10-Q 1 stt-2012930_10q.htm 10-Q STT-2012.9.30_10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2012
or
¨
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. 001-07511
STATE STREET CORPORATION
(Exact name of registrant as specified in its charter)
Massachusetts
 
04-2456637
(State or other jurisdiction
of incorporation or organization)
 
(I.R.S. Employer Identification No.)
One Lincoln Street
Boston, Massachusetts
 
02111
(Address of principal executive office)
 
(Zip Code)
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  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x   No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x
 
    Accelerated filer  ¨
 
    Non-accelerated filer  ¨
 
    Smaller reporting company  ¨
 
 
 
 
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
The number of shares of State Street’s common stock outstanding on October 31, 2012 was 464,808,179



STATE STREET CORPORATION
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED
SEPTEMBER 30, 2012

TABLE OF CONTENTS

 
 
PART I. FINANCIAL INFORMATION
 
PART II. OTHER INFORMATION
 



MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS






2

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

GENERAL
State Street Corporation, the parent company, is a financial holding company headquartered in Boston, Massachusetts. Unless otherwise indicated or unless the context requires otherwise, all references in this Management's Discussion and Analysis to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. Our principal banking subsidiary is State Street Bank and Trust Company, or State Street Bank. At September 30, 2012, we had total assets of $204.52 billion, total deposits of $146.29 billion, total shareholders' equity of $20.75 billion and 29,650 employees. With $23.44 trillion of assets under custody and administration and $2.07 trillion of assets under management at September 30, 2012, we are a leading specialist in meeting the needs of institutional investors worldwide.
We have two lines of business:
Investment Servicing provides services for mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations and endowments worldwide. Products include custody, product- and participant-level accounting, daily pricing and administration; master trust and master custody; record-keeping; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and alternative investment manager operations outsourcing; and performance, risk and compliance analytics to support institutional investors.
Investment Management, through State Street Global Advisors, or SSgA, provides a broad range of investment management strategies, specialized investment management advisory services and other financial services, such as securities finance, for corporations, public funds, and other sophisticated investors. Management strategies offered by SSgA include passive and active, such as enhanced indexing and hedge fund strategies, using quantitative and fundamental methods for both U.S. and non-U.S. equity and fixed-income securities. SSgA also offers exchange-traded funds.
For financial and other information about our lines of business, refer to “Line of Business Information” in this Management's Discussion and Analysis and note 14 to the consolidated financial statements included in this Form 10-Q.
This Management's Discussion and Analysis is part of our Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, and updates the Management's Discussion and Analysis in our Annual Report on Form 10-K for the year ended December 31, 2011, referred to as our 2011 Form 10-K, and in our Quarterly Reports on Form 10-Q for the quarters ended March 31, 2012 and June 30, 2012, all of which we previously filed with the SEC. You should read the financial information contained in this Management's Discussion and Analysis and elsewhere in this Form 10-Q in conjunction with the financial and other information contained in those reports. Certain previously reported amounts presented in this Form 10-Q have been reclassified to conform to current period classifications.
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the U.S., referred to as GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in its application of certain accounting policies that materially affect the reported amounts of assets, liabilities, equity, revenue and expenses. The significant accounting policies that require us to make estimates and assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods are accounting for fair value measurements; interest revenue recognition and other-than-temporary impairment; and impairment of goodwill and other intangible assets. These significant accounting policies require the most subjective or complex judgments, and underlying estimates and assumptions could be subject to revision as new information becomes available. An understanding of the judgments, estimates and assumptions underlying these significant accounting policies is essential in order to understand our reported consolidated results of operations and financial condition.
Additional information about these significant accounting policies is included under “Significant Accounting Estimates” in Management’s Discussion and Analysis in our 2011 Form 10-K. We did not change these significant accounting policies during the first nine months of 2012.
Certain financial information presented in this Management's Discussion and Analysis is prepared on both a GAAP, or reported basis and a non-GAAP, or operating basis. We measure and compare certain financial information on an operating basis, as we believe that this presentation supports meaningful comparisons from period to period and the analysis of comparable financial trends with respect to State Street's normal ongoing business operations. We believe that operating-basis financial information, which reports revenue from non-taxable sources on a fully taxable-equivalent basis and excludes the impact of revenue and expenses outside of the normal course of our business, facilitates an investor's understanding and analysis of State Street's underlying financial performance and trends in addition to financial information prepared and reported in conformity with GAAP. Operating-basis financial information should be considered in addition to, not as a substitute for or superior to, financial information prepared in conformity with GAAP. Any non-GAAP, or operating-basis, financial information presented in this Management’s Discussion and Analysis is reconciled to its nearest GAAP-basis measure.

3

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

FORWARD-LOOKING STATEMENTS
This Form 10-Q, as well as other reports filed by us under the Securities Exchange Act of 1934, registration statements filed by us under the Securities Act of 1933, our annual report to shareholders and other public statements we may make, contain statements (including statements in this Management's Discussion and Analysis) that are considered “forward-looking statements” within the meaning of U.S. securities laws, including statements about industry, regulatory, economic and market trends, management's expectations about our financial performance, market growth, capital, acquisitions and divestitures, new technologies, services and opportunities and earnings, management's confidence in our strategies and other matters that do not relate strictly to historical facts. Terminology such as “expect,” “look,” “believe,” “anticipate,” “intend,” “plan,” “estimate,” “forecast,” “seek,” “may,” “will,” “trend,” “target” and “goal,” or similar statements or variations of such terms, are intended to identify forward-looking statements, although not all forward-looking statements contain such terms.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management's expectations and assumptions at the time the statements are made, and are not guarantees of future results. Management's expectations and assumptions, and the continued validity of the forward-looking statements, are subject to change due to a broad range of factors affecting the national and global economies, the equity, debt, currency and other financial markets, as well as factors specific to State Street and its subsidiaries, including State Street Bank. Factors that could cause changes in the expectations or assumptions on which forward-looking statements are based cannot be foreseen with certainty and may include, but are not limited to:

the financial strength and continuing viability of the counterparties with which we or our clients do business and to which we have investment, credit or financial exposure, including, for example, the direct and indirect effects on counterparties to the current sovereign debt risks in Europe and other regions;
financial market disruptions or economic recession, whether in the U.S., Europe or other regions internationally;
increases in the volatility of, or declines in the level of, our net interest revenue, changes in the composition of the assets recorded in our consolidated statement of condition and the possibility that we may be required to change the manner in which we fund those assets;
the liquidity of the U.S. and international securities markets, particularly the markets for fixed-income securities and inter-bank credits, and the liquidity requirements of our clients;
the level and volatility of interest rates and the performance and volatility of securities, credit, currency and other markets in the U.S. and internationally;
the credit quality, credit agency ratings, and fair values of the securities in our investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the respective securities and the recognition of an impairment loss in our consolidated statement of income;
our ability to attract deposits and other low-cost, short-term funding, and our ability to deploy deposits in a profitable manner consistent with our liquidity requirements and risk profile;
the manner in which the Federal Reserve and other regulators implement the Dodd-Frank Act, Basel III, European legislation with respect to banking and financial activities and other regulatory initiatives in the U.S. and internationally, including regulatory developments that result in changes to our structure or operating model, increased costs or other changes to the provision of our services;
adverse changes in required regulatory capital ratios, whether arising under the Dodd-Frank Act, Basel II or Basel III, or due to changes in regulatory positions or regulations in jurisdictions in which we engage in banking activities;
increasing requirements to obtain necessary approvals of the Federal Reserve and our other regulators for the use, allocation or distribution of our capital or for other specific capital actions or programs, including acquisitions, dividends and equity repurchases, without which our growth plans, distributions to shareholders, equity purchase programs or other capital initiatives may be restricted;
changes in law or regulation that may adversely affect our, our clients' or our counterparties' business activities and the products or services that we sell, including additional or increased taxes or assessments thereon, capital adequacy requirements and changes that expose us to risks related to compliance;
the maintenance of credit agency ratings for our debt and depository obligations as well as the level of credibility of credit agency ratings;

