FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
EXHIBIT 13.2
Management's Discussion and Analysis of Financial Condition and Results of
Operations for the 3 years ended December 31, 1994
This section provides a discussion and analysis of State Street Boston
Corporation's consolidated results of operation for the three years ended
December 31, 1994, its financial condition at year-end 1994 and its approach to
risk management. It should be read in conjunction with the Financial Statements
and Supplemental Financial Data.
Narrative description of graphic and image material appearing in paper
format version of Form 10-K.
Pages 22 contains line graphs (bar charts) of Earnings Per
Share, and Total Revenue.
The Data points comprising these graphs appear below in tabular format.
Earnings Per Share
(Fully Diluted)
(Dollars)
Earnings
Year Per Share
1989 .................................... $1.38
1990 .................................... 1.55
1991 .................................... 1.81
1992 .................................... 2.07
1993 .................................... 2.33
1994 .................................... 2.68
Total Revenue
(Millions of Dollars)
Year Total Revenue
1989 .................................... $ 656.7
1990 .................................... 748.8
1991 .................................... 852.4
1992 .................................... 986.6
1993 .................................... 1,160.0
1994 .................................... 1,360.4
RESULTS OF OPERATIONS
Summary
State Street continued to grow rapidly and strengthened its global
franchise in 1994. Earnings per share were $2.68 on a fully diluted basis, up
$.35, or 15%, from $2.33 in 1993. Net income was $207.4 million, up from $179.8
million a year ago. Return on stockholders' equity was 17.5%, compared with
17.4% in 1993.
Strong revenue growth continued. State Street attracted new customers with
significant continuing and/or one-time revenue, and existing customers grew and
used additional services. State Street's expanding product line facilitated
revenue growth.
In 1994, State Street benefited particularly from increased cross-border
investing by customers worldwide. Non-U.S. securities under custody increased
51%, and the number of non-U.S. trades processed was up 47%. Non-U.S. securities
require multicurrency accounting and other, more complex services; this is
reflected in higher revenue received from servicing these assets. Mutual funds
continued to grow worldwide. In addition, State Street continued to benefit from
institutional investors' insatiable demand for information, driven by the
increasingly competitive environment in which they operate.
Since many customers generate various types of fee revenue and net interest
revenue, State Street's focus is on total revenue. Total revenue is defined as
fee revenue plus taxable equivalent net interest revenue, less the provision for
loan losses. In 1994, fee revenue accounted for 72% of total revenue, clearly
differentiating State Street from other major banking companies.
Total revenue grew $200.4 million to $1.4 billion, up 17%, driven primarily
by a $147.6 million, or 18%, increase in fee revenue. The year-over-year growth
rate of revenue decelerated as 1994 progressed. Some of the factors causing this
deceleration may continue in 1995. These include a slowdown in U.S. mutual fund
growth and in the rate of cross-border investing from the United States, as well
as rising interest rates.
Operating expenses were $1.0 billion, up $154.1 million, or 18%, supporting
growth. A higher than normal level of strategic investment spending continued.
Capabilities were expanded, and capacity increased.
Fee Revenue
In 1994, fee revenue was $981.0 million, up $147.6 million, or 18%, over
1993. Fiduciary compensation, the largest component of fee revenue, was $717.4
million, up $89.6 million, or 14%; foreign exchange trading revenue was $113.8
million, up $31.1 million, or 38%; and processing service fees were $66.8
million, up $20.7 million, or 45%.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
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FEE REVENUE Compound
Growth
Change Rate
(Dollars in millions) 1994 1993 1992 1991 1990 1989 93-94 89-94
------------------------------------------------------------------------------------------------------------------------
Fiduciary compensation .......... $717.4 $627.8 $545.4 $442.5 $381.3 $336.3 14% 16%
Foreign exchange trading ........ 113.8 82.7 57.9 39.3 33.0 28.9 38 32
Processing service fees ......... 66.8 46.1 30.4 19.8 20.2 26.3 45 20
Service fees .................... 47.2 40.0 31.3 23.3 18.1 16.2 18 24
Bank card fees .................. 3.6 4.3 4.9 13.3 26.5 26.5 (16) (33)
Securities gains (losses), net .. (.5) 15.4 12.3 3.3 .2 (3.9) - -
Other ........................... 32.7 17.1 20.7 22.4 23.6 13.3 91 20
------ ------ ------ ------ ------ ------
Total fee revenue ............. $981.0 $833.4 $702.9 $563.9 $502.9 $443.6 18 17
====== ====== ====== ====== ====== ======
FIDUCIARY COMPENSATION. Fiduciary compensation, the largest component of
fee revenue, is derived from accounting, custody, information, investment
management and trusteeship services. The fee charged is negotiated and is
usually based on the volume of assets under custody or management, the number of
securities held, portfolio transactions, income collected and the broadening
array of other, value-added services such as daily pricing and securities
lending.
Fiduciary compensation increased $89.6 million, or 14%, to $717. 4 million
in 1994. Growth in fiduciary compensation in 1994 came from growth in
cross-border investing, non-U.S. operations and current customers who used
additional and more complex services. The installation of new customers also
added to revenue and provides a base for future growth.
Asset-based fees are usually on a sliding scale. When the assets in a
portfolio under management or custody grow as a result of market-value changes
or cash inflows, State Street's fee may be a smaller percentage of those assets.
Investment management fees are derived from a variety of products-including
index funds, active quantitative strategies and traditional active
management-all with different fee structures. Thus, changes in portfolio size do
not always have a corresponding impact on State Street's revenue.
Because of the broadening range of services used by customers, a decreasing
percentage of total revenue is derived from asset-based fees. As a result, State
Street's revenue is becoming less sensitive to changes in prices of securities.
If equity values worldwide were to increase or decrease 10%, State Street
estimates that this, by itself, would cause less than a 1% change in total
revenue. Similarly, if bond values were to change by 10%, less than a 1% change
in total revenue would be anticipated.
While State Street's custody capabilities attract customers, less than 30%
of fiduciary revenue is derived from mutual funds for whom State Street provides
only basic custody, and from custody and portfolio accounting for customers
other than mutual funds. Portfolio transactions account for less than 10% of
fiduciary compensation.
In addition to fiduciary compensation, certain financial asset services
customers generate other types of fee revenue, particularly foreign exchange
trading revenue and net interest revenue. Noninterest-bearing deposits from
these customers comprise about 85% of total noninterest-bearing deposits
available for investment. These customers also invest substantial short-term
funds with State Street in the form of foreign deposits and other short-term
liabilities, particularly repurchase agreements. Revenue from investing these
deposits and funds is reported as interest revenue.
MUTUAL FUND SERVICES. State Street is the largest custodian of mutual funds
in the United States, servicing 35% of registered funds, and provides services
to offshore funds and in-country funds outside the United States. In 1994,
nearly half of the increase in fiduciary compensation came from servicing the
mutual fund/collective investment fund industry worldwide. This growth in
revenue reflected in part the full-year effect of strong net U.S. mutual fund
sales in 1993. In 1994, new U.S. mutual fund sales slowed and were off 48% from
a year ago.
State Street's capabilities and offshore locations enabled it to benefit
from increasingly complex global custody and accounting requirements of U.S.,
offshore and in-country funds. The increase in revenue reflected the growth of
non-U.S. assets, particularly assets held in emerging markets, new funds, a 10%
increase in the number of trades processed and 95 additional funds offering more
than one class of shares.
The total number of funds serviced increased 15%, from 2,140 at year-end
1993 to 2,463 at year-end 1994. New funds, primarily from existing customers,
totaled 504 and were partially offset by transfers, liquidations, and mergers
and consolidations. New daily-pricing and global-custody capabilities in Canada
attracted Canadian mutual funds. Offshore mutual fund service centers in Canada,
Luxembourg, Hong Kong and Grand Cayman saw a 31% increase in funds serviced,
from 192 at year-end 1993 to 252 at year-end 1994.
Mutual fund assets under custody declined 1% from year-end 1993 to year-end
1994. A decline in bond mutual funds was only partially offset by increases in
equity funds and money market funds.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
INSTITUTIONAL ASSET MANAGEMENT. State Street Global Advisors, which derives
most of its revenue from managing assets for institutions, achieved revenue
growth throughout its product line despite lackluster U.S. bond and equity
markets. Particularly strong revenue growth came from non-U.S. locations and the
management of international equities.
