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Fitch Affirms State Street Corporation's IDR at 'AA-'; Outlook Stable
August 22, 2017 / 1:21 PM / a month ago

Fitch Affirms State Street Corporation's IDR at 'AA-'; Outlook Stable

(The following statement was released by the rating agency) CHICAGO, August 22 (Fitch) Fitch Ratings has affirmed State Street Corporation's (State Street) Long-Term Issuer-Default Rating (IDR) at 'AA-'. The Rating Outlook remains Stable. A full list of rating actions follows at the end of this release. KEY RATING DRIVERS IDRs, VRs AND SENIOR DEBT The affirmation of State Street's ratings reflects its strong franchise in asset custody, growing position in asset management, stable operating performance, and relatively conservative overall balance sheet posture. The company's high ratings continue to be supported primarily by its business model, which Fitch believes benefits from scale economies and possess high barriers to entry. Ratings are further bolstered by the company's good funding profile, consisting mainly of institutional custody deposits that Fitch considers to be core in nature. While business models with high barriers to entry such as State Street's typically result in some pricing power in its core business, the scale economies of the trust and processing business have resulted in oligopolistic price competition. Those firms with the best operating model and cost structure are better able to withstand pricing pressures in the core custody business. As such, State Street's management continues to work on streamlining the company's businesses and driving operational excellence through the use of technology and automation. This effort was initially dubbed the Ops and IT Transformation Program (Ops & IT) and has continued in a newer initiative named Project Beacon (Beacon). Beacon aims to achieve $550 million in annual operating cost savings by 2020. Management reports that the program has already realized $175 million in savings in 2016 and expects to achieve at least $140 million in additional pre-tax net expense savings in 2017. Fitch believes these savings will allow State Street to partially offset revenue associated lost with the $1 trillion in assets under custody that its large client BlackRock plans to transfer to JP Morgan (JPM) over the next five years. The savings will also help State Street generate more significant operating leverage should short-term interest rates continue to rise. State Street's earnings remain sensitive to higher short-term interest rates. Since the Federal Reserve began rising interest rates late in 2015, State Street's net interest margin (NIM) has risen from a low of 1.01% at the end of 2015 to 1.27% and the end of the second quarter of 2017 (2Q17). Further, State Street indicates that its net income would increase by an additional $523 million, or approximately 25% of annual net income, should short-term interest rates rise by 100 basis points in a parallel shock. Over the last few years, State Street's stated return on average equity (ROAE) has hovered just below 10%. To the extent that short-term rates continue to rise and State Street's earnings rise by the amount indicated above, Fitch expects the company's ROAE could consistently exceed 12%, all else equal. This would be closer to its longer-term averages and above various estimates of the company's cost of equity. In this scenario State Street's overall operating margin would be solidly above its historical levels of 30%, and net interest income (NII) as a percentage of total revenue would be in the mid-20% range, well above the 20% contribution to total revenue at 2Q17. At the same time, State Street has also worked to build out its asset management offerings with the closing of the purchase of General Electric's (GE) asset management business in July 2016. This added $125 billion of assets under management (AUM) at a cost of $485 million but also importantly adds fundamental asset management capabilities to State Street's asset management platform that has historically been more quantitatively oriented. Fitch believes the recurring nature of asset management revenue and the low balance sheet usage of this business enhances the franchise by adding more diversity and stability to the overall business model. Additionally, State State's asset management business continues to benefit from the shift to passively managed investment products from actively managed products. Further supporting State Street's rating is the company's strong funding position. Custody deposits, which Fitch considers core in nature, constitute 84% of State Street's liabilities as of 2Q17. Additionally given that these deposits continue to be invested predominantly in high credit quality and low duration securities suggests State Street's