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, 2010

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x  No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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.  ¨

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 Act).  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 ($33.82) 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, 2010) was approximately $16.87 billion.

The number of shares of the registrant’s common stock outstanding as of January 31, 2011 was 502,189,618.

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 2011 Annual Meeting of Shareholders to be filed pursuant to Regulation 14A on or before April 30, 2011 (Part III).

 

 

 


Table of Contents

STATE STREET CORPORATION

Table of Contents

 

    

Description

   Page Number  

PART I

     

Item 1

   Business      1   

Item 1A

   Risk Factors      7   

Item 1B

   Unresolved Staff Comments      27   

Item 2

   Properties      27   

Item 3

   Legal Proceedings      28   

Item 4

   Removed and Reserved      30   
   Executive Officers of the Registrant      30   

PART II

     

Item 5

  

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

     32   

Item 6

   Selected Financial Data      34   

Item 7

  

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

     35   

Item 7A

   Quantitative and Qualitative Disclosures About Market Risk      86   

Item 8

   Financial Statements and Supplementary Data      86   

Item 9

  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     167   

Item 9A

   Controls and Procedures      167   

Item 9B

   Other Information      169   

PART III

     

Item 10

   Directors, Executive Officers and Corporate Governance      169   

Item 11

   Executive Compensation      169   

Item 12

  

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

     169   

Item 13

   Certain Relationships and Related Transactions, and Director Independence      170   

Item 14

   Principal Accounting Fees and Services      170   

PART IV

     

Item 15

   Exhibits, Financial Statement Schedules      171   
   SIGNATURES      172   
   EXHIBIT INDEX      173   


Table of Contents

PART I

 

ITEM 1. BUSINESS

GENERAL

State Street Corporation is a financial holding company; we were organized in 1969 under the laws of the Commonwealth of Massachusetts, and through our subsidiaries, including our principal banking subsidiary State Street Bank and Trust Company, we provide a broad range of financial products and services to institutional investors worldwide. At December 31, 2010, we had consolidated total assets of $160.51 billion, consolidated total deposits of $98.35 billion, consolidated total shareholders’ equity of $17.79 billion and 28,670 employees. Our executive offices are located at One Lincoln Street, Boston, Massachusetts 02111 (telephone (617) 786-3000).

For purposes of this Form 10-K, unless the context requires otherwise, references to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis; references to “parent company” mean State Street Corporation; and references to “State Street Bank” mean State Street Bank and Trust Company. The parent company is a legal entity separate and distinct from its subsidiaries, assisting those subsidiaries by providing financial resources and management.

Our website is www.statestreet.com, through which we make available, free of charge, 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 & 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.

BUSINESS DESCRIPTION

Overview

We are a leader in providing financial services and products to meet the needs of institutional investors worldwide, with $21.53 trillion of assets under custody and administration and $2.01 trillion of assets under management at year-end 2010. Our clients 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 26 countries and more than 100 geographic markets worldwide. We conduct our business primarily through 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.

Significant Developments

On April 1, 2010, we acquired Mourant International Finance Administration, or MIFA. Through this acquisition, we strengthened our position in fund administration and alternative asset servicing by adding $122 billion to our assets under administration as of June 30, 2010. We further expanded our reach in Europe and Asia, and we broadened our capabilities for servicing investors’ growing real estate administration requirements. This transaction builds on prior acquisitions completed over the past several years, each of which has contributed to our capabilities and reach in the alternative asset servicing segment of the global fund administration business. In 2002, we acquired International Fund Services, and in 2007, we acquired Investors Financial Services Corp. and Palmeri Fund Administrators. Additional information about our acquisition of MIFA is provided in note 2 to the consolidated financial statements included under Item 8.

 

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On May 17, 2010, we completed our acquisition of the securities services business of Intesa Sanpaolo, or Intesa, composed of global custody, depository banking, correspondent banking and fund administration, with approximately €369 billion of assets under custody and administration as of March 31, 2010. As part of our acquisition of Intesa, we also assumed approximately €9 billion of client deposits. This transaction also added approximately 530 employees to our operations in Milan, Turin and Luxembourg, enhanced our position as the largest service provider in Italy and strengthened our presence in Luxembourg. As part of this acquisition, we entered into a long-term servicing agreement with Intesa Sanpaolo to service its investment management affiliates, including Eurizon Capital, which with its affiliates comprises the largest fund family in Italy, with approximately €139 billion of assets under management as of March 31, 2010. Additional information about our acquisition of Intesa is provided in note 2 to the consolidated financial statements included under Item 8.

On November 30, 2010, we announced a multi-year program to enhance service excellence and innovation, increase efficiencies and position us for accelerated growth. This program includes operational and information technology enhancements and targeted cost initiatives, including a reduction in force and a plan to reduce our occupancy costs. Additional information concerning actions taken by us in connection with, and charges resulting from, this program in 2010 is included in the “Overview of Financial Results—Financial Highlights” and “Consolidated Results of Operations—Expenses” sections of Management’s Discussion and Analysis of Financial Condition and Results of Operations, or Management’s Discussion and Analysis, included under Item 7 and in note 9 to the consolidated financial statements included under Item 8.

On January 10, 2011, we completed our acquisition of Bank of Ireland Asset Management, or BIAM. Our acquisition of BIAM provided State Street Global Advisors, or SSgA, with new Dublin-based clients and employees and additional assets under management, including global fundamental equities, fixed-income, cash, asset allocation, property and balanced funds. Aggregate BIAM assets under management as of December 31, 2010 were approximately €26 billion. The acquisition also expanded SSgA’s range of investment management solutions, and expanded State Street’s overall presence in Ireland, where we have been servicing institutional clients for fifteen years. Our resulting new operation in that country, known as State Street Global Advisors Ireland Limited, became SSgA’s tenth global investment center, from which investment teams manage client assets.

Additional Information

Additional information about our business activities is provided in the sections that follow. 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, Risk Factors included under Item 1A and our consolidated financial statements and accompanying footnotes included under Item 8, including notes 22 and 25 with respect to income taxes and non-U.S. activities.

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, 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 and note 24 to the 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.

 

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We believe that these markets have key competitive considerations. 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 clients and to attract new clients.

SUPERVISION AND REGULATION

The parent company is registered with the Board of Governors of the Federal Reserve System, or 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 qualifies as a financial holding company, which extends to some extent the scope of activities in which it may engage. 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.

The Dodd-Frank Wall Street Reform and Consumer Protection Act, which became law in July 2010, will have a significant effect on the regulatory structure of the financial markets. The Dodd-Frank Act, among other things, establishes a new Financial Stability Oversight Council to monitor systemic risk posed by financial institutions, restricts proprietary trading and private fund investment activities by banking institutions, creates a new framework for the regulation of derivative instruments, alters the regulatory capital treatment of trust preferred and other hybrid capital securities, and revises the FDIC’s assessment base for deposit insurance assessment. In addition, rapid regulatory change is occurring internationally with respect to financial institutions, including, but not limited to, the implementation of Basel III and the Alternative Investment Fund Managers Directive, and the potential adoption of European Union derivatives initiatives and revisions to the European collective investment fund, or UCITS, directive.

Additional information about the Dodd-Frank Act and other new or modified laws and regulations applicable to our business is provided in Risk Factors included under Item 1A, in particular the risk factor titled “We face extensive and changing government regulation, including changes to capital requirements under the Dodd-Frank Act, Basel II and Basel III, which may increase our costs and expose us to risks related to compliance.”

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.

 

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governmental and regulatory agencies and self-regulatory organizations. Aspects of our public disclosure, 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.

Regulatory 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 regulatory capital ratio levels. State Street Bank is subject to similar risk-based capital and leverage ratio guidelines. As of December 31, 2010, our regulatory capital levels on a consolidated basis, and the regulatory capital levels of State Street Bank, exceeded the applicable minimum capital requirements and the requirements to qualify as a financial holding company.

We are currently in the qualification period that is required to be completed prior to our full implementation of the Basel II final rules. During the qualification period, we must demonstrate that we comply with the Basel II requirements to the satisfaction of the Federal Reserve. During or subsequent to this qualification period, the Federal Reserve may determine that we are not in compliance with certain aspects of the final rules and may require us to take certain actions to achieve compliance that could adversely affect our business operations, our capital structure, our regulatory capital ratios or our financial performance. Basel III, the Dodd-Frank Act and the regulatory rules to be adopted for the implementation of Basel III and the Dodd-Frank Act are expected to result in an increase in the minimum regulatory capital that we will be required to maintain and changes in the manner in which our regulatory capital ratios are calculated. Banking regulators have not yet issued final rules and guidance with respect to the regulatory capital rules under Basel III and the Dodd-Frank Act.

Failure to meet regulatory 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, or FDIC, and to certain restrictions on our business that are described further in this “Supervision and Regulation” section.

For additional information about our regulatory capital position and regulatory capital adequacy, refer to the “Capital” section of Management’s Discussion and Analysis, Risk Factors, including the risk factor titled “Our business may be adversely affected upon our implementation of the revised capital requirements under Basel II Capital Rules, Basel III and the Dodd-Frank Act or in the event our capital structure is determined to be insufficient as a result of mandated stress testing,” and note 16 to the 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, 2010, the capital of each of these banking subsidiaries was in excess of the minimum legal capital requirements as set by those regulatory authorities.

The parent company and its non-banking subsidiaries are affiliates of State Street Bank under federal banking laws, which impose restrictions on transactions involving loans, extensions of credit, investments or asset purchases from State Street Bank to the parent company and its non-banking subsidiaries. Transactions of this kind to affiliates by State Street Bank are limited with respect to each affiliate to 10% of State Street Bank’s

 

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capital and surplus, as defined, and to 20% in the aggregate for all affiliates, and, in addition, 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, 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 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. Our activities as a futures commission merchant are subject to regulation by the Commodities Futures Trading Commission in the U.S. and various regulatory authorities internationally, as well as the membership requirements of the applicable clearinghouses. 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.

The majority 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 make investments that exceed 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 also 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.

 

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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 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 consolidated 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,” to the consolidated financial statements (Item 8) and “Investment Securities” section included in Management’s Discussion and Analysis—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 Leases,” to the consolidated financial statements (Item 8)—discloses our policy for placing loans and leases on non-accrual status.

Note 4, “Loans and Leases,” to the consolidated financial statements (Item 8) and “Loans and Leases” section included in Management’s Discussion and Analysis—disclose distribution of loans, loan maturities and sensitivities of loans to changes in interest rates.

“Loans and Leases” and “Cross-Border Outstandings” sections of Management’s Discussion and Analysis—disclose information regarding cross-border outstandings and other loan concentrations of State Street.

“Credit Risk” section of Management’s Discussion and Analysis and note 4, “Loans and Leases,” to the 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.

 

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Note 8, “Short-Term Borrowings,” to the consolidated financial statements (Item 8)—discloses information regarding short-term borrowings of State Street.

 

ITEM 1A. RISK FACTORS

This Form 10-K, as well as other reports filed by us under the Securities Exchange Act of 1934 or registration statements filed by us under the Securities Act of 1933, contain statements (including statements in Management’s Discussion and Analysis 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 expectations about our financial performance, market growth, acquisitions and divestitures, new technologies, services and opportunities and earnings, management’s confidence in our strategies and other matters that do not relate strictly to historical facts. Forward-looking statements are often identified by such forward-looking terminology as “expect,” “look,” “believe,” “anticipate,” “estimate,” “forecast,” “seek,” “may,” “will,” “trend,” “target” and “goal,” or similar statements or variations of such terms.

Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management’s expectations and assumptions at the time the statements are made, and are not guarantees of future results. Management’s expectations and assumptions, and the continued validity of the forward-looking statements, are subject to change due to a broad range of factors affecting the national and global economies, the equity, debt, currency and other financial markets, as well as factors specific to State Street and its subsidiaries, including State Street Bank. Factors that could cause changes in the expectations or assumptions on which forward-looking statements are based include, but are not limited to:

 

   

the manner in which the Federal Reserve implements the Dodd-Frank Act, including any changes to our minimum regulatory capital ratios;

 

   

changes to our business model, or how we provide services, required by our compliance with the Dodd-Frank Act, and similar non-U.S. rules and regulations;

 

   

required regulatory capital ratios under Basel II and Basel III, in each case as fully implemented by State Street and State Street Bank (and in the case of Basel III, when finally adopted by the Federal Reserve), which may result in the need for substantial additional capital or increased levels of liquidity in the future;

 

   

changes in law or regulation that may adversely affect our, our clients’ or our counterparties’ business activities and the products or services that we sell, including additional or increased taxes or assessments thereon, capital adequacy requirements and changes that expose us to risks related to compliance;

 

   

financial market disruptions and the economic recession, whether in the U.S. or internationally;

 

   

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

 

   

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 clients do business and to which we have investment, credit or financial exposure;

 

   

the credit quality, credit agency ratings, and fair values of the securities in our investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the respective securities and the recognition of an impairment loss in our consolidated statement of income;

 

   

delays or difficulties in the execution of our previously announced global multi-year program designed to enhance our operating model, which could lead to changes in our estimates of the charges, expenses or savings associated with the planned program, resulting in increased volatility of our earnings;

 

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

 

   

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 client and deposit retention goals will not be met, that other regulatory or operational challenges will be experienced and that disruptions from the transaction will harm relationships with clients, employees or regulators;

 

   

the ability to complete acquisitions, divestitures and joint ventures, including the ability to obtain regulatory approvals, the ability to arrange financing as required and the ability to satisfy closing conditions;

 

   

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

 

   

the possibility of our clients incurring substantial losses in investment pools where we act as agent, and the possibility of significant 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;

 

   

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 prove insufficient, fail or be circumvented;

 

   

adverse publicity or other reputational harm;

 

   

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;

 

   

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 affect 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 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

 

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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.

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

The financial markets are characterized by extensive interdependencies among financial institutions, including banks, broker/dealers, collective investment funds and insurance companies. As a result of these interdependencies, we and many of our clients have concentrated counterparty exposure to other financial institutions, particularly large and complex 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 is on large institutional investors and their businesses. From time to time, we assume concentrated credit risk at the individual obligor, counterparty or guarantor level. Such concentrations may be material and can from time to time exceed 10% of our consolidated total shareholders’ equity. Our material counterparty exposures change daily, and the counterparties to which our risk exposure exceeds 10% of our consolidated total shareholders’ equity are also variable during any reported period; however, our largest exposures tend to be to other financial institutions. Further, exposure to such counterparties generally is the result of our role as agent to numerous entities affiliated with a single counterparty. These affiliated entities and our risk exposures to them also vary.

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

The instability of the financial markets since 2007 has resulted in many financial institutions becoming significantly less creditworthy, and as a result we may be exposed to increased counterparty risks, both in our role as principal and in our capacity as agent for our clients. Changes in market perception of the financial strength of particular financial institutions can occur rapidly, are often based upon a variety of factors and are 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. A counterparty default can also have adverse effects on, and financially weaken, other of our counterparties, which could also materially adversely affect our businesses and our consolidated results of operations and financial condition.

