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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 June 30, 2000
[_]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)
COMMONWEALTH OF MASSACHUSETTS 04-2456637
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
225 Franklin Street 02110
Boston, Massachusetts (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.
Yes [X] No [_]
The number of shares of the Registrant's Common Stock outstanding on July 31,
2000 was 161,231,268.
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STATE STREET CORPORATION
Table of Contents
Page
----
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income........................................ 1
Consolidated Statement of Condition...................................... 3
Consolidated Statement of Cash Flows..................................... 4
Consolidated Statement of Changes in Stockholders' Equity................ 5
Notes to Consolidated Financial Statements............................... 6
Independent Accountants' Review Report................................... 13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 14
Item 3. Quantitative and Qualitative Disclosure About Market Risk....... 23
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................ 23
Signatures............................................................... 24
Exhibits
PART I. ITEM 1.
FINANCIAL STATEMENTS
Consolidated Statement of Income - State Street Corporation (Unaudited)
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(Dollars in millions, except per share data) Three months
ended June 30, 2000 1999
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Fee Revenue
Fiduciary compensation:
Services for Institutional Investors........................ $ 362 $ 288
Investment Management....................................... 131 144
-------- --------
Total fiduciary compensation................................ 493 432
Foreign exchange trading.................................... 101 69
Servicing and processing.................................... 57 56
Other....................................................... 5 18
-------- --------
Total fee revenue.......................................... 656 575
Net Interest Revenue
Interest revenue............................................ 768 610
Interest expense............................................ 553 416
-------- --------
Net interest revenue....................................... 215 194
Provision for loan losses................................... 2 4
-------- --------
Net interest revenue after provision for loan losses....... 213 190
-------- --------
Total Revenue.............................................. 869 765
Operating Expenses
Salaries and employee benefits.............................. 366 323
Information systems and communications...................... 75 73
Transaction processing services............................. 66 57
Occupancy................................................... 48 46
Other....................................................... 87 78
-------- --------
Total operating expenses................................... 642 577
-------- --------
Income before income taxes................................. 227 188
Income taxes................................................ 79 65
-------- --------
Net Income................................................. $ 148 $ 123
======== ========
Earnings Per Share
Basic...................................................... $ .92 $ .77
Diluted.................................................... .90 .75
Average Shares Outstanding (in thousands)
Basic...................................................... 160,847 161,158
Diluted.................................................... 164,045 164,171
Cash Dividends Declared Per Share........................... $ .17 $ .15
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
1
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Income - State Street Corporation (Unaudited)
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(Dollars in millions, except per share data) Six months
ended June 30, 2000 1999
- ------------------------------------------------------------------------------
Fee Revenue
Fiduciary compensation:
Services for Institutional Investors........................ $ 711 $ 563
Investment Management....................................... 312 277
-------- --------
Total fiduciary compensation............................... 1,023 840
Foreign exchange trading.................................... 207 163
Servicing and processing.................................... 119 101
Other....................................................... 12 23
-------- --------
Total fee revenue.......................................... 1,361 1,127
Net Interest Revenue
Interest revenue............................................ 1,494 1,174
Interest expense............................................ 1,067 786
-------- --------
Net interest revenue....................................... 427 388
Provision for loan losses................................... 5 8
-------- --------
Net interest revenue after provision for loan losses....... 422 380
-------- --------
Total Revenue.............................................. 1,783 1,507
Operating Expenses
Salaries and employee benefits.............................. 752 632
Information systems and communications...................... 153 145
Transaction processing services............................. 141 109
Occupancy................................................... 98 92
Other....................................................... 182 156
-------- --------
Total operating expenses................................... 1,326 1,134
-------- --------
Income before income taxes................................. 457 373
Income taxes................................................ 160 128
-------- --------
Net Income................................................. $ 297 $ 245
======== ========
Earnings Per Share
Basic...................................................... $ 1.85 $ 1.52
Diluted.................................................... 1.82 1.49
Average Shares Outstanding (in thousands)
Basic...................................................... 160,341 161,050
Diluted.................................................... 163,415 164,007
Cash Dividends Declared Per Share........................... $ .33 $ .29
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
2
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Condition - State Street Corporation
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June 30, December 31,
(Dollars in millions) 2000 1999
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(Unaudited)
Assets
Cash and due from banks.............................. $ 2,506 $ 2,930
Interest-bearing deposits with banks................. 17,637 16,902
Securities purchased under resale agreements and
securities borrowed................................. 16,570 17,518
Federal funds sold................................... 2,115 410
Trading account assets............................... 1,325 786
Investment securities (principally available-for-
sale)............................................... 15,506 14,703
Loans (less allowance of $53 and $48)................ 5,330 4,245
Premises and equipment............................... 655 732
Accrued income receivable............................ 696 717
Other assets......................................... 2,290 1,953
-------- --------
Total Assets...................................... $ 64,630 $ 60,896
======== ========
Liabilities
Deposits:
Noninterest-bearing................................. $ 9,533 $ 8,943
Interest-bearing:
U.S................................................ 2,537 1,917
Non-U.S............................................ 25,300 23,285
-------- --------
Total deposits.................................... 37,370 34,145
Securities sold under repurchase agreements.......... 18,429 18,399
Federal funds purchased.............................. 65 1,054
Other short-term borrowings.......................... 275 1,104
Accrued taxes and other expenses..................... 1,151 1,133
Other liabilities.................................... 3,189 1,488
Long-term debt....................................... 1,220 921
-------- --------
Total Liabilities................................. 61,699 58,244
Stockholders' Equity
Preferred stock, no par: authorized 3,500,000; issued
none................................................
