================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 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 MARCH 31, 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) State Street Boston Corporation (Former name) ----------------- 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 April 30, 1997 was 80,184,534. ================================================================================
STATE STREET CORPORATION Table of Contents Page PART I. FINANCIAL INFORMATION -------- - ------------------------------ Item 1. Financial Statements Consolidated Statement of Income ..................................... 1 Consolidated Statement of Condition .................................. 2 Consolidated State of Cash Flows ..................................... 3 Consolidated Statement of Changes in Stockholders' Equity ............ 4 Notes to Consolidated Financial Statements ........................... 5 - 10 Independent Accountants' Review Report ............................... 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ................... 12 - 18 PART II. OTHER INFORMATION Item 1. Legal Proceedings ..................................... 19 Item 2. Changes in Securities ................................. 19 Item 3. Defaults Upon Senior Securities ....................... 19 Item 4. Submission of Matters to a Vote of Security Holders ... 19 Item 5. Other Information ..................................... 19 Item 6. Exhibits and Reports on Form 8-K ...................... 19 Signatures ........................................................... 20 Exhibits ............................................................. 21 - 24
PART I. ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED STATEMENT OF INCOME - STATE STREET CORPORATION (UNAUDITED) - ------------------------------------------------------------------------------- (Dollars in millions, except per share data) Three months ended March 31, 1997 1996 - ------------------------------------------------------------------------------- FEE REVENUE Fiduciary compensation ................................... $ 286 $ 234 Foreign exchange trading ................................. 46 34 Servicing and processing ................................. 40 28 Other 2 11 ------- -------- Total fee revenue .................................. 374 307 NET INTEREST REVENUE Interest revenue ......................................... 398 346 Interest expense ......................................... 248 215 ------- -------- Net interest revenue ............................... 150 131 Provision for loan losses ................................ 3 2 ------- -------- Net interest revenue after provision for loan losses 147 129 ------- -------- TOTAL REVENUE ...................................... 521 436 OPERATING EXPENSES Salaries and employee benefits ........................... 219 181 Transaction processing services .......................... 44 37 Equipment ................................................ 38 32 Occupancy ................................................ 28 25 Other 62 53 ------- -------- Total operating expenses ........................... 391 328 ------- -------- Income before income taxes ......................... 130 108 Income taxes ............................................. 44 38 ======= ======== NET INCOME ......................................... $ 86 $ 70 ======= ======== EARNINGS PER SHARE Primary ............................................ $ 1.06 $ .85 Fully diluted ...................................... $ 1.05 .84 AVERAGE SHARES OUTSTANDING (in thousands) Primary ............................................ 81,555 82,261 Fully diluted ...................................... 82,104 82,896 CASH DIVIDENDS DECLARED PER SHARE ........................ $ .20 $ .18 - -------------------------------------------------------------------------------- The accompanying notes are an integral part of these financial statements.
