10-Q 1 d10q.htm FORM 10-Q FORM 10-Q
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
Form 10-Q
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2001
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From                      To                      
 
Commission File No. 0-5108
 
STATE STREET CORPORATION
(Exact name of registrant as specified in its charter)
 
COMMONWEALTH OF MASSACHUSETTS    04-2456637
(State or other jurisdiction
of incorporation)		    (I.R.S. Employer
Identification No.)
 
225 Franklin Street
Boston, Massachusetts
(Address of principal
executive office)		    02110
(Zip Code)
 
617-786-3000
(Registrant’s telephone number, including area code)
 
 
        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
    Yes  x        No  ¨
 
The number of shares of the Registrant’s Common Stock outstanding on September 30, 2001 was 325,366,361.
 
 
STATE STREET CORPORATION
 
Table of Contents
 
       Page
PART I.    FINANCIAL INFORMATION
 
Item 1.    Financial Statements
 
Consolidated Statements of Income      1-2
Consolidated Statement of Condition      3
Consolidated Statement of Changes in Stockholders’ Equity      4
Consolidated Statement of Cash Flows      5
Notes to Consolidated Financial Statements      6
Independent Accountants’ Review Report      14
 
Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations      15
 
Item 3.    Quantitative and Qualitative Disclosure About Market Risk      24
 
PART II.    OTHER INFORMATION
 
Item 6.    Exhibits and Reports on Form 8-K      25
 
Signatures      26
 
Exhibits
 
PART I.  ITEM 1.
FINANCIAL STATEMENTS
 
Consolidated Statement of Income – State Street Corporation (Unaudited)
 
(Dollars in millions, except per share data) Three months ended September 30,      2001      2000
Fee Revenue
Servicing fees      $    398      $    359
Management fees      124      140
Foreign exchange trading      87      89
Processing fees      70      56
Other      29      12
     
  
     Total fee revenue      708      656
 
Net Interest Revenue
Interest revenue      705      838
Interest expense      451      603
     
  
     Net interest revenue      254      235
Provision for loan losses      3      3
     
  
     Net interest revenue after provision for loan losses      251      232
     
  
     Total Revenue      959      888
 
Operating Expenses
Salaries and employee benefits      420      377
Information systems and communications      93      78
Transaction processing services      61      68
Occupancy      57      51
Other      81      91
     
  
     Total operating expenses      712      665
     
  
     Income before income taxes      247      223
Income taxes      77      73
     
  
     Net Income      $    170      $    150
     
  
 
Earnings Per Share
     Basic      $      .52      $      .46
     Diluted      .51      .45
Average Shares Outstanding (in thousands)
     Basic      326,731      322,443
     Diluted      331,764      328,963
Cash Dividends Declared Per Share      $      .10      $    .085
 
 
The accompanying notes are an integral part of these financial statements.
 
 
Consolidated Statement of Income – State Street Corporation (Unaudited)
 
(Dollars in millions, except per share data) Nine months ended September 30,      2001      2000
Fee Revenue
Servicing fees      $  1,210      $  1,070
Management fees      383      452
Foreign exchange trading      285      296
Processing fees      195      175
Other      2      24
     
  
     Total fee revenue      2,075      2,017
 
Net Interest Revenue
Interest revenue      2,292      2,332
Interest expense      1,552      1,670
     
  
     Net interest revenue      740      662
Provision for loan losses      7      8
     
  
     Net interest revenue after provision for loan losses      733      654
     
  
     Total Revenue      2,808      2,671
 
Operating Expenses
Salaries and employee benefits      1,228      1,129
Information systems and communications      270      231
Transaction processing services      185      209
Occupancy      166      149
Other      281      273
     
  
     Total operating expenses      2,130      1,991
     
  
     Income before income taxes      678      680
Income taxes      220      232
     
  
     Net Income      $    458      $    448
     
  
 
Earnings Per Share
     Basic      $    1.41      $    1.39
     Diluted      1.38      1.36
Average Shares Outstanding (in thousands)
     Basic      325,550      321,274
     Diluted      330,813      327,475
Cash Dividends Declared Per Share      $    .295      $      .25
 
 
The accompanying notes are an integral part of these financial statements.
 
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Consolidated Statement of Condition – State Street Corporation
 
(Dollars in millions)      September 30,
2001		      December 31,
2000
       (Unaudited)       
Assets
Cash and due from banks      $    2,235        $    1,618  
Interest-bearing deposits with banks      20,887        21,295  
Securities purchased under resale agreements and securities borrowed      16,788        21,134  
Federal funds sold      3,650        650  
Trading account assets      1,103        1,004  
Investment securities (including securities pledged to creditors of $7,439 and $7,152)      18,000        13,740  
Loans (less allowance of $55 and $57)      5,957        5,216  
Premises and equipment      817        726  
Accrued income receivable      831        845  
Other assets      2,908        3,070  
     
     
  
        Total Assets      $ 73,176        $ 69,298  
     
     
  
Liabilities
Deposits:
    Interest-bearing—U.S.      $    4,964        $    2,241  
    Noninterest-bearing      12,340        10,009  
    Interest-bearing—Non-U.S.      26,625        25,687  
     
     
  
        Total deposits      43,929        37,937  
Securities sold under repurchase agreements      18,099        21,351  
Federal funds purchased      747        955  
Other short-term borrowings      1,400        632  
Accrued taxes and other expenses      1,509        1,431  
Other liabilities      2,467        2,511  
Long-term debt      1,217        1,219  
     
     
  
        Total Liabilities      69,368        66,036  
Stockholders’ Equity
Preferred stock, no par: authorized 3,500,000; issued none          
Common stock, $1 par: authorized 500,000,000; issued 329,999,000 and 167,219,000      330        167  
Surplus      107        69  
Retained earnings      3,477        3,278  
Other unrealized comprehensive gain (loss)      85        (1 )
Treasury stock, at cost (4,633,000 and 5,508,000 shares)      (191 )      (251 )
     
     
  
        Total Stockholders’ Equity      3,808        3,262  
     
     
  
        Total Liabilities and Stockholders’ Equity      $  73,176        $  69,298  
     
     
  
 
 
The accompanying notes are an integral part of these financial statements.
 