4

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

delays or difficulties in the execution of our previously announced Business Operations and Information Technology Transformation program, which could lead to changes in our estimates of the charges, expenses or savings associated with the planned program, resulting in increased volatility of our earnings;
the results of, and costs associated with, government investigations, litigation, and similar claims, disputes, or proceedings;
the possibility that our clients will incur substantial losses in investment pools for which we act as agent, and the possibility of significant reductions in the valuation of assets;
adverse publicity or other reputational harm;
dependencies on information technology, complexities and costs of protecting the security of our systems and difficulties with protecting our intellectual property rights;
our ability to grow revenue, attract and/or retain and compensate highly skilled people, control expenses and attract the capital necessary to achieve our business goals and comply with regulatory requirements;
potential changes to the competitive environment, including changes due to regulatory and technological changes, the effects of consolidation, and perceptions of State Street as a suitable service provider or counterparty;
potential changes in how clients compensate us for our services, and the mix of services that clients choose from us;
the risks that acquired businesses and joint ventures will not achieve their anticipated financial and operational benefits or will not be integrated successfully, or that the integration will take longer than anticipated, that expected synergies will not be achieved or unexpected disynergies will be experienced, that client and deposit retention goals will not be met, that other regulatory or operational challenges will be experienced and that disruptions from the transaction will harm relationships with clients, employees or regulators;
the ability to complete acquisitions, divestitures and joint ventures, including the ability to obtain regulatory approvals, the ability to arrange financing as required and the ability to satisfy closing conditions;
our ability to recognize emerging needs of clients and to develop products that are responsive to such trends and profitable to the company; the performance of and demand for the products and services we offer, including the level and timing of redemptions and withdrawals from our collateral pools and other collective investment products; and the potential for new products and services to impose additional costs on us and expose us to increased operational risk;
our ability to measure the fair value of the investment securities recorded in our consolidated statement of condition;
our ability to control operating risks, data security breach risks, information technology systems risks and outsourcing risks, and our ability to protect our intellectual property rights, the possibility of errors in the quantitative models we use to manage our business and the possibility that our controls will prove insufficient, fail or be circumvented;
changes in accounting standards and practices; and
changes in tax legislation and in the interpretation of existing tax laws by U.S. and non-U.S. tax authorities that affect the amount of taxes due.
Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed in this section and elsewhere in this Form 10-Q or disclosed in our other SEC filings, including the risk factors discussed in our 2011 Form 10-K. Forward-looking statements should not be relied upon as representing our expectations or beliefs as of any date subsequent to the time this Form 10-Q is filed with the SEC. We undertake no obligation to revise our forward-looking statements after the time they are made. The factors discussed above are not intended to be a complete summary of all risks and uncertainties that may affect our businesses. We cannot anticipate all developments that may adversely affect our consolidated results of operations and financial condition.
Forward-looking statements should not be viewed as predictions, and should not be the primary basis upon which investors evaluate State Street. Any investor in State Street should consider all risks and uncertainties disclosed in our SEC filings, including our filings under the Securities Exchange Act of 1934, in particular our reports on Forms 10-K, 10-Q and 8-K, or registration statements filed under the Securities Act of 1933, all of which are accessible on the SEC's website at www.sec.gov or on our website at www.statestreet.com.



5

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

OVERVIEW OF FINANCIAL RESULTS
 
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions, except per share amounts)
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
Total fee revenue
$
1,719

 
$
1,844

 
(7
)%
 
$
5,282

 
$
5,527

 
(4
)%
Net interest revenue
619

 
578

 
7

 
1,916

 
1,727

 
11

Gains related to investment securities, net
18

 
5

 
 
 
2

 
25

 
 
Total revenue
2,356

 
2,427

 
(3
)
 
7,200

 
7,279

 
(1
)
Provision for loan losses

 

 
 
 
(1
)
 
1

 
 
Expenses:
 
 
 
 
 
 
 
 
 
 
 
Expenses from operations
1,664

 
1,713

 
(3
)
 
5,191

 
5,153

 
1

Claims resolution(1)
(362
)
 

 
 
 
(362
)
 

 
 
Provisions for litigation exposure and other costs(2)
85

 

 
 
 
107

 

 
 
Acquisition costs
13

 
19

 
 
 
41

 
46

 
 
Restructuring charges
15

 
66

 
 
 
45

 
75

 
 
Total expenses
1,415

 
1,798

 
(21
)
 
5,022

 
5,274

 
(5
)
Income before income tax expense
941

 
629

 
50

 
2,179

 
2,004

 
9

Income tax expense
267

 
74

 
 
 
588

 
465

 
 
Net income
$
674

 
$
555

 
21

 
$
1,591

 
$
1,539

 
3

Adjustments to net income:
 
 
 
 
 
 
 
 
 
 
 
Dividends on preferred stock(3)
$
(15
)
 
$
(6
)
 
 
 
$
(29
)
 
$
(13
)
 
 
Earnings allocated to participating securities(4)
(5
)
 
(6
)
 
 
 
(11
)
 
(15
)
 
 
Net income available to common shareholders
$
654

 
$
543

 
 
 
$
1,551

 
$
1,511

 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
Basic
$
1.39

 
$
1.11

 
 
 
$
3.23

 
$
3.05

 
 
Diluted
1.36

 
1.10

 
24

 
3.19

 
3.03

 
5

Average common shares outstanding (in thousands):
 
 
 
 
 
 
 
 
 
 
 
Basic
472,355

 
490,840

 
 
 
479,536

 
495,015

 
 
Diluted
480,010

 
494,780

 
 
 
485,813

 
498,417

 
 
Cash dividends declared per common share
$
.24

 
$
.18

 
 
 
$
.72

 
$
.54

 
 
Return on average common equity
13.3
%
 
11.2
%
 
 
 
10.7
%
 
10.8
%
 
 
 
 
 
 

(1) Represented a benefit related to claims associated with the 2008 Lehman Brothers bankruptcy; refer to "Consolidated Results of Operations - Expenses" in this Management's Discussion and Analysis.
(2) Composed of provisions of $60 million and $82 million for the quarter and nine months, respectively, for exposure related to previously disclosed litigation associated with asset management and securities lending, and a special one-time additional charitable contribution of $25 million. Additional information about our litigation exposure is provided in note 6 to the consolidated financial statements included in this Form 10-Q.
(3) Quarter and nine months ended September 30, 2012 included $8 million related to Series C preferred stock, issued in August 2012, and $7 million and $21 million, respectively, related to Series A preferred stock, redeemed in October 2012; prior-period amounts related to Series A preferred stock.
(4) Refer to note 13 to the consolidated financial statements included in this Form 10-Q.

6

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

The following "Highlights" and "Financial Results" sections provide information related to notable events, as well as highlights of our financial results for the third quarter of 2012 presented in the preceding table. More detailed information about our financial results is provided under “Consolidated Results of Operations,” which follows these sections.

Highlights
On October 15, 2012, we completed our acquisition of Goldman Sachs Administration Services, or GSAS, a global hedge fund administrator with approximately $200 billion of hedge fund assets under administration, in a cash transaction with a total purchase price of approximately $550 million, subject to certain adjustments. As of September 30, 2012, we had aggregate alternative assets under administration of approximately $900 billion, including hedge fund assets under administration of approximately $500 billion, which amounts did not include GSAS hedge fund assets under administration.
During the third quarter, we reached an agreement to settle our claims against the Lehman Brothers estate in the U.K., resolving the remainder of our indemnified repurchase and securities lending claims in the U.S. and the U.K. associated with the 2008 Lehman Brothers bankruptcy. In connection with the final resolution of these claims in the U.S. and the U.K., we recognized a benefit of approximately $362 million in our consolidated statement of income. Additional information about the settlement and related benefit is provided under "Consolidated Results of Operations - Expenses" in this Management's Discussion and Analysis.
On August 21, 2012, we issued and sold 20,000,000 depositary shares, each representing a 1/4,000th ownership interest in a share of State Street’s non-cumulative perpetual preferred stock, Series C, without par value, with a liquidation preference of $100,000 per share (equivalent to $25 per depositary share), in a public offering. We issued 5,000 shares of Series C preferred stock in connection with the depositary share offering. The aggregate proceeds from the offering, net of underwriting discounts, commissions and other issuance costs, were approximately $488 million.
On October 4, 2012, we used the proceeds from the offering, together with cash on hand, to redeem all 5,001 outstanding shares of our floating-rate non-cumulative perpetual preferred stock, Series A, liquidation preference per share of $100,000, for an aggregate of approximately $500 million. The Series A preferred stock, issued in March 2011, was held by State Street Capital Trust III, and constituted the principal asset of the trust. Additional information about the Series C offering and the Series A redemption is provided under "Financial Condition – Capital" in this Management's Discussion and Analysis and in note 8 to the consolidated financial statements included in this Form 10-Q.
During the third quarter, we declared a quarterly common stock dividend of $0.24 per share, or approximately $113 million, which was paid in October 2012. This dividend compares to a quarterly common stock dividend of $0.18 per share, or approximately $90 million, which was declared during the third quarter of 2011 and paid in October 2011. In addition, we declared aggregate preferred stock dividends of approximately $15 million, with $8 million related to the Series C preferred stock and $7 million related to the Series A preferred stock. The dividends on the Series A preferred stock included dividends paid in connection with the above-described redemption.
During the third quarter, we purchased approximately 11.4 million shares of our common stock under the program approved by the Board of Directors in March 2012, under which we are authorized to purchase up to $1.8 billion of our common stock through March 31, 2013. The shares were purchased at an average and aggregate cost of $42.11 and $480 million, respectively. Additional information about dividends and the common stock purchase program is provided under "Financial Condition – Capital" in this Management's Discussion and Analysis.
During the third quarter, we continued the implementation of our Business Operations and Information Technology Transformation program. With respect to this program, in 2011 we achieved approximately $86 million of annual pre-tax run-rate expense savings. In addition to the $86 million of annual pre-tax run-rate expense savings achieved in 2011, we expect to achieve incremental annual pre-tax run-rate expense savings in 2012 in the range of approximately $90 million to $100 million. These expected pre-tax expense savings relate only to the Business Operations and Information Technology Transformation program and are based on projected incremental improvement in 2012 from our total 2010 expenses from operations of $6.18 billion, all else being equal; our actual expenses from operations may increase or decrease due to other factors.
Additional information about our Business Operations and Information Technology Transformation program is provided under “Consolidated Results of Operations – Expenses” in this Management’s Discussion and Analysis.
Financial Results
Total revenue for the third quarter of 2012 decreased 3% compared to the same period in 2011, the result of a decline in fee revenue, partly offset by higher levels of net interest revenue and net gains related to investment securities.
Servicing fees declined 1% from last year's third quarter, generally reflective of the impact of the weaker Euro, as well as