Revenue growth from outside the United States was fueled in part by a late
1993 surge in sales of SICAVs (the equivalent of a mutual fund) in France that
carried into the first quarter of 1994. The front-end fees on these funds are
recorded at the time the funds are sold. In the United States, new customers for
active emerging market and asset allocation strategies, increasing values of
non-U.S. equities, and additional monies from existing customers for
international passive products contributed importantly to revenue growth.
MASTER TRUST/MASTER CUSTODY/GLOBAL CUSTODY. State Street provides custody,
portfolio accounting, information and other, related services for retirement and
other financial assets of corporations, public funds, endowments, foundations
and nuclear decommissioning trusts.
Revenue from service locations outside the United States grew 21%, with the
increase coming from all regions serviced. Existing customers grew, and they
used more services, including performance measurement and analytics, and
securities lending. New customers using a broad range of services were added.
In the United States, State Street is ranked as the largest servicer of
tax-exempt assets for corporations and public funds. In 1994, revenue grew from
new customers and growth of existing customers, partially offset by lost
business. Revenue from securities lending was higher. Securities lending revenue
is a function of the volume of securities lent and interest rate spreads on the
specific securities lent. In 1994, total assets on loan increased 26% and
spreads widened on non-U.S. fixed income instruments. Spreads declined on
non-U.S. equities and U.S. equities and bonds. Securities lending revenue from
all types of customers comprises less than 5% of total revenue.
OTHER FIDUCIARY SERVICES. Personal trust revenue increased primarily as a
result of new business and also because of a fee increase. Revenue from
servicing defined contribution plans, such as 401(k) plans, and retirees also
grew as a result of new business, attracted in part by a new customer-service
workstation. The number of participant accounts serviced increased 42% to
1,157,000.
Corporate trust revenue was essentially unchanged. The acquisition of a
municipal trust and agency unit in the second quarter of 1993 contributed to
1994 revenue growth. 1993 was a very active year for the refinancing of
residential mortgages and the issuance of municipal bonds. In 1994, the issuance
of residential mortgage-backed securities in the United States was 57% lower
than in 1993. Issuers continued to repay their debt, and mortgage holders
continued to prepay their mortgages. One State Street customer began servicing
its $47 billion of collateral at the end of May 1994. State Street continued to
provide some services, and 30% of the revenue was retained. This reconfigured
customer relationship explains most of the decline in the corporate
trust-related assets shown in the Assets Under Custody table on page 25.
ASSETS UNDER CUSTODY, TRUSTEESHIP AND MANAGEMENT. Assets under custody,
trusteeship and management serve to indicate the relative size of various types
of customers and, in the context of market-value changes, as proxies for
business growth. There is not a direct correlation between assets serviced and
revenue. This is due to the increasing number of services used by many of State
Street's customers and the declining percentage of revenue coming from
asset-based basic custody fees, combined with the broad range of basis-point
fees charged depending upon the specific service provided.
U.S. bond values and equity-market values declined in 1994. From year-end
1993 to year-end 1994, total return in the U.S. bond market, as measured by the
Lehman Brothers Aggregate Bond index, declined 3%, and values declined 10%. This
compares with total return of 10% and a value increase of 3% in 1993. The U.S.
equity market, as measured by the S&P 500 index, declined 2%, compared with an
increase of 7% in the previous year. International equity markets, as measured
in dollars by the EAFE index, increased 6%, which compares with an increase of
30% in 1993.
In 1994, total assets under custody increased $44 billion, or 3%, to more
than $1.6 trillion. The increase was primarily due to new business and reflected
the growth of assets of existing customers. This was partially offset by
reconfigured relationships and the effect of lower market values. As noted
above, a corporate trust customer with $47 billion of assets under custody
assumed custody of its own assets in 1994. Using simplifying assumptions, when
changes in indices are applied to asset categories, the net market impact of
lower U.S. bond and equity values, partially offest by increased values of
non-U.S. equities, lowered assets under custody by approximately $10 billion in
1994.
At year-end, approximately 35% of assets under custody were fixed income
instruments, 35% were equities and 30% were short-term instruments. Non-U.S.
securities comprised 12% of total assets under custody.
In 1994, bonds under trusteeship increased $9 billion to $210 billion. New
trusteeships of $28 billion were partially offset by a high volume of
prepayments, calls, paydowns and a slowdown in bond issuances.
Institutional assets managed increased to $154.5 billion, up $18.2 billion,
or 13%, from year-end 1993. The $9.8 billion increase in equities and bonds
reflected growth in both international equities and U.S. equities. An $8.7
billion, or 17%, increase in money market funds resulted from an increase in the
cash collateral managed for State Street's securities-lending program.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
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ASSETS UNDER CUSTODY, TRUSTEESHIP AND MANAGEMENT Compound
DECEMBER 31, Growth
Change Rate
(Dollars in billions) 1994 1993 1992 1991 1990 1989 93-94 89-94
-----------------------------------------------------------------------------------------------------------------------------
ASSETS UNDER CUSTODY
Mutual funds/collective
investment funds .............. $ 674.6 $ 683.1 $ 560.3 $ 498.4 $429.3 $404.0 (1)% 11%
Customers in:
North America:
Master trust/master
custody/global custody ..... 663.9 574.1 465.9 335.2 250.3 242.0 16 22
Corporate trust ............. 46.8 104.0 93.2 66.9 47.0 35.3 (55) 6
Insurance ................... 62.4 60.4 46.8 37.9 23.1 21.3 3 24
Other ....................... 95.1 83.7 83.9 71.3 66.0 61.1 14 9
Europe ........................ 25.2 20.0 13.2 13.2 9.5 11.2 26 18
Asia/Pacific .................. 47.0 46.1 30.7 31.9 16.1 12.1 2 31
-------- -------- -------- -------- ------ ------
Total assets under custody $1,615.0 $1,571.4 $1,294.0 $1,054.8 $841.3 $787.0 3 15
======== ======== ======== ======== ====== ======
BONDS UNDER TRUSTEESHIP
Corporate trust ................. $ 210.0 $ 201.0 $ 136.0 $ 132.0 $108.4 $ 60.7 4 28
======== ======== ======== ======== ====== ======
ASSETS UNDER MANAGEMENT
Institutional:
Equities and bonds .......... $ 74.7 $ 64.9 $ 50.3 $ 44.4 $ 34.4 $ 31.9 15 19
Money markets ............... 60.4 51.7 37.1 21.9 14.0 10.8 17 41
Employer securities ......... 19.4 19.7 18.8 17.8 13.8 10.6 (2) 13
Personal ........................ 6.0 5.8 5.2 4.8 3.4 3.5 3 11
-------- -------- -------- -------- ------ ------
Total assets under
management ............... $ 160.5 $ 142.1 $ 111.4 $ 88.9 $ 65.6 $ 56.8 13 23
======== ======== ======== ======== ====== ======
FOREIGN EXCHANGE TRADING. In 1994, foreign exchange trading revenue was
$113.8 million, up 38% from $82.7 million in 1993. State Street's foreign
exchange customers are primarily money managers around the world, many of whom
have custody relationships with State Street. These customers use foreign
exchange contracts in order to trade securities and to protect the domestic
value of their international investments. In 1994, there was an explosion of
cross-border investing in the first quarter that continued through the second
quarter. Rising interest rates worldwide, particularly in the United States,
resulted in a general slowing of international investment activity in the second
half of the year, particularly among global bond managers.
In addition to cross-border investing activity, the opening of a branch in
Sydney, Australia contributed to year-over-year revenue growth. The number of
investment managers around the world, both custody-related managers and others
for whom State Street trades foreign currencies, continued to increase.
FEES AND OTHER REVENUE. Processing service fees were $66.8 million, up
$20.7 million, or 45%, from 1993. Processing service fees are derived from
mortgage servicing, processing unclaimed securities for state governments and
corporations, card-replacement and other services for a bank-card association,
and accounting services for retained-asset accounts of insurance companies. The
increase in 1994 was due to the acquisition of an unclaimed property business in
the fourth quarter of 1993, growth of the existing unclaimed securities
processing business, additional mortgage loans serviced and an increase in the
geographic scope of the services provided for the bank-card association.