balance sheet is relatively low risk, further supporting the company's high ratings. State Street submitted its updated resolution plan in July 2017, which included the creation of an intermediate funding entity (IFE), State Street Intermediate Funding LLC (IFE - a wholly-owned, direct subsidiary of State Street's holding company), meant to improve the resolvability of State Street. Under this structure, State Street's holding company has contributed substantial liquidity and capital to IFE, which it will hold for the benefit of material entities. IFE is not expected to have external third-party debt. It will, instead, channel capital and liquidity among material entities as and when required to supplement pre-positioned resources at these entities. This structure is designed to prevent capital and liquidity from becoming unduly trapped in any legal entities, thus improving the likelihood of an orderly resolution. A committed credit facility for the holding company from IFE is in place to supplement dividends from IFE and SSBT, allowing liquidity to flow to the holding company under business as usual (BAU) terms in order to service holding company obligations. Fitch believes the new structure will result in a meaningful increase in double leverage, above 120%, which is a sensitivity outlined in criteria that would typically result in additional notching between State Street and its operating subsidiaries. However, the agency believes specific protections within the legal structure make it appropriate to look through the IFE when calculating double leverage and will provide for uninterrupted liquidity availability from the IFE under BAU conditions. The absence of additional notching between State Street and its subsidiaries is a noted variation from criteria. As such, Fitch considers the company to be appropriately capitalized for the risk of the balance sheet. As of 2Q17, State Street's fully phased-in Common Equity Tier 1 (CET1) Ratio was 11%, essentially unchanged from the end of 2016. Fitch believes, however, that State Street's more binding capital ratio is the Enhanced Supplementary Leverage Ratio (ESLR) which goes into effect on Jan. 1, 2018. State Street estimates that on a fully phased-in pro forma basis, its ESLR was 6.1% at the parent company and 6.5% at the main operating bank as of 2Q17, both already above regulatory minimums. Fitch expects State Street to continue to aggressively optimize its deposit base away from non-operational wholesale deposits in order to maintain ESLR compliance and potentially reduce the recently finalized Global Systemically Important Bank (GSIB) surcharge of 150 basis points. DERIVATIVE COUNTERPARTY RATINGS (DCR) The DCRs are at the same level as the respective entities' Long-Term IDRs because they have no definitive preferential status over other senior obligations in a resolution scenario. SUBSIDIARY AND AFFILIATED COMPANY SSBT's rating is one notch above the parent company's Long-Term IDR, reflecting the implementation of total loss absorbing capital (TLAC) requirements for U.S. Global Systemically Important Banks (GSIBs). The Viability Ratings (VRs) remain equalized between State Street and its material operating subsidiaries, namely SSBT. The common VR of State Street and its operating companies reflects the correlated performance or failure rate between State Street and these subsidiaries. SUPPORT RATING AND SUPPORT RATING FLOOR The Support Ratings (SR) of '5' and Support Rating Floors (SRF) of 'No Floor' reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that State Street becomes non-viable. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by State Street and by various issuing vehicles are all notched down from its VR or those of its bank subsidiaries in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles. Subordinated debt is notched one notch down from the VR, and preferred stock is notched down five notches from the VR. Capital trust securities have been notched down four notches from the VR. LONG- AND SHORT-TERM DEPOSITS SSBT's Deposit ratings are one notch higher than the entity's IDR and senior debt reflecting the deposits' superior recovery prospects in case of default given depositor preference in the U.S. RATING SENSITIVITIES IDRs, VRs AND SENIOR DEBT State Street's ratings are already near the top of Fitch's global rated bank universe. Thus, Fitch sees limited potential for upwards ratings momentum. Fitch believes that the main threat to State Street's business model and ratings would result from a large idiosyncratic technological or operational loss resulting in reputational damage that causes clients to leave the firm. State Street has been making significant investments in its technology and automation, which Fitch believes will help to reduce the incidence of potential