Common stock, $1 par: authorized 250,000,000; issued
167,222,000 and 167,225,000......................... 167 167
Surplus.............................................. 66 55
Retained earnings.................................... 3,038 2,795
Net unrealized losses................................ (75) (57)
Treasury stock, at cost (6,080,000 and 7,635,000
shares)............................................. (265) (308)
-------- --------
Total Stockholders' Equity........................ 2,931 2,652
-------- --------
Total Liabilities and Stockholders' Equity........ $ 64,630 $ 60,896
======== ========
- --------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
3
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Cash Flows - State Street Corporation (Unaudited)
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(Dollars in millions) Six months ended June 30, 2000 1999
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Operating Activities
Net Income................................................... $ 297 $ 245
Non-cash charges for depreciation, amortization, provision
for loan losses and deferred income taxes................... 125 139
------- -------
Net income adjusted for non-cash charges.................. 422 384
Adjustments to reconcile to net cash (used) provided by
operating activities:
Securities gains, net....................................... (5)
Net change in:
Trading account assets..................................... (539) (394)
Other, net................................................. (8) (94)
------- -------
Net Cash Used by Operating Activities..................... (125) (109)
------- -------
Investing Activities
Payments for purchases of:
Available-for-sale securities............................... (3,594) (7,153)
Held-to-maturity securities................................. (194) (582)
Lease financing assets...................................... (518) (20)
Premises and equipment...................................... (42) (89)
Proceeds from:
Maturities of available-for-sale securities................. 2,757 3,348
Maturities of held-to-maturity securities................... 177 563
Sales of available-for-sale securities...................... 39 414
Principal collected from lease financing.................... 34 76
Net (payments for) proceeds from:
Interest-bearing deposits with banks........................ (735) (2,124)
Federal funds sold, resale agreements and securities
borrowed................................................... (757) 1,331
Loans....................................................... (939) (1,015)
------- -------
Net Cash Used by Investing Activities..................... (3,772) (5,251)
------- -------
Financing Activities
Proceeds from issuance of:
Non-recourse debt for lease financing....................... 435
Long-term debt.............................................. 300
Treasury stock.............................................. 50 14
Payments for:
Non-recourse debt for lease financing....................... (46) (93)
Long-term debt.............................................. (2) (1)
Cash dividends.............................................. (51) (48)
Purchase of common stock.................................... (37) (38)
Net proceeds from (payments for):
Deposits.................................................... 3,225 5,243
Short-term borrowings....................................... (401) 709
------- -------
Net Cash Provided by Financing Activities................. 3,473 5,786
------- -------
Net (Decrease) Increase................................... (424) 426
Cash and due from banks at beginning of period............... 2,930 1,365
------- -------
Cash and Due From Banks at End of Period.................. $ 2,506 $ 1,791
======= =======
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The accompanying notes are in integral part of these financial statements.
4
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Changes in Stockholders' Equity - State Street
Corporation (Unaudited)
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(Dollars in millions, except share data) Six
months ended June 30, 2000 1999
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Common Stock
Balance at end of period (no change during
period)...................................... $ 167 $ 167
Surplus
Balance at beginning of period................ 55 63
Treasury stock issued......................... (29) (27)
Stock options exercised....................... 40 15
------- -------
Balance at end of period..................... 66 51
------- -------
Retained Earnings
Balance at beginning of period................ 2,795 2,272
Net income.................................... 297 $ 297 245 $ 245
Cash dividends declared ($.33 and $.29 per
share)....................................... (54) (48)
------- -------
Balance at end of period..................... 3,038 2,469
------- -------
Net Unrealized (Losses) Gains--Other
Comprehensive Income
Balance at beginning of period................ (57) 22
Foreign currency translation.................. (9) (9) (12) (12)
Net unrealized loss on available-for-sale
securities................................... (9) (9) (48) (48)
------- ----- ------- -----
(18) (60)
----- -----
Balance at end of period..................... (75) (38)
------- -------
Comprehensive Income.......................... $ 279 $ 185
===== =====
Treasury Stock, at Cost
Balance at beginning of period................ (308) (213)
Common stock acquired (419,000 and 495,000
shares)...................................... (37) (38)
Treasury stock issued (1,974,000 and 904,000
shares)...................................... 80 43
------- -------
Balance at end of period..................... (265) (208)
------- -------
Total Stockholders' Equity.................. $ 2,931 $ 2,441
======= =======
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The accompanying notes are in integral part of these financial statements.
5
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note A--Basis of Presentation
State Street Corporation ("State Street" or the "Corporation") is a
financial holding company that provides trust, investment management, global
custody, banking, administration and information services to both U.S. and
non-U.S. customers. State Street reports two lines of business. Services for
Institutional Investors includes accounting, custody, daily pricing,
administration, foreign exchange, cash management, lending activities, lease
financing and information services to support institutional investors.
Investment Management provides an extensive array of services for managing
financial assets worldwide for both institutional and individual investors as
well as recordkeeping, administration and investment services for defined
contribution plans and other employee benefit programs. The impact of a
divested business for the prior period has been presented separately under the
caption "Business Divestiture" in Note I.
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"). The preparation of financial
statements 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. 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 50%-owned affiliates are accounted for using the
equity method. Certain previously reported amounts have been reclassified to
conform to the current method of presentation.
Total comprehensive income for the three months ended June 30, 2000 and 1999
was $155 million and $80 million, respectively. Total comprehensive income for
the six months ended June 30, 2000 and 1999 was $279 million and $185 million,
respectively. Tax benefits of $6 million and $34 million related to fair value
adjustments for the investment portfolio, and tax benefits of $6 million and
$8 million related to foreign currency translation, were included in other
comprehensive income for the six months ended June 30, 2000 and 1999,
respectively.
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 June 30, 2000 and December 31,
1999, its cash flows for the six months ended June 30, 2000 and 1999, and
consolidated results of its operations for the three months and six months
ended June 30, 2000 and 1999, have been made. 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.
Note B--Joint Venture
In April 2000, State Street and Citigroup completed the formation of
CitiStreet, LLC, a 50/50 joint venture designed to service employee benefit
programs. State Street's contribution to the joint venture consisted of its
retirement investment services businesses and the total outsourcing business
of Wellspring Resources, LLC, a wholly owned subsidiary.