The degree of client 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 clients, the nature of the settlement process and our systems may result in the extension of short-term credit in such circumstances. For some types of clients, we provide credit to allow them to leverage their portfolios, which may expose us to potential loss if the client experiences credit difficulties. In addition to our exposure to financial institutions, we are from time to time 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 that are affiliated entities and may not be able in all circumstances to net exposures to the same legal entity across multiple products. 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.

 

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In addition, our clients 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 client 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 clients 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 client’s counterparty. In those instances, we, rather than our client, are exposed to the risks associated with counterparty default and collateral value.

We also engage in certain off-balance sheet activities that involve risks. For example, we provide benefit responsive contracts, known as wraps, to defined contribution plans that offer a stable value option to their participants. During the financial crisis, the book value of obligations under many of these contracts exceeded the market value of the underlying portfolio holdings. Concerns regarding the portfolio of investments protected by such contracts, or regarding the investment manager overseeing such an investment option, may result in redemption demands from stable value products covered by benefit responsive contracts at a time when the portfolio’s market value is less than its book value, potentially exposing us to risk of loss. Similarly, we provide credit facilities in connection with the remarketing of municipal obligations, potentially exposing us to credit exposure to the municipalities issuing such bonds and to increased liquidity demands. In the current economic environment, where municipal credits are subject to increased investor concern, the risks associated with such businesses increase. Further, our off-balance sheet activities also include indemnified securities financing obligations, where we indemnify our clients against losses they incur in connection with the failure of borrowers under our program to return securities on loan. Finally, certain of our clients reinvest cash collateral in repurchase arrangements, and we may indemnify such clients against counterparty default.

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

Our business involves significant European operations, and disruptions in European economies could have a material adverse effect on our operations or financial performance.

The financial markets remain concerned about the ability of certain European countries, particularly Greece, Ireland and Portugal, but also others such as Spain and Italy, to finance their deficits and service growing debt burdens amidst difficult economic conditions. This loss of confidence has led to rescue measures for Greece and Ireland by Euro-zone countries and the International Monetary Fund. The actions required to be taken by those countries as a condition to rescue packages, and by other countries to mitigate similar developments in their economies, have resulted in increased political discord within and among Euro-zone countries. The interdependencies among European economies and financial institutions have also exacerbated concern regarding the stability of European financial markets generally and certain institutions in particular. Given the scope of our European operations, clients and counterparties, persistent disruptions in the European financial markets, the attempt of a country to abandon the Euro, the failure of a significant European financial institution, even if not an immediate counterparty to us, or persistent weakness in the Euro, could have a material adverse impact on our operations or financial performance.

Our investment portfolio and financial condition could be adversely affected by changes in various interest, market and credit risks.

Our investment portfolio represented approximately 59% of our consolidated total assets as of December 31, 2010, and the interest revenue associated with our investment portfolio represented approximately 31% of our consolidated total gross revenue for the year ended December 31, 2010. As such, our consolidated

 

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results of operations and financial condition are materially exposed to the risks associated with our investment portfolio, including, without limitation, changes in interest rates, credit spreads, credit performance, credit ratings, access to liquidity, mark-to-market valuations and our ability to reinvest repayments of principal with respect to portfolio securities. Relative to many other major financial institutions, investment securities represent a greater percentage of our consolidated balance sheet and commercial loans represent a smaller percentage. Our investment portfolio continues to have significant concentrations in certain classes of securities, including non-agency residential mortgage-backed securities, commercial mortgage-backed securities and other asset-backed securities and securities with concentrated exposure to consumers. These classes and types of securities experienced significant liquidity, valuation and credit quality deterioration during the financial disruption that began in mid-2007. We also have material holdings of non-U.S. mortgage-backed and asset-backed securities with exposures to European countries whose sovereign debt markets have, to varying degrees, been under stress over the past year and may continue to experience stress in the future. For further information, see the risk factor above titled “Our business involves significant European operations, and disruptions in European economies could have a material adverse effect on our operations or financial performance.”

Further, we hold a portfolio of state and municipal bonds; in view of the budget deficits that most states and many municipalities are currently incurring due to the continued depressed economic environment, the risks associated with this portfolio have increased. If market conditions similar to those experienced in 2007 and 2008 were to return, our portfolio could experience a decline in liquidity and market value, regardless of our credit view of our portfolio holdings. For example, we recorded significant non-credit losses in connection with the consolidation of our off-balance sheet asset-backed commercial paper conduits in 2009 and the repositioning of our investment portfolio in 2010 with respect to these asset classes. In addition, deterioration in the credit quality of our portfolio holdings could result in other-than-temporary impairment. Our investment portfolio is further subject to changes in both domestic interest rates and foreign interest rates (primarily in Europe) and could be negatively impacted by rising interest rates. In addition, while the securities in our investment portfolio are primarily rated “AAA” or “AA,” if a material portion of our investment portfolio were to experience rating declines below investment grade, our capital ratios under the requirements of Basel II and Basel III could be adversely affected, which risk is greater with portfolios of investment securities than with loans or holdings of Treasury securities.

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, and our net interest revenue is affected by 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. Our ability to anticipate these changes or to hedge the related on- and off-balance sheet exposures 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 as well as the currencies in which they are denominated. Sustained lower interest rates, a flat or inverted yield curve and narrow interest-rate spreads generally have a constraining effect on our net interest revenue. In particular, if short-term interest rates rise, our net interest revenue is likely to decline, and any such decline could be material.

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 clients 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. If clients demand a return of their cash or assets, particularly on limited notice, and our investment portfolio does not have the liquidity to support those demands, we could be forced to sell investment securities at unfavorable prices.

 

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If we are unable to continuously attract deposits and other short-term funding, our 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 client base. We generally use our sources of funds to:

 

   

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

 

   

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

 

   

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

Because the demand for credit by our clients 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 client 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 client 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 deposits and the perception of safety of those deposits or short-term obligations relative to alternative short-term investments available to our clients, including 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 for us to invest our available liquidity, which has adversely affected the rate of return that we have earned on these assets, which could harm our ability to attract client 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.

The global recession and financial crisis that began in mid-2007 have adversely affected us and increased the uncertainty and unpredictability we face in managing our businesses. Continued or additional disruptions in the global economy or financial markets could further adversely affect our business and financial performance.

Our businesses have been significantly affected by global economic conditions and their impact on financial markets. Since mid-2007, global credit and other financial markets have suffered from substantial volatility, illiquidity and disruption as a result of the global recession and financial crisis. The resulting economic pressure and lack of confidence in the financial markets have adversely affected our business, as well as the businesses of our clients and significant counterparties. These events, and the potential for continuing or additional disruptions, have also affected overall confidence 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 businesses and have had an adverse effect on our consolidated results of operations and our financial condition. While global economies and financial markets have shown initial signs of stabilizing, the occurrence of additional disruptions in, or a worsening of, global markets or economic conditions could adversely affect our businesses and the financial services industry in general.

Market disruptions can adversely affect our revenue if the value of assets under custody, administration or management decline, while the costs of providing the related services remain constant due to the fixed nature of

 

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such costs. These factors can reduce our asset-based fee revenue and could adversely affect our other transaction-based revenue, such as revenues from securities finance and foreign exchange activities, and the volume of transactions that we execute for or with our clients, 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 exchange trading revenue. In general, increased currency volatility tends to increase our market risk but also our foreign exchange revenue. Conversely, periods of lower currency volatility tend to decrease market risk and our foreign exchange revenue.

In addition, as our business grows globally and as a greater percentage of our revenue is earned in currencies other than U.S. dollars, our exposure to foreign currency volatility could affect our levels of consolidated revenue, our expenses and our consolidated results of operations, as well as the value of our investment in our non-U.S. operations and our investment portfolio holdings. As our product offering within our Global Markets businesses expands, in part to seek to take advantage of perceived opportunities arising under various regulatory reforms and resulting market changes, our exposure to volatility in currencies and interest rates may increase, potentially resulting in greater revenue volatility in our trading businesses. We also may need to make additional investments to enhance our risk management capabilities to support these businesses, which may increase the operating expenses of such businesses or, if our risk management resources fail to keep pace with product expansion, result in increased risk of loss from our trading businesses.

We face extensive and changing government regulation, including changes to capital requirements under the Dodd-Frank Act, Basel II and Basel III, 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 clients 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. The regulations affect, among other things, the scope of our activities and client services, our capital structure and our ability to fund the operations of our subsidiaries, our lending practices, our dividend policy, the manner in which we market our services and our interactions with foreign regulatory agencies and officials, for example, as a result of the Foreign Corrupt Practices Act.

The Dodd-Frank Act, which became law in July 2010, will have a significant impact on the regulatory structure of the financial markets and will impose additional costs on us. It also could adversely affect certain of our business operations and competitive position, or those of our clients. The Dodd-Frank Act, among other things, establishes a new Financial Stability Oversight Council to monitor systemic risk posed by financial institutions, restricts proprietary trading and private fund investment activities by banking institutions, creates a new framework for the regulation of derivatives, alters the regulatory capital treatment of trust preferred securities and other hybrid capital securities and revises the FDIC’s assessment base for deposit insurance. Provisions in the Dodd-Frank Act may also restrict the flexibility of financial institutions to compensate their employees. In addition, provisions in the Dodd-Frank Act may require changes to the existing Basel II capital rules or affect their interpretations by institutions or regulators, which could have an adverse effect on our ability to comply with Basel II regulations, our business operations, capital structure, capital ratios or financial performance. The final effects of the Dodd-Frank Act on our business will depend largely on the implementation of the Act by regulatory bodies and the exercise of discretion by these regulatory bodies.

In addition, rapid regulatory change is occurring internationally with respect to financial institutions, including, but not limited to, the implementation of Basel III and the Alternative Investment Fund Managers Directive and the potential adoption of the EU derivatives initiatives and revisions to the European collective investment fund, or UCITS, directive. Among current regulatory developments are proposed rules to enhance the responsibilities of custodians to their clients for asset losses. The Dodd-Frank Act and these other international regulatory changes could limit our ability to pursue certain business opportunities, increase our regulatory capital requirements and impose additional costs on us, and otherwise adversely affect our business operations and have other negative consequences, including a reduction of our credit ratings. Different countries may respond to the

 

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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, including under Basel III and the Dodd-Frank Act, may have unforeseen or unintended adverse effects on the financial services industry. 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 our 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 clients 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 clients. If we cause clients 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.

Our business may be adversely affected upon our implementation of the revised capital requirements under Basel II Capital Rules, Basel III and the Dodd-Frank Act or in the event our capital structure is determined to be insufficient as a result of mandated stress testing.

We are currently in the qualification period that is required to be completed prior to our full implementation of the Basel II capital rules. During the qualification period we must demonstrate that we comply with the Basel II requirements to the satisfaction of the Federal Reserve. During or subsequent to this qualification period, the Federal Reserve may determine that we are not in compliance with certain aspects of the regulation and may require us to take certain actions to come into compliance that could adversely affect our business operations, capital structure, capital ratios or financial performance. In addition, regulators could change the Basel II capital rules or their interpretations as they apply to State Street, potentially due to the rulemaking associated with certain provisions of the Dodd-Frank Act, which could adversely affect us and our ability to comply with Basel II.

Basel III, the Dodd-Frank Act and the regulatory rules to be adopted for the implementation of Basel III and the Dodd-Frank Act will result in an increase in the minimum levels of capital and liquidity that we will be required to maintain and changes in the manner in which our capital ratios are calculated. In addition, we are required by the Federal Reserve to conduct periodic stress testing of our business operations, and our capital structure and liquidity management are subject to periodic review and stress testing by the Federal Reserve, which is used by the Federal Reserve to evaluate the adequacy of our capital and the potential requirement to maintain capital levels in addition to regulatory minimums. Banking regulators have not yet issued final rules and guidance for our implementation of the revised capital and liquidity rules under Basel III and the Dodd-Frank Act. Consequently, we cannot determine at this time the alignment of our regulatory capital and our business operations with the regulatory capital requirements to be implemented. Our implementation of the new capital requirements may not be approved by the Federal Reserve and the Federal Reserve may impose capital requirements in excess of our expectations, and maintenance of high levels of liquidity may adversely affect our revenues. In the event our implementation of the new capital requirements under Basel III and the Dodd-Frank Act or our current capital structure are determined not to conform with current and future capital requirements,

 

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our ability to deploy capital in the operation of our business or our ability to distribute capital to shareholders may be constrained and our business may be adversely affected.

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 ratings were 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 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 clients or counterparties or may have other adverse reputational effects.

Additionally, our counterparties, as well as our clients, 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 the effects of 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 clients may reduce or place limits upon the level of services we provide them or seek other service providers and our prospective clients 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 clients, on our or our clients’ behalf, will be materially compromised. If our clients reduce their deposits with us or select other service providers for all or a portion of the services we provide them, our revenues will decrease accordingly.

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.

We may need to raise additional capital in order to maintain our credit ratings, in response to changes in regulatory capital rules or for other purposes, including to finance acquisitions. However, our ability to access the capital markets, if needed, will depend on a number of factors, including the state of the financial markets. In the event of rising interest rates, disruptions in financial markets, negative perception of our business and financial strength, or other factors that would increase our cost of borrowing, we cannot be sure of our ability to raise additional capital, if needed, on terms acceptable to us, which could adversely affect our business and ability to implement our business plan and strategic goals, including the financing of acquisitions.

Our businesses may be adversely affected by litigation.

From time to time, our clients, or the government on their behalf, may make claims and take legal action relating to, among other things, our performance of fiduciary or contractual responsibilities. 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 client 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

 

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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.

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 against 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 period in which such actions or matters are resolved or a reserve is established.

We may incur losses, which could be material to our financial performance 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 those which we believe to be due.

For example, in connection with the resolution of our obligations pursuant to the repurchase agreements between our clients in the U.S. and a Lehman entity, we indemnified our clients against loss and assumed our clients’ rights with respect to collateral consisting of direct and indirect 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 on 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, certain of our clients 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 clients 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 the 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 on 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 the collateral supporting repurchase agreements and applied excess collateral supporting Lehman’s obligations under securities lending

 

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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 are 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.

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

In our capacity as manager and trustee, we appointed Lehman as prime broker for certain common trust funds. Of the seven investors in these funds, one has obtained a judgment against us, we have entered into a settlement agreement with another and four others have commenced litigation against us. The aggregate net asset value, at September 15, 2008 (the date two of the Lehman entities involved entered into insolvency proceedings), of cash and securities held by Lehman entities attributable to clients with whom we have not resolved claims was approximately $170 million. The claims of these clients should be reduced by the value of the distributions from the Lehman entities to these common trust funds, which amounts cannot be determined at this time. 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.

We face litigation and governmental and client inquiries in connection with our provision of foreign exchange services to custody clients.

