<PAGE>
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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 September 30, 2000
[_]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 02110
Boston, Massachusetts (Zip Code)
(Address of principal
executive office)
617-786-3000
(Registrant's telephone number, including area code)
-------------------------------------
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 October
31, 2000 was 161,469,188.
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<PAGE>
STATE STREET CORPORATION
Table of Contents
<TABLE>
<CAPTION>
Page
----
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Statements of Income........................................ 1
Consolidated Statement of Condition...................................... 3
Consolidated Statement of Cash Flows..................................... 4
Consolidated Statement of Changes in Stockholders' Equity................ 5
Notes to Consolidated Financial Statements............................... 6
Independent Accountants' Review Report................................... 13
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 14
Item 3. Quantitative and Qualitative Disclosure About Market Risk........ 23
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K................................. 23
Signatures............................................................... 24
Exhibits
</TABLE>
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS
Consolidated Statement of Income - State Street Corporation (Unaudited)
<TABLE>
------------------------------------------------------------------------------
<CAPTION>
(Dollars in millions, except per share data) Three months
ended September 30, 2000 1999
------------------------------------------------------------------------------
<S> <C> <C>
Fee Revenue
Fiduciary compensation:
Services for Institutional Investors........................ $ 359 $ 297
Investment Management....................................... 140 155
-------- --------
Total fiduciary compensation............................... 499 452
Foreign exchange trading.................................... 89 68
Servicing and processing.................................... 56 47
Other....................................................... 12 4
-------- --------
Total fee revenue.......................................... 656 571
Net Interest Revenue
Interest revenue............................................ 838 626
Interest expense............................................ 603 428
-------- --------
Net interest revenue....................................... 235 198
Provision for loan losses................................... 3 4
-------- --------
Net interest revenue after provision for loan losses....... 232 194
-------- --------
Total Revenue.............................................. 888 765
Operating Expenses
Salaries and employee benefits.............................. 377 321
Information systems and communications...................... 78 73
Transaction processing services............................. 68 60
Occupancy................................................... 51 48
Other....................................................... 91 74
-------- --------
Total operating expenses................................... 665 576
-------- --------
Income before income taxes................................. 223 189
Income taxes................................................ 73 63
-------- --------
Net Income................................................. $ 150 $ 126
======== ========
Earnings Per Share
Basic...................................................... $ .93 $ .78
Diluted.................................................... .91 .77
Average Shares Outstanding (in thousands)
Basic...................................................... 161,221 160,829
Diluted.................................................... 164,482 163,316
Cash Dividends Declared Per Share........................... $ .17 $ .15
</TABLE>
--------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
1
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Income - State Street Corporation (Unaudited)
<TABLE>
------------------------------------------------------------------------------
<CAPTION>
(Dollars in millions, except per share data) Nine months
ended September 30, 2000 1999
------------------------------------------------------------------------------
<S> <C> <C>
Fee Revenue
Fiduciary compensation:
Services for Institutional Investors........................ $ 1,070 $ 860
Investment Management....................................... 452 432
-------- --------
Total fiduciary compensation............................... 1,522 1,292
Foreign exchange trading.................................... 296 231
Servicing and processing.................................... 175 148
Other....................................................... 24 27
-------- --------
Total fee revenue.......................................... 2,017 1,698
Net Interest Revenue
Interest revenue............................................ 2,332 1,800
Interest expense............................................ 1,670 1,214
-------- --------
Net interest revenue....................................... 662 586
Provision for loan losses................................... 8 12
-------- --------
Net interest revenue after provision for loan losses....... 654 574
-------- --------
Total Revenue.............................................. 2,671 2,272
Operating Expenses
Salaries and employee benefits.............................. 1,129 953
Information systems and communications...................... 231 218
Transaction processing services............................. 209 169
Occupancy................................................... 149 140
Other....................................................... 273 230
-------- --------
Total operating expenses................................... 1,991 1,710
-------- --------
Income before income taxes................................. 680 562
Income taxes................................................ 232 192
-------- --------
Net Income................................................. $ 448 $ 370
======== ========
Earnings Per Share
Basic...................................................... $ 2.78 $ 2.30
Diluted.................................................... 2.73 2.26
Average Shares Outstanding (in thousands)
Basic...................................................... 160,637 160,939
Diluted.................................................... 163,738 163,794
Cash Dividends Declared Per Share........................... $ .50 $ .44
</TABLE>
--------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
2
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Condition - State Street Corporation
<TABLE>
------------------------------------------------------------------------------
<CAPTION>
September 30, December 31,
(Dollars in millions) 2000 1999
------------------------------------------------------------------------------
(Unaudited)
<S> <C> <C>
Assets
Cash and due from banks............................ $ 1,266 $ 2,930
Interest-bearing deposits with banks............... 18,101 16,902
Securities purchased under resale agreements and
securities borrowed............................... 18,134 17,518
Federal funds sold................................. 2,150 410
Trading account assets............................. 891 786
Investment securities (principally available-for-
sale)............................................. 14,923 14,703
Loans (less allowance of $56 and $48).............. 5,633 4,245
Premises and equipment............................. 675 732
Accrued income receivable.......................... 754 717
Other assets....................................... 2,452 1,953
-------- --------
Total Assets.................................... $ 64,979 $ 60,896
======== ========
Liabilities
Deposits:
Noninterest-bearing............................... $ 8,855 $ 8,943
Interest-bearing:
U.S.............................................. 2,342 1,917
Non-U.S.......................................... 25,742 23,285
-------- --------
Total deposits.................................. 36,939 34,145
Securities sold under repurchase agreements........ 19,293 18,399
Federal funds purchased............................ 577 1,054
Other short-term borrowings........................ 729 1,104
Accrued taxes and other expenses................... 1,311 1,133
Other liabilities.................................. 1,821 1,488
Long-term debt..................................... 1,220 921
-------- --------
Total Liabilities............................... 61,890 58,244
Stockholders' Equity
Preferred stock, no par: authorized 3,500,000;
issued none.......................................