7

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

changes in asset mix, partly offset by the impact of improvement in equity market valuations and net new business installed. Servicing fees generated outside the U.S. during both the third quarter of 2012 and the third quarter of 2011 were approximately 42% of total servicing fees. Management fees increased 10% in the same comparison, primarily due to the impact of stronger equity market valuations and net new business. Average month-end equity valuations for the S&P 500 index were up 16%, and for the MSCI® EAFE Indexes were down approximately 3%, from the third quarter of 2011. Management fees generated outside the U.S. during the third quarter of 2012 and the third quarter of 2011 were approximately 35% and 41%, respectively, of total management fees.
Trading services revenue declined 31% from last year's third quarter, mainly the result of lower currency volatility in foreign exchange trading partly offset by higher foreign exchange trading volumes (foreign exchange trading revenue), as well as lower levels of revenue from electronic foreign exchange trading (brokerage and other trading services revenue). Securities finance revenue increased 7% from last year's third quarter as a result of higher spreads, partly offset by lower lending volumes associated with lower overall demand.
For the third quarter of 2012, net interest revenue increased 7% compared to the third quarter of 2011. Both periods included discount accretion related to investment securities added to our consolidated statement of condition in connection with the 2009 asset-backed commercial paper conduit consolidation. The increase resulted from higher levels of interest-earning assets, mainly related to our investment of higher levels of client deposits with the Federal Reserve, the European Central Bank and other non-U.S. central banks; growth in the investment portfolio, as we purchased additional securities; and lower funding costs. These increases were partly offset by the impact of lower rates on interest-earning assets.
Net interest margin, calculated on fully taxable-equivalent net interest revenue, declined 3 basis points to 1.53% in the third quarter of 2012 from 1.56% in the third quarter of 2011. The investment of the additional client deposits increased our average interest-earning assets; however, they negatively affected our net interest margin, as a result of the relatively low interest rates paid by the central banks on these deposits. Discount accretion, fully taxable-equivalent net interest revenue and net interest margin are discussed in more detail under “Net Interest Revenue” in the "Consolidated Results of Operations” section of this Management's Discussion and Analysis.
As presented in the foregoing "Overview of Financial Results" table, our total expenses from operations for the third quarter of 2012 declined 3% compared to the third quarter of 2011. Compensation and employee benefits expenses for the third quarter of 2012 declined 5% compared to the third quarter of 2011, as the continuing implementation of our Business Operations and Information Technology Transformation program reduced these expenses. Total expenses presented in the foregoing "Overview of Financial Results" table reflected the aforementioned benefit of $362 million related to claims associated with the 2008 Lehman Brothers bankruptcy. Total expenses also reflected $85 million of provisions for litigation exposure and other costs, composed of a provision of $60 million related to previously disclosed litigation arising out of our asset management and securities lending businesses, and a special one-time additional contribution of $25 million to fund our charitable grant-making activities.
During the third quarter of 2012, we secured mandates for approximately $211 billion of new business in assets to be serviced; of the total, $86 billion was installed prior to September 30, 2012, with the remaining $125 billion expected to be installed during the remainder of 2012 and later. In the third quarter of 2012, we also installed approximately $116 billion of new business in assets to be serviced that we were awarded in periods prior to the third quarter of 2012. The new business not installed by September 30, 2012 was not included in assets under custody and administration at that date, and had no impact on servicing fee revenue for the third quarter of 2012, as the assets are not included until their installation is complete and we begin to service them. Once installed, the assets generate servicing fee revenue in subsequent periods in which the assets are serviced. We will provide one or more of various services for these assets including accounting, fund administration, custody, foreign exchange, securities finance, transfer agency, performance analytics, compliance reporting and monitoring, hedge fund servicing, private equity administration, real estate administration, depository banking services, wealth management services, and investment manager and alternative investment manager operations outsourcing.
During the third quarter of 2012, SSgA added approximately $78 billion of net new business in assets to be managed; this net new business was generally composed of approximately $61 billion of net inflows into institutional and fixed-income funds, primarily passive; approximately $13 billion of net inflows into exchange-traded funds, or ETFs; and approximately $5 billion of net inflows into managed cash; partly offset by approximately $1 billion of net outflows out of active and enhanced equity funds, as clients shifted their investment preferences.
An additional $12 billion of new business awarded to SSgA but not installed by September 30, 2012 was not included in assets under management at that date, and had no impact on management fee revenue for the third quarter of 2012, as the assets are not included until their installation is complete and we begin to manage them. Once installed, the assets generate management fee revenue in subsequent periods in which the assets are managed.

8

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

CONSOLIDATED RESULTS OF OPERATIONS
This section discusses our consolidated results of operations for the third quarter and first nine months of 2012 compared to the same periods in 2011, and should be read in conjunction with the consolidated financial statements and accompanying condensed notes included in this Form 10-Q.
TOTAL REVENUE
Additional information with respect to the sources of our revenue, the products and activities that generate it, and the factors that influence the levels of revenue generated during any period is provided under “Consolidated Results of Operations – Total Revenue” in Management’s Discussion and Analysis included in our 2011 Form 10-K.

 
Quarters Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions)
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
Servicing fees
$
1,100

 
$
1,106

 
(1
)%
 
$
3,264

 
$
3,325

 
(2
)%
Management fees
251

 
229

 
10

 
733

 
715

 
3

Trading services
232

 
334

 
(31
)
 
767

 
947

 
(19
)
Securities finance
91

 
85

 
7

 
331

 
288

 
15

Processing fees and other
45

 
90

 
(50
)
 
187

 
252

 
(26
)
Total fee revenue
1,719

 
1,844

 
(7
)
 
5,282

 
5,527

 
(4
)
 
 
 
 
 
 
 
 
 
 
 
 
Net interest revenue:
 
 
 
 
 
 
 
 
 
 
 
Interest revenue
730

 
728

 

 
2,281

 
2,181

 
5

Interest expense
111

 
150

 
(26
)
 
365

 
454

 
(20
)
Net interest revenue
619

 
578

 
7

 
1,916

 
1,727

 
11

 
 
 
 
 
 
 
 
 
 
 
 
Gains related to investment securities, net
18

 
5

 
 
 
2

 
25

 
 
Total revenue
$
2,356

 
$
2,427

 
(3
)
 
$
7,200

 
$
7,279

 
(1
)
Fee Revenue
Servicing and management fees collectively composed approximately 79% and 76% of our total fee revenue for the third quarter and first nine months of 2012, respectively, compared to approximately 72% and 73%, respectively, for the corresponding periods in 2011. The level of these fees is influenced by several factors, including the mix and volume of assets under custody and administration and assets under management, securities positions held and the volume of portfolio transactions, and the types of products and services used by clients, and is generally affected by changes in worldwide equity and fixed-income security valuations.
 Generally, servicing fees are affected, in part, by changes in daily average valuations of assets under custody and administration. Additional factors, such as asset mix, the level of transaction volumes, changes in service level, balance credits, client minimum balances, pricing concessions and other factors, may have a significant effect on our servicing fee revenue.
Generally, management fees are affected, in part, by changes in month-end valuations of assets under management. Management fee revenue is more sensitive to market valuations than servicing fee revenue. Additional factors, such as asset mix, the level of transaction volumes, changes in service level and other factors, may have a significant effect on our management fee revenue. While certain management fees are directly determined by the value of assets under management and the investment strategy employed, management fees reflect other factors as well, including our relationship pricing for clients using multiple services. Management fees for actively managed products are generally earned at higher rates than those for passive products. Actively managed products may also involve performance fee arrangements.
In light of the above, we estimate, assuming all other factors remain constant, that a 10% increase or decrease in worldwide equity values would result in a corresponding change in our total revenue of approximately 2%. If fixed-income security values were to increase or decrease by 10%, we would anticipate a corresponding change of approximately 1% in our total revenue.
The following table presents selected equity market indices as of September 30, 2012 and 2011, and for the quarters and

9

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

nine months then ended. Daily averages and the averages of month-end indices demonstrate worldwide changes in equity market valuations that affect our servicing and management fee revenue, respectively. Quarter-end indices affect the values of assets under custody and administration and assets under management as of those dates. The index names listed in the table are service marks of their respective owners.
INDEX
 
Daily Averages of Indices
 
Averages of Month-End Indices
 
Quarter-End Indices
 
Quarters Ended September 30,
 
Quarters Ended September 30,
 
As of September 30,
 
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
S&P 500®
1,401

 
1,225

 
14
 %
 
1,409

 
1,214

 
16
 %
 
1,441

 
1,131

 
27
%
NASDAQ®
3,027

 
2,607

 
16

 
3,041

 
2,584

 
18

 
3,116

 
2,415

 
29

MSCI EAFE®
1,468

 
1,531

 
(4
)
 
1,474

 
1,526

 
(3
)
 
1,511

 
1,373

 
10

 
Daily Averages of Indices
 
Averages of Month-End Indices
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
Nine Months Ended September 30,
 
 
 
 
 
 
 
2012
 
2011
 
% Change   
 
2012
 
2011
 
% Change
 
 
 
 
 
 
S&P 500®
1,367

 
1,282

 
7
 %
 
1,376

 
1,290

 
7
 %
 
 
 
 
 
 
NASDAQ®
2,954

 
2,703

 
9

 
2,978

 
2,722

 
9

 
 
 
 
 
 
MSCI EAFE®
1,470

 
1,646

 
(11
)
 
1,478

 
1,663

 
(11
)
 
 
 
 
 
