STT-2014.06.30_10Q
Table of Contents

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q

(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014

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)
______________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes  x   No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes  x   No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
    Large accelerated filer  x
 
Accelerated filer  ¨
 
Non-accelerated filer  ¨
 
Smaller reporting company  ¨
 
 
 
 
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes  ¨  No  x
The number of shares of the registrant’s common stock outstanding as of July 31, 2014 was 423,519,383.











 




STATE STREET CORPORATION
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED
JUNE 30, 2014

TABLE OF CONTENTS

 
 
PART I. FINANCIAL INFORMATION
 
PART II. OTHER INFORMATION
 



Table of Contents



MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
 
TABLE OF CONTENTS
 
 
 
 




3

Table of Contents
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS


GENERAL
State Street Corporation, or the parent company, is a financial holding company headquartered in Boston, Massachusetts. Unless otherwise indicated or unless the context requires otherwise, all references in this Management's Discussion and Analysis to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. Our principal banking subsidiary is State Street Bank and Trust Company, or State Street Bank. As of June 30, 2014, we had consolidated total assets of $282.32 billion, consolidated total deposits of $218.83 billion, consolidated total shareholders' equity of $21.70 billion and 29,420 employees. With $28.40 trillion of assets under custody and administration and $2.48 trillion of assets under management as of June 30, 2014, we are a leading specialist in meeting the needs of institutional investors worldwide.
We have two lines of business:
Investment Servicing provides services for mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations and endowments worldwide. Products include custody; product- and participant-level accounting; daily pricing and administration; master trust and master custody; record-keeping; cash management; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and alternative investment manager operations outsourcing; and performance, risk and compliance analytics to support institutional investors.
Investment Management, through State Street Global Advisors, or SSgA, provides a broad array of investment management, investment research and investment advisory services to corporations, public funds and other sophisticated investors. SSgA offers active and passive asset management strategies across equity, fixed-income and cash asset classes. Products are distributed directly and through intermediaries using a variety of investment vehicles, including exchange-traded funds, or ETFs, such as the SPDR® ETF brand.
For financial and other information about our lines of business, refer to “Line of Business Information” included in this Management's Discussion and Analysis and note 17 to the consolidated financial statements included in this Form 10-Q.
This Management's Discussion and Analysis is part of our Quarterly Report on Form 10-Q for the
 


quarter ended June 30, 2014, and updates the Management's Discussion and Analysis in our Annual Report on Form 10-K for the year ended December 31, 2013, referred to as our 2013 Form 10-K, and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2014, both of which we previously filed with the SEC. You should read the financial information contained in this Management's Discussion and Analysis and elsewhere in this Form 10-Q in conjunction with the financial and other information contained in those reports. Certain previously reported amounts presented in this Form 10-Q have been reclassified to conform to current-period presentation.
We prepare our consolidated financial statements in conformity with accounting principles generally accepted in the U.S., referred to as GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in its application of certain accounting policies that materially affect the reported amounts of assets, liabilities, equity, revenue and expenses.
The significant accounting policies that require us to make judgments, estimates and assumptions that are difficult, subjective or complex about matters that are uncertain and may change in subsequent periods consist of accounting for fair value measurements; other-than-temporary impairment of investment securities; and impairment of goodwill and other intangible assets. These significant accounting policies require the most subjective or complex judgments, and underlying estimates and assumptions could be subject to revision as new information becomes available.
Additional information about these significant accounting policies is included under “Significant Accounting Estimates” in Management's Discussion and Analysis in our 2013 Form 10-K. We did not change these significant accounting policies in the first six months of 2014.
Certain financial information provided in this Management's Discussion and Analysis is prepared on both a GAAP, or reported basis, and a non-GAAP, or operating basis, including certain non-GAAP measures used in the calculation of identified regulatory capital ratios. We measure and compare certain financial information on an operating basis, as we believe that this presentation supports meaningful comparisons from period to period and the analysis of comparable financial trends with respect to State Street's normal ongoing business operations. We believe that operating-basis financial information,


4

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

which reports non-taxable revenue, such as interest revenue associated with tax-exempt investment securities, on a fully taxable-equivalent basis, facilitates an investor's understanding and analysis of State Street's underlying financial performance and trends in addition to financial information prepared and reported in conformity with GAAP.
We also believe that the use of certain non-GAAP measures in the calculation of identified regulatory capital ratios is useful in understanding State Street's capital position and is of interest to investors. Operating-basis financial information should be considered in addition to, not as a substitute for or superior to, financial information prepared in conformity with GAAP. Any non-GAAP, or operating-basis, financial information presented in this Management’s Discussion and Analysis is reconciled to its most directly comparable GAAP-basis measure.
We provide additional disclosures required by applicable bank regulatory standards, including supplemental qualitative and quantitative information with respect to regulatory capital (including market risk associated with our trading activities), and summary results of semi-annual State Street-run stress tests which we conduct under the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act. These additional disclosures are accessible under "Filings and Reports" on the “Investor Relations” section of our corporate website at www.statestreet.com. We have included our website address in this report as an inactive textual reference only. Information on our website is not incorporated by reference into this Form 10-Q.
FORWARD-LOOKING STATEMENTS
This Form 10-Q, as well as other reports submitted by us under the Securities Exchange Act of 1934, registration statements filed by us under the Securities Act of 1933, our annual report to shareholders and other public statements we may make, contain statements (including statements in this Management's Discussion and Analysis) that are considered “forward-looking statements” within the meaning of U.S. securities laws, including statements about our goals and expectations regarding our business, financial and capital condition, results of operations, strategies, financial portfolio performance, dividend and stock purchase programs, market growth, acquisitions, joint ventures and divestitures and new technologies, services and opportunities, as well as regarding industry, regulatory, economic and market trends, initiatives and developments, the business environment and other matters that do not relate strictly to historical facts.
Terminology such as “plan,” “expect,” “intend,” “objective,” “forecast,” “outlook,” “believe,”
 
“anticipate,” “estimate,” “seek,” “may,” “will,” “trend,” “target,” “strategy” and “goal,” or similar statements or variations of such terms, are intended to identify forward-looking statements, although not all forward-looking statements contain such terms.
Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management's expectations and assumptions at the time the statements are made, and are not guarantees of future results. Management's expectations and assumptions, and the continued validity of the forward-looking statements, are subject to change due to a broad range of factors affecting the national and global economies, the equity, debt, currency and other financial markets, as well as factors specific to State Street and its subsidiaries, including State Street Bank. Factors that could cause changes in the expectations or assumptions on which forward-looking statements are based cannot be foreseen with certainty and include, but are not limited to:
the financial strength and continuing viability of the counterparties with which we or our clients do business and to which we have investment, credit or financial exposure, including, for example, the direct and indirect effects on counterparties of the sovereign-debt risks in the U.S., Europe and other regions;
increases in the volatility of, or declines in the level of, our net interest revenue, changes in the composition or valuation of the assets recorded in our consolidated statement of condition (and our ability to measure the fair value of investment securities) and the possibility that we may change the manner in which we fund those assets;
the liquidity of the U.S. and international securities markets, particularly the markets for fixed-income securities and inter-bank credits, and the liquidity requirements of our clients;
the level and volatility of interest rates and the performance and volatility of securities, credit, currency and other markets in the U.S. and internationally;
the credit quality, credit-agency ratings and fair values of the securities in our investment securities portfolio, a deterioration or downgrade of which could lead to other-than-temporary impairment of the respective securities and the recognition of an impairment loss in our consolidated statement of income;
our ability to attract deposits and other low-cost, short-term funding, and our ability to deploy deposits in a profitable manner


5

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

consistent with our liquidity requirements and risk profile;
the manner and timing with which the Federal Reserve and other U.S. and foreign regulators implement the Dodd-Frank Act, changes to the Basel III capital framework and European legislation, such as the Alternative Investment Fund Managers Directive and Undertakings for Collective Investment in Transferable Securities Directives, with respect to the levels of regulatory capital we must maintain, our credit exposure to third parties, margin requirements applicable to derivatives, banking and financial activities and other regulatory initiatives in the U.S. and internationally, including regulatory developments that result in changes to our structure or operating model, or other changes to how we provide services;
the impact of evolving and increasing regulatory compliance requirements and expectations on our expenses;
adverse changes in the regulatory capital ratios that we are required or will be required to meet, whether arising under the Dodd-Frank Act or the Basel III capital and liquidity standards, or due to changes in regulatory positions, practices or regulations in jurisdictions in which we engage in banking activities, including changes in internal or external data, formulae, models, assumptions or other advanced systems used in the calculation of our capital ratios that cause changes in those ratios as they are measured from period to period;
increasing requirements to obtain the prior approval of the Federal Reserve or our other regulators for the use, allocation or distribution of our capital or other specific capital actions or programs, including acquisitions, dividends and equity purchases, without which our growth plans, distributions to shareholders, equity purchase programs or other capital initiatives may be restricted;
changes in law or regulation, or the enforcement of law or regulation, that may adversely affect our business activities or those of our clients or our counterparties, and the products or services that we sell, including additional or increased taxes or assessments thereon, capital adequacy requirements, margin requirements and changes that expose us to risks related to the adequacy of our controls or compliance programs;
 
financial market disruptions or economic recession, whether in the U.S., Europe, Asia or other regions;
our ability to promote a strong culture of risk management, operating controls, compliance oversight and governance that meet our expectations and those of our clients and our regulators;
the results of, and costs associated with, governmental or regulatory inquiries and investigations, litigation and similar claims, disputes, or proceedings;
delays or difficulties in the execution of our previously announced Business Operations and Information Technology Transformation program, which could lead to changes in our estimates of the charges, expenses or savings associated with the planned program and may cause volatility of our earnings;
the potential for losses arising from our investments in sponsored investment funds;
the possibility that our clients will incur substantial losses in investment pools for which we act as agent, and the possibility of significant reductions in the liquidity or valuation of assets underlying those pools;
our ability to anticipate and manage the level and timing of redemptions and withdrawals from our collateral pools and other collective investment products;
the credit agency ratings of our debt and depository obligations and investor and client perceptions of our financial strength;
adverse publicity, whether specific to State Street or regarding other industry participants or industry-wide factors, or other reputational harm;
our ability to control operational risks, data security breach 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;
dependencies on information technology and our ability to control related risks, including cyber-crime and other threats to our information technology infrastructure and systems and their effective operation both independently and with external systems, and complexities and costs of protecting the security of our systems and data;
our ability to grow revenue, control expenses, attract and retain highly skilled people and raise the capital necessary to achieve our business goals and comply with regulatory requirements;


6

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

changes or potential changes to the competitive environment, including changes due to regulatory and technological changes, the effects of industry consolidation and perceptions of State Street as a suitable service provider or counterparty;
changes or potential changes in how and in what amounts clients compensate us for our services, and the mix of services provided by us that clients choose;
our ability to complete acquisitions, joint ventures and divestitures, including the ability to obtain regulatory approvals, the ability to arrange financing as required and the ability to satisfy closing conditions;
the risks that our acquired businesses and joint ventures will not achieve their anticipated financial and operational benefits or will not be integrated successfully, or that the integration will take longer than anticipated, that expected synergies will not be achieved or unexpected negative synergies 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 our relationships with our clients, our employees or regulators;
our ability to recognize emerging needs of our clients and to develop products that are responsive to such trends and profitable to us, the performance of and demand for the products and services we offer, and 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.
Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed in this section and elsewhere in this Form 10-Q or disclosed in our other SEC filings, including the risk factors discussed in our 2013 Form 10-K. Forward-looking statements in this Form 10-Q should not be relied on as representing our expectations or beliefs as of any date subsequent to the time this Form 10-Q is filed with the SEC. We undertake no obligation to revise our forward-looking statements after the time they are made. The factors discussed above are not intended to be a complete statement of all risks and uncertainties that may affect our businesses. We
 
cannot anticipate all developments that may adversely affect our business or operations or our consolidated results of operations or financial condition.
Forward-looking statements should not be viewed as predictions, and should not be the primary basis on which investors evaluate State Street. Any investor in State Street should consider all risks and uncertainties disclosed in our SEC filings, including our filings under the Securities Exchange Act of 1934, in particular our annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 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 the “Investor Relations” section of our corporate website at www.statestreet.com.
OVERVIEW OF FINANCIAL RESULTS
The following tables present our financial results for the quarters and six months ended June 30, 2014 and 2013:
 
Quarters Ended June 30,
 
 
(Dollars in millions, except per share amounts)
2014
 
2013
 
% Change
Total fee revenue
$
2,039

 
$
1,971

 
3
 %
Net interest revenue
561

 
596

 
(6
)
Gains (losses) related to investment securities, net
(2
)
 
(7
)
 
 
Total revenue
2,598

 
2,560

 
1

Provision for loan losses
2

 

 
 
Total expenses
1,850

 
1,798

 
3

Income before income tax expense
746

 
762

 
(2
)
Income tax expense
124

 
183

 
 
Net income
$
622

 
$
579

 
7

Adjustments to net income:
 
 
 
 
 
Dividends on preferred stock
(19
)
 
(6
)
 
 
Earnings allocated to participating securities
(1
)
 
(2
)
 
 
Net income available to common shareholders
$
602

 
$
571

 
 
Earnings per common share:
 
 
 
 
 
Basic
$
1.41

 
$
1.26

 
 
Diluted
1.38

 
1.24

 
11

Average common shares outstanding (in thousands):
 
 
 
 
 
Basic
427,824

 
452,176

 
 
Diluted
435,320

 
461,040

 
 
Cash dividends declared per common share
$
.30

 
$
.26

 
 
Return on average common equity
11.9
%
 
11.3
%
 
 


7

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

 
Six Months Ended June 30,
 
 
(Dollars in millions, except per share amounts)
2014
 
2013
 
% Change
Total fee revenue
$
3,963

 
$
3,828

 
4
 %
Net interest revenue
1,116

 
1,172

 
(5
)
Gains (losses) related to investment securities, net
4

 
(5
)
 
 
Total revenue
5,083

 
4,995

 
2

Provision for loan losses
4

 

 
 
Total expenses
3,878

 
3,624

 
7

Income before income tax expense
1,201

 
1,371

 
(12
)
Income tax expense
216

 
328

 
 
Net income
$
985

 
$
1,043

 
(6
)
Adjustments to net income:
 
 
 
 
 
Dividends on preferred stock
(25
)
 
(13
)
 
 
Earnings allocated to participating securities
(2
)
 
(4
)
 
 
Net income available to common shareholders
$
958

 
$
1,026

 
 
Earnings per common share:
 
 
 
 
 
Basic
$
2.23

 
$
2.26

 
 
Diluted
2.19

 
2.22

 
(1
)
Average common shares outstanding (in thousands):
 
 
 
 
 
Basic
429,215

 
453,240

 
 
Diluted
436,958

 
461,630

 
 
Cash dividends declared per common share
$
.56

 
$
.52

 
 
Return on average common equity
9.6
%
 
10.2
%
 
 
The following “Highlights” and “Financial Results” sections provide information related to significant events, as well as highlights of our consolidated financial results for the second quarter of 2014 presented in the preceding table. More detailed information about our consolidated financial results, including comparisons of our financial results for the second quarter of 2014 to those for the second quarter of 2013 and for the six months ended June 30, 2014 to those for the six months ended June 30, 2013, is provided under “Consolidated Results of Operations,” which follows these sections.
Highlights
We were notified by the Federal Reserve on February 21, 2014 that we completed our Basel III qualification period, or parallel run, and would be required to begin using the advanced approaches framework in the Basel III final rule in the determination of our risk-based capital requirements. Pursuant to this notification, we have begun to use the advanced approaches framework to calculate and disclose our regulatory capital ratios starting with the second quarter of 2014.
 
Information about our regulatory capital ratios as of June 30, 2014 is provided under "Financial Condition - Capital" in this Management's Discussion and Analysis, and in note 11 to the consolidated financial statements, included in this Form 10-Q.
In the second quarter of 2014, under a purchase program approved by our Board of Directors in March 2014 which authorizes us to purchase up to $1.70 billion of our common stock through March 31, 2015, we purchased approximately 6.3 million shares of our common stock at an average price of $65.02 per share and an aggregate cost of approximately $410 million.
In the second quarter of 2014, we declared a quarterly common stock dividend of $0.30 per share, totaling approximately $128 million, which was paid in July 2014.
Additional information about our common stock purchase program and our common stock dividends is provided under “Financial Condition – Capital” in this Management's Discussion and Analysis. Information about our common stock purchase program is also provided in Part II Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds,” included in this Form 10-Q.
State Street is registered with the Federal Reserve as a bank holding company pursuant to the Bank Holding Company Act of 1956. The Bank Holding Company Act limits the activities in which we (and non-banking entities that we are deemed to control under that Act) may engage to activities the Federal Reserve considers to be closely related to banking or to managing or controlling banks. Financial holding company status expands the activities permissible for a bank holding company to those that are deemed to be “financial in nature” by the Federal Reserve. State Street elected to become a financial holding company under the Bank Holding Company Act. Financial holding company status requires State Street and its banking subsidiaries to remain well capitalized and well managed and to comply with Community Reinvestment Act obligations. Currently, under the Bank Holding Company Act, we may not be able to engage in new activities or acquire shares or control of other businesses.
In addition, we meet the criteria for a systemically important financial institution under the Dodd-Frank Act and we are one of 29 banking organizations identified as a


8

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

global systemically important bank, or G-SIB, by the Financial Stability Board. 
Our compliance obligations have increased significantly due to new regulations in the U.S. and internationally that have been adopted or proposed in response to the financial crisis. As a systemically important financial institution, we are subject to enhanced supervision and prudential standards. In Europe, we anticipate that certain of our European banking subsidiaries may become subject to the European Central Bank's new supervisory authority. Our status as a G-SIB has also resulted in heightened prudential and conduct expectations of our U.S. and international regulators with respect to our capital and liquidity management and our compliance and risk oversight programs. These heightened expectations have increased our regulatory compliance costs, including personnel and systems, as well as significant additional implementation and related costs to enhance our programs.
In addition, we and other large banking organizations are required under the Dodd-Frank Act to periodically submit a resolution plan to the Federal Reserve and the Federal Deposit Insurance Corporation, or FDIC, describing our strategy for rapid and orderly resolution in the event of material financial distress or failure.  In August 2014, the Federal Reserve and the FDIC announced the completion of their reviews of resolution plans submitted in 2013 by 11 large, complex banking organizations, including State Street, under the requirements of the Dodd-Frank Act, and informed each of these organizations of specific shortcomings with their respective 2013 resolution plans. If we fail to meet regulatory expectations to the satisfaction of the Federal Reserve and the FDIC in the submission of our 2015 resolution plan, we could be subject to more stringent capital, leverage or liquidity requirements, restrictions on our growth, activities or operations, or be required to divest certain of our assets or operations.
Financial Results
Total revenue in the second quarter of 2014 increased 1% compared to the second quarter of 2013, as a 7% increase in aggregate servicing fee and management fee revenue and a 12% increase in securities finance revenue were partly offset by declines in trading services revenue and net interest revenue of 14% and 6%,
 
respectively. Total fee revenue increased 3% compared to the second quarter of 2013.
Servicing fee revenue in the second quarter of 2014 increased 7% compared to the second quarter of 2013, mainly the result of stronger global equity markets, the positive revenue impact of net new business (revenue added from new servicing business less revenue lost from the removal of assets serviced), and the impact of the weaker U.S. dollar. Servicing fees generated outside the U.S. in the second quarter of 2014 and the second quarter of 2013 were approximately 42% and 41%, respectively, of total servicing fees for those periods.
Management fee revenue increased 8% in the second quarter of 2014 compared to the second quarter of 2013, primarily the result of stronger global equity markets, partly offset by the negative impact of the excess of revenue lost from liquidations of managed assets over revenue added from newly installed assets to be managed. Management fees generated outside the U.S. in the second quarter of 2014 and the second quarter of 2013 were approximately 36% and 35%, respectively, of total management fees for those periods.
In the second quarter of 2014, trading services revenue, composed of revenue generated by foreign exchange trading and revenue from brokerage and other trading services, declined 14% compared to the second quarter of 2013. Revenue from foreign exchange trading declined 16%, with estimated indirect foreign exchange revenue down 24% and direct sales and trading foreign exchange revenue down 8%, from the second quarter of 2013. Both declines were mainly the result of lower volatility. Brokerage and other trading services revenue in the second quarter of 2014 declined 13% compared to the second quarter of 2013, mainly reflective of lower client volumes in electronic trading.
Securities finance revenue increased 12% in the second quarter of 2014 compared to the second quarter of 2013, generally reflective of growth in our enhanced custody business, where we participate in securities finance transactions as a principal.
Net interest revenue in the second quarter of 2014 declined 6% compared to the second quarter of 2013, generally the result of lower yields on interest-earning assets, as lower global interest rates affected revenue from


9

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

floating-rate assets, partly offset by lower interest expense and higher interest-earning assets.
Net interest margin, calculated on fully taxable-equivalent net interest revenue, declined 25 basis points to 1.17% in the second quarter of 2014 from 1.42% in the second quarter of 2013. Continued elevated levels of client deposits increased our average interest-earning assets, but negatively affected our net interest margin, as we placed a portion of these deposits with U.S. and non-U.S. central banks and earned the relatively low interest rates paid by the central banks on these balances.
Fully taxable-equivalent net interest revenue and net interest margin are discussed in more detail under “Consolidated Results of Operations - Net Interest Revenue” in this Management's Discussion and Analysis.
Total expenses in the second quarter of 2014 increased 3% compared to the second quarter of 2013. Compensation and employee benefits expenses increased 7%, primarily due to costs for additional staffing related to the installation of new business, higher incentive compensation, the impact of the weaker U.S. dollar, annual merit increases and higher regulatory compliance costs. These aggregate increases were partly offset by savings generated from the implementation of our Business Operations and Information Technology Transformation program.
Other expenses decreased 8% in the second quarter of 2014 compared to the second quarter of 2013, as lower levels of charitable contributions and sales promotion costs were partly offset by higher levels of professional services associated with regulatory compliance requirements.
We anticipate that evolving and increasing regulatory compliance requirements and expectations will continue to affect our expenses. Our employee compensation and benefits, information systems and other expenses could increase, as we further adjust our operations in response to new or proposed requirements and heightened expectations.
With respect to our Business Operations and Information Technology Transformation program, we expect to achieve additional pre-tax expense savings for full-year 2014 of approximately $130 million. These pre-tax
 
expense savings relate only to the Business Operations and Information Technology Transformation program and are based on projected improvement from our total 2010 expenses from operations, all else being equal. Our actual total expenses have increased since 2010, and may in the future increase or decrease, due to other factors.
Additional information with respect to our expenses, including our Business Operations and Information Technology Transformation program, is provided under “Consolidated Results of Operations - Expenses” in this Management's Discussion and Analysis.
In the second quarter of 2014, we secured an estimated $250 billion of new business in assets to be serviced; of the total, $89 billion was installed prior to June 30, 2014, with the remaining $161 billion expected to be installed in the remainder of 2014. In the second quarter of 2014, we also installed approximately $54 billion of new asset servicing business that we were awarded in prior periods. As of June 30, 2014, we had an estimated $243 billion of new business in assets to be serviced, including the $161 billion referenced above, which remained to be installed in future periods. New business in assets to be serviced includes assets from new servicing clients, as well as additional assets to be serviced for existing clients.
The new business not installed by June 30, 2014 was not included in our assets under custody and administration as of that date, and had no impact on our servicing fee revenue in the second quarter of 2014, as the assets are not included until their installation is complete and we begin to service them. Once installed, the assets generate servicing fee revenue in subsequent periods in which the assets are serviced.
With respect to these new assets, we will provide various services, including accounting, bank loan servicing, compliance reporting and monitoring, custody, depository banking services, foreign exchange, fund administration, hedge fund servicing, middle-office outsourcing, performance and analytics, private equity administration, real estate administration, securities finance, transfer agency, and wealth management services.
In the second quarter of 2014, SSgA added approximately $15 billion of net new business in assets to be managed, composed primarily of $22 billion of net inflows, substantially into


10

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

institutional products and ETFs, partly offset by net outflows of $7 billion from managed cash.
In addition, approximately $6 billion of new business awarded to SSgA but not installed by June 30, 2014 was not included in our assets under management as of that date, and had no impact on our management fee revenue for the second quarter of 2014, as the assets are not included until their installation is complete and we begin to manage them. Once installed, the assets generate management fee revenue in subsequent periods in which the assets are managed.
CONSOLIDATED RESULTS OF OPERATIONS
This section discusses our consolidated results of operations for the second quarter and first six months of 2014 compared to the same periods in 2013 in more detail, and should be read in conjunction with the consolidated financial statements and accompanying condensed notes included in this Form 10-Q.
Total Revenue
Additional information with respect to the sources of our revenue, the products and activities that generate it, and the factors that influence the levels of revenue generated during any period is provided under “Consolidated Results of Operations – Total Revenue” in Management’s Discussion and Analysis included in our 2013 Form 10-K.
 