Common stock, $1 par: authorized 250,000,000;
issued 167,174,000 and 167,225,000................ 167 167
Surplus............................................ 71 55
Retained earnings.................................. 3,162 2,795
Net unrealized losses.............................. (51) (57)
Treasury stock, at cost (5,839,000 and 7,635,000
shares)........................................... (260) (308)
-------- --------
Total Stockholders' Equity...................... 3,089 2,652
-------- --------
Total Liabilities and Stockholders' Equity...... $ 64,979 $ 60,896
======== ========
------------------------------------------------------------------------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
3
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Cash Flows - State Street Corporation (Unaudited)
<TABLE>
---------------------------------------------------------------------------------
<CAPTION>
(Dollars in millions) Nine months ended September 30, 2000 1999
---------------------------------------------------------------------------------
<S> <C> <C>
Operating Activities
Net Income.................................................... $ 448 $ 370
Non-cash charges for depreciation, amortization, provision for
loan losses and deferred income taxes........................ 199 253
------- -------
Net income adjusted for non-cash charges................... 647 623
Adjustments to reconcile to net cash (used) provided by
operating activities:
Securities gains, net........................................ (1) (11)
Net change in:
Trading account assets...................................... (105) (175)
Other, net.................................................. (141) (271)
------- -------
Net Cash Provided by Operating Activities.................. 400 166
------- -------
Investing Activities
Payments for purchases of:
Available-for-sale securities................................ (4,336) (9,685)
Held-to-maturity securities.................................. (305) (667)
Lease financing assets....................................... (772) (177)
Premises and equipment....................................... (97) (148)
Proceeds from:
Maturities of available-for-sale securities.................. 3,691 4,192
Maturities of held-to-maturity securities.................... 263 641
Sales of available-for-sale securities....................... 504 804
Principal collected from lease financing..................... 29 80
Net (payments for) proceeds from:
Interest-bearing deposits with banks......................... (1,199) (1,991)
Federal funds sold, resale agreements and securities
borrowed.................................................... (2,356) 437
Loans........................................................ (1,147) (744)
------- -------
Net Cash Used by Investing Activities...................... (5,725) (7,258)
------- -------
Financing Activities
Proceeds from issuance of:
Non-recourse debt for lease financing........................ 638 127
Long-term debt............................................... 300
Treasury stock............................................... 72 20
Payments for:
Non-recourse debt for lease financing........................ (41) (101)
Long-term debt............................................... (4) (1)
Cash dividends............................................... (79) (70)
Purchase of common stock..................................... (61) (125)
Net proceeds from (payments for):
Deposits..................................................... 2,794 4,414
Short-term borrowings........................................ 42 3,036
------- -------
Net Cash Provided by Financing Activities.................. 3,661 7,300
------- -------
Net (Decrease) Increase.................................... (1,664) 208
Cash and due from banks at beginning of period................ 2,930 1,365
------- -------
Cash and Due From Banks at End of Period................... $ 1,266 $ 1,573
======= =======
</TABLE>
--------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
4
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Consolidated Statement of Changes in Stockholders' Equity - State Street
Corporation (Unaudited)
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
(Dollars in millions, except share data) Nine
months ended September 30, 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Common Stock
Balance at end of period (no change during
period)........................................ $ 167 $ 167
Surplus
Balance at beginning of period.................. 55 63
Treasury stock issued........................... (36) (54)
Stock options exercised......................... 52 38
------- -------
Balance at end of period....................... 71 47
------- -------
Retained Earnings
Balance at beginning of period.................. 2,795 2,272
Net income...................................... 448 $ 448 370 $ 370
Cash dividends declared ($.50 and $.44 per
share)......................................... (81) (70)
------- -------
Balance at end of period....................... 3,162 2,572
------- -------
Net Unrealized (Losses) Gains--Other
Comprehensive Income
Balance at beginning of period.................. (57) 22
Foreign currency translation.................... (19) (19) (4) (4)
Net unrealized gain on available-for-sale
securities..................................... 25 25 (58) (58)
------- ----- ------- -----
6 (62)
----- -----
Balance at end of period....................... (51) (40)
------- -------
Comprehensive Income............................ $ 454 $ 308
===== =====
Treasury Stock, at Cost
Balance at beginning of period.................. (308) (213)
Common stock acquired (644,000 and 1,894,000
shares)........................................ (61) (125)
Treasury stock issued (2,439,000 and 1,139,000
shares)........................................ 109 54
------- -------
Balance at end of period....................... (260) (284)
------- -------
Total Stockholders' Equity.................... $ 3,089 $ 2,462
======= =======
</TABLE>
--------------------------------------------------------------------------------
The accompanying notes are an integral part of these financial statements.
5
<PAGE>
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" or the "Corporation") is a
financial holding company that provides trust, investment management, global
custody, banking, administration and information services to both U.S. and
non-U.S. customers. State Street reports two lines of business. Services for
Institutional Investors includes accounting, custody, daily pricing,
administration, foreign exchange, cash management, lending activities, lease
financing and information services to support institutional investors.
Investment Management provides an extensive array of services for managing
financial assets worldwide for both institutional and individual investors as
well as recordkeeping, administration and investment services for defined
contribution plans and other employee benefit programs. The impact of the
business divestiture for nine months ended September 30, 1999, has been
presented separately under the caption "Business Divestiture" in Note I.
The consolidated financial statements include the accounts of State Street
and its subsidiaries, including its principal subsidiary, State Street Bank
and Trust Company ("State Street 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 using the
equity method. Certain previously reported amounts have been reclassified to
conform to the current method of presentation.
Total comprehensive income for the three months ended September 30, 2000 and
1999 was $175 million and $123 million, respectively. Total comprehensive
income for the nine months ended September 30, 2000 and 1999 was $454 million
and $308 million, respectively. A tax provision of $18 million and a benefit
of $41 million related to fair value adjustments for the investment portfolio,
and tax benefits of $13 million and $3 million related to foreign currency
translation, were included in other comprehensive income for the nine months
ended September 30, 2000 and 1999, respectively.
SFAS No. 138, "Accounting for Certain Derivative Instruments and Certain
Hedging Activities," was issued in June 2000. This statement requires
companies to record the fair value of derivatives on the balance sheet as
assets or liabilities. Fair market valuation adjustments for derivatives
meeting hedge criteria will be recorded as either other comprehensive income
or through earnings in the Consolidated Statement of Income, depending on
their classification. Derivatives used for trading purposes will continue to
be marked to market through earnings. State Street expects to adopt this
statement beginning January 1, 2001. Management does not expect the adoption
of this statement to have a material impact on the financial statements.
On December 3, 1999, the SEC issued Staff Accounting Bulletin 101, "Revenue
Recognition in Financial Statements" that provides guidance in applying
generally accepted accounting principles to revenue recognition in financial
statements. Management does not expect that the application of their guidance
will have a material impact on the financial statements.
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 September 30, 2000 and December
31, 1999, its cash flows for the nine months ended September 30, 2000 and
1999, and consolidated results of its operations for the three months and nine
months ended September 30, 2000 and 1999, have been made. These statements
should be read in conjunction with the financial statements and other
information included in State Street's latest annual report on Form 10-K.
Note B--Joint Venture
In April 2000, State Street and Citigroup completed the formation of
CitiStreet ("CitiStreet"), a 50/50 joint venture designed to service employee
benefit programs. State Street's contribution to the joint venture consisted
6
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
of its retirement investment services businesses and the total outsourcing
business of Wellspring Resources, LLC, a wholly owned subsidiary.
