DBRS Confirms State Street Corporation at AA (low); Trend Revised to Positive from Stable

DBRS, Inc. (DBRS) confirmed the ratings for State Street Corporation (State Street or the Company), including the Company’s Long-Term Issuer rating of AA (low). At the same time, DBRS confirmed the ratings of its primary banking subsidiary, State Street Bank and Trust Company (the Bank). With the exception of the Company’s and the Bank’s short-term ratings, the trend on all other ratings has been revised to Positive from Stable. The Intrinsic Assessment (IA) for the Bank is AA, while its Support Assessment remains SA1. The Company’s Support Assessment is SA3 and its Long-Term Issuer Rating is positioned one notch below the Bank’s IA.

KEY RATING CONSIDERATIONS
State Street’s ratings reflect its powerful franchise, which includes a dominant global market position in investment servicing and top-tier investment management business. DBRS views these businesses as defensible and sustainable, considering their significant barriers to entry and that many of the related activities are critical to the functioning of financial markets, regardless of the business cycle stage. Further, these businesses produce a substantial amount of recurring, fee-based revenues, as well as a low risk and highly liquid balance sheet. Finally, the ratings also consider the operational and reputational risks associated with the important role State Street plays in the global financial markets that are growing increasingly complex, as well as fee pressures within its asset management business. DBRS notes that State Street’s business mix is more heavily weighted towards equity market valuations to generate fees than other trust bank peers, which are typically more volatile.

RATING DRIVERS
Given State Street’s long history of stable, predictable and favorable results, the ratings could be upgraded if the Company continues to generate similar financial results, while maintaining its strong balance sheet. The Positive trend also assumes a seamless CEO transition once Jay Hooley steps down at year end. While DBRS sees downward rating action as unlikely, sustained negative operating leverage, missteps in managing operational and/or reputational risk that negatively impact franchise strength, or the inability to consistently win new business would have negative rating implications.

RATING RATIONALE
State Street reported strong and improved results for the first six months of 2018 (1H18), including positive operating leverage and $1.3 billion of net income available to common shareholders (up 27% versus 1H17), representing a ROE of 13.7% (up from 11.3%). Notably, the Company generated $1.5 trillion of new business wins primarily due to the onboarding of Vanguard, offsetting the BlackRock transition (announced in early 2017), of which more than half has been completed.

With this momentum and continued favorable financial markets, assets under custody and/or administration (AUC/A) increased 9% over the past year, reaching $33.9 trillion. In addition, assets under management (AUM) grew 5% from the end of 2Q17 to $2.6 trillion, reflecting ETF inflows, partially offset by lower-yielding institutional outflows. Strong trading activity and significantly improved net interest income also boosted top-line results, as total revenues were 10% higher in the period, mitigating a moderate amount of expense growth largely related to continued strategic investments and higher incentive compensation.

In late July, State Street also announced its acquisition of Charles River Development (CRD), a provider of investment management front office solutions across all asset classes for portfolio management, trading and compliance. DBRS views the deal favorably, recognizing the potential long-term benefits for the entire franchise, including significant revenue synergies, enhanced digital capabilities and a differentiated product suite, as State Street would have the industry’s first front-to-middle-to-back office platform. The purchase price of the transaction is $2.6 billion, which will be funded with the suspension of buybacks through the end of the year (about $950 million) and the remainder via equity and preferred issuance, about two-thirds and one-third, respectively.

Incorporating the impact from CRD, the Federal Reserve did not object to State Street’s capital plan, which included a 12% increase in the quarterly dividend and approval of a $1.2 billion share buyback that the Company would likely resume beginning in 2019. While not subject to a resubmission, the Fed has required State Street to enhance its management and analysis of counterparty exposures under stress due to its outsized trading and counterparty losses experienced in the Fed’s stress tests. Although State Street had been a top-tier performer in previous stress tests, DBRS notes that this year’s hypothetical scenarios were the most onerous to date, recognizing that results of the exercise remain opaque. Nonetheless, DBRS still views State Street’s capital position as robust even considering the Fed’s “conditional” non-objection.

State Street’s funding and liquidity profile remains very strong, providing key support to the ratings. At the end of 2Q18, the Company’s deposit base represented 83% of total liabilities and its high-quality securities portfolio comprised 40% of total assets. Additionally, 90% of State Street’s investment securities are rated at least AA, and the duration of the total portfolio remains relatively short at 3.2 years. Meanwhile, the Company’s loan portfolio, which represents 10% of total assets, is still the smallest of the trust banks, though it continues to grow, with credit quality remaining pristine. DBRS notes that State Street’s $3.7 billion leveraged loan portfolio, while large, remains manageable, considering its modest contribution to the Company’s balance sheet (1.5% of total assets).

State Street Corporation, a diversified financial services corporation headquartered in Boston, Massachusetts, reported $248 billion in consolidated assets as of June 30, 2018.

The Grid Summary Grades for State Street are as follows: Franchise Strength – Very Strong/Strong; Earnings Power – Very Strong/Strong; Risk Profile – Very Strong/Strong; Funding & Liquidity – Very Strong; Capitalisation – Very Strong/Strong.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (July 2018), which can be found on our website under Methodologies.

The primary sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

Lead Analyst: Michael McTamney, Vice President – Global FIG
Rating Committee Chair: Michael Driscoll, Managing Director, Head of NA FIG – Global FIG
Initial Rating Date: 11 November 2005
Last Rating Date: 18 August 2017

The rated entity or its related entities did participate in the rating process for this rating action. DBRS had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

For more information on this credit or on this industry, visit www.dbrs.com.