The following tables present the components of total revenue for the periods indicated:
 
Quarters Ended June 30,
 
 
 
2014
 
2013
 
% Change
(Dollars in millions)
 
 
 
 
 
Fee revenue:
 
 
 
 
 
Servicing fees
$
1,288

 
$
1,201

 
7
 %
Management fees
300

 
277

 
8

Trading services:
 
 
 
 
 
Foreign exchange trading
144

 
171

 
(16
)
Brokerage and other trading services
116

 
133

 
(13
)
Total trading services
260

 
304

 
(14
)
Securities finance
147

 
131

 
12

Processing fees and other
44

 
58

 
(24
)
Total fee revenue
2,039

 
1,971

 
3

Net interest revenue:
 
 
 
 
 
   Interest revenue
650

 
700

 
(7
)
   Interest expense
89

 
104

 
(14
)
Net interest revenue
561

 
596

 
(6
)
Gains (losses) related to investment securities, net
(2
)
 
(7
)
 
 
Total revenue
$
2,598

 
$
2,560

 
1

 
Six Months Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
% Change
Fee revenue:
 
 
 
 
 
Servicing fees
$
2,526

 
$
2,376

 
6
 %
Management fees
592

 
540

 
10

Trading services:
 
 
 
 


Foreign exchange trading
278

 
317

 
(12
)
Brokerage and other trading services
235

 
276

 
(15
)
Total trading services
513

 
593

 
(13
)
Securities finance
232

 
209

 
11

Processing fees and other
100

 
110

 
(9
)
Total fee revenue
3,963

 
3,828

 
4

Net interest revenue:
 
 
 
 
 
   Interest revenue
1,305

 
1,387

 
(6
)
   Interest expense
189

 
215

 
(12
)
Net interest revenue
1,116

 
1,172

 
(5
)
Gains (losses) related to investment securities, net
4

 
(5
)
 
 
Total revenue
$
5,083

 
$
4,995

 
2



11

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

Fee Revenue
Servicing and management fees collectively composed approximately 78% and 79% of our total fee revenue in the second quarter and first six months of 2014, respectively, compared to 75% and 76%, respectively, for the corresponding periods in 2013. The level of these fees is influenced by several factors, including the mix and volume of our assets under custody and administration and our assets under management, the value and type of securities positions held (with respect to assets under custody) and the volume of portfolio transactions, and the types of products and services used by our clients, and is generally affected by changes in worldwide equity and fixed-income security valuations and trends in market asset class preferences.
 Generally, servicing fees are affected by changes in daily average valuations of assets under custody and administration. Additional factors, such as the relative mix of assets serviced, the level of transaction volumes, changes in service level, the nature of services provided, balance credits, client minimum balances, pricing concessions and other factors, may have a significant effect on our servicing fee revenue.
Generally, management fees are affected by changes in month-end valuations of assets under management. Management fees for certain components of managed assets, such as ETFs, are affected by daily average valuations of assets under management. Management fee revenue is more sensitive to market valuations than servicing fee revenue, since a higher proportion of the underlying services provided, and the associated management fees earned, are dependent on equity and fixed-income security valuations. Additional factors, such as the relative mix of assets managed, changes in service level and other factors, may have a significant effect on our management fee revenue. While certain management fees are directly determined by the values of assets under management and the investment strategies employed, management fees may reflect other factors as well, including performance fee arrangements, discussed later in this section, as
 
well as our relationship pricing for clients using multiple services.
Asset-based management fees for actively managed products are generally charged at a higher percentage of assets under management than for passive products. 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, using relevant information as of June 30, 2014 and assuming that all other factors remain constant, that: (1) a 10% increase or decrease, over the relevant periods for or on which our servicing and management fees are calculated, in worldwide equity valuations would result in a corresponding change in our total revenue of approximately 2%; and (2) a 10% increase or decrease, over the relevant periods for or on which our servicing and management fees are calculated, in worldwide fixed-income security valuations would result in a corresponding change in our total revenue of approximately 1%.
The following table presents selected equity market indices. While the specific indices presented are indicative of general market trends, the asset types and classes relevant to individual client portfolios can and do differ, and the performance of associated relevant indices can therefore differ from the performance of the indices presented.
Daily averages and the averages of month-end indices demonstrate worldwide changes in equity markets that affect our servicing and management fee revenue. Quarter-end indices affect the values of assets under custody and administration and assets under management as of those dates. The index names listed in the table are service marks of their respective owners.


12

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

INDEX
 
Daily Averages of Indices
 
Averages of Month-End Indices
 
Quarter-End Indices
 
Quarters Ended June 30,
 
Quarters Ended June 30,
 
As of June 30,
 
2014
 
2013
 
% Change
 
2014
 
2013
 
% Change
 
2014
 
2013
 
% Change
S&P 500®
1,900

 
1,609

 
18
%
 
1,923

 
1,612

 
19
%
 
1,960

 
1,606

 
22
%
NASDAQ®
4,196

 
3,368

 
25

 
4,255

 
3,396

 
25

 
4,408

 
3,403

 
30

MSCI EAFE®
1,942

 
1,707

 
14

 
1,955

 
1,698

 
15

 
1,972

 
1,639

 
20

 
Daily Averages of Indices
 
Averages of Month-End Indices
 
 
 
Six Months Ended June 30,
 
Six Months Ended June 30,
 
 
 
2014
 
2013
 
% Change
 
2014
 
2013
 
% Change
 
 
 
 
 
 
S&P 500®
1,868

 
1,563

 
20
%
 
1,880

 
1,569

 
20
%
 
 
 
 
 


NASDAQ®
4,203

 
3,275

 
28

 
4,229

 
3,293

 
28

 
 
 
 
 


MSCI EAFE®
1,918

 
1,687

 
14

 
1,926

 
1,687

 
14

 
 
 
 
 



The following tables present the components of fee revenue for the periods indicated:
FEE REVENUE
 
Quarters Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
% Change
Servicing fees
$
1,288

 
$
1,201

 
7
 %
Management fees
300

 
277

 
8

Trading services:
 
 
 
 
 
   Foreign exchange trading
144

 
171

 
(16
)
Brokerage and other trading services
116

 
133

 
(13
)
   Total trading services
260

 
304

 
(14
)
Securities finance
147

 
131

 
12

Processing fees and other
44

 
58

 
(24
)
Total fee revenue
$
2,039

 
$
1,971

 
3

 
Six Months Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
% Change
Servicing fees
$
2,526

 
$
2,376

 
6
 %
Management fees
592

 
540

 
10

Trading services:
 
 
 
 
 
   Foreign exchange trading
278

 
317

 
(12
)
Brokerage and other trading services
235

 
276

 
(15
)
   Total trading services
513

 
593

 
(13
)
Securities finance
232

 
209

 
11

Processing fees and other
100

 
110

 
(9
)
Total fee revenue
$
3,963

 
$
3,828

 
4

Servicing Fees
Servicing fees in the second quarter and first six months of 2014 increased 7% and 6%, respectively, compared to the second quarter and first six months of 2013, primarily the result of stronger global equity markets, the positive revenue impact of net new business (revenue added from new servicing
 
business less revenue lost from the removal of assets serviced), and the impact of the weaker U.S. dollar. For both the second quarter and first six months of 2014, servicing fees generated outside the U.S. were approximately 42% of total servicing fees, compared to approximately 41% for both the second quarter and first six months of 2013.
The following tables present the components, financial instrument mix and geographic mix of assets under custody and administration, as of the dates indicated:
COMPONENTS OF ASSETS UNDER CUSTODY AND ADMINISTRATION
(In billions)
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
Mutual funds
 
$
7,122

 
$
6,811

 
$
6,278

Collective funds
 
6,956

 
6,428

 
5,826

Pension products(1)
 
5,613

 
5,851

 
5,447

Insurance and other products
 
8,709

 
8,337

 
8,191

Total
 
$
28,400

 
$
27,427

 
$
25,742

 
 
(1) Decline as of June 30, 2014 compared to December 31, 2013 resulted primarily from the loss of assets serviced referenced below in this “Servicing Fees” section.
FINANCIAL INSTRUMENT MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION
(In billions)
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
Equities
 
$
15,607

 
$
15,050

 
$
13,407

Fixed-income
 
9,255

 
9,072

 
9,046

Short-term and other investments
 
3,538

 
3,305

 
3,289

Total
 
$
28,400

 
$
27,427

 
$
25,742



13

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

GEOGRAPHIC MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION(1) 
(In billions)
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
North America
 
$
21,199

 
$
20,764

 
$
19,390

Europe/Middle East/Africa
 
5,923

 
5,511

 
5,245

Asia/Pacific
 
1,278

 
1,152

 
1,107

Total
 
$
28,400

 
$
27,427

 
$
25,742

 
 
(1) Geographic mix is based on the location at which the assets are serviced.
The increase in total assets under custody and administration as of June 30, 2014 compared to both December 31, 2013 and June 30, 2013, resulted primarily from stronger global equity markets and net shareholder subscriptions experienced by our custody clients, partly offset by net losses of assets serviced. Asset levels as of June 30, 2014 did not reflect the estimated $243 billion of new business in assets to be serviced awarded to us in the second quarter of 2014 and prior periods but not installed prior to June 30, 2014. This new business will be reflected in assets under custody and administration in future periods after installation, and will generate servicing fee revenue in subsequent periods.
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 from period to period do not necessarily result in proportional changes in our servicing fee revenue.
Management Fees
Management fees increased 8% and 10% during the second quarter and first six months of 2014, respectively, compared to the same periods in 2013, primarily the result of stronger global equity markets, partly offset by the negative impact of the excess of revenue lost from liquidations of managed assets over revenue added from newly installed assets to be managed. For both the second quarter and first six months of 2014, management fees generated outside the U.S. were approximately 36% of total management fees, compared to 35% and 36%, respectively, for the same periods in 2013.
The following tables present assets under management by asset class and investment approach, ETFs by asset class, and the geographic mix of assets under management, as of the dates indicated:
 
ASSETS UNDER MANAGEMENT BY ASSET CLASS AND INVESTMENT APPROACH(1) 
(In billions)
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
Equity:
 
 
 
 
 
 
   Active
 
$
42

 
$
42

 
$
44

   Passive
 
1,390

 
1,334

 
1,152

Total Equity
 
1,432

 
1,376

 
1,196

Fixed-Income:
 
 
 
 
 
 
   Active
 
16

 
16

 
18

   Passive
 
336

 
311

 
306

Total Fixed-Income
 
352

 
327

 
324

Cash(2)
 
413

 
385

 
385

Multi-Asset-Class Solutions:
 
 
 
 
 
 
   Active
 
34

 
23

 
22

   Passive
 
116

 
110

 
97

Total Multi-Asset-Class Solutions
 
150

 
133

 
119

Alternative Investments(3):
 
 
 
 
 
 
   Active
 
18

 
14

 
12

   Passive
 
115

 
110

 
110

Total Alternative Investments
 
133

 
124

 
122

Total
 
$
2,480

 
$
2,345

 
$
2,146

 
 
(1) As of December 31, 2013, the presentation was changed to align with the reporting of core businesses. Amounts reported as of June 30, 2013 have been adjusted for comparative purposes.
(2) Includes both floating- and constant-net-asset-value portfolios held in commingled structures or separate accounts.
(3) Includes real estate investment trusts, currency and commodities, including SPDR® Gold Fund, for which State Street is not the investment manager, but acts as distribution agent.
  
EXCHANGE-TRADED FUNDS BY ASSET CLASS(1)(2) 
(In billions)
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
Alternative Investments
 
$
43

 
$
39

 
$
44

Cash
 
1

 
1

 
2

Equity
 
331

 
325

 
261

Fixed-income
 
38

 
34

 
30

Total Exchange-Traded Funds
 
$
413

 
$
399

 
$
337

 
 
(1) Exchange-traded funds are a component of assets under management presented in the preceding table.
(2) Includes SPDR® Gold Fund, for which State Street is not the investment manager, but acts as distribution agent.


14

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

GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1) 
(In billions)
 
June 30, 2014
 
December 31, 2013
 
June 30, 2013
North America
 
$
1,533

 
$
1,456

 
$
1,347

Europe/Middle East/Africa
 
589

 
560

 
498

Asia/Pacific
 
358

 
329

 
301

Total
 
$
2,480

 
$
2,345

 
$
2,146

 
 
(1) Geographic mix is based on client location or fund management location. Amounts reported as of June 30, 2013 were adjusted for comparative purposes to reflect realignment of reporting.
 

The increase in total assets under management as of June 30, 2014 compared to December 31, 2013 resulted primarily from net market appreciation during the first half of 2014 in the values of the assets managed, as well as net new business of approximately $18 billion. The net new business of $18 billion in the first six months of 2014 was primarily composed of $27 billion of net inflows into money market funds, partly offset by net outflows of $9 billion from ETFs.

The following table presents activity in assets under management, by product category, for the twelve months ended June 30, 2014:
ASSETS UNDER MANAGEMENT
(In billions)
Equity
 
Fixed-Income
 
Cash
 
Multi-Asset-Class Solutions
 
Alternative Investments
 
Total
Balance as of June 30, 2013
$
1,196

 
$
324

 
$
385

 
$
119

 
$
122

 
$
2,146

Long-term institutional inflows(1)
119

 
31

 

 
17

 
8

 
175

Long-term institutional outflows(1)
(151
)
 
(31
)
 

 
(14
)
 
(8
)
 
(204
)
Long-term institutional flows, net
(32
)
 

 

 
3

 

 
(29
)
ETF flows, net
26

 
4

 

 

 
(6
)
 
24

Cash fund flows, net

 

 
(2
)
 

 

 
(2
)
Total flows, net
(6
)
 
4

 
(2
)
 
3

 
(6
)
 
(7
)
Market appreciation(2)
180

 

 

 
8

 
7

 
195

Foreign exchange impact(2)
6

 
(1
)
 
2

 
3

 
1

 
11

Total market/foreign exchange impact
186

 
(1
)
 
2

 
11

 
8

 
206

Balance as of December 31, 2013
1,376

 
327

 
385

 
133

 
124

 
2,345

Long-term institutional inflows(1)
138

 
44

 

 
26

 
6

 
214

Long-term institutional outflows(1)
(153
)
 
(37
)
 

 
(18
)
 
(6
)
 
(214
)
Long-term institutional flows, net
(15
)
 
7

 

 
8

 

 

ETF flows, net
(13
)
 
3

 

 

 
1

 
(9
)
Cash fund flows, net

 

 
27

 

 

 
27

Total flows, net
(28
)
 
10

 
27

 
8

 
1

 
18

Market appreciation(2)
78

 
12

 

 
8

 
6

 
104

Foreign exchange impact(2)
6

 
3

 
1

 
1

 
2

 
13

Total market/foreign exchange impact
84

 
15

 
1

 
9

 
8

 
117

Balance as of June 30, 2014
$
1,432

 
$
352

 
$
413

 
$
150

 
$
133

 
$
2,480

 
 
(1) Amounts represent long-term portfolios, excluding ETFs.
(2) Amounts represent aggregate impact on each product category for the period.
The net new business of approximately $18 billion in the first six months 2014 presented in the preceding table did not include $6 billion of new asset management business, substantially all of which was awarded to SSgA in the second quarter of 2014 but not installed prior to June 30, 2014. This new business will be reflected in assets under management in future periods after installation, and will generate management fee revenue in subsequent periods.
 
Total assets under management as of June 30, 2014 included managed assets lost but not yet liquidated. Lost business occurs from time to time and it is difficult to predict the timing of client behavior in transitioning these assets. This timing can vary significantly.


15

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

Trading Services
The following tables summarize the components of trading services revenue for the periods indicated:
 
Quarters Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
% Change
Foreign exchange trading:
 
 
 
 
 
   Direct sales and trading
$
79

 
$
86

 
(8
)%
   Indirect foreign exchange trading
65

 
85

 
(24
)
   Total foreign exchange trading
144

 
171

 
(16
)
Brokerage and other trading services:
 
 
 
 
 
Electronic foreign exchange trading
43

 
63

 
(32
)
Other trading, transition management and brokerage
73

 
70

 
4

Total brokerage and other trading services
116

 
133

 
(13
)
Total trading services revenue
$
260

 
$
304

 
(14
)
 
Six Months Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
% Change
Foreign exchange trading:
 
 
 
 
 
   Direct sales and trading
$
150

 
$
167

 
(10
)%
   Indirect foreign exchange trading
128

 
150

 
(15
)
   Total foreign exchange trading
278

 
317

 
(12
)
Brokerage and other trading services:
 
 
 
 
 
Electronic foreign exchange trading
91

 
124

 
(27
)
Other trading, transition management and brokerage
144

 
152

 
(5
)
Total brokerage and other trading services
235

 
276

 
(15
)
Total trading services revenue
$
513

 
$
593

 
(13
)
Trading services revenue is composed of revenue generated by foreign exchange, or FX, trading, as well as revenue generated by brokerage and other trading services. We earn FX trading revenue by acting as a principal market maker. We offer a range of FX products, services and execution models. Most of our FX products and execution services can be grouped into three broad categories, which are further explained below: “direct sales and trading FX,” “indirect FX” and “electronic FX trading.” With respect to electronic FX trading, we provide an execution venue but do not act as agent or principal.
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 and commission recapture. In addition, we act as distribution agent for the SPDR® Gold ETF. These products and services are generally differentiated by our role as an agent of the institutional investor. Revenue earned from these
 
services is recorded in other trading, transition management and brokerage revenue within brokerage and other trading services revenue.
FX trading revenue is influenced by three principal factors: the volume and type of client FX transactions and related spreads; currency volatility; and the management of market risk associated with currencies and interest rates. Revenue earned from direct sales and trading FX and indirect FX is recorded in FX trading revenue. Revenue earned from electronic FX trading is recorded in brokerage and other trading services revenue.
The 14% and 13% decrease in total trading services revenue for the second quarter and first six months of 2014, respectively, compared to the second quarter and first six months of 2013, composed of separate changes related to FX trading and brokerage and other trading services, is explained below.
Total FX trading revenue declined 16% and 12% in the second quarter and first six months of 2014, respectively, compared to the same periods in 2013, primarily the result of lower currency volatility and spreads, partly offset by higher client volumes in direct sales and trading foreign exchange.
We enter into FX transactions with clients and investment managers that contact our trading desk directly. These trades are all executed at negotiated rates. We refer to this activity, and our principal market-making activities, as “direct sales and trading FX.” Alternatively, clients or their investment managers may elect to route FX transactions to our FX desk through our asset-servicing operation; we refer to this activity as “indirect FX.” We execute indirect FX trades as a principal at rates disclosed to our clients. We calculate revenue for indirect FX using an attribution methodology based on estimated effective mark-ups/downs and observed client volumes. All other FX trading revenue, other than this indirect FX revenue estimate, is considered by us to be direct sales and trading FX revenue. Our clients that utilize indirect FX can, in addition to executing their FX transactions through dealers not affiliated with us, transition from indirect FX to either direct sales and trading FX execution, including our “Street FX” service that enables our clients to define their FX execution strategy and automate the FX trade execution process, in which State Street continues to act as a principal market maker, or to one of our electronic trading platforms.
For the second quarter and first six months of 2014, our estimated indirect FX revenue declined 24% and 15%, respectively, compared to the same periods in 2013. The declines mainly resulted from lower currency volatility and lower client volumes. For the second quarter and first six months of 2014,


16

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

compared to the same periods in 2013, our direct sales and trading FX revenue declined 8% and 10%, respectively. The declines mainly resulted from lower currency volatility, partly offset by higher client volumes.
We continue to expect that some clients may choose, over time, to reduce their level of indirect FX transactions in favor of other execution methods, including either direct FX transactions or electronic FX trading which we provide. To the extent that clients shift to other execution methods that we provide, our FX trading revenue may decrease, even if volumes remain consistent.
Total brokerage and other trading services revenue declined 13% and 15% in the second quarter and first six months of 2014, respectively, compared to the same periods in 2013. Our clients may choose to execute FX transactions through one of our electronic trading platforms. This service generates revenue through a “click” fee. Revenue from such electronic FX trading declined 32% and 27% in the second quarter of 2014 and first six months of 2014, respectively, compared to the same periods in 2013, mainly due to declines in client volumes.
In the first six months of 2014, other trading, transition management and brokerage revenue declined 5% compared to the same period in 2013. The decrease mainly resulted from a decline in distribution fees associated with the SPDR® Gold ETF, which resulted from outflows as average gold prices declined during the period, partly offset by an increase in currency management revenue. With respect to the SPDR® Gold ETF, fees earned by us as distribution agent are recorded in other trading, transition management and brokerage revenue within brokerage and other trading services revenue, and not in management fee revenue.
Our revenue from transition management and related expenses in the first six months of 2014, as well as in full-years 2013, 2012 and 2011, were adversely affected by compliance issues in our U.K. business, the reputational and regulatory impact of which may continue to adversely affect our transition management revenue in future periods.
Securities Finance
Our agency securities finance business consists of two components: an agency lending program for SSgA-managed investment funds with a broad range of investment objectives, 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.
 
Securities finance revenue earned from our agency lending activities, which is 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, the interest-rate spreads and fees earned on the underlying collateral, and our share of the fee split.
 We also participate in securities lending transactions as a principal, which we refer to as our enhanced custody business. 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, or elects not to, transact directly with the market and requires us to execute the transaction and furnish the securities. In our role as principal, we provide support to the transaction through our credit rating. While a significant proportion of the securities furnished by us in our role as principal is sourced from third parties, we have the ability to source securities through our assets under custody and administration, from clients who have designated State Street as an eligible borrower.
Securities finance revenue in the second quarter and first six months of 2014 increased 12% and 11%, respectively, compared to the same periods in 2013, generally reflective of growth in our enhanced custody business.
Market influences may continue to affect client demand for securities finance, and as a result our revenue from, and the profitability of, our securities lending activities in future periods. In addition, proposed or anticipated regulatory changes may affect the volume of our securities lending activity and related revenue and profitability in future periods.
Processing Fees and Other
Processing fees and other revenue decreased 24% and 9% in the second quarter and first six months of 2014, respectively, compared to the same periods in 2013. The decrease was mainly due to higher amortization of tax-advantaged investments, partly offset by higher revenue from our investment in bank-owned life insurance.
Net Interest Revenue
Net interest revenue is defined as interest revenue earned on interest-earning assets less interest expense incurred on interest-bearing liabilities. Interest-earning assets, which principally consist of investment securities, interest-bearing deposits with banks, repurchase agreements, loans and leases and other liquid assets, are financed primarily by client deposits, short-term borrowings and long-term debt. Net interest margin represents the relationship between annualized fully taxable-equivalent net interest revenue and average total


17

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

interest-earning assets for the period. Revenue that is exempt from income taxes, mainly that earned from certain investment securities (state and political subdivisions), is adjusted to a fully taxable-equivalent
 
basis using a federal statutory income tax rate of 35%, adjusted for applicable state income taxes, net of the related federal tax benefit.