PART I. ITEM 1. FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATED STATEMENT OF CONDITION - STATE STREET CORPORATION - -------------------------------------------------------------------------------- (UNAUDITED) MARCH 31, December 31, (Dollars in millions) 1997 1996 - -------------------------------------------------------------------------------- ASSETS Cash and due from banks ....................... $ 1,712 $ 1,623 Interest-bearing deposits with banks .......... 8,198 7,565 Securities purchased under resale agreements and securities borrowed ..................... 4,502 4,613 Federal funds sold ............................ 1,451 1,155 Trading account assets ........................ 144 255 Investment securities (principally available for sale) ..................................... 10,236 9,387 Loans (less allowance of $70 and $73) ......... 4,771 4,640 Premises and equipment ........................ 466 468 Customers' acceptance liability ............... 46 35 Accrued income receivable ..................... 477 442 Other assets .................................. 1,628 1,341 -------- -------- TOTAL ASSETS ............................ $ 33,631 $ 31,524 ======== ======== LIABILITIES Deposits: Noninterest-bearing ........................... $ 6,367 $ 6,395 Interest-bearing: Domestic ................................... 1,951 2,071 Non-U.S .................................... 12,126 11,053 -------- -------- Total deposits .......................... 20,444 19,519 Securities sold under repurchase agreements ... 8,112 7,387 Federal funds purchased ....................... 96 117 Other short-term borrowings ................... 722 649 Notes payable ................................. 81 86 Acceptances outstanding ....................... 46 35 Accrued taxes and other expenses .............. 634 657 Other liabilities ............................. 983 823 Long-term debt ................................ 775 476 -------- -------- TOTAL LIABILITIES ....................... 31,893 29,749 STOCKHOLDERS' EQUITY Preferred stock, no par: authorized 3,500,000; issued none ................................ - - Common stock, $1 par: authorized 112,000,000; issued 83,614,000 and 83,615,000 ........ 84 84 Surplus ....................................... 103 105 Retained earnings ............................. 1,760 1,694 Net unrealized (loss) gain on available-for-sale securities ............... (15) 12 Treasury stock, at cost (3,394,000 and 2,461,000 shares) ........................... (194) (120) -------- -------- TOTAL STOCKHOLDERS' EQUITY .............. 1,738 1,775 -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................ $ 33,631 $ 31,524 ======== ======== - -------------------------------------------------------------------------------- The accompanying notes are an integral part of these financial statements.
PART I. ITEM 1. FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATED STATEMENT OF CASH FLOWS - STATE STREET CORPORATION (UNAUDITED) - -------------------------------------------------------------------------------- (Dollars in millions) Three months ended March 31, 1997 1996 - -------------------------------------------------------------------------------- OPERATING ACTIVITIES Net Income ......................................... $ 86 $ 70 Noncash charges for depreciation, amortization, provision for loan losses and deferred income taxes 64 115 -------- -------- Net income adjusted for noncash charges ........ 150 185 Adjustments to reconcile to net cash provided by operating activities: Securities gains, net .......................... - (1) Net change in: Trading account assets ...................... 111 99 Other, net .................................. (208) 133 -------- -------- NET CASH PROVIDED BY OPERATING ACTIVITIES . 53 416 -------- -------- INVESTING ACTIVITIES Payments for purchase of: Available-for sale securities .................... (1,524) (1,728) Held to-maturity securities ...................... (216) (284) Lease financing assets ........................... (230) (137) Premises and equipment ........................... (27) (17) Proceeds from: Maturities of available-for sale securities ...... 597 889 Maturities of held-to-maturity securities ........ 203 272 Sales of available-for-sale securities ........... 49 120 Principal collected from lease financing ......... 19 38 Net (payments for) proceeds from: Interest-bearing deposits with banks ............. (633) (2,066) Federal funds sold, resale agreements and securities borrowed ............................ (185) 1,573 Loans ............................................ (86) (164) -------- -------- NET CASH USED BY INVESTING ACTIVITIES ..... (2,033) (1,504) -------- -------- FINANCING ACTIVITIES Proceeds from issuance of: Long-term debt ................................... 300 - Nonrecourse debt for lease financing ............. 193 85 Notes payable .................................... - 88 Treasury stock ................................... - 5 Payments for: Maturity of notes payable ........................ - (137) Nonrecourse debt for lease financing ............. (28) (39) Long-term debt ................................... (1) - Cash dividends ................................... (16) (15) Purchase of common stock ......................... (81) (72) Net proceeds from: Deposits ......................................... 925 1,090 Short-term borrowings ............................ 777 185 -------- -------- NET CASH PROVIDED BY FINANCING ACTIVITIES . 2,069 1,190 -------- -------- NET INCREASE .............................. 89 102 Cash and due from banks at beginning of period ..... 1,623 1,422 ======== ======== CASH AND DUE FROM BANKS AT END OF PERIOD .. $ 1,712 $ 1,524 ======== ======== SUPPLEMENTAL DISCLOSURE Interest paid .................................... $ 247 $ 204 Income taxes paid ................................ $ 20 $ 31 - -------------------------------------------------------------------------------- The accompanying notes are in integral part of these financial statements.