 
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Consolidated Statement of Changes in Stockholders’ Equity – State Street Corporation (Unaudited)
 
(Dollars in millions, except per share data,
shares in thousands)		    Common Stock
    Surplus    Retained
Earnings		    Other Unrealized
Comprehensive
Gain (Loss)		    Treasury Stock
      Total
   Shares    Amount    Shares    Amount
Balance at December 31, 1999    167,225      $ 167    $   55      $ 2,795      $ (57 )    7,635      $ (308 )      $ 2,652  
Comprehensive income:
     Net income                                448                                      448  
     Change in net unrealized gain/loss
          on available-for-sale securities,
          net of deferred tax expense of
          $6		                                          25                            25  
     Foreign currency translation, net of
          deferred tax benefit of $6		                                          (19 )                          (19 )
    
    
 
    
    
    
    
     
  
Comprehensive income                                448      6                            454  
Cash dividends declared—$.25 per
     share		                                (81 )                                    (81 )
Common stock issued pursuant to:
     Stock awards and options
          exercised, including nonqualified
          tax benefit of $52		    (51 )            27                          (2,191 )    97        124  
     Debt conversion                      (11 )                        (226 )    12        1  
Common stock acquired                                                    621      (61 )      (61 )
    
    
 
    
    
    
    
     
  
Balance at September 30, 2000    167,174      $  167    $    71      $  3,162      $  (51 )    5,839      $  (260 )      $  3,089  
    
    
 
    
    
    
    
     
  
 
Balance at December 31, 2000    167,219      $  167    $    69      $  3,278      $    (1 )    5,508      $  (251 )      $  3,262  
Comprehensive income:
     Net income                                458                                      458  
     Change in net unrealized gain/loss
          on available-for-sale securities,
          net of deferred tax expense of
          $66		                                          108                            108  
     Foreign currency translation, net of
          deferred tax benefit of $9		                                          (13 )                          (13 )
     Other, net of deferred tax benefit
          of $7		                                          (9 )                          (9 )
    
    
 
    
    
    
    
     
  
Comprehensive income                                458      86                            544  
Cash dividends declared—$.295 per
     share		                                (96 )                                    (96 )
Stock split in the form of a 100%
     stock dividend		    162,785      163              (163 )              139                        
Common stock issued pursuant to:
     Acquisitions                      43                          (2,490 )    139        182  
     Stock awards and options
          exercised, including nonqualified
          tax benefit of $15		    (5 )            (1 )                        (1,012 )    52        51  
     Debt conversion                      (4 )                        (147 )    4              
Common stock acquired                                                    2,635      (135 )      (135 )
    
    
 
    
    
    
    
     
  
Balance at September 30, 2001    329,999      $ 330    $ 107      $ 3,477      $ 85      4,633      $ (191 )      $ 3,808  
    
    
 
    
    
    
    
     
  
 
 
The accompanying notes are an integral part of these financial statements.
 
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Consolidated Statement of Cash Flows – State Street Corporation (Unaudited)
 
(Dollars in millions)    Nine months ended September 30,      2001      2000
Operating Activities
Net Income      $      458        $      448  
Non-cash charges for depreciation, amortization, provision for loan losses and deferred
     income taxes		      248        304  
Securities gains, net      (36 )      (1 )
Change in trading account assets, net      (162 )      (105 )
Other, net      117        (246 )
     
     
  
                    Net Cash Provided by Operating Activities      625        400  
     
     
  
Investing Activities
Payments for purchases of:
          Available-for-sale securities       (13,480 )        (4,336 )
          Held-to-maturity securities      (3,804 )      (305 )
          Lease financing assets      (850 )      (772 )
          Premises and equipment      (172 )      (97 )
          Business acquisitions, net of cash acquired      (91 )     
Proceeds from:
          Maturities of available-for-sale securities      5,682        3,691  
          Maturities of held-to-maturity securities      3,675        263  
          Sales of available-for-sale securities      4,005        504  
          Principal collected from lease financing      24        29  
Net proceeds from (payments for):
          Interest-bearing deposits with banks      408        (1,199 )
          Federal funds sold, resale agreements and securities borrowed      1,346        (2,356 )
          Loans      (445 )      (1,147 )
     
     
  
                    Net Cash Used by Investing Activities      (3,702 )       (5,725 )
     
     
  
Financing Activities
Proceeds from issuance of:
          Non-recourse debt for lease financing      669        638  
          Long-term debt           300  
          Treasury stock      36        72  
Payments for:
          Non-recourse debt for lease financing      (81 )      (41 )
          Long-term debt      (1 )      (4 )
          Cash dividends      (94 )      (79 )
          Purchase of common stock      (135 )      (61 )
Net (payments for) proceeds from:
          Deposits      5,992        2,794  
          Short-term borrowings      (2,692 )      42  
     
     
  
                    Net Cash Provided by Financing Activities      3,694        3,661  
     
     
  
                    Net Increase (Decrease)      617        (1,664 )
Cash and due from banks at beginning of period      1,618        2,930  
     
     
  
                    Cash and Due From Banks at End of Period      $    2,235        $    1,266  
     
     
  
 
 
The accompanying notes are an integral part of these financial statements.
 
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
 
Note A—Basis of Presentation
 
        State Street Corporation (“State Street” or the “Corporation”) is a financial holding company that provides accounting, administration, custody, daily pricing, investment management, securities lending, foreign exchange, cash management, trading and information services to clients worldwide. State Street reports two lines of business. Investment Servicing includes accounting, administration, custody, daily pricing, operations outsourcing for investment managers, securities lending, foreign exchange, recordkeeping, deposit and short-term investment facilities, lease financing, brokerage, and information services to support institutions. Investment Management offers a broad array of services for managing financial assets worldwide for both institutions and individual investors, and other financial products. These services include passive and active equity, money market, and fixed income strategies, and other related services.
 
        The consolidated financial statements include the accounts of State Street and its subsidiaries, including its principal subsidiary, State Street Bank and Trust Company (“State Street Bank”). Servicing and management fee revenue is recognized when earned based on contractual terms. Transaction-based revenue is recognized as the services are provided. Revenue on interest-earning assets is recognized based on the effective yield of the financial instrument. All significant intercompany balances and transactions have been eliminated upon consolidation. The results of operations of businesses purchased are included from the date of acquisition. Investments in affiliates in which the Corporation has the ability to exercise significant influence, but not control, are accounted for using the equity method.
 
        The preparation of financial statements requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Certain previously reported amounts have been reclassified to conform to the current method of presentation.
 
        In June 2001, the Financial Accounting Standards Board issued SFAS No. 142, “Goodwill and Other Intangible Assets”, effective for years beginning after December 15, 2001. Under the new rules, goodwill and intangible assets deemed to have indefinite lives will no longer be amortized, but will be subject to annual impairment tests in accordance with the Statement. The Corporation will apply the new rules beginning in the first quarter of 2002, which will include the reclassification of certain goodwill to other intangible assets that will be amortized. State Street is currently evaluating the net impact of the cessation of amortization of goodwill and the reclassification of certain goodwill to other intangible assets. During 2002, the Corporation will perform the first of the required impairment tests of goodwill and indefinite-lived intangible assets as of January 1, 2002. State Street has not yet determined what impact these tests, the cessation of amortization of goodwill or the reclassification of certain goodwill to other intangible assets will have on earnings or the financial position of the Corporation.
 
        In the opinion of management, all adjustments consisting of normal recurring accruals, which are necessary for a fair presentation of the financial position of State Street and subsidiaries at September 30, 2001 and December 31, 2000, its cash flows for the nine months ended September 30, 2001 and 2000, and consolidated results of its operations for the three and nine months ended September 30, 2001 and 2000, have been made. These statements should be read in conjunction with the financial statements and other information included in State Street’s latest annual report on Form 10-K.
 