6
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note C--Investment Securities
Available-for-sale securities are recorded at fair value and held-to-
maturity securities are recorded at amortized cost on the Consolidated
Statement of Condition. Investment securities consisted of the following as of
the dates indicated:
- -----------------------------------------------------------------------------------------
June 30, 2000 December 31, 1999
------------------------------- -------------------------------
Unrealized Unrealized
Amortized ------------ Fair Amortized ------------ Fair
(Dollars in millions) Cost Gains Losses Value Cost Gains Losses Value
- -----------------------------------------------------------------------------------------
Available for sale:
U.S. Treasury and
federal agencies...... $ 7,103 $ 8 $ 50 $ 7,061 $ 6,899 $ 2 $ 36 $ 6,865
State and political
subdivisions.......... 2,011 2 10 2,003 1,886 2 11 1,877
Asset-backed
securities............ 3,610 2 28 3,584 3,261 1 25 3,237
Collateralized mortgage
obligations........... 867 1 13 855 841 10 831
Other investments...... 728 1 9 720 630 1 5 626
-------- ---- ----- -------- -------- --- ---- --------
Total.................. $ 14,319 $ 14 $ 110 $ 14,223 $ 13,517 $ 6 $ 87 $ 13,436
-------- ---- ----- -------- -------- --- ---- --------
Held to maturity:
U.S. Treasury and
federal agencies...... $ 1,235 $ 1 $ 8 $ 1,228 $ 1,219 $ $ 11 $ 1,208
Other investments...... 48 48 48 48
-------- ---- ----- -------- -------- --- ---- --------
Total.................. $ 1,283 $ 1 $ 8 $ 1,276 $ 1,267 $ $ 11 $ 1,256
======== ==== ===== ======== ======== === ==== ========
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During the six months ended June 30, 2000, there were gross gains and gross
losses of less than $1 million realized on the sales of $39 million of
available-for-sale securities. During the six months ended June 30, 1999,
there were gross gains of $6 million and gross losses of $1 million realized
on the sales of $414 million of available-for-sale securities.
Note D--Allowance for Loan Losses
State Street establishes an allowance for loan losses to absorb probable
credit losses. Management's review of the adequacy of the allowance for loan
losses is ongoing throughout the year and is based, among other factors, on
previous loss experience, current economic conditions and adverse situations
that may affect the borrowers' ability to repay, timing of future payments,
estimated value of the underlying collateral, the performance of individual
credits in relation to contract terms and other relevant factors.
While the allowance is established to absorb probable losses inherent in the
total loan portfolio, management allocates the allowance for loan losses to
specific loans, selected portfolio segments and certain off-balance sheet
exposures and commitments. Adversely classified loans in excess of $1 million
are individually reviewed to evaluate risk of loss and are assigned a specific
allocation of the allowance. The allocations are based on an assessment of
potential risk of loss and include evaluations of the borrowers' financial
strength, discounted cash flows, collateral, appraisals and guarantees. The
allocations to portfolio segments and off-balance sheet exposures are based on
management's evaluation of relevant factors, including the current level of
problem loans and current economic conditions which are subject to change from
quarter to quarter. In addition, a portion of the allowance remains
unallocated as a general reserve for the entire loan portfolio. The general
reserve is based upon such factors as portfolio concentration, historical
losses and current economic conditions.
On October 1, 1999, State Street completed the sale of its commercial
banking business, which included the transfer of $2.4 billion of commercial,
financial and real estate loans, and a $36 million allowance for loan losses.
7
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note D--Allowance for Loan Losses (continued)
Changes in the allowance for loan losses were as follows:
- --------------------------------------------------------------------------------
Six
Three Months Months
Ended Ended
June 30, June 30,
------------- ----------
(Dollars in millions) 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Balance at beginning of period....................... $ 50 $ 85 $ 48 $ 84
Provision for loan losses............................ 2 4 5 8
Loan charge-offs..................................... (1) (1) (4)
Recoveries........................................... 1 1
------ ------ ---- ----
Balance at end of period............................ $ 53 $ 88 $ 53 $ 88
====== ====== ==== ====
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Note E--Long-term Debt
On April 11, 2000, State Street filed a universal shelf registration
statement to increase the amount available for issuance of unsecured debt from
$200 million to $1 billion. The shelf registration statement allows for the
offering and sale of unsecured debt securities, capital securities, common
stock, depositary shares and preferred stock, and warrants to purchase such
securities, including any shares into which the preferred stock or depositary
shares may be convertible. On June 15, 2000, State Street issued $300 million
in subordinated notes due 2010 at a coupon rate of 7.65%. At June 30, 2000,
$700 million of the shelf registration is available for issuance.
Note F--Net Interest Revenue
Net interest revenue consisted of the following:
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Three Months Six Months
Ended Ended
June 30, June 30,
------------- -------------
(Dollars in millions) 2000 1999 2000 1999
- -------------------------------------------------------------------------------
Interest Revenue
Deposits with banks............................... $ 168 $ 135 $ 315 $ 251
Investment securities:
U.S. Treasury and federal agencies............... 134 89 262 162
State and political subdivisions (exempt from
federal tax).................................... 21 16 42 33
Other investments................................ 84 48 160 94
Loans............................................. 74 112 141 220
Securities purchased under resale agreements,
securities borrowed and federal funds sold....... 272 205 546 407
Trading account assets............................ 15 5 28 7
------ ------ ------ ------
Total interest revenue.......................... 768 610 1,494 1,174
====== ====== ====== ======
Interest Expense
Deposits.......................................... 240 186 458 343
Other borrowings.................................. 295 212 573 408
Long-term debt.................................... 18 18 36 35
------ ------ ------ ------
Total interest expense.......................... 553 416 1,067 786
------ ------ ------ ------
Net interest revenue............................ $ 215 $ 194 $ 427 $ 388
====== ====== ====== ======
- -------------------------------------------------------------------------------
8
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note G--Operating Expenses - Other
The other category of operating expenses consisted of the following:
- -------------------------------------------------------------------------------
Three Months Six Months
Ended Ended
June 30, June 30,
------------- -----------
(Dollars in millions) 2000 1999 2000 1999
- -------------------------------------------------------------------------------
Professional services................................ $ 34 $ 28 $ 67 $ 55
Advertising and sales promotion...................... 15 15 30 30
Other................................................ 38 35 85 71
------ ------ ----- -----
Total operating expenses -- other................... $ 87 $ 78 $ 182 $ 156
====== ====== ===== =====
- -------------------------------------------------------------------------------
Note H--Regulatory Matters
The regulatory capital amounts and ratios were the following at June 30,
2000, and December 31, 1999:
- ------------------------------------------------------------------------------------
Regulatory
Guidelines(/1/)
-------------------
State Street State Street Bank
Well ------------------ ------------------
(Dollars in millions) Minimum Capitalized 2000 1999 2000 1999
- ------------------------------------------------------------------------------------
Risk-based ratios:
Tier 1 capital......... 4% 6% 13.8% 14.7% 12.6% 13.5%
Total capital.......... 8 10 14.9 14.7 12.7 13.7
Leverage ratio.......... 3 5 5.6 5.6 5.5 5.7
Tier 1 capital......... $ 3,400 $ 3,119 $ 3,088 $ 2,841
Total capital.......... 3,683 3,121 3,125 2,889
Adjusted risk-weighted
assets and market-risk
equivalents:
On-balance sheet...... $ 17,754 $ 15,293 $ 17,561 $ 15,108
Off-balance sheet..... 6,336 5,451 6,351 5,464
Market-risk
equivalents.......... 630 475 600 454
-------- -------- -------- --------
Total................ $ 24,720 $ 21,219 $ 24,512 $ 21,026
======== ======== ======== ========
- -------------------------------------------------------------------------------
(1) 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. 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 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%).
