State Street Corporation's (STT) third quarter of 2013 (3Q'13) stated net income of $540 million has declined from both the sequential and year-ago quarters. Nevertheless, Fitch Ratings believes the company's 3Q'13 earnings, which equated to a 10.8% return on average equity (ROE), while satisfactory from a credit perspective, remain below STT's historical returns. Furthermore, Fitch does not believe a meaningful pick-up in earnings will occur without a significant increase in short-term interest rates.
Overall revenue was down 4.3% from the sequential quarter, but up 3.4% from a year-ago. STT's core asset servicing and asset management revenue was essentially flat from the sequential quarter, but there was a more marked decline in the company's market-based revenues. Fitch considers securities lending revenue and foreign exchange trading revenue as market based revenue. The former was down amid continued weak demand for securities lending as well as some seasonality, and foreign exchange trading revenue declined amid lower volatility in the market during the quarter.
Net interest revenue (NIR) declined 8% relative to the sequential quarter as a modestly smaller earning asset base and lower short-term interest rates more than offset the increase in yields from lower pre-payments on mortgage backed securities (MBS) amid the steepening of the long-end of the yield curve. As such, the company's net interest margin (NIM) declined to 1.27% from 1.31% in the sequential quarter. Fitch would expect, in general, continued pressure on NIM as some benefit from the yield curve steepening and higher yielding assets will likely be offset by the continued downward pressure of the low short-term interest rates.
STT continues to deliver on its expense and efficiency initiatives, as total expenses declined 3.4% from the sequential quarter. Fitch notes that this is significant as the company continues to incur elevated regulatory, compliance, and professional services costs over the near term. As such, Fitch believes that these initiatives have more strongly positioned the company for higher positive operating leverage over a longer-term time horizon.
STT continues to have and build a leading global platform in asset servicing and asset management. Total assets under custody and administration (AUCA) increased to $26.03 trillion in 3Q'13, up from $25.7 trillion in the sequential quarter. Fitch would note that the company continues to make good traction in its alternative asset servicing business, which is a growth area for the company.
Additionally, total assets under management (AUM) increased to $2.24 trillion in 3Q'13, up from $2.14 trillion in the sequential quarter. This was driven by growth in passively managed products, and Fitch believes that growth in exchange traded fund (ETF) AUM will be one of the key growth drivers for STT going forward.
Fitch notes that STT's capital position remains strong with a Tier 1 common equity ratio (CET1) of 15.5% under Basel 1. Under the Basel III final rule, the company's CET1 under the standardized approach is 10.2%, which Fitch would note compares favorably to peer banks.
STT's pro-forma Basel III supplementary leverage ratio (SLR) as of 3Q'13 was 5.4% for the holding company, which is above the proposed 5.0% minimum, and 5.0% for the main bank subsidiary, State Street Bank and Trust Company, which is below the current 6.0% proposed minimum.
Additional information is available at www.fitchratings.com.
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Justin Fuller, CFA, +1-312-368-2057
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Doriana Gamboa, +1-212-908-0865
Brian Bertsch, +1-212-908-0549