Service fees of $47.2 million were up $7.2 million, or 18%, from 1993.
Revenue reflected the expansion of trade banking activities, including an
acquisition in Australia in the second quarter of 1993 and increased volume in
the Hong Kong branch. Investment banking fees, a recently introduced currency
overlay product and bank service fees also contributed to revenue growth.
There were net securities losses of $.5 million on the available-for-sale
portfolio, compared with securities gains of $15.4 million in 1993. The
available-for-sale portfolio is managed for total return, which is comprised of
gains and/or losses and interest revenue. In 1994, nearly all revenue came in
the form of interest revenue.
The $15.4 million increase in other fee revenue was due to $8.7 million of
currency-translation gains on the foreign bond investment portfolio, compared
with translation losses of $2.4 million a year ago; put fees on tax-exempt
secondary market securities backed by diverse pools of tax-exempt assets; growth
and new business at Boston Financial Data Services, an affiliate engaged in
mutual fund shareholder accounting; and sale of a foreclosed asset. These
increases were partially offset by lower trading-account profits and less
revenue from the disposition of leasing residuals.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
NET INTEREST REVENUE
Net interest revenue is the interest revenue on earning assets reduced by
the interest expense on interest-bearing liabilities that are used to fund these
assets. State Street manages its balance sheet to support the growth of its
financial asset services business worldwide. As a result, net interest revenue
growth is being driven by increasing amounts of customer funds on the balance
sheet. Throughout the year, State Street experienced strong growth as existing
customer relationships expanded and new customers were added.
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NET INTEREST REVENUE -- TAXABLE EQUIVALENT Compound
Growth
Change Rate
(Dollars in millions) 1994 1993 1992 1991 1990 1989 93-94 89-94
-------------------------------------------------------------------------------------------------------------------
Interest revenue ............... $904.7 $698.9 $714.3 $737.7 $817.5 $648.3
Taxable equivalent adjustment... 23.8 20.3 13.7 18.8 20.8 15.5
------ ------ ------ ------ ------ ------
928.5 719.2 728.0 756.5 838.3 663.8
Interest expense ............... 537.5 381.3 432.1 464.2 546.7 431.3
------ ------ ------ ------ ------ ------
Net interest revenue ....... $391.0 $337.9 $295.9 $292.3 $291.6 $232.5 16% 11%
====== ====== ====== ====== ====== ======
In this analysis, net interest revenue is expressed on a fully taxable
equivalent basis to adjust for the tax-exempt status of revenue earned on
certain investment securities and loans. Taxable equivalent net interest revenue
in 1994 was $391.0 million, up $53.1 million, or 16%, over 1993.
Average interest-earning assets grew $3.0 billion, or 18%, to $19.2
billion, which contributed to the improvement in net interest revenue. Larger
volumes of foreign deposits, repurchase agreements and noninterest-bearing
deposits helped to fund the increase in interest-bearing assets. These
additional short-term funds accommodated the transaction and investment needs of
financial asset services customers. In addition, during the year, 90% of
customers' cash balances were converted from subcustodian banks to State Street
accounts. These non-U.S. transaction account deposits provide favorable spreads
to State Street.
U.S. market interest rates rose dramatically as the Federal Reserve
tightened monetary policy by raising the federal funds rate from 3.00% to 5.50%,
or 250 basis points, during 1994. Average overnight rates for the year increased
by approximately 110 basis points, and the two-year Treasury rate rose 189 basis
points. The average prime rate for 1994 also increased 114 basis points from
last year. State Street's net interest revenue is sensitive to the level of
market interest rates, particularly U.S. interest rates, due to its large volume
of noninterest-bearing deposits. Contributing to the increase in net interest
revenue was the investment of these noninterest-bearing sources of funds at
higher rates.
These positive factors were partially offset by a narrower spread between
interest rates earned and paid, which decreased nine basis points to 1.41% in
1994 from 1.50% in 1993. Because State Street is liability sensitive in the
short term-interest-bearing liabilities reprice faster than interest-earning
assets-a rising-rate environment has a negative impact on the spread, as
explained further in the interest rate sensitivity management discussion on page
32.
NET INTEREST MARGIN. Net interest margin is defined as taxable equivalent
net interest revenue expressed as a percentage of average interest-earning
assets. The margin declined four basis points to 2.04% in 1994, compared with
2.08% in 1993. The narrower spread between interest rates earned and paid
outweighed the benefits of asset growth and of increased volume of
noninterest-bearing deposits. The contribution to the margin from
noninterest-bearing sources was five basis points above 1993 as a result of the
investment of these funds in higher yielding assets.
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NET INTEREST MARGIN 1994 1993 1992 1991 1990 1989
---------------------------------------------------------------------------------------------------------------------
Yield on interest-earning assets ...................... 4.84% 4.43% 5.26% 7.47% 9.37% 9.55%
Rate on interest-bearing liabilities .................. 3.43 2.93 3.85 5.87 7.91 8.73
---- ---- ---- ---- ---- ----
Excess of rate earned over rate paid .............. 1.41 1.50 1.41 1.60 1.46 .82
Contribution of noninterest-bearing sources ........... .63 .58 .73 1.29 1.80 2.52
---- ---- ---- ---- ---- ----
Net interest margin ............................... 2.04% 2.08% 2.14% 2.89% 3.26% 3.34%
==== ==== ==== ==== ==== ====
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
PROVISION FOR LOAN LOSSES. The provision for loan losses is the amount
charged to income during the current period to maintain the allowance for loan
losses at a level that management considers appropriate, relative to the level
of risk in the loan portfolio and other extensions of credit. The provision for
loan losses was $11.6 million in 1994, which compares with $11.3 million in
1993. Net charge-offs were $7.7 million, compared with $16.3 million a year ago.
Additional discussion of the allowance for loan losses, asset quality, and
loan charge-offs and recoveries is presented in the credit risk section on page
35.
OPERATING EXPENSES
In 1994, operating expenses were $1.0 billion, up $154.1 million, or 18%,
with most of the increase supporting business growth. Higher than normal
strategic investment spending continued.
In 1993, State Street increased its level of investment spending to expand
market leadership and to position it for future growth. In 1993 and 1994,
strategic investment spending equaled 10% of total revenue. Investment spending
is expected to decline over the course of 1995 to a more normal 8% level by the
end of the year, averaging about 9% of revenue for the year.
Investment spending is for information technology, core processing
infrastructure, and product and market development. In 1994, significant
enhancements were made to State Street Interchange(R), a message-based network
architecture. This included the further automation of the pricing of forward
foreign exchange contracts, variable expense processing for mutual funds and
complex fixed income capabilities. A global cash management program linking
accounting, custody and cash systems was installed, improving global cash
management capabilities for investment managers and reducing settlement risk.
Value-added products were created, including Private EdgeSM, which provides
accounting, financial reporting and performance measurement for real-estate and
venture-capital investments, and a core set of portfolio-management tools, known
as the Fixed Income Workstation.
In 1994, substantial benefits were realized from the ongoing investment
spending program. Enhanced capabilities attracted new customers, and new
products continued to generate incremental revenue. Global expansion continued
to pay off, yielding more revenue from non-U.S. operations. Productivity and
efficiency improved. Subcustody unit costs were reduced by 14%, and a
significant portion of worldwide securities operations was consolidated in
Massachusetts, resulting in greater efficiency.