Note C--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>
September 30, 2000 December 31, 1999
------------------------------ ------------------------------
Unrealized Unrealized
Amortized ------------ Fair Amortized ------------ Fair
(Dollars in millions) Cost Gains Losses Value Cost Gains Losses Value
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Available for sale:
U.S. Treasury and
federal agencies...... $ 6,944 $ 9 $23 $ 6,930 $ 6,899 $ 2 $36 $ 6,865
State and political
subdivisions.......... 1,936 4 6 1,934 1,886 2 11 1,877
Asset-backed
securities............ 3,278 5 15 3,268 3,261 1 25 3,237
Collateralized mortgage
obligations........... 929 1 7 923 841 10 831
Other investments...... 567 2 9 560 630 1 5 626
------- --- --- ------- ------- --- --- -------
Total.................. $13,654 $21 $60 $13,615 $13,517 $ 6 $87 $13,436
======= === === ======= ======= === === =======
Held to maturity:
U.S. Treasury and
federal agencies...... $ 1,261 $ 2 $ 4 $ 1,259 $ 1,219 $ $11 $ 1,208
Other investments...... 47 47 48 48
------- --- --- ------- ------- --- --- -------
Total.................. $ 1,308 $ 2 $ 4 $ 1,306 $ 1,267 $ $11 $ 1,256
======= === === ======= ======= === === =======
</TABLE>
-------------------------------------------------------------------------------
During the nine months ended September 30, 2000, there were gross gains of
$1 million realized on the sales of $504 million of available-for-sale
securities. During the nine months ended September 30, 1999, there were gross
gains of $12 million and gross losses of $1 million realized on the sales of
$804 million of available-for-sale securities.
Note D--Allowance for Loan Losses
State Street establishes an allowance for loan losses to absorb probable
credit losses. Management's review of the adequacy of the allowance for loan
losses is ongoing throughout the year and is based, among other factors, on
previous loss experience, current economic conditions and adverse situations
that may affect the borrowers' ability to repay, timing of future payments,
estimated value of the underlying collateral, the performance of individual
credits in relation to contract terms and other relevant factors.
While the allowance is established to absorb probable losses inherent in the
total loan portfolio, management allocates the allowance for loan losses to
specific loans, selected portfolio segments and certain off-balance sheet
exposures and commitments. Adversely classified loans in excess of $1 million
are individually reviewed to evaluate risk of loss and are assigned a specific
allocation of the allowance. The allocations are based on an assessment of
potential risk of loss and include evaluations of the borrowers' financial
strength, discounted cash flows, collateral, appraisals and guarantees. The
allocations to portfolio segments and off-balance sheet exposures are based on
management's evaluation of relevant factors, including the current level of
problem loans and current economic conditions which are subject to change from
quarter to quarter. In addition, a portion of the allowance remains
unallocated as a general reserve for the entire loan portfolio. The general
reserve is based upon such factors as portfolio concentrations, historical
losses and current economic conditions.
On October 1, 1999, State Street completed the sale of its commercial
banking business, which included the transfer of $2.4 billion of commercial,
financial and real estate loans, and a $36 million allowance for loan losses.
7
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note D--Allowance for Loan Losses (continued)
Changes in the allowance for loan losses were as follows:
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- --------------
(Dollars in millions) 2000 1999 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Balance at beginning of period................... $ 53 $ 88 $ 48 $ 84
Provision for loan losses........................ 3 4 8 12
Loan charge-offs................................. (3) (1) (7)
Recoveries....................................... 3 1 3
------ ------ ------ ------
Balance at end of period........................ $ 56 $ 92 $ 56 $ 92
====== ====== ====== ======
</TABLE>
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Note E--Long-term Debt
On April 11, 2000, State Street filed a universal shelf registration
statement that allows for the offering and sale of unsecured debt securities,
capital securities, common stock, depositary shares and preferred stock, and
warrants to purchase such securities, including any shares into which the
preferred stock or depositary shares may be convertible. On June 15, 2000,
State Street issued $300 million in subordinated notes due 2010 at a coupon
rate of 7.65%. At September 30, 2000, $700 million of the shelf registration
is available for issuance.
Note F--Net Interest Revenue
Net interest revenue consisted of the following:
<TABLE>
-------------------------------------------------------------------------------
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- -------------
(Dollars in millions) 2000 1999 2000 1999
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest Revenue
Deposits with banks............................... $ 195 $ 121 $ 510 $ 372
Investment securities:
U.S Treasury and federal agencies................ 129 112 391 274
State and political subdivisions (exempt from
federal tax).................................... 22 18 64 51
Other investments................................ 83 59 243 153
Loans............................................. 75 117 216 337
Securities purchased under resale agreements,
securities borrowed and federal funds sold....... 319 193 865 600
Trading account assets............................ 15 6 43 13
------ ------ ------ ------
Total interest revenue.......................... 838 626 2,332 1,800
------ ------ ------ ------
Interest Expense
Deposits.......................................... 260 183 718 526
Other borrowings.................................. 320 227 893 635
Long-term debt.................................... 23 18 59 53
------ ------ ------ ------
Total interest expense.......................... 603 428 1,670 1,214
------ ------ ------ ------
Net interest revenue............................ $ 235 $ 198 $ 662 $ 586
====== ====== ====== ======
</TABLE>
-------------------------------------------------------------------------------
8
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note G--Operating Expenses - Other
The other category of operating expenses consisted of the following:
<TABLE>
-------------------------------------------------------------------------------
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
------------- -------------
(Dollars in millions) 2000 1999 2000 1999
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Professional services.............................. $ 31 $ 29 $ 98 $ 84
Advertising and sales promotion.................... 15 12 45 42
Other.............................................. 45 33 130 104
------ ------ ------ ------
Total operating expenses -- other................. $ 91 $ 74 $ 273 $ 230
====== ====== ====== ======
</TABLE>
-------------------------------------------------------------------------------
Note H--Regulatory Matters
The regulatory capital amounts and ratios were the following at September
30, 2000, and December 31, 1999:
<TABLE>
------------------------------------------------------------------------------------
<CAPTION>
Regulatory
Guidelines(/1/) State Street State Street Bank
------------------- ------------------ ------------------
Well
(Dollars in millions) Minimum Capitalized 2000 1999 2000 1999
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Risk-based ratios:
Tier 1 capital......... 4% 6% 14.1% 14.7% 13.0% 13.5%
Total capital.......... 8 10 15.2 14.7 13.2 13.7
Leverage ratio.......... 3 5 5.6 5.6 5.5 5.7
Tier 1 capital......... $ 3,512 $ 3,119 $ 3,198 $ 2,841
Total capital.......... 3,791 3,121 3,233 2,889
Adjusted risk-weighted
assets and market-risk
equivalents:
On-balance sheet...... $ 17,713 $ 15,293 $ 17,435 $ 15,108
Off-balance sheet..... 6,590 5,451 6,597 5,464
Market-risk
equivalents.......... 562 475 539 454
-------- -------- -------- --------
Total................ $ 24,865 $ 21,219 $ 24,571 $ 21,026
======== ======== ======== ========
</TABLE>
-------------------------------------------------------------------------------
(1) State Street Bank must meet the regulatory designation of "well
capitalized" in order for State Street to maintain its status as a
financial holding company. In addition, Regulation Y defines "well
capitalized" for a bank holding company such as State Street for the
purpose of determining eligibility for a streamlined review process for
acquisition proposals (for such purposes, "well capitalized" requires
State Street to maintain a minimum Tier 1 risk-based capital ratio of 6%
and a minimum total risk-based capital ratio of 10%).