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 certain California state pension plans. The California Attorney General has asserted 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 has asserted actual damages of $56 million for periods from 2001 to 2007 and seeks additional penalties, including treble damages. We provide custody and principal foreign exchange services to government pension plans in other jurisdictions, and attorneys general from a number of these other jurisdictions, as well as U.S. Attorney’s offices, have requested information or issued subpoenas in connection with inquiries into our foreign exchange pricing. We have entered into a settlement with respect to our foreign exchange services to the State of Washington, to which we had contractual obligations different from those owed to the California state pension plans.

Litigation concerning foreign exchange pricing could have a material impact on our reputation and on our future revenues. 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. We are responding to information requests from other clients. Two clients have commenced litigation with respect to our foreign exchange services, including a putative class action filed in Massachusetts in February 2011 that seeks unspecified damages on behalf of all custodial clients that executed foreign exchange transactions through State Street. There can be no assurance as to the outcome of the pending proceedings in California or Massachusetts or any other proceedings that might be commenced against us by any other Attorneys General or clients, and the resolution of any such proceedings could have a material adverse effect on our future consolidated results of operations. In light of the action commenced by the California Attorney General, we are providing clients with more information about the way that we set the rates for this product and the alternatives offered by us for addressing foreign exchange requirements. Although we believe this disclosure will address client interests for increased information, over time it could result in pressure on our pricing of these services or result in clients electing other foreign exchange execution options, which would have an adverse impact on the revenue from, and profitability of, these services for us.

 

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

Our management of collective investment pools on behalf of clients exposes us to reputational risk and, in some cases, operational losses. If our clients incur 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), receive redemptions as in-kind distributions rather than in cash, or experience significant underperformance relative to the market or our competitors’ products, our reputation could be significantly harmed, which harm could significantly and adversely affect the prospects of our associated business units. 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 to support our reputation in circumstances where we are not statutorily or contractually obligated to do so 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 clients.

We may be exposed to client claims, financial loss, reputational damage and regulatory scrutiny in connection with our securities lending programs.

A portion of the cash collateral received by clients under our securities lending program is invested in cash collateral pools that we manage. Interests in these cash collateral pools are held by unaffiliated clients 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.

The net asset values of our collateral pools have been below $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 agency 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.

SSgA lending funds. From 2007 until June 2010, the net asset value of the assets held by the collateral pools underlying the SSgA lending funds declined below $1.00 per unit; however, the SSgA lending funds continued to transact purchase and sale transactions with these collateral pools at $1.00 per unit. In response to market conditions following the Lehman bankruptcy, SSgA limited cash redemptions from the lending funds commencing in 2008. In June 2010, at our election we made a one-time cash contribution of $330 million to the collateral pools and liquidity trusts underlying the SSgA lending funds that restored the net asset value per unit of such collateral pools to $1.00 as of the date of such contribution and allowed us to eliminate the restrictions on redemption from the SSgA lending funds. These actions contributed to the pre-tax charge of $414 million in the second quarter of 2010 ($330 million plus $9 million of associated costs and the $75 million reserve discussed on page 20), which was recorded in our consolidated statement of income.

Agency lending collateral pools. Similarly, in 2007, the net asset value of the assets held by the agency lending collateral pools declined below $1.00 per unit. The agency lending collateral pools 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 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 pools’ assets arose, depending upon the collateral pool, at various points since the commencement of the financial crisis in mid-2007 and has declined but persisted throughout 2008, 2009 and 2010. In 2008, we imposed restrictions on cash redemptions from the agency lending collateral pools.

 

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Because of differences between the two lending programs, we did not make a cash contribution to the agency lending collateral pools in June 2010, as we did with respect to the SSgA lending funds. In December 2010, in order to increase participants’ control over the degree of their participation in the lending program, we divided certain agency lending collateral pools into liquidity pools, from which clients can obtain cash redemptions, and duration pools, which are restricted and operate as liquidating accounts. Depending upon the agency lending collateral pool, the percentage of the collateral pool’s assets that were represented by interests in the liquidity pool varied as of such division date from 58% to 84%.

The following table shows the aggregate net asset values of our unregistered cash collateral pools underlying the agency lending program at December 31, 2010, 2009, 2008 and 2007, based on a constant net asset value of $1.00 per unit:

 

(In billions)    December 31, 2010      December 31, 2009      December 31, 2008      December 31, 2007  

Agency lending collateral pools

   $ 49       $ 85       $ 85       $ 150   

Additionally, the table below indicates 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 (including, for December 31, 2010, the net asset value of the duration pools) underlying the agency lending program for the periods ending December 31, 2010, 2009, 2008 and 2007:

 

     December 31, 2010     December 31, 2009     December 31, 2008     December 31, 2007  
     Range     Weighted
Average
    Range     Weighted
Average
    Range     Weighted
Average
    Range     Weighted
Average
 

Agency lending collateral pools

  $ 0.91 to $1.00      $ 0.993      $ 0.93 to $1.00      $ 0.986      $ 0.92 to $1.00      $ 0.941      $ 0.99 to $1.00      $ 0.993   

As of December 31, 2010, the aggregate net asset value of the duration pools was approximately $11.8 billion, and as of such date the range of net asset values of such pools was $0.91 to $0.99 per unit. The return obligations of participants in the agency lending program represented by interests in the duration pools exceeded the market value of the assets in the duration pools by approximately $319 million, which amount is expected to be eliminated as the assets in the duration pools mature or amortize.

We may incur losses, which could be material to our consolidated results of operations in the period incurred, as a result of our past practice of effecting purchase and redemptions of interests in the collateral pools based upon a consistent $1.00 per unit net asset value during periods when those pools had a market value of less than $1.00 per unit.

We believe that our practice of effecting purchases and redemptions of units of the collateral pools at $1.00 per unit, notwithstanding that the underlying portfolios have a market value of less than $1.00 per unit, was in compliance with the terms of our unregistered cash collateral pools and in the best interests of participants in the agency lending program and the SSgA lending funds. We continued this practice until June 30, 2010 for the SSgA lending funds and until the end of 2010 for the agency lending collateral pools for a number of reasons, including that none of the securities in the cash collateral pools were in default or considered to be materially impaired, and that the collective investment funds restricted withdrawals.

Although the market value of the assets in the collateral pools improved during 2009 and 2010, a portion of these assets are floating rate instruments with several years of remaining maturity; consequently, the rate of valuation improvement for the duration pools is likely to slow in 2011 or the market value may decline again as a result of changes in market sentiment or in the credit quality of such instruments. In addition, the assets of the liquid pools are currently insufficient to satisfy in full the obligations of participants in the agency lending program to return cash collateral to borrowers. Participants in the agency lending program who received units of the duration pool, or who previously received in-kind redemptions from the agency lending collateral pools, could seek to assert claims against us in connection with either their loss of liquidity or unrealized mark-to-market losses. If such claims were successfully asserted, such a resolution could adversely affect our results of operations in future periods.

 

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The SEC is conducting an inquiry into the management of our securities lending program and disclosures made to agency 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 and the redemption policy applicable to agency lending participants. 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 agency lending program referred to below, 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 Security Act, or ERISA. 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, and breaches of ERISA with respect to compensation paid to us for the operation of the securities lending program on behalf of the SSgA lending funds. A determination by the SEC or any other regulatory authority to commence an enforcement proceeding with regard to our agency 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 on our securities lending operations or the operations of SSgA, on our consolidated results of operations or on our reputation.

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 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 interests of all participants in the agency 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 clients and the financial performance of our agency lending operation. We established a $75 million reserve on June 30, 2010 (part of the $414 million charge discussed on page 18) to address potential inconsistencies in connection with our implementation of those redemption restrictions prior to May 31, 2010. The reserve, which still existed as of December 31, 2010, reflects our assessment, as of the same date, of the amount required to compensate clients for the dilutive effect of redemptions which may not have been consistent with the intent of the policy; however, there can be no assurance that participants in the agency lending program will not assert additional damages as a result of the implementation or existence of the redemption restrictions.

Despite these redemption restrictions, one significant participant in the agency lending program redeemed a substantial portion of its interest in a collateral pool 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 the participant 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 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.

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

We manage assets on behalf of clients in several forms, including in collective investment pools, money market funds, securities finance collateral pools, cash collateral and other cash products and short-term

 

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investment funds. In addition to the impact on the market value of client portfolios, at various times since 2007 the illiquidity and volatility of both the global fixed-income and equity markets have negatively affected our ability to manage client 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 clients 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 clients.

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, declined dramatically, and providing liquidity to meet all client demands in these investment pools without adversely affecting the return to non-withdrawing clients became more difficult. For clients 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 client 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 implemented limitations, which were terminated in 2010, on the portion of an investor’s interest in such fund that may be withdrawn during 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 clients were to return to post-Lehman-bankruptcy levels or increase, managing the liquidity requirements of our collective investment pools could become more difficult 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 clients 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 selling the assets held by the fund at a reasonable price, if at all, may then be difficult.

Alternatively, although we have no such obligations or arrangements currently in place, we have in the past guaranteed, and may in the future guarantee, liquidity to investors desiring to make withdrawals from a fund, and making a significant amount of such guarantees could adversely affect our own liquidity and 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 clients. The extreme volatility in the equity markets has led to potential for the return on passive and quantitative products deviating from their target returns. The temporary closures of securities exchanges in certain markets create a risk that client 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.

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

Our relationship with many of our clients 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 client 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 clients 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 client expectations. If any of these developments has a material effect on our reputation, our business will suffer.

 

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We may not be successful in implementing our announced multi-year program to transform our operating model.

In order to maintain and grow our business, we must continuously make strategic decisions about our current and future business plans, including plans to target cost initiatives and enhance operational efficiencies, 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. On November 30, 2010, we announced a multi-year program to enhance service excellence and innovation, increase efficiencies and position us for accelerated growth.

Operating model transformations, including this program, entail significant risks. The program, and any future strategic or business plan we implement, may prove to be inadequate for the achievement of the stated objectives, may result in increased or unanticipated costs, may result in earnings volatility, may take longer than anticipated to achieve and may not be successfully implemented. In particular, elements of the program include investment in new technologies, such as private processing clouds, to increase global computing capabilities, and also the development of new, and the evolution of existing, methods and tools to accelerate the pace of innovation, the introduction of new services and solutions and the security of our systems. The transition to new operating models and technology infrastructure may cause disruptions in our relationships with clients and employees and may present other unanticipated technical or operational hurdles. The success of the program and our other strategic plans could also be affected by continuing market disruptions and unanticipated changes in the overall market for financial services and the global economy. We also may not be able to abandon or alter these plans without significant loss, as the implementation of our decisions may involve significant capital outlays, often far in advance of when we expect to generate any related revenues. Accordingly, our business, our consolidated results of operations and our consolidated financial condition may be adversely affected by any failure or delay in our strategic decisions, including the program. For additional information about the program, see the “Consolidated Results of Operations — Expenses” section of Management’s Discussion and Analysis, included under Item 7, and note 9 to the consolidated financial statements included under Item 8.

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 and other data, 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 non-U.S. 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 locations, such as Poland, India and China, and by 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 client 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 client 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.

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

 

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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.

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

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. These markets are changing as a result of new and evolving laws and regulations applicable to financial services institutions. Regulatory-driven market changes cannot always be anticipated, and may adversely affect the demand for, and profitability of, the products and services that we offer. In addition, new market entrants and competitors may address changes in the markets more rapidly than us, or may provide customers with a more attractive offering of products and services, adversely affecting our business. We have also 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 clients, and the retention of these clients 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 client after a short notice period. In addition, pricing pressures as a result of the activities of competitors, client 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.

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. In January 2011, we completed our acquisition, for cash, of Bank of

 

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Ireland Asset Management, or BIAM, and during 2010 we completed our acquisition of 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. We undertake transactions such as these to, among other reasons, expand our geographic footprint, access new clients, 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, tax, 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, we may not achieve anticipated cost savings or we may otherwise be adversely affected by acquisition-related charges. Further, past acquisitions, including the acquisitions of Intesa, MIFA and BIAM, have resulted in the recording of goodwill and other significant intangible assets on our consolidated statement of condition. These assets are not eligible for inclusion in regulatory capital under current proposals, and we may be required to record impairment in our consolidated statement of income in future periods if we determine that we will not realize the value of these assets. Through our acquisitions we may also assume unknown or undisclosed business, operational, tax, regulatory and other 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 due diligence we have conducted is adequate or that the indemnification provisions and other risk mitigants we put in place will be sufficient.

Various regulatory approvals or consents are generally required prior to closing of acquisitions and, which may include approvals of the Federal Reserve and other domestic and non-U.S. 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, or cross-sell our products or services to, the clients of acquired companies. Acquisitions of investment servicing businesses entail information technology systems conversions, which involve operational risks and may result in client dissatisfaction and defection. Clients of asset servicing businesses that we have acquired may be competitors of our non-custody businesses. The loss of some of these clients 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 clients and employees or to achieve the anticipated benefits of the acquisition. Integration efforts may also divert management attention and resources.

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,

 

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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 clients 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 clients. 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.

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 clients, 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 client 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 clients’ management, whether due to general declines in the securities markets or client-specific issues. In addition, the profitability of these arrangements may be based on our ability to cross sell additional services to these clients, 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 client. 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

 

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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 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 clients, vendors and counterparties could suffer from such events. Should these events affect us, or the clients, 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.

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

New accounting standards, including the potential adoption of International Financial Reporting Standards, or changes in the interpretation of existing accounting standards, by the Financial Accounting Standards Board, the International 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. 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.

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 clients are dependent upon our ability to maintain the confidentiality of our and our clients’ trade secrets and confidential information (including client transactional data and personal data about our employees, our clients and our clients’ clients). 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 clients and our reputation and could subject us to regulatory inquiries and enforcement, civil litigation and possible financial liability or costs.

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,

 

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hedging, asset and liability management and whether to change business strategy. In all of these uses, errors in the underlying model or model assumptions, or inadequate model assumptions, 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 may incur losses as a result of unforeseen events, including terrorist attacks, the emergence of a pandemic or acts of embezzlement.

Acts of terrorism or the emergence of a pandemic could significantly affect our business. We have instituted disaster recovery and continuity plans to address risks from terrorism and pandemic; however, forecasting or addressing all potential contingencies is not possible for events of this nature. Acts of terrorism, either targeted or broad in scope, could damage our physical facilities, harm our employees and disrupt our operations. A pandemic, or concern about a possible pandemic, could lead to operational difficulties and impair our ability to manage our business. Acts of terrorism and pandemics could also negatively affect our clients and counterparties, as well as result in disruptions in general economic activity and the financial markets.

Terrorism may also take the form of the theft or misappropriation of property, confidential information or financial assets. Due to our role as a financial services institution, our businesses are already subject to similar risks of theft, misappropriation and embezzlement with respect to our and our clients’ property, information and assets. Our employees and contractors and other partners have access to our facilities and internal systems and may seek to create the opportunity to engage in these activities. In the event our controls and procedures to prevent theft, misappropriation or embezzlement fail or are circumvented, our business would be negatively affected by, among other things, the related financial losses, diminished reputation and threat of litigation and regulatory inquiry and investigation.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

ITEM 2. PROPERTIES

We occupy a total of approximately 9.0 million square feet of office space and related facilities around the world, of which approximately 8.1 million square feet are leased. Of the total leased space, approximately 3.2 million square feet are located in eastern Massachusetts. An additional 2.2 million square feet are located elsewhere throughout the U.S. and in Canada. We lease approximately 2.0 million square feet in the U.K. and elsewhere in Europe, and approximately 725,000 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 (677,000 square feet owned and 380,000 square feet leased), function as State Street Bank’s principal operations facilities.

