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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1997
[ ] 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
Boston, Massachusetts 02110
(Address of principal executive office) (Zip Code)
617-786-3000
(Registrant's telephone number, including area code)
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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 October 31, 1997 was 160,815,370.
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STATE STREET CORPORATION
Table of Contents
Page
PART I. FINANCIAL INFORMATION .........
- ------------------------------
Item 1. Financial Statements
Consolidated Statements of Income................................... 1 - 2
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 - 13
Independent Accountants' Review Report.............................. 14
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations.............. 15 - 23
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K .......................... 23
Signatures.......................................................... 24
Exhibits ........................................................... 25 - 29
PART I. ITEM 1.
FINANCIAL STATEMENTS
CONSOLIDATED STATEMENT OF INCOME - STATE STREET CORPORATION (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------
(Dollars in millions, except per share data) Three months ended September 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------
FEE REVENUE
Fiduciary compensation................................................................. $ 324 $ 259
Foreign exchange trading............................................................... 74 28
Servicing and processing .............................................................. 37 31
Other ................................................................................. 7 6
--------- ---------
Total fee revenue................................................................ 442 324
NET INTEREST REVENUE
Interest revenue....................................................................... 452 369
Interest expense....................................................................... 288 230
--------- ---------
Net interest revenue............................................................. 164 139
Provision for loan losses.............................................................. 5 2
--------- ---------
Net interest revenue after provision for loan losses............................. 159 137
--------- ---------
TOTAL REVENUE.................................................................... 601 461
OPERATING EXPENSES
Salaries and employee benefits......................................................... 250 194
Transaction processing services........................................................ 48 41
Equipment.............................................................................. 42 35
Occupancy.............................................................................. 30 25
Other ................................................................................. 81 55
--------- ---------
Total operating expenses......................................................... 451 350
--------- ---------
Income before income taxes....................................................... 150 111
Income taxes........................................................................... 49 37
--------- ---------
NET INCOME....................................................................... $ 101 $ 74
========= =========
EARNINGS PER SHARE
Primary.......................................................................... $ .62 $ .45
Fully diluted.................................................................... .62 .45
AVERAGE SHARES OUTSTANDING (in millions)
Primary.......................................................................... 162.8 162.0
Fully diluted.................................................................... 164.1 163.3
CASH DIVIDENDS DECLARED PER SHARE...................................................... $ .11 $ .095
- ------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
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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) Nine months ended September 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------
FEE REVENUE
Fiduciary compensation................................................................. $ 918 $ 749
Foreign exchange trading............................................................... 170 91
Servicing and processing .............................................................. 116 88
Other ................................................................................. 16 26
-------- ---------
Total fee revenue................................................................ 1,220 954
NET INTEREST REVENUE
Interest revenue....................................................................... 1,275 1,057
Interest expense....................................................................... 807 653
-------- ---------
Net interest revenue............................................................. 468 404
Provision for loan losses.............................................................. 11 6
-------- ---------
Net interest revenue after provision for loan losses............................. 457 398
-------- ---------
TOTAL REVENUE.................................................................... 1,677 1,352
OPERATING EXPENSES
Salaries and employee benefits......................................................... 704 564
Transaction processing services........................................................ 138 120
Equipment.............................................................................. 118 102
Occupancy.............................................................................. 87 75
Other ................................................................................. 213 162
-------- ---------
Total operating expenses......................................................... 1,260 1,023
-------- ---------
Income before income taxes....................................................... 417 329
Income taxes........................................................................... 137 114
-------- ---------
NET INCOME....................................................................... $ 280 $ 215
======== =========
EARNINGS PER SHARE
Primary.......................................................................... $ 1.72 $ 1.31
Fully diluted.................................................................... 1.71 1.31
AVERAGE SHARES OUTSTANDING (in millions)
Primary.......................................................................... 162.6 163.2
Fully diluted.................................................................... 163.8 164.6
CASH DIVIDENDS DECLARED PER SHARE...................................................... $ .32 $ .28
- ------------------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
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PART I. ITEM 1.
- -------------------------------------------------------------------------------
FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATED STATEMENT OF CONDITION - STATE STREET CORPORATION
- --------------------------------------------------------------------------------------------------------------------------
(UNAUDITED)
SEPTEMBER 30, December 31,
(Dollars in millions) 1997 1996
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ASSETS
Cash and due from banks............................................................ $ 1,510 $ 1,623
Interest-bearing deposits with banks............................................... 8,826 7,565
Securities purchased under resale agreements and securities borrowed............... 4,694 4,613
Federal funds sold................................................................. 1,644 1,155
Trading account assets............................................................. 106 255
Investment securities (principally available for sale) ............................ 10,462 9,387
Loans (less allowance of $79 and $73).............................................. 5,277 4,640
Premises and equipment............................................................. 478 468
Customers' acceptance liability.................................................... 83 35
Accrued income receivable.......................................................... 550 442
Other assets....................................................................... 1,774 1,341
-------- --------
TOTAL ASSETS................................................................. $ 35,404 $ 31,524
======== ========
LIABILITIES
Deposits:
Noninterest-bearing................................................................ $ 6,040 $ 6,395
Interest-bearing:
Domestic........................................................................ 2,132 2,071
Non-U.S......................................................................... 13,939 11,053
-------- --------
Total deposits............................................................... 22,111 19,519
Securities sold under repurchase agreements........................................ 7,550 7,387
Federal funds purchased ........................................................... 103 117
Other short-term borrowings........................................................ 671 649
Notes payable...................................................................... 87 86
Acceptances outstanding............................................................ 86 35
Accrued taxes and other expenses................................................... 805 657
Other liabilities.................................................................. 1,300 823
Long-term debt..................................................................... 775 476
-------- --------
TOTAL LIABILITIES............................................................ 33,488 29,749
STOCKHOLDERS' EQUITY
Preferred stock, no par: authorized 3,500,000; issued none......................... - -
Common stock, $1 par: authorized 250,000,000;
issued 167,500,000 and 83,615,000............................................ 167 84
Surplus............................................................................ 97 105
Retained earnings.................................................................. 1,833 1,694
Net unrealized gain on available-for-sale securities............................... 18 12
Treasury stock, at cost (6,692,000 and 2,461,000 shares)........................... (199) (120)
-------- --------
TOTAL STOCKHOLDERS' EQUITY................................................... 1,916 1,775
-------- --------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................... $ 35,404 $ 31,524
======== ========
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The accompanying notes are an integral part of these financial statements.
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PART I. ITEM 1.
