Fitch: Weaker Markets Weigh on State Street's 1Q16 Results
OREANDA-NEWS. State Street Corporation's (STT) first quarter 2016 (1Q16) earnings were impacted by a weaker global market environment, according to Fitch Ratings. On a GAAP basis this dropped the company's return on average equity (ROE) to 6.8% in 1Q16, down from 11.6% in the sequential quarter and 7.9% in the year-ago quarter. This quarter's results included a $62 million net after tax restructuring charge ($97 million pre-tax) related to the company's cost or 'Beacon' initiatives.
On an operating basis, which adjusts for the charge above as well as some other items, STT's 1Q16 ROE was 8.4%, down from 10.5% in the sequential quarter and 10.4% in the year-ago quarter. This is below Fitch's range of estimate for STT's cost of equity of between 10% to 12%. This was due to lower servicing and management fees as equity values were down globally, as well as higher compensation expenses.
Given the weaker quarterly results, expense management continues to be a key focus for STT. The company's recently rolled out efficiency initiative, labeled the Beacon program, should significantly aid in this effort. As noted above, while some restructuring charges from Beacon were evident in this quarter's results, Fitch believes STT may incur an additional $300 million of pre-tax restructuring charges over the next 19 quarters.
To the extent that longer-term this initiative permanently reduces STT's cost base, it could help the company's returns to potentially exceed its cost of equity. In 2016, the Beacon program is forecast to deliver $100 million of annualized expense savings, inclusive of the company's headcount reduction announced in October 2015.
On an operating basis, in 1Q16 STT still produced negative operating leverage relative to both the sequential and year-ago quarters. Relative to the sequential quarter expenses were up 6.8% due primarily to higher compensation expenses related to seasonal deferred incentive compensation expense. Compared to the year-ago quarter, expenses were only up 0.1%, though there were higher information systems and communication expenses.
The revenue environment for STT remains challenging amid weaker global equity markets, given the company's higher proportion of equity related business segments On an operating basis revenues were down 0.5% from the sequential quarter, and down 3.7% from the year ago quarter. Revenue performance in 1Q16 was also unfavorably impacted by the strong U.S. Dollar.
Servicing and management fees also declined relative to the sequential and year-ago quarters given weaker global equity conditions, as STT tends to have a higher proportion of equity related servicing assets. This began to reverse during the latter half of 1Q16 and into 2Q16 due to improvements in developed markets, though emerging markets remain challenging.
Market-based revenue was primarily higher. Foreign exchange (FX) revenue was up relative to the sequential quarter on higher volumes due to some increased FX volatility but down relative to the year-ago quarter. Similarly, securities finance revenue also increased relative to both the sequential and year-ago quarters. Despite these increases, market based revenue is proportionately much smaller than the servicing and management fees noted above, so they couldn't fully offset the declines.
Net interest revenue (NIR) expanded by 5.1% relative to the sequential quarter due in large part to the Federal Reserve's 25 basis point interest rate increase last year. NIR was down 4.6% relative to the year-ago quarter due primarily to fewer earning assets.
Given the rate increase previously noted, the company's net interest margin (NIM) on an operating basis increased to 1.12% in 1Q16, up from 1.01% in both the sequential and year-ago quarters.
Fitch continues to view STT's capital and liquidity positions as solid and supportive of the company's ratings.
STT's estimated fully phased-in Basel III Common Equity Tier 1 (CET1) ratio on a standardized basis was 12% at 1Q16 and on an advanced approach basis was 11.9%. Fitch continues to expect convergence between the standardized and advanced approach CET1 ratios, but the lower of the two in any one quarter is STT's binding constraint.
More binding than the CET1 ratios noted above, however, is the enhanced supplementary leverage ratio (SLR) for STT and its peer large processing banks. As of 1Q16, STT's SLR at the holding company was 6%, 100 basis points above the requirement, and at the main bank subsidiary was 6.2%, 20 basis points above the requirement.
Additionally, STT's balance sheet remains very liquid with client deposits representing nearly 76% of total assets and with 93% of the company's investment portfolio carrying either 'AAA' or 'AA' ratings.
Two weeks ago the Federal Reserve and FDIC released their review of STT's July 2015 resolution plan submission and indicated it is not credible. Fitch expects STT to address additional modeling and monitoring capabilities among others concerns and to address all the deficiencies by Oct. 1, 2016.
Fitch does not view the lack of acceptance of STT's resolution plan by regulators to be indicative of the company's current and ongoing financial health. STT's ratings incorporate the expectation that it will satisfy the regulators' requirements around its resolution planning.