CHICAGO--(BUSINESS WIRE)--State Street Corporation's (STT) third quarter 2016 (3Q16) earnings were satisfactory, and adversely impacted by the closing of the company's acquisition of General Electric's asset management (GEAM) business, according to Fitch Ratings.
STT's overall return on average equity (ROE) was 10.6% in 3Q16, down 12.4% in the sequential quarter and down from 11.3% in the year-ago quarter. The decline was due to higher costs associated with the closing of the GEAM transaction noted above.
STT's overall revenue was up 1.8% relative to the sequential quarter and essentially flat from the year ago quarter. Despite $65 million of incremental fee revenue from the GEAM transaction, overall fee revenue was up only 1.3% relative to the sequential quarter, and down 1.1% from the year-ago quarter.
The year-over-year decline was due to lower trading revenue, including lower foreign exchange (fx) trading revenue relative to the prior year period. Higher asset management fees largely due to the closing GEAM transaction were offset by lower fx trading revenue and lower securities finance revenue relative to the sequential quarter, which was particularly strong for fx trading given the market volatility surrounding the BREXIT vote.
Higher net interest revenue (NIR) offset some of the comparatively lower serving fee revenue and declines in fx trading and securities finance revenue. NIR was up 3.1% sequentially and 4.7% year-over-year. This was due to continued deposit growth as well as a modestly higher net interest margin relative to the year-ago period.
Total deposits grew 2.9% sequentially and 6.7% year-over-year, despite management's continued efforts at optimizing its overall deposit base in light of Enhanced Supplementary Leverage Ratio (ESLR) requirements.
STT's NIM on a fully taxable equivalent basis was 1.14% at 3Q16, unchanged from the sequential quarter, but up 14 basis points from the year-ago quarter. Sequentially the higher deposit growth was offset by lower yields on residential mortgage backed securities given higher levels of mortgage pre-payments during the quarter. On a year-over-year basis, NIM benefited from the Federal Reserve's rate hike late last year.
Overall expenses on a stated basis were up 6.7% sequentially, and 1.1% year-over-year. 3Q16 expenses included $57 million of run-rate expenses related to GEAM and $29 million of one-time acquisition related costs related to this transaction. Additionally, STT incurred a modest $10 million restructuring charge in 3Q16 related to its cost savings initiative, Project Beacon.
Taken together, on a stated (or GAAP) basis and therefore inclusive of all costs related to GEAM, STT did not achieve positive operating leverage in 3Q16 relative to the prior or year-ago quarter. However, STT remains focused on Project Beacon, which over the life of the program is expected to achieve $550 million of expense savings by the end of 2020.
In 2016, Beacon is estimated to generate $165 million in expense savings, and in 2017 it is expected to generate an additional $125 million of savings. This has the potential to create positive operating leverage in the future to the extent that it continues to digitize more and more of STT's back and middle office operations.
Given the muted revenue growth noted previously, this initiative remains a key lever management can use to at least maintain, if not improve, overall earnings on a go-forward basis.
STT continues to maintain a very liquid balance sheet. The $99.8 billion investment portfolio represents 38.9% of total assets, with 92.5% of its bonds rated 'AAA'/'AA' and a modest duration of 2.1 years. In addition to the investment portfolio, STT has cash on balance sheet which amounted to $82.5 billion at 3Q16, or 32.2% of total assets.
Given the large cash component of the balance sheet as well as the modest duration of the investment portfolio, STT remains very asset sensitive. At the same time, the company estimates that a 100 basis point upwards shock to interest rates would cause a mark-to-market loss of $0.8 billion, or .80% impact, to the investment portfolio. Fitch considers this manageable.
STT's estimated fully phased-in Basel III Common Equity Tier 1 (CET1) ratio on a standardized basis was 12.0% at 3Q16 up from 11.5% at 2Q16 and on an advanced approach basis was 11.8% in 3Q16 up from 11.6% in 2Q16. 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 ESLR for STT and its peer large processing banks. As of 3Q16, STT's SLR at the holding company was 6.0%, 100 basis points above the requirement, and at the main bank subsidiary was 6.3%, 30 basis points above the requirement.
Additional information is available at www.fitchratings.com.
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