- -------------------------------------------------------------------------------
FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATED STATEMENT OF CASH FLOWS - STATE STREET CORPORATION (UNAUDITED)
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(Dollars in millions) Nine Months Ended Spetember 30, 1997 1996
- ------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income ................................................................................ $ 280 $ 215
Noncash charges for depreciation, amortization, provision for loan losses and
deferred income taxes ................................................................... 171 178
-------- --------
Net income adjusted for noncash charges.............................................. 451 393
Adjustments to reconcile to net cash (used) provided by operating activities:
Securities gains, net................................................................ (1) (5)
Net change in:
Trading account assets.......................................................... 149 304
Other, net...................................................................... (11) (106)
-------- --------
NET CASH (USED) PROVIDED BY OPERATING ACTIVITIES........................... 588 586
-------- --------
INVESTING ACTIVITIES
Payments for purchases of:
Available-for-sale securities........................................................ (3,999) (5,462)
Held-to-maturity securities.......................................................... (661) (756)
Lease financing assets............................................................... (882) (378)
Premises and equipment............................................................... (84) (70)
Proceeds from:
Maturities of available-for-sale securities.......................................... 2,675 2,700
Maturities of held-to-maturity securities............................................ 640 728
Sales of available-for-sale securities............................................... 277 414
Principal collected from lease financing............................................. 49 48
Net (payments for):
Interest-bearing deposits with banks................................................. (1,261) (231)
Federal funds sold, resale agreements and securities borrowed........................ (569) (53)
Loans................................................................................ (416) (152)
-------- --------
NET CASH USED BY INVESTING ACTIVITIES...................................... (4,231) (3,212)
-------- --------
FINANCING ACTIVITIES
Proceeds from issuance of:
Long-term debt....................................................................... 300 150
Nonrecourse debt for lease financing................................................. 687 281
Notes payable........................................................................ 1 177
Treasury stock....................................................................... 8 7
Payments for:
Maturity of notes payable............................................................ - (257)
Nonrecourse debt for lease financing................................................. (78) (60)
Long-term debt....................................................................... (1) (1)
Cash dividends....................................................................... (51) (45)
Purchase of common stock............................................................. (99) (124)
Net proceeds from:
Deposits............................................................................. 2,592 729
Short-term borrowings................................................................ 171 1,784
-------- --------
NET CASH PROVIDED BY FINANCING ACTIVITIES.................................. 3,530 2,641
-------- --------
NET (DECREASE) INCREASE.................................................... (113) 15
Cash and due from banks at beginning of period............................................. 1,623 1,422
-------- --------
CASH AND DUE FROM BANKS AT END OF PERIOD................................... $ 1,510 $ 1,437
======== ========
SUPPLEMENTAL DISCLOSURE
Interest paid........................................................................ $ 810 $ 643
Income taxes paid.................................................................... 61 69
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The accompanying notes are integral part of these financial statements.
PART I. ITEM I.
FINANCIAL STATEMENTS (CONTINUED)
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY - STATE STREET CORPORATION (UNAUDITED)
- -------------------------------------------------------------------------------------------------------------------------
(Dollars in millions, except per share data) Nine months ended September 30, 1997 1996
- -------------------------------------------------------------------------------------------------------------------------
COMMON STOCK
Balance at beginning of period.............................................................. $ 84 $ 83
Stock dividend, two-for-one split........................................................... 83 -
------- -------
Balance at end of period.............................................................. 167 83
------- -------
SURPLUS
Balance at beginning of period.............................................................. 105 40
Treasury stock issued....................................................................... (8) (4)
------- -------
Balance at end of period.............................................................. 97 36
------- -------
RETAINED EARNINGS
Balance at beginning of period.............................................................. 1,694 1,465
Net Income.................................................................................. 280 215
Stock dividend, two-for-one split........................................................... (83) -
Cash dividends declared ($.32 and $.28 per share)........................................... (51) (45)
Currency translation........................................................................ (7) (2)
------- -------
Balance at end of period.............................................................. 1,833 1,633
------- -------
NET UNREALIZED GAIN (LOSS) ON AVAILABLE-FOR-SALE SECURITIES
Balance at beginning of period.............................................................. 12 13
Changes in unrealized gain (loss)........................................................... 6 (21)
------- -------
Balance at end of period.............................................................. 18 (8)
------- -------
TREASURY STOCK, AT COST
Balance at beginning of period.............................................................. (120) (13)
Common stock acquired (2,559,200 and 5,177,800 shares)..................................... (99) (123)
Treasury stock issued (788,276 and 680,950 shares).......................................... 20 14
------- -------
Balance at end of period.............................................................. (199) (122)
------- -------
TOTAL STOCKHOLDERS' EQUITY............................................................ $ 1,916 $ 1,622
======= =======
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The accompanying notes are integral part of these financial statements.
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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"), formerly named State Street Boston
Corporation, is a financial services corporation and provides banking, trust,
investment management, global custody, administration and securities processing
services to both U.S. and non-U.S. customers. State Street reports three lines
of business: Financial Asset Services, Investment Management, and Commercial
Lending. Financial Asset Services provides global custody, accounting,
administration, foreign exchange, treasury, cash management, transaction
settlement and clearing, securities lending, and other services for investors
with large pools of investment assets worldwide such as mutual funds and pension
plans; and corporate trusteeship. Investment Management is comprised of the
business components that manage financial assets worldwide, for both
institutions and individuals, and provides related participant recordkeeping for
defined contribution plans. Commercial Lending activities include loans, credit
facilities and other banking services for regional middle-market companies, for
nationwide companies in selected industries and for broker/dealers. Other credit
facilities include asset-based finance, leasing and international trade finance.
The consolidated financial statements include the accounts of State Street and
its subsidiaries, principally State Street Bank and Trust Company ("State Street
Bank" or "the 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 by the equity method. Certain previously reported
amounts have been reclassified to conform to the current method of presentation.
For the Consolidated Statement of Cash Flows, State Street has defined cash
equivalents as those amounts included in the Statement of Condition caption,
"Cash and due from banks." For the nine months ended September 30, 1997 and
1996, long-term debt converted into common stock was $185,000 and $30,000,
respectively.
In June 1996, Statement of Financial Accounting Standard ("SFAS") No. 125,
"Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities", was issued. This statement provides standards for transfers and
servicing of financial assets and extinguishing liabilities. Certain provisions
of this statement are effective for fiscal years beginning after December 31,
1996. State Street adopted the required provisions of this new statement in
1997, and the provisions have not had a material impact on the financial
statements.