Note B—Acquisitions
 
        In June 2001, State Street completed the purchase of DST Portfolio Systems, Inc. (“DPS”) for 1,483,000 shares of State Street common stock and cash in a transaction accounted for as a purchase. Included in the purchase was the Portfolio Accounting System, an integrated system that automates mutual fund accounting and investment management recordkeeping processes such as security pricing and dividend calculations, income and expense accruals, securities inventories, accounting for daily shareholder activity and calculation of daily net asset values.
 
        In February 2001, State Street completed the purchase of a majority interest in Bel Air Investment Advisors LLC (“Bel Air”) for 2,015,000 shares, after adjustment for the stock split, of State Street common stock and cash in a transaction accounted for as a purchase. Bel Air is a Los Angeles-based independent investment management firm focused on providing wealth management services to ultra-high-net-worth individuals.
 
        The pro forma results of operations adjusted to include DPS and Bel Air for prior periods are not presented, as the results would not have been materially different.
 
Note C—Investment Securities
 
        Available-for-sale securities are recorded at fair value and held-to-maturity securities are recorded at amortized cost on the Consolidated Statement of Condition. Investment securities consisted of the following as of the dates indicated:
 
     September 30, 2001
    December 31, 2000
              Unrealized
                    Unrealized
       
(Dollars in millions)      Amortized
Cost		      Gains      Losses      Fair
Value		      Amortized
Cost		      Gains      Losses      Fair
Value
Available for sale:
    U.S. Treasury and federal agencies      $    7,326      $  109                    $    7,435      $    5,855      $  24      $    4      $    5,875
    State and political subdivisions      1,654      30      $  10      1,674      1,673      9      2      1,680
    Asset-backed securities      3,446      74      7      3,513      3,273      11      4      3,280
    Collateralized mortgage obligations      849      7           856      1,008      3      2      1,009
    Other investments      3,066      7      3      3,070      578           2      576
     
  
  
  
  
  
  
  
        Total      $ 16,341      $ 227      $  20      $ 16,548      $ 12,387      $ 47      $ 14      $ 12,420
     
  
  
  
  
  
  
  
Held to maturity:
    U.S. Treasury and federal agencies      $    1,308      $    16           $    1,324      $    1,272      $    4      $    1      $    1,275
    Other investments      144                144      48                48
     
  
  
  
  
  
  
  
        Total      $    1,452      $    16           $    1,468      $    1,320      $    4      $    1      $    1,323
     
  
  
  
  
  
  
  
 
 
        During the nine months ended September 30, 2001, there were gross gains of $36 million and gross losses of less than $1 million realized on sales of available-for-sale securities. During the nine months ended September 30, 2000, there were gross gains of $1 million and no gross losses realized on sales of available-for-sale securities.
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
 
Note D—Allowance for Loan Losses
 
        State Street establishes an allowance for loan losses to absorb probable credit losses. Changes in the allowance for loan losses were as follows:
 
       Three Months
Ended
September 30,
      Nine Months
Ended
September 30,
(Dollars in millions)      2001      2000      2001      2000
Balance at beginning of period      $ 61        $ 53      $ 57        $ 48  
Provision for loan losses      3        3      7        8  
Loan charge-offs      (9 )           (9 )      (1 )
Recoveries                     1  
       
       
    
       
  
     Balance at end of period      $  55        $  56      $  55        $  56  
       
       
    
       
  
 
Note E—Stockholders’ Equity
 
        A proposal to increase the authorized number of shares of common stock from 250 million to 500 million was approved by stockholders at the Annual Meeting in April 2001. On May 30, 2001, State Street distributed a two-for-one stock split in the form of a 100% stock dividend to stockholders of record on April 30, 2001. The par value of the additional shares was capitalized by a transfer from retained earnings to common stock. Earnings per share, dividends per share and average shares outstanding have been restated for the stock split. Period-end share data is presented on a historical basis. Treasury stock, not including shares held in trust for deferred compensation plans, was not affected by the stock split.
 
Note F—Processing Fees and Other Fee Revenue
 
        Processing fees of $195 million and $175 million for the nine months ended September 30, 2001 and 2000, included $66 million and $69 million, respectively, for brokerage services.
 
        Other fee revenue includes gains and losses on sales of investment securities, leased equipment and other assets, trading account profits and losses, profits and losses from joint ventures, and amortization of investments in tax-advantaged financings. Additionally, other fee revenue included the March 2001 write-off of $50 million for State Street’s investment in Bridge Information Systems, Inc. The write-off decreased after-tax net income by $33 million, equal to $.10 per basic and diluted share.
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
 
Note G—Net Interest Revenue
 
Net interest revenue consisted of the following:
 
       Three Months
Ended
September 30,
      Nine Months
Ended
September 30,
(Dollars in millions)      2001      2000      2001      2000
Interest Revenue
     Deposits with banks      $ 204      $ 195      $649      $510
     Investment securities:
          U.S. Treasury and federal agencies      104      129      332      391
          State and political subdivisions (exempt from federal tax)      18      22      55      64
          Other investments      100      83      287      243
     Loans      60      75      202      216
     Securities purchased under resale agreements, securities borrowed
          and federal funds sold		      204      319      723      865
     Trading account assets      15      15      44      43
       
    
    
    
                    Total interest revenue      705      838      2,292      2,332
       
    
    
    
Interest Expense
     Deposits      212      260      722      718
     Other borrowings      215      320      760      893
     Long-term debt      24      23      70      59
       
    
    
    
                    Total interest expense      451      603      1,552      1,670
       
    
    
    
                    Net interest revenue      $ 254      $ 235      $740      $662
       
    
    
    
 
 
Note H—Operating Expenses—Other
 
The other category of operating expenses consisted of the following:
 
       Three Months
Ended
September 30,
      Nine Months
Ended
September 30,
(Dollars in millions)      2001      2000      2001      2000
Professional services      $  28      $  31      $    92      $    98
Advertising and sales promotion      14      15      46      45
Other      39      45      143      130
       
    
    
    
     Total operating expenses—other      $ 81      $ 91      $ 281      $ 273
       
    
    
    
 
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
 
Note I—Regulatory Matters
 
          The regulatory capital amounts and ratios were the following at September 30, 2001 and
December 31, 2000:
 
       Regulatory
Guidelines (1)
     State Street
      State Street Bank
(Dollars in millions)      Minimum      Well
Capitalized		      2001      2000      2001      2000
Risk-based ratios:
     Tier 1 capital      4 %      6 %      12.8 %      14.5 %      12.3 %      13.4 %
     Total capital      8        10        13.7        15.6        12.4        13.5  
Leverage ratio      3        5        5.1        5.4        5.2        5.3  
 
Tier 1 capital                $    3,825        $    3,611        $    3,629        $    3,297  
Total capital                4,081        3,885        3,658        3,331  
 
Adjusted risk-weighted assets and
     market-risk equivalents:		                      
          On-balance sheet                $ 22,785        $ 17,382        $ 22,452        $ 17,114  
          Off-balance sheet                6,344        6,930        6,346        6,935  
          Market-risk equivalents                663        629        634        598  
                       
     
     
     
  
               Total                $  29,792        $  24,941        $  29,432        $  24,647  
                       
     
     
     
  
Quarterly average adjusted assets                $  75,410        $  66,944        $  70,116        $  62,201  
                       
     
     
     
  
 
(1) 
State Street must meet the regulatory designation of “well capitalized” in order to maintain its status as a financial holding company. In addition, Regulation Y defines “well capitalized” for a bank holding company such as State Street for the purpose of determining eligibility for a streamlined review process for acquisition proposals. For such purposes, “well capitalized” requires State Street to maintain a minimum Tier 1 risk-based capital ratio of 6% and a minimum total risk-based capital ratio of 10%.
 
