63  $1.62  $.01  1 

(a)As defined and reconciled to reported results on earlier schedules

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Summary

State Street reported net income for the first nine months of 2003 of $.82 per share, reflecting net income of $275 million and total revenue of $3.228 billion. For the first nine months of 2002, State Street earned net income of $538 million, or $1.64 per share, on $2.940 billion of revenue. Reported results for 2003 include a loss of $.01 per share related to the GSS business. In addition, State Street recorded pre-tax restructuring charges of $295 million related to the Corporation’s expense-reduction program, pre-tax merger and integration costs of $81 million related to the acquisition of the GSS business, an after-tax charge of $12 million for settlement of a tax matter related to a real estate investment trust issue with the Massachusetts Department of Revenue and a pre-tax charge of $13 million for the loss on sale of certain real estate. These items, in the aggregate, resulted in a net charge of $.80 per share for the first nine months of 2003. Reported results for 2002 included the operating results of the divested Corporate Trust business that added $.06 per share, and included a restructuring charge of $20 million, or $.04 per share, for a reduction-in-force initiative taken in April 2002.

Baseline earnings were $523 million or $1.63 per share in the third quarter of 2003. Comparable baseline earnings for the third quarter of 2002 were $534 million, or $1.62 per share. The decline in baseline earnings was primarily due to lower net interest revenue, reflecting the continuing decline in interest rates and narrower interest rate spreads, and lower net gains on the sales of available-for-sale securities, largely offset by increases in fee revenue and operating expense reductions.

Total Revenue

In the first nine months of 2003, total reported revenue was $3.228 billion, up $288 million, compared to $2.940 billion a year ago and included eight months of revenue from the GSS business of $405 million. Reported revenue in 2003 included a charge of $13 million related to the write-off of certain real estate sold. Total revenue for 2002 included $70 million from the divested Corporate Trust business. On a baseline basis, total revenue was $2.875 billion compared to $2.916 billion in 2002, a decrease of $41 million. The decrease was primarily due to lower net interest revenue, down $143 million for the first nine months of 2003, reflecting the continuing decline in interest rates and narrower interest rate spreads, and lower net gains on the sales of available-for-sale securities. Higher fee revenue largely offset these decreases.

Fee revenue on a reported basis for the first nine months of 2003 was $2.599 billion, up $455 million, from 2002. Reported fee revenue for 2003 included $414 million of revenue from the GSS business, primarily in servicing fees, securities lending and processing fees and other revenue, offset by a charge of $13 million for the write-off of certain real estate. Reported revenue for the first nine months of 2002 included $61 million of fee revenue, primarily servicing fees, attributable to the divested Corporate Trust business. On a baseline basis, fee revenue was $2.198 billion, up $115 million compared to $2.083 billion for the same period in 2002.

Baseline servicing fees for the first nine months of 2003 were $1.170 billion, up $85 million from the $1.085 billion in 2002. The increase in baseline servicing fee revenue was attributable to business gained through an acquisition in July 2002 and new business from new and existing clients.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Baseline management fees from investment management services were $384 million, compared to $369 million a year ago, reflecting the effects of continued new business success and improvement in month-end average equity market valuations from a year ago.


(Dollars in billions) Assets Under Management   

December 31, 2002  $763
Net inflows from clients   109
Market appreciation   93
     

September 30, 2003  $965
     


Baseline securities lending revenue was down $27 million for the first nine months of 2003 to $150 million. This decrease reflected narrower interest-rate spreads due to a less favorable interest-rate environment compared to a year ago, which more than offset growth in volume of securities on loan. Baseline-basis foreign exchange trading revenue was $249 million for the first nine months of 2003, up from $238 a year ago. Brokerage fee revenue for the first nine months was $85 million, compared to $86 million a year ago. Baseline processing fees and other revenue was $160 million, up $32 million from 2002, reflecting improvement in earnings from joint ventures, structured products and tax-advantaged financings.

Baseline net interest revenue was $648 million for the first nine months of 2003, a decline of $143 million from $791 million a year ago, when net interest revenue still benefited from the residual benefits of the multiple rate cuts of 2001. Lower yields on assets in 2003 reflected the continued decline in interest rates, as maturing assets were reinvested at the lower market rates.

State Street realized securities gains of $29 million in the first nine months of 2003, down from $45 million for the first nine months of the prior year.

Operating Expenses

Reported operating expenses for the first nine months of 2003 were $2.794 billion, up $657 million from $2.137 billion a year ago. This increase includes $295 million of expenses related to restructuring costs associated with the Corporation’s expense-reduction program, up from $20 million for the comparable period in 2002. In addition, the increase was attributable to $374 million of expenses from the GSS business, and $81 million of merger and integration costs related to the acquisition, offset by a $44 million decrease in expenses as a result of the divestiture of the Corporate Trust business in 2002. On a baseline basis, expenses decreased $29 million to $2.044 billion. Lower salaries and benefits expense and direct controllable expenses more than offset increases in information systems and communication, transaction processing, and occupancy expenses.

Baseline salaries and employee benefits expense decreased $65 million to $1.153 billion as a result of lower incentive compensation expense and the cost savings associated with reduction in headcount from the voluntary separation program. Baseline information systems and communications expense increased $20 million to $294 million due to continued investment in core processing capabilities and costs related to IFS, which was acquired in July 2002. On a baseline basis, transaction processing services expense was up $16 million, driven by sub-custodian fees and costs associated with IFS. Occupancy expense increased $25 million to $203 million, reflecting additional office space in State Street’s new office building located in Boston, Massachusetts. On a baseline basis, other expenses decreased $25 million to $200 million due to continued cost control measures.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Income Taxes

On a reported basis, State Street recorded tax expense of $159 million for the first nine months of 2003, compared to $265 million a year ago. In the second quarter of 2003, State Street settled a REIT-related tax matter with the Massachusetts Department of Revenue. State Street’s effective rate for the first nine monthsquarter of 20032004 was 36.7%30%, including the impact of the REIT tax matter. Excluding the REIT matter, the effective rate was 34.0% compared with 33.0% for the year earlier period.leveraged lease adjustment. The estimated full-yearexpected tax rate for 2003the full year 2004 is 34% excluding the impact33.0%, compared with an effective tax rate of the REIT settlement and 35% if the REIT settlement is included.35.1% in 2003.