PART I. ITEM 1. FINANCIAL STATEMENTS (CONTINUED) CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY - STATE STREET CORPORATION (UNAUDITED) - -------------------------------------------------------------------------------- (Dollars in millions, except per share data) Three months ended March 31, 1997 1996 - -------------------------------------------------------------------------------- COMMON STOCK Balance at end of period (no change during period) .. $ 84 $ 83 ------- ------- SURPLUS Balance at beginning of period ...................... 105 40 Treasury stock issued ............................... (2) (3) ------- ------- Balance at end of period ...................... 103 37 ------- ------- RETAINED EARNINGS Balance at beginning of period ...................... 1,694 1,465 Net Income .......................................... 86 70 Cash dividends declared ($.20 and $.18 per share).... (16) (15) Currency translation ................................ (4) (1) ------- ------- Balance at end of period ...................... 1,760 1,519 ------- ------- NET UNREALIZED GAIN (LOSS) ON AVAILABLE-FOR-SALE SECURITIES Balance at beginning of period ...................... 12 13 Changes in unrealized gain (loss) ................... (27) (17) ------- ------- Balance at end of period ...................... (15) (4) ------- ------- TREASURY STOCK, AT COST Balance at beginning of period ...................... (120) (13) Common stock acquired (1,079,600 and 1,583,800 shares) ........................................... (81) (72) Treasury stock issued (145,876 and 243,831 shares) 7 10 ------- ------- Balance at end of period....................... (194) (75) ------- ------- TOTAL STOCKHOLDERS' EQUITY..................... $ 1,738 $ 1,560 ======= ======= - -------------------------------------------------------------------------------- The accompanying notes are in integral part of these financial statements.
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 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 institutional and individuals, and provides related participant recordkeeping for defined contribution plans. Commercial Lending activities include loans and other banking services for regional middle-market companies, for nationwide companies in selected industries and for broker/dealers. Other credit services include asset-based finance, leasing and international trade finance. The consolidated financial statements include the accounts of State Street and its subsidiary, State Street Bank and Trust Company ("State Street Bank," "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 three months ended March 31, 1997 and 1996, long-term debt converted into common stock was $20,000 and $10,000, 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 did not have 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 March 31, 1997 and 1996 would have resulted in basic earnings per share of $1.07 and $.85, respectively, and diluted earnings per share of $1.05 and $.84, respectively. 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 March 31, 1997 and December 31, 1996, and its cash flows and consolidated results of its operations for the three months ended March 31, 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: <TABLE> <CAPTION> - ------------------------------------------------------------------------------------------------------------------------------------ MARCH 31, 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): <S> <C> <C> <C> <C> <C> <C> <C> <C> U.S. Treasury and Federal agencies............... $ 5,172 $ 7 $ 23 $ 5,156 $ 4,630 $ 18 $ 5 $ 4,643 State and political subdivisions................. 1,636 4 10 1,630 1,557 10 8 1,559 Asset-backed securities.......................... 1,344 1 3 1,342 1,198 3 1 1,200 Collateralized mortgage obligations.............. 627 1 10 618 638 1 8 631 Other investments................................ 611 8 1 618 485 12 2 495 ------- ---- ---- ------- ------- ---- ---- ------- Total................................................ $ 9,390 $ 21 $ 47 $ 9,364 $ 8,508 $ 44 $ 24 $ 8,528 ========= ==== ===== ======= ======= ==== ==== ======= Held to maturity (at amortized cost): U.S. Treasury and Federal agencies............... $ 872 - $ 4 $ 868 $ 859 $ 2 $ 2 $ 859 ======= ==== ===== ======== ======= ==== ==== ======= - ------------------------------------------------------------------------------------------------------------------------------------ </TABLE> During the three months ended March 31, 1997, there were less than one million of gains and losses realized on sales of available-for-sale securities of $49 million. During the three months ended March 31, 1996, gains of $3 million and losses of $3 million were realized on sales of available-for-sale securities of $120 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 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 and other relevant factors. 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 for the three months ended March 31: - ------------------------------------------------------------------------------- (Dollars in millions) 1997 1996 - ------------------------------------------------------------------------------- Balance at beginning of year.................. $ 73 $ 63 Provision for loan losses..................... 