idiosyncratic events that are prone to cause large losses. While Fitch believes these operational risks have been well monitored and controlled to date, the risks are inherently difficult to predict and quantify. As such, a large occurrence that causes a revenue loss of 5% or greater or causes significant reputational damage would likely prompt Fitch to review the ratings to determine if a negative rating action was appropriate. Fitch's analysis also indicates that State Street's earnings and business model may be more sensitive to equity markets than its peer trust and processing banks, which may impact ratings in a period of equity market stress. Should certain regulatory rules incentivize State Street's management to aggressively expand its currently small secured bank loan portfolio such that in Fitch's opinion it alters the agency's view of State Street's balance sheet risk or overall risk posture this could, over time, result in negative ratings pressure. Currently, Fitch does not expect the affirmative BREXIT vote to overly impact State Street's business, but it may change the way the company conducts business with some of its foreign clients. State Street and its peer trust and processing banks are beginning to face risk of potential technological disruption from distributed ledger technology. More commonly referred to as "blockchain", it is an electronic means of settling, reconciling, and reporting on client transactions, which is the core business of State Street and its peer banks. Fitch believes it is highly probable that State Street and its peer trust and processing banks will work to harness this technology to drive efficiencies across their respective platforms. However, it's also possible that over a long period of time a new entrant could offer an alternative distributed ledger solution that potentially disrupts the trust banks' business and erodes their barriers to entry, which would be viewed negatively from a rating perspective. At present, Fitch views this risk as well outside of the Rating Outlook horizon. DERIVATIVE COUNTERPARTY RATINGS DCRs are primarily sensitive to changes in the respective issuers' Long-Term IDRs. In addition, they could be upgraded to one notch above the IDR if a change in legislation (for example as recently proposed in the EU) creates legal preference for derivatives over certain other senior obligations and if Fitch then believes the volume of all legally subordinated obligations provides a substantial enough buffer to protect derivative counterparties from default in a resolution scenario. SUPPORT RATING AND SUPPORT RATING FLOOR Any upward revision to the SR and SRF would be contingent on a positive change in the U.S.'s propensity to support its banks. While not impossible, Fitch views this as highly unlikely. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES State Street's subordinated debt ratings are broadly sensitive to the same considerations that might affect the company's VR. SUBSIDIARY AND AFFILIATED COMPANIES Given that SSBT's and State Street's VRs remain equalized, SSBT's ratings are broadly sensitive to the same considerations that would affect State Street's VR. LONG- AND SHORT-TERM DEPOSITS The ratings of SSBT's long- and short-term deposits of SSBT primarily sensitive to any change in State Street's IDR. Should State Street Corporation's IDR be downgraded, the deposit ratings could be similarly impacted. Fitch has affirmed the following ratings: State Street Corporation --Long-Term IDR at 'AA-'; Outlook Stable; --Derivative Counterparty Rating at 'AA-(dcr)'; --Short-Term IDR at 'F1+'; --Support at '5'; --Support Rating Floor at 'NF'; --Viability rating at 'aa-'; --Junior subordinated debt at 'BBB+'; --Commercial paper at 'F1+'; --Preferred stock at 'BBB'; --Long-Term senior debt at 'AA-'; --Long-Term subordinated notes at 'A+'. State Street Bank and Trust Company --Long-Term IDR at 'AA'; Outlook Stable; --Derivative Counterparty Rating at 'AA(dcr)'; --Short-Term IDR at 'F1+'; --Support at '5'; --Support Rating Floor at 'NF'; --Viability rating at 'aa-'; --Short-Term deposits at 'F1+'; --Long-Term deposits at 'AA+'; --Long-Term subordinated at 'A+'. State Street Capital Trust I State Street Capital Trust IV --Trust Preferred Securities at 'BBB+'. Contact: Primary Analyst Justin Fuller, CFA Senior Director +1-312-268-2057 Fitch Ratings, Inc. 70 W. Madison Street Chicago, IL 60606 Secondary Analyst Chris VanBell Associate Director +1-212-908-0777 Committee Chairperson Meghan Neenan, CFA Managing Director +1-212-908-9121 Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: sandro.scenga@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Global Bank Rating Criteria (pub. 25 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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