The following tables present the components of average interest-earning assets and average interest-bearing liabilities, related interest revenue and interest expense, and rates earned and paid, for the periods indicated:
 
Quarters Ended June 30,
 
2014
 
2013
(Dollars in millions; fully taxable-equivalent basis)
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
 
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
Interest-bearing deposits with banks
$
53,564

 
$
51

 
.38
 %
 
$
28,244

 
$
31

 
.44
%
Securities purchased under resale agreements
4,307

 
10

 
.94

 
5,852

 
12

 
.79

Trading account assets
953

 

 

 
638

 

 

Investment securities
117,593

 
568

 
1.94

 
118,522

 
609

 
2.06

Loans and leases
15,061

 
61

 
1.62

 
14,003

 
79

 
2.29

Other interest-earning assets
14,845

 
2

 
.06

 
11,016

 
2

 
.04

Average total interest-earning assets
$
206,323

 
$
692

 
1.34

 
$
178,275

 
$
733

 
1.64

Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
U.S.
$
20,698

 
$
4

 
0.09
 %
 
$
7,969

 
$
3

 
.13
%
Non-U.S.
109,290

 
14

 
0.05

 
102,127

 
24

 
.09

Securities sold under repurchase agreements
8,747

 

 

 
8,469

 

 

Federal funds purchased
19

 

 

 
300

 

 

Other short-term borrowings
4,000

 
(12
)
 
(1.20
)
 
3,641

 
15

 
1.63

Long-term debt
9,340

 
64

 
2.73

 
8,200

 
54

 
2.65

Other interest-bearing liabilities
7,559

 
19

 
0.99

 
6,273

 
8

 
.52

Average total interest-bearing liabilities
$
159,653

 
$
89

 
0.22

 
$
136,979

 
$
104

 
.30

Interest-rate spread
 
 
 
 
1.12
 %
 
 
 
 
 
1.34
%
Net interest revenue—fully taxable-equivalent basis

 
$
603

 
 
 
 
 
$
629

 
 
Net interest margin—fully taxable-equivalent basis
 
 
 
 
1.17
 %
 
 
 
 
 
1.42
%
Tax-equivalent adjustment
 
 
(42
)
 
 
 
 
 
(33
)
 
 
Net interest revenue—GAAP basis
 
 
$
561

 
 
 
 
 
$
596

 
 


18

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

 
Six Months Ended June 30,
 
2014
 
2013
(Dollars in millions; fully taxable-equivalent basis)
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
 
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
Interest-bearing deposits with banks
$
43,543

 
$
85

 
.40
%
 
$
29,408

 
$
62

 
.42
%
Securities purchased under resale agreements
5,463

 
19

 
.69

 
5,751

 
25

 
.87

Trading account assets
927

 

 

 
682

 

 

Investment securities
117,713

 
1,165

 
1.98

 
119,059

 
1,227

 
2.06

Loans and leases
14,833

 
119

 
1.61

 
13,374

 
135

 
2.04

Other interest-earning assets
14,190

 
3

 
.04

 
10,025

 
3

 
.05

Average total interest-earning assets
$
196,669

 
$
1,391

 
1.42

 
$
178,299

 
$
1,452

 
1.64

Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
U.S.
$
16,409

 
$
5

 
.07
%
 
$
10,669

 
$
9

 
.17
%
Non-U.S.
105,308

 
28

 
.05

 
100,930

 
52

 
.10

Securities sold under repurchase agreements
8,586

 

 

 
8,156

 

 

Federal funds purchased
20

 

 

 
331

 

 

Other short-term borrowings
3,955

 
3

 
.16

 
4,138

 
31

 
1.51

Long-term debt
9,503

 
127

 
2.66

 
7,802

 
110

 
2.83

Other interest-bearing liabilities
7,161

 
26

 
.73

 
6,384

 
13

 
.41

Average total interest-bearing liabilities
$
150,942

 
$
189

 
.25

 
$
138,410

 
$
215

 
.31

Interest-rate spread
 
 
 
 
1.17
%
 
 
 
 
 
1.33
%
Net interest revenue—fully taxable-equivalent basis
 
 
$
1,202

 
 
 
 
 
$
1,237

 
 
Net interest margin—fully taxable-equivalent basis
 
 
 
 
1.23
%
 
 
 
 
 
1.40
%
Tax-equivalent adjustment
 
 
(86
)
 
 
 
 
 
(65
)
 
 
Net interest revenue—GAAP basis
 
 
$
1,116

 
 
 
 
 
$
1,172

 
 
Average total interest-earning assets for the first six months of 2014 were higher compared to the first six months of 2013, the result of the investment of elevated levels of client deposits in interest-bearing deposits with banks, as well as higher levels of cash collateral (included in other interest-earning assets in the preceding tables) provided in connection with our enhanced custody business, and higher average loans and leases.
Our average other interest-earning assets, largely associated with enhanced custody, composed approximately 7% of our total average interest-earning assets for both the second quarter and first six months of 2014, compared to approximately 6% for both the second quarter and first six months of 2013, as this business continued to grow. While these securities finance activities support our overall profitability by generating securities finance revenue, they put downward pressure on our net interest margin, as interest on the collateral provided is earned at a lower rate than on our investment securities portfolio.
The higher level of investment in interest-bearing deposits with banks resulted from continued higher levels of client deposits, discussed further below, while the increase in average loans and leases
 
resulted from growth in mutual fund lending and senior secured bank loans.
During the past year, our clients have continued to place elevated levels of deposits with us, as low global interest rates have made deposits attractive relative to other investment options. The portion of these client deposits characterized as transient in nature has been generally placed with various central banks globally, while deposits characterized as more stable have been invested in our investment securities portfolio and used to support growth in other client-related activities.
Net interest revenue decreased 6% in the second quarter of 2014, and on a fully taxable-equivalent basis declined 4%, compared to the second quarter of 2013. In the first six months of 2014, net interest revenue decreased 5%, and on a fully taxable-equivalent basis declined 3%, compared to the first six months of 2013. The decreases were generally the result of lower yields on interest-earning assets, as lower global interest rates affected our revenue from floating-rate assets, partly offset by the benefit of those rates on interest expense and a higher level of interest-earning assets.
Subsequent to the commercial paper conduit consolidation in 2009, we have recorded aggregate discount accretion in interest revenue of $1.96 billion


19

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

($621 million in 2009, $712 million in 2010, $220 million in 2011, $215 million in 2012, $137 million in 2013 and $55 million in the first six months of 2014). The timing and ultimate recognition of any applicable discount accretion depends, in part, on factors that are outside of our control, including anticipated prepayment speeds and credit quality. The impact of these factors is uncertain and can be significantly influenced by general economic and financial market conditions. The timing and recognition of any applicable discount accretion can also be influenced by our ongoing management of the risks and other characteristics associated with our investment securities portfolio, including sales of securities which would otherwise generate interest revenue through accretion.
Depending on the factors discussed above, among others, we anticipate that, until the former conduit securities remaining in our investment portfolio mature or are sold, discount accretion will continue to contribute, though generally in declining amounts, to our net interest revenue. Assuming that we hold the remaining former conduit securities to maturity, all else being equal, we expect the remaining former conduit securities carried in our investment portfolio as of June 30, 2014 to generate aggregate discount accretion in future periods of approximately $522 million over their remaining terms, with approximately half of this aggregate discount accretion to be recorded over the next four years.
Changes in the components of interest-earning assets and interest-bearing liabilities are discussed in more detail below. Additional detail about the components of interest revenue and interest expense is provided in note 14 to the consolidated financial statements included in this Form 10-Q.
Interest-bearing deposits with banks averaged $53.56 billion for the quarter ended June 30, 2014, compared to $28.24 billion for the quarter ended June 30, 2013. For the first six months of 2014, such deposits averaged $43.54 billion, compared to $29.41 billion for the first six months of 2013. While these deposits reflect our maintenance of cash balances at the Federal Reserve, the European Central Bank, or ECB, and other non-U.S. central banks to satisfy regulatory reserve requirements, the above-described amounts also reflect the additional impact of continued elevated levels of client deposits and our investment of the excess deposits with these banks.
Certain client deposits were characterized as transient in nature and were placed with various central banks globally. If client deposits remain at or close to current elevated levels, we expect to continue to invest them in either money market assets, including central bank deposits, or in
 
investment securities, depending on our assessment of the underlying characteristics of the deposits.
 Average investment securities decreased slightly to $117.59 billion for the quarter ended June 30, 2014 from $118.52 billion for the quarter ended June 30, 2013, and in the year-to-date comparison decreased to $117.71 billion from $119.06 billion. The decreases were generally the result of an asset allocation shift from our investment portfolio to loans and leases. Detail with respect to our investment portfolio as of June 30, 2014 and December 31, 2013 is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
Loans and leases averaged $15.06 billion for the second quarter of 2014, compared to $14.00 billion for the second quarter of 2013, and $14.83 billion for the first six months of 2014, up from $13.37 billion for the same period in 2013. The increases were mainly related to mutual fund lending and our increased investment in senior secured bank loans, which in the aggregate averaged $10.13 billion for the quarter ended June 30, 2014 compared to $8.64 billion, the latter of which was all mutual fund lending, for the quarter ended June 30, 2013.
Average loans and leases also include short-duration advances. The proportion of the daily average of short-duration advances to average loans and leases declined to approximately 26% for the second quarter of 2014 from approximately 30% for the second quarter of 2013, and declined to approximately 25% for the first six months of 2014 from approximately 29% for the first six months of 2013. Short-duration advances provide liquidity to clients in support of their investment activities.
The following table presents average U.S. and non-U.S. short-duration advances for the periods indicated:
 
Quarters Ended June 30,
(In millions)
2014
 
2013
Average U.S. short-duration advances
$
2,338

 
$
2,652

Average non-U.S. short-duration advances
1,511

 
1,587

Average total short-duration advances
$
3,849

 
$
4,239

 
Six Months Ended June 30,
(In millions)
2014
 
2013
Average U.S. short-duration advances
$
2,209

 
$
2,372

Average non-U.S. short-duration advances
1,461

 
1,494

Average total short-duration advances
$
3,670

 
$
3,866

The decreases in average short-duration advances for the second quarter and first six months of 2014 compared to the second quarter and first six


20

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

months of 2013 were mainly the result of clients continuing to hold higher levels of liquidity.
Average other interest-earning assets increased to $14.85 billion for the second quarter of 2014 from $11.02 billion for the second quarter of 2013, and increased to $14.19 billion from $10.03 billion in the year-to-date comparison. The increased levels were primarily the result of higher levels of cash collateral provided in connection with our enhanced custody business.
Aggregate average interest-bearing deposits increased to $129.99 billion for the second quarter of 2014 from $110.10 billion for second quarter of 2013, and increased to $121.72 billion from $111.60 billion in the year-to-date comparison. Higher levels of interest-bearing deposits were primarily the result of increases in both U.S. and non-U.S. transaction accounts. Future transaction account levels will be influenced by the underlying asset servicing business, as well as market conditions, including the general levels of U.S. and non-U.S. interest rates.
Average other short-term borrowings increased slightly to $4.00 billion for the second quarter of 2014 from $3.64 billion for the second quarter of 2013. In the year-to-date comparison, average other short-term borrowings declined to $3.96 billion from $4.14 billion, as higher levels of client deposits provided additional liquidity. The negative rate paid in the second quarter, and the significant decline in the rate paid in the first six months of 2014 compared to the first six months of 2013, resulted from a reclassification of certain derivative contracts that hedge our interest-rate risk on certain assets and liabilities, which reduced interest revenue and interest expense.
Average long-term debt increased to $9.34 billion for the second quarter of 2014 from $8.20 billion for the second quarter of 2013, and increased to $9.50 billion from $7.80 billion in the year-to-date comparison. The increase primarily reflected the issuance of $1.5 billion of senior and subordinated debt in May 2013 and the issuance of $1.0 billion of senior debt in November 2013, partly offset by the maturity of $500 million of senior debt in May 2014 and $250 million of senior debt in March 2014.
 Average other interest-bearing liabilities increased to $7.56 billion for the second quarter of 2014 from $6.27 billion for the second quarter of 2013 and increased to $7.16 billion from $6.38 billion in the year-to-date comparison, primarily the result of higher levels of cash collateral received from clients in connection with our enhanced custody business.
Several factors could affect future levels of our net interest revenue and margin, including the mix of client liabilities; actions of various central banks;
 
changes in U.S. and non-U.S. interest rates; changes in the various yield curves around the world; revised or proposed regulatory capital or liquidity standards, or interpretations of those standards; the amount of discount accretion generated by the former conduit securities that remain in our investment securities portfolio; and the yields earned on securities purchased compared to the yields earned on securities sold or matured.
Based on market conditions and other factors, we continue to reinvest the majority of the proceeds from pay-downs and maturities of investment securities in highly-rated securities, such as U.S. Treasury and agency securities, federal agency mortgage-backed securities and U.S. and non-U.S. mortgage- and asset-backed securities. The pace at which we continue to reinvest and the types of investment securities purchased will depend on the impact of market conditions and other factors over time. We expect these factors and the levels of global interest rates to influence what effect our reinvestment program will have on future levels of our net interest revenue and net interest margin.
Gains (Losses) Related to Investment Securities, Net
The following tables present net realized gains from sales of available-for-sale securities and the components of net impairment losses, included in net gains and losses related to investment securities, for the periods indicated:
 
Quarters Ended June 30,
(In millions)
2014
 
2013
Net realized gains from sales of available-for-sale securities
$

 
$

Net impairment losses:
 
 
 
Gross losses from other-than-temporary impairment

 
(6
)
Losses reclassified (from) to other comprehensive income
(2
)
 
(1
)
Net impairment losses(1)
(2
)
 
(7
)
Gains (losses) related to investment securities, net
$
(2
)
 
$
(7
)
 
 
 
 
(1) Net impairment losses, recognized in our consolidated statement of income, were composed of the following:
 
 
 
Impairment associated with expected credit losses
$
(1
)
 
$

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

 
(6
)
Impairment associated with adverse changes in timing of expected future cash flows
(1
)
 
(1
)
Net impairment losses
$
(2
)
 
$
(7
)


21

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

 
Six Months Ended June 30,
(In millions)
2014
 
2013
Net realized gains from sales of available-for-sale securities
$
15

 
$
5

Net impairment losses:
 
 
 
Gross losses from other-than-temporary impairment
(1
)
 
(6
)
Losses reclassified (from) to other comprehensive income
(10
)
 
(4
)
Net impairment losses(1)
(11
)
 
(10
)
Gains (losses) related to investment securities, net
$
4

 
$
(5
)
 
 
 
 
(1) Net impairment losses, recognized in our consolidated statement of income, were composed of the following:
 
 
 
Impairment associated with expected credit losses
$
(10
)
 
$

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

 
(6
)
Impairment associated with adverse changes in timing of expected future cash flows
(1
)
 
(4
)
Net impairment losses
$
(11
)
 
$
(10
)
From time to time, in connection with our ongoing management of our investment securities portfolio, we sell available-for-sale securities to manage risk, to take advantage of favorable market conditions, or for other reasons. In the first six months of 2014, we sold approximately $2.84 billion of such investment securities, compared to approximately $4.82 billion in the first six months of 2013, and recorded net realized gains of $15 million and $5 million, respectively, as presented in the preceding table.
We regularly review our investment securities portfolio to identify other-than-temporary impairment of individual securities. Additional information about investment securities, the gross gains and losses that compose the net gains from sales of securities and other-than-temporary impairment is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
 
Expenses
The following tables present the components of expenses for the periods indicated:
 
Quarters Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
%  Change
Compensation and employee benefits
$
978

 
$
917

 
7
 %
Information systems and communications
244

 
235

 
4

Transaction processing services
193

 
186

 
4

Occupancy
115

 
114

 
1

Acquisition costs
15

 
19

 
 
Restructuring charges, net
13

 
11

 
 
Other:
 
 
 
 
 
Professional services
116

 
103

 
13

Amortization of other intangible assets
54

 
54

 

Securities processing costs
8

 
5

 
 
Regulatory fees and assessments
19

 
17

 
 
Other
95

 
137

 
(31
)
Total other
292

 
316

 
(8
)
Total expenses
$
1,850

 
$
1,798

 
3

Number of employees as of quarter-end
29,420

 
29,225

 
 
 
Six Months Ended June 30,
 
 
(Dollars in millions)
2014
 
2013
 
%  Change
Compensation and employee benefits
$
2,135

 
$
1,952

 
9
 %
Information systems and communications
488

 
472

 
3

Transaction processing services
384

 
366

 
5

Occupancy
229

 
230

 

Acquisition costs
36

 
34

 


Restructuring charges, net
25

 
10

 


Other:
 
 
 
 

Professional services
221

 
182

 
21

Amortization of other intangible assets
108

 
107

 
1

Securities processing costs
31

 
10

 


Regulatory fees and assessments
38

 
32

 


Other
183

 
229

 
(20
)
Total other
581

 
560

 
4

Total expenses
$
3,878

 
$
3,624

 
7

Total expenses in the second quarter and first six months of 2014 increased 3% and 7%, respectively, compared to the second quarter and first six months of 2013.
Compensation and employee benefits expenses in the second quarter and first six months of 2014 increased 7% and 9%, respectively, compared to the


22

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

second quarter and first six months of 2013. The increases were primarily the result of costs for additional staffing associated with the installation of new business, higher incentive compensation, the impact of the weaker U.S. dollar, annual merit increases, and higher regulatory compliance costs. These increases were partly offset by savings generated from the implementation of our Business Operations and Information Technology Transformation program.
The six-month increase in compensation and employee benefits expenses also included $76 million of severance costs associated with staff reductions recorded in the first six months of 2014.
Compensation and employee benefits expenses in the second quarter and first six months of 2014 included approximately $15 million and $27 million, respectively, of costs related to the implementation of our Business Operations and Information Technology Transformation program, compared to approximately $19 million and $42 million, respectively, in the second quarter and first six months of 2013. These costs are not expected to recur subsequent to full implementation of the program, planned for the end of 2014.
The increases in information systems and communications expenses in the second quarter and first six months of 2014 of 4% and 3%, respectively, compared to the same periods in 2013 were mainly associated with higher infrastructure costs related to the implementation of our Business Operations and Information Technology Transformation program and the support of new business.
Additional information with respect to the impact of the Business Operations and Information Technology Transformation program on future compensation and employee benefits and information systems and communications expenses is provided in the following “Restructuring Charges” section.
Transaction processing services expenses increased 4% and 5% in the second quarter and first six months of 2014, respectively, compared to the second quarter and first six months of 2013. The increase primarily reflected higher equity market values and higher transaction volumes in the investment servicing business.
The 8% decrease in other expenses in the second quarter of 2014 compared to the second quarter of 2013 was primarily due to lower levels of charitable contributions and sales promotion costs, partly offset by higher levels of professional services associated with regulatory compliance requirements. The 4% increase in the first six months of 2014 compared to the first six months of 2013 was primarily the result of higher levels of professional
 
services associated with regulatory compliance requirements, as well as securities processing costs associated with our transition management business, partly offset by a lower level of charitable contributions.
Our compliance obligations have increased significantly due to new regulations in the U.S. and internationally that have been adopted or proposed in response to the financial crisis. As a systemically important financial institution, we are subject to enhanced supervision and prudential standards. Our status as a G-SIB has also resulted in heightened prudential and conduct expectations of our U.S. and international regulators with respect to our capital and liquidity management and our compliance and risk oversight programs. These heightened expectations have increased our regulatory compliance costs, including personnel and systems, as well as significant additional implementation and related costs to enhance our programs. We anticipate that these evolving and increasing regulatory compliance requirements and expectations will continue to affect our expenses. Our employee compensation and benefits, information systems and other expenses could increase, as we further adjust our operations in response to new or proposed requirements and heightened expectations.
Acquisition Costs
In the second quarter and first six months of 2014, we recorded acquisition costs of $15 million and $36 million, respectively, compared to $19 million and $34 million, respectively, for the same periods in 2013. These amounts related to previously disclosed acquisitions, mainly our October 2012 acquisition of Goldman Sachs Administration Services.
Restructuring Charges
Information with respect to our Business Operations and Information Technology Transformation program and our 2012 expense control measures, including charges, employee reductions and aggregate activity in the related accruals, is provided in the following sections.
Business Operations and Information Technology Transformation Program
In November 2010, we announced a global multi-year Business Operations and Information Technology Transformation program. The program includes operational, information technology and targeted cost initiatives, including plans related to reductions in both staff and occupancy costs.
With respect to our business operations, we are standardizing certain core business processes, primarily through our execution of the State Street Lean methodology, and driving automation of these


23

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

business processes. We are currently creating a new technology platform, including transferring certain core software applications to a private cloud, and have expanded our use of third-party service providers associated with components of our information technology infrastructure and application maintenance and support. We transferred the majority of our core software applications to a private cloud in 2013, and we expect to transfer the remaining core software applications in 2014.
 
To implement this program, we expect to incur aggregate pre-tax restructuring charges of approximately $400 million to $450 million over the four-year period ending December 31, 2014. To date, we have recorded aggregate restructuring charges of $400 million in our consolidated statement of income, as presented in the following table by type of cost:

(In millions)
Employee-Related
Costs
 
Real Estate
Consolidation
 
Information
Technology Costs
 
Total
2010
$
105

 
$
51

 
$

 
$
156

2011
85

 
7

 
41

 
133

2012
27

 
20

 
20

 
67

2013
13

 
13

 
(1
)
 
25

First six months of 2014
16

 
3

 

 
19

Total
$
246

 
$
94

 
$
60

 
$
400

Employee-related costs included severance, benefits and outplacement services. Real estate consolidation costs resulted from actions taken to reduce our occupancy costs through the consolidation of leases and properties. Information technology costs included transition fees related to the above-described expansion of our use of third-party service providers.
In 2010, in connection with the program, we initiated the involuntary termination of 1,400 employees, or approximately 5% of our global workforce, which we completed by the end of 2011. In addition, in connection with our announcement in 2011 of the expansion of our use of third-party service providers associated with our information technology infrastructure and application maintenance and support, as well as the continued implementation of the business operations transformation component of the program, we identified 1,554 additional involuntary terminations. As of June 30, 2014, we eliminated 1,437 of these positions.
In connection with the continuing implementation of the program, we achieved incremental pre-tax expense savings of approximately $220 million in 2013, $112 million in 2012 and $86 million in 2011, in each case compared to our 2010 expenses from operations, all else being equal. We expect to achieve additional pre-tax expense savings in 2014 of approximately $130 million.
These pre-tax expense savings relate only to the Business Operations and Information Technology
 
Transformation program and are based on projected improvement from our total 2010 expenses from operations, all else being equal. Our actual total expenses have increased since 2010, and may in the future increase or decrease, due to other factors. The majority of the annual savings have affected compensation and employee benefits expenses. These savings have been modestly offset by increases in information systems and communications expenses.
Excluding the expected aggregate restructuring charges of $400 million to $450 million described earlier, we expect the program to reduce our pre-tax expenses from operations, on an annualized basis, by approximately $575 million to $625 million by the end of 2014 compared to 2010, all else being equal, with the full effect to be realized in 2015. We expect the business operations transformation component of the program to result in approximately $450 million of these savings and the information technology transformation component of the program to result in approximately $150 million of these savings.
2012 Expense Control Measures
In the fourth quarter of 2012, in connection with expense control measures designed to better align our expenses to our business strategy and related outlook for 2013, we identified additional targeted staff reductions. As a result of these actions, we have recorded aggregate pre-tax restructuring charges of $142 million in our consolidated statement of income, as presented in the following table by type of cost:


24

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

(In millions)
Employee-Related
Costs
 
Asset and Other Write-Offs
 
Total
2012
$
129

 
$
4

 
$
133

2013
(4
)
 
7

 
3

First six months of 2014

 
6

 
6

Total
$
125

 
$
17

 
$
142

Employee-related costs included severance, benefits and outplacement services. Costs for asset and other write-offs were primarily related to contract
terminations. We originally identified involuntary terminations of 960 employees (630 positions after
 
replacements). As of March 31, 2014, we substantially completed these reductions. 

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

 
$
51

 
$

 
$

 
$

 
$
156

Payments
(15
)
 
(4
)
 

 

 

 
(19
)
Balance as of December 31, 2010
90

 
47

 

 

 

 
137

Additional accruals for Business Operations and Information Technology Transformation program
85

 
7

 
41

 

 

 
133

Accruals for 2011 expense control measures
62

 

 

 
38

 
20

 
120

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

 
(5
)
 
(103
)
Balance as of December 31, 2011
162

 
39

 
33

 
38

 
15

 
287

Additional accruals for Business Operations and Information Technology Transformation program
27

 
20

 
20

 

 

 
67

Additional accruals for 2011 expense control measures
3

 

 

 
(9
)
 
5

 
(1
)
Accruals for 2012 expense control measures
129

 

 

 

 
4

 
133

Payments and adjustments
(126
)
 
(10
)
 
(48
)
 
(29
)
 
(11
)
 
(224
)
Balance as of December 31, 2012
195

 
49

 
5

 

 
13

 
262

Additional accruals for Business Operations and Information Technology Transformation program
13

 
13

 
(1
)
 

 

 
25

Additional accruals for 2012 expense control measures
(4
)
 

 

 

 
7

 
3

Payments and adjustments
(154
)
 
(13
)
 
(4
)
 

 
(13
)
 
(184
)
Balance as of December 31, 2013
50

 
49

 

 

 
7

 
106

Additional accruals for Business Operations and Information Technology Transformation program
16

 
3

 

 

 

 
19

Additional accruals for 2012 expense control measures

 

 

 

 
6

 
6

Payments and adjustments
(26
)
 
(29
)
 

 

 
(4
)
 
(59
)
Balance as of June 30, 2014
$
40

 
$
23

 
$

 
$

 
$
9

 
$
72


25

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

Income Tax Expense
Income tax expense was $124 million in the second quarter of 2014 compared to $183 million in the second quarter of 2013. In the first six months of 2014 and 2013, income tax expense was $216 million and $328 million, respectively. Our effective tax rate for the first six months of 2014 was 18.0% compared to 23.9% for the same period in 2013, with the decline primarily associated with an increase in tax-advantaged investments, primarily renewable energy.
LINE OF BUSINESS INFORMATION
We have two lines of business: Investment Servicing and Investment Management. Given our services and management organization, the results of operations for these lines of business are not necessarily comparable with those of other companies, including companies in the financial services industry. Information about our two lines of business, as well as the revenues, expenses and capital allocation methodologies associated with them, is provided in note 25 to the consolidated financial statements included in our 2013 Form 10-K.
 
The following is a summary of our line-of-business results for the periods indicated. The “Other” column for the second quarter and first six months of 2014 included severance costs associated with staff reductions of $4 million and $76 million, respectively, as well as net acquisition and restructuring costs of $28 million and $61 million, respectively. In addition, the first six months of 2014 included net provisions for litigation exposure and other costs of $6 million. The “Other” column for the second quarter and first six months of 2013 included net acquisition and restructuring costs of $30 million and $44 million, respectively, as well as net provisions for litigation exposure and other costs of $15 million for both periods. The amounts in the “Other” columns were not allocated to State Street's business lines. Results for the 2013 periods reflect reclassifications, for comparative purposes, related to management changes in methodologies associated with allocations of revenue and expenses reflected in line-of-business results for 2014.