 
Servicing Fees
The decreases in servicing fees of 1% and 2% for the third quarter and first nine months of 2012, respectively, compared to the same periods in 2011 primarily resulted from the impact of the weaker Euro, as well as changes in asset mix, as clients remained conservative in their investment allocations. These factors were partly offset by overall improvement in equity market valuations, as presented in the foregoing "INDEX" table, and the impact of net new business installed on current-period revenue. For both the third quarter and first nine months of 2012 and the same periods in 2011, servicing fees generated outside the U.S. were approximately 42% of total servicing fees.
The following tables present the components, financial instrument mix and geographic mix of assets under custody and administration as of the dates indicated:
ASSETS UNDER CUSTODY AND ADMINISTRATION
(In billions)
September 30,
2012
 
December 31,
2011
 
September 30,
2011
Mutual funds
$
5,828

 
$
5,265

 
$
5,117

Collective funds
4,912

 
4,437

 
4,317

Pension products
5,258

 
4,837

 
4,940

Insurance and other products
7,443

 
7,268

 
7,136

Total
$
23,441

 
$
21,807

 
$
21,510

FINANCIAL INSTRUMENT MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION 
(In billions)
September 30,
2012
 
December 31,
2011
 
September 30,
2011
Equities
$
12,021

 
$
10,849

 
$
10,420

Fixed-income
8,518

 
8,317

 
8,345

Short-term and other investments
2,902

 
2,641

 
2,745

Total
$
23,441

 
$
21,807

 
$
21,510


10

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

GEOGRAPHIC MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION(1)
(In billions)
September 30,
2012
 
December 31,
2011
 
September 30,
2011
United States
$
17,066

 
$
15,745

 
$
15,262

Other Americas
703

 
622

 
651

Europe/Middle East/Africa
4,636

 
4,400

 
4,547

Asia/Pacific
1,036

 
1,040

 
1,050

Total
$
23,441

 
$
21,807

 
$
21,510

 
 
 
 
(1) Geographic mix is based on the location at which the assets are custodied or serviced.
The increases in total assets from December 31, 2011 and September 30, 2011 to September 30, 2012 primarily resulted from net increases in equity market valuations, net client subscriptions and the net installation of new servicing business. Servicing asset levels as of September 30, 2012 did not reflect the $125 billion of new business in assets to be serviced that was awarded to us during the third quarter of 2012 and had not been installed prior to September 30, 2012. The value of assets under custody and administration is a broad measure of the relative size of various markets served. Changes in the values of assets under custody and administration do not necessarily result in proportional changes in our servicing fee revenue.
Management Fees
Management fees increased 10% and 3% during the third quarter and first nine months of 2012, respectively, compared to the same periods in 2011. Both increases were primarily the result of stronger equity market valuations and the impact of net new business installed on current-period revenue. Average month-end equity market valuations, individually presented in the foregoing “INDEX” table, were up an average of 11% for the third quarter of 2012 compared to the third quarter of 2011, and were up an average of 3% in the nine-month comparison. For the third quarter and first nine months of 2012, management fees generated outside the U.S. were approximately 35% and 36%, respectively, of total management fees, compared to approximately 41% for the same periods in 2011.
The following tables present the components and geographic mix of assets under management as of the dates indicated. Assets under management as of December 31, 2011 and September 30, 2011 included certain assets managed for the U.S. government under programs adopted during the financial crisis.

ASSETS UNDER MANAGEMENT
(In billions)
September 30,
2012
 
December 31,
2011
 
September 30,
2011
Passive:
 
 
 
 
 
Equities
$
727

 
$
638

 
$
596

Fixed-income
295

 
246

 
287

Exchange-traded funds(1)
336

 
274

 
247

Other
199

 
195

 
188

Total Passive
1,557

 
1,353

 
1,318

Active:
 
 
 
 
 
Equities
51

 
50

 
47

Fixed-income
18

 
19

 
19

Other
56

 
45

 
43

Total Active
125

 
114

 
109

Cash
383

 
378

 
428

Total
$
2,065

 
$
1,845

 
$
1,855

 
 
 
 
  (1) Includes SPDR® Gold Fund, for which State Street is not the investment manager but acts as distribution agent.


11

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1)
(In billions)
September 30,
2012
 
December 31,
2011
 
September 30,
2011
United States
$
1,385

 
$
1,285

 
$
1,296

Other Americas
34

 
30

 
30

Europe/Middle East/Africa
341

 
320

 
331

Asia/Pacific
305

 
210

 
198

Total
$
2,065

 
$
1,845

 
$
1,855

 
 
 
 
(1) Geographic mix is based on the location at which the assets are managed.
The following table presents activity in assets under management during the twelve months ended September 30, 2012:
ASSETS UNDER MANAGEMENT
(In billions)
 
September 30, 2011
$
1,855

Net lost business(1)
(89
)
Market appreciation
79

December 31, 2011
$
1,845

Net new business(1)
82

Market appreciation
138

September 30, 2012
$
2,065

 
 
 
 
(1) Amounts for the fourth quarter of 2011 and the first nine months of 2012 included redemptions of approximately $41 billion and $31 billion, respectively, of U.S. government securities associated with the Department of the U.S. Treasury's portfolio of agency-guaranteed mortgage-backed securities.  
The overall increase in assets under management as of September 30, 2012 compared to December 31, 2011 resulted from net market appreciation during the nine-month period in the values of the assets managed, as well as net new business installed of $82 billion. This net new business reflected the impact of the planned redemption during the period of $31 billion of assets in connection with the Department of the U.S. Treasury's portfolio of agency-guaranteed mortgage-backed securities. In the first nine months of 2012, exchange-traded funds, or ETFs, increased 23%, due to $30 billion of net inflows, passive equities increased 14% and passive fixed-income assets under management increased 20%, the result of net inflows, partly offset by the impact of the above-described U.S. Treasury asset redemptions.
The net new business of $82 billion described above did not include $12 billion of new business awarded to SSgA that had not been installed prior to September 30, 2012. This new business will be included in assets under management in future periods after installation, and will generate management fee revenue in subsequent periods in which the assets are managed.  
The overall decrease in assets under management as of December 31, 2011 compared to September 30, 2011 resulted from net lost business of $89 billion, which included approximately $41 billion of the above-described planned U.S. Treasury asset redemptions during the three-month period, mostly offset by net market appreciation during the three-month period in the values of the assets managed.
Trading Services
Trading services revenue includes revenue from foreign exchange trading, as well as brokerage and other trading services. We earn foreign exchange trading revenue by acting as a market maker. We offer a range of foreign exchange, or FX, products, services and execution models which focus on clients' global requirements for our proprietary research and the execution of trades in any time zone. Most of our FX products and execution services can be grouped into three broad categories: “direct FX,” “indirect FX,” and electronic trading. Direct and indirect FX revenue is recorded in foreign exchange trading revenue. Revenue from electronic trading is recorded in brokerage and other trading services revenue.
We also offer a range of brokerage and other trading products tailored specifically to meet the needs of the global pension community, including transition management, commission recapture and self-directed brokerage. These products are

12

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

differentiated by our position as an agent of the institutional investor.
Trading services revenue declined 31% for the third quarter of 2012 compared to the third quarter of 2011, and declined 19% for the nine months ended September 30, 2012 compared to the 2011 period. The components of these declines, composed of changes related to foreign exchange trading and brokerage and other trading services, are explained below.
Foreign exchange trading revenue of $115 million declined 44% for the third quarter of 2012 from $204 million for the third quarter of 2011 and declined 26% to $393 million from $533 million in the nine-month comparison. The decreases in both comparisons were primarily the result of declines in currency volatility, which is at its lowest level in 5 years, partly offset by higher client volumes.
Brokerage and other trading services revenue of $117 million declined 10% for the third quarter of 2012 compared to $130 million for the third quarter of 2011, with the decrease largely related to lower levels of revenue from electronic trading associated with a decline in client volumes. For the first nine months of 2012, brokerage and other trading services revenue was $374 million, down 10% from $414 million for the first nine months of 2011, largely the result of lower levels of revenue from electronic trading, associated with a decline in client volumes, and transition management. Our transition management revenue and expenses in 2011 and 2012 were adversely affected by compliance issues in our U.K. business, the reputational and regulatory impact of which may continue to adversely affect our revenue from transition management in the remainder of 2012 and in future periods.
With respect to foreign exchange trading, we enter into FX transactions with clients and investment managers that contact our trading desk directly. These trades are all executed at negotiated rates. We refer to this activity, and our market-making activities, as "direct FX." Alternatively, clients or their investment managers may elect to route FX transactions to our FX desk through our asset servicing operation; we refer to this activity as "indirect FX." We execute indirect FX trades as a principal at rates disclosed to our clients. We calculate revenue for indirect FX using an attribution methodology based on estimated effective mark-ups/downs and observed client volumes.
For the third quarter and first nine months of 2012, our estimated indirect FX revenue was approximately $55 million and $196 million, respectively, compared to $88 million and $259 million, respectively, for the same periods in 2011. All other FX revenue, other than this indirect FX revenue estimate and FX revenue from electronic trading, is estimated and considered by us to be direct FX revenue. For the third quarter and first nine months of 2012, our estimated direct FX revenue was $60 million and $197 million, respectively, compared to $116 million and $274 million, respectively, for the same periods in 2011.
Our clients may choose to execute FX transactions through one of our electronic trading platforms. This service generates revenue through a “click” fee. For the third quarter and first nine months of 2012, our revenue from electronic FX trading platforms was approximately $51 million and $160 million, respectively, compared to $67 million and $187 million, respectively, for the same periods in 2011. As described above, this revenue was recorded in brokerage and other trading services revenue.
During the first nine months of 2012, some of our clients who relied on our indirect model to execute their FX transactions transitioned to other methods to conduct their FX transactions. Through State Street Global Markets, a unit of our Investment Servicing line of business, they can transition to either direct FX execution, including our “Street FX” service which enables our clients to define their FX execution strategy and automate the foreign exchange trade execution process, where State Street continues to act as a principal market maker, or to one of our electronic trading platforms. We continue to expect that some clients may choose, over time, to reduce their level of indirect foreign exchange transactions in favor of other execution methods, including either direct foreign exchange transactions or electronic trading, which we provide.
Securities Finance
Our agency securities finance business consists of two principal components: investment funds with a broad range of investment objectives which are managed by SSgA and engage in agency securities lending, which we refer to as the SSgA lending funds; and an agency lending program for third-party investment managers and asset owners, which we refer to as the agency lending funds.
 We also participate in securities lending transactions as a principal rather than an agent. As a principal, we borrow securities from the lending client and then lend such securities to the subsequent borrower, either a State Street client or a broker/dealer. Our involvement as principal is utilized when the lending client is unable to, or elects not to, transact directly with the market and requires us to execute the transaction and furnish the securities. In our role as principal, we provide support to the transaction through our credit rating, and we have the ability to source securities through our assets under custody and administration.
Securities finance revenue, composed of our split of both the spreads related to cash collateral and the fees related to non-