 

GSS ACQUISITION AND INTEGRATIONUPDATE

 

On January 31, 2003, State Street completed the primary closing of its acquisition of a substantial part of the Global Securities Services (“GSS”) business (“GSS business”) fromof Deutsche Bank AG. Under the termsAG for a premium of the definitive agreements, first announced on November 5, 2002, State Street’s initial payment to Deutsche Bank for all business units to be acquired was approximately $1.1 billion. On July 1, 2003, State Street completed the acquisition of the Italian business units of GSS, and on July 31, 2003, completed the acquisition of the Austrian units of the business. In the period ending on the one-year anniversary of the primary closing, State Street will make additional payments of upThe purchase price is subject to an estimated €360 million,adjustments based upon performance of the acquired business. Thebusiness for the year following the closing. State Street may make additional payments up to an estimated €360 million; however, State Street anticipates that the actual payment will be much less.

Excluding merger and integration costs, associated with the acquisition are expected to be $90-$110 million for 2003 on a pre-tax basis, with $81 million recorded through theState Street’s first nine months. The GSS business had approximately $2.0 trillionquarter of assets under custody at September 30, 2003, and contributed $414 million2004 included $.02 per share of fee revenue in the eight months since acquisition, including $255 million of servicing fees, $12 million of management fees, $42 million of securities lending revenue, and $27 million of foreign exchange trading revenue. Deutsche Bank compensated State Street with $78 million, recorded in processing fees, for revenue earned during the eight months ended September 30, 2003, on client deposits not yet transferred to State Street.

State Street recorded $15 million of interest costs associated with the acquisition financing in net interest revenue in the first nine months of 2003. Operating expensesincome attributable to the GSS business were $374 million, including $141 millioncompared with a loss of salaries and benefits expenses, $116 million of information systems and communications expenses, $37 million of transaction processing services expenses, $28 million of occupancy expenses, and $52 million of other expenses.

$.02 per share a year earlier. The GSS business increased net income by $21contributed $160 million for the first nine months of 2003; however, the issuance of common stock used to partially fund the acquisition resulted in a $.01 per share loss for the period attributable to the GSS business.

State Street incurred $81 million of merger and integration costs related to GSSrevenue in the first nine monthsquarter of 2003. These one-time expenses consisted primarily2004, net of financing costs, for employee retention, system conversion costs and consulting services.

When initially announced in November 2002, the acquired business represented approximately €700compared with $92 million in annualized revenue. Based on the run-rate from the third quarter of 2003, the business as acquired, excluding revenue from out-of-scope business, is generating approximately $628 million of annualized revenue. Based on the run rate from the third quarter of 2003, the business as acquired, excluding financing costs and expenses related to out-of-scope business, is generating approximately $520 million of annualized expenses and reflects implementation of planned expense reductions. State Street is on schedule in reducing GSS expenses, and plans to meet its targets for cost savings.

Based on the first eight months operating results, State Street believes it will meet or better its previously-disclosed expectation that the acquisition is expected to be dilutive to earnings per share by approximately $0.01 to $0.03 per share in the first year of operation.prior

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

year, and added $138 million of expenses in 2004, compared with $92 million in the first quarter of 2003. This comparison reflects two months of recorded operating activity for the GSS business acquired on January 31, 2003, compared with three full months in the first quarter of 2004.

Merger and integration costs related to client conversions were $18 million for the first quarter of 2004. State Street’s estimates merger and integration costs of approximately $50 to $60 million for the full year 2004. To date, State Street has completed approximately 70% of the worldwide client conversions, including all clients in the Far East and substantially all clients in the U.S. The Corporation expects to be substantially complete in Europe by the end of 2004, with the exception of Germany, which is expected to be complete by the end of 2005.

LINES OF BUSINESS

 

State Street has two primary lines of business - Investment Servicing and Investment Management.

Investment Servicing includes custody, accounting, daily pricing and administration; master trust and master custody; trustee and recordkeeping; foreign exchange and trading services; securities lending; deposit and short-term investment facilities; loans and lease financing; investmentwealth manager and hedge fund manager operations outsourcing;services; and performance, risk and compliance analytics to support institutional investors. State Street’s 50%-owned affiliates, Boston Financial Data Services, Inc. and the International Financial Data Services group of companies, provide shareholder services, including mutual fund and collective fund shareholder accounting. Revenue from Investment Servicing comprised 85% of State Street’s total revenue excluding other/one-time charges, for the three- and nine-monthsthree months ended September 30, 2003.March 31, 2004.

 

Investment Management offers a broad array of services for managing financial assets, including investment management and investment research, servicesprimarily for both institutions and individualinstitutional investors worldwide. These services included activepassive and passiveactive U.S. and non-U.S. equity and fixed income strategies, and other related services, such as securities lending. Retirement benefit services are provided through State Street’s 50%-owned affiliate, CitiStreet, LLC. Revenue from the Investment Management line of business comprised 15% of State Street’s total revenue excluding the Other/One-Time charges, for the three- and nine-monthsthree months ended September 30, 2003.March 31, 2004.

 

Business DivestitureDivesture included the revenue and expenses related to the Corporate TrustPrivate Asset Management operations sold in December 2002.October 2003.

 

Other/One-Time charges infor the third quarter and first ninethree months of 2004 and 2003 included restructuring costs of $3 million and $295 million, respectively; and merger and integration costs related to the acquisition of GSS of $26$18 million and $81$37 million, respectively. The first nine months of 2003 included the $13 million write-down of certain real estate sold recorded in fee revenue. For the first nine months of 2002, Other/One-Time charges included $20 million of restructuring costs. See Note 2 for more detail on the acquisition of GSS and Note 12 for more detail on restructuring costs.

 

The total columns represent consolidated results in accordance with accounting principles generally accepted in the United States as they appear in the Consolidated Statements of Income included in the financial statements.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

Results for the Three Months Ended September 30, 2003

Following is a summary of line of business financial results for the third quarter of 2003 and 2002:


   For the Three Months Ended September 30,

   

Investment

Servicing


  

Investment

Management


  

Business

Divestiture


  

Other/ One-

Time


  Total

(Dollars in millions, except

where otherwise noted)

  2003  2002  2003  2002  2003  2002  2003  2002  2003  2002

Fee Revenue:                                      
Servicing fees  $505  $371             $19         $505  $390
Management fees        $141  $116                141   116
Global securities lending   51   37   10   8                61   45
Foreign exchange trading   101   78                      101   78
Brokerage fees   28   32                      28   32
Processing fees and other   83   33   9   7      1          92   41
   


 


 


 


    


 


    


 

Total fee revenue   768   551   160   131      20          928   702

Net interest revenue after provision for loan losses

   195   206   8   14      3          203   223

(Losses) gains on sale of available-for-sale securities, net

   (5)  31                      (5)  31
   


 


 


 


    


 


    


 

Total Revenue   958   788   168   145      23          1,126   956
Operating Expenses   665   550   127   120      14  $29(a)     821   684
   


 


 


 


    


 


    


 

Income (Loss) Before Income Taxes

  $293  $238  $41  $25     $9  $(29)    $305  $272
   


 


 


 


    


 


    