3 2 Loan charge-offs.............................. (6) - Recoveries.................................... - 1 ---- ---- Balance at end of period............................ $ 70 $ 66 ==== ==== - -------------------------------------------------------------------------------- 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, issued by State Street Institutional Capital B (the "Trust"), a newly created subsidiary business trust of State Street. The Capital Securities are fully guaranteed by 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 March 31, 1997, a total of $500 million of capital securities is included in long-term debt. Note E - Income Taxes The provision for income taxes included in the Consolidated Statement of Income is comprised of the following for the three months ended March 31: - ------------------------------------------------------------------------------- (Dollars in millions) 1997 1996 - ------------------------------------------------------------------------------- Current............................................... $ 12 $ 11 Deferred.............................................. 32 27 ---- ---- Total provision................................. $ 44 $ 38 ==== ==== - ------------------------------------------------------------------------------- Taxes were $44 million, up from $38 million a year ago. The effective tax rate was 33.6%, down from 35.4% in the first quarter of 1996. Note F - Regulatory Matters: The regulatory capital amounts and ratios were the following at March 31, 1997 and December 31, 1996: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Regulatory Guidelines (1) ------------------------- State Street State Street Bank Well -------------------- ------------------------- (Dollars in millions) Minimum Capitalized 1997 1996 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Risk-based ratios: <S> <C> <C> <C> <C> <C> <C> <C> Tier 1 capital................... 4% 6% 14.9% 13.4% 12.1% 13.1% Total capital.................... 8 10 15.0 13.6 11.8 13.4 Leverage ratio....................... 3 4 6.4 5.9 5.2 5.2 Tier 1 capital....................... $ 2,110 $ 1,818 $ 1,696 $ 1,391 Total capital........................ 2,130 1,847 1,666 1,422 Risk-based assets: On-balance sheet................. $ 10,867 $ 10,311 $ 10,772 $ 8,296 Off-balance sheet................ 3,300 3,249 3,300 2,339 -------- -------- -------- -------- Total risk-based assets...... $ 14,167 $ 13,560 $ 14,072 $ 10,635 ======== ========== ======== ======== - ----------------------------------------------------------------------------------------------------------------------------------- </TABLE> (1) The regulatory framework for prompt corrective action is not applicable to bank holding companies (State Street). Note G - Net Interest Revenue Net interest revenue consisted of the following for the three months ended March 31: - ------------------------------------------------------------------------------- (Dollars in millions) 1997 1996 - ------------------------------------------------------------------------------- INTEREST REVENUE Deposits with banks................................ $ 90 $ 88 Investment securities: U.S Treasury and Federal agencies.............. 85 48 State and political subdivisions (exempt from Federal tax)............................. 18 14 Other investments............................... 36 28 Loans ............................................. 76 65 Securities purchased under resale agreements, securities borrowed and Federal funds sold....... 90 100 Trading account assets............................. 3 3 ----- ----- Total interest revenue....................... 398 346 ----- ----- INTEREST EXPENSE Deposits........................................... 109 111 Other borrowings................................... 129 102 Long-term debt..................................... 10 2 ----- ----- Total interest expense....................... 248 215 ----- ----- Net interest revenue......................... $ 150 $ 131 ===== ===== - ------------------------------------------------------------------------------- Note H - Operating Expenses - Other The other category of operating expenses consisted of the following for the three months ended March 31: - ------------------------------------------------------------------------------- (Dollars in millions) 1997 1996 - ------------------------------------------------------------------------------- Professional services.............................. $ 16 $ 13 Advertising and sales promotion.................... 11 9 Postage, forms and supplies........................ 7 7 Telecommunications................................. 6 6 Other 22 18 ---- ---- Total operating expenses - other............. $ 62 $ 53 ==== ==== - ------------------------------------------------------------------------------- Note I - Commitments and Contingent Liabilities State Street provides banking, trust, investment management, global custody, accounting, administration and securities processing services to both domestic and global 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 of these services and considers the results in preparing its financial statements. In the opinion of management, there are no contingent liabilities at March 31, 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 J - Off-Balance Sheet Financial Instruments, Including Derivatives State Street uses various off-balance sheet financial instruments, including derivatives, to satisfy the financing and risk management needs of customers, to manage interest rate and currency risk and to conduct trading activities. 