OREANDA-NEWS. July 28, 2015. Similar to the first quarter of 2015 (1Q15), State Street Corporation's (STT) 2Q15 earnings were significantly impacted by litigation accruals regarding the company's indirect foreign exchange (FX) litigation matters. In 2Q15, STT incurred a \\$250 million pre-tax litigation charge, which equates to a net \\$156 million after-tax charge. This compares to a \\$150 million both pre-tax and after-tax litigation charge in 1Q15.

The company's 2Q15 earnings equated to an 8.3% return on average common equity (ROAE), which is slightly higher than the 7.9% ROAE earned in 1Q15. On an operating basis, which for comparison purposes excludes the notable charges described above, STT earned a 12.0% ROAE in 2Q15, up from a 10.4% ROAE in the sequential quarter and flat from the ROAE in the year-ago quarter.

In Fitch's view, if not for the persistent litigation accruals, STT's earnings would have been good.

On a stated GAAP basis, STT's total revenue expanded very modestly, increasing 0.3% from the sequential quarter and 0.6% from the year-ago quarter.

That said, STT did grow fee revenue 1.1% from the sequential quarter and 2.1% from the year-ago quarter, driven in large part by higher servicing fees in STT's core custody and administration business.

Offsetting the fee growth was the continued contraction of net interest revenue (NIR) relative to both the sequential and year-ago quarters due to the persistently low interest rate environment as maturing investments are re-invested at lower yields.

To wit, STT's fully taxable equivalent net interest margin (NIM) declined to 1.00% in 2Q15, down from 1.06% in the sequential quarter, and 1.17% in the year-ago quarter. Fitch continues to expect STT's NIM to keep moving lower at least until short-term interest rate rise, whenever that may be.

Expenses relative to the year-ago quarter increased 15.4% due largely to the litigation accrual that occurred in 2Q15. Compared to the sequential quarter, which as noted included a similar litigation accrual, expenses grew 1.8%. Fitch notes that this expense growth was due largely to higher professional services expenses offset by sequentially lower compensation and benefits expense.

STT's balance sheet continued to expand modestly in 2Q15 as the company continues to accumulate deposits. This growth in deposits has generally been placed with other banks or at the Federal Reserve.

While Fitch believes this deposit growth helps to keep STT's balance sheet very liquid, it also has an adverse impact on the company's enhanced Supplementary Leverage Ratio (SLR), which on a fully phased-in basis is effective in January 2018.

The fully phased-in SLR at the operating company improved to 4.9% in 2Q15 from 4.8% in 1Q15 but is currently below the 6% requirement in 2018, and the SLR at the holding company improved to 5.1%, slightly above the 5.0% requirement in 2018.

Fitch believes STT will continue to pursue avenues to move some client deposits away from STT or at least its balance sheet in order to help the company reach compliance with the SLR.

In Fitch's view this strategy is even more critical now given the Federal Reserve's recently finalized rules regarding GSIB buffers. At present, Fitch estimates STT's GSIB buffer to be 150 basis points, but should the company be successful at pushing deposits off the balance sheet, it may be able to reduce its GSIB buffer requirement.

In Fitch's view STT's capital position remains good, particularly given Fitch's view of the comparatively low-risk nature of the balance sheet.

As of 2Q15, STT's fully phased-in Basel III Common Equity Tier 1 (CET1) ratio under the advanced approaches was 11.4%, relatively unchanged from the prior quarter, and under the standardized approach was 10.9%. Fitch notes that the standardized approach will likely remain STT's binding constraint ratio.