Note J—Lines of Business
 
          The following is a summary of the lines of business operating results for the nine months ended
September 30:
 
       Investment
Servicing
      Investment
Management
(Dollars in millions; taxable equivalent)      2001      2000      2001      2000
Total revenue      $ 2,447      $ 2,192      $ 458      $ 529
Income before income taxes      711      608      64      122
Average assets (billions)      69.2      60.3      2.0      1.2
 
 
        Total revenue presented above is greater than the consolidated statement of income by the taxable equivalent adjustments of $47 million and $50 million for the nine months ended September 30, 2001 and 2000, respectively. For the nine months ended September 30, 2001, total revenue and income before income taxes presented above is greater than the reported consolidated statement of income by $50 million for the write-off of the investment in Bridge.
PART I.  ITEM 1.
FINANCIAL STATEMENTS (continued)
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
 
        Certain products, including brokerage, previously included in Investment Management are now classified under Investment Servicing. Management changes were implemented in order to focus the Investment Management business primarily on asset management and to more closely align asset servicing activities with the Investment Servicing line of business.
 
Note K—Earnings Per Share
 
        The following table sets forth the computation of basic and diluted earnings per share:
 
     Three Months
Ended
September 30,
      Nine Months
Ended
September 30,
 
(Dollars in millions, except per share data; shares in thousands)      2001      2000      2001      2000
Net Income      $    170      $    150      $    458      $    448
Earnings per share
     Basic      $      .52      $      .46      $    1.41      $    1.39
     Diluted      .51      .45      1.38      1.36
 
Basic average shares      326,731      322,443      325,550      321,274
     Stock options and stock awards      4,398      5,480      4,594      5,003
     7.75% convertible subordinated debentures      635      1,040      669      1,198
     
  
  
  
Dilutive average shares      331,764      328,963      330,813      327,475
     
  
  
  
 
Note L—Commitments and Contingent Liabilities
 
        State Street provides accounting, administration, custody, daily pricing, investment management, securities lending, foreign exchange, cash management, trading and information services to clients worldwide. Assets under custody and assets under management are held by State Street in a custodial or fiduciary capacity and are not included in the Consolidated Statement of Condition because such items are not assets of State Street. Management conducts regular reviews of its responsibilities for these services and considers the results in preparing its financial statements. In the opinion of management, there are no contingent liabilities at September 30, 2001 that would have a material adverse effect on State Street’s financial position or results of operations.
 
        State Street is subject to pending and threatened legal actions that arise in the normal course of business. In the opinion of management, after discussion with counsel, these actions can be successfully defended or resolved without a material adverse effect on State Street’s financial position or results of operations.
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
 
Note M—Off-Balance Sheet Financial Instruments, Including Derivatives
 
        State Street uses various off-balance sheet financial instruments, including derivatives. The following table summarizes the contractual or notional amounts of derivative financial instruments held or issued by State Street for trading and balance sheet management:
 
(Dollars in millions)      September 30,
2001		      December 31,
2000
Trading:          
     Interest rate contracts:          
          Swap agreements      $      2,812      $      3,025
          Options and caps purchased      285      323
          Options and caps written      380      413
          Futures—short position      6,055      5,046
          Options on futures purchased      410      320
          Options on futures written      390      460
     Foreign exchange contracts:          
          Forward, swap and spot        195,586        138,057
          Options purchased      1,125      2
          Options written      905      2
Balance Sheet Management:          
     Interest rate contracts:          
          Swap agreements      962      180
 
 
        In connection with its balance sheet activities, State Street designates $812 million of interest rate swap agreements as a fair value hedge of certain available-for-sale securities. For the quarter and nine months ended September 30, 2001, State Street recognized net pre-tax losses of approximately $2 million, which represented the ineffective portion of the hedge.
 
        In addition, State Street has designated interest rate swaps with a notional value of $150 million as cash flow hedges to its floating rate debt. These interest rate swaps constitute a fully-effective hedge.
 
        The following is a summary of the contractual amount of State Street’s credit-related, off-balance sheet financial instruments:
 
(Dollars in millions)      September 30,
2001		      December 31,
2000
Indemnified securities on loan      $ 104,076      $ 101,438
Loan commitments      12,815      11,367
Asset purchase agreements      9,846      7,112
Standby letters of credit      3,846      4,028
Letters of credit      157      218
 
Notes to Consolidated Financial Statements – State Street Corporation (Unaudited)
 
Note M—Off-Balance Sheet Financial Instruments, Including Derivatives (continued)
 
 
        On behalf of its clients, State Street lends their securities to creditworthy brokers and other institutions. In certain circumstances, State Street may indemnify its clients for the fair market value of those securities against a failure of the borrower to return such securities. State Street requires the borrowers to provide collateral in an amount equal to or in excess of 102% of the fair market value of the securities borrowed. The borrowed securities are revalued daily to determine if additional collateral is necessary. State Street held, as collateral, cash and U.S. government securities totaling $108 billion and $105.9 billion for indemnified securities on loan at
September 30, 2001, and December 31, 2000, respectively.
 
        Approximately 90% of the loan commitments and asset purchase agreements will expire in one year or less from the date of issue. Since many of the commitments are expected to expire without being drawn, the total commitment amounts do not necessarily represent future cash requirements.
 
Independent Accountants’ Review Report
 
The Stockholders and Board of Directors
State Street Corporation
 
We have reviewed the accompanying consolidated statement of condition of State Street Corporation as of September 30, 2001, and the related consolidated statements of income for the three-month and nine-month periods ended September 30, 2001 and 2000, and the consolidated statements of changes in stockholders’ equity and cash flows for the nine-month periods ended September 30, 2001 and 2000. These financial statements are the responsibility of the Corporation’s management.
 
We conducted our reviews in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data, and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with auditing standards generally accepted in the United States, which will be performed for the full year with the objective of expressing an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
 
Based on our reviews, we are not aware of any material modifications that should be made to the accompanying consolidated financial statements referred to above for them to be in conformity with accounting principles generally accepted in the United States.
 