 

Pre-tax margin   31%  30%  25%  17%     39%              
Average assets(billions)  $79.6  $73.8  $2.2  $1.8     $.5         $81.8  $76.1

(a)$3 million of restructuring costs—$3 million for Investment Servicing; $26 million of merger and integration expenses for Investment Servicing

   For the Three Months Ended March 31,

   Investment
Servicing


  Investment
Management


  Business
Divestiture(1)


  Other/
One-Time


  Total

(Dollars in millions, except

where otherwise noted)

  2004  2003  2004  2003  2004  2003  2004  2003  2004  2003

Fee Revenue:

                                       

Servicing fees

  $555  $438                         $555  $438

Management fees

        $147  $108     $17           147   125

Securities lending

   53   47   11   8                 64   55

Foreign exchange trading

   118   72                       118   72

Brokerage fees

   45   30                       45   30

Processing fees and other

   70   64   14   5      1           84   70
   


 


 


 


    

          

  

Total fee revenue

   841   651   172   121      18           1,013   790

Net interest revenue after provision for loan losses

   194   194   9   10                 203   204

Gains on sale of available-for-sale securities, net

   3   26                       3   26
   


 


 


 


    

          

  

Total Revenue

   1,038   871   181   131      18           1,219   1,020

Operating Expenses

   755   669   135   116      12  $18  $37   908   834
   


 


 


 


    

  


 


 

  

Income (Loss) Before Income Taxes

  $283  $202  $46  $15     $6  $(18) $(37) $311  $186
   


 


 


 


    

  


 


 

  

Pre-tax margin

   27%  23%  25%  12%                      
Average assets(billions)  $90.6  $75.8  $2.4  $1.8     $.1          $93.0  $77.7

 

Investment Servicing.    Total revenue for the three months ended September 30, 2003,March 31, 2004, increased $170$167 million to $958 million,$1.038 billion, up 22%19% from 2002,the comparable period in 2003, driven by growth in fee revenue, somewhat offset by losses on the sales of securities and a decline in net interest revenue.gains on sales of available-for-sale securities.

 

FeeGrowth in fee revenue increased by $217 million to $768of $190 million for the thirdfirst quarter of 2003 and2004 to $841 million was primarily attributable to $161 million from the GSS business.servicing fees, securities lending, foreign exchange trading and brokerage fee revenue. Servicing fees for the first quarter of 2004 were $555 million, up $134$117 million, $105 millionor 27%, from servicing fees a year earlier due to the extra month of which was attributable toservicing fee revenue generated by the GSS business, with the remainder attributable tohigher equity market valuations and new business from existing and new and existing clients and improvement in equity market valuations. Fee revenue from global2004. The increase in securities lending was up $14 million to $51 million. GSS contributed $13 million to the increase. Narrow interest rate spreads offset most of the growthrevenue reflected a 35% increase in the volume of securities on loan from non-GSS clients.lent, partially offset by significantly narrower interest rate spreads. Foreign exchange trading revenue was up $23$118 million for the first quarter of 2004, an increase of $46 million from a year ago, attributable to $101 million. GSS contributed $12 million to the increase. Processing feessignificantly higher currency volatility, and otherhigher volumes reflecting increased cross-border investment activities of State Street’s clients. Brokerage fee revenue was $45 million in the first quarter, up $50 million51% from 2003 due to $83 million, of which GSS contributed $31 million, including fees from Deutsche Bankan increase in transition management for revenue earned on client deposits not yet transferred to State Street.Street’s clients and growth in electronic trade execution.

 

Net interest revenue after provision for loan losses for the thirdfirst quarter of 20032004 was $195$194 million, compared to $206 million in 2002.unchanged from the first quarter of 2003. Net interest revenue reflectedfor the challenging interest rate environment, including lower rates earned on investments.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)first quarter was reduced due to a cumulative charge of $19 million resulting from a change in assumptions used for recognition of income from leveraged lease transactions due to a change in the effective state tax rate. This charge was offset by increased earnings resulting from an increase in the average balance sheet during the quarter.

 

Operating expenses for the thirdfirst quarter of 20032004 were $665$755 million, up $115$86 million from the prior year. GSS contributed $142 millionThe majority of expenses. Excluding GSS, operatingthe increase was attributable to an extra full month of expenses were down $27 million duerelated to State Street’s cost reduction programs, including the previously disclosed voluntary separation program.

Investment Management.    Total revenue for the third quarter of 2003 was $168 million, up $23 million, from $145 million reported in 2002. An increase in management fees more than offset the decline in net interest revenue.

Management fees from investment management services, delivered through State Street Global Advisors, were $141 million in the third quarter of 2003 compared to $116 million a year ago. Fees from the GSS business added $4 million to management fees. Management fees principally reflected continued new business success and an increase in average month-end equity valuations.activity, as well as higher incentive compensation expense.

Operating expenses for the three months ended September 30, 2003 were $127 million, up $7 million from the prior year.

Results for the Nine Months Ended September 30, 2003

Following is a summary of line of business financial results for the first nine months of 2003 and 2002:


   For the Nine Months Ended September 30,

   

Investment

Servicing


  

Investment

Management


  

Business

Divestiture


  

Other/ One-

Time


  Total

(Dollars in millions, except

where otherwise noted)

  2003  2002  2003  2002  2003  2002  2003  2002  2003  2002

Fee Revenue:                                       
Servicing fees  $1,425  $1,085             $58          $1,425  $1,143
Management fees        $396  $369                 396   369
Global securities lending   162   146   30   31                 192   177
Foreign exchange trading   276   238                       276   238
Brokerage fees   85   86                       85   86
Processing fees and other   215   112   23   16      3  $(13)(a)      225   131
   


 


 


 


    


 


     

  

Total fee revenue   2,163   1,667   449   416      61   (13)      2,599   2,144

Net interest revenue after provision for loan losses

   572   697   28   45      9          600   751

Gains on sale of available-for-sale securities, net

   29   45                      29   45
   


 


 


 


    


 


     

  

Total Revenue   2,764   2,409   477   461      70   (13)      3,228   2,940
Operating Expenses   2,029   1,686   389   388      43   376(b) $20(c)  2,794   2,137
   


 


 


 


    


 


 


 

  

Income (Loss) Before Income Taxes

  $735  $723  $88  $73     $27  $(389) $(20) $434  $803
   


 


 


 


    


 


 


 

  

Pre-tax margin   27%  30%  18%  16%     39%               
Average assets(billions)  $79.0  $74.8  $2.0  $1.8     $.5          $81.0  $77.1

(a)Represents the loss on sale of certain real estate
(b)$295 million of restructuring costs—$261 million for Investment Servicing and $34 million for Investment Management; $81 million of merger and integration expenses for Investment Servicing
(c)$20 million of restructuring costs — $17 million for Investment Servicing and $3 million for Investment Management

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

Investment Servicing.Management.    Total revenue for the nine months ended September 30,first quarter of 2004 was $181 million, up $50 million, from $131 million reported in the first quarter of 2003, increased $355representing a $51 million to $2.764 billion, up 15% from 2002 driven by growthincrease in fee revenue somewhat offset byand a $1 million decline in net interest revenue and lower gains on the sales of available-for-sale securities.