 
Quarters Ended June 30,
 
Investment
Servicing
 
Investment
Management
 
Other
 
Total
(Dollars in millions, except where otherwise noted)
2014
 
2013
 
% Change Q2 2014 vs. Q2 2013
 
2014
 
2013
 
% Change Q2 2014 vs. Q2 2013
 
2014
 
2013
 
2014
 
2013
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicing fees
$
1,288

 
$
1,201

 
7
 %
 
$

 
$

 
 
 
$

 
$

 
$
1,288

 
$
1,201

Management fees

 

 
 
 
300

 
277

 
8
 %
 

 

 
300

 
277

Trading services
249

 
287

 
(13
)
 
11

 
17

 
(35
)
 

 

 
260

 
304

Securities finance
147

 
131

 
12

 

 

 
 
 

 

 
147

 
131

Processing fees and other
42

 
58

 
(28
)
 
2

 

 
 
 

 

 
44

 
58

Total fee revenue
1,726

 
1,677

 
3

 
313

 
294

 
6

 

 

 
2,039

 
1,971

Net interest revenue
545

 
571

 
(5
)
 
16

 
25

 
(36
)
 

 

 
561

 
596

Gains (losses) related to investment securities, net
(2
)
 
(7
)
 
 
 

 

 
 
 

 

 
(2
)
 
(7
)
Total revenue
2,269

 
2,241

 
1

 
329

 
319

 
3

 

 

 
2,598

 
2,560

Provision for loan losses
2

 

 
 
 

 

 
 
 

 

 
2

 

Total expenses
1,593

 
1,549

 
3

 
225

 
204

 
10

 
32

 
45

 
1,850

 
1,798

Income before income tax expense
$
674

 
$
692

 
(3
)
 
$
104

 
$
115

 
(10
)
 
$
(32
)
 
$
(45
)
 
$
746

 
$
762

Pre-tax margin
30
%
 
31
%
 
 
 
32
%
 
36
%
 
 
 
 
 
 
 
29
%
 
30
%
Average assets (in billions)
$
231.3

 
$
203.6

 
 
 
$
3.4

 
$
4.1

 
 
 
 
 
 
 
$
234.7

 
$
207.7


26

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

 
Six Months Ended June 30,
 
Investment
Servicing
 
Investment
Management
 
Other
 
Total
(Dollars in millions, except where otherwise noted)
2014
 
2013
 
% Change 6 mos. 2014 vs. 6 mos. 2013
 
2014
 
2013
 
% Change 6 mos. 2014 vs. 6 mos. 2013
 
2014
 
2013
 
2014
 
2013
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicing fees
$
2,526

 
$
2,376

 
6
 %
 
$

 
$

 
 
 
$

 
$

 
$
2,526

 
$
2,376

Management fees

 

 
 
 
592

 
540

 
10
 %
 

 

 
592

 
540

Trading services
490

 
552

 
(11
)
 
23

 
41

 
(44
)
 

 

 
513

 
593

Securities finance
232

 
209

 
11

 

 

 
 
 

 

 
232

 
209

Processing fees and other
97

 
105

 
(8
)
 
3

 
5

 
 
 

 

 
100

 
110

Total fee revenue
3,345

 
3,242

 
3

 
618

 
586

 
5

 

 

 
3,963

 
3,828

Net interest revenue
1,083

 
1,128

 
(4
)
 
33

 
44

 
(25
)
 

 

 
1,116

 
1,172

Gains (losses) related to investment securities, net
4

 
(5
)
 
 
 

 

 
 
 

 

 
4

 
(5
)
Total revenue
4,432

 
4,365

 
2

 
651

 
630

 
3

 

 

 
5,083

 
4,995

Provision for loan losses
4

 

 
 
 

 

 
 
 

 

 
4

 

Total expenses
3,266

 
3,139

 
4

 
469

 
426

 
10

 
143

 
59

 
3,878

 
3,624

Income before income tax expense
$
1,162

 
$
1,226

 
(5
)
 
$
182

 
$
204

 
(11
)
 
$
(143
)
 
$
(59
)
 
$
1,201

 
$
1,371

Pre-tax margin
26
%
 
28
%
 
 
 
28
%
 
32
%
 
 
 
 
 
 
 
24
%
 
27
%
Average assets (in billions)
$
221.8

 
$
204.0

 
 
 
$
3.4

 
$
4.0

 
 
 
 
 
 
 
$
225.2

 
$
208.0

Investment Servicing
Total revenue in the second quarter and first six months of 2014 for our Investment Servicing line of business, as presented in the preceding tables, increased 1% and 2%, respectively, compared to the same periods in 2013. Total fee revenue increased 3% in both comparisons, generally the result of increases in servicing fees and securities finance revenue, partly offset by a decline in trading services revenue.
Servicing fees in the second quarter and first six months of 2014 increased 7% and 6%, respectively, compared to the same periods in 2013. The increases for both comparisons primarily reflected stronger global equity markets, the positive revenue impact of net new business (revenue added from new servicing business less revenue lost from the removal of assets serviced), and the impact of the weaker U.S. dollar.
Trading services revenue in the second quarter and first six months of 2014 declined 13% and 11%, respectively, compared to the same periods in 2013. The decreases in both comparisons were mainly the result of lower volatility (partly offset by higher client volumes in direct sales and trading foreign exchange) and lower client volumes in electronic trading.
Securities finance revenue in the second quarter and first six months of 2014 increased 12% and 11%, respectively, compared to the same periods in 2013. The increase was generally reflective of growth in our enhanced custody business.
Processing fees and other revenue in the second quarter and first six months of 2014
 
decreased 28% and 8%, respectively, compared to the same periods in 2013, mainly due to higher amortization of tax-advantaged investments, partly offset by higher revenue from our investment in bank-owned life insurance.
Servicing fees, securities finance revenue and net gains (losses) related to investment securities for our Investment Servicing business line are identical to the respective consolidated results. Refer to “Servicing Fees,” "Securities Finance" and “Gains (Losses) Related to Investment Securities, Net” under “Total Revenue” in this Management’s Discussion and Analysis for a more in-depth discussion. A discussion of trading services revenue and processing fees and other revenue is provided under “Trading Services” and “Processing Fees and Other” in “Total Revenue.”
Net interest revenue in the second quarter and the first six months of 2014 decreased 5% and 4%, respectively, compared to the same periods in 2013. The decreases were generally the result of lower yields on interest-earning assets, as lower global interest rates affected revenue from floating-rate assets, partly offset by lower interest expense and higher interest-earning assets. A discussion of net interest revenue is provided under “Net Interest Revenue” in “Total Revenue.”
Total expenses in the second quarter and first six months of 2014 increased 3% and 4%, respectively, compared to the same periods in 2013. Both comparisons reflected increases in compensation and employee benefits expenses, driven primarily by costs associated with the installation of new business, higher incentive compensation, the impact of the weaker U.S. dollar, annual merit increases, and higher regulatory


27

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

compliance costs. The increase was partly offset by savings generated from the continued implementation of our Business Operations and Information Technology Transformation program. A more detailed discussion of expenses is provided under “Expenses” in “Consolidated Results of Operations.”
Investment Management
Total revenue in the second quarter and first six months of 2014 for our Investment Management line of business, as presented in the preceding tables, increased 3% compared to the same periods in 2013. Total fee revenue increased 6% and 5%, respectively compared to the same periods in 2013, primarily the result of increases in management fees, partly offset by decreases in trading services revenue.
Management fees in the second quarter and first six months of 2014 increased 8% and 10%, respectively, compared to the same periods in 2013. The increases in both comparisons primarily resulted from stronger global equity markets, partly offset by the negative impact of the excess of revenue lost from liquidations of managed assets over revenue added from newly installed assets to be managed. Trading services revenue in the second quarter and first six months of 2014 declined 35% and 44%, respectively, compared to the same periods in 2013, mainly due to lower distribution fees associated with the SPDR® Gold ETF, which resulted from outflows as average gold prices declined during the periods.
Management fees for the Investment Management business line are identical to the
 
respective consolidated results. Refer to “Management Fees” in “Total Revenue” in this Management's Discussion and Analysis for a more in-depth discussion. A discussion of trading services revenue is provided under “Trading Services” in “Total Revenue.”
Total expenses in the second quarter and first six months of 2014 both increased 10% compared to the same periods in 2013. The increases in both comparisons generally resulted from credits related to gains and recoveries associated with Lehman Brothers-related assets recorded in the second quarter of 2013. In addition, the year-to-date comparison reflected higher incentive compensation, higher sales promotion expenses, and increased costs associated with information technology contract staff.
FINANCIAL CONDITION
The following table presents the components of our average total interest-earning and noninterest-earning assets, average total interest-bearing and noninterest-bearing liabilities, and average preferred and common shareholders' equity for the six months ended June 30, 2014 and 2013. Additional information about our average statement of condition, primarily our interest-earning assets and interest-bearing liabilities, is included under “Consolidated Results of Operations - Total Revenue - Net Interest Revenue” in this Management's Discussion and Analysis.


28

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

Six Months Ended June 30,
2014
 
2013
(In millions)
Average Balance
 
Average Balance
Assets:
 
 
 
Interest-bearing deposits with banks
$
43,543

 
$
29,408

Securities purchased under resale agreements
5,463

 
5,751

Trading account assets
927

 
682

Investment securities
117,713

 
119,059

Loans and leases
14,833

 
13,374

Other interest-earning assets
14,190

 
10,025

Average total interest-earning assets
196,669

 
178,299

Cash and due from banks
4,963

 
3,897

Other noninterest-earning assets
23,538

 
25,782

Average total assets
$
225,170

 
$
207,978

Liabilities and shareholders’ equity:
 
 
 
Interest-bearing deposits:
 
 
 
U.S.
$
16,409

 
$
10,669

Non-U.S.
105,308

 
100,930

Total interest-bearing deposits
121,717

 
111,599

Securities sold under repurchase agreements
8,586

 
8,156

Federal funds purchased
20

 
331

Other short-term borrowings
3,955

 
4,138

Long-term debt
9,503

 
7,802

Other interest-bearing liabilities
7,161

 
6,384

Average total interest-bearing liabilities
150,942

 
138,410

Noninterest-bearing deposits
41,312

 
34,421

Other noninterest-bearing liabilities
11,786

 
14,281

Preferred shareholders’ equity
979

 
489

Common shareholders’ equity
20,151

 
20,377

Average total liabilities and shareholders’ equity
$
225,170

 
$
207,978


29

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

Investment Securities
The following tables present the carrying values of investment securities by type as of the dates indicated:
(In millions)
June 30, 2014
 
December 31, 2013
Available for sale:
 
 
 
U.S. Treasury and federal agencies:
 
 
 
Direct obligations
$
3,435

 
$
709

Mortgage-backed securities
22,139

 
23,563

Asset-backed securities:
 
 
 
Student loans(1) 
13,962

 
14,542

Credit cards
6,566

 
8,210

Sub-prime
1,101

 
1,203

Other
4,635

 
5,064

Total asset-backed securities
26,264

 
29,019

Non-U.S. debt securities:
 
 
 
Mortgage-backed securities
11,435

 
11,029

Asset-backed securities
4,200

 
5,390

Government securities
3,823

 
3,761

Other
5,757

 
4,727

Total non-U.S. debt securities
25,215

 
24,907

State and political subdivisions
10,617

 
10,263

Collateralized mortgage obligations
5,374

 
5,269

Other U.S. debt securities
4,842

 
4,980

U.S. equity securities
37

 
34

Non-U.S. equity securities
1

 
1

U.S. money-market mutual funds
615

 
422

Non-U.S. money-market mutual funds
7

 
7

Total
$
98,546

 
$
99,174


 
(In millions)
June 30, 2014
 
December 31, 2013
Held to Maturity:
 
 
 
U.S. Treasury and federal agencies:
 
 
 
Direct obligations
$
5,119

 
$
5,041

Mortgage-backed securities
74

 
91

Asset-backed securities:
 
 
 
Student loans(1) 
1,900

 
1,627

Credit cards
897

 
762

Other
692

 
782

Total asset-backed securities
3,489

 
3,171

Non-U.S. debt securities:
 
 
 
Mortgage-backed securities
4,274

 
4,211

Asset-backed securities
2,898

 
2,202

Government securities
2

 
2

Other
245

 
192

Total non-U.S. debt securities
7,419

 
6,607

State and political subdivisions
15

 
24

Collateralized mortgage obligations
2,641

 
2,806

Total
$
18,757

 
$
17,740

 
 
(1) Substantially composed of securities guaranteed by the federal government with respect to at least 97% of defaulted principal and accrued interest on the underlying loans.
Additional information about our investment securities portfolio is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
We manage our investment securities portfolio to align with the interest-rate and duration characteristics of our client liabilities and in the context of the overall structure of our consolidated statement of condition, in consideration of the global interest-rate environment. We consider a well-diversified, high-credit quality investment securities portfolio to be an important element in the management of our consolidated statement of condition.
Our portfolio is concentrated in securities with high credit quality, with approximately 89% of the carrying value of the portfolio rated “AAA” or “AA” as of both June 30, 2014 and December 31, 2013.








30

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

The following table presents the composition of the carrying value of the portfolio, by external credit rating, as of the dates indicated:
 
June 30, 2014
 
December 31, 2013
AAA(1)
70
%
 
70
%
AA
19

 
19

A
6

 
6

BBB
3

 
3

Below BBB
2

 
2

 
100
%
 
100
%
 
 
(1) Includes U.S. Treasury and federal agency securities that are split-rated, “AAA” by Moody’s Investors Service and “AA+” by Standard & Poor’s.
As of June 30, 2014, the investment portfolio of 9,720 securities was diversified with respect to asset class. As of June 30, 2014 and December 31, 2013, approximately 71% and 74%, respectively, of the aggregate carrying value of the portfolio as of that date was composed of mortgage-backed and asset-backed securities. The asset-backed portfolio, of which approximately 97% of the carrying value as of both dates was floating-rate, consisted primarily of student loan-backed and credit card-backed securities. Mortgage-backed securities were composed of securities issued by the Federal National Mortgage Association and Federal Home Loan Mortgage Corporation, as well as U.S. and non-U.S. large-issuer collateralized mortgage obligations.
In December 2013, U.S. regulators issued final regulations to implement the so-called “Volcker rule,” one of many provisions of the Dodd-Frank Act. The Volcker rule will, among other things, require banking organizations covered by the rule to either restructure or divest certain investments in and relationships with “covered funds,” as defined in the final Volcker rule regulations. The classification of certain types of investment securities or structures, such as collateralized loan obligations, or CLOs, as “covered funds” remains subject to market, and ultimately regulatory, interpretation, based on the specific terms and other characteristics relevant to such investment securities and structures.
As of June 30, 2014, we held an aggregate of approximately $5.10 billion of investments in CLOs. As of the same date, these investments had an aggregate pre-tax net unrealized gain of approximately $120 million, composed of gross unrealized gains of $132 million and gross unrealized losses of $12 million. In the event that we or our banking regulators conclude that such investments in CLOs, or other investments, are “covered funds,” we will be required to divest such investments if we are
 
unable to “cure” those investments before the conformance period ends on July 21, 2017. If other banking entities reach similar conclusions with respect to similar investments held by them, the prices of such investments could decline significantly, and we may be required to divest such investments at a significant discount compared to the investments' book value. This could result in a material adverse effect on our consolidated results of operations in the period in which such a divestment occurs or on our consolidated financial condition.
Based on our assessment to date of the remaining conformance period, we believe that it is not likely that we will be required to sell those investments before they recover in value.
Non-U.S. Debt Securities
Approximately 28% and 27% of the aggregate carrying value of our investment securities portfolio as of June 30, 2014 and December 31, 2013, respectively, was composed of non-U.S. debt securities.
The following table presents the carrying values of our non-U.S. debt securities available for sale and held to maturity, included in the preceding table of investment securities carrying values, by significant country of issuer or location of collateral, as of the dates indicated:


31

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

(In millions)
June 30, 2014
 
December 31, 2013
Available for Sale:
 
 
 
United Kingdom
$
8,768

 
$
9,357

Australia
4,168

 
3,551

Netherlands
3,479

 
3,471

Canada
2,568

 
2,549

France
1,541

 
1,581

Germany
1,155

 
1,410

Japan
1,008

 
971

South Korea
620

 
744

Finland
452

 
397

Norway
447

 
369

Italy
434

 

Sweden
141

 
142

Belgium
136

 

Austria
82

 
83

Other
216

 
282

Total
$
25,215

 
$
24,907

Held to Maturity:
 
 
 
Australia
$
2,348

 
$
2,216

Germany
1,729

 
1,263

United Kingdom
1,615

 
1,474

Netherlands
1,002

 
934

Italy
260

 
270

Spain
197

 
206

Ireland
81

 
86

Other
187

 
158

Total
$
7,419

 
$
6,607

Approximately 90% and 89% of the aggregate carrying value of these non-U.S. debt securities was rated “AAA” or “AA” as of June 30, 2014 and December 31, 2013, respectively. The majority of these securities comprise senior positions within the security structures; these positions have a level of protection provided through subordination and other forms of credit protection. As of June 30, 2014 and December 31, 2013, approximately 73% and 72%, respectively, of the aggregate carrying value of these non-U.S. debt securities was floating-rate, and accordingly, the securities are considered to have minimal interest-rate risk. As of June 30, 2014, these non-U.S. debt securities had an average market-to-book ratio of 101.5%, and an aggregate pre-tax net unrealized gain of approximately $482 million, composed of gross unrealized gains of $515 million and gross unrealized losses of $33 million. These unrealized amounts included a pre-tax net unrealized gain of $286 million, composed of gross unrealized gains of $297 million and gross unrealized losses of $11 million, associated with non-U.S. debt securities available for sale.
As of June 30, 2014, the underlying collateral for these mortgage- and asset-backed securities
 
primarily included U.K. prime mortgages, Australian and Dutch mortgages and German automobile loans. The securities listed under “Canada” were composed of Canadian government securities and corporate debt. The securities listed under “France” were composed of automobile loans and corporate debt. The securities listed under “Japan” were substantially composed of Japanese government securities. The securities listed under “South Korea” were composed of South Korean government securities. The “other” category of available-for-sale securities as of June 30, 2014 and December 31, 2013 included approximately $76 million and $133 million, respectively, related to Portugal, Ireland and Spain, all of which were mortgage-backed securities. The “other” category of held-to-maturity securities as of June 30, 2014 and December 31, 2013 included approximately $42 million and $44 million, respectively, of securities related to Portugal, all of which were mortgage-backed securities.
Our aggregate exposure to Spain, Italy, Ireland and Portugal as of June 30, 2014 did not include any direct sovereign debt exposure to any of these countries. Our indirect exposure to these countries as of June 30, 2014 totaled approximately $1.09 billion, including approximately $926 million of mortgage- and asset-backed securities, composed of $197 million in Spain, $530 million in Italy, $119 million in Ireland and $80 million in Portugal. These mortgage- and asset-backed securities had an aggregate pre-tax net unrealized gain of approximately $120 million as of June 30, 2014, composed of gross unrealized gains of $122 million and gross unrealized losses of $2 million. We recorded no other-than-temporary impairment on these mortgage- and asset-backed securities in our consolidated statement of income in the first six months of 2014. We recorded other-than-temporary impairment of $6 million on one of these securities in our consolidated statement of income in the first six months of 2013, all in the second quarter of 2013, associated with management's intent to sell an impaired security prior to its recovery in value.
Throughout the sovereign debt crisis, the major independent credit rating agencies have downgraded, and may in the future do so again, U.S. and non-U.S. financial institutions and sovereign issuers which have been, and may in the future be, significant counterparties to us, or whose financial instruments serve as collateral on which we rely for credit risk mitigation purposes. As a result, we may be exposed to increased counterparty risk, leading to negative ratings volatility.
Municipal Securities
We carried an aggregate of approximately $10.63 billion and $10.29 billion of municipal


32

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

securities, classified as state and political subdivisions in the preceding table of investment securities carrying values, in our investment securities portfolio as of June 30, 2014 and December 31, 2013, respectively. Substantially all of these securities were classified as available for sale, with the remainder classified as held to maturity. As of the same dates, we also provided approximately $7.50 billion and $8.16 billion, respectively, of credit and liquidity facilities to municipal issuers as a form of credit enhancement.
 
The following tables present our combined credit exposure to state and municipal obligors that represented 5% or more of our aggregate municipal credit exposure of approximately $18.13 billion as of June 30, 2014 and $18.45 billion as of December 31, 2013 across our businesses, grouped by state to display geographic dispersion:

June 30, 2014
Total Municipal
Securities
 
Credit and
Liquidity Facilities
 
Total
 
% of Total Municipal
Exposure
(Dollars in millions)
 
 
 
 
 
 
 
State of Issuer:
 
 
 
 
 
 
 
Texas
$
1,265

 
$
1,566

 
$
2,831

 
16
%
New York
919

 
996

 
1,915

 
11

California
409

 
1,479

 
1,888

 
10

Massachusetts
993

 
756

 
1,749

 
10

Maryland
422

 
504

 
926

 
5

Total
$
4,008

 
$
5,301

 
$
9,309

 
 
December 31, 2013
Total Municipal
Securities
 
Credit and
Liquidity Facilities
 
Total 
 
% of Total Municipal Exposure  
(Dollars in millions)
 
 
 
 
 
 
 
State of Issuer:
 
 
 
 
 
 
 
Texas
$
1,233

 
$
1,628

 
$
2,861

 
16
%
New York
919

 
1,000

 
1,919

 
10

Massachusetts
967

 
759

 
1,726

 
9

California
373

 
1,266

 
1,639

 
9

Maryland
327

 
643

 
970

 
5

Total
$
3,819

 
$
5,296

 
$
9,115

 
 
Our aggregate municipal securities exposure presented in the foregoing table was concentrated primarily with highly-rated counterparties, with approximately 90% of the obligors rated “AAA” or “AA” as of June 30, 2014, compared to approximately 84% rated “AAA” or “AA” as of December 31, 2013. As of June 30, 2014, approximately 68% and 31% of our aggregate exposure was associated with general obligation and revenue bonds, respectively, compared to 64% and 34%, respectively, as of December 31, 2013. In addition, we had no exposures associated with healthcare, industrial development or land development bonds. The portfolios are also diversified geographically, with the states that represent our largest exposures widely dispersed across the U.S.
Additional information with respect to our assessment of other-than-temporary impairment of our municipal securities is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
 
Impairment
Impairment exists when the fair value of an individual security is below its amortized cost basis. Impairment of a security is further assessed to determine whether such impairment is other-than-temporary. When the impairment is deemed to be other-than-temporary, we record the loss in our consolidated statement of income. In addition, for debt securities available for sale and held to maturity, we record impairment in our consolidated statement of income when management intends to sell (or may be required to sell) the securities before they recover in value, or when management expects the present value of cash flows expected to be collected from the securities to be less than the amortized cost of the impaired security (a credit loss).
The following table presents the amortized cost and fair value, and associated net unrealized gains and losses, of investment securities available for sale and held to maturity as of the dates indicated:


33

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

 
June 30, 2014(1)
 
December 31, 2013(1)
(In millions)
Amortized Cost
 
Net Unrealized Gains(Losses)
 
Fair Value
 
Amortized Cost
 
Net Unrealized Gains(Losses)
 
Fair Value
Available for sale(2)
$
97,739

 
$
807

 
$
98,546

 
$
99,159

 
$
15

 
$
99,174

Held to maturity(2)
18,757

 
107

 
18,864

 
17,740

 
(180
)
 
17,560

Total investment securities
$
116,496

 
$
914

 
$
117,410

 
$
116,899

 
$
(165
)
 
$
116,734

Net after-tax unrealized gain (loss)
 
 
$
548

 
 
 
 
 
$
(96
)
 
 
 
 
 
 
(1) Amounts excluded the remaining net unrealized losses primarily related to reclassifications of securities available for sale to securities held to maturity in 2008, recorded in accumulated other comprehensive income, or AOCI, within shareholders' equity in our consolidated statement of condition. Additional information is provided in note 10 to the consolidated financial statements included in this Form 10-Q.
(2) Securities available for sale are carried at fair value, with after-tax net unrealized gains and losses recorded in AOCI. Securities held to maturity are carried at cost, and unrealized gains and losses are not recorded in our consolidated financial statements.