We have previously audited, in accordance with auditing standards generally accepted in the United States, the consolidated statement of condition of State Street Corporation as of December 31, 2000, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for the year then ended (not presented herein) and in our report dated January 17, 2001, except for Note Y, as to which the date is
February 6, 2001, we expressed an unqualified opinion on those consolidated financial statements.
 
ERNST & YOUNG LLP
 
Boston, Massachusetts
October 17, 2001
PART I.  ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
Summary
 
        Diluted earnings per share for the third quarter were $.51, an increase of 13% from $.45 in the third quarter of 2000. Total revenue increased $72 million to $977 million. Net income was $170 million, up 13% from $150 million a year ago. Return on stockholders’ equity was 17.9%.
 
        For the nine months ended September 30, 2001, reported diluted earnings per share were $1.38, up from $1.36 per share a year ago. Reported results for the nine months ended September 30, 2001 include the write-off of State Street’s $50 million investment in Bridge Information Systems, Inc. (“Bridge”). The write-off of the investment in Bridge, recorded in March 2001, decreased net income by $33 million and diluted earnings per share by $.10. Excluding the write-off of the investment in Bridge, defined as operating results, diluted earnings per share were $1.48 for the nine months ended September 30, 2001, total operating revenue was $2.9 billion and operating earnings were $491 million.
 
Condensed Income Statement—Taxable Equivalent Basis
       Three Months Ended
September 30,
      Nine Months Ended
September 30,
(Dollars in millions, except per share data)      2001      2000      Change      %      2001      2000      Change      %
Reported Results                                        
Fee revenue:                                        
Servicing fees      $ 398      $ 359      $39        11        $ 1,210      $ 1,070      $ 140        13  
Management fees      124      140       (16 )      (11 )      383      452      (69 )      (16 )
Foreign exchange trading      87      89      (2 )      (1 )      285      296      (11 )      (3 )
Processing fees      70      56      14        24        195      175      20        12  
Other      29      12      17        131        2      24      (22 )      (91 )
     
  
  
     
     
  
  
     
  
    Total fee revenue      708      656      52        8        2,075      2,017      58        3  
Net interest revenue      272      252      20        8        787      712      75        11  
Provision for loan losses      3      3                7      8      (1 )      (7 )
     
  
  
     
     
  
  
     
  
    Total revenue      977      905      72        8        2,855      2,721      134        5  
Operating expenses      712      665      47        7        2,130      1,991      139        7  
     
  
  
     
     
  
  
     
  
    Income before income taxes      265      240      25        10        725      730      (5 )      (1 )
Income taxes      77      73      4        4        220      232      (12 )      (6 )
Taxable equivalent adjustment      18      17      1        10        47      50      (3 )      (5 )
     
  
  
     
     
  
  
     
  
    Net income      $  170      $  150      $20        13        $    458      $    448      $    10        2  
     
  
  
     
     
  
  
     
  
Earnings Per Share (2)                                        
    Basic      $    .52      $    .46      $.06        13        $    1.41      $    1.39      $    .02        1  
    Diluted      .51      .45      .06        13        1.38      1.36      .02        1  
 
Operating Results (1)                                        
Total operating revenue      $  977      $  905      $72        8        $  2,905      $  2,721      $  184        7  
Operating earnings      170      150      20        13        491      448      43        10  
Diluted operating earnings per share (2)      .51      .45      .06        13        1.48      1.36      .12        9  
 
(1) 
Operating results for the nine months ended September 30, 2001 exclude the write-off of $50 million for State Street’s investment in Bridge, equal to $33 million after tax, or $.10 per diluted share.
(2) 
Per share amounts have been restated to reflect the 2-for-1 stock split in the form of a 100% stock dividend distributed on May 30, 2001 to stockholders of record as of April 30, 2001.
 
Total Revenue
 
        In the third quarter of 2001, total revenue was $977 million, up $72 million, or 8%, from a year ago. Growth came primarily from servicing fees and net interest revenue. New business from investment managers installed over the last four quarters drove growth in servicing fees, despite lower equity values worldwide. Strong securities lending revenue, which increased compared to the third quarter of 2000, contributed as well. Higher net interest revenue was driven by balance sheet growth from increased client activity and wider interest rate spreads from a year ago.
 
        For the nine months ended September 30, 2001, growth in operating revenue was partially offset by the effect of the formation of CitiStreet, LLC (“CitiStreet”) in April 2000. Businesses contributed to CitiStreet are now accounted for using the equity method, reducing revenue and expenses subsequent to the formation. Adjusted to exclude the results of CitiStreet in first quarter of the prior year, total operating revenue would have increased 9%, primarily from growth in servicing fees and net interest revenue.
 
Fee Revenue
 
        Fee revenue was $708 million, up $52 million, or 8%, over 2000. Fee revenue growth came principally from servicing fees.
 
        Servicing fees in the third quarter of 2001 were $398 million, up 11% from a year ago. Servicing fees are derived from accounting, administration, custody, daily pricing, securities lending, performance and analytics, compliance monitoring, and operations outsourcing for investment managers. New business from investment managers installed over the last four quarters drove growth in servicing fees, despite lower equity values worldwide. Strong securities lending revenue on behalf of investment servicing clients, which increased compared to the third quarter of 2000, contributed as well, reflecting a favorable interest rate environment. Total assets under custody were $5.8 trillion, compared to $6.2 trillion a year ago, reflecting market value declines, partially offset by new business and additional assets from existing clients.
 
        Management fees from investment management services, delivered through State Street Global Advisors ®, were $124 million compared to $140 million a year ago. Management fees include revenue from an extensive range of investment management strategies, securities lending on behalf of investment management clients, specialized investment management advisory services, and other services. Revenue in the third quarter reflects continued declines in equity values worldwide, offset in part by new business, including business gained in an acquisition. Total assets managed were $663 billion, compared to $712 billion a year ago. Equities assets were down 15%, while fixed income and money market assets under management increased 13% from a year ago.
 
        Foreign exchange trading revenue was $87 million, compared to $89 million a year ago. Foreign exchange trading revenue reflects three primary factors: the volume of cross-border transactions, currency volatility, and the mix of currencies being traded.
 
        Processing fees grew $14 million, to $70 million, driven by growth in fees for structured financial products.
 
        Other fee revenue, which includes profits and losses from joint ventures, gains and losses on sales of securities, and other items, was $29 million in the quarter, which included securities gains of $15 million and a gain on the sale of a non-strategic business by a joint venture. Excluding securities gains, other revenue increased $2 million from $12 million a year ago.
 
        For the nine months ended September 30, 2001, fee revenue was $2.1 billion, up $58 million from a year ago. Servicing fees were $1.2 billion, up $140 million or 13%, reflecting new business and strong securities lending revenue. Management fees were $383 million, down $69 million, or 16%. Excluding the results of businesses contributed to CitiStreet from the prior year, management fees were down 6%, reflecting the decline in global equity valuations over the past year and reduced performance fees.
 