9
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note I--Lines of Business
Further financial information by lines of business is contained within the
Lines of Business section of Management's Discussion and Analysis of Financial
Condition and Results of Operation on pages 17 and 18.
The following is a summary of the lines of business operating results for
the nine months ended September 30:
<TABLE>
------------------------------------------------------------------------------
<CAPTION>
Services for Investment Business
Institutional Investors Management Divestiture
----------------------- ----------- -------------
(Dollars in millions;
taxable equivalent) 2000 1999 2000 1999 2000 1999
------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Total revenue.............. $ 2,121 $ 1,695 $ 600 $ 516 $ 88
Income before income
taxes..................... 590 443 140 96 50
Average assets (billions).. 59.8 49.9 1.7 1.4 2.4
</TABLE>
-------------------------------------------------------------------------------
Note J--Earnings Per Share
The following table sets forth the computation of basic and diluted earnings
per share:
<TABLE>
------------------------------------------------------------------------------
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
----------------- -----------------
(Dollars in millions, except per share
data; shares in thousands) 2000 1999 2000 1999
------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Net Income................................ $ 150 $ 126 $ 448 $ 370
Earnings per share
Basic.................................... $ .93 $ .78 $ 2.78 $ 2.30
Diluted.................................. .91 .77 2.73 2.26
Basic average shares...................... 161,221 160,829 160,637 160,939
Stock options and stock awards........... 2,741 1,722 2,502 2,074
7.75% convertible subordinated
debentures.............................. 520 765 599 781
-------- -------- -------- --------
Dilutive average shares................... 164,482 163,316 163,738 163,794
======== ======== ======== ========
</TABLE>
-------------------------------------------------------------------------------
Note K--Income Taxes
The provision for income taxes included in the Consolidated Statement of
Income consisted of the following:
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
-------------- --------------
(Dollars in millions) 2000 1999 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Current......................................... $ 7 $ 27 $ 68 $ 95
Deferred........................................ 67 36 164 97
------ ------ ------ ------
Total provision................................ $ 74 $ 63 $ 232 $ 192
====== ====== ====== ======
Effective tax rate.............................. 33.1% 33.5% 34.3% 34.1%
====== ====== ====== ======
</TABLE>
-------------------------------------------------------------------------------
10
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note L--Commitments and Contingent Liabilities
State Street acts in a fiduciary or custodial capacity on behalf of its
customers. Assets under custody and assets under management are held by State
Street in a fiduciary or custodial capacity and 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 for these
services and considers the results in preparing its financial statements. In
the opinion of management, there are no contingent liabilities at September
30, 2000, which 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 actions can be successfully defended or
resolved without a material adverse effect on State Street's financial
position or results of operations.
Note M--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. A
derivative instrument is a contract or agreement whose value is derived from
interest rates, currency exchange rates or other financial indices. Derivative
instruments include forwards, swaps, options and other instruments with
similar characteristics. The use of these instruments generates fee, interest
or trading revenue. Associated with these instruments are market and credit
risks that could expose State Street to potential losses.
The following table summarizes the contractual or notional amounts of
derivative financial instruments held or issued by State Street for trading
and balance sheet management:
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
September 30, December 31,
(Dollars in millions) 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C>
Trading:
Interest rate contracts:
Swap agreements.................................... $ 2,625 $ 1,986
Options and caps purchased......................... 368 148
Options and caps written........................... 457 279
Futures--short position............................ 4,975 3,836
Options on futures purchased....................... 158 705
Options on futures written......................... 260 900
Foreign exchange contracts:
Forward, swap and spot............................. 152,080 122,795
Options purchased.................................. 388 187
Options written.................................... 240 205
Balance Sheet Management:
Interest rate contracts:
Swap agreements.................................... 180 180
Options and caps purchased......................... 30
</TABLE>
-------------------------------------------------------------------------------
11
<PAGE>
PART I. ITEM 1.
FINANCIAL STATEMENTS (continued)
Notes to Consolidated Financial Statements - State Street Corporation
(Unaudited)
Note M--Off-Balance Sheet Financial Instruments, Including Derivatives
(continued)
The following table represents the fair value as of September 30, 2000, and
December 31, 1999 and average fair value for the nine and twelve months then
ended, respectively, for State Street's financial instruments held or issued
for trading purposes:
<TABLE>
-------------------------------------------------------------------------------
<CAPTION>
September 30, December 31,
2000 1999
--------------- ---------------
Average Average
Fair Fair Fair Fair
(Dollars in millions) Value Value Value Value
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Foreign exchange contracts:
Contracts in a receivable position............ $ 1,422 $ 1,474 $ 1,160 $ 1,222
Contracts in a payable position............... 1,423 1,419 1,127 1,251
Other financial instrument contracts:
Contracts in a receivable position............ 14 27 40 19
Contracts in a payable position............... 16 13 7 4
</TABLE>
-------------------------------------------------------------------------------
The preceding amounts have been reduced by offsetting balances with the same
counterparty where a master netting agreement exists. Contracts in a
receivable position are reported in other assets in the Consolidated Statement
of Condition and contracts in a payable position are reported in other
liabilities.
Credit-related financial instruments include indemnified securities on loan,
commitments to extend credit or purchase assets, standby letters of credit and
letters of credit. 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:
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
September 30, December 31,
(Dollars in millions) 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C>
Indemnified securities on loan....................... $105,486 $ 77,352
Loan commitments..................................... 12,997 10,404
Asset purchase agreements............................ 5,696 3,585
Standby letters of credit............................ 4,047 3,128
Letters of credit.................................... 213 171
</TABLE>
-------------------------------------------------------------------------------
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 additional collateral
is necessary. State Street held, as collateral, cash and U.S. government
securities totaling $110.8 billion and $79.7 billion for indemnified
securities on loan at September 30, 2000, and December 31, 1999, respectively.