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 provided in note 20 to the consolidated financial statements included under Item 8.

 

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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. To the extent that we have established balance sheet reserves for probable loss contingencies, such reserves may not be sufficient to cover our ultimate financial exposure associated with any settlements or judgments. 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. Except where otherwise noted below, we have not recorded a reserve with respect to the claims discussed and do not believe that potential exposure, if any, as to any matter discussed can be reasonably estimated.

As previously reported, the SEC has requested information regarding registered mutual funds managed by SSgA that invested in sub-prime securities. 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. During the course of our responding to such inquiry, certain potential compliance issues have been identified and are in the process of being resolved with the SEC staff. These funds were not covered by our regulatory settlement with the SEC, the Massachusetts Attorney General and the Massachusetts Securities Division of the Office of the Secretary of State announced in February 2010, which concerned certain unregistered SSgA-managed funds that pursued active fixed-income strategies. Four lawsuits by individual investors in those active fixed-income strategies remain pending. The U.S. Attorney’s office in Boston has also requested information in connection with our active-fixed income strategies.

We are currently defending a putative ERISA class action by investors in unregistered SSgA-managed funds which challenges the division of our securities lending-related revenue between the SSgA lending funds and State Street in its role as lending agent. Another putative ERISA class action relating to such unregistered funds was voluntarily dismissed in February 2011.

As previously reported, two related participants in our agency securities lending program have brought suit against us challenging actions taken by us in response to their withdrawal from the program. We believe that certain withdrawals by these participants were inconsistent with the redemption policy applicable to the agency lending collateral pools and, consequently, redeemed their remaining interests through an in-kind distribution that reflected the assets these participants would have received had they acted in accordance with the collateral pools’ redemption policy. The participants have asserted damages of $120 million, an amount that plaintiffs have stated was the difference between the amortized cost and market value of the assets that State Street proposed to distribute to the plans in-kind in or about August 2009. While management does not believe that such difference is an appropriate measure of damages, as of September 30, 2010, the last date on which State Street acted as custodian for the participants, the difference between the amortized cost and market value of the in-kind distribution was approximately $49 million. In taking these actions, we believe that we acted in the best interests of all participants in the collateral pools. We have not established a reserve with respect to this litigation.

We instituted redemption restrictions with respect to our agency lending collateral pools in the fall of 2008 during the disruption in the financial markets. As previously reported, we established a $75 million reserve on June 30, 2010 to address potential inconsistencies in connection with our implementation of those redemption restrictions. The reserve, which still existed as of December 31, 2010, reflects our assessment, as of the same date, of the amount required to compensate clients for the dilutive effect of redemptions which may not have been consistent with the intent of the policy. For a discussion of the aggregate net assets and net asset values per unit at December 31, 2010 of the agency lending collateral pools and our division of such collateral pools into

 

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liquidity and duration pools, see the “Consolidated Results of Operations—Fee Revenue—Securities Finance” section of Management’s Discussion and Analysis included under Item 7.

We continue to cooperate with the SEC in its investigation with respect to the SSgA lending funds and the agency lending program. Neither the civil proceedings described above nor the SEC investigation have been terminated as a result of our one-time $330 million cash contribution to the cash collateral pools and liquidity trusts underlying the SSgA lending funds or the above-described establishment of the $75 million reserve, and the outcome of those matters cannot be assured.

As previously reported, 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 governed by the custody contracts for these plans and that our pricing was not consistent with the terms of those 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. We provide custody and principal foreign exchange services to government pension plans in other jurisdictions, and attorneys general from a number of these other jurisdictions, as well as U.S. Attorney’s offices, have requested information or issued subpoenas in connection with inquiries into our foreign exchange pricing. In October 2010, we entered into a $12 million settlement with the State of Washington. This settlement resolves a contract dispute related to the manner in which we priced some foreign exchange transactions during our ten-year relationship with the State of Washington that ended in 2007. Our contractual obligations to the State of Washington were significantly different from those presented in our ongoing litigation in California. In addition, we are responding to information requests from other clients with respect to our foreign exchange services. Two clients have commenced litigation against us, including a putative class action filed in February 2011 in federal court in Boston that seeks unspecified damages, including treble damages, on behalf of all custodial clients that executed foreign exchange transactions through State Street. The putative class action alleges, among other things, that the rates at which State Street executed foreign currency trades constituted an unfair and deceptive practice and a breach of the duty of loyalty.

Three shareholder-related class action complaints are currently pending in federal court in Boston. One complaint purports to be brought on behalf of State Street shareholders. The two other complaints purport to be brought on behalf of participants and beneficiaries in the State Street Salary Savings Program who invested in the program’s State Street common stock investment option. The complaints variously 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 conduit 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 funds that were the subject of the February 2010 settlement with the SEC referred to above. In January 2011, the trial court granted State Street’s motion to dismiss the complaint based on the Board of Directors’ consideration and rejection of the shareholders’ original demand letter.

As previously reported, we managed, through SSgA, four common trust funds for which, in our capacity as manager and trustee, we appointed various Lehman entities 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 clients 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 clients 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 clients, one of which was entered into after the client obtained a €42 million judgment from a Dutch court. As of September 15, 2008, the five clients with whom we have not entered into settlement agreements had approximately $170 million invested in the funds at issue.

 

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ITEM 4. REMOVED AND RESERVED

EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information with regard to each of our executive officers as of February 25, 2011.

 

Name

   Age     

Position

Joseph L. Hooley

     53       Chairman, President and Chief Executive Officer

Joseph C. Antonellis

     56       Vice Chairman

Jeffrey N. Carp

     54       Executive Vice President, Chief Legal Officer and Secretary

John L. Klinck, Jr.

     47       Executive Vice President

Andrew Kuritzkes

     50       Executive Vice President and Chief Risk Officer

James J. Malerba

     56       Executive Vice President, Corporate Controller and Chief Accounting Officer

David C. O’Leary

     64       Executive Vice President and Chief Administrative Officer

James S. Phalen

     60       Executive Vice President

David C. Phelan

     53       Executive Vice President, General Counsel and Assistant Secretary

Scott F. Powers

     51       President and Chief Executive Officer of State Street Global Advisors

David W. Puth

     54       Executive Vice President

Alison A. Quirk

     48       Executive Vice President

Edward J. Resch

     58       Executive Vice President and Chief Financial Officer

Michael F. Rogers

     53       Executive Vice President

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. Hooley joined State Street in 1986 and has served as our President and Chief Executive Officer since March 2010, prior to which he had 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, and he was appointed Chairman of the Board effective January 1, 2011.

Mr. Antonellis joined State Street in 1991 and has served as head of all Europe and Asia/Pacific Global Services and Global Markets businesses since March 2010. Prior to this, 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.

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. Mr. Carp served as interim Chief Risk Officer from February 2010 until September 2010.

Mr. Klinck joined State Street in 2006 and has served as Executive Vice President and global head of Corporate Development and Global Relationship Management since March 2010, prior to which he served as Executive Vice President and global head of Alternative Investment Solutions. 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.

 

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Mr. Kuritzkes joined State Street in 2010 as Executive Vice President and Chief Risk Officer. Prior to joining State Street, Mr. Kuritzkes was a partner at Oliver, Wyman & Company, an international management consulting firm, and led the firm’s Public Policy practice in North America. He joined Oliver, Wyman & Company in 1988, was a managing director in the firm’s London office from 1993 to 1997, and served as vice chairman of Oliver, Wyman & Company globally from 2000 until the firm’s acquisition by MMC in 2003. From 1986 to 1988, he worked as an economist and lawyer for the Federal Reserve Bank of New York.

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 and has served as Executive Vice President and Chief Administrative Officer since March 2010. Prior to that, Mr. O’Leary served 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.

Mr. James Phalen joined State Street in 1992 and has served as Executive Vice President and head of Global Operations, Technology and Product Development since March 2010. Prior to that, starting in 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 SSgA, following which he returned to his role as head of international operations for Investment Servicing and Investment Research and Trading.

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 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 2001 through 2008.

Mr. Puth joined State Street in 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.

Ms. Quirk joined State Street in 2002 and has served as Executive Vice President and head of Global Human Resources since March 2010. Prior to that, Ms. Quirk served as Executive Vice President in Global Human Resources and held various senior roles in that group.

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.

Mr. Rogers joined State Street in 2007 as part of our acquisition of Investors Financial Services Corp., and he has served as Executive Vice President and head of Global Services, including alternative investment solutions, for all of the Americas since March 2010. Mr. Rogers was previously head of the Relationship Management group, a role which he 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 3,878 shareholders of record as of January 31, 2011. 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, included under Item 7, and in note 13 to the 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.

In 2009, in light of the continued disruption in the global capital markets experienced since the middle of 2007, and as part of a plan to strengthen our tangible common equity, we announced a reduction of our quarterly dividend on our common stock to $0.01 per share. Currently, any increase in our common stock dividend requires the prior approval of the Federal Reserve. 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, included under Item 7, and in note 16 to the 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, 2006 and ended December 31, 2010. The cumulative total shareholder return assumes the investment of $100 in State Street common stock and in each index on December 31, 2005, and also assumes reinvestment of dividends. The S&P Financial Index is a publicly available measure of 81 of the Standard & Poor’s 500 companies, representing 27 diversified financial services companies, 22 insurance companies, 16 banking companies and 16 real estate companies.

Comparison of Five-Year Cumulative Total Shareholder Return

LOGO

 

     2005      2006      2007      2008      2009      2010  

State Street Corporation

   $ 100       $ 123       $ 150       $ 74       $ 82       $ 88   

S&P 500 Index

     100         116         122         77         97         112   

S&P Financial Index

     100         119         97         43         51         57   

 

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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:    2010     2009     2008     2007     2006  

Total fee revenue

   $ 6,540      $ 5,935      $ 7,747      $ 6,633      $ 5,186   

Net interest revenue

     2,699        2,564        2,650        1,730        1,110   

Gains (Losses) related to investment securities, net(1)

     (286     141        (54     (27     15   

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

                   350                 
                                        

Total revenue

     8,953        8,640        10,693        8,336        6,311   

Provision for loan losses

     25        149                        

Expenses:

          

Expenses from operations

     6,176        5,667        6,780        5,768        4,540   

Provisions for legal exposure, net(2)

            250               467          

Securities lending charge

     414                               

Provision for investment account infusion

                   450                 

Restructuring charges

     156               306                 

Provision for indemnification exposure

                   200                 

Merger and integration costs and U.K. bonus tax

     96        49        115        198          
                                        

Total expenses

     6,842        5,966        7,851        6,433        4,540   
                                        

Income from continuing operations before income tax expense and extraordinary loss

     2,086        2,525        2,842        1,903        1,771   

Income tax expense from continuing operations

     530        722        1,031        642        675   
                                        

Income from continuing operations before extraordinary loss

     1,556        1,803        1,811        1,261        1,096   

Extraordinary loss, net of taxes

            (3,684                     

Income (Loss) from discontinued operations, net of taxes

                                 10   
                                        

Net income (loss)

   $ 1,556      $ (1,881   $ 1,811      $ 1,261      $ 1,106   
                                        

Adjustments to net income (loss)(3)

     (16     (163     (22              
                                        

Net income before extraordinary loss available to common shareholders

   $ 1,540      $ 1,640      $ 1,789      $ 1,261      $ 1,106   
                                        

Net income (loss) available to common shareholders

   $ 1,540      $ (2,044   $ 1,789      $ 1,261      $ 1,106   
                                        

PER COMMON SHARE:

          

Basic earnings before extraordinary loss:

          

Continuing operations

   $ 3.11      $ 3.50      $ 4.32      $ 3.49      $ 3.30   

Net income

     3.11        3.50        4.32        3.49        3.33   

Basic earnings:

          

Continuing operations

   $ 3.11      $ (4.32   $ 4.32      $ 3.49      $ 3.30   

Net income (loss)

     3.11        (4.32     4.32        3.49        3.33   

Diluted earnings before extraordinary loss:

          

Continuing operations

   $ 3.09      $ 3.46      $ 4.30      $ 3.45      $ 3.26   

Net income

     3.09        3.46        4.30        3.45        3.29   

Diluted earnings:

          

Continuing operations

   $ 3.09      $ (4.31   $ 4.30      $ 3.45      $ 3.26   

Net income (loss)

     3.09        (4.31     4.30        3.45        3.29   

Cash dividends declared

     .04        .04        .95        .88        .80   

Closing market price (at year end)

     46.34        43.54        39.33        81.20        67.44   

AT YEAR END:

          

Investment securities

   $ 94,130      $ 93,576      $ 76,017      $ 74,559      $ 64,992   

Total assets

     160,505        157,946        173,631        142,543        107,353   

Deposits

     98,345        90,062        112,225        95,789        65,646   

Long-term debt

     8,550        8,838        4,419        3,636        2,616   

Total shareholders’ equity

     17,787        14,491        12,774        11,299        7,252   

Assets under custody and administration (in billions)

     21,527        18,795        15,907        20,213        15,648   

Assets under management (in billions)

     2,010        1,951        1,466        1,996        1,758   

Number of employees

     28,670        27,310        28,475        27,110        21,700   

RATIOS:

          

Continuing operations:

          

Return on common shareholders’ equity before extraordinary loss

     9.5     13.2     14.8     13.4     16.2

Return on average assets before extraordinary loss

     1.02        1.12        1.11        1.02        1.03   

Common dividend payout before extraordinary loss

     1.29        1.17        22.4        25.2        24.2   

Net income:

          

Return on common shareholders’ equity before extraordinary loss

     9.5     13.2     14.8     13.4     16.4

Return on average assets before extraordinary loss

     1.02        1.12        1.11        1.02        1.04   

Common dividend payout before extraordinary loss

     1.29        1.17        22.4        25.2        24.0   

Average common equity to average total assets

     10.8        8.5        7.5        7.6        6.3   

Net interest margin, fully taxable-equivalent basis

     2.24        2.19        2.08        1.71        1.25   

Tier 1 risk-based capital

     20.5        17.7        20.3        11.2        13.7   

Total risk-based capital

     22.0        19.1        21.6        12.7        15.9   

Tier 1 leverage ratio

     8.2        8.5        7.8        5.3        5.8   

 

(1)

Amount for 2010 included a net sale loss related to a repositioning of the investment portfolio.

 

(2)

Amount for 2007 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.

 

(3)

Amount for 2010 represented the allocation of earnings to participating securities using the two-class method. Amounts for 2009 and 2008 represented dividends and discount 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, 2010, we had total assets of $160.51 billion, total deposits of $98.35 billion, total shareholders’ equity of $17.79 billion and employed 28,670. With $21.53 trillion of assets under custody and administration and $2.01 trillion of assets under management at year-end 2010, we are a leading specialist in meeting the needs of institutional investors worldwide.