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OPERATING EXPENSES COMPOUND
Growth
Change Rate
(Dollars in millions) 1994 1993 1992 1991 1990 1989 93-94 89-94
--------------------------------------------------------------------------------------------------------------------------
Salaries and employee benefits ........ $ 571.1 $479.2 $409.9 $336.8 $300.0 $264.8 19% 17%
Occupancy, net ........................ 71.8 60.6 53.3 45.7 41.7 38.8 18 13
Equipment ............................. 110.7 100.3 67.0 48.4 45.3 40.8 10 22
Contract services ..................... 87.8 64.1 45.4 47.3 40.7 32.6 37 22
Professional services ................. 47.5 35.4 30.1 24.7 19.2 14.0 34 28
Advertising and sales promotion ....... 23.0 18.7 15.1 11.1 10.6 9.7 23 19
Telecommunications .................... 21.0 21.3 18.1 14.7 13.6 13.0 (1) 10
Postage, forms and supplies ........... 19.9 17.9 16.8 16.5 16.3 16.4 11 4
FDIC and other insurance .............. 19.0 17.3 16.9 12.4 7.4 7.8 10 19
Operating and processing losses ....... .2 4.7 7.0 17.7 15.0 17.4 (96) (59)
Other ................................. 44.4 42.8 36.8 33.2 34.8 22.7 4 14
-------- ------ ------ ------ ------ ------
Total operating expenses .......... $1,016.4 $862.3 $716.4 $608.5 $544.6 $478.0 18 16
======== ====== ====== ====== ====== ======
Salaries and employee benefits, the largest component of expense, were
$571.1 million, up $91.9 million, or 19%, from 1993, due to an 11% increase in
full-time equivalent staff, higher salaries and incentive compensation,
increased costs per employee for various benefits, and FICA taxes.
Occupancy expense increased $11.2 million, or 18%, to $71.8 million as a
result of additional space to accommodate worldwide growth, particularly in
Boston and Quincy, Massachusetts.
Equipment expense of $110.7 million was up $10.4 million, or 10%, due to
additional computers and related information-technology equipment needed to
support business growth and a broader product line. Total processing power in
the data centers increased 15%. Upgrades to higher performance processors were
made, which will accommodate growth and enable State Street to benefit from more
sophisticated technology in the future.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
Contract services expense includes the cost of subcustodian services in
more than 65 countries used in delivering global custody services, as well as
other outside services, including pricing and processing services. In 1994,
contract services expense increased $23.7 million, or 37%, due in part to
increased subcustodian expense, increased costs related to mutual funds and
currency exchange rate fluctuations. The volume of securities held at
subcustodians averaged 51% higher than last year, and non-U.S. trades were up
47%.
Professional services expense was $47.5 million, up $12.2 million, or 34%,
due to the development and enhancement of application systems and products,
reengineering, increased legal expense, and increased bank exam fees based on
balance sheet growth.
Advertising and sales promotion expense was $23.0 million, up 23%, due to
additional advertising and an expanded sales effort. FDIC and other insurance
expense was up $1.7 million, or 10%, due to an increase in deposits. State
Street incurs costs from errors in securities processing and settlement,
valuations, corporate actions, and the usual banking losses. In 1994, the $4.5
million decrease was enabled by a reduction in operating and processing losses.
The $1.6 million increase in "other" expense was due to additional international
travel and upgrades to the disaster recovery system.
Income Taxes
Income tax expense charged to earnings was $112.8 million in 1994 and $97.6
million in 1993. The effective tax rate was 35.2% in each year, reflecting a
similar mix of taxable and nontaxable income.
Comparison of 1993 versus 1992
In 1993, fully diluted earnings per share were $2.33, up 13% from $2.07 in
1992.
In 1993, total revenue was $1.2 billion, up 18%, or $173.4 million, from
1992. Fee revenue increased $130.5 million, or 19%, to $833.4 million. This
increase resulted primarily from continued growth in fiduciary compensation, up
$82.4 million, or 15%. Growth in fiduciary compensation came from the growth of
current customers and their use of additional and more complex services. Total
assets under custody were $1.6 trillion, up 22%. Total assets under management
were $142.1 billion, up 28%.
In 1993, operating expenses were $862.3 million, up $145.9 million, or 20%,
supporting growth and a higher level of strategic investment spending in
information technology, product and market development, and the core processing
infrastructure.
Lines of Business
The results for State Street's three lines of business are derived from
internal accounting systems. These systems allocate revenue and expenses related
to each business, as well as certain corporate overhead, operations and
systems-development expenses. They also allocate assets and liabilities with
applicable interest rates to each business. Capital is allocated using the
federal regulatory guidelines as a basis, as well as management's judgment
regarding the operational risks inherent in the businesses. The capital
allocations may not be representative of the capital levels that would be
required if the three lines of business were independent companies.
This section of the financial review presents three lines of business:
financial asset services, investment management and commercial lending. The
line-of-business information is based on management accounting practices that
conform to and support the strategic objectives and management structure of
State Street and are not necessarily comparable with similar information for any
other company.
Line-of-business results are subject to restatements whenever there are
refinements to management accounting practices or to the organization's
structure.
-----------------------------------------------------------------------------------------------------------------------------------
LINES OF BUSINESS
(Taxable equivalent Financial Investment Commercial
basis, dollars in Asset Services Management Lending Corporate
millions) 1994 1993 1992 1994 1993 1992 1994 1993 1992 1994 1993 1992
-----------------------------------------------------------------------------------------------------------------------------------
Fee revenue ...... $ 795.2 $ 676.1 $ 561.9 $149.7 $127.5 $108.8 $ 41.5 $ 36.5 $ 34.8 $ (5.4) $ (6.7) $ (2.6)
Net interest
revenue ........ 281.2 256.4 221.9 6.1 3.7 2.5 108.6 86.1 78.0 (5.0) (8.3) (6.4)
Provision for loan
losses ......... 1.5 .5 10.0 10.8 12.2
------- ------- ------- ------ ------ ------ ------ ------ ------ ------ ------- ------
Total revenue .. 1,074.9 932.0 783.8 155.8 131.2 111.3 140.1 111.8 100.6 (10.4) (15.0) (9.0)
Operating expenses 817.8 682.9 558.4 98.5 86.1 72.3 73.7 64.5 63.6 26.4) 28.8 22.1
------- ------- ------- ------ ------ ------ ------ ------ ------ ------ ------- ------
Income before
income taxes 257.1 249.1 225.4 57.3 45.1 39.0 66.4 47.3 37.0 (36.8) (43.8) (31.1)
Income taxes ..... 106.9 109.5 95.1 24.7 19.4 18.7 28.6 20.1 15.6 (23.6) (31.2) (19.4)
------- ------- ------- ------ ------ ------ ------ ------ ------ ------ ------- ------
Net Income ....... $ 150.2 $ 139.6 $ 130.3 $ 32.6 $ 25.7 $ 20.3 $ 37.8 $ 27.2 $ 21.4 $(13.2) $ (12.6) $(11.7)
======= ======= ======= ====== ====== ====== ====== ====== ====== ====== ======= ======
Percentage
contribution ... 72% 78% 81% 16% 14% 13% 18% 15% 13% (6)% (7)% (7)%
Average assets ... $19,536 $15,906 $13,518 $17 $12 $7 $2,350 $2,251 $1,977
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
FINANCIAL ASSET SERVICES. Financial asset services, which contributed 72%
of State Street's net income in 1994, primarily offers custody-related services
for large pools of assets such as mutual funds and pension plans -- both defined
benefit and defined contribution -- and corporate trusteeship. A broad array of
services is provided, including accounting, custody of securities, information
services and recordkeeping. Also provided are banking services, such as
accepting deposits and other short-term funds, foreign exchange trading and cash
management. Revenue for these services is reflected in fee revenue and net
interest revenue.
In 1994, net income was $150.2 million, an increase of $10.6 million, or
8%, from $139.6 million in 1993. Total revenue growth of $142.9 million was
partially offset by a $134.9 million increase in operating expenses.
The increase in total revenue was driven by a $119.1 million, or 18%,
increase in fee revenue. This was primarily due to increased fiduciary
compensation and foreign exchange trading revenue. Fiduciary compensation is the
largest component of fee revenue and is derived from accounting, custody of
securities, information services, recordkeeping and trusteeship. Increased
revenue from servicing the mutual fund/collective investment fund industry
worldwide contributed substantially to the year-over-year increase in fiduciary
compensation. Foreign exchange trading was fueled, in part, by cross-border
investing by money managers who have a custody relationship with State Street.
Taxable equivalent net interest revenue was up $24.8 million, or 10%,
primarily reflecting growth in deposits, particularly foreign deposits, and the
investment of noninterest-bearing deposits at higher interest rates. These
positive changes were offset by a narrower spread between interest rates earned
and paid. The contribution of the investment securities portfolio declined as a
result of rising rates.