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. State Street uses derivative financial instruments in trading and balance sheet management activities. The following table summarizes the contractual or notional amounts of significant derivative financial instruments held or issued by State Street at: - ------------------------------------------------------------------------------- MARCH 31, December 31, (Dollars in millions) 1997 1996 - ------------------------------------------------------------------------------- Trading: Interest rate contracts: Swap agreements......................... $ 933 $ 880 Options and caps purchased.............. 50 25 Options and caps written................ 139 116 Futures - short position................ 1,620 1,252 Options on futures purchased............ 520 430 Options on futures written.............. 540 28 Foreign exchange contracts: Forward, swap and spot.................. 79,667 62,109 Options purchased....................... 66 206 Options written......................... 60 60 Options on futures purchased............ 567 330 Balance Sheet Management : Interest rate contracts: Swap agreements.................... 307 296 Options and caps purchased......... 50 50 Foreign exchange contracts: Forward, swap and spot............. - 65 - ------------------------------------------------------------------------------- The following table represents the fair value of financial instruments held or issued for trading purposes as of: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------- MARCH 31, 1997 December 31, 1996 ----------------------- ------------------------- AVERAGE Average FAIR FAIR Fair Fair (Dollars in millions) VALUE VALUE Value Value - ----------------------------------------------------------------------------------------------------- Foreign exchange contracts: <S> <C> <C> <C> <C> Contracts in a receivable position..... $ 813 $ 1,097 $ 620 $ 615 Contracts in a payable position........ 806 1,164 634 617 Other financial instrument contracts: Contracts in a receivable position..... 6 8 6 6 Contracts in a payable position........ 3 6 4 4 - ----------------------------------------------------------------------------------------------------- </TABLE> 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: - ------------------------------------------------------------------------------- MARCH 31, December 31, (Dollars in millions) 1997 1996 - ------------------------------------------------------------------------------- Indemnified securities on loan................ $ 50,247 $ 41,518 Loan commitments.............................. 5,128 4,974 Standby letters of credit..................... 1,720 1,777 Letters of credit............................. 179 160 - ------------------------------------------------------------------------------- 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 102% of the fair market value of the securities borrowed. The borrowed securities are revalued daily to determine if the additional collateral is necessary. State Street held as collateral, cash and U.S. Government securities totaling $52.4 billion and $42.8 billion for indemnified securities on loan at March 31, 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 March 31, 1997, and the related consolidated statements of income, cash flows and changes in stockholders' equity for the three-month periods ended March 31, 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 Boston 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 April 14, 1997
PART I. ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Summary Earnings per share were $1.05 on a fully diluted basis, an increase of 25% from $.84 in the first quarter of 1996. Revenue grew 20%, from $444 million to $531 million. Net income was $86 million, up from $70 million a year ago. Return on stockholders' equity was 19.9%. <TABLE> <CAPTION> Condensed Income Statement - Taxable Equivalent Basis - ------------------------------------------------------------------------------------------- Three months ended March 31, (Dollars in millions, except per share data) 1997 1996 Change % - ------------------------------------------------------------------------------------------- Fee revenue: <S> <C> <C> <C> <C> Fiduciary compensation..................... $ 286 $ 234 $ 52 22 Foreign exchange trading................... 46 34 12 37 Servicing and processing................... 40 28 12 40 Other...................................... 2 11 (9) - ------ ----- ----- -- Total fee revenue....................... 374 307 67 22 Net interest revenue.......................... 160 139 21 15 Provision for loan losses..................... 3 2 1 50 ------- ----- ----- -- Total revenue........................... 531 444 87 20 Operating expenses............................ 391 328 63 19 ------- ----- ----- -- Income before taxes..................... 140 116 24 21 Income taxes.................................. 