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 clients, 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; loan 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 24 to the 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 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 by us 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. securities laws. Forward-looking statements are based on our current expectations about revenue and market growth, acquisitions and divestitures, new technologies, services,

 

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opportunities, earnings and other matters that do not relate strictly to historical facts. 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 provided in Risk Factors included under Item 1A.

OVERVIEW OF FINANCIAL RESULTS

 

Years ended December 31,    2010(1)     2009     2008  
(Dollars in millions, except per share amounts)                   

Total fee revenue

   $ 6,540      $ 5,935      $ 7,747   

Net interest revenue

     2,699        2,564        2,650   

Gains (Losses) related to investment securities, net

     (286     141        (54

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

                   350   
                        

Total revenue

     8,953        8,640        10,693   

Provision for loan losses

     25        149          

Expenses:

      

Expenses from operations

     6,176        5,667        6,780   

Provision for legal exposure, net

            250          

Securities lending charge

     414                 

Provision for investment account infusion

                   450   

Restructuring charges

     156               306   

Provision for indemnification exposure

                   200   

Merger and integration costs and U.K. bonus tax

     96        49        115   
                        

Total expenses

     6,842        5,966        7,851   
                        

Income before income tax expense and extraordinary loss

     2,086        2,525        2,842   

Income tax expense

     530        722        1,031   
                        

Income before extraordinary loss

     1,556        1,803        1,811   

Extraordinary loss, net of taxes

            (3,684       
                        

Net income (loss)

   $ 1,556      $ (1,881   $ 1,811   
                        

Adjustments to net income (loss):

      

Preferred stock dividends and accretion/prepayment of discount(2)

            (163     (22

Earnings allocated to participating securities(3)

     (16              
                        

Net income before extraordinary loss available to common shareholders

   $ 1,540      $ 1,640      $ 1,789   
                        

Net income (loss) available to common shareholders

   $ 1,540      $ (2,044   $ 1,789   
                        

Earnings per common share before extraordinary loss:

      

Basic

   $ 3.11      $ 3.50      $ 4.32   

Diluted

     3.09        3.46        4.30   

Earnings (Loss) per common share:

      

Basic

   $ 3.11      $ (4.32   $ 4.32   

Diluted

     3.09        (4.31     4.30   

Average common shares outstanding (in thousands):

      

Basic

     495,394        470,602        413,182   

Diluted

     497,924        474,003        416,100   

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

     9.5     13.2     14.8

 

(1)

Financial results for 2010 included those of acquired businesses from their respective dates of acquisition, as described in the following “Financial Highlights” section.

 

(2)

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

 

(3)

Adjustments represented the allocation of earnings to participating securities using the two-class method. See note 23 to the consolidated financial statements included under Item 8.

 

(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

This section provides highlights with respect to our financial results for 2010 presented in the preceding table. Additional information is provided under “Consolidated Results of Operations,” which follows this section. Our financial results for 2010 reflected the following:

During the second quarter of 2010, we completed our acquisitions of Intesa Sanpaolo’s securities services business (May 17, 2010) and Mourant International Finance Administration (April 1, 2010). For full-year 2010, from their respective acquisition dates through December 31, 2010, the acquired Intesa and MIFA businesses added in the aggregate approximately $300 million of revenue and $235 million of expenses, excluding merger and integration costs, to our consolidated statement of income. We also recorded aggregate merger and integration costs of $57 million in connection with these two acquisitions in 2010, from their respective acquisition dates through December 31, 2010 (see note 2 to the consolidated financial statements included under Item 8).

During the second quarter of 2010, we recorded an aggregate pre-tax charge of $414 million, including associated legal costs of $9 million, in our consolidated statement of income related to the following:

 

   

a pre-tax charge of $330 million to provide for a one-time cash contribution to certain cash collateral pools and liquidity trusts underlying SSgA-managed investment funds engaged in securities lending (see the “Investment Management” section under “Line of Business Information” in this Management’s Discussion and Analysis), and

 

   

a pre-tax charge of $75 million to establish a reserve to address potential inconsistencies in connection with our implementation of the redemption restrictions applicable to the cash collateral pools underlying our agency lending program (see the “Securities Finance” section under “Consolidated Results of Operations—Total Revenue” in this Management’s Discussion and Analysis).

During the fourth quarter of 2010, as previously reported, we recorded pre-tax restructuring charges of approximately $156 million in our consolidated statement of income, related primarily to a reduction in force of approximately 1,400 employees that began in December 2010 and is intended to be completed by the end of 2011, as well as actions taken in 2010 to reduce our occupancy costs. The charges were part of a global multi-year program that began during the fourth quarter of 2010, and which will include operational and information technology enhancements and targeted cost initiatives (see the “Expenses” section under “Consolidated Results of Operations” in this Management’s Discussion and Analysis).

During the fourth quarter of 2010, as previously reported, we recorded a pre-tax loss of approximately $344 million in our consolidated statement of income associated with the sale of approximately $11 billion of mortgage- and asset-backed investment securities. The securities were sold in connection with a repositioning of our investment portfolio to allow for enhanced capital ratios under evolving regulatory capital standards, increased balance sheet flexibility, and a reduction of our exposure to certain asset classes (see the “Investment Securities” section under “Financial Condition” in this Management’s Discussion and Analysis).

Total revenue increased 4% compared to 2009. A 10% increase in total fee revenue from 2009 levels and a 5% increase in net interest revenue were partly offset by higher net losses related to investment securities, which resulted from the above-mentioned securities portfolio repositioning completed during the fourth quarter of 2010.

Servicing and management fees were up 18% and 8%, respectively, from 2009. Servicing fee revenue increased mainly due to the impact of new business, the addition of revenue from the acquired Intesa and MIFA businesses and improvement in equity market valuations. Management fee revenue increased primarily due to the improvement in equity markets as well as the impact of new business. Trading services revenue increased 1%, primarily as a result of higher electronic trading revenues in brokerage and other fees, offset slightly by the impact of lower levels of foreign exchange trading volatility. Securities finance revenue was down 44% as a result of continued lower spreads and securities lending demand. Processing fees and other revenue increased 104% due to higher net revenue from structured products and higher net revenue related to certain tax-advantaged investments.

 

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In 2010, we recorded net interest revenue of $2.70 billion, which included $712 million of discount accretion related to investment securities added to our consolidated statement of condition in connection with the May 2009 conduit consolidation (see the “Net Interest Revenue” section under “Consolidated Results of Operations” in this Management’s Discussion and Analysis and note 12 to the consolidated financial statements included under Item 8). Net interest revenue increased 5% on both a GAAP and fully taxable-equivalent basis (the latter $2.83 billion compared to $2.69 billion, reflecting increases from tax-equivalent adjustments of $129 million and $126 million, respectively). These increases were primarily the result of the impact of the Intesa deposits added in May 2010 in connection with that acquisition, spread improvement and increased volume associated with non-U.S. investment securities and higher discount accretion ($712 million for 2010 compared to $621 million for 2009), offset by a decreased spread on our long-term cost of borrowing and spread compression in our floating-rate investment securities. Net interest margin increased 5 basis points, from 2.19% in 2009 to 2.24% in 2010.

Total expenses of $6.84 billion increased 15% from $5.97 billion in 2009, and included merger and integration costs of $89 million associated with acquisitions, as well as the previously referenced pre-tax charges of $414 million related to our securities lending business and $156 million related to our global multi-year program. Expenses from operations of $6.18 billion ($6.84 billion net of $659 million delineated above) increased 9% compared to 2009 expenses from operations of $5.67 billion ($5.97 billion net of $299 million composed of a $250 million provision for legal exposure and $49 million of merger and integration costs), mainly as a result of increases in salaries and benefits expense associated with higher levels of incentive compensation accruals and the addition of expenses from the Intesa and MIFA acquisitions. Salaries and benefits expenses in 2009 were abnormally low, as we did not accrue cash incentive compensation for the first half of 2009 as part of our plan to increase tangible common equity.

For 2010, net income available to common shareholders decreased 6% to $1.54 billion, or $3.09 per diluted share, compared to net income before extraordinary loss available to common shareholders of $1.64 billion, or $3.46 per diluted share, for 2009. The after-tax extraordinary loss of $3.68 billion, or $7.77 per diluted share, was related to the consolidation of the asset-backed commercial paper conduits completed in May 2009. Return on common equity was 9.5% compared to 13.2% for 2009, the latter before the extraordinary loss.

During 2010, we won mandates for approximately $1.37 trillion in assets to be serviced; of the total, $976 billion was installed prior to December 31, 2010, with the remainder expected to be installed in subsequent periods. The new business not installed by December 31, 2010 was not included in assets under custody and administration at that date, and had no impact on servicing fee revenue for 2010, as the assets are not included until their installation is complete and we begin to service them. Once installed, the assets generate servicing fee revenue in subsequent periods. We will provide various services for these assets including accounting, fund administration, custody, foreign exchange, securities finance, transfer agency, performance analytics, compliance reporting and monitoring, hedge fund servicing, private equity administration, real estate administration, depository banking services, wealth management services and investment manager operations outsourcing.

CONSOLIDATED RESULTS OF OPERATIONS

This section discusses our consolidated results of operations for 2010 compared to 2009, 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 2009 with those for 2008 is provided in the “Comparison of 2009 and 2008” section of this Management’s Discussion and Analysis.

 

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TOTAL REVENUE

 

Years ended December 31,    2010     2009      2008     % Change
2009-2010
 
(Dollars in millions)                          

Fee revenue:

         

Servicing fees

   $ 3,938        $3,334       $ 3,798        18

Management fees

     829        766         975        8   

Trading services

     1,106        1,094         1,467        1   

Securities finance

     318        570         1,230        (44

Processing fees and other

     349        171         277        104   
                           

Total fee revenue

     6,540        5,935         7,747        10   

Net interest revenue:

         

Interest revenue

     3,462        3,286         4,879        5   

Interest expense

     763        722         2,229        6   
                           

Net interest revenue

     2,699        2,564         2,650        5   

Gains (Losses) related to investment securities, net

     (286     141         (54  

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

                    350          
                           

Total revenue

   $ 8,953      $ 8,640       $ 10,693        4   
                           

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 fees and other revenue. We earn net interest revenue from client deposits and short-term investment activities by providing deposit services and short-term investment vehicles, such as repurchase agreements and commercial paper, to meet clients’ needs for high-grade liquid investments, and investing these sources of funds and additional borrowings in assets yielding a higher rate.

Fee Revenue

Servicing and management fees collectively composed approximately 73% of our total fee revenue for 2010 and 69% for 2009. These fees are influenced by several factors, including the mix and volume of assets under custody and administration and assets under management, securities positions held and the volume of portfolio transactions, and the types of products and services used by clients, and are generally affected by changes in worldwide equity and fixed-income security valuations.

Generally, servicing fees are affected, in part, by changes in daily average valuations of assets under custody and administration, 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, client 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, which we have not experienced since mid-2007. The disrupted conditions that began during the second half of 2007 have adversely affected our market-driven revenues, particularly those from foreign exchange trading services and securities finance. Even though the financial markets began to

 

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improve during the second half of 2009, the effect of the disrupted conditions on our total revenue, particularly our market-driven revenue, has been more significant through 2010 than we would anticipate in normalized markets.

The following table presents selected equity market indices for the years ended December 31, 2010 and 2009. 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     Averages of Month-End Indices     Year-End Indices  
     2010      2009      % Change         2010          2009          % Change         2010      2009      % Change  

S&P 500®

     1,140         948         20     1,131         949         19     1,258         1,115         13

NASDAQ®

     2,350         1,845         27        2,334         1,857         26        2,653         2,269         17   

MSCI EAFE®

     1,525         1,336         14        1,511         1,344         12        1,658         1,581         5   

FEE REVENUE

 

Years ended December 31,    2010      2009      2008      % Change
2009-2010
 
(Dollars in millions)                            

Servicing fees

   $ 3,938       $ 3,334       $ 3,798         18

Management fees(1)

     829         766         975         8   

Trading services

     1,106         1,094         1,467         1   

Securities finance

     318         570         1,230         (44

Processing fees and other

     349         171         277         104   
                             

Total fee revenue

   $ 6,540       $ 5,935       $ 7,747         10   
                             

 

(1)

Included performance fees of $4 million, $9 million and $21 million for 2010, 2009 and 2008, 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; master trust and master custody; and performance, risk and compliance analytics.

We are the largest provider of mutual fund custody and accounting services in the U.S. 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 99.97%. We service U.S. tax-exempt assets for corporate and public pension funds, and we provide trust and valuation services for more than 5,000 daily-priced portfolios.

We are a service provider outside of the U.S. as well. In Germany, we provide Depotbank services for retail and institutional fund assets. In the U.K., we provide custody services for pension fund assets and administration services for mutual fund assets. We service approximately $700 billion of offshore assets, primarily domiciled in Ireland, Luxembourg and Toronto. We have more than $970 billion in assets under administration in the Asia/Pacific region, and in Japan, we hold approximately 92% of the trust assets held by non-domestic trust banks in that region.

We are an alternative asset servicing provider worldwide, with approximately $660 billion of assets under administration. We are also a hedge fund administration provider worldwide, as well as a worldwide provider of private equity administration services and real estate administration services.

 

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The 18% increase in servicing fees from 2009 primarily resulted from the impact of new business awarded to us and installed during 2010 and prior periods on current-period revenue, the addition of revenue generated by the acquired Intesa and MIFA businesses from May 17 and April 1, respectively, through December 31 and increases in daily average equity market valuations. For 2010, servicing fees generated outside the U.S. were approximately 41% of total servicing fees compared to approximately 37% for 2009.

At year-end 2010, our total assets under custody and administration were $21.53 trillion, compared to $18.79 trillion a year earlier. The increase compared to 2009 was primarily the result of increases in equity market valuations and a higher level of new servicing business won and installed prior to December 31, 2010, as well as the effects of the Intesa and MIFA acquisitions. These asset levels as of year-end did not reflect new business awarded to us during 2010 that had not been installed prior to December 31, 2010. The value of assets under custody and administration is a broad measure of the relative size of various markets served. Changes in the values of assets under custody and administration do not necessarily result in proportional changes in our servicing fee revenue. Assets under custody and administration consisted of the following as of December 31:

ASSETS UNDER CUSTODY AND ADMINISTRATION

 

As of December 31,    2010      2009      2008      2007      2006      2009-2010
Annual
Growth
Rate
    2006-2010
Compound
Annual
Growth
Rate
 
(Dollars in billions)                                                

Mutual funds

   $ 5,540       $ 4,734       $ 4,093       $ 5,200       $ 4,007         17     8

Collective funds

     4,350         3,580         2,679         3,968         1,947         22        22   

Pension products

     4,726         4,395         3,621         5,246         4,914         8        (1

Insurance and other products

     6,911         6,086         5,514         5,799         4,780         14        10   
                                                 

Total

   $ 21,527       $ 18,795       $ 15,907       $ 20,213       $ 15,648         15        8   
                                                 

FINANCIAL INSTRUMENT MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION

 

As of December 31,    2010      2009      2008  
(In billions)                     

Equities

   $ 11,000       $ 8,828       $ 6,691   

Fixed-income

     7,875         7,236         6,689   

Short-term and other investments

     2,652         2,731         2,527   
                          

Total

   $ 21,527       $ 18,795       $ 15,907   
                          

GEOGRAPHIC MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION(1)

 

As of December 31,    2010      2009      2008  
(In billions)                     

United States

   $ 15,889       $ 14,585       $ 12,424   

Other Americas

     599         606         536   

Europe/Middle East/Africa

     4,067         2,773         2,391   

Asia/Pacific

     972         831         556   
                          

Total

   $ 21,527       $ 18,795       $ 15,907   
                          

 

(1)

Geographic mix is based on the location at which the assets are custodied or serviced.