Growth in fee revenue of $496 million for the first nine months of 2003 to $2.163 billion was primarily attributable to $402 million from the GSS business. Servicing fees were up $340 million, $255 million of which was attributable to the GSS business with the remainder attributable to business gained through an acquisition in July 2002 and new business from new and existing clients. Fee revenue from global securities lending was up $16 million to $162 million. GSS contributed $42 million to the increase. Narrow interest rate spreads due to a less favorable interest rate environment more than offset the growth in the volume of securities on loan from non-GSS clients. Foreign exchange trading revenue was up $38 million to $276 million. GSS contributed $27 million to the increase. Processing fees and other revenue was up $103 million to $215 million, of which GSS contributed $78 million, including fees from Deutsche Bank for revenue earned on client deposits not yet transferred to State Street.

Net interest revenue after provision for loan losses for the first nine months of 2003 was $572 million, compared to $697 million in 2002 when net interest revenue still benefited from the residual benefits of the multiple rate cuts of 2001. Lower yields on assets in 2003 reflected the continued decline in interest rates, as maturing assets were reinvested at lower market rates.

Gains on the sale of available-for-sale securities were $29 million for the first nine months of 2003, compared to $45 million a year ago.

Operating expenses for the nine months ended September 30, 2003, were $2.029 billion, up $343 million from the prior year. GSS contributed $374 million of expenses. Excluding GSS, operating expenses were down $31 million due to the continued cost control measures, including the reduction in headcount from the voluntary separation program.

Investment Management.    Total revenue for the nine months ended September 30, 2003, was $477 million, up $16 million, from $461 million reported in 2002. An increase in management fees and processing fees and other revenue more than offset the decline in net interest revenue.losses.

 

Management fees from investment management services, delivered through State Street Global Advisors, were $396$147 million forin the first nine monthsquarter of 20032004 compared to $369$108 million a year ago. The GSS business contributed $12 million to management feesago, reflecting an increase in 2003. Excluding the GSS contribution, management fees increased, principally reflecting the effects ofaverage month-end equity valuations and continued new business success and improvement in month-end average equity valuations from a year ago.success.

 

Operating expenses for the ninethree months ended September 30, 2003March 31, 2004, were $389$135 million, up slightly from $388$116 million reported in 2002.a year ago.

 

FINANCIAL GOALS AND FACTORS THAT MAY AFFECT THEM

 

State Street’s primary financial goal is sustainable real growth in operating earnings per share. The Corporation has two supporting goals, one for total operating revenue growth and one for operating return on common stockholders’ equity (ROE). The long-term revenue goal is for a 12.5% real, or inflation adjusted, compound annual growth rate of revenue from 2000 through 2010. At present, this equates to approximately a 15% nominal compound annual growth rate. The return on stockholders’ equity goal is 13%-15% for 2003 and 2004. The company will revisitCorporation is revisiting this goal induring 2004.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

State Street considers these to be financial goals, not projections or forward-looking statements. However, the discussion included in this Management’s Discussion and Analysis of Financial Condition and Results of Operations,Operation, and in other portions of this report on Form 10-Q, may contain statements that are considered “forward-looking statements” within the meaning of the federal securities laws. These statements may be identified by such forward-looking terminology as “expect,” “look,” “believe,” “anticipate,” “may,” “will,” or similar statements or variations of such terms. The Corporation’s financial goals and such forward-looking statements involve certain risks and uncertainties, including the issues and factors listed below and factors further described in conjunction with the forward-looking information, which could cause actual results to differ materially.

Factors that may cause such differences include, but are not limited to, the The following issues and factors discussed in this section and elsewhere in this Form 10-Q. Each of these factors, and others, are also discussed from time to time in the Corporation’s other filings with the Securities and Exchange Commission, including in the Corporation’s Form 10-K.should be carefully considered. The forward-looking statements contained in this report on Form 10-Q speak only as of the time the statements were given, and thegiven. The Corporation does not undertake to revise those forward-looking statements to reflect events after the date of this report.

 

Cross-border investing.Investing.    Increased cross-border investing by clients worldwide benefits State Street’s revenue. Future revenue may increase or decrease depending upon the extent of increases or decreases in cross-border investments made by clients or future clients. Economic and political uncertainties resulting from terrorist attacks, subsequent military actions or other events could result in decreased cross-border investment activities.

 

Savings rateRates of individuals.Individuals.    State Street generally benefits when individuals invest their savings in mutual funds and other collective funds or in defined contribution plans. Changes in savings rates or investment styles may affect revenue. If there is a decline in the savings rates of individuals, or if there is a change in investment preferences that leads to fewer investments in mutual funds, other collective funds, and defined contribution plans, State Street’s revenue may be adversely affected.

 

Asset valuesValues in worldwide financial markets.Worldwide Financial Markets.    As asset values in worldwide financial markets increase or decrease, State Street’s opportunities to invest and service financial assets may change. Since a portion of the Corporation’s fees areis based on the value of assets under custody and management, fluctuations in the valuation of worldwide securities markets will affect revenue. State Street estimates that a 10% increase or decrease in worldwide equity values would causeresult in a corresponding change in State Street’s total revenue of approximately

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

2%. If fixed income security values worldwide were to increase or decrease by 10%, State Street would anticipate a corresponding change of approximately 1% in its total revenue.

As asset values increase or decrease due to external credit factors, State Street has exposure related to its own investing activities. The impact of such exposure would be reflected in the Corporation’s statement of income, statement of condition and statement of changes in stockholders’ equity.

 

Dynamics of markets served.Markets Served.    Changes in markets served, including the growth rate of collective funds worldwide, outsourcing decisions, mergers, acquisitions and consolidations among clients and competitors and the pace of debt and equity issuance, can affect revenue. In general, State Street benefits from increases in the volume of financial market transactions serviced.