9
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note I--Lines of Business
Further financial information by lines of business is contained within the
Lines of Business section of Management's Discussion and Analysis of Financial
Condition and Results of Operation on pages 17 and 18.
The following is a summary of the lines of business operating results for
the six months ended June 30:
- -------------------------------------------------------------------------------
Services for Investment Business
Institutional Investors Management Divestiture
----------------------- ----------- -------------
(Dollars in millions;
taxable equivalent) 2000 1999 2000 1999 2000 1999
- -------------------------------------------------------------------------------
Total revenue............... $ 1,404 $ 1,131 $ 412 $ 335 $ 58
Income before income taxes.. 399 301 91 62 27
Average assets (billions)... 59.1 49.5 1.7 1.2 2.3
- -------------------------------------------------------------------------------
Note J--Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
- ------------------------------------------------------------------------------
Three Months Six Months
Ended Ended
June 30, June 30,
----------------- -----------------
(Dollars in millions, except per share
data; shares in thousands) 2000 1999 2000 1999
- ------------------------------------------------------------------------------
Net Income................................ $ 148 $ 123 $ 297 $ 245
Earnings per share
Basic.................................... $ .92 $ .77 $ 1.85 $ 1.52
Diluted.................................. .90 .75 1.82 1.49
Basic average shares...................... 160,847 161,158 160,341 161,050
Stock options and stock awards........... 2,597 2,225 2,434 2,168
7.75% convertible subordinated
debentures.............................. 601 788 640 789
-------- -------- -------- --------
Dilutive average shares................... 164,045 164,171 163,415 164,007
======== ======== ======== ========
- -------------------------------------------------------------------------------
Note K--Income Taxes
The provision for income taxes included in the Consolidated Statement of
Income consisted of the following:
- --------------------------------------------------------------------------------
Three Months Six Months
Ended Ended
June 30, June 30,
-------------- ------------
(Dollars in millions) 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Current........................................... $ 25 $ 44 $ 61 $ 67
Deferred.......................................... 54 21 98 61
------ ------ ----- -----
Total provision.................................. $ 79 $ 65 $ 159 $ 128
====== ====== ===== =====
Effective tax rate................................ 34.9% 34.4% 34.9% 34.4%
====== ====== ===== =====
- -------------------------------------------------------------------------------
10
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note L--Commitments and Contingent Liabilities
State Street acts in a fiduciary or custodial capacity on behalf of its
customers. Assets under custody and assets under management are held by 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 at June 30, 2000, which would have a material adverse effect on
State Street's financial position or results of operations.
State Street is subject to pending and threatened legal actions that arise
in the normal course of business. In 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.
Note M--Off-Balance Sheet Financial Instruments, Including Derivatives
State Street uses various off-balance sheet financial instruments, including
derivatives, to satisfy the financing and risk management needs of customers,
to manage interest rate and currency risk and to conduct trading activities. A
derivative instrument is a contract or agreement whose value is derived from
interest rates, currency exchange rates or other financial indices. Derivative
instruments include forwards, swaps, options and other instruments with
similar characteristics. The use of these instruments generates fee, interest
or trading revenue. Associated with these instruments are market and credit
risks that could expose State Street to potential losses.
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:
- --------------------------------------------------------------------------------
June 30, December 31,
(Dollars in millions) 2000 1999
- --------------------------------------------------------------------------------
Trading:
Interest rate contracts:
Swap agreements......................................... $ 2,557 $ 1,986
Options and caps purchased.............................. 342 148
Options and caps written................................ 441 279
Futures--short position................................. 5,826 3,836
Options on futures purchased............................ 795 705
Options on futures written.............................. 680 900
Foreign exchange contracts:
Forward, swap and spot.................................. 161,443 122,795
Options purchased....................................... 519 187
Options written......................................... 524 205
Balance Sheet Management:
Interest rate contracts:
Swap agreements......................................... 180 180
Options and caps purchased.............................. 30
- -------------------------------------------------------------------------------
11
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note M--Off-Balance Sheet Financial Instruments, Including Derivatives
(continued)
The following table represents the fair value as of June 30, 2000 and
December 31, 1999 and average fair value for the six and twelve months then
ended, respectively, for State Street's financial instruments held or issued
for trading purposes:
- --------------------------------------------------------------------------------
June 30, 2000 December 31, 1999
--------------- ------------------
Average Average
Fair Fair Fair Fair
(Dollars in millions) Value Value Value Value
- --------------------------------------------------------------------------------
Foreign exchange contracts:
Contracts in a receivable position.......... $ 1,102 $ 1,424 $ 1,160 $ 1,222
Contracts in a payable position............. 1,090 1,360 1,127 1,251
Other financial instrument contracts:
Contracts in a receivable position.......... 24 31 40 19
Contracts in a payable position............. 12 13 7 4
- -------------------------------------------------------------------------------
The preceding amounts have been reduced by offsetting balances with the same
counterparty where a master netting agreement exists. Contracts in a
receivable position are reported in other assets in the Consolidated Statement
of Condition and contracts in a payable position are reported in other
liabilities.