13

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

cash collateral, is principally a function of the volume of securities on loan and the interest-rate spreads and fees earned on the underlying collateral. For the third quarter of 2012, securities finance revenue increased 7% from the third quarter of 2011, and for the first nine months of 2012 increased 15% compared to the corresponding period in 2011. The increases were substantially the result of higher spreads across all lending programs, partly offset by 13% and 10% declines in average lending volumes comparing the third quarter and first nine months of 2012, respectively, to the same periods in 2011. Average spreads increased 25% and 33% for the third quarter and first nine months of 2012, respectively, compared to the same periods in 2011. Securities on loan averaged approximately $321 billion and approximately $330 billion for the third quarter and first nine months of 2012, respectively, compared to approximately $368 billion for both the third quarter and first nine months of 2011.
Market influences will continue to affect our revenue from, and the profitability of, our securities lending activities during 2012, and may do so in future periods. As long as securities lending spreads remain below the levels generally experienced prior to late 2007, client demand is likely to remain at a reduced level and our revenues from our securities lending activities will be similarly affected. In addition, proposed or anticipated regulatory changes may affect the volume of our securities lending activity and related revenue in future periods.
Processing Fees and Other
Processing fees and other revenue for the third quarter and first nine months of 2012 decreased 50% and 26%, respectively, compared to the same periods in 2011. The decreases were primarily the result of gains related to real estate and certain leases recorded in the third quarter of 2011 and amortization expenses related to tax-advantaged investments in renewable energy in the third quarter of 2012.
NET INTEREST REVENUE
Net interest revenue is defined as total interest revenue earned on interest-earning assets less interest expense incurred on interest-bearing liabilities. Interest-earning assets, which principally consist of investment securities, interest-bearing deposits with banks, repurchase agreements, loans and leases and other liquid assets, are financed primarily by client deposits, short-term borrowings and long-term debt. Net interest margin represents the relationship between annualized fully taxable-equivalent net interest revenue and total average interest-earning assets for the period. Revenue that is exempt from income taxes, mainly that earned from certain investment securities (state and political subdivisions), is adjusted to a fully taxable-equivalent basis using a federal statutory income tax rate of 35%, adjusted for applicable state income taxes, net of the related federal tax benefit.
The following table presents the components of average interest-earning assets and average interest-bearing liabilities, related interest revenue and interest expense, and rates earned and paid, for the periods indicated:

14

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

 
Quarters Ended September 30,
 
2012
 
2011
(Dollars in millions; fully taxable-equivalent basis)
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
 
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
Interest-bearing deposits with banks
$
26,553

 
$
31

 
.47
%
 
$
24,271

 
$
39

 
.64
%
Securities purchased under resale agreements
7,773

 
15

 
.72

 
5,728

 
6

 
.42

Trading account assets
610

 

 
.13

 
2,084

 

 

Investment securities
113,899

 
658

 
2.31

 
104,387

 
647

 
2.46

Loans and leases
11,626

 
58

 
1.99

 
12,353

 
68

 
2.18

Other interest-earning assets
8,136

 

 
.02

 
6,355

 

 
.03

Total average interest-earning assets
$
168,597

 
$
762

 
1.80

 
$
155,178

 
$
760

 
1.95

Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
U.S.
$
11,624

 
$
5

 
.14
%
 
$
3,201

 
$
2

 
.16
%
Non-U.S.
89,658

 
32

 
.14

 
84,083

 
50

 
.23

Securities sold under repurchase agreements
7,757

 

 
.01

 
9,335

 
3

 
.13

Federal funds purchased
722

 

 
.13

 
556

 

 
.01

Other short-term borrowings
4,759

 
18

 
1.55

 
4,945

 
20

 
1.65

Long-term debt
6,408

 
52

 
3.20

 
9,305

 
73

 
3.17

Other interest-bearing liabilities
6,359

 
4

 
.25

 
3,803

 
2

 
.26

Total average interest-bearing liabilities
$
127,287

 
$
111

 
.35

 
$
115,228

 
$
150

 
.52

Interest-rate spread
 
 
 
 
1.45
%
 
 
 
 
 
1.43
%
Net interest revenue—fully taxable-equivalent basis
 
 
$
651

 
 
 
 
 
$
610

 
 
Net interest margin—fully taxable-equivalent basis
 
 
 
 
1.53
%
 
 
 
 
 
1.56
%
Tax-equivalent adjustment
 
 
(32
)
 
 
 
 
 
(32
)
 
 
Net interest revenue—GAAP basis
 
 
$
619

 
 
 
 
 
$
578

 
 

15

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

 
Nine Months Ended September 30,
 
2012
 
2011
(Dollars in millions; fully taxable-equivalent basis)
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
 
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
Interest-bearing deposits with banks
$
25,776

 
$
108

 
.56
%
 
$
16,255

 
$
94

 
.77
%
Securities purchased under resale agreements
7,735

 
37

 
.63

 
4,391

 
22

 
.67

Trading account assets
659

 

 
.06

 
2,213

 

 

Investment securities
112,109

 
2,044

 
2.43

 
101,585

 
1,944

 
2.56

Loans and leases
11,232

 
184

 
2.19

 
12,602

 
216

 
2.29

Other interest-earning assets
7,253

 
2

 
.03

 
5,182

 
1

 
.03

Total average interest-earning assets
$
164,764

 
$
2,375

 
1.93

 
$
142,228

 
$
2,277

 
2.15

Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
U.S.
$
7,192

 
$
12

 
.22
%
 
$
3,312

 
$
8

 
.30
%
Non-U.S.
88,250

 
115

 
.17

 
82,069

 
146

 
.24

Securities sold under repurchase agreements
7,828

 
1

 
.01

 
9,190

 
8

 
.12

Federal funds purchased
835

 

 
.09

 
943

 

 
.05

Other short-term borrowings
4,723

 
54

 
1.53

 
5,201

 
66

 
1.70

Long-term debt
7,160

 
172

 
3.20

 
9,254

 
220

 
3.17

Other interest-bearing liabilities
6,023

 
11

 
.25

 
3,127

 
6

 
.26

Total average interest-bearing liabilities
$
122,011

 
$
365

 
.40

 
$
113,096

 
$
454

 
.55

Interest-rate spread
 
 
 
 
1.53
%
 
 
 
 
 
1.60
%
Net interest revenue—fully taxable-equivalent basis
 
 
$
2,010

 
 
 
 
 
$
1,823

 
 
Net interest margin—fully taxable-equivalent basis
 
 
 
 
1.63
%
 
 
 
 
 
1.71
%
Tax-equivalent adjustment
 
 
(94
)
 
 
 
 
 
(96
)
 
 
Net interest revenue—GAAP basis
 
 
$
1,916

 
 
 
 
 
$
1,727

 
 

For the first nine months of 2012 compared to the first nine months of 2011, average interest-earning assets increased, mainly the result of the investment of higher levels of interest-bearing and noninterest-bearing client deposits into interest-bearing deposits with banks, as well as purchases of investment securities. During the past year, our clients have placed additional deposits with us amid market and public concerns related to various economic events. The increases in average interest-bearing deposits with banks resulted from the placement of additional client deposits with various central banks globally, primarily the Federal Reserve and the European Central Bank. Although the investment of these client deposits increased our average interest-earning assets, it negatively affected our net interest margin, as these placements generate only marginal, and in some cases zero percent, returns. The investment securities portfolio grew as we took advantage of market opportunities, primarily in the first half of the year.
Securities purchased under resale agreements increased to meet client liquidity needs, as we reduced our U.S. Treasury holdings. Increased levels of cash collateral provided in connection with our role as principal in certain securities borrowing activities drove other earning assets higher. While these activities support our overall profitability, they put downward pressure on our net interest margin.
On a GAAP and fully taxable-equivalent basis, net interest revenue increased 7% for the third quarter of 2012 compared to the third quarter of 2011. On a GAAP and fully taxable-equivalent basis, net interest revenue increased 11% and 10%, respectively, for the first nine months of 2012 compared to the same period in 2011. These increases were driven by the impact of higher levels of interest-earning assets, mainly the result of higher levels of client deposits invested with the Federal Reserve, the European Central Bank and other non-U.S. central banks; the above-described growth in the investment portfolio; and lower funding costs. These increases were partly offset by the impact of generally lower rates on interest-earning assets.
Fully taxable-equivalent net interest revenue for the third quarter of 2012, if conduit-related discount accretion were excluded, would have increased 8%, from $564 million ($610 million presented in the preceding quarterly table less accretion of $46 million) in the third quarter of 2011 to $611 million ($651 million presented in the preceding quarterly table less