The aggregate improvement to a net unrealized gain as of June 30, 2014 from a net unrealized loss as of December 31, 2013 presented above was primarily attributable to narrowing spreads and declining interest rates in the first six months of 2014.
We conduct periodic reviews of individual securities to assess whether other-than-temporary impairment exists. Our assessment of other-than-temporary impairment involves an evaluation of economic and security-specific factors. Such factors are based on estimates, derived by management, which contemplate current market conditions and security-specific performance. To the extent that market conditions are worse than management's expectations, other-than-temporary impairment could increase, in particular the credit-related component that would be recorded in our consolidated statement of income.
In the aggregate, we recorded net losses from other-than-temporary impairment of $2 million and $11 million in the second quarter and first six months of 2014, respectively, compared to $7 million and $10 million in the second quarter and first six months of 2013, respectively. Additional information with respect to this other-than-temporary impairment and net impairment losses, as well as information about our assessment of impairment, is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
Given the exposure of our investment securities portfolio, particularly mortgage- and asset-backed securities, to residential mortgage and other consumer credit risks, the performance of the U.S. housing market is a factor in the portfolio's credit performance. As such, our assessment of other-than-temporary impairment relies, in part, on our estimates of trends in national housing prices in addition to
 
trends in unemployment rates, interest rates and the timing of defaults. Generally, indices that measure trends in national housing prices are published in arrears. As of March 31, 2014, national housing prices, according to the Case-Shiller National Home Price Index, had declined by approximately 21% peak-to-current. Overall, our evaluation of other-than-temporary impairment as of June 30, 2014 continued to include an expectation of a U.S. housing recovery characterized by relatively modest growth in national housing prices over the next few years. In connection with our assessment of other-than-temporary impairment with respect to relevant securities in our investment portfolio in future periods, we will consider trends in national housing prices that we observe at those times, including the Case-Shiller National Home Price Index, in addition to trends in unemployment rates, interest rates and the timing of defaults.
The other-than-temporary impairment of our investment securities portfolio continues to be sensitive to our estimates of future cumulative losses. However, given our positive outlook for U.S. national housing prices, our sensitivity analysis indicated, as of June 30, 2014, that our investment securities portfolio was less exposed to the overall housing price outlook relative to other factors, including unemployment rates and interest rates.
The residential mortgage servicing environment continues to be challenging. The time line to liquidate distressed loans continues to extend, but to a lesser degree as a result of strengthening in the national housing market. The rate at which distressed residential mortgages are liquidated may affect, among other things, our investment securities portfolio. Such effects could include the timing of cash flows or the credit quality associated with the mortgages collateralizing certain of our residential


34

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

mortgage-backed securities, which, accordingly, could result in the recognition of additional other-than-temporary impairment in future periods.
Our evaluation of potential other-than-temporary impairment of mortgage-backed securities with collateral located in Spain, Italy, Ireland and Portugal takes into account government intervention in the corresponding mortgage markets and assumes a conservative baseline macroeconomic environment for this region, factoring in slow economic growth and government austerity measures. Our baseline view assumes a recessionary period characterized by high unemployment and by additional declines in housing prices of between 2% and 15% across these four countries. Our evaluation of other-than-temporary impairment in our base case does not assume a disorderly sovereign debt restructuring or a break-up of the Eurozone.
In addition, we perform stress testing and sensitivity analysis in order to assess the impact of more severe assumptions on potential other-than-temporary impairment. For example, we estimate, using relevant information as of June 30, 2014 and assuming that all other factors remain constant, that in more stressful scenarios in which unemployment, gross domestic product and housing prices in these four countries deteriorate over the relevant periods more than we expected as of June 30, 2014, other-than-temporary impairment could increase by a range of $2 million to $39 million. This sensitivity estimate is based on a number of factors, including, but not limited to, the level of housing prices and the timing of defaults. To the extent that such factors differ significantly from management's current expectations, resulting loss estimates may differ materially from those stated.
Excluding other-than-temporary impairment recorded in the first six months of 2014, management considers the aggregate decline in fair value of the remaining investment securities and the resulting gross unrealized losses as of June 30, 2014 to be temporary and not the result of any material changes in the credit characteristics of the securities. Additional information about these gross unrealized losses is provided in note 3 to the consolidated financial statements included in this Form 10-Q.
Loans and Leases
The following table presents our U.S. and non-U.S. loans and leases, by segment, as of the dates indicated:
 
(In millions)
June 30, 2014
 
December 31, 2013
Institutional:
 
 
 
U.S.
$
12,765

 
$
10,623

Non-U.S.
3,771

 
2,654

Commercial real estate:
 
 
 
U.S.
263

 
209

Total loans and leases
16,799

 
13,486

Allowance for loan losses
(32
)
 
(28
)
Loans and leases, net of allowance for loan losses
$
16,767

 
$
13,458

The increase in loans in the institutional segment presented in the preceding table was mainly related to an increase in mutual fund lending, higher levels of short-duration advances, and our continued investment in the non-investment-grade lending market through participations in loan syndications, specifically senior secured bank loans, that we began in 2013. Aggregate short-duration advances to our clients included in the institutional segment were $5.41 billion and $2.45 billion as of June 30, 2014 and December 31, 2013, respectively. Senior secured bank loans are more fully described below.
Additional information about all of our loan-and-lease segments, as well as underlying classes, is provided in note 4 to the consolidated financial statements included in this Form 10-Q, and in note 5 to the consolidated financial statements included in our 2013 Form 10-K.
As of June 30, 2014 and December 31, 2013, our investment in senior secured bank loans totaled approximately $1.32 billion and $724 million, respectively. In addition, we had binding unfunded commitments as of June 30, 2014 totaling $236 million to participate in such syndications. We expect to increase our level of participation in these loan syndications in future periods.
These loans, which we have rated “speculative” under our internal risk-rating framework (refer to note 4 to the consolidated financial statements included in this Form 10-Q), are externally rated “BBB,” “BB” or “B,” with approximately 95% of the loans rated “BB” or “B” as of June 30, 2014, compared to 94% as of as of December 31, 2013. We limit our investment to larger, more liquid credits underwritten by major global financial institutions, we apply our internal credit analysis process to each potential investment, and we diversify our exposure by counterparty and industry segment. However, these loans have significant exposure to credit losses relative to higher-rated loans. As of June 30, 2014, our allowance for loan losses included approximately $20 million related to these commercial and financial loans.


35

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

As of June 30, 2014 and December 31, 2013, unearned income deducted from our investment in leveraged lease financing was $117 million and $121 million, respectively, for U.S. leases and $274 million and $298 million, respectively, for non-U.S. leases.
As of both June 30, 2014 and December 31, 2013, we held an aggregate of approximately $130 million of commercial real estate loans which were modified in troubled debt restructurings. No impairment loss was recognized upon restructuring of the loans, as the discounted cash flows of the modified loans exceeded the carrying amount of the original loans as of the modification date. No loans were modified in troubled debt restructurings in the first six months of 2014 or in all of 2013.
The following table presents activity in the allowance for loan losses for the periods indicated:
 
Six Months Ended June 30,
(In millions)
2014
 
2013
Allowance for loan losses:
 
 
 
Beginning balance
$
28

 
$
22

Provision for loan losses:
 
 
 
Institutional
4

 

Ending balance
$
32

 
$
22

The provision of $4 million recorded in the six months ended June 30, 2014 was composed of a provision of $14 million associated with an increase in our estimates of credit losses on our portfolio of senior secured bank loans, as the portfolio continues to grow and become more seasoned, net of a negative provision of $10 million associated with the pay-down of an unrelated commercial and financial loan with speculative-rated credit quality.
As of June 30, 2014, approximately $20 million of our allowance for loan losses was related to senior secured bank loans included in the institutional segment; the remaining $12 million was related to other commercial and financial loans in the institutional segment. The senior secured bank loans were purchased in connection with our participation in loan syndications in the non-investment-grade lending market beginning in 2013.
 
Cross-Border Outstandings
Cross-border outstandings are amounts payable to us by non-U.S. counterparties which are denominated in U.S. dollars or other non-local currency, as well as non-U.S. local currency claims not funded by local currency liabilities. Our cross-border outstandings consist primarily of deposits with banks; loans and lease financing, including short-duration advances; investment securities; amounts related to foreign exchange and interest-rate contracts; and securities finance.  In addition to credit risk, cross-border outstandings have the risk that, as a result of political or economic conditions in a country, borrowers may be unable to meet their contractual repayment obligations of principal and/or interest when due because of the unavailability of, or restrictions on, foreign exchange needed by borrowers to repay their obligations.
Additional information with respect to the nature of our cross-border outstandings is provided under “Financial Condition - Cross-Border Outstandings” in Management's Discussion and Analysis included in our 2013 Form 10-K.
The following table presents our cross-border outstandings in countries in which we do business, and which amounted to at least 1% of our consolidated total assets as of the dates indicated. The aggregate of the total cross-border outstandings presented in the table represented approximately 17% and 19% of our consolidated total assets as of June 30, 2014 and December 31, 2013, respectively.
(In millions)
Investment Securities and Other Assets 
 
Derivatives and Securities on Loan
 
Total Cross-Border Outstandings
June 30, 2014
 
 
 
 
 
United Kingdom
$
16,793

 
$
862

 
$
17,655

Japan
11,321

 
90

 
11,411

Australia
7,767

 
133

 
7,900

Netherlands
4,559

 
132

 
4,691

Germany
3,643

 
356

 
3,999

Canada
3,235

 
395

 
3,630

December 31, 2013
 

 
 

 
 

United Kingdom
$
15,422

 
$
1,697

 
$
17,119

Australia
7,309

 
672

 
7,981

Netherlands
4,542

 
277

 
4,819

Canada
3,675

 
620

 
4,295

Germany
4,062

 
147

 
4,209

France
2,887

 
735

 
3,622

Japan
2,445

 
605

 
3,050

Aggregate cross-border outstandings in countries which amounted to between 0.75% and 1% of our consolidated total assets totaled approximately $2.10 billion to France as of June 30, 2014, and


36

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

approximately $1.85 billion to China as of December 31, 2013.
The following table presents our cross-border outstandings in Italy, Ireland, Spain and Portugal as of the dates indicated:
(In millions)
Investment
Securities and
Other Assets 
 
Derivatives and Securities on Loan
 
Total Cross-Border Outstandings
June 30, 2014
 
 
 
 
 
Italy
$
1,060

 
$
2

 
$
1,062

Ireland
509

 
386

 
895

Spain
197

 
42

 
239

Portugal
80

 

 
80

December 31, 2013
 

 
 

 
 

Italy
$
763

 
$
2

 
$
765

Ireland
369

 
304

 
673

Spain
271

 
11

 
282

Portugal
78

 

 
78

As of June 30, 2014, none of the exposures in these countries was individually greater than 0.75% of our consolidated total assets. The aggregate exposures consisted primarily of interest-bearing deposits, investment securities, loans, including short-duration advances, and foreign exchange contracts. We had not recorded any provisions for loan losses with respect to any of our exposure in these countries as of June 30, 2014.
Risk Management
General
In the normal course of our global business activities, we are exposed to a variety of risks, some inherent in the financial services industry, others more specific to our business activities. Our risk management framework focuses on material risks, which include the following:
credit and counterparty risk;
liquidity risk, funding and management;
operational risk;
market risk associated with our trading activities;
market risk associated with our non-trading, or asset-and-liability management, activities, which consists primarily of interest-rate risk; and
business risk, including reputational risk.
Many of these risks, as well as certain of the factors underlying each of these risks that could affect our businesses and our consolidated financial statements, are discussed in detail under Item 1A, “Risk Factors,” included in our 2013 Form 10-K.
The scope of our business requires that we balance these risks with a comprehensive and well-integrated risk management function. The
 
identification, assessment, monitoring, mitigation and reporting of risks are essential to our financial performance and successful management of our businesses. These risks, if not effectively managed, can result in losses to State Street as well as erosion of our capital and damage to our reputation. Our systematic approach allows for an assessment of risks within a framework for evaluating opportunities for the prudent use of capital that appropriately balances risk and return.
Our objective is to optimize our return and to operate at a prudent level of risk. In support of this objective, we have instituted a risk appetite framework that aligns our business strategy and financial objectives with the level of risk that we are willing to incur.
Our risk management is based on the following major goals:
A culture of risk awareness that extends across all of our business activities;
The identification, classification and quantification of State Street's material risks;
The establishment of our risk appetite and associated limits and policies, and our compliance with these limits;
The establishment of a risk management structure at the “top of the house” that enables the control and coordination of risk-taking across the business lines;
The implementation of stress testing practices and a dynamic risk-assessment capability; and
The overall flexibility to adapt to the ever-changing business and market conditions.
Our risk appetite framework outlines the quantitative limits and qualitative goals that define our risk appetite, as well as the responsibilities for measuring and monitoring risk against limits, and for reporting, escalating, approving and addressing exceptions. Our risk appetite framework is established by management with the guidance of Enterprise Risk Management, or ERM, a corporate risk oversight group, in conjunction with our Board of Directors. The Board formally reviews and approves our risk appetite statement annually.
The risk appetite framework describes the level and types of risk that we are willing to accommodate in executing our business strategy, and also serves as a guide in setting risk limits across our business units. In addition to our risk appetite statement, we use stress testing as another important tool in our risk management practice. Additional information with respect to our stress testing process and practices is provided under “Capital” in Management's Discussion and Analysis of Financial Condition and Results of


37

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

Operations, or Management's Discussion, included under Item 7 of our 2013 Form 10-K.
The following table provides a reference to the disclosures about our management of significant risks provided herein.
 
Form 10-Q Page Number

Governance and Structure
We have a disciplined approach to risk management that involves all levels of management, from the Board and the Board’s Risk and Capital Committee, or RCC, its Examining & Audit, or E&A, Committee and its Technology Committee, to each business unit and each employee. We allocate responsibility for risk oversight so that risk/return decisions are made at an appropriate level, and are subject to robust and effective review and challenge. Risk management is the responsibility of each employee, and is implemented through three lines of defense: the business units, which own and manage the risks inherent in their business, are considered the first line of defense; ERM and other support
 
functions, such as Legal, Compliance, Finance and Vendor Management, provide the second line of defense; and Corporate Audit, which performs an independent assessment of the effectiveness of the first two lines of defense.
The responsibilities for effective review and challenge reside with senior managers, management oversight committees, Corporate Audit and, ultimately, the Board and its committees. While we believe that our risk management program is effective in managing the risks in our businesses, internal and external factors may create risks that are not identified or anticipated.
Corporate-level risk committees provide focused oversight, and establish corporate standards and policies for specific risks, including credit, sovereign exposure, market, liquidity, operational information technology as well as new business products, regulatory compliance and ethics, vendor risk and model risks. These committees have been delegated the responsibility to develop recommendations and remediation strategies to address issues that affect or have the potential to affect State Street.
We maintain a risk governance committee structure which serves as the formal governance mechanism through which we seek to undertake the consistent identification, management and mitigation of various risks facing State Street in connection with its business activities. This governance structure is enhanced and integrated through multi-disciplinary involvement, particularly through ERM. The following chart presents this structure.


38

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

 
Risk Governance Committee Structure
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Executive Management Committees:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Management Risk and Capital Committee
 
Business Conduct Review Committee
 
Technology and Operational Risk Committee
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Risk Committees:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset, Liability and Capital Committee
 
Credit Risk and Policy Committee
 
Fiduciary Review Committee
 
Operational Risk Committee
 
 
Technology Risk Governance Committee
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading and Markets Risk Committee
 
Basel/ICAAP Oversight Committee
 
New Business and Product Committee
 
 
 
 
Business Continuity Executive Committee
 
Executive Information Steering Committee
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Country Risk Committee
 
Securities Finance Risk Management Committee
 
Compliance and Ethics Committee
 
 
 
 
Vendor Management Steering Committee
 
Access Control Board
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Recovery and Resolution Planning Executive Steering Group
 
Model Assessment Committee
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
CCAR Steering Committee
 
 
 
 
 
 
 
 
 
 
 
Enterprise Risk Management
The goal of ERM is to ensure that risks are proactively identified, well-understood and prudently managed in support of our business strategy. ERM provides risk oversight, support and coordination to allow for the consistent identification, measurement and management of risks across business units separate from the business units' activities, and is responsible for the formulation and maintenance of enterprise-wide risk management policies and guidelines. In addition, ERM establishes and reviews limits and, in collaboration with business unit management, monitors key risks. Ultimately, ERM works to validate that risk-taking occurs within the risk appetite framework approved by the Board and conforms to associated risk policies, limits and guidelines.
The Chief Risk Officer, or CRO, is responsible for State Street’s risk management globally, leads ERM and has a dual reporting line to State Street’s Chief Executive Officer and the Board’s RCC. ERM
 
manages its responsibilities globally through a three-dimensional organization structure:
“Vertical” business unit-aligned risk groups that support business managers with risk management, measurement and monitoring activities;
“Horizontal” risk groups that monitor the risks that cross all of our business units (for example, credit and operational risk); and
Risk oversight for international activities, which adds important regional and legal entity perspectives to global vertical and horizontal risk management.
Sitting on top of this three-dimensional organization structure is a centralized group responsible for the aggregation of risk exposures across the vertical, horizontal and regional dimensions, for consolidated reporting, for setting the enterprise-level risk appetite framework and associated limits and policies, and for dynamic risk assessment across State Street.


39

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

Board Committees
The Board has three committees which assist it in discharging its responsibilities with respect to risk management: the RCC, the E&A Committee and the Technology Committee.
The RCC is responsible for oversight related to our assessment and management of risk, including credit, liquidity, operational, fiduciary, market, including interest-rate, and business risks and related policies. In addition, the RCC provides oversight on strategic capital governance principles and controls, and monitors capital adequacy in relation to risk. The RCC is also responsible for discharging the duties and obligations of the Board under applicable Basel and other regulatory requirements. Our Chief Financial Officer, or CFO, and CRO attend meetings of the RCC.
The E&A Committee oversees the operation of our system of internal controls covering the integrity of our consolidated financial statements and reports, compliance with laws, regulations and corporate policies, and the qualifications, performance and independence of our independent registered public accounting firm. The E&A Committee acts on behalf of the Board in monitoring and overseeing the performance of Corporate Audit and in reviewing certain communications with banking regulators. The E&A Committee has direct responsibility for the appointment, compensation, retention, evaluation and oversight of the work of our independent registered public accounting firm, including sole authority for the establishment of pre-approval policies and procedures for all audit engagements and any non-audit engagements.
The Technology Committee leads and assists in the Board’s oversight of the role of technology in executing State Street’s strategy and supporting State Street’s global business and operational requirements. The Technology Committee reviews the use of technology in our activities and operations, as well as significant technology and technology-related strategies, investments and policies. In addition, the Technology Committee reviews and approves technology and technology-related risk matters.
Executive Management Committees
The Management Risk and Capital Committee, or MRAC, is the senior management decision-making body for risk and capital issues, and oversees our financial risks, our consolidated statement of condition, and our capital adequacy, liquidity and recovery and resolution planning. Its responsibilities include:


 

The approval of our risk appetite framework and top level risk limits and policies;
The monitoring and assessment of our capital adequacy based on regulatory requirements and internal policies; and
The ongoing monitoring and review of risks undertaken within the businesses, and our senior management oversight and approval of risk strategies and tactics.
MRAC, which is co-chaired by our CRO and CFO, regularly presents a report to the RCC outlining developments in the risk environment and performance trends in our key business areas.
The Business Conduct Review Committee, or BCRC, provides additional risk governance and leadership, by overseeing State Street's business practices in terms of their compliance with law, regulation and our standards of business conduct, our commitments to clients and others with whom we do business, and potential reputational risks. Management considers adherence to high ethical standards to be critical to the success of our business and to our reputation. The BCRC is co-chaired by our CRO and our Chief Legal Officer.
The Technology and Operational Risk Committee, or TORC, oversees and assesses the effectiveness of corporate-wide technology and operational risk management programs, to manage and control technology and operational risk consistently across the organization. TORC is co-chaired by our CRO and our Head of Global Operations, Technology and Product Development. TORC may meet jointly with MRAC periodically to review or approve common areas of interest such as risk frameworks and policies.
Risk Committees
The following risk committees, under the oversight of the respective executive management committees, have focused responsibilities for oversight of specific areas of risk management:
Management Risk and Capital Committee
Our Asset, Liability and Capital Committee, referred to as ALCCO, oversees the management of our consolidated statement of condition; the management of our global liquidity and our interest-rate risk positions; our capital adequacy with respect to regulatory requirements, internal tangible common equity and other capital targets and the expectations of the major independent credit rating agencies; the determination of the framework for capital allocation and strategies for capital structure; and issuances


40

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

of debt and equity securities. ALCCO’s roles and responsibilities are designed to work complementary to, and be coordinated with, MRAC, which approves our balance sheet strategy and related activities. ALCCO is chaired by our Treasurer and reports directly into MRAC;
The Credit Risk and Policy Committee has primary responsibility for the oversight and review of credit and counterparty risk across business units, as well as the oversight, review and approval of the Credit Risk Guidelines; the Committee consists of many senior executives within ERM, including the CRO, and reviews policies and guidelines related to all aspects of our business which give rise to credit risk; State Street business units are also represented on the Credit Risk and Policy Committee; credit risk policies and guidelines are reviewed periodically, but at least annually;
The Trading and Markets Risk Committee, or TMRC, reviews the effectiveness of, and approves, the market risk framework at least annually; it is the senior oversight and decision-making committee for risk management within our global markets and trading-and-clearing businesses; the TMRC is responsible for the formulation of guidelines, strategies and workflows with respect to the measurement, monitoring and control of our trading market risk, and also approves market risk tolerance limits and dealing authorities; the TMRC meets regularly to monitor the management of our trading market risk activities;
The Basel / ICAAP Oversight Committee reviews and assesses compliance with regulatory capital rules, and oversees initiatives related to the development and enhancement of relevant reporting capabilities;
The Country Risk Committee oversees the identification, assessment, monitoring, reporting and mitigation, where necessary, of country risks;
The Securities Finance Risk Management Committee oversees the risks in our securities finance business, including collateral and margin policies;
The Recovery and Resolution Planning Executive Steering Group oversees the development of recovery and resolution plans as required by banking regulators;
 
The Model Assessment Committee, or MAC, provides recommendations concerning technical modeling issues and oversees the validation of financial models utilized by our business units; and
The Comprehensive Capital Analysis and Review, or CCAR, Steering Committee provides primary supervision of the stress tests performed in conformity with CCAR and the Dodd-Frank Act, and is responsible for the overall management, review, and approval of all material assumptions, methodologies, and results of each stress scenario.
Business Conduct Review Committee
The Fiduciary Review Committee reviews and assesses the risk management programs of those units in which State Street serves in a fiduciary capacity;
The New Business and Product Committee provides oversight of the evaluation of the risk inherent in proposed new products or services and new business, as well as divestitures, restructurings and outsourcing arrangements; evaluations include economic justification, material risk, compliance, regulatory and legal considerations, and capital and liquidity analyses; and
The Compliance and Ethics Committee provides review and oversight of State Street's compliance programs, including its culture of compliance and high standards of ethical behavior.
Technology and Operational Risk Committee
The Technology Risk Governance Committee provides regular reporting to the TORC and escalates technology risk issues to the TORC, as appropriate;
The Business Continuity Executive Committee reviews overall business continuity program performance; ensures executive accountability for compliance with the business continuity program and standards; and reviews and approves major changes or exceptions to program policy and standards;
The Executive Information Steering Committee is responsible for managing the Enterprise Information Security posture and program; provides enterprise-wide oversight of the Information Security Program to ensure that controls are measured and managed; serves as an escalation point for issues


41

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

identified during the execution of information technology activities and risk mitigation;
The Vendor Management Steering Committee provides oversight over vendor management program; approves policies and serves as an escalation path for program compliance exceptions; and
The Access Control Board establishes and provides appropriate governance and controls over State Street's access control security framework.
The Operational Risk Committee, which functions under the oversight of both the BCRC and TORC, provides cross-business oversight of operational risk and reviews and approves operational risk guidelines that implement the corporate operational risk policy; these guidelines and other operational risk methodologies are used to identify, measure, manage and control operational risk in a consistent manner across State Street.
Model Risk Management
The use of quantitative models is widespread throughout the financial services industry, with large and complex organizations relying on sophisticated models to support numerous aspects of their financial decision making. The models contemporaneously represent both a significant advancement in financial management and a new source of risk. In large banking organizations like State Street, model results influence business decisions, and model failure could have a harmful effect on our financial performance. As a result, we manage model risk within a comprehensive model risk management framework.
Our model risk management program has three principal components:
A model risk governance program that defines roles and responsibilities, including the authority to restrict model usage, provides policies and guidance, and evaluates the models’ key assumptions, limitations and overall degree of risk;
A model development process which focuses on sound design and computational accuracy, and includes ongoing model integrity activities designed to test for robustness, stability, and sensitivity to assumptions; and
A separate model validation process designed to verify that models are theoretically sound, performing as expected, and are in line with their design objectives.