Loan commitments, asset purchase agreements, standby letters of credit and
letters of credit are subject to the same credit policies and reviews as
loans. The amount and nature of collateral is obtained based upon management's
assessment of the credit risk. Approximately 89% of the loan commitments will
expire in one year or less from the date of issue. Since many of the
commitments are expected to expire without being drawn, the total commitment
amounts do not necessarily represent future cash requirements.
12
<PAGE>
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 September 30, 2000, and the related
consolidated statements of income for the three-month and nine-month periods
ended September 30, 2000, and 1999, and the consolidated statements of cash
flows and changes in stockholders' equity for the nine-month periods ended
September 30, 2000, and 1999. These financial statements are the
responsibility of the Corporation'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 auditing standards generally accepted in the
United States, 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 accounting principles generally
accepted in the United States.
We have previously audited, in accordance with auditing standards generally
accepted in the United States, the consolidated statement of condition of
State Street Corporation as of December 31, 1999 (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 18, 2000, we expressed an unqualified opinion on
those consolidated financial statements.
Ernst & Young LLP
Boston, Massachusetts
October 18, 2000
13
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Summary
Earnings per share for the third quarter were $.91 on a diluted basis, an
increase of 18% from $.77 in the third quarter of 1999. Revenue grew 17% from
$775 million to $905 million. Net income was $150 million, up 19% from $126
million a year ago. Return on stockholders' equity was 19.8%.
Condensed Income Statement--Taxable Equivalent Basis
<TABLE>
----------------------------------------------------------------------------------------
<CAPTION>
Nine Months Ended
Three Months Ended September 30, September 30,
--------------------------------- -----------------
(Dollars in millions,
except per share data) 2000 1999 Change % 2000 1999 Change %
----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fee revenue:
Fiduciary compensation:
Services for
Institutional
Investors............ $ 359 $ 297 $ 62 20 $1,070 $ 860 $210 24
Investment
Management........... 140 155 (15) (10) 452 432 20 5
-------- -------- -------- ------- ------ ------ ---- ---
Total fiduciary
compensation........ 499 452 47 10 1,522 1,292 230 18
Foreign exchange
trading............... 89 68 21 30 296 231 65 28
Servicing and
processing............ 56 47 9 20 175 148 27 18
Other.................. 12 4 8 24 27 (3) (8)
-------- -------- -------- ------- ------ ------ ---- ---
Total fee revenue.... 656 571 85 15 2,017 1,698 319 19
Net interest revenue.... 252 208 44 21 712 613 99 16
Provision for loan
losses................. 3 4 (1) (38) 8 12 (4) (38)
-------- -------- -------- ------- ------ ------ ---- ---
Total revenue........ 905 775 130 17 2,721 2,299 422 18
Operating expenses...... 665 576 89 15 1,991 1,710 281 16
-------- -------- -------- ------- ------ ------ ---- ---
Income before income
taxes............... 240 199 41 21 730 589 141 24
Income taxes............ 73 63 10 17 232 192 40 22
Taxable equivalent
adjustment............. 17 10 7 69 50 27 23 82
-------- -------- -------- ------- ------ ------ ---- ---
Net income........... $ 150 $ 126 $ 24 19 $ 448 $ 370 $ 78 21
======== ======== ======== ======= ====== ====== ==== ===
Earnings Per Share
Basic.................. $ .93 $ .78 $ .15 19 $ 2.78 $ 2.30 $.48 21
Diluted................ .91 .77 .14 18 2.73 2.26 .47 21
</TABLE>
--------------------------------------------------------------------------------
(Percentage change based on dollars in thousands, except per share data)
Total Revenue
In the third quarter, total revenue was $905 million, up $130 million, or
17%, from a year ago, reflecting strong business growth. This growth was
partially offset by a reduction in revenue associated with the businesses
contributed to CitiStreet and the sale of the commercial banking business. When
prior period revenues are adjusted for the businesses contributed to
CitiStreet, total revenue growth for the third quarter of 2000 would have been
24% compared to the third quarter of 1999.
14
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
For the nine months ended September 30, 2000, total revenue was $2.7
billion, up $422 million, or 18%, from 1999. Revenue growth was primarily in
fiduciary compensation and net interest revenue.
Fee Revenue
Fee revenue for the third quarter of 2000 was $656 million, up $85 million,
or 15%, over 1999 and accounted for 72% of total revenue. Fee revenue growth
came principally from strong growth in State Street's core fiduciary
compensation revenue and foreign exchange trading revenue.
Fiduciary compensation is the largest component of fee revenue and is
derived from accounting, custody, daily pricing, information services,
securities lending, trusteeship services and investment management. Fiduciary
compensation was $499 million, up 10% from a year ago. The increase reflected
continued business growth for Services for Institutional Investors and
Investment Management, partially offset by a reduction in revenue associated
with the businesses contributed to CitiStreet.
Third quarter fiduciary compensation for Services for Institutional
Investors was $359 million, up 20% from the third quarter of 1999. This growth
is driven by three markets. Revenue growth from servicing mutual funds in the
U.S. was driven by growth in mutual fund assets, including non-U.S. assets,
and expanding relationships with existing customers. Total mutual fund assets
under custody as of September 30, 2000 were $2.9 trillion, up 20% over the
prior year. Growth in revenue from servicing U.S. pension plans reflected new
business from new customers, including customers gained in the acquisition of
Wachovia's institutional trust and custody business. Revenue from serving
institutional investors outside the United States increased for the quarter,
primarily due to new business from both new and existing customers. Assets
under custody of customers outside the U.S. increased 19% from the prior year,
to $537 billion. At quarter end, total assets under custody totaled $6.2
trillion, up 18% from a year earlier.
Fiduciary compensation for investment management was $140 million, down 10%
from 1999. Adjusted for CitiStreet, revenue for this line of business was up
25%. Revenue from investment management for institutional investors reflected
new business and expanding relationships with existing customers. Customers'
use of fixed income strategies, including money markets, and U.S. indexed
equity strategies drove revenue growth. Assets under management grew to $712
billion, up 22% from a year earlier.
Foreign exchange trading revenue was $89 million, compared to $68 million a
year ago. Foreign exchange trading revenue reflects three factors: the number
of customers doing business with State Street, the volume of cross-border
transactions and currency volatility. Currency volatility increased in State
Street's most-traded currencies, and trading volumes were strong; both in the
number and total dollar value of transactions. State Street has increased its
foreign exchange trading customer base with State Street Global Link(R), an e-
finance platform.
Servicing and processing revenue for the third quarter was $56 million
compared to $47 million in the third quarter of 1999, primarily due to growth
in brokerage and information services.