 

State Street provides services worldwide. Global and regional economic factors and changes or potential changes in laws and regulations affecting the Corporation’s business—business – including volatile currencies, pace of inflation, changes in monetary policy, changes in domestic and international banking supervisory regulations including capital requirements, and social and political instability—instability – could affect results of operations. The terrorist attacks that took place in the United States on September 11, 2001, and subsequent military action and terrorist activities, have caused economic and political uncertainties. These activities and the national and global efforts to combat terrorism, and other military activities and outbreaks of hostilities have affected and may further adversely affect economic growth, and may have other adverse effects on many companies, including State Street, in ways that

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

are not predictable. In a similar manner, financialFinancial reporting irregularities involving large and well-known companies and regulatory investigations of securities and mutual fund industry practices and behavior may have other adverse effects on State Street in ways that are not predictable. State Street is broadly involved with the securities industry including, in particular, the mutual fund industry, and governmental agencies have sought information from it in connection with investigations relating to that industry.

 

Legislation may cause changes in the competitive environment in which State Street operates, which could include, among other things, broadening the scope of activities of significant competitors, or facilitating consolidation of competitors into stronger entities, or attracting large and well-capitalized new competitors into State Street’s traditional businesses. Such factors and changes, and the ability of the Corporation to address and adapt to the regulatory and competitive challenges, may affect future results of operations.

 

The Basel Committee on Banking Supervision is in the process of finalizing the New Basel Capital Accord (Basel II). The U.S. Banking and Thrift regulatory agencies have begun the process of USU.S. implementation of Basel II through the joint issuance of an Advance Notice of Proposed Rulemaking (“ANPR”) and Draft Supervisory Guidance. After obtaining comments on the ANPR and Draft Guidance, the agencies are expected to release proposed rules for comment, and ultimately final rules. State StreetThe Corporation cannot predict the final form of the Basel II accord or the related U.S. rules and their impact on State Street.the Corporation. However, State Street and its businesses would bechanges to the risk-based capital guidelines as proposed may adversely affected if rules that impact its ability to maintain its “well-capitalized” status are finalized in current form.affect the Corporation’s capital status.

 

Accounting policies.Principles.    Changes in accounting principles generally accepted in the United States applicable to State Street could have a material impact on the Corporation’s reported results of operations. While such changes may not have an economic impact on the business of State Street, these changes could affect the attainment of the current measures of the Corporation’s financial goals.

 

Tax Legislation.    Changes in tax legislation or the interpretation of existing tax laws worldwide could have a material impact on the Corporation’s reported results of operations.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

Interest rates.Rates.    The levels of market interest rates, the shape of the yield curve and the direction and speed of interest rate changes relative to the currencygeographic mix of the Corporation’s interest-bearing assets and liabilities affect net interest revenue and securities lending revenue. In the short term, State Street’s net interest revenue and securities lending revenue benefit from falling interest rates and are negatively affected by rising rates because interest-bearing liabilities reprice sooner than interest-earning assets. In general, sustained lower interest rates and a flat yield curve may have a constraining effect on the net interest revenue and securities lending revenue growth. Market interest rates also impact the value of certain derivative products whose change in value is reflected in processing fees and other in the Consolidated Statement of Income.

 

Liquidity.    Any occurrence that may limit the Corporation’s access to the funds markets, such as a decline in the confidence of debt purchasers, depositors or counterparties participating in the funds markets in general or with State Street in particular, or a downgrade of State Street’s debt rating, may adversely affect State Street’s ability to raise capital and, in turn, its liquidity.

 

Capital.    Under regulatory capital adequacy guidelines, State Street and State Street Bank must meet guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items, subject to qualitative judgments by regulators about components, risk weightings and other factors.items. Failure to meet minimum capital requirements could have a direct material effect on State Street’s financial condition; failure to maintain the status of “well capitalized” under the regulatory framework could affect State Street’s status as a financial holding company and eligibility for a streamlined review process for acquisition proposals.

In addition, failure to maintain the status of “well capitalized” could affect the confidence of State Street’s clients in the Corporation and could adversely affect its business.

Also, under Federal Reserve Board regulations In addition to being well-capitalized, State Street and related federal laws, there are limits on investments of the capital and surplus of State Street Bank in subsidiariesare subject to guidelines that in general, conduct only international activities.involve qualitative judgments by regulators about the entities’ status as well-managed and the entities’ compliance with Community Reinvestment Act obligations.

Federal laws and related regulations limit the amount that banks, including State Street Bank, is near the limit on such permitted use of capital and surplus.may invest in international subsidiaries. This limitlimitation may affect the pace of future

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

international expansion by State Street Bank through these subsidiaries, although there arethis type of subsidiary. State Street Bank is near this limit; however, available alternatives exist for international expansion by State Streetthe Corporation and State Street Bank.

 

Volatility of currency markets.Currency Markets.    The degree of volatility in foreign exchange rates can affect the amount of foreign exchange trading revenue. In general, State Street benefits from currency volatility. Accordingly, foreign exchange revenue is likely to decrease during times of decreased currency volatility. In addition, as State Street’s business grows globally, State Street’s exposure to changes in foreign currency exchange rates could impact State Street’s level of revenue and expense and net income and the value of State Street’s investments in its non-U.S. operations.

 

Pace of pension reform.Pension of Reform.    State Street expects its business to benefit from worldwide pension reform that creates additional pools of assets that use custody and related services, and investment management services. The pace of pension reform and resulting programs, including public and private pension schemes, may affect the pace of revenue growth. If the pace of pension reform and resulting programs, including public and private pension schemes, slows down or if pension reform does not occur, then revenue growth may be adversely affected.

 

Pricing/competition.Competition.    Future prices the Corporation is able to obtain for its products may increase or decrease from current levels depending upon demand for its products, its competitors’ activities, customer pricing reviews and the introduction of new products into the marketplace.

 

Pace of new business;New Business; Business mix.Mix.    A decline in the pace at which State Street attracts new clients, and the pace at which existing and new clients use additional services and assign additional assets to State Street for management or custody, will adversely affect future results of operations. A decline in the rate at which clients outsource functions such as their internal accounting activities, would also adversely affect results of operations.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

In addition, changes in business mix and in the source of revenue, including the mix of U.S. and non-U.S. business, may affect future results of operations, depending on the economic and competitive conditions of those geographic areas at the time.

 

Business continuity.Continuity.    State Street has business continuity and disaster recovery plans in place. However, external events, including terrorist or military actions and resulting political and social turmoil, could arise that would cause unforeseen damage to State Street’s physical facilities or could cause delays or disruptions to operational functions, including information processing and financial market settlement functions. Additionally, State Street’s clients, vendors and counterparties could suffer from such events. Should these events affect State Street, or the clients, vendors or counterparties with which it conducts business, State Street’s results of operations could be adversely affected.

 

Rate of technological change.Technological Change.    Technological change often creates opportunities for product differentiation and reduced costs, as well as the possibility of increased expenses. Developments in the securities processing industry, including shortened settlement cycles and straight-through-processing, will result in changes to existing procedures. Alternative delivery systems have emerged, including the widespread use of the Internet. State Street’s financial performance depends in part on its ability to develop and market new and innovative services, and to adopt or develop new technologies that differentiate State Street’s products or provide cost efficiencies.