Net Interest Revenue
 
        Taxable-equivalent net interest revenue for the third quarter was $272 million, up $20 million, or 8%, from a year ago. State Street provides repurchase agreements and deposit services for clients’ investment activities, which drives net interest revenue. Average deposits increased 19% in the quarter. Growth in net interest revenue, reflecting balance sheet growth from increased client activity and improved interest rate spreads, was partially offset by lower asset yields.
 
       Three Months Ended September 30,
       2001
      2000
(Dollars in millions)      Average
Balance		      Rate      Average
Balance		      Rate
Interest-earning assets      $ 70,527      4.07 %      $ 57,909      5.87 %
Interest-bearing liabilities      61,356      2.92        49,170      4.88  
           
           
  
     Excess of rate earned over rate paid           1.15 %           .99 %
           
           
  
     Net Interest Margin                1.53 %                1.73 %
           
           
  
 
 
        For the nine months ended September 30, 2001, net interest revenue was $787 million, up $75 million, or 11%, reflecting improved spreads and increased client deposit and investment activity. Net interest margin for the nine months ended September 30, 2001 was 1.61%, compared to 1.69% in 2000.
 
Operating Expenses
 
        Operating expenses for the quarter were $712 million, up $47 million, or 7%, from the third quarter of 2000 to support new business and initiatives to support future growth.
 
        Salaries and employee benefits expenses increased $43 million, or 12%, to $420 million, reflecting increased staff, including new hires and people joining State Street as part of the large new business wins and two acquisitions, and salary increases, partially offset by lower performance-based incentive compensation.
 
        Information systems and communications expense grew $15 million to $93 million for the third quarter, as State Street continued to invest in the hardware and software critical to continued growth and efficiency improvements.
 
        Transaction processing services expense of $61 million was down $7 million, or 12%, reflecting reduced volumes of transaction-based activities.
 
        For the nine months ended September 30, 2001, operating expenses were $2.1 billion, up $139 million, or 7%, from a year ago. Adjusted to exclude the results of CitiStreet from the prior year, operating expenses were up 10% year-over-year.
 
Income Taxes
 
        Income taxes for the third quarter of 2001 were $77 million, up from $73 million in the third quarter of last year. State Street’s estimated full-year tax rate for 2001 has been revised to 32.6%, reflecting a change in income mix, with a larger share of income coming from non-taxable revenue as taxable revenue growth slows. The effect of that change was to lower the rate for the third quarter of 2001 to 31.2% due to the year-to-date adjustment.
 
Credit Quality
 
        At September 30, 2001, total gross loans were $6.0 billion. At quarter end, the allowance for loan losses was $55 million, a decrease from $56 million a year ago. For the quarter ended September 30, 2001, the provision for loan losses charged against income was $3 million, and there were charge-offs of $9 million and no recoveries. At September 30, 2001, non-performing loans were less than $1 million, down from $4 million at year-end 2000, and $5 million a year ago.
 
Lines of Business
 
        Following is a summary of lines of business operating results for the nine months ended September 30:
 
       Investment Servicing
      Investment
Management
(Dollars in millions; taxable equivalent)      2001      2000      2001      2000
Fee revenue:                    
     Servicing fees      $ 1,210        $ 1,070            
     Management fees                $ 383        $ 452  
     Foreign exchange trading      285        296            
     Other (1)      235        191        12        8  
       
       
       
       
  
          Total fee revenue      1,730        1,557        395        460  
Net interest revenue after provision for loan losses      717        635        63        69  
       
       
       
       
  
          Total operating revenue (1)      2,447        2,192        458        529  
Operating expense      1,736        1,584        394        407  
       
       
       
       
  
          Operating earnings before income taxes (1)      $    711        $    608        $    64        $  122  
       
       
       
       
  
Pre-tax margin      29 %      28 %      14 %      23 %
Average assets (billions)      $    69.2        $    60.3        $    2.0        $    1.2  
 
(1)
Operating results for the nine months ended September 30, 2001 exclude the write-off of $50 million for State Street’s investment in Bridge.
 
        Investment Servicing.    Investment Servicing includes accounting, administration, custody, daily pricing, operations outsourcing for investment managers, securities lending, foreign exchange, recordkeeping, deposit and short-term investment facilities, lease financing, brokerage, and information services. These services support sophisticated investors in developing and executing their strategies, enhancing their returns, and evaluating and managing risk. Clients around the world include mutual funds and other collective investment funds, corporate and public pension plans, corporations, investment managers, not-for-profit organizations, unions, and other holders of investment assets. During 2000, State Street began providing an expanding array of operational outsourcing services to its investment management clients. These services enable State Street to provide global asset managers with a comprehensive suite of services, from trade order management through settlement. Revenue from Investment Servicing comprised 84% of State Street’s total operating revenue for the nine months ended September 30, 2001. Certain products, including brokerage, previously included in Investment Management are now classified under Investment Servicing. Management changes were implemented in order to focus the Investment Management business primarily on asset management and to more closely align asset servicing activities with the Investment Servicing line of business.
PART I.  ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (continued)
 
        Total operating revenue for the nine months ended September 30, 2001 increased $255 million to $2.4 billion, up 12% from $2.2 billion reported for the first nine months of 2000. This increase in revenue is driven primarily by the 13% increase in servicing fees. New business from investment managers installed over the last four quarters drove growth in servicing fees, despite lower equity values worldwide. Strong new business wins in 2000 included investment manager operations outsourcing for Pacific Investment Management Co. (“PIMCO”), fund accounting and daily pricing for Merrill Lynch, and fund accounting, daily pricing and financial reporting for Liberty Financial Companies. In the United Kingdom, business benefited from clients transferring from Lloyds TSB to State Street, and the investment manager operations outsourcing win of Scottish Widows. In Japan, business continued to grow through State Street’s alliance with Chuo Mitsui Trust & Banking Co. Strong securities lending revenue, which benefited from a favorable interest rate environment in the United States, contributed significantly as well. Total assets under custody were $5.8 trillion, compared to $6.2 trillion a year ago, reflecting market value declines, largely offset by new business and additional contributions of assets by existing clients.
 
        Foreign exchange trading revenue was $285 million, compared to $296 million a year ago. Foreign exchange trading revenue reflects three primary factors: the volume of cross-border transactions, currency volatility, and the mix of currencies being traded.
 
        Net interest revenue for the nine months ended September 30, 2001 was $717 million, up $82 million from a year ago. In serving sophisticated global investors, State Street provides short-term funds management, including deposit services and repurchase agreements for cash positions associated with clients’ investment activities. Growth in net interest revenue reflected improved spreads and increased client deposit and investment activity.
 