16

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

accretion of $40 million). For the nine-month period, if conduit-related discount accretion were excluded, fully taxable-equivalent net interest revenue would have increased 11%, from $1.66 billion ($1.82 billion presented in the preceding nine-month table less accretion of $159 million) in 2011 to $1.85 billion ($2.01 billion presented in the preceding nine-month table less accretion of $163 million). The increase in discount accretion in the nine-month comparison resulted from pay-offs of former conduit securities in the 2012 periods.
Subsequent to the 2009 conduit consolidation, we have recorded aggregate discount accretion in interest revenue of $1.72 billion ($621 million in 2009, $712 million in 2010, $220 million in 2011 and $163 million in the first nine months of 2012). The timing and ultimate recognition of discount accretion depends, in part, on factors that are outside of our control, including anticipated prepayment speeds and credit quality. The impact of these factors is uncertain and can be significantly influenced by general economic and financial market conditions. The timing and recognition of discount accretion can also be influenced by our ongoing management of the risks and other characteristics associated with our investment securities portfolio, including sales of securities which would otherwise generate accretion, such as the December 2010 investment portfolio repositioning.
Depending on the factors discussed above, among others, we anticipate that, until the former conduit securities remaining in our investment portfolio mature or are sold, discount accretion will continue to contribute to our net interest revenue. Assuming that we hold the remaining former conduit securities to maturity, all else being equal, we expect the remaining former conduit securities carried in our investment portfolio as of September 30, 2012 to generate aggregate discount accretion in future periods of approximately $850 million over their remaining terms, with approximately half of this aggregate discount accretion to be recorded over the next four years.
Changes in the components of interest-earning assets and interest-bearing liabilities are discussed in more detail below. Additional detail about the components of interest revenue and interest expense is provided in note 11 to the consolidated financial statements included in this Form 10-Q.
Interest-bearing deposits with banks, which include cash balances maintained at the Federal Reserve, the European Central Bank and other non-U.S. central banks to satisfy reserve requirements, averaged $26.55 billion for the third quarter of 2012, compared to $24.27 billion for the third quarter of 2011. For the first nine months of 2012, such deposits averaged $25.78 billion, compared to $16.26 billion for the first nine months of 2011. The increases in both comparisons reflected the investment of higher levels of client deposits. Average aggregate excess deposits approximated $16 billion and $15 billion for the third quarters of 2012 and 2011, respectively.
 Average securities purchased under resale agreements increased to $7.77 billion for the third quarter of 2012 from $5.73 billion for the third quarter of 2011, and increased to $7.74 billion from $4.39 billion in the nine-month comparison, largely due to an increase in client demand. Average trading account assets declined from $2.08 billion for the third quarter of 2011 to $610 million for the third quarter of 2012, and for the nine-month period decreased from $2.21 billion to $659 million, the result of our withdrawal from our fixed-income trading initiative.
Our average investment securities portfolio increased to $113.90 billion for the third quarter of 2012 from $104.39 billion for the third quarter of 2011, and for the nine-month period increased to $112.11 billion from $101.59 billion in 2011. The increases were generally the result of ongoing purchases of securities, partly offset by maturities and sales. As of September 30, 2012, securities rated “AAA” and “AA” comprised approximately 88% of our portfolio, compared to approximately 89% rated “AAA” and “AA” as of September 30, 2011.
Loans and leases averaged $11.63 billion for the third quarter of 2012, compared to $12.35 billion for the same period in 2011, and $11.23 billion for the first nine months of 2012, down from $12.60 billion for the 2011 period. The declines were mainly related to lower levels of client demand for short-duration liquidity, as well as decreases in leveraged leases and purchased receivables, mainly from maturities and pay-downs. For the third quarter and first nine months of 2012, approximately 27% and 28%, respectively, of our average loan and lease portfolio were composed of short-duration advances that provided liquidity to clients in support of their investment activities related to securities settlement. This average composition of short-duration advances to loans and leases was down slightly compared to the third quarter and first nine months of 2011, which composition percentages were 30% and 29%, respectively. The following table presents average U.S. and non-U.S. short-duration advances for the periods indicated:
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
(In millions)
2012
 
2011
 
2,012
 
2011
Average U.S. short-duration advances
$
1,813

 
$
2,284

 
$
1,815

 
$
2,038

Average non-U.S. short-duration advances
1,319

 
1,448

 
1,362

 
1,634

Total average short-duration advances
$
3,132

 
$
3,732

 
$
3,177

 
$
3,672


17

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

The decreases in average short-duration advances for the third quarter and first nine months of 2012 compared to the same periods in 2011 were mainly the result of clients currently holding higher levels of liquidity, as well as the impact of foreign currency translation on non-U.S. advances.
Average other interest-earning assets increased to $8.14 billion for the third quarter of 2012 from $6.36 billion for the same period in 2011, and to $7.25 billion from $5.18 billion in the nine-month comparison. The increases were primarily the result of higher levels of cash collateral provided in connection with our role as principal in certain securities borrowing activities.
Aggregate average interest-bearing deposits increased to $101.28 billion for the third quarter of 2012 from $87.28 billion for the third quarter of 2011, and in the nine-month comparison increased to $95.44 billion for the 2012 period from $85.38 billion for the 2011 period. These increases mainly reflected higher levels of wholesale certificates of deposit issued in connection with our management of liquidity (refer to our discussion of liquidity management under "Liquidity" in "Financial Condition" in this Management's Discussion and Analysis), as well as higher levels of non-U.S. transaction accounts associated with new and existing business reflected in assets under custody and administration.
Average other short-term borrowings declined slightly to $4.76 billion for the third quarter of 2012 from $4.95 billion for the third quarter of 2011 and decreased to $4.72 billion for the first nine months of 2012 from $5.20 billion for the corresponding 2011 period, as higher levels of client deposits provided additional liquidity. Average long-term debt decreased from $9.31 billion for the third quarter of 2011 to $6.41 billion for the third quarter of 2012, and decreased from $9.25 billion to $7.16 billion in the nine-month comparison. The decreases reflected the maturities of $1.45 billion of senior notes in September 2011 and $1.50 billion of senior notes in April 2012, all previously issued by us or State Street Bank under the FDIC's Temporary Liquidity Guarantee Program.
 Average other interest-bearing liabilities increased to $6.36 billion for the third quarter of 2012 from $3.80 billion for the same period in 2011, and increased to $6.02 billion from $3.13 billion in the nine-month comparison, primarily the result of higher levels of client cash collateral received in connection with our role as principal in certain securities lending activities.
Several factors could affect future levels of our net interest revenue and margin, including the mix of client liabilities; actions of the various central banks; changes in U.S. and non-U.S. interest rates; the various yield curves around the world; the amount of discount accretion generated by the former conduit securities that remain in our investment securities portfolio; and the relative impact of the yields earned on the securities purchased by us with the proceeds from the December 2010 portfolio repositioning and other maturities compared to the yields earned on the securities sold or matured.
Based on market conditions and other factors, we continue to re-invest the proceeds from pay-downs and maturities of securities in highly rated investment securities, such as U.S. Treasuries, federal agency mortgage-backed securities and U.S. and non-U.S. mortgage- and asset-backed securities. The pace at which we continue to re-invest and the types of securities purchased will depend on the impact of market conditions and other factors over time. These factors and the level of interest rates worldwide are expected to dictate what effect our re-investment program will have on future levels of our net interest revenue and net interest margin. In addition, in a prolonged period of low interest rates and low spreads, certain products that we offer, including deposit services, cash funds and securities lending, may be less attractive to our clients, and any resulting declines in assets invested in such products could adversely affect our results of operations and liquidity management.