 
Governance
Model risk is overseen at the highest level by our Board and senior management. Models can only be deployed for use after receiving a satisfactory validation review and being granted approval by the appropriate corporate oversight committee.
The MAC is composed of senior staff with technical expertise, and reports to MRAC. The MAC formally recommends proposed findings with respect to modeling weaknesses or deficiencies. Proposed findings are brought to the MAC by the Model Validation Group, or MVG, part of Model Risk Management within ERM, for discussion. The most material findings may preclude a model’s deployment and use; other findings may require resolution by specified deadlines.
ERM’s Model Risk Management and Quality Assurance group is responsible for defining the corporate-wide model risk governance framework, and maintains policies that achieve the framework’s objectives. The team is responsible for overall model risk governance capabilities, with particular emphasis in the areas of model risk reporting, model performance monitoring, tracking of new model development status, and committee-level review and challenge.
Model Development and Usage
Models are developed throughout State Street under standards governing data sourcing, methodology selection and model integrity testing. Model development includes a clear statement of purpose to align development with intended use. It also includes a comparison of alternative approaches to implement a sound modeling approach.
Model developers conduct an assessment of data quality and relevance. The development teams conduct a variety of tests of the accuracy, robustness and stability of each model.
Model owners monitor model performance, update model reference data and/or functionality as appropriate, and submit models to MVG for validation on a regular basis, as described below.
Model Validation
MVG separately validates models through a review that assesses the soundness and suitability of data inputs, methodologies, assumptions, coding and model outputs. Model validation also encompasses an assessment of a model’s potential limitations given its particular assumptions or deficiencies. MVG maintains a model risk-rating system, which assigns a risk rating to each model based on the severity of review findings. These ratings aid in the understanding and reporting of model risk across the


42

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

model portfolio, and enable the triaging of needs for remediation.
Although model validation is the primary method of subjecting models to separate review and challenge, in practice, a multi-step governance process provides the opportunity for challenge by a number of knowledgeable and unbiased parties. First, MVG conducts model validation and prepares findings. These proposed findings are then discussed with and formally recommended by the MAC. Finally, model usage decisions, made by the appropriate corporate oversight committee, are influenced by the model findings.
Credit Risk Management
Core Policies and Principles
We define credit risk as the risk of financial loss if a counterparty, borrower or obligor, collectively referred to as counterparty, is either unable or unwilling to repay borrowings or settle a transaction in accordance with underlying contractual terms. We assume credit and counterparty risk in our traditional non-trading lending activities, such as loans and contingent commitments, in our investment securities portfolio, where recourse to a counterparty exists, and in our direct and indirect trading activities, such as principal securities lending and foreign exchange and indemnified agency securities lending. We also assume credit and counterparty risk in our day-to-day treasury and securities and other settlement operations, in the form of deposit placements and other cash balances, with central banks or private sector institutions.     
We distinguish between three major types of credit and counterparty risk:
Default risk - the risk that a counterparty fails to meet its contractual payment obligations;
Country risk - the risk that we may suffer a loss, in any given country, due to any of the following reasons: deterioration of economic conditions, political and social upheaval, nationalization and appropriation of assets, government repudiation of indebtedness, exchange controls, and disruptive currency depreciation or devaluation; and
Settlement risk - the risk that the settlement or clearance of transactions will fail, and arises whenever the exchange of cash, securities and/or other assets is not simultaneous.
The extension of credit and the acceptance of counterparty risk by State Street are governed by corporate policies and guidelines, which include standardized procedures applied across the entire organization. These policies and guidelines include
 
specific requirements related to each counterparty's risk profile; the markets served; counterparty, industry and country concentrations; and regulatory compliance. These policies and procedures also implement a number of core principles, which include the following:
We measure and consolidate all credit risks to each counterparty, or group of counterparties, in accordance with a “one-obligor” principle that aggregates risks across all of State Street's business units;
ERM reviews and approves all extensions of credit, or material changes to extensions of credit (such as changes in term, collateral structure or covenants), in accordance with assigned credit-approval authorities;
Credit-approval authorities are assigned to individuals according to their qualifications, experience and training, and these authorities are periodically reviewed. Our largest exposures require approval by the Credit Committee, a sub-committee of the Credit Risk and Policy Committee. With respect to small and low-risk extensions of credit to certain types of counterparties, approval authority is granted to individuals outside of ERM;
We seek to avoid or limit undue concentrations of risk. Counterparty (or groups of counterparties), industry, country and product-specific concentrations of risk are subject to frequent review and approval in accordance with our risk appetite;
We determine the creditworthiness of all counterparties through a detailed risk assessment, including the use of comprehensive internal risk-rating methodologies;
We review all extensions of credit and the creditworthiness of all counterparties at least annually. The nature and extent of these reviews are determined by the size, nature and term of the extensions of credit and the creditworthiness of the counterparty; and
We subject all core policies and principles to annual review as an integral part of our periodic assessment of our risk appetite.
Our corporate policies and guidelines require that the business units which engage in activities that give rise to credit and counterparty risk comply with procedures that promote the extension of credit for legitimate business purposes; are consistent with the maintenance of proper credit standards; limit credit-


43

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

related losses; and are consistent with our goal of maintaining a strong financial condition.
Structure and Organization
The Credit Risk Management group, an integral part of ERM, is responsible for the assessment, approval and monitoring of all types of credit and counterparty risk across State Street. The group is managed centrally, and has dedicated teams in a number of locations worldwide, across our businesses. The Credit Risk Management group is responsible for all requisite policies and procedures, and for State Street’s advanced internal credit-rating systems and methodologies. In addition, the group, in conjunction with the appropriate business units, establishes appropriate measurements and limits to control the amount of credit risk accepted across its various business activities, both at the portfolio level and for each individual counterparty or group of counterparties, to individual industries, and also to counterparties by product and country of risk. These measurements and limits are reviewed periodically, but at least annually.
In conjunction with other groups in ERM, Credit Risk Management is jointly responsible for the design, implementation and oversight of our credit risk measurement and management systems, including data and assessment systems, quantification systems and the reporting framework.
Various key committees within State Street are responsible for the oversight of credit risk and associated credit risk policies, systems and models. All credit-related activities are governed by our Risk Appetite framework and our Credit Risk Guidelines, which define our general philosophy with respect to credit risk and the manner in which we control, manage and monitor such risks.
The previously described Credit Risk and Policy Committee (refer to "Risk Committees" under "Risk Management" in this Management's Discussion and Analysis) has primary responsibility for the oversight, review and approval of the Credit Risk Guidelines and policies. Credit Risk Guidelines and policies are reviewed periodically, but at least annually.
The Credit Committee, a sub-committee of the Credit Risk and Policy Committee, has responsibility for assigning credit authority and approving the largest and higher-risk extensions of credit to individual counterparties or groups of counterparties.
Both the Credit Risk and Policy Committee and the Credit Committee provide periodic updates to MRAC and the Board's RCC.
Credit Ratings
We seek to limit credit risk arising from transactions with our counterparties by performing
 
initial and ongoing due diligence on their creditworthiness when conducting any business with them or approving any credit limits.
This due diligence process includes the assignment of an internal credit rating, which is determined by the use of internally developed and validated methodologies, scorecards and a 15-grade rating scale. This risk-rating process incorporates the use of risk-rating tools in conjunction with management judgment; qualitative and quantitative inputs are captured in a replicable manner and, following a formal review and approval process, an internal credit rating based on our rating scale is assigned. All credit ratings are reviewed and approved by the Credit Risk Management group or designees within ERM. To facilitate comparability across the portfolio, counterparties within a given sector are rated using a risk-rating tool developed for that sector.
All risk-rating methodologies are approved by the Credit Risk and Policy Committee, after completion of internal model validation processes and are subject to an annual review, including re-validation.
We generally rate our counterparties individually, although certain portfolios defined by us as low-risk are rated on a pooled basis. We evaluate and rate the credit risk of our counterparties on at least an annual basis.
Credit Limits
Central to our philosophy for our management of credit risk is the approval and imposition of credit limits, against which we monitor the actual and potential future credit exposure arising from our business activities with counterparties or groups of counterparties. Credit limits reflect the extent of our risk appetite, which may be determined by the creditworthiness of the counterparty, the nature of the risk inherent in the business undertaken with the counterparty, or a combination of relevant credit factors. Our risk appetite for certain sectors and certain countries and geographic regions may also influence the level of risk we are willing to assume to certain counterparties.
The analysis and approval of credit limits is undertaken in a consistent manner across all of our businesses, although the nature and extent of the analysis may vary, based on the type, term and magnitude of the risk being assumed. Credit limits and underlying trading-related exposures are assessed and measured on both a gross and net basis, with net exposure determined by deducting the value of collateral. In nearly all instances, credit limit approvals, for all business units and products within State Street, are undertaken by the Credit Risk


44

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

Management group, by individuals to whom credit authority has been delegated, or by the Credit Committee.
Credit limits are re-evaluated annually, or more frequently as needed, and are revised periodically on prevailing and anticipated market conditions, changes in counterparty or country-specific credit ratings and outlook, changes in State Street's risk appetite for certain counterparties, sectors or countries, and enhancements to the measurement of credit utilization.
Reporting
Ongoing active monitoring and management of our credit risk is an integral part of our credit risk management framework. We maintain comprehensive management information systems to identify, measure, monitor and report credit risk across businesses and legal entities, enabling ERM and our businesses to have timely access to accurate information on all credit limits and exposures. Monitoring is performed along the dimensions of counterparty, industry, country and product-specific risks to facilitate the identification of concentrations of risk and emerging trends.
Key aspects of this credit risk reporting structure include governance and oversight groups, policies that define standards for the reporting of credit risk, data aggregation and sourcing systems, and separate testing of relevant risk reporting functions by Corporate Audit.
The Credit Portfolio Management group routinely assesses the composition of our overall credit risk portfolio for alignment with our stated risk appetite. This assessment includes routine analysis and reporting of the portfolio, monitoring of market-based indicators, the assessment of industry trends and developments, and regular reviews of concentrated risks. The Credit Portfolio Management group is also responsible, in conjunction with the business units, for defining the appetite for credit risk in the major sectors in which we have a concentration of business activities. These sector-level risk appetite statements, which include counterparty selection criteria and granular underwriting guidelines, are reviewed periodically and approved by the Credit Risk and Policy Committee.
Monitoring
Regular surveillance of credit and counterparty risks is undertaken by our business units, the Credit Risk Management group and designees with ERM, allowing for frequent and extensive oversight. This surveillance process includes, but is not limited to, the following components:
Annual Reviews. A formal review is conducted at least annually on all
 
counterparties, and includes a thorough review of operating performance, primary risk factors and our internal credit risk rating. This annual review also includes a review of current and proposed credit limits, an assessment of our ongoing risk appetite and verification that supporting legal documentation remains effective.
Interim Monitoring. Periodic monitoring of our largest and riskiest counterparties is undertaken more frequently, utilizing financial information, market indicators and other relevant credit and performance measures. The nature and extent of this interim monitoring is individually tailored to certain counterparties and/or industry sectors to ensure that we identify material changes to the risk profile of a counterparty (or group of counterparties) and assign an updated internal risk rating in a timely manner.
We maintain an active "watch list" for all counterparties where there is a concern that the actual or potential risk of default has increased. The watch-list status denotes a concern with some aspect of a counterparty's risk profile that warrants closer monitoring of the counterparty's financial performance and related risk factors. Our ongoing monitoring processes are designed to facilitate the early identification of counterparties whose creditworthiness is deteriorating; any counterparty may be placed on the watch list by ERM at its sole discretion.
Counterparties that receive an internal risk rating within a certain range on our rating scale are eligible for watch list designation. These risk ratings generally correspond with the non-investment grade or near non-investment grade ratings established by the major independent credit-rating agencies, and also include the regulatory classifications of “Special Mention,” “Substandard,” “Doubtful” and “Loss.” Counterparties whose internal ratings are outside this range may also be placed on the watch list.
The Global Counterparty Review, or GCR, group maintains primary responsibility for State Street’s watch list processes, and generates a monthly report of all watch list counterparties. The watch list is reviewed monthly in recurring meetings conducted by the GCR with participation from the business units, senior ERM staff, and representatives from our corporate finance and legal groups as appropriate. These meetings include a review of all individual watch list counterparties, together with credit limits and prevailing exposures, and are solely focused on actions to contain, reduce or eliminate the risk of loss


45

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

to State Street. Any identified actions are documented and monitored.
Controls
The GCR provides a separate level of surveillance and oversight over the integrity of State Street’s internal risk-rating system, by providing a review of all ratings processes. As a critical assurance function, GCR is subject to oversight by the Credit Risk and Policy Committee, and provides periodic updates to the Board’s RCC. The group reviews all counterparty credit ratings for all sectors on an ongoing basis.
Specific activities of this group include the following:
Separate and objective assessments of State Street's credit and counterparty exposures to determine the nature and extent of risk undertaken by the business units;
Periodic business unit reviews, focusing on the assessment of credit analysis, policy compliance, prudent transaction structure and underwriting standards, administration and documentation, risk-rating integrity, and relevant trends;
Identification and monitoring of developing counterparty, market and/or industry sector trends to limit risk of loss and protect capital;
Maintenance of risk-rating system integrity through testing of ratings;
Regular and formal reporting of reviews, including findings and requisite actions to remedy identified deficiencies;
Allocation of resources for specialized risk assessments (on an as-needed basis);
Assessment of the adequacy of the allowance for loan and lease losses, and
Liaison with auditors and regulatory personnel on matters relating to risk rating, reporting, and measurement.
Credit Risk Mitigation
We seek to limit our credit exposure and reduce our potential credit losses through various types of risk mitigation. In our day-to-day management of credit risks, we utilize and recognize the following types of risk mitigation.
Collateral. In many parts of our business, we regularly require or agree for collateral to be received from or provided to clients and counterparties in connection with contracts that incur credit risk. In our trading businesses, collateral is typically in the form of cash and securities (government
 
securities and other bonds or equity securities). Credit risks in our non-trading businesses and securities finance are also often secured by bonds and equity securities, real estate, business inventory and equipment, and other assets. In all instances, collateral serves to reduce the risk of loss inherent in an exposure by improving the prospect of recovery in the event of a counterparty default. While collateral is often an alternative source of repayment, it generally does not replace the requirement within our policies and guidelines for high-quality underwriting standards.
Our Credit Risk Guidelines require that the collateral we accept for risk mitigation purposes is of high quality, can be reliably valued and can be liquidated if or when required. Generally, when collateral is of lower quality, more difficult to value or more challenging to liquidate, higher discounts to market values are applied for purposes of measuring credit risk. For certain less liquid collateral, longer liquidation periods are assumed when determining the credit exposure.
All types of collateral are assessed regularly by ERM, as is the basis on which the collateral is valued. Our assessment of collateral, including the ability to liquidate collateral in the event of a counterparty default, is an integral component of our assessment of risk and approval of credit limits. We also seek to identify, limit and monitor instances of "wrong-way" risk, where a counterparty’s risk of default is positively correlated with the risk of our collateral eroding in value.
We maintain policies and procedures requiring that all documentation used to collateralize a transaction is legal, valid, binding and enforceable in the relevant jurisdictions. We also conduct legal reviews to assess whether our documentation meets these standards on an ongoing basis.
Netting. Netting is a mechanism that allows institutions and counterparties to net offsetting exposures and payment obligations against one another through the use of qualifying master netting agreements. A master netting agreement allows the netting of rights and obligations arising under derivative or other transactions that have been entered into under such an agreement upon the counterparty’s default,


46

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

resulting in a single net claim owned by, or to, the counterparty. This is commonly referred to as ”close-out netting,” and is pursued wherever possible. We may also enter into master agreements that allow for the netting of amounts payable on a given day and in the same currency, reducing our settlement risk. This is commonly referred to as “payment netting,” and is widely used in our foreign exchange activities.
As with collateral, we have policies and procedures in place to apply close-out and payment netting only to the extent that we have verified legal validity and enforceability of the master agreement. In the case of payment netting, operational constraints with our counterparties may preclude us from reducing settlement risk, notwithstanding the legal right to require the same under the master netting agreement.
Generally, given the nature of our operations and our risk profile, we do not employ risk mitigation in the form of guarantees and credit derivatives as extensively as traditional commercial and investment banks. Accordingly, while we may benefit from third-party guarantees in some instances, we do not quantify or recognize any related risk reduction in our measurement or risk-weighting of our credit exposure. We have established systematic processes to allow only eligible collateral and permitted netting, as defined in the Basel framework, to be recognized in our measurement of credit risk.
Reserve for Credit Losses
We maintain an allowance for loan losses to support our on-balance sheet credit exposures. We also maintain a reserve for unfunded commitments and letters of credit to support our off-balance credit exposure. The two components together represent the reserve for credit losses. Review and evaluation of the adequacy of the reserve for credit losses is ongoing throughout the year, but occurs at least quarterly, and is based, among other factors, on our evaluation of the level of risk in the portfolio, the volume of adversely classified loans, previous loss experience, current trends, and expected economic conditions and their effect on our counterparties. Additional information about the allowance for loan losses is provided in note 4 to the consolidated financial statements included in this Form 10-Q.
Liquidity Risk Management
Liquidity risk is defined as the potential that our financial condition or overall viability could be adversely affected by an actual or perceived inability to meet cash and collateral obligations. The goal of liquidity risk management is to maintain, even in the
 
event of stress, our ability to meet our cash and collateral obligations.
Liquidity is managed to meet our financial obligations in a timely and cost-effective manner, as well as maintain sufficient flexibility to fund strategic corporate initiatives as they arise. Our effective management of liquidity involves the assessment of the potential mismatch between the future cash needs of our clients and our available sources of cash under both normal and adverse economic and business conditions.
We generally manage our liquidity on a global, consolidated basis. We also manage liquidity on a stand-alone basis at the parent company, as well as at certain branches and subsidiaries of State Street Bank. State Street Bank generally has access to markets and funding sources limited to banks, such as the federal funds market and the Federal Reserve's discount window. Our parent company is managed to a more conservative liquidity profile, reflecting narrower market access. Our parent company typically holds enough cash, primarily in the form of interest-bearing deposits with its banking subsidiaries, to meet its current debt maturities and cash needs, as well as those projected over the next one-year period. As of June 30, 2014, the value of the parent company's net liquid assets totaled $3.83 billion, compared with $4.42 billion as of December 31, 2013. Our parent company's liquid assets generally consist of overnight placements with its banking subsidiaries.
Based on our level of consolidated liquid assets and our ability to access the capital markets for additional funding when necessary, including our ability to issue debt and equity securities under our current universal shelf registration, management considers State Street's overall liquidity as of June 30, 2014 to be sufficient to meet its current commitments and business needs, including accommodating the transaction and cash management needs of its clients.
Governance
Global Treasury is responsible for our management of liquidity. This includes the day-to-day management of our global liquidity position, the development and monitoring of early warning indicators, key liquidity risk metrics, the creation and execution of stress tests, the evaluation and implementation of regulatory requirements, the maintenance and execution of our liquidity guidelines and contingency funding plan, and routine management reporting to ALCCO and the Board's RCC.
Global Treasury Risk Management, part of ERM, provides separate oversight over the identification,


47

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

communication and management of Global Treasury’s risks in support of our business strategy. Global Treasury Risk Management reports to the CRO. Global Treasury Risk Management’s responsibilities relative to liquidity risk management include the development and review of policies and guidelines; the monitoring of limits related to adherence to the liquidity risk guidelines and associated reporting.
Liquidity Framework
Our liquidity framework contemplates areas of potential risk based on our activities, size, and other appropriate risk-related factors. In managing liquidity risk, we employ limits, maintain established metrics and early warning indicators and perform routine stress testing to identify potential liquidity needs. This process involves the evaluation of a combination of internal and external scenarios which assist us in measuring our liquidity position and in identifying potential increases in cash needs or decreases in available sources of cash, as well as the potential impairment of our ability to access the global capital markets.
We manage liquidity according to several principles that are equally important to our overall liquidity risk management framework:
Structural liquidity management addresses liquidity by monitoring and directing the composition of our consolidated statement of condition. Structural liquidity is measured by metrics such as the percentage of total wholesale funds to consolidated total assets, and the percentage of non-government investment securities to client deposits. In addition, on a regular basis and as described below, our structural liquidity is evaluated under various stress scenarios.
Tactical liquidity management addresses our day-to-day funding requirements and is largely driven by changes in our primary source of funding, which is client deposits.
Fluctuations in client deposits may be supplemented with short-term borrowings, which generally include commercial paper and certificates of deposit.
Stress testing and contingent funding planning are longer-term strategic liquidity risk management practices. Regular and ad hoc liquidity stress testing are performed under various severe but plausible scenarios at the consolidated level and at significant subsidiaries, including State Street Bank. These tests contemplate severe market and State Street-specific events under various time horizons and severities. Tests contemplate the impact of material changes
 
in key funding sources, credit ratings, additional collateral requirements, contingent uses of funding, systemic shocks to the financial markets, and operational failures based on market and State Street-specific assumptions. The stress tests evaluate the required level of funding versus available sources in an adverse environment. As stress testing contemplates potential forward-looking scenarios, results also serve as a trigger to activate specific liquidity stress levels and contingent funding actions.
Contingency Funding Plans, or “CFPs,” are designed to assist senior management with decision-making associated with any contingency funding response to a possible or actual crisis scenario. The CFPs define roles, responsibilities and management actions to be taken in the event of deterioration of our liquidity profile caused by either a State Street-specific event or a broader disruption in the capital markets. Specific actions are linked to the level of stress indicated by these measures or by management judgment of market conditions.
Liquidity Risk Metrics
In managing our liquidity, we employ early warning indicators and metrics. Early warning indicators are intended to detect situations which may result in a liquidity stress, including changes in our common stock price and the spread on our long-term debt. Additional metrics that are critical to the management of our consolidated statement of condition and monitored as part of our routine liquidity management include measures of our fungible cash position, purchased wholesale funds, unencumbered liquid assets, deposits, and the total of investment securities and loans as a percentage of total client deposits.
Asset Liquidity
Central to the management of our liquidity is asset liquidity, which generally consists of unencumbered highly liquid securities, cash and cash equivalents carried in our consolidated statement of condition. We restrict the eligibility of securities for asset liquidity to U.S. Government and federal agency securities (including mortgage-backed securities) and selected non-U.S. Government and supranational securities, which generally are more liquid than other types of assets. The following table presents the components of our asset liquidity balance as of the dates, or for the periods, indicated:


48

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

(In millions)
 
June 30, 2014
 
December 31, 2013
Asset Liquidity:
 
 
 
 
Highly liquid short-term investments(1)
 
$
98,386

 
$
64,257

Investment securities
 
22,379

 
22,322

Total
 
$
120,765

 
$
86,579

 
 
 
 
 
 
 
Six Months Ended June 30,
(In millions)
 
2014
 
2013
Average Asset Liquidity:
 
 
 
 
Highly liquid short-term investments(1)
 
$
43,487

 
$
29,414

Investment securities
 
21,835

 
25,983

Total
 
$
65,322

 
$
55,397

 
 
 
(1) Composed of interest-bearing deposits with banks.
Due to the continued elevated level of client deposits as of June 30, 2014, we maintained cash balances in excess of regulatory requirements of approximately $87.08 billion at the Federal Reserve, the ECB and other non-U.S. central banks, compared to $51.03 billion as of December 31, 2013.
Liquid securities carried in our asset liquidity include securities pledged without corresponding advances from the Federal Reserve Bank of Boston, or FRB, the Federal Home Loan Bank of Boston, or FHLB, and other non-U.S. central banks. State Street Bank is a member of the FHLB. This membership allows for advances of liquidity in varying terms against high-quality collateral, which helps facilitate asset-and-liability management.
Access to primary, intra-day and contingent liquidity provided by these utilities is an important source of contingent liquidity with utilization subject to underlying conditions. As of June 30, 2014 and December 31, 2013, State Street Bank had no outstanding primary credit borrowings from the FRB discount window or any other central bank facility, and as of the same dates, no FHLB advances were outstanding.
In addition to the securities included in our asset liquidity, we have significant amounts of other high-quality investment securities. The aggregate fair value of those securities was $68.29 billion as of June 30, 2014, compared to $66.16 billion as of December 31, 2013. These securities are available sources of liquidity, although not as rapidly deployed as those included in our asset liquidity.
Uses of Liquidity
Significant uses of our liquidity could result from the following: withdrawals of client deposits; draw-downs of unfunded commitments to extend credit or to purchase securities, generally provided through lines of credit; and short-duration advance facilities. Such circumstances would generally arise under stress conditions including deterioration in credit
 
ratings. We had unfunded commitments to extend credit with gross contractual amounts totaling $23.15 billion and $21.30 billion as of June 30, 2014 and December 31, 2013, respectively. These amounts do not reflect the value of any collateral. As of June 30, 2014, approximately 78% of our unfunded commitments to extend credit expire within one year. Since many of our commitments are expected to expire or renew without being drawn upon, the gross contractual amounts do not necessarily represent our future cash requirements.
Funding
Deposits:
Our Investment Servicing business provides products and services including custody, accounting, administration, daily pricing, foreign exchange services, cash management, financial asset management, securities finance and investment advisory services. As a provider of these products and services, we generate client deposits, which have generally provided a stable, low-cost source of funds. As a global custodian, clients place deposits with State Street entities in various currencies. These client deposits are invested in a combination of investment securities and short-duration financial instruments whose mix is determined by the characteristics of the deposits.
For the past several years, we have experienced higher client deposit inflows toward the end of the quarter or the end of the year. As a result, average client deposit balances are deemed to be more reflective of ongoing funding than period-end balances. The following table presents client deposit balances as of the dates and for the periods indicated:
 
 
 
 
 
Average Balance
 
June 30,
 
Six Months Ended June 30,
(In millions)
2014
 
2013
 
2014
 
2013
Client deposits(1)
$
208,723

 
$
166,366

 
$
159,952

 
$
140,982

 
 
 
 
(1) Balances as of June 30, 2014 and June 30, 2013 excluded term wholesale certificates of deposit, or CDs, of $10.11 billion and $154 million, respectively; average balances for the six months ended June 30, 2014 and June 30, 2013 excluded average CDs of $3.08 billion and $5.04 billion, respectively.
Short-Term Funding:
Our corporate commercial paper program, under which we can issue up to $3 billion of commercial paper with original maturities of up to 270 days from the date of issuance, had $2.33 billion of commercial paper outstanding as of June 30, 2014, compared to $1.82 billion as of December 31, 2013.