Operating expenses were $817.8 million and grew 20% over 1993, primarily in
support of growth. In 1994, expenses reflected a continuation of the investment
spending program, which includes strategic investment in systems, core data
processing infrastructure, and geographic and product development. All
categories of expenses increased, with salaries and employee benefits
contributing the highest year-over-year increase.
INVESTMENT MANAGEMENT. Investment Management, which contributed 16% of
State Street's net income in 1994, is comprised of the business components that
manage financial assets worldwide -- both institutional investment management
and personal trust services. State Street's institutional services include a
broad array of products that focus on quantitative equity management, both
passive and active, and money market funds. Revenue for these services is
reflected primarily in fee revenue.
In 1994, net income from investment management services was $32.6 million,
up 27% from 1993. Revenue growth of $24.6 million, or 19%, was driven by strong
revenue growth from non-U.S. locations, particularly France, and from management
of international equities and personal trust services in the United States. This
increase was partially offset by a $12.4 million, or 14%, increase in operating
expenses to support growth.
COMMERCIAL LENDING. In 1994, commercial lending contributed 18% of net
income. Net income increased $10.6 million, or 39%, due to a $28.3 million
increase in revenue, offset by a relatively small $9.2 million increase in
operating expenses. Net interest revenue was up $22.5 million, or 26%, due to a
wider spread between interest rates earned and paid, loan growth, and higher
interest rates. More favorable interest spreads were achieved between loan
yields and the cost of interest-bearing funds. Higher interest rates increased
the value of noninterest-bearing deposits. Fee revenue was up $5.0 million, or
14%, due in part to a $2 million gain on the sale of foreclosed property.
Commercial lending expenses were $73.7, up $9.2 million, or 14%, from 1993.
Expenses were up, in part due to increased activity and a credit to expense in
1993 for a gain on the sale of other real estate owned.
CORPORATE. Corporate includes the impact of long-term debt; investment of
corporate cash; tax credits from tax-advantaged financings, including writedowns
of these investments in fee revenue; operating expenses; and other corporate
items. In 1994, these corporate items reduced net income by $13.2 million,
compared with $12.6 million in 1993. The $.6 million decline in corporate net
income was caused in part by a lower level of tax credits from tax-advantaged
financings, which reduced net income by $2.8 million. Lower debt and operating
costs had a favorable impact.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
BALANCE SHEET REVIEW
State Street manages its balance sheet to support primarily the needs of
the financial asset services business while maximizing net interest revenue. In
1994, deposits and liabilities increased from additional customers' funds, and
short-term loans to financial asset services customers and securities brokers
increased. While the balance sheet was expanded to meet customer needs, State
Street continued to place high priority on maintaining its high credit and
deposit ratings. State Street's unusual business mix results in a balance sheet
with low credit risk. The business mix also affects State Street's approach to
managing interest rate sensitivity, liquidity and risk.
Liabilities
State Street's balance sheet is liability driven. Growth in
interest-earning assets is determined by growth in interest-bearing liabilities,
stockholders' equity and other noninterest-bearing sources. State Street
accommodates customers' transaction-processing needs and their short-term
investment needs through deposits and short-term liabilities.
------------------------------------------------------------------------------------------------------------------------------------
SOURCES OF FUNDS Average Volume Average Rate
(Dollars in millions) 1994 1993 1992 1994 1993 1992
------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing deposits:
Savings ............................................... $ 1,874 $ 2,167 $ 2,154 2.93% 2.41% 3.16%
Time .................................................. 119 157 162 3.52 2.88 3.86
Foreign ............................................... 7,392 4,954 3,955 2.92 2.95 4.42
------- ------- -------
Total interest-bearing deposits ..................... 9,385 7,278 6,271 2.93 2.79 3.97
Federal funds purchased ................................. 411 741 919 3.90 2.84 3.35
Securities sold under repurchase agreements ............. 4,927 4,134 3,290 4.08 2.89 3.42
Other short-term borrowings .............................. 563 216 194 4.40 3.78 4.27
Notes payable ............................................ 258 511 389 4.64 3.90 4.74
Long-term debt ........................................... 128 122 146 6.73 8.19 9.10
------- ------- -------
Total interest-bearing liabilities ................... 15,672 13,002 11,209 3.43 2.93 3.85
Other noninterest-bearing sources ........................ 2,330 2,187 1,758
Stockholders' equity ..................................... 1,182 1,033 887
------- ------- -------
Total sources ........................................ $19,184 $16,222 $13,854
======= ======= =======
Average interest-bearing liabilities increased $2.7 billion, or 21%, in
1994. Most of the growth was in interest-bearing foreign deposits, which
increased $2.4 billion, or 49%, over 1993, reflecting additional deposits from
investment managers of global portfolios. Of this increase, $1.4 billion
reflects additional transaction accounts resulting from the conversion of
customers' cash balances from subcustodian banks to State Street accounts.
Existing customers maintained higher cash balances because of the investment
climate, and new customers were added. Securities sold under repurchase
agreements increased $793 million, or 19%, due to additional demand by
customers, particularly mutual fund managers.
Other short-term borrowings increased $347 million, while notes payable
declined $253 million from 1993. The average rate of long-term debt declined 146
basis points. This change was due primarily to the repayment of $75 million of
8.50% senior notes in 1993 and the issuance of $100 million of 5.95% senior
notes in September 1993. Noninterest-bearing deposits increased $532 million, or
15%. Growth in these sources of funds contributed importantly to net interest
revenue in 1994. Stockholders' equity increased $149 million, or 14%, from 1993.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
Assets
In 1994, average interest-earning assets increased $3.0 billion, or 18%, as
a result of the additional deposits and other liabilities. Growth occurred
primarily in investment securities and loans. State Street's assets are
primarily comprised of money market assets and investment securities, which are
generally more marketable and have less credit risk than loans.
------------------------------------------------------------------------------------------------------------------------------------
INTEREST-EARNING ASSETS Average Volume Average Rate
(Dollars in millions) 1994 1993 1992 1994 1993 1992
------------------------------------------------------------------------------------------------------------------------------------
Interest-bearing deposits with banks ..................... $ 5,182 $ 5,022 $ 5,102 4.04% 4.01% 5.05%
Securities purchased under resale agreements
and securities borrowed ................................ 3,079 3,255 2,603 4.26 3.14 3.75
Federal funds sold ....................................... 301 413 330 4.29 3.06 3.51
Trading account assets ................................... 480 369 226 5.06 4.21 4.45
Investment securities:
U.S. Treasury and Federal agencies ..................... 3,287 2,077 1,703 5.41 5.75 6.80
State and political subdivisions ....................... 1,088 683 376 5.09 5.54 7.72
Other investments 2,366 1,827 1,444 5.41 5.33 6.09
------- ------- -------
Total investment securities 6,741 4,587 3,523 5.36 5.55 6.60
Loans:
Commercial and financial ............................... 2,304 1,865 1,556 5.18 4.81 5.64
Real estate ............................................ 96 97 114 7.57 6.97 7.11
Consumer ............................................... 43 53 66 7.72 6.81 7.65
Foreign ................................................ 586 282 117 6.41 5.82 6.08
Lease financing ........................................ 372 279 217 5.98 5.61 4.84
------- ------- -------
Total loans .......................................... 3,401 2,576 2,070 5.58 5.14 5.72
------- ------- -------
Total interest-earning assets ........................ $19,184 $16,222 $13,854 4.84 4.43 5.26
======= ======= =======
Interest-bearing deposits with banks are short-term instruments, primarily
Eurocurrency placements, invested with foreign banks in Western Europe and the
Asia/Pacific region. State Street maintains credit relationships with over 500
banks. As of December 31, 1994, the average maturity of the Eurocurrency
placements was 24 days.
Securities purchased under resale agreements are assets that are fully
collateralized by U.S. Treasury and federal agency securities. At year end,
these assets had an average maturity of four days.
The investment securities portfolio increased significantly during 1994 to
$6.7 billion, or 31% of assets, with most of the increase in the
available-for-sale portfolio. State Street classifies its investment securities
into two categories, held-to-maturity and available-for-sale. The
held-to-maturity portfolio is used to invest depositors' funds, provide asset
diversity and stabilize revenue. The available-for-sale portfolio is managed for
total return.