18

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

Gains (Losses) Related to Investment Securities, Net
The following table presents net realized gains from sales of securities and the components of net impairment losses, included in net gains and losses related to investment securities, for the periods indicated:
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
(In millions)
2012
 
2011
 
2012
 
2011
Net realized gains from sales of available-for-sale securities
$
24

 
$
15

 
$
29

 
$
81

 
 
 
 
 
 
 
 
Losses from other-than-temporary impairment
(4
)
 
(25
)
 
(50
)
 
(104
)
Losses not related to credit(1)
(2
)
 
15

 
23

 
48

Net impairment losses
(6
)
 
(10
)
 
(27
)
 
(56
)
Gains (losses) related to investment securities, net
$
18

 
$
5

 
$
2

 
$
25

 
 
 
 
 
 
 
 
Impairment associated with expected credit losses
$
(1
)
 
$
(7
)
 
$
(14
)
 
$
(36
)
Impairment associated with management’s intent to sell the impaired securities prior to their recovery in value

 

 

 
(8
)
Impairment associated with adverse changes in timing of expected future cash flows
(5
)
 
(3
)
 
(13
)
 
(12
)
Net impairment losses
$
(6
)
 
$
(10
)
 
$
(27
)
 
$
(56
)
 
 
 
 
(1) Amount for the quarter ended September 30, 2012 represented reversals of other-than-temporary impairment, or OTTI, not related to credit, previously recorded and recognized as a component of other comprehensive income, or OCI, which exceeded OTTI related to credit for the current quarter.
From time to time, in connection with our ongoing management of our investment securities portfolio, we sell available-for-sale securities, to manage risk, to take advantage of favorable market conditions, or for other reasons. During the third quarter and first nine months of 2012, we sold approximately $1.76 billion and $4.21 billion, respectively, of such investment securities and recorded net realized gains of $24 million and $29 million, respectively.
The net realized gains from sales of available-for-sale securities for the first nine months of 2012 reflected a loss of $46 million from the second-quarter 2012 sale of all of our Greek investment securities, which were previously classified as held to maturity. The sale was undertaken as a result of the effect of significant deterioration in the creditworthiness of the underlying collateral, including significant downgrades of the securities' external credit ratings.
The aggregate unrealized losses on securities for which other-than-temporary impairment was recorded in the third quarter and first nine months of 2012 were $4 million and $50 million, respectively. Of this total, $2 million and $23 million, respectively, related to factors other than credit, and were recognized, net of taxes, as a component of OCI in our consolidated statement of condition. For the third quarter and first nine months of 2012, we recorded the remaining $6 million and $27 million, respectively, of losses ($1 million and $14 million, respectively, associated with expected credit losses and $5 million and $13 million, respectively, associated with adverse changes in timing of expected future cash flows) in our consolidated statement of income.
In the third quarter and first nine months of 2012, we recorded $1 million and $8 million, respectively, of other-than-temporary impairment associated with expected credit losses related to U.S. non-agency residential mortgage-backed securities. The remaining $6 million of the total of $14 million of other-than-temporary impairment recorded in the first nine months of 2012, presented in the table above, was related to non-U.S. mortgage- and asset-backed securities. We also recorded other-than-temporary impairment of $5 million and $13 million in the third quarter and first nine months of 2012, respectively, associated with adverse changes in timing of expected future cash flows, substantially related to non-U.S. mortgage-backed securities.
We regularly review the investment securities portfolio to identify other-than-temporary impairment of individual securities. Additional information about investment securities, the gross gains and losses that compose the net gains and losses from sales of securities and our process to identify other-than-temporary impairment is provided in note 2 to the consolidated financial statements included in this Form 10-Q.

19

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

EXPENSES
The following table presents the components of expenses for the periods indicated:
 
Quarters Ended September 30,
 
Nine Months Ended September 30,
(Dollars in millions)
2012
 
2011
 
% Change
 
2012
 
2011
 
% Change
Compensation and employee benefits
$
916

 
$
965

 
(5
)%
 
$
2,922

 
$
2,948

 
(1
)%
Information systems and communications
211

 
191

 
10

 
610

 
581

 
5

Transaction processing services
170

 
180

 
(6
)
 
523

 
553

 
(5
)
Occupancy
115

 
119

 
(3
)
 
349

 
339

 
3

Claims resolution
(362
)
 

 
 
 
(362
)
 

 
 
Provisions for litigation exposure
60

 

 
 
 
82

 

 
 
Acquisition costs
13

 
19

 


 
41

 
46

 


Restructuring charges, net
15

 
66

 


 
45

 
75

 


Other:
 
 
 
 
 
 
 
 
 
 
 
Professional services
89

 
83

 
7

 
266

 
249

 
7

Amortization of other intangible assets
46

 
50

 
(8
)
 
145

 
149

 
(3
)
Securities processing costs (recoveries)
2

 
2

 


 
26

 
(15
)
 


Regulator fees and assessments
12

 
11

 
9

 
37

 
32

 
16

Other
128

 
112

 
14

 
338

 
317

 
7

Total other
277

 
258

 
7

 
812

 
732

 
11

Total expenses
$
1,415

 
$
1,798

 
(21
)
 
$
5,022

 
$
5,274

 
(5
)
Number of employees at quarter-end
29,650

 
29,685

 
 
 
 
 
 
 
 
Expenses from Operations
Total expenses for the third quarter of 2012 declined 21% compared to the third quarter of 2011, and for the first nine months of 2012 declined 5% from the 2011 period. Total expenses for both 2012 periods reflected a benefit of $362 million related to claims associated with the 2008 Lehman Brothers, Inc. bankruptcy (described below and in note 6 to the consolidated financial statements included in this Form 10-Q). Partly offsetting this benefit were provisions for litigation exposure of $60 million for the third quarter of 2012 and $82 million for the first nine months of 2012. The $60 million was related to previously disclosed litigation arising out of our asset management and securities lending businesses. Additional information about our litigation exposure is provided in note 6 to the consolidated financial statements included in this Form 10-Q. The first nine months of 2012 also included $22 million of provisions for litigation exposure recorded in the first half of 2012.
The decrease in compensation and employee benefits expenses for the third quarter of 2012 compared to the third quarter of 2011 resulted from the continued implementation of our Business Operations and Information Technology Transformation program. This decrease was partly offset by $22 million of costs related to our implementation of the program in the third quarter of 2012, compared to approximately $13 million of such costs for the third quarter of 2011. These costs are not expected to recur subsequent to full implementation of the program.
The increase in aggregate other expenses (professional services, amortization of other intangible assets, securities processing costs (recoveries), regulator fees and assessments and other costs) for the first nine months of 2012 compared to the same period in 2011 resulted primarily from securities processing costs compared to securities processing recoveries in 2011, as well as higher levels of professional services costs for litigation and regulatory matters. In addition, we recorded a special one-time additional charitable contribution of $25 million in the third quarter of 2012 (included in the "other" component of aggregate other expenses) to fund our charitable grant-making activities. The increase in aggregate other expenses for the third quarter of 2012 compared to the third quarter of 2011 resulted from the above-mentioned special one-time additional charitable contribution of $25 million and higher levels of professional services costs.
Claims Resolution
As a result of the 2008 Lehman Brothers bankruptcy, we had various claims against Lehman Brothers entities in bankruptcy proceedings in the U.S. and the U.K. We also had amounts asserted as owed, or return obligations, to Lehman Brothers entities.  The various claims and amounts owed arose from transactions that existed at the time Lehman Brothers entered bankruptcy, including foreign exchange transactions, securities lending arrangements and repurchase agreements. 

20

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

During the third quarter of 2011, we reached an agreement with certain Lehman Brothers estates in the U.S. to resolve the value of deficiency claims arising out of indemnified repurchase transactions in the U.S., and the bankruptcy court allowed those claims in the amount of $400 million.  In the third quarter of 2012, we received an initial distribution on this amount. 
During the third quarter of 2012, we reached an agreement to settle the claims against the Lehman Brothers estate in the U.K. related to the close-out of securities lending and repurchase arrangements.  This settlement resulted in a return obligation for us and a certified claim against the Lehman Brothers estate, and resolved the contingent nature of our rights and obligations with the Lehman Brothers estate.
In connection with our final resolution of the indemnified repurchase and securities lending claims in the U.S. and the U.K., we recognized a benefit of approximately $362 million in our consolidated statement of income in the third quarter of 2012. Both certified claims retained as part of the settlement agreements were sold in October 2012 at their respective fair values, resulting in an additional gain of approximately $10 million, which will be recorded in our consolidated statement of income in the fourth quarter of 2012.
Acquisition Costs
Acquisition costs for the third quarter and first nine months of 2012 were primarily related to integration costs incurred in connection with our acquisition of the Intesa securities services business. Acquisition costs incurred in the 2011 periods were mainly related to integration costs associated with the Intesa securities services business, Mourant International Finance Administration and Bank of Ireland Asset Management acquisitions.
Restructuring Charges
The net restructuring charges of $15 million and $45 million incurred in the third quarter and first nine months of 2012, respectively, more fully described below, included $15 million and $48 million, respectively, related to the continuing implementation of our Business Operations and Information Technology Transformation program. The remaining restructuring charge for the first nine months of 2012, composed of a net credit adjustment of $(3) million, was related to actions initiated by us in 2011 associated with expense control measures, specifically our withdrawal from our fixed-income trading initiative. The restructuring charges of $66 million and $75 million incurred in the third quarter and first nine months of 2011, respectively, related solely to the Business Operations and Information Technology Transformation program.
Information with respect to both initiatives (the Business Operations and Information Technology Transformation program and the expense control measures), including charges, staff reductions and aggregate activity in the related accruals, is provided in the two sections that follow.
Business Operations and Information Technology Transformation Program
In November 2010, we announced a global multi-year Business Operations and Information Technology Transformation program. The program includes operational, information technology and targeted cost initiatives, including plans related to reductions in both staff and occupancy costs.
With respect to our business operations, we are standardizing certain core business processes, primarily through our execution of the State Street Lean methodology, and driving automation of these business processes. We are currently creating a new technology platform, including transferring certain core software applications to a private cloud, and have expanded our use of service providers associated with components of our information technology infrastructure and application maintenance and support. We expect the transfer of core software applications to a private cloud to occur primarily in 2013 and 2014.
To implement this program, we expect to incur aggregate pre-tax restructuring charges of approximately $400 million to $450 million over the four-year period ending December 31, 2014. To date, we have recorded aggregate restructuring charges of $337 million in our consolidated statement of income, composed of $156 million in 2010, $133 million in 2011 and $48 million in the first nine months of 2012. The following table presents the charges by type of cost:
(In millions)
Employee-Related
Costs
 
Real Estate
Consolidation
 
Information
Technology  Costs
 
Total
2010
$
105

 
$
51

 