49

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

Our on-balance sheet liquid assets are also an integral component of our liquidity management strategy. These assets provide liquidity through maturities of the assets, but more importantly, they provide us with the ability to raise funds by pledging the securities as collateral for borrowings or through outright sales. In addition, our access to the global capital markets gives us the ability to source incremental funding at reasonable rates of interest from wholesale investors. As discussed earlier under “Asset Liquidity,” State Street Bank's membership in the FHLB allows for advances of liquidity in varying terms against high-quality collateral.
Short-term secured funding also comes in the form of securities lent or sold under agreements to repurchase. These transactions are short-term in nature, generally overnight, and are collateralized by high-quality investment securities. The balances associated with this activity are generally stable, as they represent a collateralized cash investment option for our investment servicing clients. These balances were $9.17 billion and $7.95 billion as of June 30, 2014 and December 31, 2013, respectively.
State Street Bank currently maintains a line of credit with a financial institution of CAD $800 million, or approximately $751 million as of June 30, 2014, to support its Canadian securities processing operations. The line of credit has no stated termination date and is cancelable by either party with prior notice. As of June 30, 2014, there was no balance outstanding on this line of credit.
Long-Term Funding:
As of June 30, 2014, State Street Bank had Board authority to issue unsecured senior debt securities from time to time, provided that the aggregate principal amount of such unsecured senior debt outstanding at any one time does not exceed $5 billion. As of June 30, 2014, $4.1 billion was available for issuance pursuant to this authority. As of June 30, 2014, State Street Bank also had Board authority to issue up to $1.5 billion of subordinated debt, incremental to subordinated debt outstanding as of the same date. As of June 30, 2014, $500 million was available for issuance pursuant to this authority.
We maintain an effective universal shelf registration that allows for the public offering and sale of debt securities, capital securities, common stock, depositary shares and preferred stock, and warrants to purchase such securities, including any shares into which the preferred stock and depositary shares may be convertible, or any combination thereof. We have issued in the past, and we may issue in the future, securities pursuant to our shelf registration. The issuance of debt or equity securities will depend on future market conditions, funding needs and other factors.
 
Agency Credit Ratings
Our ability to maintain consistent access to liquidity is fostered by the maintenance of high investment-grade ratings as measured by the major independent credit rating agencies. Factors essential to maintaining high credit ratings include diverse and stable core earnings; relative market position, strong risk management; strong capital ratios; diverse liquidity sources, including the global capital markets and client deposits; strong liquidity monitoring procedures; and preparedness for current or future regulatory developments. High ratings limit borrowing costs and enhance our liquidity by providing assurance for unsecured funding and depositors, increasing the potential market for our debt and improving our ability to offer products, serve markets, and engage in transactions in which clients value high credit ratings. A downgrade or reduction of our credit ratings could have a material adverse effect on our liquidity by restricting our ability to access the capital markets, which could increase the related cost of funds; causing the sudden and large-scale withdrawal of unsecured deposits by our clients, which could lead to draw-downs of unfunded commitments to extend credit or trigger requirements under securities purchase commitments; or require additional collateral or force terminations of certain trading derivative contracts.
A majority of our derivative contracts have been entered into under bilateral agreements with counterparties who may require us to post collateral or terminate the transactions based on changes in our credit ratings. We assess the impact of these arrangements by determining the collateral or termination payments that would be required assuming a downgrade by all rating agencies. The following table presents the additional collateral or termination payments related to our net derivative liabilities under these arrangements that could have been called as of the dates indicated by counterparties in the event of a one-notch or two-notch downgrade in our credit ratings. Other funding sources, such as secured financing transactions and other margin requirements, for which there are no explicit triggers, could also be adversely affected.
(In millions)
June 30, 2014
 
December 31, 2013
Additional collateral or termination payments for a one- or two-notch downgrade
$
12

 
$
7

Proposed Liquidity Framework
In October 2013, U.S. banking regulators issued a Notice of Proposed Rulemaking, or NPR, intended to implement the Basel Committee's Liquidity Coverage Ratio, or LCR, in the U.S. The LCR is intended to promote the short-term resilience of the


50

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

liquidity risk profile of internationally active banking organizations, improve the banking industry's ability to absorb shocks arising from financial and economic stress, and improve the measurement and management of liquidity risk. The proposed LCR would require a covered banking organization to maintain an amount of high-quality liquid assets, or HQLA, equal to or greater than 100% of the banking organization’s total net cash outflows over a 30-calendar-day period of significant liquidity stress, as defined. The October 2013 NPR would be phased in beginning on January 1, 2015 at 80% with full implementation by January 1, 2017. As an internationally active banking organization, we expect to be subject to the LCR standard in the U.S., as well as in other jurisdictions in which we operate.
The NPR is generally consistent with the Basel Committee’s LCR. However, it includes certain more stringent requirements, including an accelerated implementation time line and modifications to the definition of high-quality liquid assets and expected outflow assumptions. We continue to analyze the proposed rules and analyze their impact as well as develop strategies for compliance. The principles of the LCR are consistent with our liquidity management framework; however, the specific calibrations of various elements within the final LCR rule, such as the eligibility of assets as HQLA, operational deposit requirements and net outflow requirements could have a material effect on our liquidity, funding and business activities, including the management and composition of our investment securities portfolio and our ability to extend committed contingent credit facilities to our clients.
In January 2014, the Basel Committee released a revised proposal with respect to the Net Stable Funding Ratio, or NSFR, which will establish a one-year liquidity standard representing the proportion of long-term assets funded by long-term stable funding, scheduled for global implementation in 2018. The revised NSFR has made some favorable changes regarding the treatment of operationally linked deposits and a reduction in the funding required for certain securities. However, we continue to review the specifics of the Basel Committee's release and will be evaluating the U.S. implementation of this standard to analyze the impact and develop strategies for compliance. U.S. banking regulators have not yet issued a proposal to implement the NSFR.
Operational Risk Management
Overview
We define operational risk as the risk of loss
resulting from inadequate or failed internal processes
and systems, human error, or from external events. This definition encompasses legal risk and fiduciary
 
risk. We define legal risk as the risk of loss resulting from failure to comply with laws, contractual obligations or prudent business practices, often in the form of litigation or fines; we define fiduciary risk as the failure to properly exercise discretion when acting on behalf of our clients, or not properly monitoring or controlling the exercise of discretion by a third party.
Operational risk is inherent in the performance of investment servicing and investment management activities on behalf of our clients. Whether it be fiduciary risk, risk associated with execution and processing or other types of operational risk, a consistent, transparent and effective operational risk framework is key to identifying, monitoring and managing operational risk.
We have established an operational risk framework that is based on three major goals:
Strong, active governance;
Ownership and accountability; and
Consistency and transparency.
Governance
Our Board is responsible for the approval and oversight of the overall operational risk framework. It does so through its RCC, which reviews our operational risk framework and approves our operational risk policy annually.
Our operational risk policy establishes our approach to the management of operational risk across State Street. The policy identifies the responsibilities of individuals and committees charged with oversight of the management of operational risk, and articulates a broad mandate that supports implementation of the operational risk framework.
ERM and other independent control groups provide the oversight, validation and verification of the management and measurement of operational risk. Our CRO, who leads ERM, manages the day-to-day oversight.
Executive management actively manages and oversees our operational risk framework through membership on various risk management committees, including MRAC, the BCRC, TORC, the Operational Risk Committee and the Fiduciary Review Committee, all of which ultimately report to the RCC.
The Operational Risk Committee, chaired by the global head of Operational Risk, provides cross-business oversight of operational risk and reviews and approves operational risk guidelines intended to maintain a consistent implementation of our corporate operational risk policy and framework.




51

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

Ownership and Accountability
We have implemented our operational risk framework to support the broad mandate established by our operational risk policy. This framework represents an integrated set of processes and tools that assists us in the management and measurement of operational risk, including our calculation of required capital and risk-weighted assets.
The framework takes a holistic view and integrates the methods and tools used to manage and measure operational risk. The framework utilizes aspects of the Committee of Sponsoring Organizations of the Treadway Commission, or COSO, framework and other industry leading practices, and is designed foremost to address State Street's risk management needs while complying with regulatory requirements. The operational risk framework is intended to provide a number of important benefits, including:
A common understanding of operational risk management and its supporting processes;
The clarification of responsibilities for the management of operational risk across State Street;
The alignment of business priorities with risk management objectives;
The active management of risk and early identification of emerging risks;
The consistent application of policies and the collection of data for risk management and measurement; and
The estimation of our operational risk capital requirement.
The operational risk framework employs a distributed risk management infrastructure executed by ERM groups aligned with the business units, which are responsible for the implementation of the operational risk framework at the business unit level.
As with other risks, senior business unit management is responsible for the day-to-day operational risk management of their respective businesses. It is business unit management's responsibility to provide oversight of the implementation and ongoing execution of the operational risk framework within their respective organizations, as well as coordination and communication with ERM.
Consistency and Transparency
A number of independent corporate control functions are directly responsible for implementing and assessing various aspects of State Street's operational risk framework, with the overarching goal
 
of consistency and transparency to meet the evolving needs of the business.
The global head of Operational Risk, a member of the CRO’s executive management team, leads ERM’s Corporate Operational Risk Management group, or ORM, responsible for the strategy, evolution and consistent implementation our operational risk guidelines, framework and supporting tools across State Street. ORM reviews and analyzes operational key risk information, events, metrics and indicators at the business unit and corporate level for purposes of risk management, reporting and escalation to the CRO, senior management and governance committees;
ERM’s Corporate Risk Analytics group develops and maintains operational risk capital estimation models, and ERM's Operations group calculates State Street's required capital for operational risk;
ERM’s MVG separately validates the quantitative models used to measure operational risk, and ORM performs validation checks on the output of the model; and
Corporate Audit performs separate reviews of the application of operational risk management practices and methodologies utilized across State Street.
Our operational risk framework consists of five components, each described below, which provide a working structure that integrates distinct risk programs into a continuous process focused on managing and measuring operational risk in a coordinated and consistent manner.
Risk Identification, Assessment and
Measurement
The objective of risk identification, assessment and measurement is to understand business unit strategy, risk profile and potential exposures. It is achieved through a series of risk assessments across State Street using techniques for the identification, assessment and measurement of risk across a spectrum of potential frequency and severity combinations. Three primary risk assessment programs, which occur annually, augmented by other business-specific programs, are the core of this component:
The Risk and Control Self-Assessment, or RCSA, program seeks to understand the risks associated with day-to-day activities, and the effectiveness of controls intended to manage potential exposures arising from


52

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

these activities. These risks are typically frequent in nature but generally not severe in terms of exposure;
The Material Risk Identification, or MRI, program is specifically designed to consider risks that could have a material impact irrespective of their likelihood or frequency. This can include risks that may have an impact on longer-term business objectives, such as significant change management activities or long-term strategic initiatives;
The Scenario Analysis program focuses on the set of risks with the highest severity and most relevance from a capital perspective. These are generally referred to as “tail risks," and serve as important benchmarks for our loss distribution approach model (see below); they also provide inputs into stress testing; and
Business-specific programs to identify, assess and measure risk, including new business and product review and approval; new client screening; and, as deemed appropriate, targeted risk assessments.
The primary measurement tool used is an internally developed loss distribution approach, or LDA, model. We use this model to quantify required operational risk capital, which we use to calculate risk-weighted assets related to operational risk.
The LDA model incorporates the four required operational risk elements described below:
Internal loss event data is collected from across State Street in conformity with our operating loss policy that establishes the requirements for collecting and reporting individual loss events. We categorize the data into seven Basel-defined event types and further subdivide the data by business unit, as deemed appropriate. Each of these loss events are represented in a Unit of Measure, or UOM, which is used to estimate a specific amount of capital required for the types of loss events that fall into each specific category. Some UOMs are measured at the corporate level because they are not “business specific,” such as damage to physical assets, where the cause of an event is not primarily driven by the behavior of a single business unit. Internal losses of $500 or greater are captured, analyzed and included in the modeling approach. Loss event data is collected using a corporate-wide data collection tool, which stores the data in a Loss Event Data Repository, or LEDR, to support processes related to
 
analysis, management reporting and the calculation of required capital. Internal loss event data provides State Street-specific frequency and severity information to our capital calculation process for historical loss events experienced by State Street.
External loss event data provides information with respect to loss event severity from other financial institutions to inform our capital estimation process of events in similar business units at other banking organizations. This information supplements the data pool available for use in our LDA model. Assessments of the sufficiency of internal data and the relevance of external data are completed before pooling the two data sources for use in our LDA model.
Scenario analysis workshops are conducted annually across State Street to inform management of the less frequent but most severe, or “tail,” risks that the organization faces. The workshops are attended by senior business unit managers, other support and control partners and business-aligned risk-management staff. The workshops are designed to capture information about significant risks and to estimate potential exposures for individual risks should a loss event occur. Workshops are aligned, with specific UOMs and business units, where appropriate. The results of the workshops are used to benchmark our LDA model results to determine that our calculation of required capital considers relevant risk-related information.
Business environment and internal control factors, or BEICFs, are gathered as part of our scenario analysis program to inform the scenario analysis workshop participants of internal loss event data and business-relevant metrics, such as RCSA results, along with industry loss event data and case studies where appropriate. BEICFs are those characteristics of a bank’s internal and external operating environment that bear an exposure to operational risk. The use of this information indirectly influences our calculation of required capital by providing additional relevant data to workshop participants when reviewing specific UOM risks.
Risk Monitoring
The objective of risk monitoring is to proactively monitor the changing business environment and corresponding operational risk exposure. It is achieved using a series of quantitative and qualitative


53

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

monitoring tools that are designed to allow us to understand changes in the business environment, internal control factors, risk metrics, risk assessments, exposures and operating effectiveness, as well as details of loss events and progress on risk initiatives implemented to mitigate potential risk exposures.
Effectiveness and Testing
The objective of testing is to verify that internal controls are designed appropriately, are consistent with corporate and regulatory standards, and are operating effectively. It is achieved through a series of assessments by both internal and external parties, including Corporate Audit, independent public accounting firms, business self-assessments and other control function reviews, such as a Sarbanes-Oxley testing program.
Consistent with our standard model validation process, the operational risk LDA model is subject to a detailed review, overseen by the MAC. In addition, the model is subject to a rigorous internal governance process. All changes to the model or input parameters, and the deployment of model updates, are reviewed and approved by the Operational Risk Committee, which has oversight responsibility for the model, with technical input from the MAC.
Integrated Reporting
Operational risk reporting is intended to provide transparency, enabling management to manage risk, provide oversight and escalate issues in a timely manner. Integrated reporting is designed to allow the business units, executive management, and the Board's control functions and committees to gain insight into activities that may result in risks and potential exposures. Reports are intended to identify business activities that are experiencing processing issues, whether or not they result in actual loss events. Reporting includes results of monitoring activities, internal and external examinations, regulatory reviews, and independent control assessments. All of these elements provide a view of potential and emerging risks facing State Street and information that details our progress on managing risks.
Documentation and Guidelines
Documentation and guidelines create consistency and repeatability of the various processes that support the operational risk framework across State Street.
Operational risk guidelines document our practices and describe the key elements in a business unit's operational risk management program. The purpose of the guidelines is to set forth and define key operational risk terms, provide further
 
detail on State Street's operational risk programs, and detail the business units' responsibilities to identify, assess, measure, monitor and report operational risk. The guideline supports our operational risk policy.
Data standards have been established to maintain consistent data repositories and systems that are controlled, accurate and available on a timely basis to support operational risk management.
Market Risk Management
Market risk is defined by U.S. banking regulators as the risk of loss that could result from broad market movements, such as changes in the general level of interest rates, credit spreads, foreign exchange rates or commodity prices. We are exposed to market risk in both our trading and certain of our non-trading, or asset-and-liability management, activities.
Information about the market risk associated with our trading activities is provided below under “Trading Activities.” Additional qualitative and quantitative information with respect to the market risk associated with our trading activities is provided on the “Investor Relations” section of our corporate website under "Filings and Reports." Information about the market risk associated with our non-trading activities, which consists primarily of interest-rate risk, is provided below under “Asset-and-Liability Management Activities.”
Trading Activities
In the conduct of our trading activities, we assume market risk, the level of which is a function of our overall risk appetite, business objectives and liquidity needs, our clients' requirements and market volatility, and our execution against those factors.
We engage in trading activities primarily to support our clients' needs and to contribute to our overall corporate earnings and liquidity. In connection with certain of these trading activities, we enter into a variety of derivative financial instruments to support our clients' needs and to manage our interest-rate and currency risk. These activities are generally intended to generate trading services revenue and to manage potential earnings volatility. In addition, we provide services related to derivatives in our role as both a manager and a servicer of financial assets.
Our clients use derivatives to manage the financial risks associated with their investment goals and business activities. With the growth of cross-border investing, our clients often enter into foreign exchange forward contracts to convert currency for international investments and to manage the currency risk in their international investment portfolios. As an active participant in the foreign exchange markets, we provide foreign exchange forward and option


54

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

contracts in support of these client needs, and also act as a dealer in the currency markets.   
As part of our trading activities, we assume positions in the foreign exchange and interest-rate markets by buying and selling cash instruments and entering into derivative instruments, including foreign exchange forward contracts, foreign exchange and interest-rate options and interest-rate swaps, interest-rate forward contracts, and interest-rate futures. As of June 30, 2014, the aggregate notional amount of these derivative contracts was $1.27 trillion, of which $1.26 trillion was composed of foreign exchange forward, swap and spot contracts. In the aggregate, we seek to match positions closely with the objective of minimizing related currency and interest-rate risk. All foreign exchange contracts are valued daily at current market rates. Additional information about derivative contracts entered into in connection with our trading activities is provided in note 12 to the consolidated financial statements included in this Form 10-Q.
Governance
Our assumption of market risk in our trading activities is an integral part of our corporate risk appetite. Our Board reviews and oversees our management of market risk, including the approval of key market risk policies and the receipt and review of regular market risk reporting, as well as periodic updates on selected market risk topics.
The previously described TMRC (refer to "Risk Committees" under "Risk Management" in this Management's Discussion and Analysis) oversees all market risk-taking activities across State Street associated with trading. The TMRC, which reports to MRAC, is composed of members of ERM, our global markets business and our Global Treasury group, as well as our senior executives who manage our trading businesses and other members of management who possess specialized knowledge and expertise. The TMRC meets regularly to monitor the management of our trading market risk activities.
Our business units identify, actively manage and are responsible for the market risks inherent in their businesses. A dedicated market risk management group within ERM, and other groups within ERM, work with those business units to assist them in the identification, assessment, monitoring, management and control of market risk, and assist business unit managers with their market risk management and measurement activities. ERM provides an additional line of oversight, support and coordination designed to promote the consistent identification, measurement and management of market risk across business units, separate from those business units' discrete activities.
 
The ERM market risk management group is responsible for the management of corporate-wide market risk, the monitoring of key market risks and the development and maintenance of market risk management policies, guidelines, and standards aligned with our corporate risk appetite. This group also establishes and approves market risk tolerance limits and dealing authorities based on, but not limited to, measures of notional amounts, sensitivity, VaR and stress. Such limits and authorities are specified in our trading and market risk guidelines which govern our management of trading market risk.
Our risk management and our calculations of regulatory capital and economic capital are based primarily on our internal VaR models and stress-testing analysis. As discussed in detail under “Value-at-Risk” below, VaR is measured daily by ERM.
Market risk exposure is established within our risk appetite framework. These limits define threshold levels for VaR- and stressed VaR-based measures and are applicable to all trading positions subject to regulatory capital requirements.
Covered Positions
Our trading positions are subject to regulatory market risk capital requirements if they meet the regulatory definition of a “covered position.” A covered position is generally defined by U.S. banking regulators as an on- or off-balance sheet position associated with the organization's trading activities that is free of any restrictions on its tradability, including foreign exchange or commodity positions, and excluding intangible assets, certain credit derivatives recognized as guarantees and certain equity positions not publicly traded. The identification of covered positions for inclusion in our market risk capital framework is governed by our covered positions policy, which policy outlines the standards we use to determine whether a trading position is a covered position.
Our covered positions consist primarily of the trading portfolios held by our global markets business. These trading portfolios include products such as spot foreign exchange, foreign exchange forwards, non-deliverable forwards, foreign exchange options, foreign exchange funding swaps, currency futures, financial futures, and interest rate futures. Covered positions also arise from certain portfolios held by our Global Treasury group. Any new activities are analyzed to determine if the positions arising from such new activities meet the definition of a covered position and conform to our covered positions policy. This documented analysis, including any decisions with respect to market risk treatments, must receive approval from the TMRC.


55

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

Value-at-Risk, Stress Testing and Stressed VaR
As noted above, we use a variety of risk measurement tools and methodologies, including VaR, which is an estimate of potential loss for a given period within a stated statistical confidence interval. We use a risk measurement methodology to measure trading-related VaR daily. We have adopted standards for measuring trading-related VaR, and we maintain regulatory capital for market risk associated with our trading activities in conformity with currently applicable bank regulatory market risk requirements.
We utilize an internal VaR model to calculate our regulatory market risk capital requirements. We use a historical simulation model to calculate daily VaR- and stressed VaR-based measures for our covered positions in conformity with regulatory requirements. Our VaR model seeks to capture identified material risk factors associated with our covered positions, including risks arising from market movements such as changes in foreign exchange rates, interest rates and option-implied volatilities.
We have adopted standards and guidelines to value our covered positions which govern our VaR- and stressed VaR-based measures. Our regulatory VaR-based measure is calculated based on historical volatilities of market risk factors during a two-year observation period calibrated to a one-tail, 99% confidence interval and a ten-business-day holding period. We also use the same platform to calculate a one-tail, 99% confidence interval, one-business-day VaR for internal risk management purposes. A 99% one-tail confidence interval implies that daily trading losses are not expected to exceed the estimated VaR more than 1% of the time, or less than three business days out of a year.
Our market risk models, including our VaR model, are subject to change in connection with the governance, validation and back-testing processes described below. These models can change as a result of changes in our business activities, our historical experiences, market forces and events, regulations and regulatory interpretations and other factors. In addition, the models are subject to continuing regulatory review and approval. Changes in our models may result in changes in our measurements of our market risk exposures, including VaR, and related measures, including regulatory capital. These changes could result in material changes in those risk measurements and related measures as calculated and compared from period to period.
 
Value-at-Risk
VaR measures are based on the most recent two years of historical price movements for instruments and related risk factors to which we have exposure. The instruments in question are limited to foreign exchange spot, forward and options contracts and interest-rate contracts, including futures and interest-rate swaps.
Our VaR methodology uses a historical simulation approach based on market-observed changes in foreign exchange rates, U.S. and non-U.S. interest rates and implied volatilities, and incorporates the resulting diversification benefits provided from the mix of our trading positions. Our VaR model incorporates approximately 5,000 risk factors and includes correlations among currency, interest rates, and other market rates.
Stress Testing and Stressed VaR
We have a corporate-wide stress-testing program in place that incorporates an array of techniques to measure the potential loss we could suffer in a hypothetical scenario of adverse economic and financial conditions. We also monitor concentrations of risk such as concentration by branch, risk component, and currency pairs. We conduct stress testing on a daily basis based on selected historical stress events that are relevant to our positions in order to estimate the potential impact to our current portfolio should similar market conditions recur, and we also perform stress testing as part of the Federal Reserve's annual CCAR process. Stress testing is conducted, analyzed and reported at the corporate, trading desk, division and risk-factor level (for example, exchange risk, interest-rate risk and volatility risk).
We calculate a stressed VaR-based measure using the same model we use to calculate VaR, but with model inputs calibrated to historical data from a range of continuous twelve-month periods that reflect significant financial stress. The stressed VaR model identifies the continuous twelve-month period with the worst outputs for our current portfolio positions. The rolling ten-day period with an outcome that is worse than 99% of other outcomes during that twelve-month period of financial stress represents the observed stressed VaR for the day’s positions portfolio.
The sixty-day moving average of our stressed VaR-based measure was approximately $38 million for the twelve months ended June 30, 2014, compared to a sixty-day moving average of approximately $31 million for the twelve months ended March 31, 2014 and approximately $19 million for the twelve months ended June 30, 2013. The increase in the sixty-day moving average of our stressed-VaR measure for the twelve months ended


56

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

June 30, 2014 compared to the twelve months ended June 30, 2013 was principally due to increases in our exposures to basis risk in currencies that trade both on-shore and off-shore. As described following the VaR and stressed-VaR tables under "Validation and Back-Testing," we changed our stressed-VaR model to reflect such exposure as of July 1, 2013, and as a result, the averages for the two periods are not directly comparable.
Stress-testing results and limits are actively monitored on a daily basis by ERM and reported to the TMRC. Limit breaches are addressed by ERM risk managers in conjunction with the business units, escalated as appropriate, and reviewed by the TMRC if material. In addition, we have established several action triggers that prompt immediate review by management and the implementation of a remediation plan.
Validation and Back-Testing
We perform daily back-testing to assess the accuracy of our VaR-based model in estimating loss at the stated confidence level. This back-testing involves the comparison of estimated VaR model outputs to actual profit-and-loss, or P&L, outcomes observed from daily market movements. We back-test our VaR model using “clean” P&L, which excludes non-trading revenue such as fees, commissions and net interest revenue, as well as estimated revenue from intra-day trading. Our VaR definition of trading losses excludes items that are not specific to the price movement of the trading assets and liabilities themselves, such as fees, commissions, changes to reserves and gains or losses from intra-
 
day activity. We experienced no back-testing exceptions in the first six months of 2014 or the first six months of 2013.
Our market risk models are governed by our model risk governance guidelines, in conformity with our model risk governance policy, which outline the standards we use to assess the conceptual soundness and effectiveness of our models. Our market risk models are subject to regular review and validation by MVG within ERM and overseen by the MAC. The MAC includes members with expertise in modeling methodologies and has representation from the various business units throughout State Street. Additional information about the MAC and MVG is provided under “Risk Management - Model Risk Management and Governance” in this Management's Discussion and Analysis.
Our model validation process also evaluates the integrity of our VaR models through the use of regular outcome analysis. Such outcome analysis includes back-testing, which compares the VaR model's predictions to actual outcomes using out-of-sample information. MVG examined back-testing results for the market risk regulatory capital model used for 2012. Consistent with regulatory guidance, the back-testing compared “clean” P&L, defined above, with the one-day VaR produced by the model. The back-testing was performed for a time period not used for model development. The number of occurrences where “clean” trading-book P&L exceeded the one-day VaR was within our expected VaR tolerance level.