The held-to-maturity portfolio, which is carried at amortized cost, is
comprised of investment-quality, asset-backed securities, U.S. Treasury and
federal agency securities, and bonds and notes of state and political
subdivisions. State Street invests in asset-backed securities, including
collateralized mortgage obligations, for yield enhancement and earnings
stabilization. The collateralized mortgage obligations typically have reasonably
limited variability in the timing of cash flows and provide protection from
undue prepayment and extension risk. Asset-backed securities are highly rated;
96% were AAA as of December 31, 1994. At December 31, 1994, the total $5.2
billion portfolio of held-to-maturity securities had net unrealized depreciation
of $129.0 million, and the duration was 1.2 years.
The available-for-sale portfolio is comprised of securities acquired with
the intent to hold for an indefinite period of time, not necessarily until final
maturity. At December 31, 1994, this $3.2 billion portfolio was comprised of
U.S. Treasury and foreign government bonds. Available-for-sale securities are
carried at market value. At December 31, 1994, the market value of these
securities was $92.5 million lower than cost, and the duration was 1.6 years.
At year-end 1994, loans comprised 15% of State Street's assets, compared
with over 55% for other banking companies of comparable size. One-third of the
loan portfolio supports the short-term needs of financial asset services
customers and securities brokers in conjunction with their trading and
settlement activity. These are generally short-term, usually overnight, and are
structured to have relatively low credit risk.
In 1994, loans increased by $825 million, or 32%. Growth occurred in
commercial loans, foreign loans and lease financing. Commercial loans increased
$439 million, with over half of the growth in loans to securities brokers and
customers of the financial asset services business. Foreign loans increased $304
million, reflecting the conversion of customers' loans from subcustodians and
expanded trade-finance activities. Lease financing increased $93 million.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
Interest Rate Sensitivity Management
The objective of interest rate sensitivity management is to provide
sustainable and stable net interest revenue under various economic environments
and to protect asset values from adverse effects of changes in interest rates.
State Street manages the structure of interest-earning assets and
interest-bearing liabilities to meet revenue goals by adjusting the mix, yields
and maturity, or repricing characteristics, based on changing market conditions.
Interest-rate risk arises from differences in the timing of when assets and
liabilities are repriced. Depending on the degree of difference, changes in
interest rates and yield curves can result in an increase or decrease in net
interest revenue and affect the valuation of assets and liabilities. Under
policies approved by the Board of Directors, State Street seeks to limit
interest-rate risk while using timing differences to manage net interest
revenue.
State Street uses three tools for measuring interest rate risk: simulation,
duration and gap analysis. Simulation models capture the dynamics of
interest-rate movements, differences within a time frame, changes in
relationships among various market rates, certain assumed lagged movements in
money market rates and expected changes in volumes. Results from the simulation
models are evaluated as part of the forecasting, long-range planning and budget
processes to evaluate the potential range of net interest revenue under "most
likely" and alternative interest-rate scenarios.
State Street also measures duration and present value of the assets and
liabilities and evaluates the effect of changes in interest rates on the
economic value of equity.
The third measure of interest-rate risk, as shown below, is the difference
in asset and liability repricing on a cumulative basis within a specified time
frame. State Street monitors the three-month, six-month and one-year cumulative
net interest-earning assets, or gaps.
------------------------------------------------------------------------------------------------------------------------------------
INTEREST SENSITIVITY POSITION AT DECEMBER 31, 1994 Interest Sensitivity Period in Months
-----------------------------------------------------------------------
(Dollars in millions) Balance 0-3 4-6 7-12 13-24 over 24
------------------------------------------------------------------------------------------------------------------------------------
Interest-Earning Assets:
Interest-bearing deposits with banks ................. $ 4,847 $ 4,636 $ 119 $ 92 $ $
Other money market assets <F1> ....................... 2,142 2,136 6
Investment securities:
Held for investment ................................ 5,187 829 695 1,464 1,205 994
Available for sale ................................. 3,320 42 113 2,876 289
Loans ................................................ 2,874 1,890 98 72 35 779
------- ------- ------- ------ ------ ------
Total interest-earning assets ...................... 18,370 9,533 912 1,741 4,116 2,068
------- ------- ------- ------ ------ ------
Interest-Bearing Liabilities:
Domestic deposits .................................... 1,770 1,619 6 4 3 138
Foreign deposits ..................................... 7,921 7,907 9 5
Federal funds purchased and repurchase agreements .... 4,911 4,911
Other interest-bearing liabilities ................... 777 649 128
------- ------- ------- ------ ------ ------
Total interest-bearing liabilities ................. 15,379 15,086 15 9 3 266
------- ------- ------- ------ ------ ------
(5,553) 897 1,732 4,113 1,802
Interest-rate swaps .................................. 146 (146)
------- ------- ------ ------ ------
Interest rate sensitivity position ..................... (5,407) 897 1,732 4,113 1,656
Cumulative interest rate sensitivity position .......... (5,407) (4,510) (2,778) 1,335 2,991
Cumulative gap percentage <F2> ......................... (28)% (23)% (14)% 7% 15%
<FN>
<F1> Includes adjustment to normalize the one-day position.
<F2> Cumulative interest rate sensitivity position as a percent of December
average earning assets.
The table shows State Street's year-end interest rate sensitivity position,
measured by the earlier of repricing date or maturity, for various assets and
liabilities. Non-maturity items, such as asset-backed securities and deposits,
are reported in time periods based on management's evaluations of prepayments
and repricing. Available-for-sale investment securities are reported at maturity
dates, unlike the prior year's report, which included them in 0 - 3 months. The
analysis indicates that State Street was liability sensitive -- that
interest-bearing liabilities are repricing faster than interest-earning assets
-- and that, all other variables remaining the same, net interest revenue would
improve when interest rates are falling and decrease when interest rates are
rising. However, the interest rate sensitivity position is only one of several
factors determining net interest revenue. The level of rates, balance sheet
growth and mix, and rate spreads are also important determinants of net interest
revenue.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
State Street maintains flexibility in its balance sheet to adjust its
interest-rate sensitivity. Since interest-bearing sources of funds are
predominantly short-term, State Street maintains a generally short-term
structure for its interest-earning assets, including money market assets,
investments and loans. Off-balance sheet financial instruments are used as part
of overall asset and liability management. Financial futures and interest-rate
swaps are used modestly to maintain State Street's interest-rate exposure within
policy limits. At December 31, 1994, $146 million of interest-rate swaps reduced
short-term liability sensitivity.
Liquidity
The primary objective of State Street's liquidity management is to ensure
that the Corporation has sufficient funds to replace maturing liabilities,
accommodate the transaction and cash management requirements of its customers,
meet loan commitments, and accommodate other corporate needs. Liquidity is
provided from the ability to access global market sources of funding and gather
additional deposits, and from maturing short-term assets, sale of
available-for-sale securities and payment of loans.
State Street manages its assets and liabilities to maintain a high level of
liquidity. The Corporation has an extensive and diverse funding base inside and
outside the United States. A significant percentage of funding comes from
customers who have other relationships with State Street, particularly those
using custody services worldwide. Deposits are accessed through domestic as well
as international treasury centers, providing a cost-effective,
geographically-diverse source of funding. Significant funding is also provided
from institutional customers' demand for repurchase agreements for their
short-term investment needs. State Street maintains other funding alternatives,
ensuring access to additional sources of funds if needed. Relationships are
maintained with a variety of investors, for a range of financial instruments, in
various markets and time zones.
State Street maintains a large portfolio of liquid assets. At December 31,
1994, the portfolio included $4.8 billion of interest-bearing deposits with
banks and $1.9 billion of securities purchased under resale agreements and
securities borrowed. Of the total $6.7 billion, $4.5 billion mature within one
week, and nearly all mature within six months. Although not relied on for daily
liquidity needs, the $3.2 billion available-for-sale portfolio of marketable
securities provides a significant secondary source of liquidity.
State Street maintains strong liquidity ratios. When liquidity is measured
by the ratio of liquid assets to total assets, State Street ranks among the
highest of U.S. banking companies. Liquid assets consist of cash and due from
banks, interest-bearing deposits with banks, federal funds sold, securities
purchased under resale agreements and securities borrowed, trading account
assets, and investment securities. At December 31, 1994, the Corporation's
liquid assets were 78% of total assets.