In February 1997, SFAS No. 128, "Earnings per Share", was issued and is required
to be adopted as of December 31, 1997. This statement requires a change in the
method currently used to compute earnings per share and requires a restatement
of all prior period earnings per share amounts. Under SFAS No. 128, primary
earnings per share is replaced by basic earnings per share. Basic earnings per
share excludes the dilutive effect of stock options from the calculation.
Computing earnings per share in accordance with the provisions of this statement
for the three months ended September 30, 1997 and 1996 would have resulted in
basic earnings per share of $.63 and $.46, respectively, and diluted earnings
per share of $.62 and $.45, respectively. Computing earnings per share in
accordance with the provisions of this statement for the nine months ended
September 30, 1997 and 1996 would have resulted in basic earnings per share of
$1.74 and $1.33, respectively, and diluted earnings per share of $1.71 and
$1.31, respectively.
In February 1997, SFAS No. 129, "Disclosure of Information about Capital
Structure", was issued, which will be effective for 1997 year-end financial
statements. State Street's current disclosures comply with the provisions of
this statement.
In June 1997, SFAS No. 130, "Reporting Comprehensive Income", was issued. This
statement establishes standards and definitions for reporting a comprehensive
income number and its components and requires this disclosure be added to the
financial statements. This statement is effective for fiscal years beginning
after December 31, 1997. State Street will adopt SFAS No. 130 for the year
beginning January 1, 1998.
In June 1997, SFAS No. 131, "Disclosures about Segments of an Enterprise and
Related Information", was issued. This statement establishes standards for
reporting information about operating segments in annual and interim financial
statements. This statement is effective for annual periods beginning after
December 15, 1997, and for interim periods beginning after December 15, 1998.
Management does not believe that the application of the standard will result in
material changes to line of business disclosures. State Street will adopt SFAS
No. 131 for the year ending December 31, 1998, and for interim periods beginning
January 1, 1998.
The Securities and Exchange Commission recently adopted new rules that require
more detailed disclosure of accounting policies for derivative financial
instruments and will require certain information about market risk exposures.
The following accounting policy disclosures supplement the disclosures included
in Note A of the Notes to the Consolidated Financial Statements included in the
1996 Annual Report on Form 10-K:
State Street uses three methods to account for derivative financial instruments:
the deferral method, the accrual method, and the mark-to-market method.
Interest rate futures, caps, and options that are used for balance sheet
management purposes are accounted for under the deferral method. Under the
deferral method, the basis of the contract is capitalized and gains or losses
are deferred and amortized over the life of the hedged asset or liability as an
adjustment to interest revenue or interest expense. In order to qualify for
deferral accounting, interest rate contracts must meet the following criteria:
(a) the item being hedged must expose State Street to price or interest rate
risk, (b) it is probable that the contract will offset the price or interest
rate risk associated with the hedged item, and (c) the contract must be
designated as a hedge of the item. State Street periodically evaluates its
positions against these criteria. To the extent that the criteria are not met,
the contract is terminated or the underlying asset or liability is terminated,
the contracts are marked-to-market and the resulting gain or loss is recognized
either immediately or over the life of the underlying items, dependent upon the
circumstances.
Interest rate swaps that are entered into as part of interest rate management
for State Street's own account are accounted for using the accrual method. Under
accrual accounting, interest payments receivable and payable under the terms of
the interest rate swap are accrued over the period to which the payment relates.
The interest payments accrued on the swap and any swap fees paid at the
inception of the interest rate swap are treated as an adjustment of interest
income or expense related to the underlying assets or liabilities. Changes in
the underlying market value of the remaining swap payments are not recognized.
Those contracts entered into for trading purposes and those contracts that do
not meet the criteria for deferral or accrual accounting are carried at fair
value. Under the mark-to-market method of accounting, these contracts are
recorded in other assets or other liabilities and are valued periodically. The
resulting gain or loss is recorded in fee revenue. State Street uses the
mark-to-market method to account for the following: foreign exchange trading
contracts, including certain forward, swap and spot contracts and both purchased
and written options and options on futures; foreign exchange balance sheet
management contracts, including certain forward contracts; and interest rate
trading contracts, including certain swaps, written and purchased options and
caps, futures and written and purchased options on futures.
In the opinion of management, all adjustments consisting of normal recurring
accruals, which are necessary for a fair presentation of the financial position
of State Street and subsidiaries at September 30, 1997 and December 31, 1996,
and its cash flows and consolidated results of its operations for the three
months and nine months ended September 30, 1997 and 1996, have been made. These
statements should be read in conjunction with the financial statements, notes
and other information included in State Street's latest annual report on Form
10-K.
Note B - 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:
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SEPTEMBER 30, 1997 December 31, 1996
AMORTIZED UNREALIZED FAIR Amortized Unrealized Fair
(Dollars in millions) COST GAINS LOSSES VALUE Cost Gains Losses Value
- -------------------------------------------------------------------------------------------- ------------------------------------
Available for sale (at fair value):
U.S. Treasury and Federal agencies............... $ 5,020 $ 19 $ 3 $ 5,036 $ 4,630 $ 18 $ 5 $ 4,643
State and political subdivisions................. 1,671 13 6 1,678 1,557 10 8 1,559
Asset-backed securities.......................... 1,540 3 1 1,542 1,198 3 1 1,200
Collateralized mortgage obligations.............. 603 1 6 598 638 1 8 631
Other investments................................ 718 10 1 727 485 12 2 495
------- ---- ---- ------- ------- ---- ----- -------
Total................................................ $ 9,552 $ 46 $ 17 $ 9,581 $ 8,508 $ 44 $ 24 $ 8,528
======= ==== ==== ======= ======= ==== ===== =======
Held to maturity (at amortized cost):
U.S. Treasury and Federal agencies............... $ 881 $ 1 $ - $ 882 $ 859 $ 2 $ 2 $ 859
======= ==== ==== ======= ======= ==== ===== =======
- ------------------------------------------------------------------------------------------------------------------------------------
During the nine months ended September 30, 1997, there were gains of $1.3
million and losses of less than a million realized on sales of
available-for-sale securities of $277 million. During the nine months ended
September 30, 1996, gains of $7 million and losses of $2 million were realized
on sales of available-for-sale securities of $414 million.