Credit-related financial instruments include indemnified securities on loan,
commitments to extend credit or purchase assets, standby letters of credit and
letters of credit. The maximum credit risk associated with credit-related
financial instruments is measured by the contractual amounts of these
instruments. The following is a summary of the contractual amount of State
Street's credit-related, off-balance sheet financial instruments:
- --------------------------------------------------------------------------------
June 30, December 31,
(Dollars in millions) 2000 1999
- --------------------------------------------------------------------------------
Indemnified securities on loan............................ $ 97,992 $ 77,352
Loan commitments.......................................... 12,074 10,404
Asset purchase agreements................................. 5,813 3,585
Standby letters of credit................................. 3,859 3,128
Letters of credit......................................... 268 171
- -------------------------------------------------------------------------------
On behalf of its customers, State Street lends their securities to
creditworthy brokers and other institutions. In certain circumstances, State
Street may indemnify its customers for the fair market value of those
securities against a failure 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 totaling $101.4 billion and $79.7 billion for indemnified
securities on loan at June 30, 2000 and December 31, 1999, respectively.
Loan commitments, asset purchase agreements, standby letters of credit and
letters of credit are subject to the same credit policies and reviews as
loans. The amount and nature of collateral is obtained based upon management's
assessment of the credit risk. Approximately 87% of the loan commitments and
asset purchase agreements will expire in one year or less from the date of
issue. Since many of the commitments are expected to expire without being
drawn, the total commitment amounts do not necessarily represent future cash
requirements.
12
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 June 30, 2000, and the related consolidated
statements of income for the three-month and six-month periods ended June 30,
2000 and 1999, and the consolidated statements of cash flows and changes in
stockholders' equity for the six-month periods ended June 30, 2000 and 1999.
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, 1999 (presented herein), and the
related consolidated statements of income, cash flows and changes in
stockholders' equity for the year then ended (not presented herein), and in
our report dated January 18, 2000, we expressed an unqualified opinion on
those consolidated financial statements.
Ernst & Young LLP
Boston, Massachusetts
July 18, 2000
13
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Summary
Earnings per share for the second quarter were $.90 on a diluted basis, an
increase of 20% from $.75 in the second quarter of 1999. Revenue grew 15% from
$773 million to $886 million. Net income was $148 million, up 20% from $123
million a year ago. Return on stockholders' equity was 20.9%.
Condensed Income Statement--Taxable Equivalent Basis
- -------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- -------------------------
(Dollars in millions,
except per share data) 2000 1999 Change % 2000 1999 Change %
- -------------------------------------------------------------------------------
Fee revenue:
Fiduciary compensation:
Services for
Institutional
Investors............... $ 362 $ 288 $ 74 26 $ 711 $ 563 $ 148 26
Investment Management.... 131 144 (13) (9) 312 277 35 13
----- ----- ---- --- ------ ------ ----- ---
Total fiduciary
compensation........... 493 432 61 15 1,023 840 183 22
Foreign exchange trading.. 101 69 32 46 207 163 44 27
Servicing and processing.. 57 56 1 1 119 101 18 17
Other..................... 5 18 (13) (74) 12 23 (11) (49)
----- ----- ---- --- ------ ------ ----- ---
Total fee revenue....... 656 575 81 14 1,361 1,127 234 21
Net interest revenue....... 232 202 30 15 460 405 55 14
Provision for loan losses.. 2 4 (2) (38) 5 8 (3) (38)
----- ----- ---- --- ------ ------ ----- ---
Total revenue........... 886 773 113 15 1,816 1,524 292 19
Operating expenses......... 642 577 65 11 1,326 1,134 192 17
----- ----- ---- --- ------ ------ ----- ---
Income before income
taxes.................. 244 196 48 24 490 390 100 26
Income taxes............... 79 65 14 22 160 128 32 24
Taxable equivalent
adjustment................ 17 8 9 110 33 17 16 90
----- ----- ---- --- ------ ------ ----- ---
Net income.............. $ 148 $ 123 $ 25 20 $ 297 $ 245 $ 52 22
===== ===== ==== === ====== ====== ===== ===
Earnings Per Share
Basic..................... $ .92 $ .77 $.15 19 $ 1.85 $ 1.52 $ .33 22
Diluted................... .90 .75 .15 20 1.82 1.49 .33 22
- -------------------------------------------------------------------------------
(Percentage change based on dollars in thousands, except per share data)
Total Revenue
In the second quarter, total revenue was $886 million, up $113 million, or
15%, from a year ago, reflecting strong business growth. This growth was
partially offset by the contribution of businesses to CitiStreet, LLC
("CitiStreet"), a joint venture with Citigroup formed on April 4, 2000, and
the sale of the commercial banking business in October 1999. When adjusted for
the businesses contributed to CitiStreet, State Street's share of which is
accounted for using the equity method of accounting, total revenue growth for
the second quarter of 2000 would have been 21% and operating expense growth
would have been 20%, compared to the second quarter of 1999.
14
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
Fee Revenue
Fee revenue for the second quarter of 2000 was $656 million, up $81 million,
or 14%, over 1999 and accounted for 74% of total revenue. Fee revenue growth
came principally from strong growth in State Street's core fiduciary
compensation revenue and foreign exchange trading revenue.
Fiduciary compensation is the largest component of fee revenue and is
derived from accounting, custody, daily pricing, information services,
securities lending, trusteeship services and investment management. Fiduciary
compensation was $493 million, up 15% from a year ago. The increase reflected
continued business growth for Services for Institutional Investors and
Investment Management, partially offset by the contribution of businesses to
CitiStreet.
Second quarter fiduciary compensation for Services for Institutional
Investors was $362 million, up 26% from the second quarter of 1999. Revenue
growth from servicing mutual funds in the U.S. was driven by growth in mutual
fund assets, especially global assets, including expanding relationships with
existing customers. Total mutual fund assets under custody as of June 30,
2000, were $2.8 trillion, up 16% over the prior year. Revenue from servicing
U.S. pension plans increased, reflecting new business with new and existing
clients, and customers' use of State Street's global securities lending
services. New clients include business gained from the acquisition of
Wachovia's institutional trust and custody business in the fourth quarter of
1999. Revenue from serving institutional investors outside the United States
increased for the quarter, primarily due to new business from both new and
existing customers. Assets under custody for customers outside the U.S. were
$541 billion, an increase of 28% from the prior year. At quarter end, total
assets under custody totaled $6.1 trillion, up 15% from a year earlier.
Fiduciary compensation for investment management was $131 million, down 9%
from 1999. The decrease in revenue reflected the contribution of retirement
investment services businesses and the total outsourcing business of
Wellspring Resources, LLC, ("Wellspring") to CitiStreet. Joint venture
accounting reduced Investment Management revenue in the second quarter.