Other fee revenue consists of gains and losses on sales of securities,
trading account profits and losses, equity income from joint ventures and
miscellaneous gains and fees. Other fee revenue for the third quarter was $12
million, compared to $4 million a year ago. The increase primarily reflects
income from joint ventures.
15
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
For the nine months ended September 30, 2000, fee revenue was $2.0 billion,
up $319 million, or 19% from a year ago. Fiduciary compensation increased $230
million, or 18%. Foreign exchange trading revenue increased $65 million, or
28%.
Net Interest Revenue
Taxable-equivalent net interest revenue for the third quarter was $252
million, up 21% from $208 million a year ago. In serving institutional
investors worldwide, State Street provides short-term funds management,
including deposit services and repurchase agreements for cash positions
associated with customers' investment activities. The revenue associated with
deposit services and repurchase agreements, as well as from lending and lease
financing activities, is recorded as net interest revenue. Growth in net
interest revenue was primarily driven by increased customers' investment
activities, and wider interest rate spreads on that activity. Average non-U.S.
deposits increased $4.3 billion, or 21%, from the same quarter last year, and
average securities sold under repurchase agreements increased $2.2 billion, or
13%, over the prior year.
Net interest margin, which is defined as taxable-equivalent net interest
revenue as a percent of average interest-earning assets, increased from 1.66%
in the third quarter 1999 to 1.73% in the third quarter of 2000.
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
Three Months Ended
September 30,
----------------------------
2000 1999
------------- -------------
Average Average
(Dollars in millions) Balance Rate Balance Rate
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Interest-earning assets........................... $ 57,909 5.87% $ 50,024 5.04%
Interest-bearing liabilities...................... 49,170 4.88 43,243 3.92
---- ----
Excess of rate earned over rate paid............. .99% 1.12%
==== ====
Net Interest Margin.............................. 1.73% 1.66%
==== ====
</TABLE>
-------------------------------------------------------------------------------
For the nine months ended September 30, 2000, taxable equivalent net
interest revenue was $712 million, up $99 million, or 16% from the same period
in 1999, primarily driven by increased customers' investment activities.
Operating Expenses
Operating expenses for the quarter were $665 million, up 15% from the third
quarter of 1999. The increase reflects higher salaries and additional staff,
performance-based incentive compensation and investments for new products and
global expansion. When adjusted for the businesses contributed to CitiStreet,
operating expense growth would have been 24%.
Salaries and employee benefits were $377 million in the third quarter, up
17% from last year, primarily due to higher salaries, additional staff and
performance-based incentive compensation, partially offset by the transfer of
employees to CitiStreet. Higher salaries reflect the tight labor market, and
additional staff have been added to provide customer service and processing
for growing businesses. The growth in performance-based incentive compensation
reflects State Street's strong financial results in the quarter and the year-
over-year growth in the stock price.
Transaction processing services expense was $68 million in the third
quarter, up 15% from last year, reflecting increased business volumes as a
result of business growth.
Other expense, which includes professional services, advertising, sales
promotion and other expenses, was $91 million, up 21% from the third quarter
of 1999.
16
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
For the nine months ended September 30, 2000, operating expenses were up
$281 million, or 16%, from the first nine months of 1999 as a result of
business growth and strong financial results.
Income Taxes
The effective tax rate for the third quarter was 33.1%, reflecting a
revision to adjust the full year rate to 34.3%, which is the expected rate for
the year. The revision results from changes in income mix and projected tax
credits. The 34.3% rate is up slightly from the 1999 effective rate of 34.1%,
which excludes the effect of special items in 1999.
Credit Quality
At September 30, 2000, total loans (gross of allowance for loan losses) were
$5.7 billion. At quarter end, the allowance for loan losses was $56 million, a
decrease from $92 million a year ago, reflecting the sale of the commercial
banking business in 1999. During the quarter ended September 30, 2000,
recoveries were less than $1 million and the provision for loan losses charged
against income was $3 million. At September 30, 2000, non-performing loans
were $5 million, down from $7 million in the prior quarter and $17 million a
year ago.
Lines of Business
Following is a summary of line of business operating results for the nine
months ended September 30:
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
Services for Investment Business
Institutional Investors Management Divestiture
Taxable equivalent basis ------------------------ ------------ -------------
(Dollars in millions) 2000 1999 2000 1999 2000 1999
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Fee revenue:
Fiduciary
compensation.......... $1,070 $ 860 $452 $432
Foreign exchange
trading............... 296 231
Other.................. 124 111 75 49 $ 15
----------- ----------- ----- ----- ------
Total fee revenue..... 1,490 1,202 527 481 15
Net interest revenue.... 631 493 73 35 73
----------- ----------- ----- ----- ------
Total revenue......... 2,121 1,695 600 516 88
Operating expense....... 1,531 1,252 460 420 38
----------- ----------- ----- ----- ------
Income before income
taxes................ $ 590 $ 443 $140 $ 96 $ 50
=========== =========== ===== ===== ======
Pretax margin........... 28% 26% 23% 19% 57%
Average assets
(billions)............. $ 59.8 $ 49.9 $ 1.7 $ 1.4 $2.4
</TABLE>
-------------------------------------------------------------------------------
Services for Institutional Investors. Services for Institutional Investors
includes accounting, custody, daily pricing, and information services.
Customers around the world include mutual funds and other collective
investment funds, corporate and public pension plans, corporations, investment
managers, not-for-profit organizations, unions, and other holders of
investment assets. Institutional investors are offered State Street services,
including foreign exchange, cash management, securities lending, fund
administration, recordkeeping, banking services, and deposit and short-term
investment facilities. These services support institutional investors in
developing and executing their strategies, enhancing their returns, and
evaluating and managing risk. Revenue from this line of business comprised 78%
of State Street's total revenue for the nine months ended September 30, 2000.
17
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Total revenue for the nine months ended September 30, 2000, increased to
$2.1 billion, up 25% from $1.7 billion reported for the first nine months of
1999. The increase in revenue primarily reflected expanding relationships with
existing customers. Fee revenue was up $288 million, or 24%, due to growth in
fiduciary compensation and foreign exchange trading revenue. Fiduciary
compensation, up 24%, reflected revenue growth from accounting, custody,
securities lending, U.S. pension plans and customers outside the United
States. Foreign exchange trading revenue grew 28% from a year ago and reflects
the number of customers doing business with State Street, the volume of cross-
border transactions and currency volatility. Volatility within the currency
markets most-traded by State Street and trading volumes are higher, year over
year. Net interest revenue, up 27%, reflected balance sheet growth from the
increased use of securities sold under repurchase agreements and non-U.S.
deposits by institutional investors.