 

The risks inherent in this process include rapid technological change in the industry, the Corporation’s ability to access technical and other information from clients, and the significant and ongoing investments required to bring new services to market in a timely fashion at competitive prices. A further risk is the introduction by competitors of services that could replace or provide lower-cost alternatives to State Street services.

 

State Street uses trademark, trade secret, copyright and other proprietary rights procedures to protect its technology, and has applied for a limited number of patents in connection with certain software programs. Despite these efforts, State Street cannot be certain that the steps taken by it to prevent unauthorized use of

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

proprietary rights are sufficient to prevent misappropriation of technology, particularly outside the United States where laws or law enforcement practices may not protect proprietary rights as fully as in the United States. In addition, no assurance can be given that the courts will adequately enforce contractual agreements that State Street has entered into to protect its proprietary technology. If any of its proprietary information waswere misappropriated by or otherwise disclosed to its competitors, State Street’s competitive position could be adversely affected. In the event a third party asserts a claim of infringement of its proprietary rights, obtained through patents or otherwise, against the Corporation, State Street may be required to spend significant resources to defend against such claims, develop a non-infringing program or process, or obtain a license to the infringed process.

 

Acquisitions, Alliances and alliances.Divestitures.    Acquisitions of complementary businesses and technologies and development of strategic alliances and divestitures of portions of its business are an active part of State Street’s overall business strategy. The Corporation has completed several acquisitions, alliances and divestitures in recent years. However, there can be no assurance that services, technologies, key personnel or businesses of acquired companies will be effectively assimilated into State Street’s business or service offerings or that alliances will be successful. In addition, State Street may not be able to successfully complete any divestiture on satisfactory terms, if at all, and divestitures may result in a reduction of total revenue and net income.

 

FINANCIAL CONDITION

 

CREDIT QUALITY

 

At September 30, 2003,March 31, 2004, total gross loans were $6.229$5.0 billion. At quarter end, the allowance for loan losses was $61$36 million, unchangeddown $25 million from $61 million a year ago.ago due to a first quarter reclassification of reserves for off-balance

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

sheet commitments from the allowance for loan losses to other liabilities. During the first quarter subsequent to the reclassification, the reserve for off-balance sheet commitments was reduced by $10 million based on management’s assessment of risk in these exposures. For the quarter ended September 30, 2003,March 31, 2004, no provision for loan losses was charged against income; there were no charge-offs and no recoveries during the third quarter of 2003.recoveries. Non-performing assets at September 30, 2003,March 31, 2004, were $7 million, all of which were non-performing investment securities.

 

LIQUIDITY AND CAPITAL

 

Liquidity.    The primary objective of State Street’s liquidity management is to ensure that the Corporation has sufficient funds to meet its commitments and business needs, including accommodating the transaction and cash management requirements of its clients. Liquidity is provided by State Street’s access to global debt markets, its ability to gather additional deposits from its clients, maturing short-term assets, sales of securities, and repayment of clients’ loans. Client deposits and other funds provide multi-currency, geographically diverse sources of liquidity. State Street maintains a large portfolio of liquid assets. As of September 30, 2003,March 31, 2004, the Corporation’s defined liquid assets were $66.184$79.5 billion or 81%86% of total assets, a significant portionthe vast majority of which can be sold on the open market to meet liquidity needs. At September 30, 2003,March 31, 2004, State Street had defined short-term liabilities of $68.673$78.8 billion. State Street had $102$183 million in pre-tax net unrealized gains on available-for-sale investment securities at September 30, 2003.March 31, 2004.

In January 2003, in connection with its acquisition of the GSS business (see Note 2), State Street issued $345 million of floating-rate, medium-term capital securities due 2008. The floating rate capital securities were issued at LIBOR plus 50 basis points, and are subject to mandatory redemption on December 15, 2005, provided certain regulatory requirements are met, and otherwise are due on February 15, 2008. These notes qualify as Tier 1 capital for bank regulatory purposes. See Note 2 of the Notes to the Consolidated Financial Statements for further details.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

In September 2003, State Street Bank authorized $1 billion and issued $400 million of 5.25% Subordinated Bank Notes due 2018 (“the Notes”). The Notes bear an interest rate of 5.25% per annum, and State Street Bank is required to make semi-annual interest payments on the outstanding principal balance of the Notes on April 15 and October 15 of each year. The Notes qualify as Tier 2 capital for bank regulatory purposes. In connection with this offering, State Street Bank executed fair value swaps with a notional value of $400 million to in effect, convert the Notes from fixed rate to variable rate. See Note 19 to the Notes to the Consolidated Financial Statements for further details on fair value swaps.

At September 30, 2003, $227 million was included in long-term debt that related to the capital lease for One Lincoln Street. See Note 5 of the Notes to the Consolidated Financial Statements for further details.

 

Capital.    State Street’s objective is to maintain a strong capital base in order to provide financial flexibility for its business needs, including funding corporate growth and supporting clients’ cash management needs. As a state-chartered bank and member of the Federal Reserve System, State Street Bank, State Street’s principal subsidiary, is primarily regulated by the Federal Reserve Board, which has established guidelines for minimum capital ratios. State Street has developed internal capital adequacy policies to ensure that State Street Bank meets or exceeds the level required for the “well-capitalized” category, the highest of the Federal Reserve Board’s five capital categories. State Street Bank must meet the regulatory designation of “well capitalized” in order for State Street to maintain its status as a financial holding company. State Street’s capital management emphasizes risk exposure rather than asset levels.

 

At September 30, 2003,March 31, 2004, the Corporation’s Tier 1 and total risk-based capital ratios were 12.8%ratio was 13.9% and 14.7%, respectively, down from 17.1% and 18% at year-end 2002. Tier 1 and total risk-based capital were negatively impacted by the increase in goodwill and intangibles from the GSS acquisition and the restructuring charges recorded in 2003; however, Tier 1 and total risk-based capital benefited from the stock issuance and from the issuance of $345 million of capital securities that qualify as Tier 1 capital, and total risk-based capital benefited by the issuance of $400 million of subordinated notes that qualified as Tier 2 capital. Primarily, increases in outstanding off-balance sheet indemnified securities lending transactions, as a result of the GSS acquisition, drove the increase in risk-weighted assets since year-end 2002.