44 38 6 14 Taxable equivalent adjustment................. 10 8 2 24 ------ ----- ----- -- Net income.............................. $ 86 $ 70 $ 16 24 ====== ===== ===== == Earnings Per Share Primary................................. $ 1.06 $ .85 $ .21 25 Fully diluted........................... 1.05 .84 .21 25 - ------------------------------------------------------------------------------------------- </TABLE> (Percentage change based on dollars in thousands, except per share data) Total Revenue Total revenue for the quarter was $531 million, up $87 million, or 20%, from a year ago, reflecting strong growth in all lines of business. Revenue benefited particularly from cross-border investment activity, evidenced by increased levels of foreign exchange trading volume, non-U.S. investments by U.S. customers, non-U.S. equity securities on loan, and non-U.S. deposits. State Street continued to benefit from expanding relationships with its customers, who are growing and using more services and a substantial amount of the new business won was installed. Fee Revenue Fee revenue, which comprised 70% of total revenue, was $374 million, up 22% from a year ago. The largest component of fee revenue is fiduciary compensation, which is derived from accounting, custody, recordkeeping, information, investment management and trustee services. Fiduciary compensation was $286 million, up $52 million, or 22%, from a year ago due to new business and customers' growth. Fiduciary compensation grew strongly in all financial asset services businesses. Revenue from mutual funds reflected growth in accounting, custody and pricing services, particularly for non-U.S. assets. In addition to increased revenue from its traditional core products, State Street is seeing more rapid year-over-year growth in revenue from additional services it provides, notably services for offshore funds, securities lending and fund administration. The number of offshore funds serviced is up 31% from a year ago and offshore-fund assets under custody have more than doubled. Additional mutual funds are looking to securities lending to enhance their returns. State Street is providing fund administration for 14% more funds than a year ago, and for more than twice the asset volume. Revenue from servicing U.S. pension plans increased from a large amount of new business and from an increase in the volume of customers' securities on loan. Outside the United States, new customers and additional business from existing customers drove revenue growth. Assets under custody for non-U.S. customers increased 36% from a year ago. Revenue from investment management services, delivered through State Street Global Advisors, was up substantially. Revenue growth occurred across the product line-U.S. and international equities, fixed income and asset allocation strategies for institutional investors; recordkeeping for defined contribution plans; and services for high net worth individuals. Revenue from participant recordkeeping and investment management for defined contribution plans was particularly strong. This reflected growth of the current business, new business installed and an acquisition. Total assets under management were $321 billion, up 27% from a year ago. Three quarters of this growth came from additional contributions from customers and new customers, with one quarter from increased market values. Foreign exchange trading revenue was $46 million, up $12 million, or 37%, from a year ago due to additional volume, active markets and new customers looking to State Street to support their global investment strategies. Servicing and processing fee revenue was $40 million, up $12 million, or 40%, from a year ago. This reflected the acquisition of Princeton Financial Systems, Inc. in the fourth quarter of 1996, strong growth in fees from brokerage services, and increased fee revenue from currency hedging programs for customers. As is typical, other fee revenue includes a number of timing items. This quarter, the timing items netted to $2 million, a relatively low number, as compared with $11 million, a relatively high number a year ago which benefited from the sale of the unit trust business. This year, currency translation gains on foreign notes payable and gains on leasing residuals were partially offset by a write down in the value of property that is no longer intended to be used for bank premises. Net Interest Revenue Taxable equivalent net interest revenue for the first quarter was $160 million, up $21 million, or 15%, from a year ago due to a $4 billion, or 16%, increase in interest-earning assets. The primary source of growth in interest-earning assets was additional funding from securities sold under repurchase agreements and deposits from customers in conjunction with their worldwide investment activities. <TABLE> <CAPTION> - -------------------------------------------------------------------------------------------------------------------------------- Three Months Ended March 31, 1997 1996 --------------------------- --------------------------- AVERAGE Average (Dollars in millions) BALANCE RATE Balance Rate - ------------------------------------------------------------- --------------------------- --------------------------- <S> <C> <C> <C> <C> Interest-earning assets................................ $ 29,164 5.67% $ 25,094 5.67% Interest-bearing liabilities........................... 23,932 4.20 20,467 4.22 ------- ------- Excess of rates earned over rates paid................. 1.47% 1.45% ======= ======= Net Interest Margin.................................... 2.22% 2.23% ======= ====== </TABLE>