Operating expenses for the nine months ended September 30, 2000 were $1.5
billion, 22% higher than a year ago, due to higher performance-based
compensation, higher transaction processing expenses reflecting increased
business volumes, and investments for new products, efficiency initiatives and
global expansion. Income before income taxes was $590 million, an increase of
$147 million, or 33%, from 1999.
Investment Management. State Street manages financial assets worldwide for
both institutions and individuals and provides related services, including
participant services for defined contribution and other employee benefit
programs, and brokerage services. Investment management offers a broad array
of services, including passive and active equity, money market, and fixed
income strategies. Revenue from this line of business comprised 22% of State
Street's total revenue for the nine months ended September 30, 2000.
Revenue for the nine months ended September 30, 2000 increased to $600
million, up $84 million, or 16%, from $516 million reported for the first nine
months of 1999. Fiduciary compensation for the first nine months of 2000 grew
5%, to $452 million. Adjusted for CitiStreet, growth in fiduciary compensation
was up 29% due to growth across all services, primarily investment management
for institutional investors, reflecting new business and expanding
relationships with existing customers, including customers' use of fixed
income strategies. Revenue was also driven by strong performance in the equity
brokerage business.
Operating expenses of $460 million increased $40 million, or 10%, for the
first nine months of 2000, reflecting higher performance-based compensation,
higher transaction processing expenses due to increased business volumes, and
reinvestments for new products, efficiency initiatives and global expansion.
The growth in expense was partially offset by the transfer of 1,400 employees
to CitiStreet in April. Income before income taxes for the first nine months
of 2000 was $140 million, an increase of $44 million, or 46%, from the first
nine months of 1999.
Business Divestiture. Historical operating results for the commercial
banking business are contained in this caption. On October 1, 1999, State
Street completed the sale of this business, which consisted of a $2.4 billion
loan portfolio, a $36 million allowance for loan losses and $1.1 billion in
deposits. The historical revenues and expenses of this business include
allocations of other items in accordance with existing methodologies for line
of business presentation.
Joint Venture
In April 2000, State Street and Citigroup completed the formation of
CitiStreet. This transaction reduced total revenue in the third quarter of
2000, and reduced expenses by a slightly lesser amount relative to the three
months ended September 30, 1999.
18
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Liquidity and Capital
Liquidity. The primary objective of State Street's liquidity management is
to ensure that the Corporation has sufficient funds to meet its commitments
and business needs, and to accommodate the transaction and cash management
requirements of its customers. 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 payment of
loans. Customer deposits and other funds provide a multi-currency,
geographically diverse source of liquidity. State Street maintains a large
portfolio of liquid assets. As of September 30, 2000, the Corporation's liquid
assets were 85% of total assets.
On April 11, 2000, State Street filed a universal shelf registration
statement that allows for the offering and sale of unsecured debt securities,
capital securities, common stock, depositary shares and preferred stock, and
warrants to purchase such securities, including any shares into which the
preferred stock or depositary shares may be convertible. On June 15, 2000,
State Street issued $300 million in subordinated notes due 2010. The
subordinated notes have a fixed interest rate of 7.65%, are not secured, and
rank junior to State Street's senior indebtedness and its other financial
obligations.
Capital. State Street's objective is to maintain a strong capital base in
order to provide financial flexibility for its business needs, including
funding corporate growth and customers' cash management needs. As a state-
chartered bank and member of the Federal Reserve System, State Street Bank,
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 State
Street 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 asset
levels. At September 30, 2000, State Street Bank's Tier 1 risk-based capital
ratio was 13.0% and the Corporation's Tier 1 risk-based capital ratio was
14.1%. Both significantly exceed the regulatory minimum of 4%. See Note H to
the Consolidated Financial Statements for further information.
State Street's Board of Directors has authorized the purchase of 16 million
shares of State Street common stock for use in employee benefit programs and
for general corporate purposes. State Street purchased 602,000 shares in the
first nine months of 2000 as part of the stock purchase program. As of
September 30, 2000, an additional 2.4 million shares may be purchased under
this authorization.
Trading Activities: Foreign Exchange and Interest Rate Sensitivity
As part of its trading activities, the Corporation assumes positions in both
the foreign exchange and interest rate markets by buying and selling cash
instruments and using financial derivatives, including forward foreign
exchange contracts, foreign exchange and interest rate options, and interest
rate swaps. As of September 30, 2000, the notional amount of these derivative
instruments was $161.5 billion, of which $152.1 billion was foreign exchange
forward contracts. Long and short foreign exchange forward positions are
closely matched to minimize currency and interest rate risk. All foreign
exchange contracts are valued daily at current market rates.
The Corporation uses a variety of risk measurement and estimation
techniques, including value at risk. Value at risk is an estimate of potential
loss for a given period of time within a stated statistical confidence
interval. State Street uses a sophisticated risk management system, known as
Askari RiskBook(R) to estimate value at risk daily for all material trading
positions. The Corporation has adopted standards for estimating value at risk,
and maintains capital for market risk, in accordance with the Federal
Reserve's Capital Adequacy Guidelines for market risk. Value at risk is
estimated for a 99% one-tail confidence interval and an assumed one-day
holding period using a historical observation period of greater than one year.
A 99% one-tail confidence
19
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
interval implies that daily trading losses should not exceed the estimated
value at risk more than 1% of the time, or approximately three days out of the
year. The methodology uses a simulation approach based on observed changes in
interest rates and foreign exchange rates and takes into account the resulting
diversification benefits provided from the mix of the Corporation's trading
positions.
Like all quantitative measures, value at risk is subject to certain
limitations and assumptions inherent to the methodology. State Street's
methodology gives equal weight to all market rate observations regardless of
how recently the market rates were observed. The estimate is calculated using
static portfolios consisting of positions held at the end of the trading day.
Implicit in the estimate is the assumption that no intraday action is taken by
management during adverse market movements. As a result, the methodology does
not represent risk associated with intraday changes in positions or intraday
price volatility. The following table presents State Street's market risk for
its trading activities as measured by its value at risk methodology:
Value at Risk for the nine months ended September 30,
<TABLE>
--------------------------------------------------------------------------------
<CAPTION>
(Dollars in millions) Average Maximum Minimum
--------------------------------------------------------------------------------
<S> <C> <C> <C>
2000:
Foreign exchange contracts............................. $1.0 $2.1 $ .4
Interest rate contracts................................ 3.9 5.3 3.1
1999:
Foreign exchange contracts............................. 1.7 4.0 .8
Interest rate contracts................................ .2 .6
</TABLE>
-------------------------------------------------------------------------------
State Street compares actual daily profit and losses from trading activities
to estimated one-day value at risk. During the first nine months of 2000,
State Street did not experience any one-day trading loss in excess of its end
of day value at risk estimate.