        Operating expenses for the nine months ended September 30, 2001 were $1.7 billion, 10% higher than a year ago. The increase was primarily due to additional staff, including people hired in conjunction with the new business from PIMCO, Merrill Lynch, Liberty Financial Companies and Scottish Widows, and salary increases, partially offset by lower performance-based incentive compensation. Information systems and communications expense increased reflecting continued investment in hardware and software critical to State Street’s continued growth and efficiency improvements. Transaction processing services were down reflecting lower subcustodian fees.
 
        Investment Management.    State Street offers a broad array of services for managing financial assets worldwide for both institutions and individuals, and other financial products. Services included passive and active equity, money market, and fixed income strategies, and other related services. Revenue from this line of business comprised 16% of State Street’s total operating revenue for the nine months ended September 30, 2001.
 
        Total revenue for the nine months ended September 30, 2001 was $458 million, down $71 million, or 13%, from $529 million reported for the first nine months of 2000. Management fees were $383 million, down 16% from 2000. Adjusted for the formation of CitiStreet, management fees would have been down 6%, reflecting the impact of the decline in global equity valuations over the last twelve months and reduced performance fees. This decline was partially offset by continued new business success. Total assets managed were $663 billion, compared to $712 billion a year ago. Equity assets were down 15%, while fixed income and money market assets under management increased 13% from a year ago.
 
        Operating expenses for the nine months ended September 30, 2001 of $394 million decreased $13 million from the prior year. Adjusted for the formation of CitiStreet, operating expenses would have been up 13% for the first nine months of 2001. This growth reflects higher salaries and additional staff related to new business and acquisitions, offset by a decrease in performance-based incentive compensation.
 
Acquisitions
 
        In June 2001, State Street completed the purchase of DST Portfolio Systems, Inc. for 1,483,000 shares of State Street common stock and cash in a transaction accounted for as a purchase. Acquired in the purchase was the Portfolio Accounting System, an integrated system that automates mutual fund accounting and investment management recordkeeping processes such as security pricing and dividend calculations, income and expense accruals, securities inventories, accounting for daily shareholder activity and calculation of daily net asset values.
 
        In February 2001, State Street completed the purchase of a majority interest in Bel Air Investment Advisors LLC (“Bel Air”) for 2,015,000 shares, after adjustment for the stock split, of State Street common stock and cash in a transaction accounted for as a purchase. Bel Air is a Los Angeles-based independent investment management firm focused on providing wealth management services to ultra-high-net-worth individuals.
 
Liquidity and Capital
 
        Liquidity.    The primary objective of State Street’s liquidity management is to ensure that the Corporation has sufficient funds to meet its commitments and business needs, and to accommodate the transaction and cash management requirements of its clients. Liquidity is provided by State Street’s access to global debt markets, its ability to gather additional deposits from its clients, maturing short-term assets, the sales of securities and payments of loans. Client deposits and other funds provide a multi-currency, geographically diverse source of liquidity. State Street maintains a large portfolio of liquid assets. As of September 30, 2001, the Corporation’s liquid assets were 86% of total assets.
 
        Capital.    State Street’s objective is to maintain a strong capital base in order to provide financial flexibility for its business needs, including funding corporate growth and meeting clients’ cash management needs. As a state-chartered bank and member of the Federal Reserve System, State Street Bank, State Street’s principal subsidiary, is regulated by the Federal Reserve Board, which has established guidelines for minimum capital ratios. State Street has developed internal capital adequacy policies to ensure that State Street Bank meets or exceeds the level required for the “well capitalized” category, the highest of the Federal Reserve Board’s five capital categories. State Street’s capital management emphasizes risk exposure rather than asset levels. At September 30, 2001, State Street Bank’s Tier 1 risk-based capital ratio was 12.3% and the Corporation’s Tier 1 risk-based capital ratio was 12.8%. Both significantly exceed the regulatory minimum of 4% and the well-capitalized category of 6%. See Note I to the Consolidated Financial Statements for further information.
 
        In June 2001, State Street’s Board of Directors increased by 4 million shares the authorization for the purchase of State Street common stock for use in employee benefit programs and for general corporate purposes. As of September 30, 2001, 5.5 million shares may be purchased under the stock purchase program.
 
        On December 21, 2000, State Street’s Board of Directors approved a 2-for-1 stock split in the form of a 100% stock dividend, subject to stockholder approval of an increase in the authorized number of shares at the Annual Meeting of Stockholders. Approval of an increase in the authorized number of shares by stockholders was received at the Annual Meeting in April 2001. The stock dividend was distributed on May 30, 2001, to stockholders of record as of April 30, 2001.
 
Trading Activities: Foreign Exchange and Interest Rate Sensitivity
 
        As part of its trading activities, the Corporation assumes positions in both the foreign exchange and interest rate markets by buying and selling cash instruments and using financial derivatives, including forward foreign exchange contracts, foreign exchange and interest rate options, and interest rate swaps. As of
September 30, 2001, the notional amount of these derivative instruments was $207.9 billion, of which $195.6 billion was foreign exchange forward contracts. Long and short foreign exchange forward positions are closely matched to minimize currency and interest rate risk. All foreign exchange contracts are valued daily at current market rates.
 
        The following table presents State Street’s market risk for its trading activities as measured by its value at risk methodology:
 
Value at Risk for the nine months ended September 30,
 
(Dollars in millions)      Average      Maximum      Minimum
2001:
          Foreign exchange contracts      $  .9      $ 2.5      $  .4
          Interest rate contracts       4.2      5.9       3.0
2000:
          Foreign exchange contracts      1.0      2.1      .4
          Interest rate contracts      3.9      5.3      3.1
 
 
        State Street uses actual profit and loss data from daily trading activities to estimate one-day value at risk. During the first nine months of 2001, State Street did not experience any one-day trading loss in excess of its end-of-day value at risk estimate.
 
Financial Goals and Factors That May Affect Them
 
        State Street’s primary financial goal is sustainable real growth in earnings per share. The Corporation has two supporting goals, one for total revenue growth and one for return on common stockholders’ equity (ROE). The long-term revenue goal is for a 12.5% real, or inflation adjusted, compound annual growth rate of revenue from 2000 through 2010. At present, this equates to approximately a 15% nominal compound annual growth rate. The annual return on stockholders’ equity goal is 18%.
 
        State Street considers these to be financial goals, not projections or forward-looking statements. However, the discussion included in Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in other portions of this report on Form 10-Q, may contain statements that are considered “forward-looking statements” within the meaning of the federal securities laws. These statements may be identified by such forward-looking terminology as “expect,” “look,” “believe,” “anticipate,” “may,” “will,” or similar statements or variations of such terms. The Corporation’s financial goals and such forward-looking statements involve certain risks and uncertainties, including the issues and factors listed below and factors further described in conjunction with the forward-looking information, which could cause actual results to differ materially.
 
        Factors that may cause such differences include, but are not limited to, the factors discussed in this section and elsewhere in this Form 10-Q. Each of these factors, and others, are also discussed from time to time in the Corporation’s other filings with the Securities and Exchange Commission, including in the Corporation’s Form 10-K. The forward-looking statements contained in this report on Form 10-Q speak only as of the time the statements were given, and the Corporation does not undertake to revise those forward-looking statements to reflect events after the date of this report.
 