Operating Expenses Operating expenses for the first quarter of $391 million were up $63 million, or 19%, from the first quarter of 1996 supporting business growth and investments for future growth, and reflecting acquisitions. Salaries and employee benefits were $219 million, up $38 million, or 21%. Staff levels increased 13% and incentive compensation was higher reflecting strong growth in earnings. Credit Quality At March 31, 1997, total loans were $5 billion, 14% of the balance sheet. In the first quarter, the provision for loan losses was $3 million, up from $2 million a year ago and charge-offs were $6 million, due principally to one trade finance loan, versus less than a million for the first quarter of 1996. During the quarter, the allowance for loan losses decreased from $73 million to $70 million. Non-performing loans declined from $12 million to $6 million. Taxes Taxes were $44 million, up from $38 million a year ago. The effective tax rate was 33.6%, down from 35.4% in the first quarter of 1996. The improvement in the effective tax rate reflected a higher level of tax credits and the implementation of initiatives to maximize tax resources worldwide. Lines of Business Following is a summary of line of business operating results for the three months ended March 31: <TABLE> <CAPTION> - ----------------------------------------------------------------------------------------------------------------------------------- Financial Investment Commercial Taxable equivalent basis Asset Services Management Lending (Dollars in millions) 1997 1996 1997 1996 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> <C> <C> Fee revenue................................ $ 268 $ 228 $ 92 $ 67 $ 14 $ 12 Net interest revenue....................... 113 95 6 8 38 34 ----- ----- ---- ---- ---- ---- Total revenue........................ 381 323 98 75 52 46 Operating expenses......................... 289 248 79 59 23 21 ===== ===== ==== ==== ==== ==== Operating profit..................... $ 92 $ 75 $ 19 $ 16 $ 29 $ 25 ===== ===== ==== ==== ==== ==== Pretax margin.............................. 24% 23% 19% 21% 56% 55% Percentage contribution.................... 66% 64% 13% 14% 21% 22% Average assets (billions).................. $28.7 $24.8 $ .6 $ .5 $3.6 $3.0 </TABLE> Financial Asset Services Financial Asset Services provides accounting, custody, daily pricing, information, foreign exchange, 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 quarter. Revenue increased to $381 million, up 18% from $323 million in 1996. The $58 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, who are growing and using more services. Fee revenue was up 18%. This reflected strong growth in revenue 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. Net interest revenue, also up 18%, 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 were $289 million, 17% higher than a year ago, due to business growth and investments for future growth, and reflecting acquisitions. Operating profit was $92 million, an increase of $17 million, or 24%, from a year ago and reflected strong revenue growth as well as an improvement in the pre-tax 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 quarter. Revenue grew 30% to $98 million, due to revenue growth across the product line. Operating expenses increased 34% reflecting additional staff to support business growth and acquisitions. Operating profit was $19 million, an increase of $3 million, or 16%, from $16 million in 1996. The pretax profit margin declined from 14% in 1995 to 13% in 1996. Commercial Lending Reported in this line of business are loans 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 quarter. Revenue grew to $52 million, up 13% from $46 million in the first quarter a year ago, 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 increased 11%, supporting business growth. Operating profit was $29 million, an increase of $4 million, or 10% from 1996, due to revenue growth and an improvement in the pre-tax margin. Accounting Changes In June 1996, 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 did not have 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 March 31, 1997 and 1996 would have resulted in basic earnings per share of $1.07 and $.85, respectively, and diluted earnings per share of $1.05 and $.84, respectively. Capital and Liquidity State Street maintains a strong capital base to support its customers. Strong capital levels provide financial flexibility as well, which facilitates funding corporate growth and other business needs. As a state chartered bank and member of the Federal Reserve System, State Street Bank and Trust Company, State Street's principal subsidiary, 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 the Bank meets or exceeds the level required for the "well capitalized" category, the highest of the Federal Reserve Board's five capital categories. State Street's capital management emphasizes risk exposure rather than simple asset