Note C - Allowance for Loan Losses
The allowance for loan losses is maintained at a level believed adequate by
management to absorb estimated probable credit losses. Management's periodic
evaluation of the adequacy of the allowance for loan losses is based on State
Street's past loan loss experience, known and inherent risks in the portfolio,
current economic conditions and other relevant factors such as adverse
situations that may affect the borrowers' ability to repay, timing of future
payments, estimated value of any underlying collateral, and the performance of
individual credits in relation to contract terms. The provision for loan losses
charged to earnings is based upon management's judgment of the amount necessary
to maintain the allowance at a level adequate to absorb probable losses.
Changes in the allowance for loan losses were as follows:
- ----------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1997 1996 1997 1996
- ----------------------------------------------------------------------------------------------
Balance at beginning of period...... $ 74 $ 70 $ 73 $ 63
Provision for loan losses........... 5 2 11 6
Loan charge-offs.................... (1) (1) (7) (4)
Recoveries.......................... 1 2 6
---- ---- ---- ----
Balance at end of period...... $ 79 $ 71 $ 79 $ 71
==== ==== ==== ====
- ----------------------------------------------------------------------------------------------
Note D - Long-Term Debt
On March 11, 1997, State Street completed the sale of $300 million of 8.035%
Capital Securities, Series A (the "Capital Securities"), due 2027. The Capital
Securities are guaranteed by State Street and were issued by State Street
Institutional Capital B (the "Trust"), a newly created subsidiary business trust
of State Street. In connection with the sale of the Capital Securities, State
Street issued and sold to the Trust $309 million of its 8.035% Junior
Subordinated Deferrable Interest Debentures, Series B. At September 30, 1997, a
total of $500 million of capital securities is included in long-term debt.
Note E - Stockholders' Equity
The authorized number of common shares increased from 112 million at December
31, 1996 to 250 million at September 30, 1997. On May 28, 1997, State Street
distributed a two-for-one stock split in the form of a 100% stock dividend to
shareholders of record on April 30, 1997. The par value of these additional
shares was capitalized by a transfer from retained earnings to common stock. Per
share data has been restated for the stock split.
Note F - Regulatory Matters
The regulatory capital amounts and ratios were the following at September 30,
1997 and December 31, 1996:
- ----------------------------------------------------------------------------------------------------------------------------------
Regulatory Guidelines
------------------------------
Well State Street State Street Bank
--------------------------- -------------------------
(Dollars in millions) Minimum Capitalized 1997 1996 1997 1996
- ----------------------------------------------------------------------------------------------------------------------------------
Risk-based ratios:
Tier 1 capital................... 4% 6% 13.3% 13.4 % 11.6 % 12.1 %
Total capital.................... 8 10 13.4 13.6 11.9 11.9
Leverage ratio....................... 3 5 6.1 5.9 5.3 5.3
Tier 1 capital....................... $ 2,176 $ 1,818 $ 1,883 $ 1,632
Total capital........................ 2,193 1,847 1,928 1,611
Risk-based assets:
On-balance sheet................. $ 12,432 $ 10,311 $ 12,293 $ 10,234
Off-balance sheet................ 3,944 3,249 3,944 3,249
-------- -------- -------- --------
Total risk-based assets...... $ 16,376 $ 13,560 $ 16,237 $ 13,483
======== ======== ======== ========
- ----------------------------------------------------------------------------------------------------------------------------------
The regulatory designation of "well capitalized" under the prompt corrective
action regulations is not applicable to bank holding companies (State Street is
a bank holding company). However, Regulation Y defines "well capitalized" bank
holding companies for the purpose of determining eligibility for a streamlined
review process for acquisition proposals. For such proposals, "well capitalized"
requires a minimum tier 1 risk-based capital ratio of 6% and a minimum total
risk-based capital ratio of 10%.
Note G - Net Interest Revenue
Net interest revenue consisted of the following:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1997 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
INTEREST REVENUE
Deposits with banks....................................................... $ 112 $ 83 $ 297 $ 255
Investment securities:
U.S Treasury and Federal agencies..................................... 92 73 270 184
State and political subdivisions (exempt from Federal tax)............. 19 18 58 50
Other investments...................................................... 42 34 118 92
Loans 90 71 248 204
Securities purchased under resale agreements, securities borrowed
and Federal funds sold................................................. 95 85 278 259
Trading account assets.................................................... 2 5 6 13
----- ----- ------ ------
Total interest revenue.............................................. 452 369 1,275 1,057
----- ----- ------ ------
INTEREST EXPENSE
Deposits.................................................................. 135 105 363 320
Other borrowings.......................................................... 138 120 404 324
Long-term debt............................................................ 15 5 40 9
----- ----- ------ ------
Total interest expense.............................................. 288 230 807 653
----- ----- ------ ------
Net interest revenue................................................ $ 164 $ 139 $ 468 $ 404
===== ===== ====== ======
- ------------------------------------------------------------------------------------------------------------------------------------
Note H - Operating Expenses - Other
The other category of operating expenses consisted of the following:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1997 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Professional services.................................................... $ 24 $ 15 $ 61 $ 43
Advertising and sales promotion.......................................... 13 8 37 26
Postage, forms and supplies.............................................. 6 7 20 20
Telecommunications....................................................... 7 5 20 17
Other 31 20 75 56
---- ---- ----- -----
Total operating expenses - other................................... $ 81 $ 55 $ 213 $ 162
==== ==== ===== =====
- ------------------------------------------------------------------------------------------------------------------------------------
Note I - Income Taxes
The provision for income taxes included in the Consolidated Statement of Income
is comprised of the following:
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
(Dollars in millions) 1997 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Current................................................................ $ 34 $ 18 $ 58 $ 40
Deferred............................................................... 15 19 79 74
---- ---- ----- -----
Total provision.................................................. $ 49 $ 37 $ 137 $ 114
==== ==== ===== =====
- ------------------------------------------------------------------------------------------------------------------------------------
Taxes were $49 million and $137 million for the three months and nine months
ended September 30, 1997, respectively, up from $37 million and $114 million,
respectively, a year ago. The effective tax rates for the three months and nine
months ended September 30, 1997 were 32.5% and 32.9%, respectively, down from
33.6% and 34.8% in the three months and nine months ended September 30, 1996,
respectively.
Note J - Commitments and Contingent Liabilities
State Street provides banking, trust, investment management, global custody,
accounting, administration and securities processing services to both U.S. and
non-U.S customers. Assets under custody and assets under management, held or
managed by State Street in a fiduciary or custodial capacity, 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 in
providing these services and considers the results in preparing its financial
statements. In the opinion of management, there are no contingent liabilities at
September 30, 1997 that 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 can be successfully defended or resolved without a material
adverse effect on State Street's financial position or results of operations.