At September 30, 2003, State Street Bank’s Tier 1 and total risk-based capital ratio was 12.3%. These ratios were 11.5%are relatively flat from 14.0% for the Corporation and 12.8%, respectively, down from 16.4% and 16.5% at year-end 2002. Tier 1 and total risk-based capital were negatively impacted by the increase in goodwill and intangibles from the GSS acquisition and the restructuring charges recorded in 2003; however, total risk-based capital benefited from the issuance by12.4% for State Street Bank at year-end 2003. At March 31, 2004, both ratios significantly exceeded the regulatory minimum of $400 million4% and the well-capitalized threshold of subordinated notes that qualified as Tier 2 capital. Increases in outstanding off-balance sheet indemnified securities lending transactions drove the increase in risk-weighted assets since year-end 2002.6%. State Street and State Street Bank had Tier 1 leverage ratios of 5.5% and 5.3%, respectively, at September 30, 2003,March 31, 2004, exceeding the regulatory minimum of 3% and the well-capitalized threshold of 5%. See Note 1511 to the Notes to Consolidated Financial Statements for further information.

At September 30, 2003, and December 31, 2002, both ratios for State Street and State Street Bank exceed the regulatory minimum of 4% and the well-capitalized threshold of 6% for the Tier 1 capital ratio, and the minimum of 8% and well-capitalized threshold of 10% for the total risk-based capital ratio.

 

State Street’s Board of Directors has authorized the purchase of State Street common stock for use in employee benefit programs and for general corporate purposes. As of September 30, 2003,March 31, 2004, 8.3 million shares may be purchased under the stock purchase program. State Street employs a third-party broker-dealer to acquire shares for the Corporation’s stock purchase program on the open market.

PART I.    ITEM 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND

RESULTS OF OPERATIONS (continued)

 

TRADING ACTIVITIES: FOREIGN EXCHANGE AND INTEREST RATE SENSITIVITY

 

As part of its trading activities, the Corporation assumes positions in both the foreign exchange and interest rate markets by buying and selling cash instruments and using financial derivatives, including foreign exchangeforeign-exchange forward contracts, foreign exchange and interest rate options, and interest rate swaps. As of September 30, 2003,March 31, 2004, the notional amount of these derivative instruments was $358.042$452.6 billion, of which $316.521$401.0 billion were foreign exchange forward contracts. Long and short foreign-exchange forward-positions are closely matched to minimize currency and interest rate risk. All foreign exchange contracts are valued daily at current market rates.

The following table presents State Street’s market risk for its trading activities as measured by its value at risk methodology:

 

Value at Risk for the ninethree months ended September 30,March 31,

 


(Dollars in millions)  Average  Maximum  Minimum  Average  Maximum  Minimum


2004:

         
Foreign exchange products  $1.3  $3.5  $.3
Interest rate products   2.4   3.0   1.5


2003:                  
Foreign exchange products  $1.0  $2.6  $.4  $.9  $2.2  $.4
Interest rate products   1.7   2.8   1.2   1.6   2.8   1.2

2002:         
Foreign exchange products  $1.0  $2.5  $.4
Interest rate products   3.1   4.3   2.2

 

State Street compares actual daily profits and losses from trading activities to estimateestimated one-day value at risk. During the first ninethree months of 2003,2004, State Street did not experience any trading losses in excess of its end-of-day value at risk estimate.

 

CRITICAL ACCOUNTING ESTIMATES

 

The Securities and Exchange Commission (“SEC”) issued disclosure guidance for “critical accounting estimates.” The SEC defines “critical accounting estimates” as those that require application of management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.

 

State Street’s significant accounting policies are described in detail in Note 1 in the Notes to the Consolidated Financial Statements as included in State Street’s annual report on Form 10-K for the year ended December 31, 2002,2003, and have been updated in Note 1 to the consolidated financial statements included in this quarterly report on Form 10-Q. State Street’s critical accounting estimates are described in management’s discussion and analysis of results of operations and financial condition as included in State Street’s annual report on Form 10-K for the year ended December 31, 2002.2003. There have not been any significant changes in the factors or methodology used by management in determining its critical accounting estimates since December 2002,2003, that are material in relation to the Corporation’s financial condition, changes in financial condition and results of operations.

PART I.    ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSUREDISCLOSURES ABOUT MARKET RISK

 

See information under the caption “Trading Activities: Foreign Exchange and Interest Rate Sensitivity” beginning on page 49.30.

 

State Street’s Risk Management function was described in detail in the Corporation’s annual report on Form 10-K for the year ended December 31, 2002.2003.

 

PART I.    ITEM 4.

CONTROLS AND PROCEDURES

 

The Corporation has established and maintains disclosure controls and other procedures that are designed to ensure that material information relating to the Corporation and its subsidiaries required to be disclosed by the Corporation in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Corporation’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. For the period covered in this report, the Corporation carried out an evaluation, under the supervision and with the participation of the Corporation’s management, including the Corporation’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Corporation’s disclosure controls and procedures. Based on that evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the Corporation’s disclosure controls and procedures were effective as of September 30, 2003.March 31, 2004.

 

The Chief Executive Officer and Chief Financial Officer have also concluded that there waswere no changechanges in the Corporation’s internal controlscontrol over financial reporting identified in connection with the evaluation described in the preceding paragraph that occurred during the quarter ended September 30, 2003,March 31, 2004, that hashave materially affected, or isare reasonably likely to materially affect, the Corporation’s internal controlscontrol over financial reporting.

PART II—OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS

Securities industry practices and the mutual fund industry continue to be the subject of intense regulatory, governmental, and public scrutiny. The Corporation and its subsidiaries are broadly involved with the securities industry, including in particular the mutual fund industry. The Corporation has received various regulatory inquiries relating, among other things, to market timing and late trading, and continues to respond to the various requests.

In September 2003, the U.S. Securities and Exchange Commission (the “SEC”) disseminated letters throughout the industry requesting information about market timing and late trading activities. State Street responded to that request and since then has engaged in exchanges of requests and information with the SEC. Other regulatory agencies, including the U.S. Department of Labor (the “DOL”), have also distributed broad requests for information relating to market timing and late trading activities. In March 2004, State Street Corporation and some of its subsidiaries received subpoenas from the SEC seeking additional information. State Street continues to respond to the SEC and the requests received from the DOL.

ITEM 2.    CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY SECURITIES

(a) In January 2003, in connection with its acquisition of the GSS business of Deutsche Bank AG, the Corporation issued $345 million, or 1.7 million units, of SPACES. SPACES are collateralized, forward purchase contract units for shares of Common Stock of the Corporation. Each of the SPACES has a stated amount of $200 and consists of PACES, a fixed-share purchase contract, and U.S. Treasury securities, and COVERS, a variable-share repurchase contract. SPACES are listed on the New York Stock Exchange under the symbol “SBZ”. Effective March 22, 2004, the Corporation exercised its right to fix the variable-share settlement rate of the variable-share repurchase contracts constituting part of the SPACES or existing separately as Separate COVERS, in accordance with the terms of the Purchase Contract Agreement dated as of January 21, 2003 relating to the units. The variable-share settlement rate has been fixed at 0.6949 shares per contract in accordance with a formula specified in the Purchase Contract Agreement. After the effective date, a holder of the variable-share repurchase contract (whether held as a component of a SPACES or as a Separate COVERS) may settle the variable-share repurchase contract by delivery to the Purchase Contract Agent of that number of shares of common stock of State Street equal to the variable-share settlement rate, as fixed.