State Street's high ratings as a corporation and depository enhance its
liquidity. The Corporation's senior debt is rated AA- by Standard & Poor's, A1
by Moody's Investor Services and AA by IBCA, Inc. Depending upon the rating
service, six or fewer of the largest 100 bank holding companies in the United
States have higher ratings. State Street Bank's long-term certificate of deposit
ratings are AA by Standard & Poor's, Aa2 by Moody's Investor Services and AA+ by
IBCA, Inc. These ratings, as well as strong capital ratios, enhance State
Street's liquidity by making its liabilities attractive to a large number of
investors worldwide.
In August 1993, a shelf registration became effective that allows the
Corporation to issue up to $250 million of debt securities with maturities not
to exceed 10 years. Proceeds from the first tranche of $100 million issued in
1993 were used to redeem existing debt and for general corporate purposes.
In 1994, State Street began a program of issuing up to $200 million of
commercial paper. As of December 31, 1994, $135 million of commercial paper was
outstanding. This is a source of additional funding for the Corporation.
The Consolidated Statements of Cash Flows on page 40 provide additional
information.
Fair Value of Financial Instruments
The short-maturity structure of State Street's assets and liabilities
results in the fair value of its financial instruments equating to or closely
approximating its balance sheet value, with the exception of the
held-to-maturity portfolio, which had depreciation of $129 million as of
December 31, 1994. See Note S, page 54, for a further discussion.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
Capital
State Street maintains strong capital levels to support current operations
and continued growth. State Street continues to generate capital internally at a
high rate. During 1994 and each of the preceding six years, capital was
generated internally through the retention of earnings at a rate of 14% or
higher. On December 31, 1994, stockholders' equity was $1.2 billion, compared
with $597 million on December 31, 1989, a 16% compound annual growth rate.
During 1994, stockholders' equity increased $126 million. The increase was
attributable to $207 million of earnings, $12 million related to the exercise of
stock options and the conversion of debentures, and $6 million from foreign
currency translation gains. These additions were partially offset by $46 million
in common dividends and an after-tax unrealized holding loss of $53 million
recorded on securities classified as available for sale in accordance with
Statement of Financial Accounting Standards No. 115, Accounting for Certain
Investments in Debt and Equity Securities.
The Federal Reserve Board, State Street's principal regulator, has
established risk-based capital guidelines that require minimum ratios of capital
to risk-weighted assets and certain off-balance sheet credit exposures. The
Federal Reserve Board also maintains a leverage ratio guideline that is a
measure of capital to total average balance sheet assets.
--------------------------------------------------------------------------------
REGULATORY CAPITAL AT DECEMBER 31 Minimum
Regulatory
(Dollars in millions) 1994 1993 Guidelines
--------------------------------------------------------------------------------
Risk-based ratios:
Tier 1 capital 12.8% 12.1% 4%
Total capital ............................ 13.4 12.7 8
Leverage ratio ............................. 5.4 5.3 3
Tier 1 capital ............................. $1,248 $1,070
Total capital .............................. 1,302 1,122
Risk-adjusted assets ....................... 9,723 8,842
State Street has developed internal capital-adequacy policies that focus
primary importance on risk exposure rather than asset levels. These policies
emphasize the risk-based guidelines, particularly the Tier 1 risk-based capital
ratio. This emphasis is appropriate to State Street's balance sheet structure,
which has a high degree of liquidity and low credit-risk exposure. At year-end
1994, State Street's Tier 1 capital ratio of 12.8% significantly exceeded the
regulatory guidelines and was among the strongest for large U.S. banking
companies. Each of State Street's three regulatory ratios improved during 1994,
as a result of higher levels of capital, which were partially offset by higher
asset bases.
During 1992, bank regulators adopted five capital categories based on
capital ratios and other factors, which are applicable to banks for certain
regulatory supervisory purposes. These categories range from "well capitalized"
to "critically undercapitalized." The "well capitalized" category requires a
bank to maintain a minimum Tier 1 risk-based ratio of 6%, a minimum total
risk-based capital ratio of 10% and a minimum leverage ratio of 5%. State Street
manages and monitors its capital ratios to assure that they exceed the minimum
standards for "well capitalized." At December 31, 1994, State Street Bank had a
Tier 1 risk-based capital ratio of 12.8%, a total risk-based capital ratio of
13.2% and a leverage ratio of 5.4%.
Dividends and Common Stock
State Street increased the quarterly dividend to stockholders twice during
1994, continuing the pattern of dividend increases that began in 1978. At
year-end 1994, the dividend rate was 15% higher than at year-end 1993. Since
1989, dividends per share have increased at an annual rate of 15%. State
Street's policy is to increase dividends at a rate that is consistent with
long-term earnings growth and that will permit levels of internal capital
generation sufficient to allow for the full development of strategic business
opportunities. The dividend payout ratio was 22% for 1994.
There were 6,028 stockholders of record at year-end 1994.
Narrative description of graphic and image material appearing in paper
format version of Form 10-K.
Page 34 contains line graphs (bar charts) of Stockholders' Equity at
Year-End and Dividends Per Share.
The Data points comprising these graphs appear below in tabular format.
Stockholders' Equity at Year-End
(Millions of Dollars)
Stockholders' Equity
Year at Year-End
1989 .................................... $ 597.2
1990 .................................... 695.1
1991 .................................... 816.6
1992 .................................... 953.1
1993 .................................... 1,105.0
1994 .................................... 1,231.3
Dividends Per Share
(Dollars)
Dividends
Year Per Share
1989 .................................... .300
1990 .................................... .340
1991 .................................... .385
1992 .................................... .445
1993 .................................... .520
1994 .................................... .600
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
------------------------------------------------------------------------------------------------------------------------------------
DIVIDENDS AND COMMON STOCK
MARKET PRICE Market Price
--------------------------------- ---------------------------------
DIVIDENDS END OF Dividends End of
DECLARED LOW HIGH PERIOD Declared Low High Period
------------------------------------------------------------------------------------------------------------------------------------
1994 1993
First ......... $.14 $35 1/8 $39 $36 First ......... $.12 $41 $49 1/8 $44 1/2
Second ........ .15 34 3/8 43 1/8 $38 5/8 Second ........ .13 29 1/4 45 3/4 33 1/8
Third ......... .15 36 41 $36 1/2 Third ......... .13 31 3/4 35 3/4 35 5/8
Fourth ........ .16 27 5/8 37 1/4 $28 5/8 Fourth ........ .14 35 3/8 39 3/4 37 1/2
RISK MANAGEMENT
In providing financial asset services globally, certain inherent risks must
be managed and controlled. In addition to interest-rate risk, these include
counterparty credit risk, operations and settlement risk, and market risk. Risk
management is an integral part of the Corporation's business activities. The
credit and risk-management function is centrally organized with close ties to
the business units in order to identify and manage risks effectively. This
structure allows for corporate risk management across the business areas while
individual line areas remain responsible for risk management in their units.
Continuing a trend of recent years, risk-management resources are increasingly
devoted to financial asset services.
Emphasis in risk management is placed on establishing specific
authorization levels and limits and is an ongoing process by which exposure
levels are reviewed and modified as deemed appropriate to reflect changing
conditions. Counterparties are subject to a rigorous credit approval process
that covers the traditional lending services and global financial asset services
for foreign exchange, credit facilities, placements, credit-enhancement
services, securities lending and securities-clearing facilities. Concentration
is managed in terms of business-risk concentration, including specific industry
lending concentrations and country limits, as well as limits on individual
counterparties.
In managing country risk, State Street considers a broad variety of issues
and risks inherent in doing business outside the United States, including issues
related to credit quality and asset concentration. Consideration is also given
to transfer risk, which arises from the possible inability of a counterparty or
borrower to repay an obligation because of the inconvertibility of its currency.
Operating risk is actively managed in all business units of the
Corporation. Particular emphasis is placed on payment-system risk management,
overdraft monitoring and control, and global securities clearing and settlement.
In addition to specific authorization levels and limits, operating risk is also
controlled through extensive automation, operating procedures and insurance.