Adjusted for CitiStreet, retained revenue for this line of business was up
24%. Revenue from retained investment management business for institutional
investors reflected new business and expanding relationships with existing
customers. Customers' use of fixed income strategies, including money markets,
and U.S. and global indexed equity strategies, drove revenue growth. Assets
under management grew to $729 billion, up 27% from a year earlier.
Foreign exchange trading revenue was $101 million, compared to $69 million a
year ago. Foreign exchange trading revenue reflects three factors: the number
of customers doing business with State Street, the volume of cross-border
transactions and currency volatility. Currency volatility increased in State
Street's most-traded currencies. Trading volumes were strong; both the number
and total dollar value of transactions increased substantially from the second
quarter of last year. State Street has foreign exchange trading relationships
with almost 850 investment managers. Over 250 managers are using State Street
Global Link(R), an e-finance platform.
Servicing and processing revenue for the second quarter was $57 million
compared to $56 million in the second quarter of 1999. Prior period results
included on-going revenue from a non-strategic business unit sold at the end
of the second quarter of 1999. Developing businesses continue to grow
according to plan.
Other fee revenue consists of gains and losses on securities, trading
account profits and losses, and miscellaneous gains and fees. Other fee
revenue for the second quarter was $5 million, compared to $18 million a year
ago. The prior year revenue reflects the gain on the sale of a non-strategic
business.
Net Interest Revenue
Taxable-equivalent net interest revenue for the second quarter was $232
million, up 15% from $202 million a year ago. In serving institutional
investors worldwide, State Street provides short-term funds management,
15
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
including deposit services and repurchase agreements for cash positions
associated with customers' investment activities. The revenue associated with
deposit services and repurchase agreements, as well as from lending and lease
financing activities, is recorded as net interest revenue. Growth in net
interest revenue was driven by increased customer volumes, especially in non-
U.S. deposits and repurchase agreements, and higher rates worldwide. Average
non-U.S. deposits increased $4.5 billion, or 23%, from the same quarter last
year, and average securities sold under repurchase agreements increased $1.5
billion, or 9%, over the prior year.
Net interest margin, which is defined as taxable-equivalent net interest
revenue as a percent of average interest-earning assets, increased from 1.61%
in the second quarter 1999 to 1.68% in the second quarter of 2000 due to
higher interest rates worldwide and increasing interest rate spreads.
- --------------------------------------------------------------------------------
Three Months Ended June 30,
----------------------------
2000 1999
------------- -------------
Average Average
(Dollars in millions) Balance Rate Balance Rate
- --------------------------------------------------------------------------------
Interest-earning assets........................... $ 55,706 5.67% $ 50,274 4.93%
Interest-bearing liabilities...................... 47,938 4.64 43,617 3.83
---- ----
Excess of rate earned over rate paid............. 1.03% 1.11%
==== ====
Net interest margin.............................. 1.68% 1.61%
==== ====
- -------------------------------------------------------------------------------
Operating Expenses
Operating expenses for the quarter were $642 million, up 11% from the second
quarter of 1999. The increase reflects higher performance-based incentive
compensation and investments for new products, efficiency initiatives and
global expansion, offset by the CitiStreet transaction in the second quarter
of 2000.
Salaries and employee benefits were $366 million in the second quarter, up
13% from last year, primarily due to increased performance-based incentive
compensation. The growth in performance-based incentive compensation reflects
State Street's strong financial results in the quarter and the year-over-year
growth in the stock price, partially offset by the transfer of 1,400 employees
to CitiStreet. As of the second quarter of 2000, 48% of employees participate
in performance-based compensation programs.
Transaction processing services expense was $66 million in the second
quarter, up 16% from last year, reflecting increased business volumes.
Other expense, which includes professional services, advertising, sales
promotion and other expenses, was $87 million, up 12% from the second quarter
of 1999. The primary driver of the increase was professional fees for
information technology and other initiatives.
Income Taxes
Taxes for the second quarter were $79 million, up from $65 million a year
ago. The effective tax rate for the quarter was 34.9%, compared to 34.4% in
the second quarter of the prior year. The rate increase reflects continued
growth of fully taxable income.
16
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
Credit Quality
At June 30, 2000, total loans (gross of allowance for loan losses) were $5.4
billion. At quarter end, the allowance for loan losses was $53 million, a
decrease from $88 million a year ago, reflecting the sale of the commercial
banking business in the fourth quarter of 1999. During the quarter ended June
30, 2000, recoveries were less than $1 million and the provision for loan
losses charged against income was $2 million. At June 30, 2000, non-performing
loans were $7 million, compared to $7 million in the prior quarter and down
from $17 million a year ago.
Lines of Business
Following is a summary of line of business operating results for the six
months ended June 30:
- --------------------------------------------------------------------------------
Services for Investment Divestiture
Institutional Investors Management Business
Taxable equivalent basis ------------------------ ------------ -------------
(Dollars in millions) 2000 1999 2000 1999 2000 1999
- --------------------------------------------------------------------------------
Fee revenue:
Fiduciary
compensation.......... $ 711 $ 563 $ 312 $ 277
Foreign exchange
trading............... 207 163
Other.................. 77 74 54 36 $ 14
----------- ----------- ----- ----- ------
Total fee revenue..... 995 800 366 313 14
Net interest revenue.... 409 331 46 22 44
----------- ----------- ----- ----- ------
Total revenue......... 1,404 1,131 412 335 58
Operating expense....... 1,005 830 321 273 31
----------- ----------- ----- ----- ------
Income before income
taxes................ $ 399 $ 301 $ 91 $ 62 $ 27
=========== =========== ===== ===== ======
Pretax margin........... 28% 27% 22% 18% 47%
Average assets
(billions)............. $ 59.1 $ 49.5 $ 1.7 $ 1.2 $ 2.3
- -------------------------------------------------------------------------------
Services for Institutional Investors. Services for Institutional Investors
includes accounting, custody, daily pricing, and information services.
Customers around the world include mutual funds and other collective
investment funds, corporate and public pension plans, corporations, investment
managers, not-for-profit organizations, unions, and other holders of
investment assets. Institutional investors are offered State Street services,
including foreign exchange, cash management, securities lending, fund
administration, recordkeeping, banking services, and deposit and short-term
investment facilities. These services support institutional investors in
developing and executing their strategies, enhancing their returns, and
evaluating and managing risk. Revenue from this line of business comprised 77%
of State Street's total revenue for the six months ended June 30, 2000.