(e) State Street’s Board of Directors has authorized a publicly-announced stock purchase program for State Street Common Stock for use in employee benefit programs and for general corporate purposes. The program was first anounced in 1995 and has been increased several times, most recently in December 2001. As of March 31, 2004, the number of shares purchased under the program aggregated 20,571,000, and authorization for the purchase of an additional 8,316,000 shares remained available for purchase under the program. Additionally, shares may be acquired by a consolidated trust for other deferred compensation plans, held by an external trustee, that are not part of the publicly-announced stock purchase program. These shares are purchased in open-market transactions by the trustee. There were no shares purchased by the trust in the quarter ended March 31, 2004. The following table discloses purchase of Common Stock by the Corporation and related information for the three months ended March 31, 2004:


(Shares in thousands)  Number
of Shares
Purchased
  Average
Price Per
Share
  Number of
Shares Purchased
Under Publicly-
Announced
Program
  Maximum Number
of Shares Yet to Be
Purchased Under
Program

January 1– January 31, 2004    4  $52.00    4  8,316
February 1– February 29, 2004         8,316
March 1– March 31, 2004         8,316
   
  

  
  
   4  $52.00  4  8,316
   
  

  
  

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

Registrant’s annual meeting of stockholders was held on April 21, 2004. At the meeting, the following nominees for Director were elected:


   Number of Shares

   For  Withheld

Kennett F. Burnes  271,892,286  3,553,448
David P. Gruber  263,754,882  11,690,852
Linda A. Hill  271,879,353  3,566,381
Charles R. LaMantia  261,788,548  13,657,186
Robert E. Weissman  269,434,516  6,011,218

The following directors continue in office: Tenley E. Albright, M.D., Truman S. Casner, Nader F. Darehshori, Arthur L. Goldstein, Ronald E. Logue, Richard P. Sergel, Ronald L. Skates, David A. Spina, Gregory L. Summe, and Diana Chapman Walsh.

Also at the meeting, the following action (which required the favorable vote of at least two-thirds of the outstanding shares — or at least 223,676,252 favorable votes — for adoption) was voted upon:


   Number of Shares

   For  Against  Abstain or
Not Voting
  Broker
Nonvotes

Vote to exempt the Board of Directors from Massachusetts General Laws, Chapter 156B, Section 50A(a)

  140,089,787  97,622,573  2,387,508  35,345,866

ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K

 

(a) Exhibits

 

Exhibit

Number


    Page of this Report

12 Ratio of earnings to fixed charges  54
15 Letter regarding unaudited interim financial information  55
31.1 Rule 13a-14(a)/15d-14(a) Certification  56
31.2 Rule 13a-14(a)/15d-14(a) Certification  57
32 Section 1350 Certifications  58

The following exhibit is incorporated by reference:

Exhibit
Number


4Amended and Restated Rights Agreement, dated as of September 15, 1988, as amended as ofSeptember 20, 1990, as amended and restated as of June 18, 1998, and as amended as of April 5, 2004, between State Street Corporation and BankBoston, N.A., as Rights Agent (filed with the Securities and Exchange Commission as Exhibit 99.1 to Registrant’s Current Report on Form 8-K dated April 5, 2004 and incorporated by reference)

The following exhibits are included herewith:

Exhibit
Number


     Page of this
Report


12  Ratio of earnings to fixed charges  36
15  Letter regarding unaudited interim financial information  37
31.1  Rule 13a-14(a)/15d-14(a) Certification  38
31.2  Rule 13a-14(a)/15d-14(a) Certification  39
32  Section 1350 Certifications  40

 

(b) Current Reports on Form 8-K

 

A current report on Form 8-K dated July 31, 2003,March 9, 2004, was furnished,filed, by the Registrant, on August 1, 2003,March 9, 2004, to the Securities and Exchange Commission reporting that six months aftergovernment agencies have sought information from the acquisition

Registrant and its subsidiaries in connection with investigations related to the mutual fund industry and market timing and late trading activities, and on March 5, 2004, the Registrant and some of its subsidiaries received subpoenas from the Securities and Exchange Commission seeking additional information.

A current report on Form 8-K dated March 22, 2004, was filed, by the Registrant, on March 29, 2004, to the Securities and Exchange Commission reporting that the Registrant has fixed the variable-share settlement rate of the Global Securities Services business from Deutsche Bank AG,variable-share repurchase contracts constituting part of the Registrant’s integration plan is on schedule and6.75% SPACES or existing separately as Registrant’s 4.0% Separate COVERS, in accordance with the company expects to meet its goal of retaining 90% of the revenue available from former Deutsche Bank clients.Purchase Contract Agreement.

 

A current report on Form 8-K dated August 25, 2003,April 5, 2004, was furnished,filed, by the Registrant, on August 26, 2003,April 5, 2004, to the Securities and Exchange Commission providingreporting that the Registrant has entered into an update on U.S. client integration ofamendment to the Global Securities Services business acquired from Deutsche Bank AG.Amended and Restated Rights Agreement, which eliminates the requirement that certain actions related to redemption may only be taken by Continuing Directors as defined in the Rights Agreement.

 

A current report on Form 8-K dated October 14, 2003,April 13, 2004, was filed,furnished, by the Registrant, on October 14, 2003,April 13, 2004, with the Securities and Exchange Commission reporting results of operations and related financial information for its completed thirdfirst quarter of 2003.

A current report on Form 8-K dated October 16, 2003, was filed by the Registrant, on October 21, 2003, with the Securities and Exchange Commission reporting that Kennett F. Burnes had been elected to the Board of Directors.2004.

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  

STATE STREET CORPORATION

Date: NovemberMay 7, 20032004

 

By:

 

/s/    EDWARD J. RESCH        


    

Edward J. Resch,

Executive Vice President

and Chief Financial Officer

Date: November 7, 2003

By:

/s/    FREDERICK P. BAUGHMAN        


Frederick P. Baughman,

Senior Vice President, Controller and

Chief Accounting Officer

EXHIBIT INDEX

 

(filed herewith)

 

12  Ratio of earnings to fixed charges
15  Letter regarding unaudited interim financial information
31.1  Rule 13a-14(a)/15d-14(a) Certification
31.2  Rule 13a-14(a)/15d-14(a) Certification
32  Section 1350 Certifications

 

Pages 54-5537-38 intentionally not included.

53