01—Abstract
Summary
Summary of the 10-K filed February 24, 2004. Cited figures are marked; the original filing is the authoritative source.
State Street's 2003 10-K shows a transformational year.
The January 2003 acquisition of the Global Securities Services business from Deutsche Bank (a $1.1 billiona premium, roughly $2.1 trillion of assets under custody added) lifted assets under custody to $9.4 trillion, up 52% from $6.2 trillion. Reported net income fell to $722 million ($2.15 diluted EPS) from $1.0 billion ($3.10) in 2002, but that comparison is distorted by the 2002 Corporate Trust gain. Excluding non-operating items, operating EPS rose 8% to $2.33, and baseline EPS (excluding the GSS contribution) rose 7% to $2.32.
Reported results absorbed a $296 millionb restructuring charge tied to a voluntary separation program that cut roughly 2,000 net positions, plus $110 million of merger, integration and divestiture costs, partly offset by a $285 million pre-tax gain on the sale of Private Asset Management. Core revenue was flat on a baseline basis: servicing fees grew 10% and management fees 6%, but net interest revenue fell 17% to $810 million as lower rates compressed the margin (net interest margin fell to 1.17% from 1.42%). Operating ROE was 15.0% against 16.8% in 2002, and management reset the 2003 and 2004 ROE goal to 13–15% because of the acquisition's capital requirements.
Capital remained strong, with a Tier 1 risk-based ratio of 14.0%c and a total risk-based ratio of 15.8%, both well above well-capitalized thresholds, though down from 17.1% and 18.0% a year earlier. The outlook is cautious.
Management described 2004 as a challenging year, expects to convert substantially all remaining GSS clients, targets retention of about 88%d of GSS client revenue, and is pursuing a long-term goal of 12.5% real revenue growth from 2000 through 2010. Investors should weigh the integration execution risk, the sustained low-rate environment, and the leverage constraints the acquisition imposes on balance sheet growth.
02—Key points
Key Highlights
- Assets under custody reached $9.4 trillion at year-end 2003, up 52% from $6.2 trillion, driven by the $2.1 trillion added through the Deutsche Bank GSS acquisition; assets under management reached $1.1 trillion, up 45%.
- Reported diluted EPS fell to $2.15 from $3.10, but operating EPS rose 8% to $2.33 and baseline EPS rose 7% to $2.32, excluding non-operating items and the GSS contribution.
- Total reported revenue was $4.7 billion, up 8%, while baseline revenue was flat at $3.9 billion; net interest revenue declined 17% to $810 million as the net interest margin fell to 1.17% from 1.42%.
- Servicing fees rose 10% and management fees 6% on a baseline basis, supported by new business and the IFS acquisition; the GSS business contributed $573 million of revenue and $37 million of net income in its first eleven months.
- A $296 million restructuring charge from the voluntary separation program, plus $110 million of merger and divestiture costs, weighed on reported results; the $285 million gain on the sale of Private Asset Management partially offset them.
- Operating ROE fell to 15.0% from 16.8%, and the 2003–2004 ROE goal was reset to 13–15% because of acquisition-related capital needs; Tier 1 risk-based capital remained strong at 14.0%.
- Management expects 2004 to be challenging, targets converting substantially all remaining GSS clients in 2004, and maintains a long-term goal of 12.5% real revenue growth from 2000 through 2010.
03—Questions
Frequently Asked Questions
Why did reported net income decline so sharply in 2003?
Reported net income fell to $722 million from $1.0 billion because 2002 included a $495 million pre-tax gain on the Corporate Trust sale. In 2003, reported results absorbed a $296 million restructuring charge and $110 million of merger and divestiture costs, partly offset by a $285 million gain on the Private Asset Management sale. On an operating basis, net income rose 10% to $783 million, and operating EPS rose 8% to $2.33.
What was the financial impact of the Deutsche Bank GSS acquisition?
The GSS business, acquired January 31, 2003 for a $1.1 billion premium, contributed $573 million of revenue and $517 million of expenses over eleven months. It added $37 million to net income, or $0.01 per diluted share after dilution from new shares issued to finance the deal, slightly exceeding management's expectation of $0.01–$0.03 of dilution. Merger and integration costs were $103 million, within the company's $90–$110 million estimate.
Is State Street's core business growing?
Partially. On a baseline basis, total revenue was flat, with growth in servicing fees (up 10%), management fees (up 6%) and foreign exchange trading (up 10%) offset by declines in net interest revenue and securities lending. Servicing and management fees together make up about 70% of fee revenue, so fee-based growth is the key driver to watch.
What are the main risks to the outlook?
Key risks include the execution of the GSS client conversions (the company expects to retain about 88% of available client revenue), a sustained low interest rate environment that compresses net interest revenue and securities lending spreads, and capital constraints that limit balance sheet growth. Market values also drive revenue: management estimates a 10% change in equity values moves total revenue by about 2%. The filing also flags regulatory developments such as Basel II and an open IRS examination of lease-in, lease-out transactions.
04—Continue