Market risk arises from price changes in various markets. Market risk from
foreign exchange and trading activities is monitored and controlled through
established limits on positions and aggregate limits based on estimates of
potential loss of earnings under assumptions about changes in market conditions.
State Street acts as an agent to lend customer-owned securities to
broker/dealers and banks. State Street is not a principal in these transactions
and, therefore, they are not reflected on the Corporation's balance sheet.
Potential exposure to each borrower is reviewed through the Corporation's credit
risk approval and management process. Collateral in the form of cash, other
securities or letters of credit is received to secure the borrower's promise to
return these securities. Securities are marked to market and compared to the
value of collateral daily. Investment of customer cash collateral is managed by
State Street Global Advisors in compliance with approved investment parameters.
Credit Risk
Credit risk results from the possibility that a loss may occur if a
counterparty becomes unable to meet the terms of a contract. State Street has
policies and procedures to monitor and manage carefully all aspects of credit
risk. These include a comprehensive credit-review and approval process that
involves the assignment of risk ratings to all loans and off-balance sheet
credit exposures. The allowance for loan losses is available to cover potential
losses from current credit exposure in the loan portfolio and certain
off-balance sheet commitments.
At December 31, 1994, total non-performing assets were $27.4 million, a
$10.5 million decrease from year-end 1993. Non-performing assets included $23.0
million of non-accrual loans, which was less than 1% of total loans, and $4.4
million of other real estate owned. It is State Street's policy to place a loan
on non-accrual when either principal or interest becomes 60 days past due. In
1994, loans placed on non-accrual status were more than offset by charge-offs,
payments and the return to accrual status of several loans. Loans are returned
to accrual status only when interest and principal payments are brought current
and future payments are considered to be assured. The decline in other real
estate owned resulted from property sales.
FINANCIAL REVIEW
State Street Boston Corporation
In 1994, net charge-offs declined to $7.7 million from $16.3 million in
1993. Net charge-offs as a percentage of average loans were .23%, compared with
.63% for 1993.
The allowance for loan losses is increased by the provision for loan
losses, which is a charge to current income. The appropriate level of the
allowance is determined by a thorough analysis of credit risk. At December 31,
1994, the allowance for loan losses was $58.2 million, or 1.80% of loans. This
compares with an allowance of $54.3 million, or 2.03% of loans, a year ago. This
decline reflects improvement in measures of credit quality, discussed above, and
improvement in the outlook for general economic conditions and its effect on
borrowers. The decline in the allowance for loan losses as a percentage of loans
is also attributable to the growth in low-risk loan exposures to financial asset
services customers.
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CREDIT EXPERIENCE
(Dollars in millions) 1994 1993 1992 1991 1990 1989
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Provision for loan losses ....................................... $11.6 $11.3 $12.2 $60.0 $45.7 $19.4
Charge-offs ..................................................... 10.5 18.5 23.5 47.8 48.1 23.7
Recoveries ...................................................... 2.8 2.2 3.4 2.7 3.1 4.6
----- ----- ----- ----- ----- -----
Net loan charge-offs ........................................ 7.7 16.3 20.1 45.1 45.0 19.1
Allowance of subsidiary purchased ............................... 1.4
Allowance for loan losses, year end ............................. 58.2 54.3 57.9 65.9 51.0 50.3
Net loan charge-offs by loan type:
Commercial and financial ...................................... $ 8.4 $14.0 $ 8.4 $32.2 $12.0 $ 5.2
Real estate ................................................... (.2) 1.3 9.8 10.9 9.3 1.5
Consumer ...................................................... (.1) .9 .9 1.6 22.4 9.9
Foreign ....................................................... (.4) .1 1.0 .4 1.3 2.5
----- ----- ----- ----- ----- -----
Total net charge-offs ....................................... $ 7.7 $16.3 $20.1 $45.1 $45.0 $19.1
===== ===== ===== ===== ===== =====
Non-performing loans:
Commercial and financial ...................................... $20.3 $25.0 $37.2 $30.6 $31.5 $ 5.5
Real estate ................................................... 2.6 .5 .9 7.9 22.7 13.5
Other ......................................................... .1 1.3 2.2 2.4 2.3 2.8
----- ----- ----- ----- ----- -----
Total non-performing loans .................................. $23.0 $26.8 $40.3 $40.9 $56.5 $21.8
===== ===== ===== ===== ===== =====
Other real estate owned ......................................... $ 4.4 $11.1 $12.5 $15.4 $15.5
Ratios:
Allowance to ending loans ..................................... 1.80% 2.03% 2.89% 3.46% 2.42% 2.04%
Net charge-offs to average loans .............................. .23 .63 .97 2.14 1.72 .77
Non-performing loans to total loans ........................... .71 1.00 2.01 2.15 2.68 .88
Statement of Financial Accounting Standards No. 114, "Accounting by
Creditors for Impairment of a Loan," is effective for fiscal years beginning
after December 15, 1994. This statement addresses how creditors should establish
allowances for credit losses on individual loans determined to be impaired.
State Street will adopt this new statement in 1995, and it is not expected to
have a material impact.
Foreign Exchange and Derivative Financial Instruments
State Street uses foreign exchange and a variety of financial derivative
instruments to support customers' needs, to conduct trading activities, and to
manage interest rate and currency risk. These activities either generate trading
revenue or enhance the stability of net interest revenue. In addition, State
Street provides services related to derivative instruments in its role as both a
manager and servicer of financial assets.
State Street's customers use derivatives to manage the financial risks
associated with their investment goals and business activities. With the growth
of cross-border investing, State Street's customers have an increasing need for
foreign exchange forward contracts to protect the domestic value of an
international investment and to manage the currency risk in an international
investment portfolio. As an active participant in the foreign exchange markets,
State Street provides foreign exchange forward contracts and over-the-counter
options in support of these customer needs.
As a part of trading activities, State Street also assumes market positions
in both the foreign exchange and interest-rate markets using financial
derivatives -- primarily forward foreign exchange contracts, foreign exchange
and interest-rate options, and interest-rate swaps.
State Street's positions are based on market expectations and customers'
needs. As of December 31, 1994, the notional amount of these instruments was
$43.9 billion, of which $43.1 billion was foreign exchange forward contracts.
FINANCIAL REVIEW
STATE STREET BOSTON CORPORATION
State Street uses various derivatives to minimize the interest-rate and
foreign exchange risk associated with balance sheet and global business
activities. As of year-end 1994, the notional amount of these derivatives was
$229 million.
Trading activities involving both foreign exchange and interest-rate
derivatives are managed using earnings at risk measures and trading limits as
established by risk-management policies. Interest-rate and foreign exchange
derivatives that are used as part of the asset- and liability-management process
are subjected to the same credit and interest-rate risk processes for financial
instruments carried on the balance sheet.
As a manager of financial assets for others, State Street uses derivative
financial instruments to hedge against market risk, adjust portfolio duration
and enable efficient portfolio construction. These activities are undertaken in
accordance with investment guidelines supplied by, or disclosed to, State
Street's customers.
As a servicer of financial assets, State Street acts as trustee, custodian
and/or administrator for its customers' investment funds, certain of which may
use derivative instruments in their investment strategies. These activities are
part of the normal responsibilities of State Street as a service provider and
are discharged in accordance with customer service contracts. Further discussion
of derivatives is included in Note R, page 52.
ACQUISITION OF INVESTORS FIDUCIARY TRUST COMPANY
On January 31, 1995, State Street acquired Investors Fiduciary Trust
Company (IFTC), a Kansas City, Missouri-based servicer of mutual funds with
approximately $115 billion of assets under custody. This acquisition
strengthened State Street's leadership position in servicing mutual funds. IFTC
brings additional customers and different systems solutions to servicing this
market. State Street is leveraging its full range of products to this additional
customer base, and the combined entity will benefit from the consolidation of
custody operations.
This acquisition was accomplished by the issuance of 5,972,222 shares.
State Street will account for this transaction as a pooling of interests, and
prior-period financial statements will be restated. One-time transaction costs
of $.03 per share will be recorded in the first quarter. No earnings dilution is
expected for full-year 1995. See Note B, page 43, for a summary of the unaudited
pro forma financial information.