Management Fees

Through State Street Global Advisors, or SSgA, 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. Based on assets under management, SSgA is the largest manager

 

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of institutional assets worldwide, the largest manager of assets for tax-exempt organizations (primarily pension plans) in the U.S., 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® ETF brand.

The 8% increase in management fees from 2009 resulted primarily from the impact of increases in average month-end equity market valuations and, to a lesser extent, the impact of new business won and installed in prior periods on current-period revenue. Average month-end equity market valuations, individually presented in the foregoing “INDEX” table, were up an average of 20% compared to 2009. Management fees generated outside the U.S. were approximately 34% of total management fees for 2010, down from 36% for 2009.

At year-end 2010, assets under management were $2.01 trillion, compared to $1.95 trillion at year-end 2009. Such amounts include assets of the SPDR® Gold ETF, for which we act as distribution agent rather than investment manager, and certain assets managed for the U.S. government under programs adopted during the financial crisis. While certain management fees are directly determined by the value of assets under management and the investment strategy employed, management fees reflect other factors as well, including our relationship pricing for clients who use multiple services, and the benchmarks specified in the respective management agreements related to performance fees. During 2010, we benefited from the continued focus in the institutional markets on passive strategies, particularly passive equities and exchange-traded funds, where we had year-to-year increases in assets under management of 30% and 24%, respectively. These increases were partly offset by continued weakness in our sales of active products and a reduction in managed cash balances, which in part reflected the effect of reductions of securities lending volumes associated with continued weak loan demand.

The overall increase in assets under management at December 31, 2010 compared to December 31, 2009, which can be seen in the tables that follow this discussion, reflected appreciation in the values of the assets managed, partly offset by a net loss of asset management business. Our levels of assets under management were affected by a number of factors, including reaction to prior 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 net loss of business of $68 billion for 2010 presented in the table on page 43 does not reflect new business awarded to us during 2010 that had not been installed prior to December 31, 2010. This new business will be reflected in assets under management in future periods after installation, and will generate management fee revenue in subsequent periods.

 

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Assets under management consisted of the following as of December 31:

ASSETS UNDER MANAGEMENT

 

As of December 31,    2010      2009      2008      2007      2006      2009-2010
Annual
Growth
Rate
    2006-2010
Compound
Annual
Growth
Rate
 
(Dollars in billions)                                                

Passive:

                   

Equities

   $ 655       $ 504       $ 344       $ 522       $ 504         30     7

Fixed-income

     361         395         200         178         144         (9     26   

Exchange-traded funds(1)

     255         205         170         171         111         24        23   

Other

     210         211         163         171         122                15   
                                                 

Total Passive

     1,481         1,315         877         1,042         881         13        14   

Active:

                   

Equities

     55         66         72         179         152         (17     (22

Fixed-income

     20         25         32         38         34         (20     (12

Other

     28         28         17         105         114                (30
                                                 

Total Active

     103         119         121         322         300         (13     (23

Cash

     426         517         468         632         577         (18     (7
                                                 

Total

   $ 2,010       $ 1,951       $ 1,466       $ 1,996       $ 1,758         3        3   
                                                 

 

(1)

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

GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1)

 

As of December 31,    2010      2009      2008  
(In billions)                     

United States

   $ 1,425       $ 1,397       $ 1,042   

Other Americas

     29         29         24   

Europe/Middle East/Africa

     341         345         272   

Asia/Pacific

     215         180         128   
                          

Total

   $ 2,010       $ 1,951       $ 1,466   
                          

 

(1)

Geographic mix is based on the location at which the assets are managed.

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,    2010     2009      2008  
(In billions)                    

Balance at beginning of year

   $ 1,951      $ 1,466       $ 1,996   

Net new business

     (68     261         (49

Market appreciation (depreciation)

     127        224         (481
                         

Balance at end of year

   $ 2,010      $ 1,951       $ 1,466   
                         

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 clients for our proprietary research and the execution of trades in any time zone.

 

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Foreign exchange trading revenue is influenced by three principal factors: the volume and type of client foreign exchange transactions; currency volatility; and the management of currency market risks.

For 2010, foreign exchange trading revenue totaled $597 million, a 12% decrease from revenue of $677 million in 2009, primarily the result of lower spreads on foreign exchange trades and a decline in currency volatility, partly offset by higher client volumes. 60% of our total foreign exchange trading revenue for 2010 was earned in the second and fourth quarters, and such revenue for the fourth quarter increased 60% compared to the third quarter.

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 $509 million were 22% higher compared to $417 million in 2009, with the increase largely attributable to higher electronic trading volumes.

Securities Finance

Our securities finance business consists of two components: investment funds with a broad range of investment objectives which are managed by SSgA and engage in agency securities lending, which we refer to as the SSgA lending funds; and an agency lending program for third-party investment managers and asset owners, which we refer to as the agency lending funds. Additional information with respect to the SSgA lending funds is also provided under “Line of Business Information—Investment Management” in this Management’s Discussion and Analysis.

Our securities finance business provides liquidity to the financial markets, as well as an effective means for clients to earn incremental 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 clients worldwide. 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 equal to or in excess 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.

We also participate in securities lending transactions as a principal, rather than an agent. As principal, we borrow securities from the lending client and then lend such securities to the subsequent borrower, either a State Street client or a broker/dealer. Our involvement as principal is utilized when the lending client is unable to transact directly with the market and requires us to execute the transaction and furnish the securities. We provide our credit rating to the transaction as well as our ability to source securities through our assets under custody and administration.

For cash collateral, our clients pay a usage fee to the provider of the cash collateral, and we 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 2010, securities finance revenue decreased 44% from 2009, substantially the result of lower spreads across all lending programs, as average lending volumes were essentially flat year to year ($396 billion for 2010 compared to $406 billion for 2009).

Beginning in 2007, the market value per unit of the assets held in the certain of the collateral pools underlying both the agency lending program and SSgA lending funds fell below $1.00. However, we continued to transact purchases into and redemptions out of these pools at $1.00 per unit and imposed restrictions on redemptions from the SSgA lending funds and certain of the agency lending collateral pools.

 

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We continued to transact purchase and redemptions at $1.00 per unit for a number of reasons, including that none of the securities in the cash collateral pools was then in default or considered to be materially impaired, and that restrictions on withdrawals from the agency lending collateral pools were and are in place, which, absent a substantial reduction in the lending program, should permit the securities in the collateral pools to be held until they recover to their par value.

During 2010, we took several actions to seek a resolution to these issues:

 

   

In June 2010, we contributed $330 million to the collateral pools and liquidity trusts underlying the SSgA lending funds, eliminating the difference between the market value and amortized cost of the assets held by such vehicles as of June 30, 2010.

 

   

In June 2010, as a result of a review of the implementation of our policy restricting redemptions from certain agency lending collateral pools, and based on our assessment of the amount required to compensate clients for the dilutive effect of redemptions which may not have been consistent with the intent of the policy, we recorded a pre-tax charge of $75 million to address these potential inconsistencies.

 

   

In August 2010, SSgA removed the redemption restrictions from the SSgA lending funds. In the period subsequent to the elimination of the redemption restrictions, some clients that invested in SSgA lending funds transitioned their assets to other SSgA products that did not engage in securities lending, or, to a lesser degree, other investment managers. As a result of the elimination of the redemption restrictions and reduced utilization of lendable assets in the SSgA lending funds, the aggregate net assets of the collateral pools underlying the SSgA lending funds declined to $8 billion as of December 31, 2010 from $24 billion as of December 31, 2009.

 

   

In December 2010, we divided certain agency lending collateral pools into liquidity and duration pools, and in January 2011, we removed the redemption restrictions from the liquidity pools. These actions were taken to provide greater flexibility to participants with respect to their control of their level of participation in our agency lending program. As of December 31, 2010, the aggregate net assets of these liquidity pools and duration pools were $26.2 billion and $11.8 billion, respectively, and the return obligations of participants in the agency lending program represented by interests in the duration pools exceeded the market value of the assets in the duration pools by approximately $319 million, which amount is expected to be eliminated as the assets in the duration pools mature or amortize.

Market influences continued to affect our revenue from, and the profitability of, our securities lending activities during 2010, and may do so in future periods. While the average volume of securities on loan has generally stabilized over the past two years, spreads have declined significantly compared to those earned in late 2007 and throughout 2008 (which were extraordinarily high), reflecting prevailing interest rates and the effects of government actions taken to stimulate the economy.

The actions taken during 2010 outlined above are expected to provide an opportunity for increased securities lending volumes, although their effect will be influenced by overall market and client-specific factors and could, particularly in the short-term, result in decreased lending volumes. As long as securities lending spreads remain below the more normal levels generally experienced prior to late 2007, client demand is likely to remain at a reduced level and our revenues from our securities lending activities will be adversely affected relative to the revenues we earned in 2007, 2008 (which were extraordinarily high) and 2009. While these actions are also intended to address client issues, we do not know at this time how our agency lending clients will react to these measures. For additional information, refer to Risk Factors included under Item 1A.

As previously disclosed, in 2009, we determined that withdrawals by two related participants in one of the agency lending collateral pools were inconsistent with our redemption restrictions. In response, we redeemed in-kind the remaining units of such participants, effectively distributing, together with prior cash withdrawals, the same amount of cash and longer-dated securities that the participants would have received under the redemption restrictions. We are in litigation with these participants; see note 11 to the consolidated financial statements included under Item 8. We also undertook a review of our implementation of the redemption restrictions with respect to other participants in the agency lending collateral pools. This review identified the potential inconsistencies, referenced above, in connection with our implementation of the redemption policy.

 

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Processing Fees and Other

Processing fees and other revenue includes diverse types of fees and 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 our investments in tax-advantaged financings. Processing fees and other revenue was $349 million for 2010, an increase of 104% compared to 2009. This increase primarily resulted from higher net revenue from structured products, including fees from our tax-exempt investment program, and higher net revenue related to certain tax-advantaged investments.

NET INTEREST REVENUE

 

Years ended December 31,   2010     2009     2008  
    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

  $ 13,550      $ 93        .69   $ 24,162      $ 156        .64   $ 24,003      $ 760        3.17

Securities purchased under resale agreements

    2,957        24        .83        3,701        24        .65        10,195        276        2.71   

Federal funds sold

                         68               .29        2,700        63        2.33   

Trading account assets

    376                      1,914        20        1.02        2,423        78        3.22   

Investment securities

    96,123        3,140        3.27        81,190        2,943        3.63        72,227        3,163        4.38   

Investment securities purchased under AMLF(1)

                         882        25        2.86        9,193        367        4.00   

Loans and leases(2)

    12,094        331        2.73        9,703        242        2.49        11,884        276        2.32   

Other interest-earning assets

    1,156        3        .24        1,303        2        .15                        
                                                     

Total interest-earning assets

  $ 126,256      $ 3,591        2.84      $ 122,923      $ 3,412        2.78      $ 132,625      $ 4,983        3.75   
                                                     

Interest-bearing deposits:

                 

U.S.

  $ 8,632      $ 37        .43   $ 7,616      $ 61        .81   $ 11,216      $ 223        1.99

Non-U.S.

    68,326        176        .26        61,551        134        .22        68,291        1,103        1.62   

Securities sold under repurchase agreements

    8,108        4        .05        11,065        3        .03        14,261        177        1.24   

Federal funds purchased

    1,759        1        .05        956               .04        1,026        18        1.77   

Short-term borrowings under AMLF(1)

                         877        18        2.02        9,170        299        3.26   

Other short-term borrowings

    13,590        252        1.86        16,847        197        1.17        5,996        180        2.99   

Long-term debt

    8,681        286        3.30        7,917        304        3.84        4,106        229        5.59   

Other interest-bearing liabilities

    940        7        .69        1,131        5        .46                        
                                                     

Total interest-bearing liabilities

  $ 110,036      $ 763        .69      $ 107,960      $ 722        .67      $ 114,066      $ 2,229        1.95   
                                                     

Interest-rate spread

        2.15         2.11         1.80

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

    $ 2,828          $ 2,690          $ 2,754     
                                   

Net interest margin - fully taxable-equivalent basis

        2.24         2.19         2.08

Net interest revenue - GAAP basis

    $ 2,699          $ 2,564          $ 2,650     

 

(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. The AMLF expired in February 2010.

 

(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 11 to the consolidated financial statements included under Item 8.

 

(3)

Amounts included fully taxable-equivalent adjustments of $129 million for 2010, $126 million for 2009 and $104 million for 2008.

 

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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 principally consist of investment securities, interest-bearing deposits with banks, repurchase agreements, loans and leases, and other liquid assets, are financed primarily by client deposits and short-term borrowings. Net interest margin represents the relationship between fully taxable-equivalent net interest revenue and total average interest-earning assets for the period. Revenue that is exempt from income taxes, mainly that earned from certain investment securities (state and political subdivisions), is adjusted to a fully taxable-equivalent basis using a federal income tax rate of 35%, adjusted for applicable state income taxes, net of the related federal tax benefit.

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 18 to the consolidated financial statements included under Item 8.

For 2010, on both a GAAP and a fully taxable-equivalent basis, net interest revenue increased 5% compared to 2009 (with fully taxable-equivalent net interest revenue reflective of increases from tax-equivalent adjustments of $129 million and $126 million, respectively). If the discount accretion related to former conduit securities, more fully described below, is excluded, fully taxable-equivalent net interest revenue for 2010 increased to $2.12 billion ($2.83 billion presented in the preceding table less accretion of $712 million) from $2.07 billion ($2.69 billion presented in the preceding table less accretion of $621 million), an increase of 2%. The increase was primarily the result of the impact of a higher portfolio allocation to fixed-rate investment securities, U.S. and non-U.S. investment portfolio growth, and the impact of the Intesa deposits added in May 2010 in connection with that acquisition, partly offset by lower spreads on both floating-rate investment securities and non-U.S. transaction deposits.