levels; at 12.1%, the Bank's Tier 1 risk-based capital ratio significantly exceeds the regulatory minimum of 4% and is among the highest for U.S. banks. State Street's total risk-based ratio of 15.0% is likewise 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 March 31, 1997, State Street's liquid assets were 78% of total assets. Foreign Exchange And Derivative Financial Instruments State Street used foreign exchange and a variety of financial derivative instruments to support customers' needs, conduct trading activities, and manage 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 March 31, 1997, the notional amount of these instruments was $84.2 billion, of which $80.4 billion was foreign exchange forward contracts. Long and short foreign exchange forward positions are closely matched 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 March 31, 1997, the notional amount of these derivatives was $357 million. Trading activities involving both foreign exchange and interest rate derivatives are managed using earnings-at-risk measures and trading limits as established by risk management policies. Interest rate and foreign exchange derivatives 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. Stock Purchase Program State Street purchased 1,080,000 shares of its stock during the first quarter of 1997 at an average price of $75 per share. This brings the total shares purchased to 4.2 million of the 6 million shares currently authorized by the Board of Directors. Financial Goals and Factors Which 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 stockholder's 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 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 rather than lower interest rates because it has a larger amount of interest-earning assets than interest-bearing liabilities. However, if all other variables remained constant, in the short-term, rising rates would lead to lower net interest revenue; falling interest rates would lead to net interest revenue which is higher than 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. Conclusion The first quarter of 1997 was another excellent, record-breaking quarter. The strong momentum developed in 1996 was evident not only in the first quarter's financial results, but also in State Street's successful sales efforts. In the quarter, the market confirmed that State Street is on the right track, as both existing and new customers awarded State Street with a record amount of new business. Continued new business success helps extend State Street's momentum through the years ahead. Very strong financial performance in the first quarter continued the substantial earnings and sales momentum achieved in 1996. These achievements-outstanding financial performance and continued effective marketing of a wide array of products-resulted from the successful execution of State Street's strategic plan, which focuses on serving institutional investors worldwide. While management is optimistic about 1997, the 25% earnings per share growth rate in the first quarter is substantially above State Street's average of 15% per year for the last 10 years. State Street's primary objective continues to be long-term earnings per share growth for stockholders.
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Information concerning legal proceedings appears in Note I to the Consolidated Financial Statements on Pages 8 and 9 of this report, and such information is incorporated herein by reference. ITEM 2. CHANGES IN SECURITIES On February 20, 1997, the Board of Directors of State Street voted a two-for-one stock split in the form of a 100 percent stock dividend to stockholders of record on April 30, 1997 distributable on May 28, 1997. This stock dividend and an increase in the authorized shares to 250 million was approved by the stockholders at the annual meeting on April 16, 1997. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS None ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibit Index Exhibit Number Page of this Report 11 Statement re: computation of per share earnings 21 12 Ratio of Earnings to Fixed Charges 22 15 Letter re: unaudited interim financial information 23 27 Financial data schedule 24 (b) Reports on Form 8-K A current report on Form 8-K dated February 27, 1997 was filed by the Registrant with the Securities and Exchange Commission which reported that on December 20, 1996, the Registrant completed the sale of $200 million of 7.94% Capital Securities, Series A (the "Capital Securities") issued by State Street Institutional Capital A (the "Trust"), a newly created subsidiary business trust of the Registrant. The Capital Securities are fully guaranteed by the Registrant. In connection with the sale of the Capital Securities, the Registrant issued and sold to the Trust $206 million of its 7.94% Junior Subordinated Deferrable Interest Debentures, Series A (the "Debentures").
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: May 12, 1997 By: /s/ RONALD L. O'KELLEY ---------------------------------------------------- Ronald L. O'Kelley Executive Vice President and Chief Financial Officer Date: May 12, 1997 By: /s/ REX S. SCHUETTE ---------------------------------------------------- Rex S. Schuette Senior Vice President and Comptroller