 
$
156

2011
85

 
7

 
$
41

 
133

First nine months of 2012
21

 
7

 
20

 
48

Total
$
211

 
$
65

 
$
61

 
$
337

 
The employee-related costs included costs related to severance, benefits and outplacement services. Real estate

21

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

consolidation costs resulted from actions taken to reduce our occupancy costs through consolidation of leases and properties. Information technology costs included transition fees related to the above-described expansion of our use of service providers.
In 2010, in connection with the program, we initiated the involuntary termination of 1,400 employees, or approximately 5% of our global workforce, which was substantially complete at the end of 2011. In addition, in 2011, in connection with the expansion of our use of service providers associated with our information technology infrastructure and application maintenance and support, we identified 530 employees to be involuntarily terminated as their roles were eliminated. As of September 30, 2012, in connection with the planned aggregate staff reduction of 1,930 employees described above, 1,804 employees had been involuntarily terminated and left State Street, composed of 550 employees in 2010, 782 employees in 2011 and 472 employees in the first nine months of 2012.
In connection with the implementation of the program, we achieved approximately $86 million of annual pre-tax run-rate expense savings in 2011, compared to our 2010 total expense base, previously disclosed in our 2011 Form 10-K, of approximately $6.18 billion of expenses from operations, all else being equal. In addition to the $86 million, we expect to achieve incremental annual pre-tax run-rate expense savings in the range of an additional $90 million to $100 million in 2012 compared to our above-described 2010 total expense base, all else being equal.
Excluding the expected aggregate restructuring charges of $400 million to $450 million described earlier, we expect the program to reduce our pre-tax expenses from operations, on an annualized basis, by approximately $575 million to $625 million by the end of 2014 compared to 2010, all else being equal, with the full effect realized in 2015. We expect the business operations transformation component of the program to result in approximately $440 million of these savings, with the majority of these savings expected to be achieved by the end of 2013. In addition, we expect the information technology transformation component of the program to result in approximately $160 million of these savings.
These expected annual pre-tax savings relate only to the Business Operations and Information Technology Transformation program. Our actual operating expenses may increase or decrease as a result of other factors. The majority of the annual savings will affect compensation and employee benefits expenses; these savings will be modestly offset by increases in information systems and communications expenses as we implement the program.
Expense Control Measures
During the fourth quarter of 2011, in connection with expense control measures designed to calibrate our expenses to our outlook for our capital markets-facing businesses in 2012, we took two actions. First, we withdrew from our fixed-income trading initiative, under which we traded in fixed-income securities and derivatives as principal with our custody clients and other third-parties that trade in these securities and derivatives. Second, we undertook other targeted staff reductions. As a result of these actions, we recorded aggregate pre-tax restructuring charges of $120 million in 2011, and a net credit adjustment of $(3) million in the nine months ended September 30, 2012, in our consolidated statement of income. The following table presents the charges by type of cost (no charges were recorded in the third quarter of 2012):
(In millions)
Employee-Related
Costs
 
Fixed-Income Trading Portfolio
 
Asset and Other Write-Offs
 
Total
2011
$
62

 
$
38

 
$
20

 
$
120

First quarter of 2012
3

 
(10
)
 

 
(7
)
Second quarter of 2012
(2
)
 
1

 
5

 
4

Total
$
63

 
$
29

 
$
25

 
$
117

The employee-related costs included costs related to severance, benefits and outplacement services with respect to both aspects of the expense control measures. In connection with these measures, we identified 442 employees to be involuntarily terminated as their roles were eliminated. As of September 30, 2012, 372 employees had been involuntarily terminated and left State Street, composed of 15 employees in 2011 and 357 employees in the first nine months of 2012.
The costs related to the fixed-income trading portfolio resulted primarily from fair-value adjustments to the initiative's trading portfolio related to our decision to withdraw from the initiative. In connection with our withdrawal, during the first nine months of 2012, we wound down all of that initiative's remaining trading portfolio. Costs for asset and other write-offs were related to other asset write-downs and contract terminations.

22

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)


Aggregate Restructuring-Related Accrual Activity
The following table presents aggregate activity associated with accruals that resulted from the charges associated with the Business Operations and Information Technology Transformation program and expense control measures:
(In millions)
Employee-
Related
Costs
 
Real Estate
Consolidation
 
Information Technology
Costs
 
Fixed-Income Trading Portfolio
 
Asset and Other Write-Offs
 
Total
Initial restructuring-related accrual
$
105

 
$
51

 
 
 
 
 
 
 
$
156

Payments
(15
)
 
(4
)
 
 
 
 
 
 
 
(19
)
Balance at December 31, 2010
90

 
47

 
 
 
 
 
 
 
137

Accruals for Business Operations and Information Technology Transformation program
85

 
7

 
$
41

 
 
 
 
 
133

Accruals for expense control measures
62

 

 

 
$
38

 
$
20

 
120

Payments and adjustments
(75
)
 
(15
)
 
(8
)
 

 
(5
)
 
(103
)
Balance at December 31, 2011
162

 
39

 
33

 
38

 
15

 
287

Accruals for Business Operations and Information Technology Transformation program
21

 
7

 
20

 

 

 
48

Net accruals for expense control measures
1

 

 

 
(9
)
 
5

 
(3
)
Payments and adjustments
(101
)
 
(6
)
 
(36
)
 
(29
)
 
(6
)
 
(178
)
Balance at September 30, 2012
$
83

 
$
40

 
$
17

 
$

 
$
14

 
$
154


INCOME TAX EXPENSE
Income tax expense was $267 million for the third quarter of 2012 and $74 million for the third quarter of 2011. For the first nine months of 2012 and 2011, income tax expense was $588 million and $465 million, respectively. Our effective tax rates for the third quarter and first nine months of 2012 were 28.3% and 27.0%, respectively, compared to 11.7% and 23.2% for the third quarter and first nine months of 2011, respectively. The increases in the effective tax rates in both comparisons were associated with the impact of a discrete tax benefit of $91 million recorded in the third quarter of 2011 related to the cost of terminating funding obligations that supported former conduit asset structures.
 
LINE OF BUSINESS INFORMATION
We have two lines of business: Investment Servicing and Investment Management. Given our services and management organization, the results of operations for these lines of business are not necessarily comparable with those of other companies, including companies in the financial services industry. Information about our two lines of business, as well as the revenues, expenses and capital allocation methodologies associated with these lines of business, is provided in note 24 to the consolidated financial statements included in our 2011 Form 10-K.
The following is a summary of our line of business results for the periods indicated. The “Other” columns for 2012 in the quarterly and nine-month tables included the net realized loss from the second-quarter 2012 sale of all of our Greek investment securities previously classified as held to maturity (presented only in the nine-month table); a benefit related to claims associated with the 2008 Lehman Brothers bankruptcy; provisions for litigation exposure and other costs; acquisition-related integration costs; and restructuring charges associated with both our Business Operations and Information Technology Transformation program and expense control measures. The "Other" columns for 2011 included acquisition-related integration costs and restructuring charges associated with our Business Operations and Information Technology Transformation program. The amounts in the “Other” columns were not allocated to State Street's business lines. Results for the 2011 periods reflect the retroactive effect of management changes in methodology related to funds transfer pricing and expense allocation in 2012.



23

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)


 
 
Quarters Ended September 30,
 
Investment
Servicing
 
Investment
Management
 
Other
 
Total
(Dollars in millions,
except where otherwise noted)
2012
 
2011
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicing fees
$
1,100

 
$
1,106

 
 
 
 
 
 
 
 
 
$
1,100

 
$
1,106

Management fees

 

 
$
251

 
$
229

 
 
 
 
 
251

 
229

Trading services
232

 
334

 

 

 
 
 
 
 
232

 
334

Securities finance
81

 
77

 
10

 
8

 
 
 
 
 
91

 
85

Processing fees and other
15

 
57

 
30

 
33

 
 
 
 
 
45

 
90

Total fee revenue
1,428

 
1,574

 
291

 
270

 
 
 
 
 
1,719

 
1,844

Net interest revenue
600

 
553

 
19

 
25

 
 
 
 
 
619

 
578

Gains related to investment
securities, net
18

 
5

 

 

 
 
 
 
 
18

 
5

Total revenue
2,046

 
2,132

 
310

 
295

 


 
 
 
2,356

 
2,427

Expenses from operations
1,456

 
1,475

 
208

 
238

 
 
 
 
 
1,664

 
1,713

Claims resolution

 

 

 

 
$
(362
)
 
 
 
(362
)
 

Provisions for litigation exposure and other costs

 

 

 

 
85

 
 
 
85

 

Acquisition and restructuring costs

 

 

 

 
28

 
$
85

 
28

 
85

Total expenses
1,456

 
1,475

 
208

 
238

 
(249
)
 
85

 
1,415

 
1,798

Income (loss) before income tax expense
$
590

 
$
657

 
$
102

 
$
57

 
$
249

 
$
(85
)
 
$
941

 
$
629

Pre-tax margin
29
%
 
31
%
 
33
%
 
19
%
 
 
 
 
 
 
 
 
Average assets (in billions)
$
191.6

 
$
177.0

 
$
4.2

 
$
4.0

 
 
 
 
 
$
195.8

 
$
181.0



24

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS (Continued)

 
Nine Months Ended September 30,
 
Investment
Servicing
 
Investment
Management
 
Other
 
Total
(Dollars in millions,
except where otherwise noted)
2012
 
2011
 
2012
 
2011
 
2012
 
2011
 
2012
 
2011
Fee revenue: