10-K 1 d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

Form 10-K

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2009

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)   (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)

Securities registered pursuant to Section 12(b) of the Act:

(Title of Each Class)

 

(Name of each exchange on which registered)

Common Stock, $1 par value   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes  x  No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes  ¨  No  x

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date 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 Securities Exchange Act of 1934).  Yes  ¨  No  x

The aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the per share price ($47.20) at which the common equity was last sold as of the last business day of the registrant’s most recently completed second fiscal quarter (June 30, 2009) was approximately $23.29 billion.

The number of shares of the registrant’s Common Stock outstanding as of January 31, 2010 was 495,380,839.

Portions of the following documents are incorporated by reference into Parts of this Report on Form 10-K, to the extent noted in such Parts, as indicated below:

(1) The registrant’s definitive Proxy Statement for the 2010 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A on or before April 30, 2010 (Part III).

 

 

 


Table of Contents

 

STATE STREET CORPORATION

Table of Contents

 

    

Description

   Page Number

PART I

     

Item 1

   Business    1

Item 1A

   Risk Factors    5

Item 1B

   Unresolved Staff Comments    24

Item 2

   Properties    24

Item 3

   Legal Proceedings    25

Item 4

   Submission of Matters to a Vote of Security Holders    26

Item 4A

   Executive Officers of the Registrant    27

PART II

     

Item 5

  

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

   29

Item 6

   Selected Financial Data    31

Item 7

  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   32

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk    80

Item 8

   Financial Statements and Supplementary Data    81

Item 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

   154

Item 9A

   Controls and Procedures    154

Item 9B

   Other Information    156

PART III

     

Item 10

   Directors, Executive Officers and Corporate Governance    156

Item 11

   Executive Compensation    156

Item 12

  

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

   156

Item 13

   Certain Relationships and Related Transactions, and Director Independence    157

Item 14

   Principal Accounting Fees and Services    157

PART IV

     

Item 15

   Exhibits and Financial Statement Schedules    158
   SIGNATURES    159
   EXHIBIT INDEX    160


Table of Contents

PART I

 

ITEM 1. BUSINESS

State Street Corporation is a financial holding company, organized in 1969 under the laws of the Commonwealth of Massachusetts. Through its subsidiaries, including its principal banking subsidiary, State Street Bank and Trust Company, State Street Corporation provides a broad range of products and services for institutional investors worldwide. All references in this Form 10-K to the parent company are to State Street Corporation. Unless otherwise indicated or unless the context requires otherwise, all references in this Form 10-K to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. State Street Bank and Trust Company is referred to as State Street Bank. The parent company is a legal entity separate and distinct from its subsidiaries, assisting those subsidiaries by providing financial resources and management. At December 31, 2009, we had consolidated total assets of $157.95 billion, consolidated total deposits of $90.06 billion, consolidated total shareholders’ equity of $14.49 billion and employed 27,310. Our executive offices are located at One Lincoln Street, Boston, Massachusetts 02111 (telephone (617) 786-3000).

We make available, without charge, on or through our Internet website at www.statestreet.com, all reports we electronically file with, or furnish to, the Securities and Exchange Commission, or SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments to those reports, as soon as reasonably practicable after those documents have been filed with, or furnished to, the SEC. These documents are also accessible on the SEC’s website at www.sec.gov. We have included the website addresses of State Street and the SEC in this report as inactive textual references only. Except as may be specifically incorporated by reference into this Form 10-K, information on those websites is not part of this Form 10-K.

We have Corporate Governance Guidelines, as well as written charters for the Executive Committee, the Examining and Audit Committee, the Executive Compensation Committee, the Risk and Capital Committee and the Nominating and Corporate Governance Committee of our Board of Directors, and a Code of Ethics for Senior Financial Officers, a Standard of Conduct for Directors and a Standard of Conduct for our employees. Each of these documents is posted on our website.

GENERAL

With $18.79 trillion of assets under custody and administration and $1.91 trillion of assets under management at year-end 2009, we are a leading specialist in meeting the needs of institutional investors worldwide. Our customers include mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations, endowments and investment managers. Including the United States, we operate in 25 countries and more than 100 geographic markets worldwide. We conduct our business primarily through our principal banking subsidiary, State Street Bank, which traces its beginnings to the founding of the Union Bank in 1792. State Street Bank’s current charter was authorized by a special act of the Massachusetts Legislature in 1891, and its present name was adopted in 1960.

For a discussion of our business activities, refer to the “Lines of Business” section that follows. For information about our management of capital, liquidity, market risk, including interest-rate risk, and other risks inherent in our businesses, refer to Management’s Discussion and Analysis of Financial Condition and Results of Operations included under Item 7, and Risk Factors included under Item 1A. Financial information with respect to income taxes and non-U.S. activities is included in notes 21 and 24 of the Notes to Consolidated Financial Statements included under Item 8.

LINES OF BUSINESS

We have two lines of business: Investment Servicing and Investment Management. These two lines of business provide services to support institutional investors, including custody, recordkeeping, daily pricing and administration, shareholder services, foreign exchange, brokerage and other trading services, securities finance,

 

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deposit and short-term investment facilities, loan and lease financing, investment manager and alternative investment manager operations outsourcing, performance, risk and compliance analytics, investment research and investment management, including passive and active U.S. and non-U.S. equity and fixed-income strategies. For additional information about our lines of business, see the “Line of Business Information” section of Management’s Discussion and Analysis included under Item 7, and note 23 of the Notes to Consolidated Financial Statements included under Item 8.

COMPETITION

We operate in a highly competitive environment in all areas of our business worldwide. We face competition from other financial services institutions, deposit-taking institutions, investment management firms, insurance companies, mutual funds, broker/dealers, investment banking firms, benefits consultants, leasing companies, and business service and software companies. As we expand globally, we encounter additional sources of competition.

We believe that there are certain key competitive considerations in these markets. These considerations include, for investment servicing, quality of service, economies of scale, technological expertise, quality and scope of sales and marketing, and price; and for investment management, expertise, experience, the availability of related service offerings, quality of service and performance, and price.

Our competitive success will depend upon our ability to develop and market new and innovative services, to adopt or develop new technologies, to bring new services to market in a timely fashion at competitive prices, to continue and expand our relationships with existing customers and to attract new customers.

SUPERVISION AND REGULATION

The parent company is registered with the Board of Governors of the Federal Reserve System, which we refer to as the Federal Reserve, as a bank holding company pursuant to the Bank Holding Company Act of 1956. The Bank Holding Company Act, with certain exceptions, limits the activities in which we and our non-banking subsidiaries may engage, to those that the Federal Reserve considers to be closely related to banking or managing or controlling banks. These limits also apply to non-banking entities of which we own or control more than 5% of a class of voting shares. The Federal Reserve may order a bank holding company to terminate any activity or its ownership or control of a non-banking subsidiary if the Federal Reserve finds that the activity, ownership or control constitutes a serious risk to the financial safety, soundness or stability of a banking subsidiary or is inconsistent with sound banking principles or statutory purposes. The Bank Holding Company Act also requires a bank holding company to obtain prior approval of the Federal Reserve before it may acquire substantially all the assets of any bank or ownership or control of more than 5% of the voting shares of any bank.

The parent company operates as a financial holding company, which reduces to some extent the Federal Reserve’s restrictions on our activities. A financial holding company and the companies under its control are permitted to engage in activities considered “financial in nature” as defined by the Gramm-Leach-Bliley Act and Federal Reserve interpretations, and therefore the parent company may engage in a broader range of activities than permitted for bank holding companies and their subsidiaries. Financial holding companies may engage directly or indirectly in activities considered financial in nature, either de novo or by acquisition, provided the financial holding company gives the Federal Reserve after-the-fact notice of the new activities. Activities defined to be financial in nature include, but are not limited to, the following: providing financial or investment advice; underwriting; dealing in or making markets in securities; merchant banking, subject to significant limitations; and any activities previously found by the Federal Reserve to be closely related to banking. In order to maintain our status as a financial holding company, each of our depository subsidiaries must be well capitalized and well managed, as judged by regulators, and must comply with Community Reinvestment Act obligations. Failure to maintain these standards may ultimately permit the Federal Reserve to take enforcement actions against us.

Many aspects of our business are subject to regulation by other U.S. federal and state governmental and regulatory agencies and self-regulatory organizations (including securities exchanges), and by non-U.S. governmental and regulatory agencies and self-regulatory organizations. Aspects of our public disclosure,

 

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corporate governance principles and internal control systems are subject to the Sarbanes-Oxley Act of 2002 and regulations and rules of the SEC and the New York Stock Exchange.

Capital Adequacy

Like other bank holding companies, we are subject to Federal Reserve minimum risk-based capital and leverage ratio guidelines. As noted above, our status as a financial holding company also requires that we maintain specified capital ratio levels. State Street Bank is subject to similar risk-based capital and leverage ratio guidelines. As of December 31, 2009, our capital levels on a consolidated basis, and the capital levels of State Street Bank, exceeded the applicable minimum capital requirements and the requirements to qualify as a financial holding company. Failure to meet capital requirements could subject us to a variety of enforcement actions, including the termination of deposit insurance of State Street Bank by the Federal Deposit Insurance Corporation, and to certain restrictions on our business that are described further in this “Supervision and Regulation” section.

For additional information about our capital position and capital adequacy, refer to the “Capital” section of Management’s Discussion and Analysis included under Item 7, and note 15 of the Notes to Consolidated Financial Statements included under Item 8.

Subsidiaries

The Federal Reserve is the primary federal banking agency responsible for regulating us and our subsidiaries, including State Street Bank, for both our U.S. and non-U.S. operations.

Our bank subsidiaries are subject to supervision and examination by various regulatory authorities. State Street Bank is a member of the Federal Reserve System and the FDIC and is subject to applicable federal and state banking laws and to supervision and examination by the Federal Reserve, as well as by the Massachusetts Commissioner of Banks, the FDIC, and the regulatory authorities of those states and countries in which a branch of State Street Bank is located. Other subsidiary trust companies are subject to supervision and examination by the Office of the Comptroller of the Currency, other offices of the Federal Reserve System or by the appropriate state banking regulatory authorities of the states in which they are located. Our non-U.S. banking subsidiaries are subject to regulation by the regulatory authorities of the countries in which they are located. As of December 31, 2009, the capital of each of these banking subsidiaries was in excess of the minimum legal capital requirements as set by those authorities.

The parent company and its non-banking subsidiaries are affiliates of State Street Bank under federal banking laws, which impose restrictions on transfers of funds in the form of loans, extensions of credit, investments or asset purchases from State Street Bank to the parent and its non-banking subsidiaries. Transfers of this kind to affiliates by State Street Bank are limited with respect to each affiliate to 10% of State Street Bank’s capital and surplus, as defined, and to 20% in the aggregate for all affiliates, and are subject to collateral requirements. Federal law also provides that certain transactions with affiliates must be on terms and under circumstances, including credit standards, that are substantially the same or at least as favorable to the institution as those prevailing at the time for comparable transactions involving other non-affiliated companies or, in the absence of comparable transactions, on terms and under circumstances, including credit standards, that in good faith would be offered to, or would apply to, non-affiliated companies. State Street Bank is also prohibited from engaging in certain tie-in arrangements in connection with any extension of credit or lease or sale of property or furnishing of services. The Federal Reserve has jurisdiction to regulate the terms of certain debt issues of bank holding companies. Federal law provides as well for a depositor preference on amounts realized from the liquidation or other resolution of any depository institution insured by the FDIC.

Our investment management division, State Street Global Advisors, or SSgA, which acts as an investment advisor to investment companies registered under the Investment Company Act of 1940, is registered as an investment advisor with the SEC. However, a major portion of our investment management activities are conducted by State Street Bank, which is subject to supervision primarily by the Federal Reserve with respect to these activities. Our U.S. broker/dealer subsidiary is registered as a broker/dealer with the SEC, is subject to

 

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regulation by the SEC (including the SEC’s net capital rule) and is a member of the Financial Industry Regulatory Authority, a self-regulatory organization. Many aspects of our investment management activities are subject to federal and state laws and regulations primarily intended to benefit the investment holder, rather than our shareholders. These laws and regulations generally grant supervisory agencies and bodies broad administrative powers, including the power to limit or restrict us from carrying on our investment management activities in the event that we fail to comply with such laws and regulations, and examination authority. Our business relating to investment management and trusteeship of collective trust funds and separate accounts offered to employee benefit plans is subject to ERISA and is regulated by the U.S. Department of Labor.

Our businesses, including our investment management and securities and futures businesses, are also regulated extensively by non-U.S. governments, securities exchanges, self-regulatory organizations, central banks and regulatory bodies, especially in those jurisdictions in which we maintain an office. For instance, the Financial Services Authority, the London Stock Exchange, and the Euronext.liffe regulate our activities in the United Kingdom; the Federal Financial Supervisory Authority and the Deutsche Borse AG regulate our activities in Germany; and the Financial Services Agency, the Bank of Japan, the Japanese Securities Dealers Association and several Japanese securities and futures exchanges, including the Tokyo Stock Exchange, regulate our activities in Japan. We have established policies, procedures, and systems designed to comply with these requirements. However, as a global financial services institution, we face complexity and costs in our worldwide compliance efforts.

Most of our non-U.S. operations are conducted pursuant to Federal Reserve Regulation K through State Street Bank’s Edge Act corporation subsidiary or through international branches of State Street Bank. An Edge Act corporation is a corporation organized under federal law that conducts foreign business activities. In general, banks may not invest more than 20% of their capital and surplus in their Edge Act corporations (and similar state law corporations), and the investment of any amount in excess of 10% of capital and surplus requires the prior approval of the Federal Reserve.

In addition to our non-U.S. operations conducted pursuant to Regulation K, we make new investments abroad directly (through the parent company or through non-banking subsidiaries of the parent company) pursuant to Federal Reserve Regulation Y, or through international bank branch expansion, which are not subject to the 20% investment limitation for Edge Act corporation subsidiaries.

We are subject to the USA PATRIOT Act of 2001, which contains anti-money laundering and financial transparency laws and requires implementation of regulations applicable to financial services companies, including standards for verifying client identification and monitoring client transactions and detecting and reporting suspicious activities. Anti-money laundering laws outside the U.S. contain similar requirements.

We are also subject to the Massachusetts bank holding company statute. The statute requires prior approval by the Massachusetts Board of Bank Incorporation for our acquisition of more than 5% of the voting shares of any additional bank and for other forms of bank acquisitions.

Support of Subsidiary Banks

Under Federal Reserve guidelines, a bank holding company is required to act as a source of financial and managerial strength to its banking subsidiaries. Under these guidelines, the parent company is expected to commit resources to State Street Bank and any other banking subsidiary in circumstances in which it might not do so absent such guidelines. In the event of bankruptcy, any commitment by the parent company to a federal bank regulatory agency to maintain the capital of a banking subsidiary will be assumed by the bankruptcy trustee and will be entitled to a priority payment.

ECONOMIC CONDITIONS AND GOVERNMENT POLICIES

Economic policies of the U.S. government and its agencies influence our operating environment. Monetary policy conducted by the Federal Reserve directly affects the level of interest rates, which may impact overall credit conditions of the economy. Monetary policy is applied by the Federal Reserve through open market operations in U.S. government securities, changes in reserve requirements for depository institutions, and

 

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changes in the discount rate and availability of borrowing from the Federal Reserve. Government regulation of banks and bank holding companies is intended primarily for the protection of depositors of the banks, rather than for the shareholders of the institutions. We are also impacted by the economic policies of non-U.S. government agencies, such as the European Central Bank.

STATISTICAL DISCLOSURE BY BANK HOLDING COMPANIES

The following information, included under Items 6, 7 and 8, is incorporated by reference herein:

“Selected Financial Data” table (Item 6)—presents return on average common equity, return on average assets, common dividend payout and equity-to-assets ratios.

“Distribution of Average Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential” table (Item 8)—presents average balance sheet amounts, related fully taxable-equivalent interest earned or paid, related average yields and rates paid and changes in fully taxable-equivalent interest revenue and expense for each major category of interest-earning assets and interest-bearing liabilities.

Note 3, “Investment Securities,” of the Notes to Consolidated Financial Statements (Item 8) and “Investment Securities” section included in Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7)—disclose information regarding book values, market values, maturities and weighted-average yields of securities (by category).

Note 1, “Summary of Significant Accounting Policies—Loans and Lease Financing” of the Notes to Consolidated Financial Statements (Item 8)—discloses our policy for placing loans and leases on non-accrual status.

Note 4, “Loans and Lease Financing,” of the Notes to Consolidated Financial Statements (Item 8) and “Loans and Lease Financing” section included in Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7)—disclose distribution of loans, loan maturities and sensitivities of loans to changes in interest rates.

“Loans and Lease Financing” and “Cross-Border Outstandings” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7)—disclose information regarding cross-border outstandings and other loan concentrations of State Street.

“Credit Risk” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations (Item 7) and note 4, “Loans and Lease Financing,” of the Notes to Consolidated Financial Statements (Item 8)—present the allocation of the allowance for loan losses, and a description of factors which influenced management’s judgment in determining amounts of additions or reductions to the allowance, if any, charged or credited to results of operations.

“Distribution of Average Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential” table (Item 8)—discloses deposit information.

Note 8, “Short-Term Borrowings,” of the Notes to Consolidated Financial Statements (Item 8)—discloses information regarding short-term borrowings of State Street.

 

ITEM 1A. RISK FACTORS

This Form 10-K contains statements (including statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations, included under Item 7) that are considered “forward-looking statements” within the meaning of U.S. securities laws, including statements about industry trends, management’s future expectations and other matters that do not relate strictly to historical facts, are based on assumptions by management, and are often identified by such forward-looking terminology as “expect,” “look,” “believe,” “anticipate,” “estimate,” “seek,” “may,” “will,” “trend,” “target” and “goal,” or similar statements or variations of such terms. Forward-looking statements include, among other things, statements about our confidence in our strategies and our expectations about our financial performance, market growth, acquisitions and divestitures, new technologies, services and opportunities and earnings.

 

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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 include, but are not limited to:

 

   

financial market disruptions and the economic recession, whether in the U.S. or internationally, and monetary and other governmental actions, including regulation, taxes and fees, designed to address or otherwise be responsive to such disruptions and recession, including actions taken in the U.S. and internationally to address the financial and economic disruptions that began in 2007;

 

   

increases in the volatility of, or declines in the levels of, our net interest revenue, changes in the composition of the assets on our consolidated balance sheet and the possibility that we may be required to change the manner in which we fund those assets;

 

   

the financial strength and continuing viability of the counterparties with which we or our customers do business and to which we have investment, credit or financial exposure;

 

   

the liquidity of the U.S. and international securities markets, particularly the markets for fixed-income securities, and the liquidity requirements of our customers;

 

   

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 in our consolidated statement of income of an impairment loss;

 

   

the maintenance of credit agency ratings for our debt and depository obligations as well as the level of credibility of credit agency ratings;

 

   

the ability to complete our announced and pending acquisitions, as well as future acquisitions, divestitures and joint ventures, including the ability to obtain regulatory approvals, the ability to arrange financing as required, and the ability to satisfy other closing conditions;

 

   

the risks that acquired businesses 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 customer 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 customers, employees or regulators;

 

   

the possibility of our customers incurring substantial losses in investment pools where we act as agent, and the possibility of further general reductions in the valuation of assets;

 

   

our ability to attract deposits and other low-cost, short-term funding;

 

   

potential changes to the competitive environment, including changes due to the effects of consolidation, and perceptions of State Street as a suitable service provider or counterparty;

 

   

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;

 

   

our ability to measure the fair value of the investment securities on our consolidated balance sheet;

 

   

the results of litigation, government investigations and similar disputes or proceedings;

 

   

the enactment of new legislation and changes in government regulation and enforcement which affect us or our customers, and which may increase our costs and expose us to risk related to compliance;

 

   

adverse publicity or other reputational harm;

 

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the performance and demand for the products and services we offer, including the level and timing of withdrawals from our collective investment products;

 

   

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;

 

   

our ability to control operating 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 fail or be circumvented;

 

   

the potential for new products and services to impose additional costs on us and expose us to increased operational risk;

 

   

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 impact the amount of taxes due.

Therefore, 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-K or disclosed in our other SEC filings. 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-K is filed with the SEC. We undertake no obligation to revise the forward-looking statements contained in this Form 10-K to reflect events after the time it is filed with the SEC. 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 potential economic, operational and financial 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.

The following is a discussion of risk factors applicable to State Street.

Disruptions in the global financial markets that began in mid-2007 have increased the uncertainty and unpredictability we face in managing our businesses, and continued or additional disruptions could have an adverse effect on our businesses, our consolidated results of operations and financial condition.

Since mid-2007, global credit and other financial markets have suffered from substantial volatility, illiquidity and disruption. These factors resulted in the bankruptcy or acquisition of, or significant government assistance to, a number of major domestic and international financial institutions, some of which were significant counterparties with us. These events, and the potential for continuing disruptions, have affected overall confidence in the financial markets and in financial institutions, have further exacerbated liquidity and pricing issues within the fixed-income markets, have increased the uncertainty and unpredictability we face in managing our business and have had an adverse effect on our businesses, our consolidated results of operations and financial condition. The continuation of current disruptions or the occurrence of additional disruptions in the global markets could have an adverse effect on our businesses and our consolidated results of operations and financial condition.

Market disruptions could continue to adversely impact our fee revenue as the value of assets under custody, administration or management would decline, while the costs of providing the related services would remain constant due to the fixed nature of such costs. These factors could reduce our asset-based fee revenue and could adversely affect our other transaction-based revenue, such as securities finance and foreign exchange revenue, and the volume of transactions that we execute for our customers, but the costs of providing the related services would not similarly decline. Further, the degree of volatility in foreign exchange rates can affect our foreign

 

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exchange trading revenue. In general, increased currency volatility may increase our market risk, and our foreign exchange revenue, all other things being equal, is likely to decrease during times of decreased currency volatility. In addition, as our business grows globally, our exposure to changes in foreign currency exchange rates could affect our levels of consolidated revenue, expense and results of operations, as well as the value of our investment in our non-U.S. operations.

The overall worldwide economic recession has adversely affected, and is likely to continue to adversely affect, our businesses and our consolidated results of operations and financial condition.

Our businesses are affected by global economic conditions, including regional and international rates of economic growth and the impact that such economic conditions have on the financial markets. The downturn in the global economies, as well as the U.S. economy, that began in mid-2007 has led to an increased level of commercial and consumer delinquencies, a lack of consumer confidence, decreased market valuations and liquidity, increased market volatility and a widespread reduction of business activity generally. The resulting economic pressure and lack of confidence in the financial markets has adversely affected our businesses and our consolidated results of operations and financial condition, as well as the business of our customers. A worsening of economic conditions in the U.S. or globally would likely exacerbate the adverse effects of these difficult conditions on us and on the financial services industry in general.

The failure or instability of any of our significant counterparties, many of whom are financial institutions, and our assumption of significant credit and counterparty risk, could expose us to loss.

The financial markets are characterized by extensive interconnections among financial institutions, including banks, broker/dealers, collective investment funds and insurance companies. As a result of these interconnections, we and many of our customers have concentrated counterparty exposure to other financial institutions. Although we have procedures for monitoring both individual and aggregate counterparty risk, like other large financial institutions, the nature of our business is such that large individual and aggregate counterparty exposure is inherent in our business as our focus on large institutional investors and their businesses. At any point in time, having one or more counterparties to which our exposure exceeds 10% of our total shareholders’ equity, exclusive of unrealized gains or losses, is not unusual.

Concentration of counterparty exposure presents significant risks to us and to our customers because the failure or perceived weakness of any of our counterparties (or in some cases of our customers’ counterparties) has the potential to expose us to risk of loss.

The current instability of the financial markets has resulted in many financial institutions becoming significantly less creditworthy, and as a result we are exposed to increased counterparty risks, both as principal and in our capacity as agent for our customers. Changes in market perception of the financial strength of particular financial institutions can occur rapidly, is often based upon a variety of factors and is difficult to predict. In addition, as U.S. and non-U.S. governments have addressed the financial crisis in an evolving manner, the criteria for and manner of governmental support of financial institutions and other economically important sectors remain uncertain. If a significant individual counterparty defaults on an obligation to us, we could incur financial losses that materially adversely affect our businesses and our consolidated results of operations and financial condition.

The degree of customer demand for short-term credit also tends to increase during periods of market turbulence, exposing us to further counterparty-related risks. For example, investors in collective investment vehicles for which we act as custodian may engage in significant redemption activity due to adverse market or economic news that was not anticipated by the fund’s manager. Our relationship with our customers, the nature of the settlement process and our systems result in the extension of short-term credit in such circumstances. For some types of customers, we provide credit to allow them to leverage their portfolios, which increases our potential loss if the customer experiences credit difficulties. From time to time, we may assume concentrated credit risk at the individual obligor, counterparty or guarantor level. In addition, we may from time to time be exposed to concentrated credit risk at the industry or country level, potentially exposing us to a single market or political event or a correlated set of events. We are also generally not able to net exposures across counterparties

 

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that are affiliated entities and may not be able in all circumstances to net exposures across multiple products to the same legal entity. As a consequence, we may incur a loss in relation to one entity or product even though our exposure to one of its affiliates or across product types is over-collateralized. Moreover, not all of our counterparty exposure is secured, and when our exposure is secured, the realizable market value of the collateral may have declined by the time we exercise rights against that collateral. This risk may be particularly acute if we are required to sell the collateral into an illiquid or temporarily impaired market.

In addition, our customers often purchase securities or other financial instruments from a financial counterparty, including broker/dealers, under repurchase arrangements, frequently as a method of reinvesting the cash collateral they receive from lending their securities. Under these arrangements, the counterparty is obligated to repurchase these securities or financial instruments from the customer at the same price at some point in the future. The anticipated value of the collateral is intended to exceed the counterparty’s repayment obligation. In many cases, we agree to indemnify our customers from any loss that would arise upon a default by the counterparty if the proceeds from the disposition of the securities or other financial assets are less than the amount of the repayment obligation by the customer’s counterparty. In those instances, we, rather than our customer, are exposed to the risks associated with counterparty default and collateral value.

Some of the assets on our consolidated balance sheet are entitled to the benefit of guarantees from monoline insurance companies. Several of these insurance companies have experienced significant deterioration in their financial condition. To the extent that assets require credit support from the guarantors to be able to pay principal and interest in full and the guarantor does not or is not able to make payments required under the guarantee, we are exposed to risk of loss.

Although our overall business is subject to these interconnections, several of our lines of business are particularly sensitive to them, including our Global Treasury operations, currency and other trading, securities lending and investment management. Given the limited number of strong counterparties in the current market, we are not able to mitigate all of our and our customers’ counterparty credit risk. The current consolidation of financial service firms that began in 2008, and which we believe is likely to continue in 2010, and the failures of other financial institutions, have increased the concentration of our counterparty risk.

We may incur losses, which could be material to our financial results in the periods incurred, arising from bankruptcy-related claims by and against Lehman entities in the United States and the U.K.

We have claims against Lehman entities in bankruptcy proceedings in the U.S. and the U.K. We also have amounts that we owe to Lehman entities. These claims and amounts owed arise from the resolution of transactions that existed at the time the Lehman entities entered bankruptcy, including foreign exchange transactions, securities lending arrangements and repurchase agreements. In the aggregate, the amounts that we believe we owe Lehman entities, as reflected in our submissions in the bankruptcy proceedings, are less than our estimate of the realizable value of the claims we have asserted against Lehman entities. However, we may recognize gains and losses in different fiscal periods depending in part on the timing and sequence of the resolution of the claims by us and against us in the different proceedings. In addition, the process for resolving these claims and obligations is complex and may continue for some time. We do not know whether the bankruptcy courts and administrators will accept or challenge our claims; question positions we have taken as to our contractual rights and obligations; question any of the valuations or other calculations that we have used in preparing such claims; or seek amounts from us greater than that which we believe to be due.

For example, in connection with the resolution of our obligations pursuant to the repurchase agreements between our customers in the U.S. and a Lehman entity, we indemnified our customers against loss and assumed our customers’ rights with respect to collateral consisting of interests in commercial real estate loans. For purposes of our claim in the bankruptcy court, we valued this collateral at our estimate of its liquidation value following the Lehman bankruptcy; however, when we took possession of this collateral and recorded it in our consolidated balance sheet, we valued the collateral based upon our estimate of its fair value in accordance with GAAP, which fair value was significantly greater than its liquidation value. This difference in valuation, among other factors, could result in the bankruptcy court assigning a lesser value to our claim or rejecting our claim entirely. Similarly,

 

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certain of our customers had entered into securities lending arrangements and/or repurchase agreements with Lehman’s U.K. affiliate. In accordance with the terms of our lending program and repurchase agreement product, we have indemnified those customers against loss in connection with the resolution of these arrangements, and sold or taken possession of the related collateral, which included asset-backed securities. For purposes of the resolution of securities lending arrangements and repurchase agreements in the U.K. in connection with the bankruptcy proceedings, we valued asset-backed securities at their assumed liquidation values, in each case reflecting the absence of an active trading market for these securities following the bankruptcy of Lehman. We subsequently recorded these assets in our consolidated balance sheet at a significantly greater value, based upon relevant market conditions and our assessment of their fair value in accordance with GAAP at that time. As a result of these valuation decisions, we determined that there was a shortfall in collateral supporting repurchase agreements and applied excess collateral supporting Lehman’s obligations under securities lending arrangements against Lehman’s obligations under the repurchase agreements. The administrator in the U.K. bankruptcy proceedings may challenge any or all of the positions that we have taken, including our valuation of the collateral and the application of excess collateral supporting Lehman’s obligations under the securities lending arrangements against Lehman’s unsecured obligations under the repurchase agreements. Given the uncertainty in the process and the potential for a court or administrator to challenge the amounts that we believe to be owed by us or due to us, it is possible that our obligations, net of recoveries, to Lehman entities may be substantial, with the result that our net payment obligations could be potentially as much as several hundred million dollars.

If all or a significant portion of the unrealized losses in our investment securities portfolio on our consolidated balance sheet were determined to be other-than-temporarily impaired, we would recognize a material charge to our earnings and our capital ratios would be adversely affected.

During 2008 and 2009, rating agencies imposed an increasing number of downgrades and credit watches on the securities in our investment securities portfolio, which contributed to the decline in fair values. Any continued increase in downgrades and credit watches may contribute to a further decline in the fair values of these securities. Further, the measurement of the fair value of these securities, as well as our other financial assets, involves significant judgment due to the complexity of the factors contributing to the measurement. Market volatility makes measurement of the fair value of our investment portfolio even more difficult and subjective. More generally, as market conditions continue to be volatile we cannot provide assurance that the amount of the unrealized losses will not increase.

To the extent that any portion of the unrealized losses in these portfolios is determined to be other than temporary, and the loss is related to credit factors, we will recognize a charge to our earnings in the quarter during which such determination is made and our capital ratios could be adversely affected. If any such charge is significant, a rating agency might downgrade our credit rating or put us on credit watch. Even if we do not determine that the unrealized losses associated with these portfolios require an impairment charge, increases in these unrealized losses adversely affect our tangible common equity ratio, which may adversely affect credit rating agency and investor sentiment toward us. This negative perception also may adversely affect our ability to access the capital markets or might increase our cost of capital.

Further information with respect to unrealized losses on the securities in our investment portfolio is provided in note 3 of the Notes to Consolidated Financial Statements included under Item 8, and information with respect to the financial assets and liabilities which we carry at fair value on a recurring basis is provided in the “Critical Accounting Estimates” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included under Item 7, and in note 13 of the Notes to Consolidated Financial Statements, included under Item 8.

We may need to raise additional capital in the future, which may not be available to us or may only be available on unfavorable terms, and which may make future business acquisitions or dispositions difficult.

As a result of continued disruption in the global financial markets or other developments having an adverse effect on our capital ratios, we may need to raise additional capital in order to maintain our credit ratings or for

 

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other purposes. However, our ability to access the capital markets, if needed, will depend on a number of factors, including the state of the financial markets. Accordingly, we cannot be sure of our ability to raise additional capital, if needed, on terms acceptable to us.

Additionally, our ability to make acquisitions in order to achieve greater economies of scale or to expand our product offerings is dependent upon our financial resources and our ability to access the capital markets. In addition, our ability to dispose of businesses that no longer fit our business model may be difficult if attractive financing or capital is not available to prospective buyers. Due to company-specific issues or a lack of liquidity in the capital markets, our ability to expand through acquisitions or to dispose of businesses that no longer are strategic to us may be adversely affected.

Our business activities expose us to liquidity and interest-rate risk.

In our business activities, we assume liquidity and interest-rate risk in our investment portfolio of longer-and intermediate-term assets, which is funded in large part by our customer deposit base. Similarly, as a result of the May 2009 consolidation of the asset-backed commercial paper conduits that we administer, we fund the portfolio of intermediate term assets held by the conduits through our customer deposit base, through the conduits’ issuance of commercial paper or through draw-downs of other short-term sources of liquidity. In addition, we may be exposed to liquidity or other risks in managing asset pools for third parties that are funded on a short-term basis, or where the customers participating in these products have a right to the return of cash or assets on limited notice. These business activities include, among others, securities finance collateral pools, money market and other short-term investment funds and liquidity facilities utilized in connection with municipal bond programs.

Our reputation and business prospects may be damaged if our customers incur substantial losses in investment pools where we act as agent.

Our management of collective investment pools on behalf of customers exposes us to reputational risk and, in some cases, operational losses. The incurrence by our customers of substantial losses in these pools, particularly in money market funds (where there is a general market expectation that net asset value will not drop below $1.00 per share), in situations where we make distributions in-kind to satisfy redemption requests or in circumstances where one of our investment strategies significantly underperforms the market or our competitors’ products, could result in significant harm to our reputation and significantly and adversely affect the prospects of our associated business units. In some very limited circumstances, and consistent with applicable regulatory requirements, we may compensate investment pools for all or a portion of the pool’s losses even though we are not statutorily or contractually obligated to do so. Because we often implement investment and operational decisions and actions over multiple investment pools to achieve scale, we face the risk that losses, even small losses, may have a significant effect in the aggregate. While it is currently not our intention, any decision by us to provide financial support to our investment pools would potentially result in the recognition of significant losses and could in certain situations require us to consolidate the investment pools onto our consolidated balance sheet. A failure or inability to provide such support could damage our reputation among current and prospective customers. Any termination by a third-party guarantor of its guarantee could, if we were unable to replace the guarantee, adversely affect our business or result in litigation.

Our businesses may be adversely affected by litigation.

From time to time, our customers, or the government on their behalf, may make claims and take legal action relating to our performance of fiduciary or contractual responsibilities. We may also face employment lawsuits or other legal claims. In any such claims or actions, demands for substantial monetary damages may be asserted against us and may result in financial liability or an adverse effect on our reputation among investors or on customer demand for our products and services. We may be unable to accurately estimate our exposure to litigation risk when we record balance sheet reserves for probable loss contingencies. As a result, any reserves we establish to cover any settlements or judgments may not be sufficient to cover our actual financial exposure, which may have a material impact on our consolidated results of operations or financial condition.

 

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In the ordinary course of our business, we are also subject to various regulatory, governmental and law enforcement inquiries, investigations and subpoenas. These may be directed generally to participants in the businesses in which we are involved or may be specifically directed at us. In regulatory enforcement matters, claims for disgorgement, the imposition of penalties and the imposition of other remedial sanctions are possible.

In view of the inherent difficulty of predicting the outcome of legal actions and regulatory matters, we cannot provide assurance as to the outcome of any pending matter or, if determined adversely to us, the costs associated with any such matter, particularly where the claimant seeks very large or indeterminate damages or where the matter presents novel legal theories, involves a large number of parties or is at a preliminary stage. The resolution of certain pending legal actions or regulatory matters, if unfavorable, could have a material adverse effect on our consolidated results of operations for the quarter in which such actions or matters are resolved or a reserve is established.

Further information with respect to the foregoing and our other ongoing litigation matters is provided in Legal Proceedings included under Item 3.

We may incur losses, which could be material to our consolidated results of operations in the period incurred, with respect to sub-custody and prime broker arrangements we had with Lehman entities.

Various Lehman entities that served as sub-custodian or prime broker for some of our customers or funds entered insolvency proceedings in September 2008. Estimating the actual amount or timing of any recovery on our customers’ and funds’ claims against any of these Lehman entities is currently not possible. When these insolvency proceedings were commenced, cash and securities attributable to our custody customers, having approximately $325 million in net asset value at September 15, 2008, was held by or through Lehman entities. While the appointment of these Lehman entities had been made at our customer’s direction and we believe that we carried out our responsibilities with respect to our customers, our custody customers may nevertheless seek to recover from us any losses they incur as a result of the Lehman insolvency proceedings.

In the case of common trust funds managed by us, in our capacity as manager and trustee, we had appointed Lehman as prime broker for four of these funds, which at September 15, 2008 (the date two of the Lehman entities involved entered insolvency proceedings) had cash and securities with net asset values of approximately $312 million held by or though Lehman entities. The investors in these funds have commenced or threatened litigation against us, and in one case have obtained a judgment against us. There can be no assurance as to the outcome of these proceedings, and an adverse resolution could have a material adverse effect on our results of operations in the fiscal period or periods in which resolved. See Legal Proceedings included under Item 3.

We face litigation and potential additional governmental inquiries in connection with our provision of foreign exchange services to custody customers.

In October 2009, the Attorney General of the State of California commenced an action against State Street Bank under the California False Claims Act and California Business and Professional Code relating to foreign exchange services State Street Bank provides to California state pension plans. The California Attorney General asserts that the pricing of certain foreign exchange transactions for these pension plans was not consistent with the terms of the applicable custody contracts and related disclosures to the plans, and that, as a result, State Street Bank made false claims and engaged in unfair competition. The Attorney General asserts actual damages of $56 million for periods from 2001 to 2007 and seeks additional penalties, including treble damages. We provide custody and foreign exchange services to government pension plans in other jurisdictions and attorney generals from a number of these other jurisdictions, as well as the U.S. Attorney General’s office, have requested information in connection with informal inquiries into our foreign exchange pricing. If additional governmental proceedings of this nature were to be commenced, such actions could have a material impact on our reputation and on our future revenues. While no other customers have commenced legal proceedings, the services we offer to the State of California are also offered to a broad range of custody clients in the U.S. and internationally. There can be no assurance as to the outcome of the pending proceeding in California or other proceedings that might be commenced against us by any other Attorneys General or customers, and the resolution of any such proceedings could have a material adverse effect on our future consolidated results of operations. In light of the

 

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action commenced by the California Attorney General, we are providing customers with greater transparency into the pricing of this product and other alternatives offered by us for addressing their foreign exchange requirements. Although we believe such disclosures will address customer interests for increased transparency, over time such action may result in pressure on our pricing of this product or result in clients electing other foreign exchange execution options, which would have an adverse impact on the revenue from, and profitability of, this product for us.

We may be exposed to customer claims, financial loss, reputational damage and regulatory scrutiny as a result of transacting purchases and redemptions relating to the unregistered cash collateral pools underlying our securities lending program at a net asset value of $1.00 per unit rather than a lower net asset value based upon market value of the underlying portfolios.

A portion of the cash collateral received by customers under our securities lending program is invested in cash collateral pools that we manage. Interests in these cash collateral pools are held by unaffiliated customers and by registered and unregistered investment funds that we manage. Our cash collateral pools that are money market funds registered under the Investment Company Act of 1940 are required to maintain, and have maintained, a constant net asset value of $1.00 per unit. The remainder of our cash collateral pools are collective investment funds that are not required to be registered under the Investment Company Act. These unregistered cash collateral pools seek, but are not required, to maintain, and transact purchases and redemptions at, a constant net asset value of $1.00 per unit.

Our securities lending operations consist of two components; a direct lending program for third-party investment managers and asset owners, the collateral pools for which we refer to as direct lending collateral pools; and investment funds with a broad range of investment objectives that are managed by SSgA and engage in securities lending, which we refer to as SSgA lending funds. The following table shows the aggregate net asset values of the unregistered direct lending collateral pools and the aggregate net asset value of the unregistered collateral pools underlying the SSgA lending funds, in each case based on a constant net asset value of $1.00 per unit.

 

(in billions)    December 31, 2009    December 31, 2008    December 31, 2007(1)

Direct lending collateral pools

   $ 85    $ 85    $ 150

Collateral pools underlying SSgA lending funds

     24      31      44

 

(1)

Certain of the SSgA lending funds were participants in the direct lending collateral pools until October 2008. The direct lending collateral pool balances at December 31, 2007 related to SSgA lending funds have been included within the SSgA lending fund balances and excluded from the direct lending collateral pool balances presented above.

 

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We may incur losses, which could be material to our consolidated results of operations in the period incurred, as a result of continuing to transact based upon a consistent $1.00 per unit net asset value.

Both the direct lending collateral pools and the collateral pools underlying the SSgA lending funds have continued to transact purchases and redemptions at a constant net asset value of $1.00 per unit even though the market value of the unregistered cash collateral pools’ portfolio holdings, determined using pricing from third-party pricing sources, has been below $1.00 per unit. This difference between the transaction value used for purchase and redemption activity and the market value of the collateral pool’s assets arose, depending upon the collateral pool, at various points since the commencement of the financial crisis in mid-2007 and has persisted throughout 2008 and 2009. The following table sets forth the range of net asset values per unit and weighted-average net asset values per unit based upon the market value of our unregistered cash collateral pools underlying the direct lending program and SSgA lending funds as of December 31, 2009, 2008 and 2007.

 

     December 31, 2009    December 31, 2008    December 31, 2007
   Range    Weighted
Average
   Range    Weighted
Average
   Range    Weighted
Average

Direct lending collateral pools

   $0.93 to
$1.00
   $0.986    $0.92 to
$1.00
   $0.941    $0.99 to
$1.00
   $0.993

Collateral pools underlying SSgA lending funds

   $0.97 to
$0.99
   $0.981    $0.91 to
$0.95
   $0.932    $0.99 to
$1.00
   $0.991

We believe that our practice of continuing to effect purchases and redemptions at $1.00 per unit in the unregistered cash collateral pools, notwithstanding that the underlying portfolios have a market value of less than $1.00 per unit, is in compliance with the terms of our unregistered cash collateral pools and in the best interests of participants in the direct lending program and the SSgA lending funds. We have continued this practice for a number of reasons, including the fact that none of the securities in the cash collateral pools is currently in default or considered to be materially impaired, and that there are restrictions on withdrawals from the collective investment funds. Although the market value of the assets in the collateral pools has improved during 2009, a portion of these assets are floating rate instruments with several years of remaining maturity; consequently, the rate of valuation improvement is likely to slow in 2010 or the market value may decline again as a result of changes in market sentiment or in the credit quality of such instruments. However, as described below, if we continue to transact purchases and redemptions from the unregistered cash collateral pools based upon a constant net asset value of $1.00 per unit and the liquid assets of these pools turn out to be insufficient to support redemption activity at such value, or the pools suffer material credit losses on their underlying portfolio holdings, investors in the direct lending program and/or the SSgA lending funds may seek to hold us responsible for any shortfall due to prior redemptions at a value above the market value of the underlying portfolio or as a result of any such portfolio defaults.

We may incur losses, which could be material to our consolidated results of operations in the period incurred, as a result of our imposition of restrictions on redemptions from, and our management of, the direct lending program.

Beginning in October 2008, following the increased market disruption resulting from the bankruptcy of Lehman, we began to require, and continue to require, that direct participants in the collateral pools who wish to redeem their interests in the pools, other than in connection with the ordinary course operation of the securities lending program, to accept redemption proceeds in the form of in-kind distributions. While the redemption restrictions were imposed to protect the interest of all participants in the direct lending program (which include ERISA plans, governmental retirement plans, mutual funds and other institutional asset owners), the prolonged imposition of these restrictions could materially and adversely affect the relationship with our lending customers and the financial results of our direct lending operation. Despite these redemption restrictions, one significant participant in the direct lending program redeemed a substantial portion of its interest in the collateral pools in a manner that we determined not to be consistent with the ordinary course of operations of the securities lending program. After attempts to resolve the dispute with the redeeming participant and have them restore short-term liquidity to the collateral pool, we took action, as trustee, that in effect resulted in an in-kind redemption of the participant’s remaining interest in the collateral pool in a manner that caused such in-kind redemption and the

 

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prior cash redemptions, taken as a whole, to be completed on substantially the same basis as if the participant had initially requested an in-kind redemption of its entire interest in the collateral pool. The redeeming participant has commenced a legal action against us for damages that it alleges it incurred as a result of this redemption. An adverse judgment in such case could have an adverse impact on our consolidated results of operations for the period in which such judgment is issued. In addition to the actions relating to the redeeming participant, we are in discussions with a limited number of securities lending customers in the U.K. who have questioned whether our management of their participation in our securities lending program was consistent with the obligations owed by us to them. At this time, we do not know if we will enter into a settlement with respect to such claims or if the amount of any settlement would be less than or greater than the reserve established.

We may incur losses which could be material to our consolidated results of operations in the period incurred, as a result of our valuation of units of the SSgA lending funds and our imposition of restrictions on redemptions.

A broad range of SSgA lending funds participate in our securities lending program and as a result hold interests in certain of the unregistered cash collateral pools. The lending funds continue to purchase and redeem units of the lending funds at prices that assign a value of $1.00 to units of the collateral pools held by such funds. If it was determined that the historical or prospective transaction valuation for purchase or redemption of units of the lending funds should reflect a value of the units of the collateral pools of less than $1.00, lending fund investors may claim that they overpaid for their investment, or that investors who redeemed their units at prices that reflect a valuation of units of the collateral pools of $1.00 were overcompensated, and seek to hold us responsible for their alleged investment loss. For financial reporting purposes, the lending funds’ financial statements for the periods ended December 31, 2008 and 2009 reflected or will reflect net asset values for the lending funds based upon a valuation of the units of the collateral pools at market value rather than at the $1.00 transaction value. If we continue to transact purchases and redemptions of units of the lending funds based upon the $1.00 transaction value of the collateral pools rather than their financial statement reported value, such potential exposure would likely increase over time. Since the percentage of a lending fund’s assets on loan varies based on the fund’s investment focus and with changes in market demand, the potential impact of this issue on the net asset value of the lending fund will vary significantly, and in some cases may be material.

In an effort to provide investors in the SSgA lending funds equal access to liquidity in the collateral pools and limit the need to sell portfolio securities into an illiquid market in order to meet redemption requests, in March 2009, we established restrictions on the percentage of an investor’s interest in a lending fund that may be redeemed in any month. These restrictions superseded limitations on redemption other than in kind or that were to an extent consistent with the customers’ ordinary course of their participation in the lending funds. The restrictions on redemptions currently do not apply to participant level activity in defined contribution plans. Investors in the lending funds have objected to, and may claim to have been harmed by, such limitations on liquidity of their investment, notwithstanding our right to implement such restrictions under the governing documents for such funds. As a result, participants in our lending funds may seek to be compensated for any loss they incurred or allege to have incurred resulting from either the valuation of the units of the lending funds or restrictions on the liquidity of such units.

We may incur losses, which could be material to our consolidated results of operations in the period incurred, as a result of claims by investors in the direct lending program and SSgA lending funds and an inquiry by the SEC.

The SEC is conducting an informal inquiry into the management of our securities lending program and disclosures made to direct lending participants and participants in the SSgA lending funds, in particular as to the adequacy of our disclosures regarding the collateral pools during periods when those pools had a market value of less than $1.00. While we are cooperating with such inquiry, we cannot determine whether the staff of the SEC will conclude that our disclosures or conduct of the program form the basis of a potential formal proceeding seeking damages or other remedies. In addition to the action with the redeeming participant in the direct lending program referred to above, participants in certain of the lending funds have commenced putative class actions on behalf of all investors in the lending funds that are benefit plans subject to the Employee Retirement Income

 

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Security Act. The class actions allege, among other things, failure to exercise prudence in the management of the collateral pools and breach of the governing instruments in connection with our imposition of restrictions on redemptions and seek both damages and injunctive relief. A determination by the SEC or any other regulatory authority to commence an enforcement proceeding with regard to our securities lending operations or SSgA lending funds, or an adverse outcome in the class action or any future proceedings, could have a material adverse impact upon our securities lending operations or the operations of SSgA or upon our consolidated results of operations and financial condition.

If we are unable to continuously attract deposits and other short-term funding, our consolidated financial condition, including our capital ratios, our consolidated results of operations and our business prospects could be harmed.

Liquidity management is critical to the management of our consolidated balance sheet and to our ability to service our customer base. We generally use our sources of funds to:

 

   

extend credit to our customers in connection with our custody business;

 

   

meet demands for return of funds on deposit by customers; and

 

   

manage the pool of intermediate- and longer-term assets that are included in the investment securities on our consolidated balance sheet.

Because the demand for credit by our customers is difficult to forecast and control, and may be at its peak at times of disruption in the securities markets, and because the average maturity of our investment portfolio is significantly longer than the contractual maturity of our deposit base, we need to continuously attract, and are dependent upon, access to various sources of short-term funding.

In managing our liquidity, our primary source of short-term funding is customer deposits, which are predominantly transaction-based deposits by institutional investors. Our ability to continue to attract these deposits, and other short-term funding sources such as certificates of deposit and commercial paper, is subject to variability based upon a number of factors, including volume and volatility in the global securities markets, the relative interest rates that we are prepared to pay for these liabilities and the perception of safety of those deposits or short-term obligations relative to alternative short-term investments available to our customers, including in the capital markets. For example, the contraction in the number of counterparties for which we have a favorable credit assessment as a result of ongoing market disruptions has made it difficult to invest our available liquidity, which has adversely affected the rate of return that we earned on these assets, which could harm our ability to attract customer deposits.

The availability and cost of credit in short-term markets is highly dependent upon the markets’ perception of our liquidity and creditworthiness. Our efforts to monitor and manage our liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated changes in the global securities markets or other event-driven reductions in liquidity. In such events, our cost of funds may increase, thereby reducing our net interest revenue, or we may need to dispose of a portion of our investment portfolio, which, depending upon market conditions, could result in the realization of a loss in our consolidated statement of income.

Any downgrades in our credit ratings, or an actual or perceived reduction in our financial strength, could adversely affect our borrowing costs, capital costs and liquidity and cause reputational harm.

Various independent rating agencies publish credit ratings for our debt obligations based on their evaluation of a number of factors, some of which relate to our performance and other corporate developments, including financings, acquisitions and joint ventures, and some of which relate to general industry conditions. We anticipate that the rating agencies will review our ratings regularly based on our consolidated results of operations and developments in our businesses. Our credit rating was downgraded by each of the principal rating agencies during the first quarter of 2009. A further downgrade or a significant reduction in our capital ratios might adversely affect our ability to access the capital markets or might increase our cost of capital. We cannot provide assurance that we will continue to maintain our current ratings. The current market environment and our

 

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exposure to other financial institution counterparties increases the risk that we may not maintain our current ratings. Downgrades in our credit ratings may adversely affect our borrowing costs, our capital costs and our ability to raise capital and, in turn, our liquidity. A failure to maintain an acceptable credit rating may also preclude us from being competitive in certain products, may be negatively perceived by our customers or counterparties or may have other adverse reputational effects.

Additionally, our counterparties, as well as our customers, rely upon our financial strength and stability and evaluate the risks of doing business with us. If we experience diminished financial strength or stability, actual or perceived, including due to market or regulatory developments, our announced or rumored business developments or consolidated results of operations, a decline in our stock price or a reduced credit rating, our counterparties may become less willing to enter into transactions, secured or unsecured, with us, our customers may reduce or place limits upon the level of services we provide them or seek other service providers and our prospective customers may select other service providers. The risk that we may be perceived as less creditworthy relative to other market participants is increased in the current market environment, where the consolidation of financial institutions, including major global financial institutions, is resulting in a smaller number of much larger counterparties and competitors. If our counterparties perceive us to be a less viable counterparty, our ability to enter into financial transactions on terms acceptable to us or our customers, on our or our customers’ behalf, will be materially compromised. If our customers reduce their deposits with us or select other service providers for all or a portion of the services we provide them, our net interest revenues will decrease accordingly.

Our businesses may be negatively affected by adverse publicity or other reputational harm.

Our relationship with many of our customers is predicated upon our reputation as a fiduciary and a service provider that adheres to the highest standards of ethics, service quality and regulatory compliance. Adverse publicity, regulatory actions, litigation, operational failures, the failure to meet customer expectations and other issues with respect to one or more of our businesses could materially and adversely affect our reputation, our ability to attract and retain customers or our sources of funding for the same or other businesses. Preserving and enhancing our reputation also depends on maintaining systems and procedures that address known risks and regulatory requirements, as well as our ability to identify and mitigate additional risks that arise due to changes in our businesses and the marketplaces in which we operate, the regulatory environment and customer expectations. If any of these developments has a material effect on our reputation, our business will suffer.

The illiquidity and volatility of global fixed-income and equity markets has affected our ability to effectively and profitably manage assets on behalf of customers and may make our products less attractive to customers.

We manage assets on behalf of customers in several forms, including in collective investment pools, including money market funds, securities finance collateral pools, cash collateral and other cash products and short-term investment funds. In addition to the impact on the market value of customer portfolios, the illiquidity and volatility of both the global fixed-income and equity markets have negatively affected our ability to manage customer inflows and outflows from our pooled investment vehicles. Within our asset management business, we manage investment pools, such as mutual funds and collective investment funds that generally offer our customers the ability to withdraw their investments on short notice, generally daily or monthly. This feature requires that we manage those pools in a manner that takes into account both maximizing the long-term return on the investment pool and retaining sufficient liquidity to meet reasonably anticipated liquidity requirements of our customers.

During the market disruption that accelerated following the bankruptcy of Lehman, the liquidity in many asset classes, particularly short- and long-term fixed-income securities, has declined dramatically, and providing liquidity to meet all customer demands in these investment pools without adversely affecting the return to non-withdrawing customers has become more difficult. For customers that invest directly or indirectly in certain of the collateral pools and seek to terminate participation in lending programs, we have required, in accordance with the applicable customer arrangements, that these withdrawals from the collateral pools take the form of partial in-kind distributions of securities, and in the case of SSgA funds that engage in securities lending, we have implemented limitations on the portion of an investor’s interest in such fund that may be withdrawn during

 

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any month, although such limitations do not apply to participant directed activity in defined contribution plans. If higher than normal demands for liquidity from our customers were to return post-Lehman-bankruptcy levels or increase, it could become more difficult to manage the liquidity requirements of our collective investment pools and, as a result, we may elect to support the liquidity of these pools. If liquidity in the fixed-income markets were to deteriorate further or remain disrupted for a prolonged period, our relationships with our customers may be adversely affected, we could, in certain circumstances, be required to consolidate the investment pools, levels of redemption activity could increase and our consolidated results of operations and business prospects could be adversely affected.

In addition, if a money market fund that we manage were to have unexpected liquidity demands from investors in the fund that exceeded available liquidity, the fund could be required to sell assets to meet those redemption requirements, and it may then be difficult to sell the assets held by the fund at a reasonable price, if at all.

Alternatively, although we have no such obligations or arrangements currently in place, we have in the past, and may in the future, guarantee liquidity to investors desiring to make withdrawals from a fund, and a significant amount of such guarantees could adversely affect our own liquidity and consolidated financial condition. Because of the size of the investment pools that we manage, we may not have the financial ability or regulatory authority to support the liquidity demands of our customers. The extreme volatility in the equity markets has led to potential for the return on passive and quantitative products deviating from their target return. The temporary closures of securities exchanges in certain markets create a risk that customer redemptions in pooled investment vehicles may result in significant tracking error and underperformance relative to stated benchmarks. Any failure of the pools to meet redemption requests or to underperform relative to similar products offered by our competitors could harm our business and our reputation.

For further information regarding risks related to our investment pools, please refer to the risk factor titled “Our reputation and business prospects may be damaged if our customers incur substantial losses in investment pools where we act as agent” on page 11.

Acquisitions, strategic alliances and divestiture pose risks for our business.

As part of our business strategy, we acquire complementary businesses and technologies, enter into strategic alliances and divest portions of our business. During 2009, we announced definitive agreements to acquire the global custody, depository banking, correspondent banking and fund administration business of Intesa Sanpaolo, or Intesa, and the acquisition of Mourant International Finance Administration, or MIFA, for cash. We undertake transactions such as these to, among other reasons, expand our geographic footprint, access new customers, technologies or services, develop closer relationships with our business partners, efficiently deploy capital or to leverage cost savings or other financial opportunities. We may not achieve the expected benefits of these transactions, which could result in increased costs, lowered revenues, ineffective deployment of capital and diminished competitive position or reputation.

These transactions also involve a number of risks and financial, accounting, regulatory, managerial and operational challenges, which could adversely affect our consolidated results of operations and financial condition. For example, the businesses that we acquire or our strategic alliances may underperform relative to the price paid or the resources committed by us, or we may not achieve anticipated cost savings or otherwise be adversely affected by acquisition-related charges. Further, past acquisitions have resulted, and upon closing transactions such as the purchase of Intesa and MIFA will result, in the recording of goodwill and other significant intangible assets on our consolidated balance sheet. We may be required to record impairment in our consolidated statement of income in future periods if we do not realize the value of these assets. Through our acquisitions we may also assume unknown or undisclosed liabilities, fail to properly assess known contingent liabilities or assume businesses with internal control deficiencies. While in most of our transactions we seek to mitigate these risks through, among other things, adequate due diligence and indemnification provisions, we cannot be certain that the indemnification provisions and other risk mitigants we put in place will be sufficient.

 

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Various regulatory approvals or consents are generally required prior to closing or acquisitions and, which may include approvals of the Federal Reserve and other domestic and foreign regulatory authorities. These regulatory authorities may impose conditions on the completion of the acquisition or require changes to its terms that materially affect the terms of the transaction or our ability to capture some of the opportunities presented by the transaction. Any such conditions, or any associated regulatory delays, could limit the benefits of the transaction. Some acquisitions we announce may not be completed, if we do not receive the required regulatory approvals or if other closing conditions are not satisfied.

The integration of our acquisitions results in risks to our business and other uncertainties.

The integration of acquisitions presents risks that differ from the risks associated with our ongoing operations. Integration activities are complicated and time consuming. We may not be able to effectively assimilate services, technologies, key personnel or businesses of acquired companies into our business or service offerings, as anticipated, alliances may not be successful, and we may not achieve related revenue growth or cost savings. We also face the risk of being unable to retain the customer bases of acquired companies or unable to cross-sell our products and services to an acquired business’s customers. Acquisitions of investment servicing businesses entail information technology systems conversions, which involve operational risks and may result in customer dissatisfaction and defection. Customers of asset servicing businesses that we have acquired may be competitors of our non-custody businesses. The loss of some of these customers or a significant reduction in revenues generated from them, for competitive or other reasons, could adversely affect the benefits that we expect to achieve from these acquisitions. With any acquisition, the integration of the operations and resources of the businesses could result in the loss of key employees, the disruption of our and the acquired company’s ongoing businesses, or inconsistencies in standards, controls, procedures and policies that could adversely affect our ability to maintain relationships with customers and employees or to achieve the anticipated benefits of the acquisition. Integration efforts may also divert management attention and resources.

We are subject to intense competition in all aspects of our business, which could negatively affect our ability to maintain or increase our profitability.

The markets in which we operate across all facets of our business are both highly competitive and global. We have experienced, and anticipate that we will continue to experience, pricing pressure in many of our core businesses. Many of our businesses compete with other domestic and international banks and financial services companies, such as custody banks, investment advisors, broker-dealers, outsourcing companies and data processing companies. Ongoing consolidation within the financial services industry could pose challenges in the markets we serve, including potentially increased downward pricing pressure across our businesses. Many of our competitors, including our competitors in core services, have substantially greater capital resources than we do. In some of our businesses, we are service providers to significant competitors. These competitors are in some instances significant customers, and the retention of these customers involves additional risks, such as the avoidance of actual or perceived conflicts of interest and the maintenance of high levels of service quality. The ability of a competitor to offer comparable or improved products or services at a lower price would likely negatively affect our ability to maintain or increase our profitability. Many of our core services are subject to contracts that have relatively short terms or may be terminated by our customer after a short notice period. In addition, pricing pressures as a result of the activities of competitors, customer pricing reviews, and rebids, as well as the introduction of new products, may result in a reduction in the prices we can charge for our products and services.

If we fail to attract new customers and cross-sell additional products and services to our existing customers, our prospects for growth may be harmed.

Our strategy for growth depends upon both attracting new customers and cross-selling additional products and services to our existing customer base. To the extent that we are not able to achieve these goals, we may not be able to meet our financial goals. In addition, our proactive cross-selling of multiple products and services to our customers can exacerbate the negative financial effects associated with the risk of loss of any one customer.

 

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Development of new products and services may impose additional costs on us and may expose us to increased operational risk.

Our financial performance depends, in part, on our ability to develop and market new and innovative services and to adopt or develop new technologies that differentiate our products or provide cost efficiencies, while avoiding increased related expenses. The introduction of new products and services can entail significant time and resources. Substantial risks and uncertainties are associated with the introduction of new products and services, including technical and control requirements that may need to be developed and implemented, rapid technological change in the industry, our ability to access technical and other information from our customers and the significant and ongoing investments required to bring new products and services to market in a timely manner at competitive prices. Regulatory and internal control requirements, capital requirements, competitive alternatives and shifting market preferences may also determine if such initiatives can be brought to market in a manner that is timely and attractive to our customers. Failure to manage successfully these risks in the development and implementation of new products or services could have a material adverse effect on our business and reputation, as well as on our consolidated results of operations and financial condition.

It may be difficult and costly to protect our intellectual property rights, and we may not be able to ensure their protection.

We may be unable to protect our intellectual property and proprietary technology effectively, which may allow competitors to duplicate our technology and products and may adversely affect our ability to compete with them. To the extent that we are not able to protect our intellectual property effectively through patents or other means, employees with knowledge of our intellectual property may leave and seek to exploit our intellectual property for their own or others’ advantage. In addition, we may infringe upon claims of third-party patents, and we may face intellectual property challenges from other parties. We may not be successful in defending against any such challenges or in obtaining licenses to avoid or resolve any intellectual property disputes. The intellectual property of an acquired business may be an important component of the value that we agree to pay for such a business. However, such acquisitions are subject to the risks that the acquired business may not own the intellectual property that we believe we are acquiring, that the intellectual property is dependent upon licenses from third parties, that the acquired business infringes upon the intellectual property rights of others, or that the technology does not have the acceptance in the marketplace that we anticipated.

Our revenues and profits are sensitive to changes in interest rates.

Our financial performance could be negatively affected by changes in interest rates as they affect our asset and liability management activities. The levels of interest rates in global markets, changes in the relationship between short- and long-term interest rates, the direction and speed of interest-rate changes, and the asset and liability spreads relative to the currency and geographic mix of our interest-earning assets and interest-bearing liabilities, affect our net interest revenue. Our ability to anticipate these changes or to hedge the related exposures on and off our consolidated balance sheet can significantly influence the success of our asset and liability management activities and the resulting level of our net interest revenue. The impact of changes in interest rates will depend on the relative durations of assets and liabilities in accordance with their relevant currencies. In general, sustained lower interest rates, a flat or inverted yield curve and narrow interest-rate spreads have a constraining effect on our net interest revenue.

Competition for our employees is intense, and we may not be able to attract and retain the highly skilled people we need to support our business.

Our success depends, in large part, on our ability to attract and/or retain key people. Competition for the best people in most activities in which we engage can be intense, and we may not be able to hire people or retain them, particularly in light of uncertainty concerning evolving compensation restrictions applicable, or which may become applicable, to banks (and potentially not applicable to other financial services firms). The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, their knowledge of our markets, their years of industry experience and, in some cases, the

 

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difficulty of promptly finding qualified replacement personnel. Similarly, the loss of key employees, either individually or as a group, can adversely affect our customers’ perception of our ability to continue to manage certain types of investment management mandates.

Long-term contracts expose us to pricing and performance risk.

We enter into long-term contracts to provide middle office or investment manager and alternative investment manager operations outsourcing services, primarily for conversions, to customers, including services related but not limited to certain trading activities, cash reporting, settlement and reconciliation activities, collateral management and information technology development. These arrangements generally set forth our fee schedule for the term of the contract and, absent a change in service requirements, do not permit us to re-price the contract for changes in our costs or for market pricing. The long-term contracts for these relationships require, in some cases, considerable up-front investment by us, including technology and conversion costs, and carry the risk that pricing for the products and services we provide might not prove adequate to generate expected operating margins over the term of the contracts. Profitability of these contracts is largely a function of our ability to accurately calculate pricing for our services, efficiently assume our contractual responsibilities in a timely manner and our ability to control our costs and maintain the relationship with the customer for an adequate period of time to recover our up-front investment. Our estimate of the profitability of these arrangements can be adversely affected by declines in the assets under the customers’ management, whether due to general declines in the securities markets or customer specific issues. In addition, the profitability of these arrangements may be based on our ability to cross sell additional services to these customers, and we may be unable to do so.

In addition, performance risk exists in each contract, given our dependence on successful conversion and implementation onto our own operating platforms of the service activities provided. Our failure to meet specified service levels may also adversely affect our revenue from such arrangements, or permit early termination of the contracts by the customer. If the demand for these types of services were to decline, we could see our revenue decline.

Our controls and procedures may fail or be circumvented, our risk management policies and procedures may be inadequate, and operational risk could adversely affect our consolidated results of operations.

We may fail to identify and manage risks related to a variety of aspects of our business, including, but not limited to, operational risk, interest-rate risk, trading risk, fiduciary risk, legal and compliance risk, liquidity risk and credit risk. We have adopted various controls, procedures, policies and systems to monitor and manage risk. While we currently believe that our risk management process is effective, we cannot provide assurance that those controls, procedures, policies and systems will always be adequate to identify and manage the risks in our various businesses. In addition, our businesses and the markets in which we operate are continuously evolving. We may fail to fully understand the implications of changes in our businesses or the financial markets and fail to adequately or timely enhance our risk framework to address those changes. If our risk framework is ineffective, either because it fails to keep pace with changes in the financial markets or our businesses or for other reasons, we could incur losses, suffer reputational damage or find ourselves out of compliance with applicable regulatory mandates or expectations.

Operational risk is inherent in all of our business activities. As a leading provider of services to institutional investors, we provide a broad array of services, including research, investment management, trading services and investment servicing, that give rise to operational risk. In addition, these services generate a broad array of complex and specialized servicing, confidentiality and fiduciary requirements. We face the risk that the policies, procedures and systems we have established to comply with our operational requirements will fail, be inadequate or become outdated. We also face the potential for loss resulting from inadequate or failed internal processes, employee supervisory or monitoring mechanisms or other systems or controls, which could materially affect our future consolidated results of operations. Operational errors that result in us remitting funds to a failing or

 

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bankrupt entity may be irreversible, and may subject us to losses. We may also be subject to disruptions from external events that are wholly or partially beyond our control, which could cause delays or disruptions to operational functions, including information processing and financial market settlement functions. In addition, our customers, vendors and counterparties could suffer from such events. Should these events affect us, or the customers, vendors or counterparties with which we conduct business, our consolidated results of operations could be negatively affected. When we record balance sheet reserves for probable loss contingencies related to operational losses, we may be unable to accurately estimate our potential exposure, and any reserves we establish to cover operational losses may not be sufficient to cover our actual financial exposure, which may have a material impact on our consolidated results of operations or financial condition for the periods in which we recognize the losses.

We depend on information technology, and any failures of our information technology systems could result in significant costs and reputational damage.

Our businesses depend on information technology infrastructure to record and process a large volume of increasingly complex transactions, in many currencies, on a daily basis, across numerous and diverse markets. Any interruptions, delays or breakdowns of this infrastructure could result in significant costs to us and damage to our reputation.

Cost shifting to foreign jurisdictions may expose us to increased operational risk and reputational harm and may not result in expected cost savings.

We actively strive to achieve cost savings by shifting certain business processes to lower-cost geographic locations, including by forming joint ventures and by establishing operations in lower cost areas, such as Poland, India and China, and outsourcing to vendors in various jurisdictions. This effort exposes us to the risk that we may not maintain service quality, control or effective management within these business operations. The increased elements of risk that arise from conducting certain operating processes in some jurisdictions could lead to an increase in reputational risk. During periods of transition, greater operational risk and customer concern exist regarding the continuity of a high level of service delivery. The extent and pace at which we are able to move functions to lower-cost locations may also be impacted by regulatory and customer acceptance issues. Such relocation of functions also entails costs, such as technology and real estate expenses, that may offset or exceed the expected financial benefits of the lower-cost locations.

Any theft, loss or other misappropriation of the confidential information we possess could have an adverse impact on our business and could subject us to regulatory actions, litigation and other adverse effects.

Our businesses and relationships with customers are dependent upon our ability to maintain the confidentiality of our and our customers’ trade secrets and confidential information (including customer transactional data and personal data about our employees, our customers and our customers’ customers). Unauthorized access to such information may occur, resulting in theft, loss or other misappropriation. Any theft, loss or other misappropriation of confidential information could have a material adverse impact on our competitive positions, our relationships with our customers and our reputation and could subject us to regulatory inquiries and enforcement, civil litigation and possible financial liability or costs.

We face extensive and changing government regulation, which may increase our costs and expose us to risks related to compliance.

Most of our businesses are subject to extensive regulation by multiple regulatory bodies, and many of the customers to which we provide services are themselves subject to a broad range of regulatory requirements. These regulations may affect the manner and terms of delivery of our services. As a financial institution with substantial international operations, we are subject to extensive regulatory and supervisory oversight, both in the U.S. and outside the U.S. in connection with our global operations. The regulations affect, among other things, the scope of our activities and customer services, our capital structure and our ability to fund the operations of our subsidiaries, our lending practices, our dividend policy and the manner in which we market our services. The

 

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disruption of the financial markets in 2008 and 2009 and resulting governmental support of, and loss of confidence in, financial institutions has resulted in demand for increased and more extensive regulation of our business both in the U.S. and internationally. Congress is currently considering legislation that may have a significant impact on the regulatory structure for the financial markets, special taxes on financial institutions and increased deposit assessments by the FDIC, and proposals by the White House have included the potential separation of proprietary trading and the management of hedge and other alternative asset funds from banking institutions or restrictions on the flexibility of financial institutions with respect to the compensation of their employees. The proposals currently being considered by Congress, depending upon their final form, could affect our business positively or adversely or may result in substantial additional costs. Different countries may respond to the market and economic environment in different and potentially conflicting manner, which could have the impact of increasing the cost of compliance for us. New or modified regulations and related regulatory guidance may have unforeseen or unintended adverse effects on the financial services industry. Evolving regulations, such as the Basel and other global regulatory capital frameworks, short-selling regulations and anti-money laundering regulations may impose significant compliance costs on us. The regulatory perspective, particularly that of the Federal Reserve Board, on regulatory capital requirements may affect our ability to make acquisitions, declare dividends or repurchase common stock unless we can demonstrate, to the satisfaction of our regulators, that such actions would not adversely affect our regulatory capital position in the event of a severely stressed market environment. In addition, the implementation of certain of the proposals with regard to regulatory capital could disproportionately affect our regulatory capital position relative to that of our competitors.

If we do not comply with governmental regulations, we may be subject to fines, penalties, lawsuits or material restrictions on our businesses in the jurisdiction where the violation occurred, which may adversely affect our business operations and, in turn, our consolidated results of operations. Similarly, many of our customers are subject to significant regulatory requirements, and retain our services in order for us to assist them in complying with those legal requirements. Changes in these regulations can significantly affect the services that we are asked to provide, as well as our costs. In addition, adverse publicity and damage to our reputation arising from the failure or perceived failure to comply with legal, regulatory or contractual requirements could affect our ability to attract and retain customers. If we cause customers to fail to comply with these regulatory requirements, we may be liable to them for losses and expenses that they incur. In recent years, regulatory oversight and enforcement have increased substantially, imposing additional costs and increasing the potential risks associated with our operations. If this regulatory trend continues, it could adversely affect our operations and, in turn, our consolidated results of operations.

Changes in accounting standards may be difficult to predict and may adversely affect our consolidated results of operations and financial condition.

New accounting standards, or changes in the interpretation of existing accounting standards, by the Financial Accounting Standards Board or the SEC, can potentially affect our consolidated results of operations and financial condition. These changes are difficult to predict, and can materially affect how we record and report our consolidated results of operations and financial condition and other financial information. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the revised treatment of certain transactions or activities, and, in some cases, the restatement of consolidated prior period financial statements.

Changes in tax laws or regulations, and challenges to our tax positions with respect to historical transactions, may adversely affect our net income, our effective tax rate and our consolidated results of operations and financial condition.

Our businesses can be directly or indirectly affected by new tax legislation, the expiration of existing tax laws, or the interpretation of existing tax laws worldwide. U.S. tax laws that have favorably affected the taxation of certain of our overseas operations expired at the end of 2009, and it is uncertain when and whether they will be re-enacted. In addition, recent federal government budget submissions include proposals that would have a material adverse effect on the taxation of our overseas operations.

 

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In the normal course of business, we are subject to reviews by U.S. and non-U.S. tax authorities. These reviews may result in adjustments to the timing or amount of taxes due and the allocation of taxable income among tax jurisdictions. These adjustments could affect the attainment of our financial goals.

The quantitative models we use to manage our business may contain errors that result in imprecise risk assessments, inaccurate valuations or poor business decisions.

We use quantitative models to help manage many different aspects of our businesses. As an input to our overall assessment of capital adequacy, we use models to measure the amount of credit risk, market risk, operational risk, interest rate risk and business risk we face. During the preparation of our consolidated financial statements, we sometimes use models to measure the value of positions for which reliable market prices are not available. We also use models to support many different types of business decisions including trading activities, hedging, asset and liability management and whether to change business strategy. In all of these uses, errors in the underlying model could result in unanticipated and adverse consequences. Because of our widespread usage of models, potential errors in models pose an ongoing risk to us.

Additionally, we may fail to accurately quantify the magnitude of the risks we face. Our measurement methodologies rely upon many assumptions and historical analyses and correlations. These assumptions may be incorrect, and the historical correlations we rely on may not continue to be relevant. Consequently, the measurements that we make for regulatory and economic capital may not adequately capture or express the true risk profiles of our businesses. Additionally, as businesses and markets evolve, our measurements may not accurately reflect those changes. While our risk measures may indicate sufficient capitalization, we may in fact have inadequate capital to conduct our businesses.

We face significant risks developing and implementing our future business plans and strategies.

In order to maintain and grow our business, we must continuously make strategic decisions about our future business plans, including plans for entering or exiting business lines or geographic markets, plans for acquiring or disposing of businesses and plans to build new systems and other infrastructure. Our business, our consolidated results of operations and financial condition may be adversely affected by incorrect business and strategic decisions or improper implementation of our decisions. If the business decisions that we make prove erroneous, we may fail to be responsive to industry changes or customer demands. Moreover, the implementation of our decisions may involve significant capital outlays, often far in advance of when we expect to derive any related revenues, and therefore it may be difficult to alter or abandon plans without incurring significant loss.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

We occupy a total of approximately 8.7 million square feet of office space and related facilities around the world, of which approximately 7.8 million square feet are leased. Of the total leased space, approximately 3.9 million square feet are located in eastern Massachusetts. An additional 1.6 million square feet are located elsewhere throughout the U.S. and in Canada. We lease approximately 1.8 million square feet in the U.K. and elsewhere in Europe, and approximately 500,000 square feet in the Asia/Pacific region.

Our headquarters is located at State Street Financial Center, One Lincoln Street, Boston, Massachusetts, a 36-story office building. Various divisions of our two lines of business, as well as support functions, occupy space in this building. We lease the entire 1,025,000 square feet of this building, as well as the entire 366,000-square-foot parking garage at One Lincoln Street, under 20-year non-cancelable capital leases expiring in 2023. A portion of the lease payments is offset by subleases for 153,000 square feet of the building. We occupy three buildings located in Quincy, Massachusetts, one of which we own and two of which we lease. The buildings, containing a total of approximately 1,057,000 square feet, function as State Street Bank’s principal operations facilities.

 

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We believe that our owned and leased facilities are suitable and adequate for our business needs. Additional information about our occupancy costs, including our commitments under non-cancelable leases, is in note 19 of the Notes to Consolidated Financial Statements included under Item 8.

 

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of business, we and our subsidiaries are involved in disputes, litigation and regulatory inquiries and investigations, both pending and threatened. These matters, if resolved adversely against us, may result in monetary damages, fines and penalties or require changes in our business practices. The resolution of these proceedings is inherently difficult to predict. However, we do not believe that the amount of any judgment, settlement or other action arising from any pending proceeding will have a material adverse effect on our consolidated financial condition; although the outcome of certain of the matters described below may have a material adverse effect on our consolidated results of operations for the period in which such matter is resolved or a reserve is determined to be required. We may be subject to proceedings in the future that, if adversely resolved, would have a material adverse effect on our businesses or on our future consolidated results of operations or financial condition.

On February 4, 2010, we announced that we had entered into settlements with the SEC, the Massachusetts Attorney General and the Massachusetts Securities Division of the Office of the Secretary of State to resolve their investigations into losses incurred by, and disclosures made with respect to, certain active fixed-income strategies managed by SSgA during 2007 and earlier periods. In reaching these settlements, we neither admitted nor denied the allegations made by the regulators. Under the terms of the agreements, we agreed to establish a $313 million fair fund, which includes a fine of $50 million and disgorgement of advisory fees and interest of approximately $8 million. The fair fund will be distributed to affected investors in the active fixed-income strategies. The settlement with the SEC is subject to approval by a federal court. Combined with approximately $350 million in prior customer settlements, the compensation to investors will total approximately $663 million. Under the settlements with the Commonwealth of Massachusetts, we agreed to pay $10 million to each of the Massachusetts Secretary of State and the Massachusetts Attorney General. Our previously established legal reserve will fully cover the cost of these regulatory settlements.

The SEC had previously requested information regarding two registered funds that invested in sub-prime securities. These funds were not covered by this settlement and the SEC staff has declined to advise us of the status of its inquiry with regard to those funds. As of June 30, 2007, these funds had net assets of less than $300 million, and the net asset value per share of the funds experienced an average decline of approximately 7.23% during the third quarter of 2007. Average returns for industry peer funds were positive during the same period. The U.S. Attorney’s office in Boston has also requested information in connection with our active-fixed income strategies. Several customers who invested in the SSgA active fixed-income strategies covered by the settlement with the SEC have filed litigation claims against us. Of the seven lawsuits filed, we have settled three, including an $89.75 million ERISA class action settlement.

Our U.K. affiliate is currently engaged in an arbitration proceeding in the U.K. arising from its conduct as investment manager of a separate investment account. The claimants allege that we breached certain investment guidelines applicable to the accounts, resulting in alleged losses of approximately €132 million.

An indirect participant in certain of the collective funds managed by SSgA which engage in securities lending commenced during 2009 a putative class action on behalf of all investors in such funds that are ERISA benefit plans. Such action alleges, among other things, that we failed to exercise prudence in the management of our collateral pools in which the collective funds had invested cash collateral from securities lending. A second, related class action complaint was filed in December 2009 by a direct investor in an SSgA lending fund. The complaint additionally alleges that investors in the SSgA lending funds were injured as a result of the limitations on withdrawals from our lending programs imposed in October 2008. In addition, two participants in our securities lending program have brought suit in Missouri challenging actions taken by us in response to their

 

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withdrawal from the program. We believe that the withdrawals were unauthorized and that we acted in the best interests of all program participants. In February 2010, one of these customers threatened to commence litigation against us. As previously disclosed, we have also been responding to inquiries from the SEC in connection with our cash collateral pools.

The Attorney General of the State of California has commenced an action under the California False Claims Act and California Business and Professional Code related to services State Street provides to California state pension plans. The California Attorney General asserts that the pricing of certain foreign exchange transactions for these pension plans was not consistent with the terms of the applicable custody contracts and related disclosures to the plans, and that, as a result, State Street made false claims and engaged in unfair competition. The Attorney General asserts actual damages of $56 million for periods from 2001 to 2007 and seeks additional penalties. A similar action has been commenced in the District of Columbia by an anonymous whistleblower who purports to sue on behalf of DC public pension funds. We provide custody and foreign exchange services to government pension plans in other jurisdictions, and attorneys general from a number of these other jurisdictions, as well as the U.S. Attorney General’s office, have requested information in connection with inquiries into our foreign exchange pricing.

Two related securities class actions against us were commenced between December 2009 and January 2010. In addition, two participants in the State Street Salary Savings Program have filed class action complaints purportedly on behalf of participants and beneficiaries who invested in the program’s State Street stock option. Those complaints were filed in May 2009 and February 2010. The complaints, all of which are pending in federal court in Boston, allege violations of the federal securities laws and ERISA in connection with our foreign exchange trading business, our investment securities portfolio and our asset-backed commercial paper conduits program. In addition, two State Street shareholders have filed a shareholder derivative complaint in Massachusetts state court alleging fiduciary breaches by present and former directors and officers of State Street in connection with the SSgA active fixed-income matters discussed above. We have moved to dismiss the complaint based on the Board of Directors’ consideration and rejection of the shareholders’ original demand letter.

We managed, through SSgA, four common trust funds for which, in our capacity as manager and trustee, we appointed Lehman as prime broker. As of September 15, 2008 (the date two of the Lehman entities involved entered insolvency proceedings), these funds had cash and securities held by Lehman with net asset values of approximately $312 million. Some customers who invested in the funds managed by us brought litigation against us seeking compensation and additional damages, including double or treble damages, for their alleged losses in connection with our prime brokerage arrangements with Lehman’s entities. A total of seven customers were invested in such funds, of which four currently have suits pending against us. Three cases are pending in federal court in Boston and the fourth is pending in Nova Scotia. We have entered into settlements with two customers, one of which was entered into after the customer obtained a €42 million judgment from a Dutch court. At September 15, 2008, the five customers with whom we have not entered into settlement agreements had approximately $180 million invested in the funds at issue.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS

None.

 

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ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information with regard to each of our executive officers as of February 22, 2010.

 

Name

   Age   

Position

Ronald E. Logue

   64    Chairman and Chief Executive Officer

Joseph L. Hooley

   52    President and Chief Operating Officer

Joseph C. Antonellis

   55    Vice Chairman

Jeffrey N. Carp

   53    Executive Vice President, Chief Legal Officer and Secretary

James J. Malerba

   55    Executive Vice President and Corporate Controller

David C. O’Leary

   63    Executive Vice President

James S. Phalen

   59    Executive Vice President

David C. Phelan

   52    Executive Vice President, General Counsel and Assistant Secretary

Scott F. Powers

   50    President and Chief Executive Officer of State Street Global Advisors

David W. Puth

   53    Executive Vice President

Edward J. Resch

   57    Executive Vice President and Chief Financial Officer

All executive officers are appointed by the Board of Directors. All officers hold office at the discretion of the Board. There are no family relationships among any of our directors and executive officers.

Mr. Logue joined State Street in 1990 and has served as Chairman and Chief Executive Officer since 2004. Mr. Logue joined State Street as Senior Vice President and head of investment servicing for U.S. mutual funds and was elected Vice Chairman in 1999. Mr. Logue served as President from 2001 to April 2008 and as Chief Operating Officer from 2000 to April 2008. As previously announced, Mr. Logue will retire on March 1, 2010. Following his retirement, Mr. Logue will serve as non-executive Chairman of the Board of Directors. With re-election at the 2010 Annual Meeting of Shareholders, Mr. Logue plans to serve in that role until he retires as a director on January 1, 2011.

Mr. Hooley joined State Street in 1986 and has served as President and Chief Operating Officer since April 2008. From 2002 to April 2008, Mr. Hooley served as Executive Vice President and head of Investor Services and, in 2006, was appointed Vice Chairman and Global Head of Investment Servicing and Investment Research and Trading. Mr. Hooley was elected to serve on the Board of Directors effective October 22, 2009. As previously announced, Mr. Hooley will serve as President and Chief Executive Officer upon Mr. Logue’s retirement on March 1, 2010.

Mr. Antonellis joined State Street in 1991. In 2003, he was named head of Information Technology and Global Securities Services. In 2006, he was appointed Vice Chairman with additional responsibility as head of Investor Services in North America and Global Investment Manager Outsourcing Services. Beginning on March 1, 2010, Mr. Antonellis will serve as head of all Europe and Asia/Pacific Global Services and Global Markets businesses.

Mr. Carp joined State Street in 2006 as Executive Vice President and Chief Legal Officer. In 2006, he was also appointed Secretary. From 2004 to 2005, Mr. Carp served as executive vice president and general counsel of Massachusetts Financial Services, an investment management and research company. From 1989 until 2004, Mr. Carp was a senior partner at the law firm of Hale and Dorr LLP, where he was an attorney since 1982. Beginning in February 2010, Mr. Carp began serving as the interim Chief Risk Officer.

Mr. Malerba joined State Street in 2004 as Deputy Corporate Controller. In 2006, he was appointed Corporate Controller. Prior to joining State Street, he served as Deputy Controller at FleetBoston Financial Corporation from 2000 and continued in that role after the merger with Bank of America Corporation in 2004.

Mr. O’Leary joined State Street in 2005 as Executive Vice President and head of Global Human Resources. In 2004, he served as a senior advisor to Credit Suisse First Boston Corporation, a global financial services company, after serving as Managing Director from 1990 to 2003 and Global Head of Human Resources from 1988 to 2003. Beginning on March 1, 2010, Mr. O’Leary will serve as Chief Administrative Officer.

 

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Mr. James Phalen joined State Street in 1992. As of 2003, he served as Executive Vice President of State Street and Chairman and Chief Executive Officer of CitiStreet, a global benefits provider and retirement plan record keeper. In February 2005, he was appointed head of Investor Services in North America. In 2006, he was appointed head of international operations for Investment Servicing and Investment Research and Trading, based in Europe. From January 2008 until May 2008, he served on an interim basis as President and Chief Executive Officer of State Street Global Advisors. Beginning on March 1, 2010, Mr. Phalen will serve as head of Global Operations, Technology and Product Development.

Mr. David Phelan joined State Street in 2006 as Executive Vice President, General Counsel and Assistant Secretary. From 1995 until 2006, he was a senior partner at the law firm of Hale and Dorr LLP (and, following a merger, of Wilmer Cutler Pickering Hale and Dorr LLP), where he was an attorney since 1993.

Mr. Powers joined State Street in May 2008 as President and Chief Executive Officer of State Street Global Advisors. Prior to joining State Street, Mr. Powers served as Chief Executive Officer of Old Mutual US, the U.S. operating unit of London-based Old Mutual plc, an international savings and wealth management company, from September 2001 through April 2008.

Mr. Puth joined State Street in August 2008 as Executive Vice President and head of State Street’s Securities Finance, Global Markets and Investment Research businesses. Prior to joining State Street, Mr. Puth was the President of the Eriska Group, a risk management advisory firm that he founded in 2007. Prior to that time, Mr. Puth was with JPMorgan Chase and heritage corporations from 1988 where he was a Managing Director and a member of the bank’s Executive Committee.

Mr. Resch joined State Street in 2002 as Executive Vice President and Chief Financial Officer. He also served as Treasurer from 2006 until January 2008.

In addition, effective March 1, 2010, each of the following individuals will also begin serving as executive officers of State Street.

John L. Klinck, Jr., age 46, will, beginning on March 1, 2010, serve as Executive Vice President and global head of Corporate Development and Global Relationship Management. Presently, Mr. Klinck is Executive Vice President and global head of Alternative Investment Solutions, a role in which he has served since 2006, when he joined State Street. Prior to joining State Street, Mr. Klinck was with Mellon Financial Corporation, a global financial services company, from 1997 to 2006. During that time, he served as vice chairman and president of its Investment Manager Solutions group and before that as chairman for Mellon Europe, where he was responsible for the company’s investor services business in the region.

Alison A. Quirk, age 48, will, beginning on March 1, 2010, serve as Executive Vice President and head of Global Human Resources. Presently, Ms. Quirk is Executive Vice President, Global Human Resources and has held various senior roles in that group since she joined State Street in 2002.

Michael F. Rogers, age 52, will, beginning on March 1, 2010, serve as Executive Vice President and head of Global Services, including alternative investment solutions, for all of the Americas. Presently, Mr. Rogers is Executive Vice President and head of the Relationship Management group, a role which he has held since 2009. From State Street’s acquisition of Investors Financial Services Corp. in July 2007 to 2009, Mr. Rogers headed the post-acquisition Investors Financial Services Corp. business and its integration into State Street. Before joining State Street at the time of the acquisition, Mr. Rogers spent 27 years at Investors Financial Services Corp. in various capacities, most recently as President beginning in 2001.

 

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PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

MARKET FOR REGISTRANT’S COMMON EQUITY

Our common stock is listed on the New York Stock Exchange under the ticker symbol STT. There were 4,079 shareholders of record as of January 31, 2010. Information concerning the market prices of, and dividends on, our common stock during the past two years is included under Item 8, under the caption “Quarterly Summarized Financial Information.”

Additional information about our common stock, including existing Board of Directors authorization with respect to purchases by us of our common stock, and other equity securities is provided in the “Capital—Regulatory Capital” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included under Item 7, and in note 12 of the Notes to Consolidated Financial Statements included under Item 8.

RELATED STOCKHOLDER MATTERS

As a bank holding company, the parent company is a legal entity separate and distinct from its principal banking subsidiary, State Street Bank, and its non-banking subsidiaries. The right of the parent company to participate as a shareholder in any distribution of assets of State Street Bank upon its liquidation, reorganization or otherwise is subject to the prior claims by creditors of State Street Bank, including obligations for federal funds purchased and securities sold under repurchase agreements and deposit liabilities. Payment of dividends by State Street Bank is subject to the provisions of Massachusetts banking law, which provide that dividends may be paid out of net profits provided (i) capital stock and surplus remain unimpaired, (ii) dividend and retirement fund requirements of any preferred stock have been met, (iii) surplus equals or exceeds capital stock, and (iv) losses and bad debts, as defined, in excess of reserves specifically established for such losses and bad debts, have been deducted from net profits.

Under the Federal Reserve Act and Massachusetts state law, regulatory approval of the Federal Reserve and the Massachusetts Division of Banks would be required if dividends declared by State Street Bank in any year exceeded the total of its net profits for that year combined with its retained net profits for the preceding two years, less any required transfers to surplus. Information about dividends from the parent company and from our subsidiary banks is provided in the “Capital—Regulatory Capital” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations, included under Item 7, and in note 15 of the Notes to Consolidated Financial Statements included under Item 8. Future dividend payments of State Street Bank and other non-banking subsidiaries cannot be determined at this time.

 

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SHAREHOLDER RETURN PERFORMANCE PRESENTATION

The graph presented below compares the cumulative total shareholder return on State Street’s common stock to the cumulative total return of the S&P 500 Index and the S&P Financial Index for the five fiscal years which commenced January 1, 2005 and ended December 31, 2009. The cumulative total shareholder return assumes the investment of $100 in State Street common stock and in each index on December 31, 2004, and also assumes reinvestment of dividends. The S&P Financial Index is a publicly available measure of 78 of the Standard & Poor’s 500 companies, representing 27 diversified financial services companies, 16 banking companies, 20 insurance companies and 15 real estate companies.

Comparison of Five-Year Cumulative Total Shareholder Return

LOGO

 

     2004    2005    2006    2007    2008    2009

State Street Corporation

   $ 100    $ 115    $ 141    $ 172    $85    $ 94

S&P 500 Index

     100      105      121      128    81      102

S&P Financial Index

     100      107      127      103    46      54

 

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ITEM 6. SELECTED FINANCIAL DATA

(Dollars in millions, except per share amounts or where otherwise noted)

 

FOR THE YEAR ENDED DECEMBER 31:   2009     2008     2007     2006     2005  

Total fee revenue

  $ 5,935      $ 7,747      $ 6,633      $ 5,186      $ 4,553   

Net interest revenue

    2,564        2,650        1,730        1,110        907   

Gains (Losses) related to investment securities, net

    141        (54     (27     15        (3

Gain on sale of CitiStreet interest, net of exit and other associated costs

           350                        

Gain on sale of Private Asset Management business, net of exit and other associated costs

                                16   
                                       

Total revenue

    8,640        10,693        8,336        6,311        5,473   

Provision for loan losses

    149                               

Expenses:

         

Expenses from operations

    5,667        6,780        5,768        4,540        4,041   

Provision for legal exposure, net

    250               467 (1)               

Provision for investment account infusion

           450                        

Restructuring charges

           306                        

Provision for indemnification obligation

           200                        

Merger and integration costs

    49        115        198                 
                                       

Total expenses

    5,966        7,851        6,433        4,540        4,041   
                                       

Income from continuing operations before income tax expense and extraordinary loss

    2,525        2,842        1,903        1,771        1,432   

Income tax expense from continuing operations

    722        1,031        642        675        487   
                                       

Income from continuing operations before extraordinary loss

    1,803        1,811        1,261        1,096        945   

Extraordinary loss, net of taxes

    (3,684                            

Income (Loss) from discontinued operations, net of taxes

                         10        (107
                                       

Net income (loss)

  $ (1,881   $ 1,811      $ 1,261      $ 1,106      $ 838   
                                       

Adjustments to net income (loss)(2)

    (163     (22                     
                                       

Net income before extraordinary loss available to common shareholders

  $ 1,640      $ 1,789      $ 1,261      $ 1,106      $ 838   
                                       

Net income (loss) available to common shareholders

  $ (2,044   $ 1,789      $ 1,261      $ 1,106      $ 838   
                                       

PER COMMON SHARE:

         

Basic earnings before extraordinary loss:

         

Continuing operations

  $ 3.50      $ 4.32      $ 3.49      $ 3.30      $ 2.86   

Net income

    3.50        4.32        3.49        3.33        2.53   

Basic earnings:

         

Continuing operations

  $ (4.32   $ 4.32      $ 3.49      $ 3.30      $ 2.86   

Net income (loss)

    (4.32     4.32        3.49        3.33        2.53   

Diluted earnings before extraordinary loss:

         

Continuing operations

  $ 3.46      $ 4.30      $ 3.45      $ 3.26      $ 2.82   

Net income

    3.46        4.30        3.45        3.29        2.50   

Diluted earnings:

         

Continuing operations

  $ (4.31   $ 4.30      $ 3.45      $ 3.26      $ 2.82   

Net income (loss)

    (4.31     4.30        3.45        3.29        2.50   

Cash dividends declared

    .04        .95        .88        .80        .72   

Closing market price (at year end)

    43.54        39.33        81.20        67.44        55.44   

AT YEAR END:

         

Investment securities

  $ 93,576      $ 76,017      $ 74,559      $ 64,992      $ 59,870   

Total assets

    157,946        173,631        142,543        107,353        97,968   

Deposits

    90,062        112,225        95,789        65,646        59,646   

Long-term debt

    8,838        4,419        3,636        2,616        2,659   

Total shareholders’ equity

    14,491        12,774        11,299        7,252        6,367   

Assets under custody and administration (in billions)

    18,795        15,907        20,213        15,648        13,207   

Assets under management (in billions)

    1,911        1,444        1,979        1,749        1,441   

Number of employees

    27,310        28,475        27,110        21,700        20,965   

RATIOS:

         

Continuing operations:

         

Return on common shareholders’ equity before extraordinary loss

    13.2     14.8     13.4     16.2     15.3

Return on average assets before extraordinary loss

    1.12        1.11        1.02        1.03        .95   

Common dividend payout before extraordinary loss

    1.17        22.4        25.2        24.2        25.3   

Net income:

         

Return on common shareholders’ equity before extraordinary loss

    13.2     14.8     13.4     16.4     13.6

Return on average assets before extraordinary loss

    1.12        1.11        1.02        1.04        .84   

Common dividend payout before extraordinary loss

    1.17        22.4        25.2        24.0        28.5   

Average common equity to average total assets

    8.5        7.5        7.6        6.3        6.2   

Net interest margin, fully taxable-equivalent basis

    2.19        2.08        1.71        1.25        1.08   

Tier 1 risk-based capital

    17.7        20.3        11.2        13.7        11.7   

Total risk-based capital

    19.1        21.6        12.7        15.9        14.0   

Tier 1 leverage ratio

    8.5        7.8        5.3        5.8        5.6   

 

(1)

Amount was composed of a provision for legal exposure of $600 million, a reduction of salaries and benefits expense of $141 million, and other expenses of $8 million.

 

(2)

Adjustments were related to preferred stock issued in connection with the U.S. Treasury’s TARP program in 2008 and redeemed in 2009.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

State Street Corporation is a financial holding company organized under the laws of the Commonwealth of Massachusetts. All references in this Management’s Discussion and Analysis to the parent company are to State Street Corporation. 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. State Street Bank and Trust Company is referred to as State Street Bank. At December 31, 2009, we had total assets of $157.95 billion, total deposits of $90.06 billion, total shareholders’ equity of $14.49 billion and employed 27,310. With $18.79 trillion of assets under custody and administration and $1.91 trillion of assets under management at year-end 2009, we are a leading specialist in meeting the needs of institutional investors worldwide.

On December 22, 2009, we announced a definitive agreement to acquire the global custody, depository banking, correspondent banking and fund administration businesses of Intesa Sanpaolo, or Intesa, a securities services provider with operations in Italy and Luxembourg, for approximately €1.28 billion in a cash transaction. We also expect to provide additional balance sheet capital of approximately €400 million in cash at closing. Intesa had approximately €343 billion of average assets under custody, and approximately €141 billion of average assets under depository bank services, during the first half of 2009. The U.S. dollar equivalent of these amounts will be determined at closing, and will depend on the currency exchange rate at that time. In January 2010, we entered into derivative contracts to minimize the impact of an adverse change in the currency exchange rate on the U.S. dollar equivalent purchase price. We expect to finance the acquisition with internal liquidity.

The acquisition agreement also includes a long-term investment servicing arrangement with Intesa to service all of its investment management affiliates, including Eurizon Capital, the largest fund manager in Italy with approximately €135 billion of assets under management as of September 30, 2009. We expect to close the acquisition during the second quarter of 2010, subject to regulatory approvals and satisfaction of other closing conditions.

On December 1, 2009, we announced a definitive agreement to acquire Mourant International Finance Administration, or MIFA, in a cash transaction. Headquartered in Jersey in the Channel Islands with approximately $170 billion of assets under administration and operations in locations including Dublin, Singapore and New York, MIFA is a provider of fund administration services, particularly for alternative investments, such as private equity, real estate and hedge funds. We expect to close the acquisition during the first half of 2010, subject to regulatory approvals and satisfaction of other closing conditions.

We report two lines of business: Investment Servicing and Investment Management. These lines of business provide a broad range of products and services for our customers, which include mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations, endowments and investment managers. Investment Servicing provides services to support institutional investors, such as custody, product- and participant-level accounting, daily pricing and administration; master trust and master custody; recordkeeping; shareholder services, including mutual fund and collective investment fund shareholder accounting; 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. Investment Management provides a broad array of services for managing financial assets, such as investment research services and investment management, including passive and active U.S. and non-U.S. equity and fixed-income strategies. For additional information about our lines of business, see the “Line of Business Information” section of this Management’s Discussion and Analysis and note 23 of the Notes to Consolidated Financial Statements included under Item 8.

This Management’s Discussion and Analysis should be read in conjunction with the Consolidated Financial Statements and accompanying Notes to Consolidated Financial Statements included under Item 8. Certain previously reported amounts presented have been reclassified to conform to current period classifications. We

 

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prepare our consolidated financial statements in accordance with accounting principles generally accepted in the U.S., referred to as GAAP. The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions in the application of certain accounting policies that materially affect the reported amounts of assets, liabilities, revenue and expenses. Accounting policies that require management to make assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods are discussed in more depth in the “Significant Accounting Estimates” section of this Management’s Discussion and Analysis.

Certain financial information provided in this Management’s Discussion and Analysis, or in other public statements, announcements or reports filed with the SEC, is prepared on both a GAAP basis and a non-GAAP basis, the latter of which we refer to as “operating” basis. Management measures and compares certain financial information on an operating basis, as it believes 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. Management believes 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 in accordance with GAAP.

This Management’s Discussion and Analysis contains statements that are considered “forward-looking statements” within the meaning of U.S. federal securities laws. Forward-looking statements are based on our current expectations about revenue and market growth, acquisitions and divestitures, new technologies, services and opportunities, earnings and other factors. These forward-looking statements involve certain risks and uncertainties which could cause actual results to differ materially. We undertake no obligation to revise the forward-looking statements contained in this Management’s Discussion and Analysis to reflect events after the time we file this Form 10-K with the SEC. Additional information about forward-looking statements and related risks and uncertainties is included in Risk Factors included under Item 1A.

 

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OVERVIEW OF FINANCIAL RESULTS

 

Years ended December 31,    2009     2008     2007(1)  
(Dollars in millions, except per share amounts)                   

Total fee revenue

   $ 5,935      $ 7,747      $ 6,633   

Net interest revenue

     2,564        2,650        1,730   

Gains (Losses) related to investment securities, net

     141        (54     (27

Gain on CitiStreet interest, net of exit and other associated costs

            350          
                        

Total revenue

     8,640        10,693        8,336   

Provision for loan losses

     149                 

Expenses:

      

Expenses from operations

     5,667        6,780        5,768   

Provision for legal exposure, net

     250               467 (2) 

Provision for investment account infusion

            450          

Restructuring charges

            306          

Provision for indemnification exposure

            200          

Merger and integration costs

     49        115        198   
                        

Total expenses

     5,966        7,851        6,433   
                        

Income before income tax expense and extraordinary loss

     2,525        2,842        1,903   

Income tax expense

     722        1,031        642   
                        

Income before extraordinary loss

     1,803        1,811        1,261   

Extraordinary loss, net of taxes

     (3,684              
                        

Net income (loss)

   $ (1,881   $ 1,811      $ 1,261   
                        

Adjustments to net income (loss)(3)

     (163     (22       
                        

Net income before extraordinary loss available to common shareholders

   $ 1,640      $ 1,789      $ 1,261   
                        

Net income (loss) available to common shareholders

   $ (2,044   $ 1,789      $ 1,261   
                        

Earnings per common share before extraordinary loss:

      

Basic

   $ 3.50      $ 4.32      $ 3.49   

Diluted

     3.46        4.30        3.45   

Earnings (Loss) per common share:

      

Basic

   $ (4.32   $ 4.32      $ 3.49   

Diluted

     (4.31     4.30        3.45   

Average common shares outstanding (in thousands):

      

Basic

     470,602        413,182        360,675   

Diluted

     474,003        416,100        365,488   

Return on common shareholders’ equity before extraordinary loss(4)

     13.2     14.8     13.4

 

(1)

Financial results for 2007 include results for the third and fourth quarters of 2007 of the acquired business of Investors Financial Services Corp., which we acquired on July 1, 2007.

 

(2)

Amount was composed of a provision for legal exposure of $600 million, a reduction of salaries and benefits expense of $141 million, and other expenses of $8 million; refer to the “Comparison of 2008 and 2007” section of this Management’s Discussion and Analysis.

 

(3)

Adjustments were related to preferred stock issued in connection with the U.S. Treasury’s TARP program in 2008 and redeemed in 2009.

 

(4)

For 2009, return on common shareholders’ equity was determined by dividing net income before extraordinary loss available to common shareholders by average common shareholders’ equity for the year.

 

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Financial Highlights

For 2009, we recorded a net loss available to common shareholders of $2.04 billion, or $4.31 per diluted share. This included income before the extraordinary loss of $1.64 billion, or $3.46 per diluted share, and an after-tax extraordinary loss of $3.68 billion, or $7.77 per diluted share, related to the consolidation of the asset-backed commercial paper conduits that we administer onto our balance sheet in May 2009. Net income available to common shareholders before the extraordinary loss decreased 8% to $1.64 billion compared to $1.79 billion in 2008, and associated diluted earnings per common share decreased 20% to $3.46 per share from $4.30 per share in 2008. Return on common equity before the extraordinary loss was 13.2% compared to 14.8% for 2008.

Total revenue declined 19% compared to 2008. A 23% decline in total fee revenue from 2008 levels was partly offset by an increase in net gains from investment securities. The decline in total revenue also reflected the absence of the $350 million gain from the sale of our joint venture interest in CitiStreet in 2008.

Servicing and management fees were down 13% and 20%, respectively, from 2008, mainly due to the impact of declines in equity market valuations, partly offset by the impact of new business on current-period revenue. Trading services revenue declined 25% to $1.09 billion from $1.47 billion, primarily as a result of lower foreign exchange trading volumes, offset by an increase in brokerage fees and other trading services revenue from higher transitions and electronic trading revenues attributable to higher volumes. Securities finance revenue was down 54% to $570 million from $1.23 billion, as a result of lower spreads and lending volumes. Processing fees and other revenue decreased 38% to $171 million from $277 million due to lower product-related revenue.

Net interest revenue decreased 3% to $2.56 billion compared to $2.65 billion for 2008, or 2% on a fully taxable-equivalent basis ($2.69 billion compared to $2.75 billion, reflecting increases from tax-equivalent adjustments of $126 million and $104 million, respectively). These decreases were primarily due to the impact of lower levels of customer deposits and lower interest-rate spreads, largely offset by $621 million of discount accretion recorded in connection with the conduit assets added to our balance sheet in May 2009. Net interest margin increased 11 basis points, from 2.08% in 2008 to 2.19% in 2009.

Total expenses of $5.97 billion decreased 24% from 2008, and included merger and integration costs of $49 million associated with the July 2007 Investors Financial acquisition and an additional provision of $250 million associated with the reserve for litigation exposure related to SSgA fixed-income strategies, more fully discussed below. Total expenses in 2009 compared to $7.85 billion in 2008, which included the following: merger and integration costs associated with the July 2007 Investors Financial acquisition ($115 million); a charge associated with a cash infusion into SSgA investment management accounts ($450 million); restructuring charges associated with the reduction in workforce and other cost initiatives ($306 million); and a provision for estimated net exposure on an indemnification obligation associated with collateralized repurchase agreements ($200 million). Expenses from operations of $5.67 billion ($5.97 billion net of $299 million delineated above) decreased 16% compared to 2008 expenses from operations of $6.78 billion ($7.85 billion net of $1.07 billion delineated above), mainly as a result of a reduction in salaries and benefits expense associated with our previously announced workforce reduction as well as lower accruals for cash incentive compensation.

Our financial results for 2009 reflected the following:

 

   

Effective May 15, 2009, we elected to take action that resulted in the consolidation onto our balance sheet, for financial reporting purposes, of all of the assets and liabilities of the four third-party-owned, special purpose, multi-seller asset-backed commercial paper conduits that we administer, and recorded a related after-tax extraordinary loss of approximately $3.68 billion in our consolidated statement of income (see note 11);

 

   

In May 2009, we completed two public securities offerings. First, we issued approximately 58.97 million shares of our common stock at an offering price of $39 per share, and received aggregate proceeds from the offering, net of underwriting commissions and related offering costs, of approximately $2.23 billion. Second, we issued $500 million of 4.30% fixed-rate senior unsecured notes due 2014. We completed these offerings primarily in connection with our intention to conclude our participation in the U.S. Treasury’s TARP Capital Purchase Program, with the remaining proceeds intended for general corporate purposes;

 

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In June 2009, we redeemed the $2 billion preferred stock portion of the equity investment issued to Treasury in October 2008 under the TARP Capital Purchase Program, reducing retained earnings, and as a result earnings available to common shareholders, by approximately $106 million for 2009, by accelerating the accretion of the remaining discount on the preferred stock into 2009. In July 2009, we repurchased the related warrant to purchase shares of our common stock from Treasury for $60 million, concluding our participation in the program (see note 12);

 

   

We recorded interest revenue of $621 million in 2009 associated with discount accretion on investment securities added in connection with the May 2009 conduit consolidation (see the “Net Interest Revenue” section of this Management’s Discussion and Analysis and note 11);

 

   

During the third quarter of 2009, we recorded an additional provision for legal exposure of $250 million, to increase the reserve initially established in 2007 associated with certain active fixed-income strategies managed by SSgA. We settled regulatory inquiries by the SEC, the Massachusetts Secretary of State and the Massachusetts Attorney General’s Office related to this exposure in February 2010, and the reserve remaining at that time was sufficient to cover the cost of the settlements (see notes 10 and 20); and

 

   

We recorded provisions for loan losses of $149 million, of which $124 million related to commercial real estate loans acquired in 2008 pursuant to indemnification obligations, reflecting management’s change in expectations of future principal and interest cash flows with respect to certain of the loans (see note 4).

CONSOLIDATED RESULTS OF OPERATIONS

This section discusses our consolidated results of operations for 2009 compared to 2008, and should be read in conjunction with the consolidated financial statements and accompanying notes included under Item 8. A comparison of consolidated results of operations for 2008 with those for 2007 is provided in the “Comparison of 2008 and 2007” section of this Management’s Discussion and Analysis.

TOTAL REVENUE

 

Years ended December 31,    2009    2008     2007     % Change
2008-2009
 
(Dollars in millions)                        

Fee revenue:

         

Servicing fees

   $ 3,276      $3,745      $ 3,388      (13 )% 

Management fees

     824      1,028        1,141      (20

Trading services

     1,094      1,467        1,152      (25

Securities finance

     570      1,230        681      (54

Processing fees and other

     171      277        271      (38
                         

Total fee revenue

     5,935      7,747        6,633      (23

Net interest revenue:

         

Interest revenue

     3,286      4,879        5,212      (33

Interest expense

     722      2,229        3,482      (68
                         

Net interest revenue

     2,564      2,650        1,730      (3

Gains (Losses) related to investment securities, net

     141      (54     (27  

Gain on sale of CitiStreet interest, net of exit and other associated costs

          350               
                         

Total revenue

   $ 8,640    $ 10,693      $ 8,336      (19
                         

Our broad range of services generates fee revenue and net interest revenue. Fee revenue generated by our investment servicing and investment management businesses is augmented by securities finance, trading services and processing fee and other revenue. We earn net interest revenue from customers’ deposits and short-term investment activities, by providing deposit services and short-term investment vehicles, such as repurchase agreements and commercial paper, to meet customers’ needs for high-grade liquid investments, and investing these sources of funds and additional borrowings in assets yielding a higher rate.

 

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Fee Revenue

Servicing and management fees collectively composed approximately 69% of our total fee revenue for 2009 and 62% for 2008. These fees are a function of 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 customers, and are generally affected by changes in worldwide equity and fixed-income valuations.

Generally, servicing fees are affected, in part, by changes in daily average valuations of assets under custody and administration, while management fees are affected by changes in month-end valuations of assets under management. Additional factors, such as the level of transaction volumes, changes in service level, balance credits, customer minimum balances, pricing concessions and other factors, may have a significant effect on servicing fee revenue. Generally, management fee revenue is more sensitive to market valuations than servicing fee revenue. Management fees for enhanced index and actively managed products are generally earned at higher rates than those for passive products. Enhanced index and actively managed products may also involve performance fee arrangements. Performance fees are generated when the performance of certain managed funds exceeds benchmarks specified in the management agreements. Generally, we experience more volatility with performance fees than with more traditional management fees.

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. We would expect the foregoing relationships to exist in normalized financial markets. These relationships were not experienced in 2008 or 2009, in light of the global financial markets disruption that began in 2007. These disrupted conditions adversely affected our servicing and management fee revenues for 2008 and 2009, which are based, in part, on the value of assets under custody and administration or assets under management as described earlier in this section. In addition, our revenues from trading services and securities finance during 2009 were adversely affected by a reduction in the significant volatility in the financial markets experienced during 2008 associated with the aforementioned disruption. Even though the market disruption lessened during this year’s third and fourth quarters, the impact of market conditions on our total revenue for the year was more significant than we would anticipate in normalized markets.

The following table presents selected equity market indices for the years ended December 31, 2009 and 2008. Daily averages and the averages of month-end indices demonstrate worldwide changes in equity market valuations that affect servicing and management fee revenue, respectively. Year-end indices affect the value of assets under custody and administration and assets under management at those dates. The index names listed in the table are service marks of their respective owners.

INDEX

 

     Daily Averages of Indices     Average of Month-End Indices     Year-End Indices  
     2009    2008    % Change         2009        2008        % Change         2009    2008    % Change  

S&P 500®

   948    1,220    (22 )%    949    1,215    (22 )%    1,115    903    23

NASDAQ®

   1,845    2,162    (15   1,857    2,149    (14   2,269    1,577    44   

MSCI EAFE®

   1,336    1,792    (25   1,344    1,777    (24   1,581    1,237    28   

 

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FEE REVENUE

 

Years ended December 31,    2009    2008    2007    % Change
2008-2009
 
(Dollars in millions)                      

Servicing fees

   $ 3,276    $ 3,745    $ 3,388    (13 )% 

Management fees(1)

     824      1,028      1,141    (20

Trading services

     1,094      1,467      1,152    (25

Securities finance

     570      1,230      681    (54

Processing fees and other

     171      277      271    (38
                       

Total fee revenue

   $ 5,935    $ 7,747    $ 6,633    (23
                       

 

(1)

Included performance fees of $9 million, $21 million and $72 million for 2009, 2008 and 2007, respectively.

Servicing Fees

Servicing fees include fee revenue from U.S. mutual funds, collective investment funds worldwide, corporate and public retirement plans, insurance companies, foundations, endowments, and other investment pools. Products and services include custody; product- and participant-level accounting; daily pricing and administration; recordkeeping; investment manager and alternative investment manager operations outsourcing services; master trust and master custody; and performance, risk and compliance analytics.

The 13% decline in servicing fees from 2008 primarily resulted from the impact of declines in daily average equity market valuations, partly offset by the impact of new business on current-period revenue. For 2009, servicing fees generated from customers outside the U.S. were approximately 37% of total servicing fees compared to approximately 41% for 2008.

We are the largest provider of mutual fund custody and accounting services in the United States. We distinguish ourselves from other mutual fund service providers by offering customers a broad array of integrated products and services, including accounting, daily pricing and fund administration. We calculate more than 40% of the U.S. mutual fund prices provided to NASDAQ that appear daily in The Wall Street Journal and other publications with an accuracy rate of 99.9%.

We have a leading position for servicing U.S. tax-exempt assets for corporate and public pension funds. We provide trust and valuation services for more than 5,000 daily-priced portfolios, making us a leader for both monthly and daily valuation services.

We are a leading service provider outside of the U.S. as well. In Germany, we provide Depotbank services for approximately 13% of retail and institutional fund assets. In the United Kingdom, we provide custody services for 14% of pension fund assets and provide administration services for approximately 16% of mutual fund assets. We service more than $650 billion of offshore assets, primarily domiciled in Ireland, Luxembourg and Toronto. We have more than $800 billion in assets under administration in the Asia/Pacific region, and hold over 85% of the trust assets held by non-domestic trust banks in that region.

 

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At year-end 2009, our total assets under custody and administration were $18.79 trillion, compared to $15.91 trillion a year earlier. The increase compared to 2008 was primarily the result of increases in equity market valuations and a higher level of new business. The value of assets under custody and administration is a broad measure of the relative size of various markets served. Changes in the value of assets under custody and administration do not necessarily result in proportional changes in revenue. Assets under custody and administration consisted of the following at December 31:

ASSETS UNDER CUSTODY AND ADMINISTRATION

 

As of December 31,    2009    2008    2007    2006    2005    2008-2009
Annual
Growth
Rate
    2005-2009
Compound
Annual
Growth
Rate
 
(Dollars in billions)                                      

Mutual funds

   $ 4,734    $ 4,093    $ 5,200    $ 4,007    $ 3,301    16   9

Collective funds

     3,580      2,679      3,968      1,947      1,489    34      25   

Pension products

     4,395      3,621      5,246      4,914      4,334    21        

Insurance and other products

     6,086      5,514      5,799      4,780      4,083    10      10   
                                       

Total

   $ 18,795    $ 15,907    $ 20,213    $ 15,648    $ 13,207    18      9   
                                       

FINANCIAL INSTRUMENT MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION

 

As of December 31,    2009    2008    2007
(In billions)               

Equities

   $ 8,828    $ 6,691    $ 9,532

Fixed-income

     7,236      6,689      7,739

Short-term and other investments

     2,731      2,527      2,942
                    

Total

   $ 18,795    $ 15,907    $ 20,213
                    

GEOGRAPHIC MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION(1)

 

As of December 31,    2009    2008    2007
(In billions)               

United States

   $ 14,585    $ 12,424    $ 15,335

Other Americas

     606      536      830

Europe/Middle East/Africa

     2,773      2,391      3,233

Asia/Pacific

     831      556      815
                    

Total

   $ 18,795    $ 15,907    $ 20,213
                    

 

(1)

Geographic mix is based on the location where the assets are serviced.

Management Fees

We provide a broad range of investment management strategies, specialized investment management advisory services and other financial services for corporations, public funds, and other sophisticated investors. These services are offered through SSgA. Based upon assets under management, SSgA is the largest manager of institutional assets worldwide, the largest manager of assets for tax-exempt organizations (primarily pension plans) in the United States, and the third largest investment manager overall in the world. SSgA offers a broad array of investment management strategies, including passive and active, such as enhanced indexing and hedge fund strategies, using quantitative and fundamental methods for both U.S. and global equities and fixed-income securities. SSgA also offers exchange traded funds, or ETFs, such as the SPDR® Gold ETF.

The 20% decline in management fees from 2008 resulted primarily from the impact of declines in average month-end equity market valuations and the impact of a higher percentage of assets invested in lower-rate passive strategies, partly offset by the impact of new business on current-period revenue. Average month-end

 

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equity market valuations, individually presented in the foregoing “INDEX” table, were down an average of 19% compared to 2008. Management fees generated from customers outside the United States were approximately 33% of total management fees for 2009, down from 40% for 2008.

At year-end 2009, assets under management were $1.91 trillion, compared to $1.44 trillion at year-end 2008. 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 customers who use multiple services, and the benchmarks specified in the respective management agreements related to performance fees.

The overall increase in assets under management at December 31, 2009 compared to December 31, 2008 primarily reflected an aggregate increase in net new business of approximately $248 billion, compared to an aggregate net loss of business of approximately $55 billion during 2008, and increases in equity market valuations. Our levels of assets under management were affected by a number of factors, including investor issues related to SSgA’s active fixed-income strategies, restrictions on redemptions related to funds engaged in securities lending, and the relative under-performance of certain of our passive equity products. The increase in net new business of $248 billion for 2009 reflected new business awarded to us during 2009, primarily in passive strategies, which was installed prior to December 31, 2009.

Assets under management consisted of the following at December 31:

ASSETS UNDER MANAGEMENT

 

As of December 31,    2009    2008    2007    2006    2005    2008-2009
Annual
Growth
Rate
    2005-2009
Compound
Annual
Growth
Rate
 
(Dollars in billions)                                      

Equities:

                   

Passive

   $ 787    $ 576    $ 803    $ 691    $ 625    37   6

Active and other

     88      91      206      181      147    (3   (12

Company stock/ESOP

     49      39      79      85      76    26      (10
                                       

Total equities

     924      706      1,088      957      848    31      2   

Fixed-income:

                   

Passive

     445      238      218      180      128    87      37   

Active

     25      32      41      34      28    (22   (3

Cash and money market

     517      468      632      578      437    10      4   
                                       

Total fixed-income and cash/money market

     987      738      891      792      593    34      14   
                                       

Total

   $ 1,911    $ 1,444    $ 1,979    $ 1,749    $ 1,441    32      7   
                                       

GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1)

 

As of December 31,    2009    2008    2007
(In billions)               

United States

   $ 1,357    $ 1,020    $ 1,353

Other Americas

     29      24      36

Europe/Middle East/Africa

     345      272      427

Asia/Pacific

     180      128      163
                    

Total

   $ 1,911    $ 1,444    $ 1,979
                    

 

(1)

Geographic mix is based on the location where the assets are managed.

 

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The following table presents a roll-forward of assets under management for the three years ended December 31:

ASSETS UNDER MANAGEMENT

 

Years Ended December 31,    2009    2008     2007
(In billions)                

Balance at beginning of year

   $ 1,444    $ 1,979      $ 1,749

Net new business

     248      (55     116

Market appreciation (depreciation)

     219      (480     114
                     

Balance at end of year

   $ 1,911    $ 1,444      $ 1,979
                     

Trading Services

Trading services revenue includes revenue from foreign exchange trading and brokerage and other trading services. We offer a complete range of foreign exchange services under an account model that focuses on the global requirements of our customers for our proprietary research and the execution of trades in any time zone. Foreign exchange trading revenue is influenced by three principal factors: the volume and type of customer foreign exchange transactions; currency volatility; and the management of currency market risks.

For 2009, foreign exchange trading revenue totaled $677 million, a 37% decrease from 2008 revenue of $1.08 billion, mainly driven by a 16% decline in customer volumes and a 4% decrease in currency volatility, as the financial markets were relatively more stable during 2009 than during 2008.

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 differentiated by our position as an agent of the institutional investor. Brokerage and other trading fees of $417 million were higher by 8% compared to $385 million in 2008. The increase was attributable to higher brokerage revenue, principally from growth in fixed-income transition management and equity trading, as well as to an increase in revenues from electronic trading services associated with higher volumes.

Securities Finance

Securities finance provides liquidity to the financial markets, as well as an effective means for customers to earn revenue on their securities portfolios. By acting as a lending agent and coordinating loans between lenders and borrowers, we lend securities and provide liquidity to customers around the world. Borrowers provide collateral in the form of cash or securities to State Street in return for loaned securities. Borrowers are generally required to provide collateral equal to a contractually agreed percentage of the fair value of the loaned securities. As the fair value of the loaned securities changes, additional collateral is provided by the borrower or collateral is returned to the borrower. Such movements are typically referred to as daily mark-to-market collateral adjustments.

For cash collateral, we pay a usage fee to the provider of the cash collateral, and invest the cash collateral in certain investment vehicles or managed accounts as directed by the owner of the loaned securities. In some cases, the investment vehicles or managed accounts may be managed by SSgA. The spread between the yield on the investment vehicle and the usage fee paid to the provider of the collateral is split between the lender of the securities and State Street as agent. For non-cash collateral, the borrower pays a fee for the loaned securities, and the fee is split between the lender of the securities and State Street.

Securities finance revenue, composed of our split of both the spreads related to cash collateral and the fees related to non-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 2009, securities finance revenue decreased 54% from a year earlier, primarily as a result of compression of spreads across all lending programs as well as a 32% decrease in the average volume of securities on loan during 2009 compared to 2008.

 

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Market influences are expected to continue to affect our revenue from, and the profitability of, our securities lending activities in 2010. Over the past 18 months, the aggregate volume of securities on loan under our direct lending program has decreased significantly, from an average of approximately $670 billion of aggregate securities on loan during the second quarter of 2008 to approximately $440 billion during the fourth quarter of 2008 and approximately $405 billion during the fourth quarter of 2009. This decline in average lending volume reflects both the general de-leveraging of the securities markets following the Lehman bankruptcy proceedings and, to a lesser degree, regulatory measures affecting securities lending. At the same time, during 2009, the spreads, described above, earned by participants decreased significantly, reflecting prevailing interest rates and government actions to stimulate the economy. Until securities lending volumes and spreads return to more normal levels, our revenues from securities lending activities will be adversely affected, which in turn may discourage customers who exited securities lending in 2007 and 2008 from returning to the practice.

Purported class actions have been filed regarding certain collateral pools underlying funds managed by SSgA, and we are responding to inquiries from the SEC and other regulatory authorities in connection with our cash collateral pools. Additional information is included in the Risk Factors and Legal Proceedings sections included under Items 1A and 3, respectively.

Processing Fees and Other

Processing fees and other revenue includes diverse types of fees and other revenue, including fees from our structured products business, fees from software licensing and maintenance, equity income from our joint venture investments, gains and losses on sales of leased equipment and other assets, and amortization of investments in tax-advantaged financings. Processing fees and other revenue was $171 million for 2009, a decrease of 38% compared to 2008. This decrease was mainly the result of declines in fees from our deposit service and structured products businesses, including our tax-exempt investment and conduit commercial paper programs, the latter the result of the May 2009 conduit consolidation.

Prior to the conduit consolidation, we earned administrative fees for providing administrative services to each of the conduits, which generally represented the conduits’ residual earnings after the payment of interest on outstanding commercial paper and the payment of other fees to independent third parties. We earned fee revenue of approximately $19 million for 2009 up to the date of the consolidation, compared to $59 million for all of 2008 and $63 million for all of 2007. Since the conduits’ assets and liabilities are now recorded in our consolidated balance sheet, the conduits’ business activities generate net interest revenue rather than processing fees and other revenue. More information about the impact of the conduit consolidation on our net interest revenue is provided in the “Net Interest Revenue” section of this Management’s Discussion and Analysis.

 

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NET INTEREST REVENUE

 

Years ended December 31,   2009     2008     2007  
    Average
Balance
  Interest
Revenue/
Expense
  Rate     Average
Balance
  Interest
Revenue/
Expense
  Rate     Average
Balance
  Interest
Revenue/
Expense
  Rate  

(Dollars in millions; fully
taxable-equivalent basis)

                 

Interest-bearing deposits with banks

  $ 24,162   $ 156   .64   $ 24,003   $ 760   3.17   $ 7,433   $ 416   5.60

Securities purchased under resale agreements

    3,701     24   .65        10,195     276   2.71        12,466     664   5.32   

Federal funds sold

    68       .29        2,700     63   2.33        1,936     92   4.77   

Trading account assets

    1,914     20   1.02        2,423     78   3.22        972     55   5.60   

Investment securities

    81,190     2,943   3.63        72,227     3,163   4.38        70,990     3,649   5.14   

Investment securities purchased under AMLF(1)

    882     25   2.86        9,193     367   4.00                

Loans and leases(2)

    9,703     242   2.49        11,884     276   2.32        10,753     394   3.67   

Other interest-earning assets

    1,303     2   .15                             
                                         

Total interest-earning assets

  $ 122,923   $ 3,412   2.78      $ 132,625   $ 4,983   3.75      $ 104,550   $ 5,270   5.04   
                                         

Interest-bearing deposits:

                 

U.S

  $ 7,616   $ 61   .81   $ 11,216   $ 223   1.99   $ 7,557   $ 313   4.13

Non-U.S

    61,551     134   .22        68,291     1,103   1.62        60,663     1,985   3.27   

Securities sold under repurchase agreements

    11,065     3   .03        14,261     177   1.24        16,132     701   4.35   

Federal funds purchased

    956       .04        1,026     18   1.77        1,667     86   5.15   

Short-term borrowings under AMLF(1)

    877     18   2.02        9,170     299   3.26                

Other short-term borrowings

    16,847     197   1.17        5,996     180   2.99        4,225     172   4.09   

Long-term debt

    7,917     304   3.84        4,106     229   5.59        3,402     225   6.62   

Other interest-bearing liabilities

    1,131     5   .46                             
                                         

Total interest-bearing liabilities

  $ 107,960   $ 722   .67      $ 114,066   $ 2,229   1.95      $ 93,646   $ 3,482   3.72   
                                         

Interest-rate spread

      2.11       1.80       1.32

Net interest revenue - fully taxable-equivalent basis(3)

    $ 2,690       $ 2,754       $ 1,788  
                             

Net interest margin - fully taxable-equivalent basis

      2.19       2.08       1.71

Net interest revenue - GAAP basis

    $ 2,564       $ 2,650       $ 1,730  

 

(1)

Amounts represent averages of asset-backed commercial paper purchases from eligible unaffiliated money market mutual funds under the Federal Reserve’s Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility, or AMLF, and associated borrowings. Additional information about the AMLF, which recently expired, is provided in note 8 of the Notes to Consolidated Financial Statements included under Item 8.

 

(2)

Interest revenue for 2008 reflected a cumulative reduction of $98 million recorded in connection with our SILO lease transactions. Additional information about our SILO lease transactions is provided in note 10 of the Notes to Consolidated Financial Statements included under Item 8.

 

(3)

Amounts include fully taxable-equivalent adjustments of $126 million for 2009, $104 million for 2008 and $58 million for 2007.

Net interest revenue is defined as the total of interest revenue earned on interest-earning assets less interest expense incurred on interest-bearing liabilities. Interest-earning assets, which consist of investment securities, loans and leases and other liquid assets, are financed primarily by customer deposits and short-term borrowings. Net interest margin represents the relationship between net interest revenue and average interest-earning assets. 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 17 of the Notes to Consolidated Financial Statements included under Item 8.

 

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For 2009, on a fully taxable-equivalent basis, net interest revenue decreased 2% (3% on a GAAP basis) compared to 2008. This decline was generally the result of lower rates on floating-rate investment securities and both lower volumes and lower rate spreads on customer deposits, as well as the re-investment of amortizing and maturing investment securities into short-term interest-bearing deposits rather than investment securities during the first half of 2009, in connection with our previously announced plan to improve our tangible common equity. The decrease in fully taxable-equivalent net interest revenue was partially offset by discount accretion, described below, on securities added in connection with the May 2009 conduit consolidation. Average aggregate interest-bearing deposits decreased 13% compared to 2008, primarily due to the current low-yield environment and a decrease in customers’ cash balances more reflective of historical levels as global market disruptions lessened.

In May 2009, we elected to take action that required the consolidation onto our balance sheet, for financial reporting purposes, of the assets and liabilities of the asset-backed commercial paper conduits that we sponsored and administered. Upon consolidation, the aggregate fair value of the conduits’ investment securities was established as their carrying amount, resulting in a discount to the assets’ par value. To the extent that the expected future cash flows from the securities exceed their carrying amount, the portion of the discount not related to credit will accrete into interest revenue over the securities’ remaining terms. The timing and ultimate recognition of this accretion will depend on factors including future credit conditions and the timing of underlying collateral prepayment, the predictability of which is challenged by the continuing global financial markets disruption. During 2009, we recorded discount accretion in interest revenue of approximately $621 million, and we anticipate that discount accretion will continue to be a material component of our net interest revenue for 2010. Because the rate of recognition of discount accretion is dependent, in part, on the rate of underlying prepayments, which is beyond our control, the volatility of our net interest revenue may increase.

Interest-bearing deposits with banks, including cash balances held at the Federal Reserve to satisfy reserve requirements, averaged $24.16 billion for 2009, relatively flat compared to $24.00 billion in 2008. An average of $12.42 billion was held at the Federal Reserve Bank during 2009, an increase of $6.06 billion compared to $6.36 billion for 2008, with the balances in both periods exceeding minimum reserve requirements. This increase resulted from our investment of excess liquidity, beginning in the second half of 2008, in reserve balances held at the Federal Reserve Bank. Beginning with the fourth quarter of 2008, these balances earn a minimal rate of interest, which rate is subject to change at the Federal Reserve’s discretion.

Average securities purchased under resale agreements decreased 64%, or $6.49 billion, from $10.20 billion for 2008 to $3.70 billion for 2009. Average federal funds sold decreased $2.63 billion, or 97%, to $68 million for 2009 compared to 2008. The decrease in federal funds sold and securities purchased under resale agreements was mainly due to the re-allocation of liquidity to U.S. Treasury securities in the investment securities portfolio and the placement of excess liquidity at the Federal Reserve, as described above, and other central banks.

Average trading account assets decreased 21%, or $509 million, from $2.42 billion for 2008 to $1.91 billion in 2009, due to the absence of conduit asset-backed commercial paper which was eliminated for financial reporting purposes when the conduits were consolidated onto our balance sheet as described above.

Our average investment securities portfolio increased 12%, or $8.96 billion, from $72.23 billion in 2008 to approximately $81.19 billion in 2009, due to the effect of the conduit consolidation and an increase in U.S. Treasury and agency securities, as well as the re-investment of amortizing and maturing securities, partially offset by sales. During the second half of 2009, we re-initiated our investment strategy of investing in “AAA” and “AA” rated securities. Securities rated “AAA” and “AA” comprised approximately 80% of the investment securities portfolio, with approximately 69% “AAA” rated, at December 31, 2009, compared to 89% “AAA” and “AA” rated and 78% “AAA” rated, respectively, at December 31, 2008.

Loans and leases averaged $9.70 billion for the 2009, down 18% from $11.88 billion for 2008. The decrease was primarily related to lower levels of short-term liquidity required by customers, partially offset by the structured asset-backed loans added in connection with the conduit consolidation. Approximately 31% of the average loan and lease portfolio, compared to 67% for 2008, was composed of U.S. and non-U.S. short-duration advances that provide liquidity to customers in support of their transaction flows, which averaged approximately $2.97 billion for 2009, down $5.03 billion, or 63%, from $8.00 billion for 2008. The lower levels of liquidity we

 

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provided to customers during 2009 were due to a decrease in customer demand and not a reduction in credit availability from, or committed lines provided by, State Street. As transaction flows returned to more normalized levels compared to the extraordinarily high levels experienced in 2008, customer demand for short-term liquidity declined.

Average interest-bearing deposits decreased $10.34 billion, or 13%, from $79.51 billion to $69.17 billion for 2009 compared to 2008. The decrease was due to lower levels of U.S. and non-U.S. deposits, including foreign transaction deposits, which were particularly high during 2008. This decrease also reflected the current low-yield interest rate environment and a decrease in customers’ cash balances, the latter more reflective of historical levels as global market disruptions lessened.

Average other short-term borrowings increased $10.85 billion, or 181%, to $16.85 billion for 2009 primarily due to the addition of commercial paper in connection with the conduit consolidation and borrowings under the Federal Reserve’s term auction facility, which is a secured lending program available to financial institutions, to fund conduit assets. Average long-term debt increased $3.81 billion, or 93%, to $7.92 billion for 2009 due to the issuance of an aggregate of approximately $4 billion of unsecured senior notes by State Street and State Street Bank in March 2009 under the FDIC’s Temporary Liquidity Guarantee Program, or TLGP, and the issuance by State Street of $500 million of unsecured senior notes in May 2009.

Several factors could affect future levels of our net interest revenue and margin, including the mix of customer liabilities, actions of the various central banks, changes in U.S. and non-U.S. interest rates, the shapes of the various yield curves around the world and the amount of discount accretion on the investment securities added to our consolidated balance sheet in connection with the conduit consolidation. Based on market conditions, we re-initiated our investment strategy of re-investing proceeds from amortizing and maturing securities in highly rated investment securities, such as U.S. Treasuries and federal agency mortgage-backed securities and asset-backed securities, which enhanced our net interest revenue and margin during the second half of 2009. The pace at which we continue to re-invest and the types of securities purchased will depend on market conditions over time. These factors and the level of interest rates worldwide are expected to dictate what impact the re-investment program will have on our net interest revenue and net interest margin in the future.

Gains (Losses) Related to Investment Securities, Net

We recorded net gains of $368 million from sales of available-for-sale securities for 2009, compared to net gains of $68 million for 2008. The aggregate unrealized loss on securities for which other-than-temporary impairment was recorded in 2009 was $1.15 billion. Of this total, $928 million related to factors other than credit, and was recognized, net of taxes, as a component of other comprehensive income in our consolidated statement of condition. We recorded losses from other-than-temporary impairment related to credit of the remaining $227 million in our 2009 consolidated statement of income, compared to $122 million in 2008, which resulted from our assessment of impairment.

 

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For 2009, the $227 million of losses was composed of $151 million associated with expected credit losses, $54 million related to management’s decision to sell the impaired securities prior to their recovery in value, and $22 million associated with adverse changes in the timing of expected future cash flows from the securities. The majority of the impairment losses related to non-agency mortgage-backed securities which management concluded had experienced credit losses. These securities are reported as asset-backed securities in note 3 of the Notes to Consolidated Financial Statements included under Item 8.

 

Years ended December 31,    2009     2008  

(In millions)

    

Net gains from sales of available-for-sale securities

   $ 368      $ 68   

Losses from other-than-temporary impairment

     (1,155     (122

Losses not related to credit(1)

     928          
                

Net impairment losses

     (227     (122
                

Gains (Losses) related to investment securities, net

   $ 141      $ (54
                

 

(1)

These losses were not recorded in our consolidated results of operations, but were recognized as a component of other comprehensive income, net of related taxes, in our consolidated balance sheet; refer to the following discussion and to note 12 of the Notes to Consolidated Financial Statements included under Item 8.

Management regularly reviews the investment securities portfolio to identify other-than-temporary impairment of individual securities. Pursuant to the provisions of a new accounting standard, which we adopted effective April 1, 2009, impairment related to expected losses represents the difference between the discounted values of the expected future cash flows from the securities compared to their current amortized cost basis, with each discount rate commensurate with the effective yield on the underlying security. For debt securities held to maturity, other-than-temporary impairment remaining after credit-related impairment (which credit-related impairment is recorded in our consolidated statement of income) is recognized, net of taxes, as a component of other comprehensive income in the shareholders’ equity section of our consolidated balance sheet, and is accreted prospectively over the remaining terms of the securities based on the timing of their estimated future cash flows. For other-than-temporary impairment of debt securities that results from management’s decision to sell the security prior to its recovery in value, the entire difference between the security’s fair value and its amortized cost basis is recorded in our consolidated statement of income.

The aforementioned accounting for other-than-temporary impairment was adopted by us, pursuant to new accounting standards, effective April 1, 2009. Prior to that date, we recognized losses from other-than-temporary impairment of debt and equity securities for either a change in management’s intent to hold the securities or expected credit losses, and such impairment losses, which reflected the entire difference between the fair value and amortized cost basis of each individual security, were recorded in our consolidated statement of income.

Additional information about investment securities, the gross gains and losses that compose the net sale gains and our process to identify other-than-temporary impairment, is provided in note 3 of the Notes to Consolidated Financial Statements included under Item 8.

 

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PROVISION FOR LOAN LOSSES

We recorded provisions for loan losses of $149 million during 2009. Of the aggregate provisions, $124 million resulted from changes in management’s expectations with respect to future principal and interest cash flows from certain of the commercial real estate loans acquired in 2008 in connection with indemnification obligations. The changes in management’s expectations were primarily based on its assessment of the impact of the deteriorating economic conditions in the commercial real estate markets on certain of these loans during 2009. Future changes in expectations with respect to collection of principal and interest on these loans could result in additional provisions for loan losses.

EXPENSES

 

Years Ended December 31,    2009    2008    2007    % Change
2008-2009
 

(Dollars in millions)

           

Salaries and employee benefits

   $ 3,037    $ 3,842    $ 3,256    (21 )% 

Information systems and communications

     656      633      546    4   

Transaction processing services

     583      644      619    (9

Occupancy

     475      465      408    2   

Other:

           

Provision for legal exposure

     250           600   

Provision for investment account infusion

          450        

Restructuring charges

          306        

Merger and integration costs

     49      115      198    (57

Professional services

     264      360      236    (27

Amortization of other intangible assets

     136      144      92    (6

Customer indemnification obligation

          200        

Securities processing

     114      187      79    (39

Regulator fees and assessments

     71      45      3    58   

Other

     331      460      396    (28
                       

Total other

     1,215      2,267      1,604    (46
                       

Total expenses

   $ 5,966    $ 7,851    $ 6,433    (24
                       

Number of employees at year end

     27,310      28,475      27,110   

The decrease in salaries and employee benefits for 2009 compared to 2008 was primarily due to the effect of our previously announced reduction in force, described below, which was substantially completed in the first quarter of 2009, as well as lower accruals for cash incentive compensation and lower contract services spending.

The increase in information systems and communications expense for 2009 reflected higher levels of spending on telecommunications hardware and software. Transaction processing services expense, which is volume-related and includes equity trading services and fees related to securities settlement, sub-custodian services and external contract services, decreased due to lower volumes in the investment servicing business and lower costs related to external contract services. Occupancy expense increased slightly from 2008, mainly as a result of higher occupancy costs domestically and in Europe.

The provision for legal exposure of $250 million resulted from an increase in the reserve initially established in 2007 associated with certain active fixed-income strategies managed by SSgA. We settled regulatory inquiries related to this exposure in February 2010. The provision and subsequent settlement are more fully discussed in notes 20 and 10, respectively, of the Notes to Consolidated Financial Statements included under Item 8.

In December 2008, we announced a plan to reduce our operating costs and support our long-term growth while aligning the organization to meet the challenges and opportunities presented by the then current market environment. As a primary component of this plan, we initiated a reduction of approximately 8% of our global workforce, which we substantially completed at the end of the first quarter of 2009, and during 2008, recorded

 

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aggregate restructuring charges of $306 million. Additional information with respect to the charges, and activity during 2009 in the related balance sheet reserve, is provided in note 6 of the Notes to Consolidated Financial Statements included under Item 8.

During 2009, in connection with the Investors Financial acquisition, we recorded merger and integration costs of $49 million, compared to $115 million for 2008. These costs consisted only of direct and incremental costs to integrate the acquired Investors Financial business into our operations, and did not include ongoing expenses of the combined organization. The costs were primarily related to employee retention and system and customer integration.

The decrease in aggregate other expenses (professional services, securities processing, amortization of other intangible assets, regulator fees and assessments and other) from $1.2 billion for 2008 to $916 million for 2009 resulted primarily from a 39% decrease in securities processing costs due to lower processing volume and a 27% decrease in professional services spending, primarily legal and consulting costs. This overall decrease was offset slightly by higher regulatory assessments associated with the increased cost of deposit insurance.

Income Taxes

Income tax expense before the extraordinary loss totaled $722 million for 2009, compared to $1.03 billion a year ago. Our overall effective tax rate for 2009 was 28.6%, compared to 36.2% for 2008. The decline in both income tax expense and the effective rate was generally the result of an increase in the proportion of earnings from certain of our non-U.S. subsidiaries, where management’s intention is to reinvest those earnings indefinitely overseas. Our intent to reinvest these earnings overseas is consistent with our business strategy to pursue growth in non-U.S. markets, and allowed us to reduce taxes accrued with respect to 2009 earnings, as well as certain taxes accrued in prior periods.

Information about income tax contingencies related to our SILO lease transactions is provided in note 10 of the Notes to Consolidated Financial Statements included under Item 8.

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 revenues, expenses and capital allocation methodologies with respect to these lines of business is provided in note 23 of the Notes to Consolidated Financial Statements included under Item 8.

 

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The following is a summary of our line of business results. The amounts in the “Divestitures” columns represent the operating results of our joint venture interest in CitiStreet prior to our sale of that interest in July 2008. The amounts presented in the “Other” column for 2009 represent net interest revenue earned in connection with our participation in the Federal Reserve’s AMLF, the provision for loan losses associated with the commercial real estate loans acquired in 2008 and merger and integration costs recorded in connection with our July 2007 acquisition of Investors Financial. The amounts in the “Other” column for 2008 represent the net interest revenue associated with our participation in the AMLF; the gain on the sale of our joint venture interest in CitiStreet; the restructuring charges recorded primarily in connection with our plan to reduce our expenses from operations; the provision related to our estimated net exposure for customer indemnification associated with collateralized repurchase agreements; and merger and integration costs recorded in connection with the Investors Financial acquisition. The amounts in the “Other” column for 2007 represent merger and acquisition costs recorded in connection with the Investors Financial acquisition. The amounts in the “Divestitures” and “Other” columns were not allocated to State Street’s business lines.

 

    Investment
Servicing
    Investment
Management
    Divestitures   Other     Total  
Years ended
December 31,
  2009     2008     2007     2009     2008     2007     2009   2008     2007   2009     2008     2007     2009   2008     2007  
(Dollars in millions,
except where
otherwise noted)
                                                                                   

Fee revenue:

                             

Servicing fees

  $ 3,276      $ 3,745      $ 3,388                        $ 3,276   $ 3,745      $ 3,388   

Management fees

                       $ 824      $ 1,028      $ 1,141                    824     1,028        1,141   

Trading services

    1,094        1,467        1,152                                         1,094     1,467        1,152   

Securities finance

    387        900        518        183        330        163                    570     1,230        681   

Processing fees and other

    72        200        196        99        85        73        $ (8   $ 2           171     277        271   
                                                                                             

Total fee revenue

    4,829        6,312        5,254        1,106        1,443        1,377          (8     2           5,935     7,747        6,633   

Net interest revenue

    2,489        2,472        1,573        68        104        135          6        22   $ 7      $ 68          2,564     2,650        1,730   

Gains (Losses) related to investment securities, net

    141        (54     (27                                                       141     (54     (27

Gain on sale of CitiStreet interest, net of exit and other associated costs

                                                                  350              350          
                                                                                                         

Total revenue

    7,459        8,730        6,800        1,174        1,547        1,512          (2     24     7        418          8,640     10,693        8,336   

Provision for loan losses

    24                      1                                   124                 149              

Expenses from operations

    4,867        5,642        4,787        800        1,133        974          5        7                     5,667     6,780        5,768   

Provision for legal exposure, net

                  (47     250               514                                     250            467   

Provision for investment account infusion

                                450                                                450          

Restructuring charges

                                                                  306              306          

Customer indemnification obligation

                                                                  200              200          

Merger and integration costs

                                                           49        115      $ 198        49     115        198   
                                                                                                               

Total expenses

    4,867        5,642        4,740        1,050        1,583        1,488          5        7     49        621        198        5,966     7,851        6,433   
                                                                                                               

Income (Loss) from continuing operations before income taxes

  $ 2,568      $ 3,088      $ 2,060      $ 123      $ (36   $ 24        $ (7   $ 17   $ (166   $ (203   $ (198   $ 2,525   $ 2,842      $ 1,903   
                                                                                                               

Pre-tax margin

    34     35     30     10     (2 )%      2                  

Average assets (in billions)

  $ 143.4      $ 157.9      $ 120.0      $ 3.4      $ 3.3      $ 3.0        $ 0.5      $ 0.5         $ 146.8   $ 161.7      $ 123.5   

Investment Servicing

Total revenue for 2009 decreased 15% from 2008, with decreases in all fee revenue line items, generally reflective of the impact of the ongoing global financial markets disruption. Servicing fees decreased partly as a result of the impact of declines in the equity markets, partly offset by the impact of new business on current-period revenue. The decrease in trading services revenue primarily reflected a decrease in foreign exchange trading revenue, caused primarily by lower levels of volatility and customer volumes, partly offset by higher revenue from

 

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transition management and higher levels of fees from electronic trading attributable to higher volumes. Securities finance revenue decreased primarily due to compression of credit spreads as well as lower volumes of assets on loan. Processing fees and other revenue declined primarily as a result of the May 2009 consolidation of the conduits, as fees generated from administrative services provided to the conduits were no longer recorded subsequent to the consolidation.

Servicing fees, trading services revenue and gains (losses) related to investment securities, net, for our Investment Servicing business line are identical to the respective consolidated results. Refer to the “Servicing Fees,” “Trading Services” and “Gains (Losses) Related to Investment Securities, Net” captions in the “Total Revenue” section of this Management’s Discussion and Analysis for a more in-depth discussion. A discussion of processing fees and other revenue is provided under the caption “Processing Fees and Other” in the “Total Revenue” section.

Net interest revenue remained relatively flat compared to 2008, as the negative impact of lower rates on the yields generated by floating-rate assets was offset by discount accretion recorded subsequent to the consolidation of the conduits. A portion of net interest revenue is recorded in the Investment Management business line based on the volume of customer liabilities attributable to that business.

Total expenses declined 14% from 2008, primarily driven by the reduction in the accrual of cash incentive compensation, lower levels of salaries and benefits costs and lower costs related to contract services.

Investment Management

Total revenue for 2009 decreased 24% compared to 2008, reflecting the impact of a 23% decrease in total fee revenue and a 34% decrease in net interest revenue. The 20% decline in management fees, generated by SSgA, resulted primarily from the impact of declines in equity market valuations, partly offset by the impact of new business on current-period revenue. Securities finance revenue decreased primarily due to compression of credit spreads as well as lower volumes of assets on loan. Management fees for the Investment Management business line are identical to the respective consolidated results. Refer to the “Management Fees” caption in the “Total Revenue” section of this Management’s Discussion and Analysis for a more in-depth discussion.

Expenses from operations declined 29% from 2008, primarily due to lower accruals of cash incentive compensation and reductions in staffing levels, as well as lower levels of professional fees. The $250 million and $450 million provisions for legal exposure and investment account infusion, respectively, are discussed in the “Expenses” section of this Management’s Discussion and Analysis and in note 20 of the Notes to Consolidated Financial Statements included under Item 8.

Certain funds managed by SSgA that engage in securities lending continue to invest in cash collateral pools underlying these funds, the net asset values of which remain less than $1.00 per unit. These funds have imposed limitations on participant redemptions. Our continuation of the limitations on participant redemptions and the difference between the net asset value used for purchase and redemption transactions ($1.00 per unit) and the net asset value of the pools could, if either or both continue, adversely effect SSgA’s reputation, the marketing of its lending funds and its future results of operations. Refer to a discussion of the funds and the underlying cash collateral pools in the Risk Factors section included under Item 1A.

Purported class actions have been filed regarding certain collateral pools underlying funds managed by SSgA, and we are responding to inquiries from the SEC and other regulatory authorities in connection with our cash collateral pools. Refer to the Risk Factors and Legal Proceedings sections included under Items 1A and 3, respectively.

 

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COMPARISON OF 2008 AND 2007

OVERVIEW OF CONSOLIDATED RESULTS OF OPERATIONS

 

Years ended December 31,    2008     2007     % Change  

(Dollars in millions, except per share amounts)

      

Total fee revenue

   $ 7,747      $ 6,633      17

Net interest revenue

     2,650        1,730      53   

Gains (Losses) related to investment securities, net

     (54     (27  

Gain on sale of CitiStreet interest, net of exit and other associated costs

     350            
                  

Total revenue

     10,693        8,336      28   

Total expenses

     7,851        6,433      22   
                  

Income before income tax expense

     2,842        1,903      49   

Income tax expense

     1,031        642      61   
                  

Net income

     1,811        1,261      44   
                  

Adjustment to net income (loss)(1)

     (22     —       
                  

Net income available to common shareholders

   $ 1,789      $ 1,261      42   
                  

Earnings per common share:

      

Basic

   $ 4.32      $ 3.49      24   

Diluted

     4.30        3.45      25   

Earnings per common share:

      

Basic

   $ 4.32      $ 3.49     

Diluted

     4.30        3.45     

Return on common shareholders’ equity

     14.8     13.4  

(1)    Adjustment was related to preferred stock issued in connection with the U.S. Treasury’s TARP Program.

       

TOTAL REVENUE

 

Years ended December 31,    2008     2007     % Change  

(Dollars in millions)

      

Fee revenue:

      

Servicing fees

   $ 3,745      $ 3,388      11

Management fees

     1,028        1,141      (10

Trading services

     1,467        1,152      27   

Securities finance

     1,230        681      81   

Processing fees and other

     277        271      2   
                  

Total fee revenue

     7,747        6,633      17   

Net interest revenue:

      

Interest revenue

     4,879        5,212      (6

Interest expense

     2,229        3,482      (36
                  

Net interest revenue

     2,650        1,730      53   

Gains (Losses) related to investment securities, net

     (54     (27  

Gain on sale of CitiStreet interest, net of exit and other associated costs

     350            
                  

Total revenue

   $ 10,693      $ 8,336      28   
                  

The increase in total revenue for 2008 compared to 2007 reflected growth in fee revenue, primarily trading services and securities finance, with almost 78% of the overall growth in fee revenue generated from these two activities.

The growth in trading services revenue was the result of higher levels of currency volatility in foreign exchange trading, as well as the contribution of revenue of both the acquired Investors Financial business (with

 

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respect to foreign exchange) and the acquired Currenex business (with respect to brokerage and other) for a full year. Brokerage and other trading revenue increased 10% from 2007 to 2008, due to higher revenues from electronic trading, both from the acquired Currenex business and from our Global Link product, as well as an increase in brokerage revenue, principally transition management and equity trading.

Securities finance revenue for 2008 was up 81% compared to 2007, primarily as a result of wider credit spreads across all lending programs. Spreads benefited from the Federal Reserve’s aggregate 400-basis-point reduction in the federal funds rate during 2008, as well as from the continued disruption of the global fixed-income securities markets. The increases were offset partially by a decline in lending volumes.

The 11% increase in servicing fees was the result of the inclusion of servicing fee revenue from the acquired Investor Financial business for a full year, the impact of new business on 2008 revenue and higher transaction volumes. Approximately 41% of our servicing fees were derived from non-U.S. customers in each of 2008 and 2007.

Management fees decreased 10% from 2007 to 2008, $1.14 billion to $1.03 billion respectively, primarily from the impact of declines in average month-end equity market valuations and performance fees. Approximately 40% of our management fees were derived from customers outside the U.S. in 2008, down from 41% for 2007. Assets under management decreased to $1.44 trillion at December 31, 2008, down $535 billion from $1.98 trillion a year earlier, as we experienced a net loss of business and, more significantly, market depreciation.

The increase in net interest revenue was the result of several favorable trends. Interest-earning assets and related net interest revenue from the acquired Investors Financial business and widening spreads on fixed-rate and tax-exempt investment securities were the primary reasons for the growth. In addition, transaction deposit volume increased, particularly with respect to non-U.S. deposits.

EXPENSES

 

Years ended December 31,    2008    2007    % Change  

(Dollars in millions)

        

Salaries and employee benefits

   $ 3,842    $ 3,256    18

Information systems and communications

     633      546    16   

Transaction processing services

     644      619    4   

Occupancy

     465      408    14   

Provision for legal exposure

          600   

Provision for investment account infusion

     450        

Restructuring charges

     306        

Merger and integration costs

     115      198    (42

Professional services

     360      236    53   

Amortization of other intangible assets

     144      92    57   

Customer indemnification obligation

     200        

Other

     692      478    45   
                

Total expenses

   $ 7,851    $ 6,433    22   
                

The increase in salaries and employee benefits for 2008 compared to 2007 was driven primarily by the contribution of a full year of salaries and benefits expense from the acquired Investors Financial business, the impact of higher staffing levels to support new business, higher average salaries and benefits expense and increased contract services spending. The increases were offset by a decline in accruals for cash incentive compensation.

Information systems and communications expense increased due to the addition of expenses from the acquired Investors Financial business, as well as increased spending on telecommunications hardware and software. Transaction processing services expenses increased over 2007, and resulted primarily from higher transaction volumes and costs of external contract services, primarily in Europe.

 

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The increase in occupancy expense from 2007 to 2008 was primarily the result of leased space acquired to support growth in the alternative investments servicing and investment manager operations outsourcing businesses, as well as higher occupancy costs in support of growth in Europe, including our then new facility in the U.K.

During 2008, we elected to provide support to certain investment accounts managed by SSgA through the purchase of asset- and mortgage-backed securities and a cash infusion, which resulted in an income statement provision of $450 million. This change is more fully described in note 20 of the Notes to Consolidated Financial Statements included under Item 8.

In 2008, we announced a plan to reduce our operating costs and support our long-term growth while aligning the organization to meet the challenges and opportunities presented by the current market environment, and subsequently recorded aggregate restructuring charges of $306 million. This change is more fully described in note 6 of the Notes to Consolidated Financial Statements included under Item 8.

For 2008, in connection with the Investors Financial acquisition, we recorded merger and integration costs of $115 million, compared to $198 million for 2007. These costs consisted only of direct and incremental costs to integrate the acquired Investors Financial business into our operations, and did not include ongoing expenses of the combined organization. The costs were primarily related to employee retention and system and customer integration.

During 2008, we recorded a $200 million provision related to our estimated net exposure on an indemnification obligation associated with collateralized repurchase agreements. The reserve was based on the cost of satisfying the indemnification obligation net of the fair value of the collateral. This provision is more fully described in note 20 of the Notes to Consolidated Financial Statements included under Item 8.

The increase in aggregate other expenses resulted from a 53% increase in professional services spending, primarily legal and consulting costs, amortization of other intangible assets for the full year in connection with the acquisitions of Investors Financial and Currenex, higher securities processing costs and higher regulatory fees and assessments, the latter mainly fees and assessments paid in connection with our participation in certain federal government and banking regulatory agency programs.

Income Taxes

The increase in income tax expense for 2008 compared to 2007 resulted from the a higher level of pre-tax earnings for 2008, partially offset by a net benefit related to the aggregate pre-tax impact of significant transactions outside the ordinary course of our business. The overall effective tax rate for 2008 was 36.2% compared to 33.7% for 2007.

SIGNIFICANT ACCOUNTING ESTIMATES

Our consolidated financial statements are prepared in accordance with GAAP, and we apply accounting policies that affect the determination of amounts reported in these financial statements. Our significant accounting policies are described in note 1 of the Notes to Consolidated Financial Statements included under Item 8.

The majority of these accounting policies do not involve difficult, subjective or complex judgments or estimates in their application, or the variability of the estimates is not material to the consolidated financial statements. However, certain of these accounting policies, by their nature, require management to make judgments, involving significant estimates and assumptions, about the effects of matters that are inherently uncertain. These estimates and assumptions are based on information available as of the date of the financial statements, and changes in this information over time could materially affect the amounts of assets, liabilities, equity, revenue and expenses reported in subsequent financial statements.

Based on the sensitivity of reported financial statement amounts to the underlying estimates and assumptions, the relatively more significant accounting policies applied by State Street have been identified by management as those associated with fair value measurements; interest revenue recognition and other-than-temporary impairment;

 

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and goodwill and other intangible assets. These accounting policies require the most subjective or complex judgments, and underlying estimates and assumptions could be most subject to revision as new information becomes available. An understanding of the judgments, estimates and assumptions underlying these accounting policies is essential in order to understand our reported consolidated results of operations and financial condition.

The following is a brief discussion of the above-mentioned significant accounting policies. Management of State Street has discussed these significant accounting estimates with the Examining and Audit Committee of our Board of Directors.

Fair Value Measurements

We carry certain of our financial assets and liabilities at fair value in our consolidated financial statements on a recurring basis, including trading account assets, investment securities available for sale and various types of derivative instruments.

As discussed in further detail below, changes in the fair value of these financial assets and liabilities are recorded either as components of our consolidated statement of income, or as components of other comprehensive income within shareholders’ equity in our consolidated statement of condition. In addition to those financial assets and liabilities that are carried at fair value in our consolidated financial statements, we disclose the estimated fair value in the notes to the consolidated financial statements of other of our financial assets and liabilities that are carried at amortized cost in our consolidated statement of condition. We estimate the fair value of these financial assets and liabilities using the definition of fair value described below.

At December 31, 2009, approximately $77.36 billion of our financial assets and approximately $4.77 billion of our financial liabilities were carried at fair value, compared to $66.92 billion and $12.36 billion, respectively, at December 31, 2008. The amounts at December 31, 2009 represented approximately 49% of our consolidated total assets and approximately 3% of our consolidated total liabilities, compared to 39% and 8%, respectively, at December 31, 2008. The increase in the relative percentage of consolidated total assets as of December 31, 2009 resulted primarily from the addition of investment securities in connection with the conduit consolidation and portfolio purchases of investment securities. The decrease in the relative percentage of consolidated total liabilities as of December 31, 2009 resulted from lower levels of derivatives related to our foreign exchange activities.

As described in more detail in note 13 of the Notes to Consolidated Financial Statements included under Item 8, we adopted new accounting standards that govern fair value measurement effective January 1, 2008. These accounting standards do not require us to measure our financial assets and liabilities at fair value, but provide a consistent definition of fair value and provide a framework for measuring fair value in accordance with GAAP. These standards also provided for the election of a fair value option for assets and liabilities not previously carried at fair value on a recurring basis. In connection with our application of these accounting standards, we have not elected the fair value option for any of our financial assets or financial liabilities since adoption, although we may do so in the future.

The accounting standards define fair value as the price that would be received to sell an asset or paid to transfer a liability (an “exit price”) in the principal or most advantageous market for an asset or liability in an orderly transaction between market participants on the measurement date. When we measure fair value for our financial assets and liabilities, we consider the principal or most advantageous market in which we would transact, and we consider assumptions that market participants would use when pricing the asset or liability. When possible, we look to active and observable markets to measure the fair value of identical, or similar, financial assets or liabilities. When identical financial assets and liabilities are not traded in active markets, we look to market-observable data for similar assets and liabilities. In some instances, certain assets and liabilities are not actively traded in observable markets, and as a result we use alternative valuation techniques to measure their fair value.

In accordance with the standards, we categorize the financial assets and liabilities that we carry at fair value in our consolidated statement of condition on a recurring basis based upon the standards’ three-level valuation hierarchy. The hierarchy gives the highest priority to quoted prices in active markets for identical assets or

 

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liabilities (level 1) and the lowest priority to valuation methods using significant unobservable inputs (level 3). We categorized approximately 13% of our financial assets carried at fair value in level 1, 77% in level 2 and 10% in level 3 of the fair value hierarchy, including the effect of master netting agreements. We categorized approximately 97% of our financial liabilities carried at fair value in level 2, with the remaining 3% in level 3, including the effect of master netting agreements.

The fair value of the investment securities categorized in level 1 was composed of U.S. Treasury securities, specifically Treasury bills, which have a maturity of one year or less. Fair value was measured by management using unadjusted quoted prices in active markets for identical securities.

The fair value of the investment securities categorized in level 2 was measured by management primarily using information obtained from independent third parties. Information obtained from third parties is subject to review by management as part of a validation process. Management utilizes a process to review information provided by third parties, including an understanding of underlying assumptions and the level of market participant information used to support those assumptions. In addition, management compares significant assumptions used by third parties to available market information. Such information may include known trades or, to the extent that trading activity is limited, comparisons to market research information pertaining to credit expectations, execution prices and the timing of cash flows.

The fair value of the derivative instruments categorized in level 2 predominantly represented foreign exchange contracts used in our trading activities, for which fair value was measured by management using discounted cash flow techniques with inputs consisting of observable spot and forward points, as well as observable interest rate curves. With respect to derivative instruments, we evaluated the impact on valuation of the credit risk of our counterparties and our own credit. We considered factors such as the likelihood of default by us and our counterparties, our current and potential future net exposures and remaining maturities in determining the appropriate measurements of fair value. Valuation adjustments associated with these factors were not significant for 2009 or 2008.

While the substantial majority of our financial assets categorized in level 3 were composed of asset-backed securities available for sale, level 3 also included foreign exchange derivatives. The aggregate fair value of our financial assets and liabilities categorized in level 3 as of December 31, 2009, compared to December 31, 2008, decreased approximately 29%, and was primarily composed of transfers of asset-backed securities, principally those collateralized by student loans, to level 2.

Interest Revenue Recognition and Other-Than-Temporary Impairment

A significant portion of the assets carried in our consolidated balance sheet is our portfolio of fixed-income investment securities. At December 31, 2009, this portfolio included securities added as a result of the May 2009 conduit consolidation. Additional information with respect to the conduits and the consolidation is provided in note 11 of the Notes to Consolidated Financial Statements included under Item 8.

As discussed below, the estimation of future cash flows from the securities is a significant factor in the recognition of both interest revenue and other-than-temporary impairment with respect to our fixed-income investment securities.

Expectations of defaults and prepayments are the most significant estimates underlying our determination of expected future cash flows. In determining these estimates, management relies on relevant and reliable information, including but not limited to deal structure, including optional and mandatory calls, market interest rate curves, industry standard asset-class-specific prepayment models, recent prepayment history, independent credit ratings, and recent actual and projected credit losses. Management considers this information based on its relevance and uses its best judgment in order to determine its assumptions for underlying cash flow expectations and resulting estimates. Management reviews its underlying assumptions and determines expected future cash flow estimates at least quarterly. Additional detail with respect to the sensitivity of these default and prepayment assumptions is provided in the “Financial Condition—Investment Securities” section of this Management’s Discussion and Analysis.

 

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Interest Revenue Recognition

Our investment portfolio, excluding the conduit assets, consists of securities which were not typically acquired at significant discounts or premiums to their face amount. In connection with the conduit consolidation, we recorded certain of the conduits’ investment securities at a significant discount to their face amount. To the extent that future cash flows from these securities is expected to exceed their recorded carrying amounts, the portion of the discount not related to credit will be accreted into interest revenue in our consolidated statement of income over the securities’ remaining lives. As a result of the magnitude of the discount, the estimates associated with the timing and amount of the accretion of these security discounts into interest revenue have become significant.

A portion of the conduit securities, primarily asset-backed securities, had expected credit losses on the date of consolidation, or were considered to be certain beneficial interests in a securitization that are not of high credit quality, and therefore are accounted for pursuant to specific accounting guidance. As a result, interest revenue recognition for these securities differs from the accounting for the remainder of our portfolio. The accounting for these securities requires an estimation of the timing and amount of each of the securities’ expected future principal, interest and other contractual cash flows, and the calculation of an effective yield based upon these estimates is used to record interest revenue. Generally, the timing and amount of these securities’ future cash flows are inherently uncertain, due to the unknown timing and amount of principal payments (including potential credit losses) and the variability of future interest rates.

Other-Than-Temporary Impairment

Existing accounting standards also require the use of cash flow estimates to evaluate other-than-temporary impairment of our investment securities. The amount and timing of expected cash flows is a significant estimate in the determination of other-than-temporary impairment. Additional information with respect to management’s assessment of impairment is provided in note 3 of the Notes to Consolidated Financial Statements included under Item 8.

Goodwill and Other Intangible Assets

Goodwill is created when the purchase price exceeds the assigned value of net assets of acquired businesses, and represents the value attributable to unidentifiable intangible elements being acquired. Other acquired identifiable intangible assets are recorded at their estimated fair value. Goodwill is not amortized. Other intangible assets are amortized over their estimated useful lives, and both goodwill and other intangible assets are subject to an impairment adjustment if events or circumstances indicate the potential inability to realize the carrying amount. As required by GAAP, we evaluate goodwill and other intangible assets for impairment annually, based on undiscounted cash flows. Substantially all of the goodwill and other intangible assets recorded in our consolidated statement of condition have resulted from business acquisitions of our Investment Servicing line of business. The remainder is recorded by Investment Management.

The sustained value of the majority of goodwill is supported ultimately by revenue from our investment servicing business. A decline in earnings as a result of a lack of growth, or our inability to deliver cost-effective services over sustained periods, could lead to a perceived impairment of goodwill, which would be evaluated and, if necessary, be recorded as a write-down of the reported amount of goodwill through a charge to earnings in our consolidated statement of income.

On an annual basis, or more frequently if circumstances dictate, management reviews goodwill and evaluates events or other developments that may indicate impairment in the carrying amount. We perform this evaluation at the reporting unit level, which is one level below our two major business lines. The evaluation methodology for potential impairment is inherently complex and involves significant management judgment in the use of estimates and assumptions.

 

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We evaluate goodwill for impairment using a two-step process. First, we compare the aggregate fair value of the reporting unit to its carrying amount, including goodwill. If the fair value exceeds the carrying amount, no impairment exists. If the carrying amount of the reporting unit exceeds the fair value, then we compare the “implied” fair value of the reporting unit’s goodwill with its carrying amount. If the carrying amount of the goodwill exceeds the implied fair value, then goodwill impairment is recognized by writing the goodwill down to the implied fair value. The implied fair value of the goodwill is determined by allocating the fair value of the reporting unit to all of the assets and liabilities of that unit, as if the unit had been acquired in a business combination and the overall fair value of the unit was the purchase price.

To determine the aggregate fair value of the reporting unit being evaluated for goodwill impairment, we use one of two principal methodologies—a market approach, based on a comparison of the reporting unit to publicly-traded companies in similar lines of business; or an income approach, based on the value of the cash flows the business can be expected to generate in the future.

Events that may indicate impairment include significant or adverse changes in the business, economic or political climate; an adverse action or assessment by a regulator; unanticipated competition; and a more-likely-than-not expectation that we will sell or otherwise dispose of a business to which the goodwill or other intangible assets relate. Additional information about goodwill and other intangible assets, including information by line of business, is provided in note 5 of the Notes to Consolidated Financial Statements included under Item 8.

Our evaluation of goodwill and other intangible assets for impairment in 2009 indicated that none was impaired. Goodwill and other intangible assets recorded in our consolidated statement of condition at December 31, 2009 totaled approximately $4.55 billion and $1.81 billion, respectively.

 

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FINANCIAL CONDITION

 

Years ended December 31,    2009
Average
Balance
   2008
Average
Balance
(In millions)          

Assets:

     

Interest-bearing deposits with banks

   $ 24,162    $ 24,003

Securities purchased under resale agreements

     3,701      10,195

Federal funds sold

     68      2,700

Trading account assets

     1,914      2,423

Investment securities

     81,190      72,227

Investment securities purchased under AMLF(1)

     882      9,193

Loans

     9,703      11,884

Other earning assets

     1,303     
             

Total interest-earning assets

     122,923      132,625

Cash and due from banks

     2,237      5,096

Other assets

     21,650      23,976
             

Total assets

   $ 146,810    $ 161,697
             

Liabilities and shareholders’ equity:

     

Interest-bearing deposits:

     

U.S.

   $ 7,616    $ 11,216

Non-U.S.

     61,551      68,291
             

Total interest-bearing deposits

     69,167      79,507

Securities sold under repurchase agreements

     11,065      14,261

Federal funds purchased

     956      1,026

Short-term borrowings under AMLF(1)

     877      9,170

Other short-term borrowings

     16,847      5,996

Long-term debt

     7,917      4,106

Other interest-bearing liabilities

     1,131      —  
             

Total interest-bearing liabilities

     107,960      114,066

Non-interest-bearing deposits

     15,443      20,609

Other liabilities

     10,090      14,614

Shareholders’ equity

     13,317      12,408
             

Total liabilities and shareholders’ equity

   $ 146,810    $ 161,697
             

 

(1)

Amounts represent averages of asset-backed commercial paper purchases and related borrowings in connection with our participation in the AMLF. Additional information about the AMLF, which recently expired, is provided in note 8 of the Notes to Consolidated Financial Statements included under Item 8.

Overview of Consolidated Statement of Condition

The structure of our consolidated statement of condition, or balance sheet, is primarily driven by the liabilities generated by our core Investment Servicing and Investment Management businesses. As our customers execute their worldwide cash management and investment activities, they use short-term investments and deposits that constitute the majority of our liabilities. These liabilities are generally in the form of non-interest-bearing demand deposits; interest-bearing transaction account deposits, which are denominated in a variety of currencies; and repurchase agreements, which generally serve as short-term investment alternatives for our customers.

Our customers’ needs and our operating objectives determine the volume, mix and currency denomination of our consolidated balance sheet. Deposits and other liabilities generated by customer activities are invested in assets that generally match the liquidity and interest-rate characteristics of the liabilities. As a result, our assets consist primarily of securities held in our available-for-sale or held-to-maturity portfolios and short-term money-market instruments, such as interest-bearing deposits, federal funds sold and securities purchased under resale

 

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agreements. The actual mix of assets is determined by the characteristics of the customer liabilities and our desire to maintain a well-diversified portfolio of high-quality assets. Managing our consolidated balance sheet structure is conducted within specific Board-approved policies for interest-rate risk, credit risk and liquidity.

Additional information about our average balance sheet, primarily our interest-earning assets and interest-bearing liabilities, is included in the “Consolidated Results of Operations—Net Interest Revenue” section of this Management’s Discussion and Analysis.

Investment Securities

The carrying values of investment securities by type were as follows as of December 31:

 

(In millions)    2009    2008    2007

Available for sale:

        

U.S. Treasury and federal agencies:

        

Direct obligations

   $ 11,162    $ 11,579    $ 8,181

Mortgage-backed securities

     14,936      10,798      14,585

Asset-backed securities:

        

Credit cards

     6,607      3,090      3,276

Student loans(1)

     11,928      7,860      9,006

Sub-prime

     3,197      3,859      5,683

Other

     2,797      1,464      2,067
                    

Total asset-backed

     24,529      16,273      20,032
                    

Collateralized mortgage obligations

     2,409      1,441      11,892

State and political subdivisions

     5,937      5,712      5,813

Non-U.S. debt securities

     10,311      5,714      6,766

Other debt securities

     2,234      2,160      2,312

Money-market mutual funds

     1,110      344      243

Non-U.S. equity securities

     35      123      320

Other equity securities

     36      19      182
                    

Total

   $ 72,699    $ 54,163    $ 70,326
                    

Held to maturity purchased under AMLF:

        

Asset-backed commercial paper

   $    $ 6,087    $
                    

Held to maturity:

        

U.S. Treasury and federal agencies:

        

Direct obligations

   $ 500    $ 501    $ 757

Mortgage-backed securities

     620      810      940

Asset-backed securities:

        

Credit cards

     20          

Other

     447      321     
                    

Total asset-backed

     467      321     
                    

Collateralized mortgage obligations

     8,262      9,979      2,190

State and political subdivisions

     206      382      180

Non-U.S. debt securities

     10,822      3,774      166
                    

Total

   $ 20,877    $ 15,767    $ 4,233
                    

 

(1)

Substantially composed of securities guaranteed by the federal government with respect to the payment of principal and interest.

We manage our investment securities portfolio to align with interest-rate and duration characteristics of our customer liabilities and in the context of our overall balance sheet structure, which is maintained within internally approved risk limits, and in consideration of the global interest-rate environment.

 

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We consider a well-diversified, high-credit quality investment securities portfolio to be an important element in the management of our consolidated balance sheet. The portfolio continues to be concentrated in securities with high credit quality, with approximately 80% of the carrying value of the portfolio “AAA” or “AA” rated. The percentages of the carrying value of the investment securities portfolio by external credit rating, excluding securities purchased under the AMLF for 2008, were as follows as of December 31:

 

     2009     2008  

AAA(1)(2)

   69   78

AA

   11      11   

A

   7      5   

BBB

   4      4   

BB(2)

   8      1   

Non-rated

   1      1   
            
   100   100
            

 

(1)

Includes U.S. Treasury securities.

(2)

Change in percentage compared to 2008 generally resulted from downgrades of securities.

The investment portfolio of approximately 9,700 securities is also diversified with respect to asset class. Approximately 73% of the carrying value of the portfolio is composed of mortgage-backed and asset-backed securities. The largely floating-rate asset-backed portfolio consists primarily of credit card- and student loan-backed securities. Mortgage-backed securities are split between securities of Federal National Mortgage Association, Federal Home Loan Mortgage Corporation and U.S. and non-U.S. large-issuer collateralized mortgage obligations. During 2009, 1,259 securities were downgraded. The 2009 downgrades included 425 municipal securities (state and political subdivisions), 272 of which were based on downgrades of the underlying third-party financial guarantor.

The carrying amounts, by contractual maturity, of debt securities available for sale and held to maturity, and the related weighted-average contractual yields, were as follows as of December 31, 2009:

 

    Under 1 Year     1 to 5 Years     6 to 10 Years     Over 10 Years  
(Dollars in millions)   Amount   Yield     Amount   Yield     Amount   Yield     Amount   Yield  

Available for sale(1):

               

U.S. Treasury and federal agencies:

               

Direct obligations

  $ 10,001        $ 398   1.02   $ 183   3.72   $ 580   3.13

Mortgage-backed securities

    89   4.16     582   4.27        8,489   3.99        5,776   2.95   

Asset-backed securities

    569   1.36        10,304   0.76        8,545   0.64        5,111   0.74   

Collateralized mortgage obligations

    58   5.26        656   5.13        199   5.61        1,496   2.02   

State and political subdivisions(2)

    354   6.65        2,168   6.45        2,126   6.14        1,289   5.88   

Non-U.S. debt securities

    2,899   3.34        1,896   1.45        1,509   1.69        4,007   0.94   

Other debt securities

    303   5.22        1,240   5.38        657   5.32        34   0.84   
                               

Total

  $ 14,273     $ 17,244     $ 21,708     $ 18,293  
                               

Held to maturity(1):

               

U.S. Treasury and federal agencies:

               

Direct obligations

  $ 500   4.38            

Mortgage-backed securities

           $ 48   4.46   $ 199   4.88   $ 373   5.38

Asset-backed securities

    49   0.46        79   0.83        112   1.71        227   0.94   

Collateralized mortgage obligations

    600   4.71        2,945   4.94        1,904   4.10        2,813   4.07   

State and political subdivisions(2)

    56   5.76        135   7.47        14   6.39        1   7.25   

Non-U.S. debt securities

    1,214   1.10        2,912   1.07        411   3.66        6,285   2.66   
                               

Total

  $ 2,419     $ 6,119     $ 2,640     $ 9,699  
                               

 

(1)

The maturities of mortgage-backed securities, asset-backed securities and collateralized mortgage obligations are based upon contractual principal payments.

 

(2)

Yields have been calculated on a fully taxable-equivalent basis, using applicable federal and state income tax rates.

 

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Impairment

Net unrealized losses on securities available for sale were as follows as of December 31:

 

(In millions)    2009     2008  

Fair value

   $ 72,699      $ 54,163   

Amortized cost

     74,843        60,786   
                

Net unrealized loss, pre-tax

   $ (2,144   $ (6,623
                

Net unrealized loss, after-tax

   $ (1,316   $ (4,057