        Cross-border investing.    Increases in cross-border investing by clients worldwide benefit State Street’s revenue. Future revenue may increase or decrease depending upon the extent of increases or decreases in cross-border investments made by clients or future clients. Economic and political uncertainties resulting from terrorist activities and military response to the activities could result in decreases in cross-border investing activities.
 
        Savings rate of individuals.    State Street benefits from the savings of individuals that are invested in mutual funds and other collective funds or in defined contribution plans. Changes in savings rates or investment styles may affect revenue.
 
        Value of worldwide financial markets.    As worldwide financial markets increase or decrease in value, State Street’s opportunities to invest and service financial assets may change. Since a portion of the Corporation’s fees are based on the value of assets under custody and management, fluctuations in the valuation of worldwide securities markets will affect revenue. State Street estimates that if equity values worldwide were to increase or decrease by 10%, this rate of change, by itself, would cause approximately a 2% change in State Street’s total revenue. If bond values worldwide were to change by 10%, State Street would anticipate a corresponding 1% change in its total revenue.
 
        Dynamics of markets served.    Changes in markets served, including the growth rate of collective funds worldwide, the pace of debt issuance, and outsourcing decisions, mergers, acquisitions and consolidations among clients and competitors, can affect revenue. In general, State Street benefits from an increase in the volume of financial market transactions serviced.
 
        State Street provides services worldwide. Global and regional economic factors and changes or potential changes in laws and regulations affecting the Corporation’s business, including volatile currencies, pace of inflation, changes in monetary policy, and social and political instability, could affect results of operations. For example, the significant slowing of economic growth globally is affecting worldwide equity values and business growth. The terrorist attacks, which took place in the United States on September 11, 2001, and subsequent terrorist activities, have caused further economic and political uncertainties. These attacks and activities and the national and global efforts to combat terrorism, many of which are still being formulated, have affected and may further adversely affect economic growth, and may have other adverse effects on many companies, including State Street, in ways that cannot be predicted at the present.
 
        Legislation enacted by the U.S. Congress in 1999 may cause changes in the competitive environment in which State Street operates, which could include, among other things, broadening the scope of activities of significant competitors, or facilitating consolidation of competitors into stronger entities, or attracting large and well-capitalized new competitors into State Street’s traditional businesses. Such factors and changes and the ability of the Corporation to address and adapt to the regulatory and competitive challenges may affect future results of operations.
 
        Interest rates.    The levels of market interest rates, the shape of the yield curve, and the direction of interest rate changes affect net interest revenue, as well as securities lending revenue recorded in servicing and management fees. All else being equal, in the short term, State Street’s net interest revenue and securities lending revenue benefit from falling interest rates and are negatively affected by rising rates because interest-bearing liabilities reprice sooner than interest-earning assets. In general, sustained lower interest rates have a constraining effect on the net interest revenue growth rate.
          Volatility of currency markets.    The degree of volatility in foreign exchange rates can affect the amount of foreign exchange trading revenue. In general, State Street benefits from currency volatility.
 
        Pace of pension reform.    State Street expects to benefit from worldwide pension reform that creates additional pools of assets that use custody and related services, and investment management services. The pace of pension reform and resulting programs, including public and private pension schemes may affect the pace of revenue growth.
 
        Pricing/competition.    Future prices the Corporation is able to obtain for its products may increase or decrease from current levels depending upon demand for its products, its competitors’ activities and the introduction of new products into the marketplace.
 
        Pace of new business.    The pace at which State Street attracts new clients, and the pace at which existing and new clients use additional services and assign additional assets to State Street for management or custody will affect future results of operations.
 
        Business mix.    Changes in business mix, including the mix of U.S. and non-U.S. business, may affect future results of operations.
 
        Business continuity.    State Street has business continuity and disaster recovery plans in place. However, events, including terrorist or military actions and resulting political and social turmoil, could arise that would cause unforeseen damage to State Street’s physical facilities or could cause delays or disruptions to operational functions, including information processing and financial market settlement functions. Additionally, State Street has clients, vendors and counterparties who could suffer from such events. Should these events affect State Street, or the clients, vendors or counterparties with which it conducts business, State Street’s results of operations could be negatively impacted.
 
        Rate of technological change.    Technological change creates opportunities for product differentiation and reduced costs, as well as the possibility of increased expenses. Developments in the securities processing industry, including shortened settlement cycles and ultimately straight-through-processing, will result in changes to existing procedures. Alternative delivery systems have emerged, including the widespread utilization of the Internet. State Street’s financial performance depends in part on its ability to develop and market new and innovative services, and to adopt or develop new technologies that differentiate State Street’s products or provide cost efficiencies.
 
        The risks inherent in this process include rapid technological change in the industry, the Corporation’s ability to access technical and other information from clients, and the significant and ongoing investments required to bring new services to market in a timely fashion at competitive prices. A further risk is the introduction by competitors of services that could replace or provide lower-cost alternatives to State Street services.
 
        State Street uses appropriate trademark, trade secret, copyright and other proprietary rights procedures to protect its technology, and has applied for a limited number of patents in connection with certain software programs. However, in the event a third party asserts a claim of infringement of its proprietary rights, obtained through patents or otherwise, against the Corporation, State Street may be required to spend significant resources to defend against such claims, develop a non-infringing program or process, or obtain a license to the infringed process.
 
        Acquisitions and alliances.    Acquisitions of complementary businesses and technologies, and development of strategic alliances are an active part of State Street’s overall business strategy. The Corporation has completed several acquisitions and alliances in recent years. However, there can be no assurance that services, technologies, key personnel and businesses of acquired companies will be effectively assimilated into State Street’s business or service offerings or that alliances will be successful.
 
PART I.  ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
 
        See information under the caption “Trading Activities: Foreign Exchange and Interest Rate Sensitivity” on pages 21.
 
        State Street’s Risk Management function is described in detail in the Corporation’s 2000 Annual Report and Form 10-K.
 
PART II—OTHER INFORMATION
 
ITEM 6.    EXHIBITS AND REPORTS ON FORM 8-K
 
(a)  Exhibit Index
 
Exhibit
Number
   
    
 10.1      Memorandum of Agreement with Nicholas A. Lopardo     
 12      Ratio of earnings to fixed charges     
 15      Letter regarding unaudited interim financial information     
 
(b)  Current Reports on Form 8-K
 
        None
 
SIGNATURES
 
        Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
STATE STREET CORPORATION
 
Date:  November 2, 2001
By:    /S / RONALD L. O’KELLEY
Ronald L. O’Kelley
Executive Vice President, Treasurer
and Chief Financial Officer
 
Date:  November 2, 2001
By:    /S / FREDERICK P. BAUGHMAN
Frederick P. Baughman
Senior Vice President, Controller and
Chief Accounting Officer