In May 2009, we elected to take actions 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 of approximately $16.6 billion on the date of consolidation was established as their carrying amount, resulting in a $6.1 billion discount to the assets’ aggregate par value of approximately $22.7 billion. To the extent that the expected future cash flows from the securities held by us exceed their carrying amount, the portion of the discount not related to credit will accrete into interest revenue over the securities’ remaining terms.

Subsequent to the May 2009 consolidation, we have recorded aggregate discount accretion in interest revenue of $1.33 billion ($712 million in 2010 and $621 million in 2009). The timing and ultimate recognition of accretion depends, in part, on factors that are outside of our control, including anticipated prepayment speeds and credit quality. The impact of these factors is uncertain and can be significantly influenced by general economic and financial market conditions. The timing and recognition of accretion can also be influenced by our ongoing management of the risk and other characteristics associated with our investment portfolio, including any resulting sales of securities from which we would otherwise generate accretion.

As we discussed in the “Overview of Financial Results – Financial Highlights” section of this Management’s Discussion and Analysis, and as more fully described in note 3 to the consolidated financial statements included under Item 8, during the fourth quarter of 2010, we sold approximately $11 billion of mortgage- and asset-backed investment securities, including $4.93 billion of former conduit securities, to reposition our investment portfolio and allow for enhanced capital ratios under evolving regulatory capital standards, increased balance sheet flexibility, and a reduction of our exposure to certain asset classes. Depending on the factors discussed above, among others, we anticipate that, until the former conduit securities remaining in our portfolio mature or are sold, discount accretion will affect our net interest revenue, and may increase the volatility of our net interest revenue and margin; however, the portfolio repositioning resulted in a significant decrease in the accretion that we expect to recognize in future periods. Assuming that we hold the remaining former conduit securities to maturity, all other things equal, we expect the former conduit securities carried in our investment portfolio as of December 31, 2010 to generate aggregate accretion in future periods of approximately $1.3 billion over their remaining terms.

Interest-bearing deposits with banks, including cash balances held at the Federal Reserve to satisfy reserve requirements, averaged $13.55 billion for 2010, a decrease of 44% compared to $24.16 billion for 2009. An

 

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average of $4.98 billion was held at the Federal Reserve Bank during 2010, a decrease of 60% compared to $12.42 billion for 2009, with balances in both periods exceeding minimum reserve requirements. The overall decreases in both comparisons reflected excess liquidity held by us during 2009 due to the then-ongoing financial markets instability that was re-allocated to higher-yielding investment securities.

Average securities purchased under resale agreements decreased 20% from $3.70 billion for 2009 to $2.96 billion for 2010, mainly due to lower client demand for short-term investment.

Average trading account assets declined 80% from $1.91 billion for 2009 to $376 million for 2010, due to the absence of conduit asset-backed commercial paper purchased by us, which was eliminated for financial reporting purposes when the conduits were consolidated onto our balance sheet in May 2009 as previously described.

Our average investment securities portfolio increased 18% from $81.19 billion for 2009 to approximately $96.12 billion for 2010, generally the result of the continued execution of our re-investment strategy that we began in the second half of 2009, partly offset by maturities and sales of securities during the year. In addition, as described earlier in this section, we repositioned our portfolio in December 2010 by selling approximately $11 billion of mortgage- and asset-backed securities. By the end of 2010, we had re-invested approximately $7 billion of the proceeds from the repositioning, primarily in agency mortgage-backed securities. As of December 31, 2010, securities rated “AAA” and “AA” comprised approximately 90% of our investment securities portfolio (approximately 79% rated “AAA”), compared to 80% “AAA” and “AA” rated (approximately 69% rated “AAA”) as of December 31, 2009, with the improvement primarily due to the repositioning.

Loans and leases averaged $12.09 billion for 2010, up 25% from $9.70 billion for 2009. The increase was primarily due to increased client demand for short-term liquidity and the addition of structured asset-backed loans in connection with the May 2009 conduit consolidation. Approximately 27% of the average loan and lease portfolio, compared to 31% for 2009, was composed of U.S. and non-U.S. short-duration advances that provided liquidity to clients in support of their transaction flows, which averaged approximately $3.29 billion for 2010, up 11% from $2.97 billion for 2009. U.S. short-duration advances averaged approximately $1.92 billion for 2010, down 13% compared to $2.21 billion for 2009. Average non-U.S. short-duration advances increased 80% to $1.37 billion for 2010, mainly due to activity associated with clients added in connection with the Intesa acquisition.

Average interest-bearing deposits increased 11%, from $69.17 billion to $76.96 billion for 2010 compared to 2009. The increases reflected the deposits added in connection with the Intesa acquisition, partly offset by the return of client deposits to levels more consistent with those experienced prior to late 2007.

Average other short-term borrowings decreased 19% to $13.59 billion for 2010, primarily due to the absence of borrowings under the Federal Reserve’s term auction facility, which is further discussed in the “Liquidity” section under “Financial Condition” in this Management’s Discussion and Analysis. Average long-term debt increased 10% to $8.68 billion for 2010, as a result of the full-year impact of 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, as well as the May 2009 issuance of unsecured senior notes, partly offset by a subordinated debt maturity in 2010.

Several factors could affect future levels of our net interest revenue and margin, including the mix of client liabilities; actions of the various central banks; changes in U.S. and non-U.S. interest rates; the shapes of the various yield curves around the world; the amount of discount accretion generated by the former conduit securities that remain in our investment portfolio (discussed earlier in this section); and the relative impact of the yields earned on the securities purchased by us with the proceeds from the portfolio repositioning compared to the yields earned on the securities sold. In the second half of 2009, based on market conditions, we re-initiated our strategy of re-investing proceeds from amortizing and maturing securities into highly rated investment securities, such as U.S. Treasuries and federal agency mortgage-backed securities and asset-backed securities. 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 effect the re-investment program will have on future levels of our net interest revenue and net interest margin.

 

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Gains (Losses) Related to Investment Securities, Net

In connection with our ongoing management of the investment portfolio, we may, from time to time, sell investment securities, including former conduit securities, to manage risk, to reduce our risk profile, to take advantage of favorable market conditions, or for other reasons. In 2010, we recorded net realized losses of $55 million from sales of approximately $29.41 billion of investment securities, compared to net realized gains of $368 million from sales of approximately $8.27 billion of investment securities in 2009. The $55 million of net sale losses realized during 2010 included the $344 million net realized loss that resulted from the investment portfolio repositioning described below. For 2010, $1.08 billion of net gains were realized from sales of $5.53 billion of former conduit securities, composed of gross realized gains of $1.11 billion and gross realized losses of $27 million. For 2009, $104 million of net gains were realized from sales of $333 million of former conduit securities, composed of gross realized gains of $125 million and gross realized losses of $21 million.

In December 2010, we undertook a repositioning of our investment securities portfolio by selling approximately $11 billion of securities, composed of $4.3 billion of asset-backed securities, $4.1 billion of non-agency mortgage-backed securities and $2.5 billion of mortgage-backed securities. The repositioning was undertaken to enhance our capital ratios under evolving regulatory capital standards, increase our balance sheet flexibility in deploying our capital, and reduce our exposure to certain asset classes. The sale resulted in a pre-tax loss of approximately $344 million, which was recorded in our consolidated statement of income and is reflected in the $55 million of net sale losses described in the preceding paragraph. The repositioning included the sale of approximately $4.93 billion of former conduit securities at a net realized gain of $964 million.

Of the $11 billion of securities sold in the repositioning, approximately $4.8 billion were classified as held to maturity in our consolidated statement of condition. Additional information about the sale, including the held-to-maturity portion, is included in note 3 to the consolidated financial statements included under Item 8.

The aggregate unrealized loss on securities for which other-than-temporary impairment was recorded in 2010 was $651 million. Of this total, $420 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 $231 million in our 2010 consolidated statement of income, compared to $227 million in 2009, which resulted from our assessment of impairment.

For 2010, the substantial majority of the impairment losses related to non-agency mortgage-backed securities which management concluded had experienced credit losses resulting from deterioration in financial performance of those securities during the year. The securities are reported as asset-backed securities in note 3 to the consolidated financial statements included under Item 8.

 

Years ended December 31,   2010     2009  

(In millions)

   

Net realized gains (losses) from sales of investment securities(1)

  $ (55   $ 368   

Gross losses from other-than-temporary impairment

    (651     (1,155

Losses not related to credit(2)

    420        928   
               

Net impairment losses

    (231     (227
               

Gains (Losses) related to investment securities, net

  $ (286   $ 141   
               

Impairment associated with expected credit losses

  $ (203   $ (151

Impairment associated with management’s intent to sell the impaired securities prior to their recovery in value

    (1     (54

Impairment associated with adverse changes in timing of expected future cash flows

    (27     (22
               

Net impairment losses

  $ (231   $ (227
               

 

(1)

Amount for 2010 included the net sale loss of $344 million associated with the repositioning of the investment portfolio.

(2)

Pursuant to new GAAP adopted on April 1, 2009, these losses were not recorded in our consolidated statement of income, 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 note 13 to the consolidated financial statements included under Item 8.

 

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Management regularly reviews the investment securities portfolio to identify other-than-temporary impairment of individual securities. Pursuant to the provisions of new GAAP, which we adopted on 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.

Prior to our adoption of new GAAP on April 1, 2009, 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 to the consolidated financial statements included under Item 8.

PROVISION FOR LOAN LOSSES

We recorded provisions for loan losses of $25 million in 2010 and $149 million in 2009. The substantial majority of the provisions recorded in both years resulted from changes in expectations with respect to future cash flows from certain of the commercial real estate loans acquired in 2008 in connection with indemnified repurchase agreements with an affiliate of Lehman as a result of the Lehman Brothers bankruptcy.

The commercial real estate loans are reviewed on a quarterly basis, and any provisions for loan losses that are recorded reflect management’s current expectations with respect to future cash flows from these loans, based on an assessment of economic conditions in the commercial real estate market and other factors. Future changes in expectations with respect to these loans could result in additional provisions for loan losses.

 

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EXPENSES

 

Years Ended December 31,    2010      2009      2008      % Change
2009-2010
 

(Dollars in millions)

           

Salaries and employee benefits

   $ 3,524       $ 3,037       $ 3,842         16

Information systems and communications

     713         656         633         9   

Transaction processing services

     653         583         644         12   

Occupancy

     463         475         465         (3

Securities lending charge

     414                      

Provision for legal exposure

             250              

Provision for investment account infusion

                     450      

Restructuring charges

     156                 306      

Merger and integration costs

     89         49         115         82   

Other:

           

Professional services

     277         264         360         5   

Amortization of other intangible assets

     179         136         144         32   

Provision for indemnification exposure

                     200      

Securities processing

     63         114         187         (45

Regulator fees and assessments

     45         71         45         (37

Other

     266         331         460         (20
                             

Total other

     830         916         1,396         (9
                             

Total expenses

   $ 6,842       $ 5,966       $ 7,851         15   
                             

Number of employees at year end

     28,670         27,310         28,475      

The increase in salaries and employee benefits expenses for 2010 compared to 2009 was primarily due to the effect of our reinstatement of cash incentive compensation accruals, as we did not accrue such incentive compensation during the first half of 2009 as part of our plan to increase our tangible common equity; the addition of the employees and associated expenses of the acquired Intesa and MIFA businesses subsequent to their respective acquisition dates; and higher benefits requirements for payroll taxes, medical insurance and pensions.

The increase in information systems and communications expenses for 2010 compared to 2009 reflected higher levels of spending on telecommunications hardware and software for our global infrastructure, as well as the addition of expenses from the acquired Intesa and MIFA businesses subsequent to their respective acquisition dates. Transaction processing services expenses, which are volume-related and include equity trading services and fees related to securities settlement, sub-custodian services and external contract services, increased due to higher levels of sub-custody expenses and higher external contract services costs related to increases in transaction volumes.

On June 30, 2010, we recorded an aggregate pre-tax charge of $414 million, which included $9 million of associated legal costs. The charge provided for a one-time cash contribution of $330 million to the cash collateral pools and liquidity trusts underlying the SSgA lending funds, which reflected the cost to us to restore the net asset value per unit of such collateral pools to $1.00 as of June 30, 2010. As a result of this contribution, SSgA removed the redemption restrictions from these SSgA lending funds in August 2010. We also established a $75 million reserve to address potential inconsistencies in connection with our implementation of redemption restrictions applicable to the collateral pools underlying our agency lending program.

Our decision with respect to the one-time cash contribution was based on many factors, including our assessment with respect to previously disclosed asserted and unasserted claims and our evaluation of the ultimate resolution of such claims, as well as the effect of the redemption restrictions originally imposed by SSgA on the lending funds. The contribution was not the result of any obligation by State Street to support the SSgA lending funds or the underlying collateral pools. State Street has no obligation to provide cash or other support to the SSgA lending funds or the collateral pools underlying the SSgA lending funds at any future date, and has no intention to provide any such support associated with realized or unrealized losses in the collateral pools that may arise in the future.

 

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The $75 million reserve was based on the results of a review of our implementation of the redemption restrictions with respect to participants in the agency lending collateral pools, and our assessment of the amount required to compensate clients for the dilutive effect of redemptions which may not have been consistent with the intent of the policy.

In November 2010, we announced a global multi-year program designed to enhance service excellence and innovation, deliver increased efficiencies in our operating model and position us for accelerated growth. The program includes operational and information technology enhancements and targeted cost initiatives, including planned reductions in staff and a plan to reduce our occupancy costs. To implement this program, we expect to recognize aggregate restructuring charges of approximately $400 million to $450 million over four years, beginning with the fourth quarter of 2010. In connection with the program, we recorded restructuring charges of $156 million during the fourth quarter of 2010, and initiated a reduction of 1,400 employees, or approximately 5% of our global workforce, which we plan to have substantially completed by the end of 2011. The fourth-quarter charges also included costs related to actions taken to reduce our occupancy costs through real estate consolidation.

Excluding related restructuring charges, we expect that the program will result in an annualized reduction of our expenses from operations of between approximately $575 million and $625 million by the end of 2014. Additional information with respect to the charges, and activity during 2010 in the related balance sheet reserve, is provided in note 9 to the consolidated financial statements included under Item 8.

During 2010, we recorded merger and integration costs of $89 million, with $57 million related to Intesa and MIFA. These costs consisted only of certain transaction-related costs and direct incremental costs to integrate the acquired businesses into our operations, and did not include ongoing expenses of the combined organization. Additional information about these costs is provided in note 2 to the consolidated financial statements included under Item 8.

The decrease in aggregate other expenses (professional services, amortization of other intangible assets, securities processing, regulator fees and assessments, and other) for 2010 compared to 2009 resulted primarily from the impact of an adverse judgment of $60 million rendered by a Netherlands court in 2009, the impact of $115 million of insurance recoveries received in 2010 and lower levels of FDIC assessments. This overall decrease was offset slightly by a higher level of other intangible assets amortization associated with the Intesa and MIFA acquisitions.

The $115 million of insurance recoveries that reduced other expenses for 2010 was received with respect to settlement payments made by us to clients in prior periods in connection with certain active fixed-income strategies managed by SSgA prior to August 2007. We account for insurance recoveries as gains in accordance with GAAP, and therefore do not record the gains until the cash is received.