Note K - Off-Balance Sheet Financial Instruments, Including Derivatives
State Street uses derivative financial instruments in trading and balance sheet
management activities. State Street uses various off-balance sheet financial
instruments, including derivatives, to satisfy the financing and risk management
needs of customers, to manage its interest rate and currency risk, and to
conduct trading activities for its own and its customers' account. In general
terms, derivative instruments are contracts or agreements whose value can be
derived from interest rates, currency exchange rates and/or other financial
indices. Derivative instruments include forwards, futures, swaps, options and
other instruments with similar characteristics. The use of these instruments
generate 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
significant derivative financial instruments held or issued by State Street as
of:
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, December 31,
(Dollars in millions) 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Trading:
Interest rate contracts:
Swap agreements.......................................................................... $ 1,111 $ 880
Options and caps purchased............................................................... 43 25
Options and caps written................................................................. 194 116
Futures - short position................................................................. 955 1,252
Options on futures purchased............................................................. 162 430
Options on futures written............................................................... - 28
Foreign exchange contracts:
Forward, swap and spot................................................................... 110,579 62,109
Options purchased........................................................................ 185 206
Options written.......................................................................... 121 60
Options on futures purchased............................................................. - 330
Balance Sheet Management :
Interest rate contracts:
Swap agreements..................................................................... 447 296
Options and caps purchased.......................................................... 50 50
Foreign exchange contracts:
Forward, swap and spot.............................................................. 88 65
- ------------------------------------------------------------------------------------------------------------------------------------
The following table represents the fair value of financial instruments held or
issued by State Street for trading purposes as of:
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 1997 December 31, 1996
------------------------- ------------------------
AVERAGE Average
FAIR FAIR Fair Fair
(Dollars in millions) VALUE VALUE Value Value
- ------------------------------------------------------------------------------------------------------------------------------------
Foreign exchange contracts:
Contracts in a receivable position..................................... $ 812 $ 1,153 $ 620 $ 615
Contracts in a payable position........................................ 826 1,201 634 617
Other financial instrument contracts:
Contracts in a receivable position..................................... 9 8 6 6
Contracts in a payable position........................................ 6 5 4 4
- ------------------------------------------------------------------------------------------------------------------------------------
The preceding amounts have been reduced by offsetting balances with the
counterparty where a master netting agreement exists. Contracts in a receivable
position are shown in other assets on the balance sheet and contracts in a
payable position are shown in other liabilities.
Credit-related financial instruments include commitments to extend credit,
standby letters of credit, letters of credit and indemnified securities lent.
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 as of:
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, December 31,
(Dollars in millions) 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Indemnified securities on loan................................................................... $ 59,161 $ 41,518
Loan commitments................................................................................. 7,256 4,974
Standby letters of credit........................................................................ 1,965 1,777
Letters of credit................................................................................ 197 160
- ------------------------------------------------------------------------------------------------------------------------------------
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 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 $60.9 billion and $42.8
billion for indemnified securities on loan at September 30, 1997 and December
31, 1996, respectively.
Loan and letter-of-credit commitments are subject to the same credit policies
and reviews as loans on the balance sheet. Collateral, both the amount and
nature, is obtained based upon management's assessment of the credit risk.
Approximately 70% of the loan commitments expire in one year or less from the
date of issue. Since many of the extensions of credit are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
Independent Accountants' Review Report
The Stockholders and Board of Directors
State Street Corporation
We have reviewed the accompanying consolidated statement of condition of State
Street Corporation as of September 30, 1997, and the related consolidated
statements of income for the three-month and nine-month periods ended September
30, 1997 and 1996, and the consolidated statements of cash flows and changes in
stockholders' equity for the nine-month periods ended September 30, 1997 and
1996. These financial statements are the responsibility of State Street'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 generally accepted auditing standards, 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 generally accepted accounting principles.
We have previously audited, in accordance with generally accepted auditing
standards, the consolidated statement of condition of State Street Corporation
as of December 31, 1996 (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 14,
1997, we expressed an unqualified opinion on those consolidated financial
statements.
ERNST & YOUNG LLP
Boston, Massachusetts
October 14, 1997
- --------------------------------------------------------------------------------
PART I. ITEM 2
- --------------------------------------------------------------------------------
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Forward-Looking Statements
This discussion contains statements that are "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.
Such forward-looking statements involve certain risks and uncertainties,
including those relating to the U.S. and global financial markets, the level of
cross-border investing by customers, and the level of investments in mutual
funds, and, in each case, actual results may differ materially from such
forward-looking information. Certain factors that may cause actual results to
differ from such forward-looking statements are included in the section below
entitled "Financial Goals and Factors That May Affect Them", as well as in the
corporation's 1996 Annual Report, including under the sections entitled
"Financial Goals and Factors That May Affect Them", "Interest Rate Sensitivity
Management", and "Risk Management"; in the corporation's Form 10-K for the year
ended December 31, 1996 filed with the Securities and Exchange Commission; and
in other periodic reports filed by the corporation with the Securities and
Exchange Commission, and you are urged to consider such factors. The corporation
assumes no obligation for updating any such forward-looking information.
Summary
Earnings per share were $.62 on a fully diluted basis, an increase of 38% from
$.45 in the third quarter of 1996. Revenue grew 30%, from $470 million to $612
million. Net income was $101 million, up from $74 million a year ago. Return on
stockholders' equity was 21.4%. For the nine months ended September 30, earnings
per share increased 31% over a year ago.
These third quarter results were unusually strong, driven by strength throughout
the corporation. Earnings per share growth of 38% in the quarter was
significantly above State Street's long-term growth rate. Additionally, a record
amount of new business was signed during the quarter, which will be installed in
the next several quarters. State Street is seeing the results of its focus on
revenue growth, its increased market penetration, its increase in business
investments made earlier in the 90s, and a global demand for its services.
In addition the corporation was positioned to benefit from several favorable
external factors in the quarter. Currency markets were active, stocks and bonds
increased in value globally as measured by major indices, net new money flowed
into mutual funds at a strong pace, and State Street's U.S. customers increased
their cross-border investments.
Condensed Income Statement - Taxable Equivalent Basis
- ------------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
(Dollars in millions, except per share data) 1997 1996 Change % 1997 1996 Change %
- ------------------------------------------------------------------------------------------------------------------------------------
Fee revenue:
Fiduciary compensation ...................... $ 324 $ 259 $ 65 25 $ 918 $ 749 $ 169 23
Foreign exchange trading .................... 74 28 46 171 170 91 79 87
Servicing and processing .................... 37 31 6 21 116 88 28 33
Other ....................................... 7 6 1 -- 16 26 (10) (43)
----- ----- ----- -- ------- ------- ------- --
Total fee revenue ........................... 442 324 118 36 1,220 954 266 28
Net interest revenue ........................ 175 148 27 18 502 432 70 16
Provision for loan losses ................... 5 2 3 150 11 6 5 83
----- ----- ----- -- ------- ------- ------- --
Total revenue ............................... 612 470 142 30 1,711 1,380 331 24
Operating expenses .......................... 451 350 101 29 1,260 1,023 237 23
----- ----- ----- -- ------- ------- ------- --
Income before taxes ......................... 161 120 41 34 451 357 94 26
Income taxes ................................ 49 37 12 31 137 114 23 20
Taxable equivalent adjustment ............... 11 9 2 13 34 28 6 20
----- ----- ----- -- ------- ------- ------- --
Net Income .................................. $ 101 $ 74 $ 27 37 $ 280 $ 215 $ 65 30
===== ===== ===== == ======= ======= ======= ==
Earnings Per Share
Primary ..................................... $ .62 $ .45 $ .17 38 $ 1.72 $ 1.31 $ .41 31
Fully diluted ............................... .62 .45 .17 38 1.71 1.31 .40 31
(Percentage change based on dollars in thousands, except per share data)
- -------------------------------------------------------------------------------
Total Revenue
Total revenue for the quarter was $612 million, up $142 million, or 30%, from a
year ago, reflecting strong growth throughout the corporation.
Year to date, total revenue was $1.7 billion, up $331 million, or 24%, from
1996, due primarily to growth in fee revenue.
Fee Revenue
Fee revenue for the quarter was $442 million, up 36% from a year ago, due
primarily to growth in fiduciary compensation and a very strong quarter for
foreign exchange trading revenue.
Fiduciary compensation, the largest component of fee revenue, is derived from
accounting, custody, recordkeeping, information, investment management and
trustee services. Fiduciary compensation was $324 million, up $65 million, or
25%, from a year ago. This was driven by expanded and new customer relationships
against a back drop of increasing cross-border investments and favorable
securities markets.
In financial asset services, revenue growth was strong across all product lines.
Total assets under custody increased 38% from a year ago to $3.8 trillion. Using
broad assumptions, management estimates that approximately one-half of the
increase was due to the impact of higher securities market values and one-half
was due to customer growth and new business. Revenue from mutual funds reflected
asset growth, particularly growth in non-U.S. assets; an increase in the number
of trades processed; and significant growth in revenue from services for
offshore funds and fund administration. Total mutual fund assets under custody
increased 34% from 1996, with the non-U.S. asset component up 35%. The number of
offshore funds that State Street services was up 25% from a year ago and
offshore fund assets more than doubled. The number of funds for which State
Street provided administration was up 33%, and the assets under administration
nearly tripled from a year ago.
Revenue from servicing U.S. pension plans increased due to new business and
growth in existing customer relationships. This revenue growth came equally from
growth in securities lending revenue and growth in portfolio accounting and
custody revenue. For the corporation as a whole, securities lending revenue
growth was driven by a 38% increase from a year ago in securities on loan.
Outside the United States, revenue growth was driven by additional business from
existing customers and by new customers. Assets under custody for non-U.S.
customers as of September 30, 1997 increased 39% from a year ago.
Revenue from investment management services, delivered through State Street
Global Advisors, grew strongly. Revenue growth occurred across the product line
- - investment management for institutional investors, recordkeeping and
investment services for defined contribution plans, and investment services for
high net worth individuals. Revenue from institutional investors was driven
primarily by new relationships, with additional contributions from existing
customers and rising equity markets also factors. Revenue growth was
particularly strong from international passive products, driven by international
diversification by both defined benefit and defined contribution plans, and from
fixed income products, particularly short term cash. Total assets managed
increased 35% from a year ago, to $379 billion. Slightly over half of this
growth came from additional funding from customers and new customers; the
remainder was from increased market values.
Foreign exchange trading revenue for the quarter was $74 million, up $46 million
from a weak third quarter a year ago. State Street continues to expand its
relationships with institutional investors covering a broad range of foreign
exchange services. State Street has introduced new research, risk management and
electronic execution services for these customers. As a result, State Street is
positioned to benefit from active currency markets and more active management of
currency exposures by cross-border investors worldwide.
Servicing and processing fee revenue was $37 million, up $6 million, or 21%,
from the third quarter of 1996. Revenue reflected, in part, the acquisition of
Princeton Financial Systems in the fourth quarter of 1996 and strong growth in
revenue from brokerage services, partially offset by the disposition of a
non-strategic business in the second quarter.
For the nine months ended September 30, 1997, fee revenue was $1.2 billion, up
$266 million, or 28%, over the same period in 1996. Growth was primarily
attributable to a $169 million increase in fiduciary compensation and a $79
million increase in foreign exchange trading revenue.
Net Interest Revenue
Taxable equivalent net interest revenue for the third quarter was $175 million,
up $27 million, or 18%, from a year ago due primarily to a $5.4 billion, or 21%,
increase in average interest-earning assets. State Street uses its balance sheet
to support the needs of institutional investors. These customers, in conjunction
with their worldwide investment activities, placed additional funds with State
Street in deposits and securities sold under repurchase agreements, which were
invested by State Street primarily in low risk assets. Non-U.S. deposits
increased $2.7 billion, with substantial growth in both call and transaction
accounts, reflecting increased cross-border investment activity. Repurchase
agreements, primarily placed with State Street by mutual funds with short-term
cash to invest, were up $1.3 billion. Non-interest bearing deposits, in part
reflecting activity by mutual funds and a corporate trust acquisition, were up
$900 million.
In the third quarter average loans increased $1.1 billion, or 26%, from a year
ago. Loans to financial asset services customers, primarily securities
settlement advances and loans to securities brokers, accounted for half of this
increase. Leases were up $300 million, or 29%, while all other loans, primarily
commercial and financial loans, were up 10%.
- -----------------------------------------------------------------------------------------------------------------------------------
Three Months Ended September 30,
1997 1996
----------------------- ----------------------------
AVERAGE Average
(Dollars in millions) BALANCE RATE Balance Rate
- -----------------------------------------------------------------------------------------------------------------------------------
Interest-earning assets................................ $ 31,899 5.76% $ 26,472 5.68%
Interest-bearing liabilities........................... 26,597 4.30 22,268 4.11
---- ----
Excess of rates earned over rates paid................. 1.46% 1.57%
==== ====
Net Interest Margin.................................... 2.17% 2.23%
==== ====
For the nine months ended September 30, 1997, taxable equivalent net interest
revenue was $502 million, up $70 million, or 16%, from the same period in 1996
due primarily to a $4.6 billion, or 18% increase in average interest-earning
assets. Growth in average interest-earning assets and associated revenue was
driven primarily by a $2.0 billion increase in securities sold under repurchase
agreements, a $1.6 billion increase in non-U.S. deposits and a $564 million
increase in noninterest- bearing deposits.
Operating Expenses
Operating expenses for the third quarter of $451 million were up $101 million,
or 29%, from the third quarter of 1996 supporting business expansion and
investments for future growth. Salaries and employee benefits were $250 million,
up $56 million, or 29%, due to 11% more staff and an increase in incentive
compensation resulting from strong financial results and a higher stock price.
The after-tax profit margin improved to 16.6% in the third quarter of 1997 from
15.7% last year.
For the nine month period ended September 30, 1997, operating expenses were up
$237 million, or 23% from the prior year, with over half the increase occurring
in increased salaries and employee benefits costs.
State Street has developed and is currently implementing a plan to ensure Year
2000 compliance. Management estimates that the cost of the Year 2000 compliance
to be approximately one to two percent of total expenses over the next three
years and intends to manage these expenses within its normal investment spending
level.
Credit Quality
Average loans for the third quarter of 1997 were $5.6 billion, and comprised 15%
of total assets. About 30% of loans outstanding supported the liquidity needs of
financial asset services customers and securities brokers in their trading and
settlement activity. These loans are short-term, usually overnight, and have
relatively low credit risk.
In the third quarter, the provision for loan losses charged against income was
$5 million, up from $2 million a year ago to support the growth in the loan
portfolio. There are no material changes in overall credit quality. During the
quarter, the allowance for loan losses increased from $74 million to $79
million.
During the third quarter, non-performing assets decreased from $11 million to $8
million. Recoveries were $1 million, compared to none in the third quarter of
1996.
Taxes
Taxes were $49 million in the third quarter of 1997, as compared with $37
million a year ago. The effective tax rate was 32.5%, down from 33.6% in the
third quarter of 1996. This lower effective tax rate resulted from higher levels
of tax credits and tax exempt revenue and the utilization of non-U.S. tax
losses.
Lines of Business
Following is a summary of line of business operating results for the nine months
ended September 30:
- ------------------------------------------------------------------------------------------------------------------------------
Financial Investment Commercial
Taxable equivalent basis Asset Services Management Lending
(Dollars in millions) 1997 1996 1997 1996 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------
Fee revenue........................... $ 877 $ 691 $ 297 $ 229 $ 46 $ 34
Net interest revenue.................. 352 301 19 18 120 107
-------- ------- ------- ------ ----- ------
Total revenue................... 1,229 992 316 247 166 141
Operating expenses.................... 938 766 251 194 71 63
======== ======= ======= ====== ===== ======
Operating profit................ $ 291 $ 226 $ 65 $ 53 $ 95 $ 78
======== ======= ======= ====== ===== ======
Pretax margin......................... 23.7% 22.8% 20.6% 21.4% 56.9% 55.2%
Percentage contribution............... 65% 63% 14% 15% 21% 22%
Average assets (billions)............. $ 30.0 $ 25.4 $ .7 $ .5 $ 3.7 $ 3.1
Financial Asset Services
Financial Asset Services provides accounting, custody, daily pricing,
information, foreign exchange trading, cash management, securities lending and
other services for investors with large pools of investment assets worldwide;
and corporate trusteeship. Revenue from this line of business comprised 72% of
State Street's total revenue for the first nine months of 1997.
Revenue increased to $1.2 billion, up 24% from $992 million in 1996. The $237
million increase in revenue resulted from increased cross-border investment
activity, the installation of a substantial amount of new business and expanding
relationships with customers, which are growing and using more services. Fee
revenue was up 27% and reflected growth across the product line and very strong
growth in foreign exchange trading revenue. Revenue increased from accounting,
custody and other services for mutual funds, U.S. pension plans, and customers
outside the U.S. Foreign exchange trading revenue was up substantially from a
relatively weak year in 1996. Net interest revenue, up 17%, reflected an
increase in interest-earning assets. The primary source of growth in interest
earning assets was additional funding from customers in conjunction with their
worldwide investment activities.
Operating expenses for the nine month period were $938 million, 22% higher than
a year ago, due to business growth, investments for future growth, higher
incentive compensation, and acquisitions.
Operating profit was $291 million, an increase of $64 million, or 28%, from a
year ago and reflected strong revenue growth and an improvement in pretax profit
margin.
Investment Management
State Street manages financial assets worldwide for both institutions and
individuals and provides related services, particularly participant
recordkeeping for defined contribution plans. State Street's investment
management services feature a broad array of products, including quantitative
equity management, both passive and active, money market funds, and fixed income
strategies. Revenue from this line of business comprised 18% of State Street's
total revenue for the first nine months of 1997.
Revenue grew 28%, to $316 million, due to revenue growth across the product
line. Operating expenses increased 29% reflecting additional staff to support
business growth and acquisitions. Operating profit was $65 million, an increase
of $12 million, or 23%, from $53 million in 1996.
Commercial Lending
Commercial lending provides loans, credit facilities and other banking services
for regional middle-market companies, for companies in selected industries
nationwide, and for broker/dealers. Other credit services include asset-based
finance, leasing and international trade finance. Revenue from this line of
business comprised 10% of State Street's total revenue for the first nine months
of 1997.
Revenue grew to $166 million, up 18% from $141 million in the nine months ended
September 30, 1996, due primarily to a 21% increase in loans. Loans to New
England businesses and specialty industries nationwide, leveraged leases, and
international trade finance all grew.
Operating expenses in the 1997 nine month period increased 13%, supporting
business growth. Operating profit was $95 million, an increase of $17 million,
or 22%, from 1996, due to revenue growth and an improvement in the pre-tax
margin.
New Accounting Developments
Information related to new accounting developments appears in Note A to the
Consolidated Financial Statements.
Capital and Liquidity
State Street maintains a strong capital base to support its customers. Strong
capital levels provide financial flexibility, which facilitates funding
corporate growth and other business needs.