Financial Goals and Factors That May Affect Them
State Street's primary financial goal is sustainable real growth in earnings
per share. The Corporation has two supporting goals, one for total revenue and
one for return on common stockholder's equity (ROE). The long-term revenue
goal is for a 12.5% real, or inflation adjusted, compound annual growth rate
of revenue from 1990 through 2010. This equates to approximately a 15% nominal
compound annual growth rate. The annual ROE goal is 18%.
State Street considers these to be financial goals, not projections or
forward-looking statements. However, the discussion included in Management's
Discussion and Analysis of Financial Condition and Results of Operations, and
in other portions of this report on Form 10-Q, may contain statements that are
considered "forward-looking statements" within the meaning of the federal
securities laws. These statements may be identified by such forward-looking
terminology as "expect," "look," "believe," "anticipate," "may," "will," or
similar statements or variations of such terms. The Corporation's financial
goals and such forward-looking statements involve certain risks and
uncertainties, including the issues and factors listed below and factors
further described in conjunction with the forward-looking information, which
could cause actual results to differ materially.
Factors that may cause such differences include, but are not limited to, the
factors discussed in this section and elsewhere in this Form 10-Q. Each of
these factors, and others, are also discussed from time to time in the
Corporation's other filings with the Securities and Exchange Commission,
including in the Corporation's Form 10-K.
20
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
Based on evaluation of the following factors, management is currently
optimistic about the Corporation's long-term prospects.
Cross-border investing. Increases in cross-border investing by customers
worldwide benefit State Street's revenue. Future revenue may increase or
decrease depending upon the extent of increases or decreases in cross-border
investments made by customers or future customers.
Savings rate of individuals. State Street benefits from the savings of
individuals that are invested in mutual funds or in defined contribution
plans. Changes in savings rates or investment styles may affect revenue.
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 the Corporation's fees
are based on the value of assets under custody and management, fluctuations in
worldwide securities market valuations will affect revenue.
Dynamics of markets served. Changes in markets served, 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,
can affect revenue. In general, State Street benefits from an increase in the
volume of financial market transactions serviced.
State Street provides services worldwide. Global and regional economic
factors and changes or potential changes in laws and regulations affecting the
Corporation's business, including volatile currencies, changes in monetary
policy, and social and political instability, could affect results of
operations.
Interest rates. Market interest rate levels, the shape of the yield curve
and the direction of interest rate changes affect net interest revenue as well
as fiduciary compensation from securities lending. All else being equal, in
the short term, State Street's net interest revenue benefits from falling
interest rates and is negatively affected by rising rates because interest-
bearing liabilities reprice sooner than interest-earning assets. In general,
sustained lower interest rates have a constraining effect on the net interest
revenue growth rate.
Volatility of currency markets. The degree of volatility in foreign exchange
rates can affect the amount of foreign exchange trading revenue. In general,
State Street benefits from currency volatility.
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 and investment management services. The pace of pension
reform and resulting programs including public and private pension schemes may
affect the pace of revenue growth.
Pricing/competition. Future prices the Corporation is able to obtain for its
products may increase or decrease from current levels depending upon demand
for its products, its competitors' activities and the introduction of new
products into the marketplace.
Pace of new business. The pace at which existing and new customers use
additional services and assign additional assets to State Street for
management or custody will affect future results of operations.
Business mix. Changes in business mix, including the mix of U.S. and non-
U.S. business, may affect future results of operations.
Rate of technological change. Technological change creates opportunities for
product differentiation and reduced costs, as well as the possibility of
increased expenses. Developments in the securities processing
21
<PAGE>
PART I. ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
industry, including shortened settlement cycles and ultimately straight-
through-processing, will result in changes to existing procedures. Alternative
delivery systems have emerged, including the widespread utilization of the
internet. State Street's financial performance depends in part on its ability
to develop and market new and innovative services and to adopt or develop new
technologies that differentiate State Street's products or provide cost
efficiencies.
There are risks inherent in this process. These include rapid technological
change in the industry, the Corporation's ability to access technical and
other information from customers, and the significant and ongoing investments
required to bring new services to market in a timely fashion at competitive
prices. Further, there is risk that competitors may introduce services that
could replace or provide lower-cost alternatives to State Street services.
State Street uses appropriate trademark, trade secret, copyright and other
proprietary rights procedures to protect its technology, and has applied for a
limited number of patents in connection with certain software programs.
However, in the event a third party asserts a claim of infringement of its
proprietary rights, obtained through patents or otherwise, against the
Corporation, State Street may be required to spend significant resources to
defend against such claims, develop a non-infringing program or process, or
obtain a license to the infringed process.
Acquisitions and alliances. Acquisitions of complementary businesses and
technologies, and development of strategic alliances are an active part of
State Street's overall business strategy. The Corporation has completed
several acquisitions and alliances in recent years. However, there can be no
assurance that services, technologies, key personnel and businesses of
acquired companies will be effectively assimilated into State Street's
business or service offerings or that alliances will be successful.
Gramm-Leach-Bliley Act of 1999. The Gramm-Leach-Bliley Act of 1999, enacted
by the U.S. Congress, may cause changes in the competitive environment in
which State Street operates. Such changes could include, among other things,
broadening the scope of activities of significant competitors, or facilitating
consolidation of competitors into larger, better capitalized companies,
offering a wide array of financial services and products; and attracting large
and well-capitalized financial services companies into activities not
previously undertaken but competitive to the Corporation's traditional
businesses. In addition, the Corporation's ability to engage in new activities
may expose it to business risks with which it has less experience than it has
with the business risks associated with its traditional businesses. Such
changes and the ability of the Corporation to address and adapt to the
regulatory and competitive challenges may affect future results of operations.
22
<PAGE>
PART I. ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
See information under the caption "Trading Activities: Foreign Exchange and
Interest Rate Sensitivity" on page 19.
PART II -- Other Information
Item 6. Exhibits and reports on Form 8-K
(a) Exhibit Index
<TABLE>
<CAPTION>
Exhibit
Number Page of this Report
------- -------------------
<C> <S> <C>
12 Ratio of Earnings to Fixed Charges.............. 25
15 Letter regarding unaudited interim financial
information..................................... 26
27 Financial data schedule......................... 27
</TABLE>
(b) Current Reports on Form 8-K
None
23
<PAGE>
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: November 9, 2000 /s/ Ronald L. O'Kelley
By: _________________________________
Ronald L. O'Kelley
Executive Vice President,
Treasurer
and Chief Financial Officer
Date: November 9, 2000 /s/ Frederick P. Baughman
By: _________________________________
Frederick P. Baughman
Senior Vice President, Controller
and
Chief Accounting Officer
24