Income Taxes

We recorded income tax expense of $530 million for 2010, compared to income tax expense before extraordinary loss of $722 million for 2009. Our effective tax rate for 2010 was 25.4% compared to 28.6% for 2009. The difference in the tax rates was primarily attributable to the restructuring of former non-U.S. conduit assets in the second quarter of 2010, the partial write-off of a deferred tax asset associated with certain of the investment securities sold in connection with the portfolio repositioning completed in the fourth quarter of 2010, and the absence of the impact of the non-deductible portion of the SSgA-related legal reserve established in 2009.

Information about income tax contingencies related to our SILO lease transactions is provided in note 11 to the 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 our two lines of business, as well as the revenues, expenses and capital allocation methodologies with respect to these lines of business, is provided in note 24 to the 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 2010 represent the net loss from sales of investment securities associated with our repositioning of the portfolio, the restructuring charges associated with our global multi-year program, and merger and integration costs associated with acquisitions.

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 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 in that year primarily in connection with our plan to reduce our expenses from operations; the provision related to our estimated net exposure for client indemnification associated with collateralized repurchase agreements; and merger and integration 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,
  2010     2009     2008     2010     2009     2008     2010     2009     2008     2010     2009     2008     2010     2009     2008  
(Dollars in millions,
except where
otherwise noted)
                                                                                         

Fee revenue:

                             

Servicing fees

  $ 3,938      $ 3,334      $ 3,798                        $ 3,938      $ 3,334      $ 3,798   

Management fees

                       $ 829      $ 766      $ 975                    829        766        975   

Trading services

    1,106        1,094        1,467                                         1,106        1,094        1,467   

Securities finance

    265        387        900        53        183        330                    318        570        1,230   

Processing fees and other

    225        72        200        124        99        85          $ (8           349        171        277   
                                                                                                     

Total fee revenue

    5,534        4,887        6,365        1,006        1,048        1,390            (8           6,540        5,935        7,747   

Net interest revenue

    2,633        2,489        2,480        66        68        96            6        $ 7      $ 68        2,699        2,564        2,650   

Gains (Losses) related to investment securities, net

    58        141        (54                                   $ (344                   (286     141        (54

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

                                                                       350                      350   
                                                                                                                       

Total revenue

    8,225        7,517        8,791        1,072        1,116        1,486            (2     (344     7        418        8,953        8,640        10,693   

Provision for loan losses

    25        148                      1                                               25        149          

Expenses from operations

    5,430        4,920        5,699        753        747        1,076            5                             6,183        5,667        6,780   

Securities lending charge

    75                      339                                                      414                 

Provision for legal exposure

                                250                                                      250          

Provision for investment account infusion

                                       450                                                      450   

Restructuring charges

                                                         156               306        156               306   

Provision for indemnification exposure

                                                                       200                      200   

Merger and integration costs

                                                         89        49        115        89        49        115   
                                                                                                                       

Total expenses

    5,505        4,920        5,699        1,092        997        1,526            5        245        49        621        6,842        5,966        7,851   
                                                                                                                       

Income (Loss) from continuing operations before income taxes

  $ 2,695      $ 2,449      $ 3,092      $ (20   $ 118      $ (40       $ (7   $ (589   $ (42   $ (203   $ 2,086      $ 2,525      $ 2,842   
                                                                                                                       

Pre-tax margin

    33     33     35     (2 )%      11     (3 )%                   

Average assets (in billions)

  $ 148.5      $ 143.7      $ 158.3      $ 3.5      $ 3.1      $ 2.9          $ 0.5            $ 152.0      $ 146.8      $ 161.7   

 

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Investment Servicing

Total revenue for 2010 increased 9% from 2009 and total fee revenue increased 13% in the same comparison. The increases in total fee revenue generally related to servicing fees and processing fees and other revenue, partly offset by a decline in securities finance revenue.

Servicing fees increased primarily as a result of the impact on current-period revenue of new business awarded to us and installed during 2010 and prior periods, the addition of revenue from the acquired Intesa and MIFA businesses and increases in daily average equity market valuations. Processing fees and other revenue increased primarily as a result of higher net revenue from structured products, including fees from our tax-exempt investment program, and higher net revenue related to certain tax-advantaged investments.

Trading services revenue was essentially flat compared to 2009, as higher brokerage and other fees attributable to higher levels of electronic trading volumes were offset by lower revenue from foreign exchange trades, caused primarily by lower spreads, and declines in volatility, partly offset by higher client volumes. Securities finance revenue declined primarily as a result of compression of credit spreads and slightly lower volumes of assets on loan associated with continued low levels of client demand.

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” sections under “Total Revenue” in this Management’s Discussion and Analysis for a more in-depth discussion. A discussion of processing fees and other revenue is provided in the “Processing Fees and Other” section under “Total Revenue.”

Net interest revenue increased 6% compared to 2009, primarily as a result of higher levels of investment securities associated with our re-investment strategy and the impact of the Intesa deposits added in May 2010 in connection with that acquisition. A portion of net interest revenue is recorded in the Investment Management business line based on the volume of client liabilities attributable to that business.

Total expenses increased 12% from 2009, primarily because of the absence of cash incentive compensation accruals during the first six months of 2009, as we did not accrue such compensation as part of our plan to increase our tangible common equity, and the addition of expenses from the acquired Intesa and MIFA businesses.

Investment Management

Total revenue for 2010 decreased 4% compared to 2009, generally reflective of the impact of decreases in total fee revenue, as increases in management fees and processing and other revenue were more than offset by a decline in securities finance revenue. The 8% increase in management fees, generated by SSgA, resulted from the impact of increases in average month-end equity market valuations and, to a lesser extent, the impact on current-period revenue of new business won and installed in prior periods. Securities finance revenue declined 71% because of lower spreads across all lending programs, reduced utilization of lendable assets in the SSgA lending funds and the transition of assets by clients from lending to non-lending products. Management fees for the Investment Management business line are identical to the respective consolidated results. Refer to the “Management Fees” section under “Total Revenue” in this Management’s Discussion and Analysis for a more in-depth discussion.

Total expenses increased 10% from 2009, primarily the result of the securities lending charge, discussed below, partly offset by the absence of the 2009 provision for legal exposure related to SSgA-managed fixed-income strategies.

Beginning in 2007, the market value per unit of the assets held in certain of the collateral pools underlying the SSgA lending funds fell below $1.00. However, we continued to transact purchases into and redemptions out of these pools at $1.00 per unit and imposed restrictions on redemptions from the SSgA lending funds.

We continued to transact purchase and redemptions at $1.00 per unit for a number of reasons, including that none of the securities in the collateral pools was then in default or considered to be materially impaired, and that withdrawals from the collateral pools were restricted, which, absent a substantial reduction in the lending program, should permit the securities in the collateral pools to be held until they recover to their par value.

 

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In June 2010, to seek a resolution of these issues, we made a one-time cash contribution of $330 million to the collateral pools and liquidity trusts underlying the SSgA lending funds, eliminating the difference between the market value and amortized cost of the assets held by such vehicles as of June 30, 2010. Consequently, in August 2010, SSgA removed the redemption restrictions from the SSgA lending funds. In the period subsequent to the elimination of the redemption restrictions, some clients that invested in SSgA lending funds transitioned their assets to other SSgA products that did not engage in securities lending, or, to a lesser degree, other investment managers. As a result of the elimination of the redemption restrictions and reduced utilization of lendable assets in the SSgA lending funds, the aggregate net assets of the collateral pools underlying the SSgA lending funds declined to approximately $8 billion as of December 31, 2010 from approximately $24 billion as of December 31, 2009.

Our decision with respect to the cash contribution was based on many factors, including our assessment relative to previously disclosed asserted and unasserted claims and our evaluation of the ultimate resolution of such claims, as well as the effect of the redemption restrictions originally imposed by SSgA on the lending funds. The contribution was not the result of any obligation by State Street to support the SSgA lending funds or the underlying collateral pools. State Street has no obligation to provide cash or other support to the SSgA lending fund or the collateral pools underlying the SSgA lending funds at any future date, and has no intention to provide any such support associated with realized or unrealized losses in the collateral pools that may arise in the future.

COMPARISON OF 2009 AND 2008

OVERVIEW OF CONSOLIDATED RESULTS OF OPERATIONS

 

Years ended December 31,    2009     2008     % Change  

(Dollars in millions, except per share amounts)

      

Total fee revenue

   $ 5,935      $ 7,747        (23 )% 

Net interest revenue

     2,564        2,650        (3

Gains (Losses) related to investment securities, net

     141        (54  

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

            350     
                  

Total revenue

     8,640        10,693        (19

Provision for loan losses

     149            

Total expenses

     5,966        7,851        (24
                  

Income before income tax expense

     2,525        2,842        (11

Income tax expense

     722        1,031        (30
                  

Net income

     1,803        1,811          

Extraordinary loss, net of taxes

     (3,684         
                  

Net income (loss)

   $ (1,881   $ 1,811     
                  

Adjustment to net income (loss)(1)

     (163     (22  
                  

Net income before extraordinary loss available to common shareholders

   $ 1,640      $ 1,789        (8
                  

Net income (loss) available to common shareholders

   $ (2,044   $ 1,789        (214
                  

Earnings per common share:

      

Basic

   $ 3.50      $ 4.32     

Diluted

     3.46        4.30     

Earnings per common share:

      

Basic

   $ (4.32   $ 4.32     

Diluted

     (4.31     4.30     

Average common shares outstanding (in thousands):

      

Basic

     470,602        413,182     

Diluted

     474,003        416,100     

Return on common shareholders’ equity before extraordinary loss(2)

     13.2     14.8  

 

(1)

Amounts represented dividends and discount related to preferred stock issued in connection with the U.S. Treasury’s TARP program in 2008 and redeemed in 2009.

 

(2)

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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TOTAL REVENUE

 

Years ended December 31,    2009      2008     % Change  

(Dollars in millions)

       

Fee revenue:

       

Servicing fees

   $ 3,334       $ 3,798        (12 )% 

Management fees

     766         975        (21

Trading services

     1,094         1,467        (25

Securities finance

     570         1,230        (54

Processing fees and other

     171         277        (38
                   

Total fee revenue

     5,935         7,747        (23

Net interest revenue:

       

Interest revenue

     3,286         4,879        (33

Interest expense

     722         2,229        (68
                   

Net interest revenue

     2,564         2,650        (3

Gains (Losses) related to investment securities, net

     141         (54  

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

             350     
                   

Total revenue

   $ 8,640       $ 10,693        (19
                   

The decline in total revenue compared to 2008 was driven primarily by a 23% decline in total fee revenue, partly offset by higher net gains related to investment securities. Total revenue also reflected the absence of the $350 million gain from the sale of our joint venture interest in CitiStreet in 2008.

The 12% decrease in servicing fees was the result of the impact of declines in daily average equity market valuations, partly offset by the impact of new business won and installed in prior periods on current-period revenue. Approximately 37% of our servicing fees were generated outside the U.S. in 2009, compared with 41% in 2008. Assets under custody and administration were $18.79 trillion, compared to $15.91 trillion in 2008, with the increase from 2008 primarily the result of increases in equity market valuations and a higher level of new business.

Management fees declined 21% from 2008 to 2009, primarily from the impact of declines in average month-end equity market valuations and the impact of client investment of a higher percentage of assets in lower-rate passive strategies, partly offset by the impact of new business on current-period revenue. Approximately 33% of our management fees were generated outside the U.S. in 2009, down from 40% in 2008. Assets under management increased to $1.95 trillion at December 31, 2009, up $485 billion from $1.47 trillion a year earlier.

Trading services revenue declined 25% primarily as a result of a decline in client volumes and currency volatility, partly offset by an increase in brokerage and other trading fees from growth in fixed-income transition management and equity trading, as well as an increase in electronic trading revenues attributable to higher volumes.

Securities finance revenue was down 54% as a result of compression of spreads and lower lending volumes. Processing fees and other revenue declined 38% due to lower product-related revenue from deposit services and structured products, the latter specifically our tax-exempt investment and conduit commercial paper programs.

Net interest revenue decreased primarily due to the impact of lower average levels of client deposits and lower deposit interest-rate spreads, largely offset by discount accretion recorded in connection with the former conduit assets added to our balance sheet in May 2009.

We recorded net gains of $368 million from sales of available-for-sale securities and losses from other-than-temporary impairment related to credit of $227 million for 2009, compared to net sale gains of $68 million and losses from other-than-temporary impairment related to credit of $122 million for 2008. The aggregate

 

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unrealized loss on securities for which other-than-temporary impairment was recorded in 2009 was $1.15 billion, of which $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. As a result, net gains related to investment securities for 2009 totaled $141 million, compared to net losses of $54 million for 2008.

For 2009, the $227 million of impairment 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.

The aforementioned accounting for other-than-temporary impairment was adopted by us, pursuant to new GAAP, 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.

PROVISION FOR LOAN LOSSES

We recorded an aggregate provision for loan losses of $149 million during 2009. Of the total provision, $124 million resulted from changes in management expectations with respect to future principal and interest cash flows from certain of the commercial real estate loans acquired in 2008 pursuant to indemnified repurchase agreements with an affiliate of Lehman as a result of the Lehman Brothers bankruptcy. The changes in management 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.

EXPENSES

 

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

Salaries and employee benefits

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

Information systems and communications

     656         633         4   

Transaction processing services

     583         644         (9

Occupancy

     475         465         2   

Provision for legal exposure

     250              

Provision for investment account infusion

             450      

Restructuring charges

             306      

Merger and integration costs

     49         115         (57

Professional services

     264         360         (27

Amortization of other intangible assets

     136         144         (6

Provision for indemnification exposure

             200      

Other

     516         692         (25
                    

Total expenses

   $ 5,966       $ 7,851         (24
                    

Number of employees at year end

     27,310         28,475      

The decrease in salaries and employee benefits for 2009 compared to 2008 was primarily due to the effect of our reduction in force, announced in December 2008 and substantially completed in the first quarter of 2009, as well as lower accruals for cash incentive compensation in 2009 in connection with our plan to increase our tangible common equity and lower contract services spending.

Information systems and communications expense increased due to higher levels of spending on telecommunications hardware and software. Transaction processing services expenses decreased due to lower volumes in the investment servicing business and lower costs related to external contract services.

 

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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.

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. In addition, as referenced above, we announced a reduction in force and related actions designed to reduce our operating costs, and recorded aggregate restructuring charges of $306 million.

In 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 certain transaction-related costs and direct incremental costs to integrate the acquired Investors Financial business into our operations, primarily related to employee retention and system and client integration, and did not include ongoing expenses of the combined organization.

During the second half of 2008, Lehman Brothers and certain of its affiliates filed for bankruptcy or other insolvency proceedings. While we had no unsecured financial exposure to Lehman or its affiliates, we indemnified certain clients in connection with collateralized repurchase agreements with Lehman entities. In the then-current market environment, the market value of the underlying collateral had decline