State Street 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 Federal Reserve Board's "well capitalized" category under
the Prompt Corrective Action Regulations. State Street's capital management
emphasizes risk exposure rather than simple asset levels; at 13.3%, State
Street's Tier 1 risk-based capital ratio significantly exceeds the regulatory
minimum of 4% and is among the highest for U.S. bank holding companies. State
Street's total risk-based ratio of 13.4% significantly exceeds the regulatory
minimum, and is among the highest for U.S. bank holding companies.
The primary objective of State Street's liquidity management is to ensure that
it has sufficient funds to conduct its activities, including accommodating the
transaction and cash management requirements of its customers, meeting loan
commitments and replacing maturing liabilities. 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 payments of loans. Customer deposits and other funds provide a
multi-currency, geographically-diverse source of funding.
State Street maintains a large portfolio of liquid assets. When liquidity is
measured by the ratio of liquid assets to total assets, State Street ranks among
the highest of U.S. banking companies. At September 30, 1997, State Street's
liquid assets were 73% of total assets.
Foreign Exchange And Derivative Financial Instruments
State Street uses foreign exchange and a variety of financial derivative
instruments to support customers' needs, conduct trading activities, and manage
its own interest rate and currency risk. These activities are designed to create
trading revenue or hedge 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, customers have an increasing need for foreign
exchange forward contracts to convert currency for 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 contracts and over-the-counter options in support of these
customer needs.
As part of its trading activities, State Street assumes market positions in both
the foreign exchange and interest rate markets using financial derivatives
including forward foreign exchange contracts, foreign exchange and interest rate
options, and interest rate swaps.
As of September 30, 1997, the notional amount of these instruments was $113.4
billion, of which $110.6 billion was foreign exchange forward contracts. Long
and short foreign exchange forward positions are closely matched by State Street
to minimize currency and interest rate risk. In order to estimate changes in the
value of the outstanding contracts, all forward foreign exchange contracts are
valued daily at current market rates.
State Street uses various derivatives to minimize the interest rate and foreign
exchange risks associated with its global business activities. As of September
30, 1997, the notional amount of these derivatives was $585 million.
Associated with derivatives are market and credit risks that could expose State
Street to potential losses. Market risk relates to the possibility that
financial instruments may change in value due to future fluctuations in market
prices. There may be considerable day-to-day variation in market-risk exposure
because of changing expectations of future currency values or interest rates.
Credit risk relates to the possibility that a loss may occur from failure of
another party to perform according to the terms of a contract.
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 used as
part of the asset and liability management process undergo the same credit and
interest rate risk analyses as on-balance sheet financial instruments.
Stockholders' Equity
The authorized number of common shares increased from 112 million at December
31, 1996 to 250 million at September 30, 1997. On May 28, 1997, State Street
distributed a two-for-one stock split in the form of a 100% stock dividend to
shareholders of record on April 30, 1997. The par value of these additional
shares was capitalized by a transfer from retained earnings to common stock. Per
share data has been restated for the stock split.
State Street purchased 200,000 shares of its stock during the third quarter of
1997. Under the current Board of Directors' authorization, the corporation was
authorized to purchase an additional 3.2 million shares as of September 30,
1997.
Financial Goals and Factors That May Affect Them
State Street's primary financial goal is sustainable real growth in earnings per
share. There are two supporting goals, one for total revenue and one for return
on common stockholders' equity ("ROE"). The revenue goal is 12.5% real, or
inflation adjusted, growth in revenue per year for the decade of the 1990s.
Decade-to-date, this has translated into a nominal growth goal of 15.2%
compounded per year. The ROE goal is to achieve 18%.
State Street considers these to be financial goals, not projections or
forward-looking statements. However, if these goals are perceived to be
forward-looking statements, they, as with any other statement that may be
considered forward looking, should be considered in conjunction with the factors
listed below, which could cause actual results to differ materially.
The following issues and factors, among others, should be considered in
evaluating the outlook for State Street's goals and forward-looking statements:
o Cross-border investing. Cross-border investing by customers worldwide
benefits State Street's revenue. Future revenue may increase or decrease
depending upon the extent of cross-border investments made by customers or
future customers.
o Savings rate of individuals. State Street benefits from the savings of
individuals which are invested in mutual funds or defined contribution plans.
Changes in savings rates or styles may lead to increased or decreased revenue.
o 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 State Street's fees are based
on the value of assets under custody and management, fluctuations in worldwide
securities market valuations will affect revenue.
o Dynamics of markets served. Changes in the markets served can affect revenue,
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.
o Interest rates. Market interest rate levels, the direction of interest rate
changes, and the shape of the yield curve affect both net interest revenue and
fiduciary compensation from securities lending. All else being equal, State
Street benefits from higher market rates along with a steeper yield curve,
which have a favorable impact by increasing asset yield as well as increasing
the return on State Street's large volume of non-interest bearing sources of
funds. However, because State Street is liability sensitive in the short-term
(interest-bearing liabilities reprice faster than interest-earning assets) a
rising rate environment will reduce net interest revenue from what it would
otherwise have been.
o 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 of investment management services. The pace of pension reform
will affect the pace of revenue growth.
o Pricing/competition. Future prices State Street is able to obtain for its
products may increase or decrease from current levels depending upon demand
for its products and its competitors' activities. State Street, or its
competitors, could introduce new products into the marketplace.
o Pace of new business. The pace at which existing and new customers use
additional services will affect future revenue.
o Business mix. Changes in business mix, including the mix of U.S. and non-U.S.
business, will affect earnings growth rates.
o Rate of technological change. Technological change creates opportunities for
product differentiation and reduced costs as well as the possibility of
increased expenses.
Based on its evaluation of these factors, management is currently optimistic
about State Street's long-term prospects.
Since the end of the quarter, there was abnormal volatility in securities
markets worldwide and currency markets continued to be active. During this
period, State Street successfully accommodated higher volumes of inquiries and
transactions for its customers without encountering significant operational
problems. These recent market actions are not expected to cause a disruption in
State Street's revenue for the remainder of 1997.
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibit Index
Exhibit Page of
Number this Report
11 Statement re: computation of per share earnings 25
12 Ratio of Earnings to Fixed Charges 26
15 Letter re: unaudited interim financial information 27
27 Financial data schedule 28
99 Press Release dated September 22, 1997 re:
Two New Directors to State Street's Board 29
(b) Reports on Form 8-K
None.
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: November 12, 1997 By: /s/ Ronald L. O'Kelley
----------------------------------------------------
Ronald L. O'Kelley
Executive Vice President and Chief Financial Officer
Date: November 12, 1997 By: /s/ Rex S. Schuette
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Rex S. Schuette
Senior Vice President and Comptroller