Total revenue for the six months ended June 30, 2000, increased to $1.4
billion, up 24% from $1.1 billion reported for the first six months of 1999.
The increase in revenue primarily reflected expanding relationships with
existing customers. Fee revenue was up $195 million, or 24%, due to growth in
fiduciary compensation and foreign exchange trading revenue. Fiduciary
compensation, up 26%, reflected revenue growth from accounting, custody,
securities lending, U.S. pension plans and customers outside the United
States. Foreign exchange trading revenue grew 27% from a year ago and reflects
the number of customers doing business with State Street, the volume of cross-
border transactions and currency volatility. Volatility within the currency
markets most-traded by State Street and trading volumes are higher, year over
year. Net interest revenue, up 24%, reflected balance sheet growth from the
increased use of securities sold under repurchase agreements and non-U.S.
deposits by institutional investors.
17
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
Operating expenses for the six months ended June 30, 2000 were $1.0 billion,
21% higher than a year ago, due to higher performance-based compensation,
higher transaction processing expenses reflecting increased business volumes,
and investments for new products, efficiency initiatives and global expansion.
Income before income taxes was $399 million, an increase of $98 million, or
33%, from 1999.
Investment Management. State Street manages financial assets worldwide for
both institutions and individuals and provides related services, including
participant services for defined contribution and other employee benefit
programs, and brokerage services. Investment management offers a broad array
of services, including passive and active equity, money market, and fixed
income strategies. Revenue from this line of business comprised 23% of State
Street's total revenue for the six months ended June 30, 2000.
Revenue for the six months ended June 30, 2000, increased to $412 million,
up $77 million, or 23%, from $335 million reported for the first six months of
1999. Fiduciary compensation for the first six months of 2000 grew 13%, to
$312 million. Adjusted for CitiStreet, growth in fiduciary compensation from
retained business was up 31% due to growth across all services, primarily
investment management for institutional investors, reflecting new business and
expanding relationships with existing customers, including customers' use of
U.S and global equity and fixed income strategies. Revenue was also driven by
strong performance in the equity brokerage business.
Operating expenses of $321 million increased $48 million, or 17%, for the
first six months of 2000, reflecting higher performance-based compensation,
higher transaction processing expenses due to increased business volumes, and
investments for new products, efficiency initiatives and global expansion. The
growth in expense was partially offset by the transfer of 1,400 employees to
CitiStreet in early April. Income before income taxes for the first six months
of 2000 was $91 million, an increase of $29 million, or 48%, from the first
six months of 1999.
Business Divestiture. Historical operating results for the commercial
banking business are contained in this caption. On October 1, 1999, State
Street completed the sale of this business, which consisted of a $2.4 billion
loan portfolio, a $36 million allowance for loan losses and $1.1 billion in
deposits. The historical revenues and expenses of this business include
allocations of other items in accordance with existing methodologies for line
of business presentation.
Joint Venture
In April 2000, State Street Corporation and Citigroup formed CitiStreet,
LLC. Jointly owned (50/50), CitiStreet provides administrative, outsourcing,
investment management, employee communication and education, one-on-one
counseling and investment advisory services to the employee benefit plans of
corporate, governmental, healthcare and not-for-profit organizations. Under
the terms of the joint venture agreement, State Street contributed its
retirement investment services businesses and Wellspring, the company's total
benefits outsourcing subsidiary. This transaction reduced total revenue in the
second quarter of 2000, and reduced expenses by a slightly lesser amount.
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, and to accommodate the transaction and cash management
requirements of its customers. Liquidity is provided by State Street's access
to global debt markets, its ability to gather additional deposits from its
customers, maturing short-term assets, the sale of securities and payment of
loans. Customer deposits and other funds provide a multi-currency,
geographically diverse source of liquidity. State Street maintains a large
portfolio of liquid assets. As of June 30, 2000, the Corporation's liquid
assets were 86% of total assets.
18
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
On April 11, 2000, State Street filed a universal shelf registration
statement to increase the amount available for issuance of unsecured debt from
$200 million to $1 billion. The shelf registration statement allows for the
offering and sale of unsecured debt securities, capital securities, common
stock, depositary shares and preferred stock, and warrants to purchase such
securities, including any shares into which the preferred stock or depositary
shares may be convertible. On June 15, 2000, State Street issued $300 million
in subordinated notes due 2010. The subordinated notes have a fixed interest
rate of 7.65%, and are not secured and will rank junior to State Street's
senior indebtedness and its other financial obligations.
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 customers' cash management needs. As a state-
chartered bank and member of the Federal Reserve System, State Street Bank,
State Street's principal subsidiary, is 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's capital management emphasizes risk exposure rather than asset
levels. At June 30, 2000, State Street Bank's Tier 1 risk-based capital ratio
was 12.6% and the Corporation's Tier 1 risk-based capital ratio was 13.8%.
Both significantly exceed the regulatory minimum of 4%. See Note H to the
Consolidated Financial Statements for further information.
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. State Street purchased 400,000 shares in the first six
months of 2000 as part of the stock purchase program. As of June 30, 2000, an
additional 2.6 million shares may be purchased within the stock purchase
program. There were an additional 19,000 shares acquired during the first six
months of 2000 for other deferred compensation plans that are not part of the
stock purchase program.
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 forward foreign
exchange contracts, foreign exchange and interest rate options, and interest
rate swaps. As of June 30, 2000, the notional amount of these derivative
instruments was $173.1 billion, of which $161.4 billion was 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 Corporation uses a variety of risk measurement and estimation
techniques, including value at risk. Value at risk is an estimate of potential
loss for a given period of time within a stated statistical confidence
interval. State Street uses a sophisticated risk management system, known as
Askari RiskBook(R), to estimate value at risk daily for all material trading
positions. The Corporation has adopted standards for estimating value at risk,
and maintains capital for market risk, in accordance with the Federal
Reserve's Capital Adequacy Guidelines for market risk. Value at risk is
estimated for a 99% one-tail confidence interval and an assumed one-day
holding period using a historical observation period of greater than one year.
A 99% one-tail confidence interval implies that daily trading losses should
not exceed the estimated value at risk more than 1% of the time, or
approximately three days out of the year. The methodology uses a simulation
approach based on observed changes in interest rates and foreign exchange
rates and takes into account the resulting diversification benefits provided
from the mix of the Corporation's trading positions.
Like all quantitative measures, value at risk is subject to certain
limitations and assumptions inherent to the methodology. State Street's
methodology gives equal weight to all market rate observations regardless of
how
19
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
recently the market rates were observed. The estimate is calculated using
static portfolios consisting of positions held at the end of the trading day.
Implicit in the estimate is the assumption that no intraday action is taken by
management during adverse market movements. As a result, the methodology does
not represent risk associated with intraday changes in positions or intraday
price volatility. 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 six months ended June 30,
- --------------------------------------------------------------------------------
(Dollars in millions) Average Maximum Minimum
- --------------------------------------------------------------------------------
2000:
Foreign exchange contracts............................. $ 1.0 $ 2.1 $ .4
Interest rate contracts................................ 3.8 5.3 3.1
1999:
Foreign exchange contracts............................. 1.8 3.7 .8
Interest rate contracts................................ .2 .5
- -------------------------------------------------------------------------------
State Street compares actual daily profit and losses from trading activities
to estimated one-day value at risk. During the first six months of 2000, State
Street did not experience any one-day trading loss in excess of its end of day
value at risk estimate.
Financial Goals and Factors That May Affect Them
State Street's primary financial goal is sustainable real growth in earnings
per share. The Corporation has two supporting goals, one for total revenue and
one for return on common stockholder's equity (ROE). The long-term revenue
goal is for a 12.5% real, or inflation adjusted, compound annual growth rate
of revenue from 1990 through 2010. This equates to approximately a 15% nominal
compound annual growth rate. The annual ROE goal is 18%.
State Street considers these to be financial goals, not projections or
forward-looking statements. However, the discussion included in Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
in other portions of this report on Form 10-Q, does 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
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.
Based on evaluation of the following factors, management is currently
optimistic about the Corporation's long-term prospects.
Cross-border investing. Increases in cross-border investing by customers
worldwide benefit State Street's revenue. Future revenue may increase or
decrease depending upon the extent of increases or decreases in cross-border
investments made by customers or future customers.
20
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
Savings rate of individuals. State Street benefits from the savings of
individuals that are invested in mutual funds or in defined contribution
plans. Changes in savings rates or investment styles may affect revenue.
Value of worldwide financial markets. As worldwide financial markets
increase or decrease in value, State Street's opportunities to invest and
service financial assets may change. Since a portion of the Corporation's fees
are based on the value of assets under custody and management, fluctuations in
worldwide securities market valuations will affect revenue.
Dynamics of markets served. Changes in markets served, including the growth
rate of U.S. mutual funds, the pace of debt issuance, outsourcing decisions,
and mergers, acquisitions and consolidations among customers and competitors,
can affect revenue. In general, State Street benefits from an increase 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, including volatile currencies and changes in monetary
policy, and social and political instability, could affect results of
operations.
Interest rates. Market interest rate levels, the shape of the yield curve
and the direction of interest rate changes affect net interest revenue as well
as fiduciary compensation from securities lending. All else being equal, in
the short term, State Street's net interest revenue benefits from falling
interest rates and is negatively affected by rising rates because interest-
bearing liabilities reprice sooner than interest-earning assets. In general,
sustained lower interest rates have a constraining effect on the net interest
revenue growth rate.
Volatility of 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.
Pace of pension reform. State Street expects 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.
Pricing/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 and the introduction of new
products into the marketplace.
Pace of new business. The pace at which existing and new customers use
additional services and assign additional assets to State Street for
management or custody will affect future results of operations.
Business mix. Changes in business mix, including the mix of U.S. and non-
U.S. business, may affect future results of operations.
Rate of technological change. Technological change 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 ultimately straight-through-
processing, will result in changes to existing procedures. Alternative
delivery systems have emerged, including the widespread utilization 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.
There are risks inherent in this process. These include rapid technological
change in the industry, the Corporation's ability to access technical and
other information from customers, and the significant and ongoing
21
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS (continued)
investments required to bring new services to market in a timely fashion at
competitive prices. Further, there is risk that competitors may introduce
services that could replace or provide lower-cost alternatives to State Street
services.
State Street uses appropriate 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. The
Corporation believes that patent protection is not a significant competitive
factor and that State Street's success depends primarily upon the technical
expertise and creative abilities of its employees, and the ability of the
Corporation to continue to develop, enhance and market its innovative business
processes and systems. However, 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 and alliances. Acquisitions of complementary businesses and
technologies, and development of strategic alliances are an active part of
State Street's overall business strategy. The Corporation has completed
several acquisitions and alliances in recent years. However, there can be no
assurance that services, technologies, key personnel and businesses of
acquired companies will be effectively assimilated into State Street's
business or service offerings or that alliances will be successful.
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999 may cause
changes in the competitive environment in which State Street operates. Such
changes could include, among other things, broadening the scope of activities
of significant competitors, or facilitating consolidation of competitors into
larger, better capitalized companies, offering a wide array of financial
services and products; and attracting large and well-capitalized financial
services companies into activities not previously undertaken but competitive
to the Corporation's traditional businesses. In addition, the Corporation's
ability to engage in new activities may expose it to business risks with which
it has less experience than it has with the business risks associated with its
traditional businesses. Such changes and the ability of the Corporation to
address and adapt to the regulatory and competitive challenges may effect
future results of operations.
22
PART I. ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See information under the caption "Trading Activities: Foreign Exchange and
Interest Rate Sensitivity" on page 19.
PART II -- Other Information
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibit Index
Exhibit
Number Page of this Report
------- -------------------
10.1 Amendment to the 1994 Stock Option and
Performance Unit Plan........................... 25
10.2 Amendment to the 1997 Equity Incentive Plan..... 26
12 Ratio of Earnings to Fixed Charges.............. 27
15 Letter regarding unaudited interim financial
information..................................... 28
27 Financial data schedule......................... 29
(b) Current Reports on Form 8-K
None
23
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: August 8, 2000 /s/ Ronald L. O'Kelley
By: _________________________________
Ronald L. O'Kelley
Executive Vice President and Chief
Financial Officer
Date: August 8, 2000 /s/ Frederick P. Baughman
By: _________________________________
Frederick P. Baughman
Senior Vice President, Controller
and Chief Accounting Officer
24