The following tables present VaR and stressed VaR associated with our trading activities for covered positions held during the six months ended June 30, 2014 and the six months ended June 30, 2013, and as of June 30, 2014 and December 31, 2013, as measured by our VaR methodology.
VaR - COVERED PORTFOLIOS (TEN-DAY VaR)
Six Months Ended June 30, 2014
 
Six Months Ended June 30, 2013
 
As of June 30, 2014
 
As of December 31, 2013
(In thousands)
Average
 
Maximum
 
Minimum
 
Average
 
Maximum
 
Minimum
 
VaR
 
VaR
Foreign exchange
$
6,547

 
$
12,327

 
$
2,273

 
$
6,972

 
$
22,835

 
$
1,626

 
$
5,099

 
$
5,463

Money market/Global Treasury
50

 
62

 
42

 
112

 
559

 
24

 
49

 
58

Total VaR
$
6,527

 
$
12,283

 
$
2,262

 
$
6,917

 
$
22,834

 
$
1,641

 
$
5,138

 
$
5,441

STRESSED VaR - COVERED PORTFOLIOS (TEN-DAY VaR)
Six Months Ended June 30, 2014
 
Six Months Ended June 30, 2013
 
As of June 30, 2014
 
As of December 31, 2013
(In thousands)
Average
 
Maximum
 
Minimum
 
Average
 
Maximum
 
Minimum
 
Stressed VaR
 
Stressed VaR
Foreign exchange
$
34,180

 
$
64,510

 
$
15,625

 
$
18,196

 
$
43,984

 
$
4,933

 
$
31,007

 
$
30,338

Money market/Global Treasury
187

 
572

 
84

 
251

 
971

 
56

 
119

 
280

Total Stressed VaR
$
34,129

 
$
64,409

 
$
15,495

 
$
18,065

 
$
43,765

 
$
4,889

 
$
30,959

 
$
30,403

The VaR-based measures presented in the preceding tables are primarily a reflection of the overall level of market volatility and our appetite for trading market risk. Overall levels of volatility have
 
been low both on an absolute basis and relative to the historical information observed at the beginning of the period used for the calculations. Both the ten-day VaR-based measures and the stressed VaR-based


57

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

measures are based on historical changes observed during rolling ten-day periods for the portfolios as of the close of business each day over the past one-year period.
The decrease in the maximum VaR measure for foreign exchange for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 was the result of declining market volatility, particularly foreign exchange volatility. 
The increases in the average stressed-VaR measures for the six months ended June 30, 2014 compared to the six months ended June 30, 2013 principally resulted from the model changes, described below, that we implemented beginning on July 1, 2013.
Beginning on July 1, 2013, we implemented two changes to our stressed-VAR model. The net effect of the two changes resulted in increases in our
 
stressed VaR-based measures, calculated based on a 99% confidence interval. The changes involved the introduction of off-shore yield curves for non-deliverable forward contracts in our portfolios of covered positions and the use of absolute changes in place of relative or percentage changes for interest-rate risk factors (both base curves and spread curves).
The changes to our stressed-VaR model described above were the principal contributing factor in the increases in the average stressed-VaR measures; as a result, the averages for the two periods are not directly comparable.
We may in the future further modify and adjust our models and methodologies used to calculate VaR, subject to regulatory review and approval, and these modifications and adjustments may result in changes in our VaR measures.

The following tables present the VaR and stressed VaR associated with our trading activities attributable to foreign exchange rates, interest rates and volatility as of June 30, 2014 and December 31, 2013. The totals of the VaR and stressed-VaR measures for the three attributes for each VaR and stressed-VaR component exceeded the related total VaR and total stressed VaR presented in the foregoing tables as of each period-end, primarily due to the benefits of diversification across risk types.
VaR - COVERED PORTFOLIOS (TEN-DAY VaR)
As of June 30, 2014
 
As of December 31, 2013
(In thousands)
Foreign Exchange
 
Interest Rate
 
Volatility
 
Foreign Exchange
 
Interest Rate
 
Volatility
By component:
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange/Global Markets
$
3,136

 
$
4,330

 
$
476

 
$
3,492

 
$
4,561

 
$
306

Money market/Global Treasury
45

 
15

 

 
46

 
52

 

Total VaR
$
3,149

 
$
4,330

 
$
476

 
$
3,457

 
$
4,577

 
$
306

STRESSED VaR - COVERED PORTFOLIOS (TEN-DAY VaR)
As of June 30, 2014
 
As of December 31, 2013
(In thousands)
Foreign Exchange
 
Interest Rate
 
Volatility
 
Foreign Exchange
 
Interest Rate
 
Volatility
By component:
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange/Global Markets
$
10,087

 
$
33,707

 
$
637

 
$
8,788

 
$
37,030

 
$
345

Money market/Global Treasury
128

 
69

 

 
119

 
299

 

Total Stressed VaR
$
10,020

 
$
33,680

 
$
637

 
$
8,845

 
$
36,949

 
$
345


Total stressed VaR as of June 30, 2014 increased slightly compared to December 31, 2013, as presented in the foregoing table of period-end total stressed-VaR measures. However, the stressed VaR attributable to interest rates as of June 30, 2014, presented in the table above, declined compared to December 31, 2013, while the stressed VaR attributable to foreign exchange as of June 30, 2014, presented in the table above, increased in the same comparison.  This relationship reflected slightly lower basis risk arising from on-shore/off-shore positions in emerging market currencies as of June 30, 2014, a time when our foreign exchange exposure was a more significant component of our stressed-VaR measure compared
 
to our foreign exchange exposure as of December 31, 2013.


58

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

Asset-and-Liability Management Activities
The primary objective of asset-and-liability management is to provide sustainable and growing net interest revenue, or NIR, under varying economic environments, while protecting the economic value of the assets and liabilities carried in our consolidated statement of condition from the adverse effects of changes in interest rates. While many market factors affect the level of NIR and the economic value of our assets and liabilities, one of the most significant factors is our exposure to movements in interest rates. Most of our NIR is earned from the investment of client deposits generated by our businesses. We invest these client deposits in assets that conform generally to the characteristics of our balance sheet liabilities, including the currency composition of our significant non-U.S. dollar denominated client liabilities, but we manage our overall interest-rate risk position in the context of current and anticipated market conditions and within internally-approved risk guidelines.
Our overall interest-rate risk position is maintained within a series of policies approved by the Board and guidelines established and monitored by ALCCO. Our Global Treasury group has responsibility for managing our day-to-day interest-rate risk. To effectively manage our consolidated statement of condition and related NIR, Global Treasury has the authority to assume a limited amount of interest-rate risk based on market conditions and its views about the direction of global interest rates over both short-term and long-term time horizons. Global Treasury manages our exposure to changes in interest rates on a consolidated basis organized into three regional treasury units, North America, Europe and Asia/Pacific, to reflect the growing, global nature of our exposures and to capture the impact of changes in regional market environments on our total risk position.
The economic value of our consolidated statement of condition is a metric designed to estimate the fair value of assets and liabilities which could be garnered if those assets and liabilities were sold today. The economic values represent discounted cash flows from all financial instruments; therefore, changes in the yield curves, which are used to discount the cash flows, affect the values of these instruments.
Our investment activities and our use of derivative financial instruments are the primary tools used in managing interest-rate risk. We invest in financial instruments with currency, repricing, and maturity characteristics we consider appropriate to manage our overall interest-rate risk position. In addition, we use certain derivative instruments, primarily interest-rate swaps, to alter the interest-rate
 
characteristics of specific balance sheet assets or liabilities.
Additional information about our measurement of fair value and our use of derivatives is provided in notes 2 and 12, respectively, to the consolidated financial statements included in this Form 10-Q.
Because no one individual measure can accurately assess all of our exposures to changes in interest rates, we use several quantitative measures in our assessment of current and potential future exposures to changes in interest rates and their impact on NIR and balance sheet values. NIR simulation is the primary tool used in our evaluation of the potential range of possible NIR results that could occur under a variety of interest-rate environments. We also use market valuation and duration analysis to assess changes in the economic value of balance sheet assets and liabilities caused by assumed changes in interest rates.
To measure, monitor, and report on our interest-rate risk position, we use NIR simulation, or NIR-at-risk, and economic value of equity, or EVE, sensitivity. NIR-at-risk measures the impact on NIR over the next twelve months to immediate, or “rate shock,” and gradual, or “rate ramp,” changes in market interest rates. EVE sensitivity is a total return view of interest-rate risk, which measures the impact on the present value of all NIR-related principal and interest cash flows of an immediate change in interest rates, and is generally used in the context of economic capital discussed under “Economic Capital” in “Financial Condition - Capital” in this Management's Discussion and Analysis. Although NIR-at-risk and EVE sensitivity measure interest-rate risk over different time horizons, both utilize consistent assumptions when modeling the positions currently held by State Street; however, NIR-at-risk also incorporates future actions planned by management over the time horizons being modeled.
In estimating our NIR-at-risk, we start with a base amount of NIR that is projected over the next twelve months, assuming our forecast yield curve over the period. Our existing balance sheet assets and liabilities are adjusted by the amount and timing of transactions that are forecast to occur over the next twelve months. That yield curve is then “shocked,” or moved immediately, +/-100 basis points in a parallel fashion, or at all points along the yield curve. Two new twelve-month NIR projections are then developed using the same balance sheet and forecast transactions, but with the new yield curves, and compared to the base scenario. We also perform the calculations using interest-rate ramps, which are +/-100-basis-point changes in interest rates that are assumed to occur gradually over the next twelve


59

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

months, rather than immediately as we do with interest-rate shocks.
EVE is based on the change in the present value of all NIR-related principal and interest cash flows for changes in market rates of interest. The present value of existing cash flows with a then-current yield curve serves as the base case. We then apply an immediate parallel shock to that yield curve of ±200 basis points and recalculate the cash flows and related present values. A large shock is used to better capture the embedded option risk in our mortgage-backed securities that results from borrowers' prepayment opportunities.
Key assumptions used in the models, described in more detail below, along with changes in market conditions, are inherently uncertain. Actual results necessarily differ from model results as market conditions differ from assumptions. As such, management performs back-testing, stress testing, and model integrity analyses to validate that the modeled results produce predictive NIR-at-risk and EVE sensitivity estimates which can be used in our management of interest-rate risk. Primary factors affecting the actual results are changes in our balance sheet size and mix; the timing, magnitude and frequency of changes in interest rates, including the slope and the relationship between the interest-rate level of U.S. dollar and non-U.S. dollar yield curves; changes in market conditions; and management actions taken in response to the preceding conditions.
Both NIR-at-risk and EVE sensitivity results are managed against ALCCO-approved limits and guidelines and are monitored regularly, along with other relevant simulations, scenario analyses and stress tests, by both Global Treasury and ALCCO. Our ALCCO-approved guidelines are, we believe, in line with industry standards and are periodically examined by the Federal Reserve.
As a result of differences between NIR-at-risk and EVE with respect to certain assumptions, such as the reinvestment of our interest-earning assets, reported results of NIR-at-risk could present an increase in NIR from an increase in rates while EVE presents a loss. Changes in assumptions may result in different outcomes under both NIR-at-risk and EVE. NIR-at-risk depicts the change in the nominal (un-discounted) dollar net interest flows which are generated from the forecast statement of condition over the next twelve months.  As interest rates increase, the interest expense associated with our client deposit liabilities is assumed to increase at a slower pace than the investment returns derived from our current balance sheet or the associated reinvestment of our interest-earning assets, resulting in an overall increase to NIR. EVE, on the other
 
hand, measures the present value change of both principal and interest cash flows based on the current period-end balance sheet. As a result, EVE does not contemplate reinvestment of our assets associated with a change in the interest-rate environment. 
Although NIR in both NIR-at-risk and EVE sensitivity is higher in response to increased interest rates, the future principal flows from fixed-rate investments are discounted at higher rates for EVE, which results in lower asset values and a corresponding reduction or loss in EVE. As noted above, NIR-at-risk does not analyze changes in the value of principal cash flows and therefore does not experience the same reduction experienced by EVE sensitivity associated with discounting principal cash flows at higher rates.
Net Interest Revenue at Risk
NIR-at-risk is designed to estimate the potential impact of changes in global market interest rates on NIR in the short term. The impact of changes in market rates on NIR is measured against a baseline NIR which encompasses management's expectations regarding the evolving balance sheet volumes and interest rates in the near-term. The goal is to achieve an acceptable level of NIR under various interest-rate environments. Assumptions regarding levels of client deposits and our ability to price these deposits under various rate environments have a significant impact on the results of the NIR simulations. Similarly, the timing of cash flows from our investment portfolio, especially option-embedded financial instruments like mortgage-backed securities, and our ability to replace these cash flows in line with management's expectations, can affect the results of NIR simulations.
The following table presents the estimated exposure of our NIR for the next twelve months, calculated as of the dates indicated, due to an immediate +/-100-basis-point shift to our internal forecast of global interest rates. We manage our NIR sensitivity to limit declines to 15% or less from baseline NIR. Estimated incremental exposures presented below are dependent on management's assumptions, and do not reflect any additional actions management may undertake in order to mitigate some of the adverse effects of changes in interest rates on our financial performance.


60

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

 
Estimated Exposure to
Net Interest Revenue
(Dollars in millions)
June 30,
2014
 
December 31,
2013
Rate change:
Exposure
 
% of Base NIR
 
Exposure
 
% of Base NIR
+100 bps shock
$
387

 
16.5
%
 
$
334

 
14.0
%
–100 bps shock
(291
)
 
(12.4
)
 
(261
)
 
(10.9
)
+100 bps ramp
156

 
6.7

 
126

 
5.3

–100 bps ramp
(158
)
 
(6.7
)
 
(124
)
 
(5.2
)
As of June 30, 2014, NIR sensitivity to an upward-100-basis-point shock in global interest rates was slightly higher compared to such sensitivity as of December 31, 2013, due to a higher level of forecast client deposits. The benefit to NIR of an upward-100-basis-point ramp is less significant than a shock, since interest rates are assumed to increase gradually.
NIR sensitivity to a downward-100-basis-point shock in global interest rates as of June 30, 2014 increased compared to such sensitivity as of December 31, 2013. Increased levels of forecast client deposits, while beneficial to baseline NIR, do not provide relief in the downward shock scenario, as the deposits have no room to fully re-price from current levels as their pricing basis falls. A downward-100-basis-point shock in global interest rates places pressure on NIR, as deposit rates reach their implicit floors due to the exceptionally low global interest-rate environment, and provide little funding relief on the liability side, while assets re-price into the lower-rate environment.
Our baseline NIR incorporates an expectation that short-term interest rates will begin to rise in anticipation of central bank tightening of current monetary policies. While this rise in rates benefits our baseline NIR, it is detrimental to our NIR sensitivity to a downward-100-basis-point shock, as rising short-term interest rates allow asset yields to re-price lower in a downward shock scenario than previously, while deposits are still priced close to natural floors.
 
Other important factors which affect the levels of NIR are the size and mix of assets carried in our consolidated statement of condition; interest-rate spreads; the slope and interest-rate level of U.S. and non-U.S. dollar yield curves and the relationship between them; the pace of change in global market interest rates; and management actions taken in response to the preceding conditions.
Economic Value of Equity
EVE sensitivity measures changes in the market value of equity to quantify potential losses to shareholders due to an immediate +/-200-basis-point rate shock compared to current interest-rate levels if the balance sheet were liquidated immediately. Management compares the change in EVE sensitivity against State Street's aggregate tier 1 and tier 2 risk-based capital, calculated in conformity with currently applicable regulatory requirements, to evaluate whether the magnitude of the exposure to interest rates is acceptable. Generally, a change resulting from a +/-200-basis-point rate shock that is less than 20% of aggregate tier 1 and tier 2 capital is an exposure that management deems acceptable. To the extent that we manage changes in EVE sensitivity within the 20% threshold, we would seek to take action to remain below the threshold if the magnitude of our exposure to interest rates approached that limit.
Similar to NIR-at-risk measures, the timing of cash flows affects EVE sensitivity, as changes in asset and liability values under different rate scenarios are dependent on when interest and principal payments are received. In contrast to NIR simulations, however, EVE sensitivity does not incorporate assumptions regarding reinvestment of these cash flows. In addition, our ability to price client deposits has a much smaller impact on EVE sensitivity, as EVE sensitivity does not consider the ongoing benefit of investing client deposits.

The following table presents estimated EVE exposures, calculated as of the dates indicated, assuming an immediate and prolonged shift in global interest rates, the impact of which would be spread over a number of years.
 
Estimated Sensitivity of
Economic Value of Equity
(Dollars in millions)
June 30,
2014
 
December 31,
2013
Rate change:
Exposure
 
% of Tier 1/Tier 2 Capital
 
Exposure
 
% of Tier 1/Tier 2 Capital
+200 bps shock
$
(2,187
)
 
(12.3
)%
 
$
(2,359
)
 
(14.9
)%
–200 bps shock
951

 
5.4

 
1,149

 
7.2

Exposure to upward- and downward-200-basis-point shocks as of June 30, 2014 improved compared to December 31, 2013. A lower concentration of
 
fixed-rate securities in the investment portfolio and related hedging activity in 2013 reduced EVE sensitivity to changes in market rates.


61

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

Business Risk Management
We define business risk as the risk of adverse changes in our earnings related to business factors, including changes in the competitive environment, changes in the operational economics of our business activities and the potential effect of strategic and reputation risks, not already captured as trading market, interest-rate, credit, operational or liquidity risks. We incorporate business risk into our assessment of our strategic plans and economic capital needs. Active management of business risk is an integral component of all aspects of our business, and responsibility for the management of business risk lies with every employee at State Street.
Separating the effects of a potential material adverse event into operational and business risk is sometimes difficult. For instance, the direct financial impact of an unfavorable event in the form of fines or penalties would be classified as an operational risk loss, while the impact on our reputation and consequently the potential loss of clients and corresponding decline in revenue would be classified as a business risk loss. An additional example of business risk is the integration of a major acquisition. Failure to successfully integrate the operations of an acquired business, and the resultant inability to retain clients and the associated revenue, would be classified as a loss due to business risk.
Business risk is managed with a long-term focus. Techniques for its assessment and management include the development of business plans and appropriate management oversight. The potential impact of the various elements of business risk is difficult to quantify with any degree of precision. We use a combination of historical earnings volatility, scenario analysis, stress-testing and management judgment to help assess the potential effect on State Street attributable to business risk. Management and control of business risks are generally the responsibility of the business units as part of their overall strategic planning and internal risk management processes.
Capital
The management of both our regulatory and economic capital involves key metrics evaluated by management to assess whether our actual level of capital is commensurate with our risk profile, is in compliance with all applicable regulatory requirements, and is sufficient to provide us with the financial flexibility to undertake future strategic business initiatives. We assess capital based on relevant regulatory capital adequacy requirements, as well as our own internal capital targets.


 
Framework
Our objective with respect to management of our capital is to maintain a strong capital base in order to provide financial flexibility for our business needs, including funding corporate growth and supporting clients’ cash management needs, and to provide protection against loss to depositors and creditors. We strive to maintain an appropriate level of capital, commensurate with our risk profile, on which an attractive return to shareholders is expected to be realized over both the short and long term, while protecting our obligations to depositors and creditors and complying with regulatory capital adequacy requirements.
Our capital management process focuses on our risk exposures, the regulatory requirements applicable to us with respect to capital adequacy, the evaluations and resulting credit ratings of the major independent credit rating agencies, our return on capital at both the consolidated and line-of-business level, and our capital position relative to our peers.
Our evaluation of capital includes the comparison of capital sources with capital uses, as well as the consideration of the quality and quantity of the various components of capital, as two of several inputs in our overall assessment of our capital adequacy. The goals of the capital evaluation process are to determine the optimal level of capital and composition of capital instruments to satisfy all constituents of capital, with the lowest overall cost to shareholders. Other factors considered in our capital evaluation process are strategic and contingency planning, stress testing and planned capital actions.
Internal Capital Adequacy Assessment
Our primary federal banking regulator is the Federal Reserve. Both State Street and State Street Bank are subject to the minimum regulatory capital requirements established by the Federal Reserve and defined in the Federal Deposit Insurance Corporation Improvement Act of 1991, or FDICIA. State Street Bank must exceed the regulatory capital thresholds for “well capitalized” in order for our parent company to maintain its status as a financial holding company. Accordingly, our primary goal with respect to capital adequacy is to exceed all applicable minimum regulatory capital requirements and to be “well-capitalized” under the Prompt Corrective Action guidelines established by the FDIC. Our capital adequacy program includes our Internal Capital Adequacy Assessment Process, or ICAAP, and associated capital policies.
We consider capital adequacy to be a key element of our financial well-being, which affects our ability to attract and maintain client relationships; operate effectively in the global capital markets; and


62

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

satisfy regulatory, security holder and shareholder needs. Capital is one of several elements that affect State Street’s debt ratings and the ratings of our principal subsidiaries.
In conformity with our capital policies, we strive to maintain adequate capital, not just at a point in time, but over time and during periods of stress, to account for changes in our strategic direction, evolving economic conditions, and financial and market volatility. We have developed and implemented a corporate-wide ICAAP to assess our overall capital and liquidity in relation to our risk profile and to provide a comprehensive strategy for maintaining appropriate capital and liquidity levels. The ICAAP considers material risks under multiple scenarios, with an emphasis on stress scenarios. The ICAAP builds on and leverages existing processes and systems used to measure our capital adequacy. Our ICAAP policy is reviewed and approved by the Board’s RCC.
Capital Contingency Planning
Contingency planning is an integral component of our capital management program. The objective of our contingency planning process is to monitor current and forecast levels of select measures that serve as early indicators of a potentially adverse capital or liquidity adequacy situation. These measures are one of the inputs used to set our capital adequacy level. We review these measures annually for appropriateness and relevance in relation to our financial budget and capital plan.
Stress Testing
We administer a robust State Street-wide stress-testing program that executes multiple stress tests each year. Our stress testing program is structured around what we determine to be the key risks incurred by State Street. These key risks serve as an organizing principle for much of our risk management framework, as well as reporting, including the “risk dashboard” provided to the Board. Over the past few years, stress scenarios have included a deep recession in the U.S., a break-up of the Eurozone, a severe recession in China and an oil shock precipitated by turmoil in the Middle East/North Africa region.
In connection with the focus on our key risks, each stress test incorporates idiosyncratic loss events tailored to State Street‘s unique risk profile. Due to the nature of our business model and our consolidated statement of condition, our risks differ from those of a traditional commercial bank.
The Federal Reserve requires bank holding companies with total consolidated assets of $50 billion or more, which includes State Street, to submit a capital plan on an annual basis. The Federal
 
Reserve uses its annual CCAR process, which incorporates hypothetical financial and economic stress scenarios, to review those capital plans and assess whether banking organizations have capital planning processes that account for idiosyncratic risks and provide for sufficient capital to continue operations throughout times of economic and financial stress. As part of its CCAR process, the Federal Reserve assesses each organization’s capital adequacy, capital planning process, and plans to distribute capital, such as dividend payments or stock purchase programs. Management and Board risk committees review and approve CCAR results and assumptions before submission to the Federal Reserve.
Governance
In order to support integrated decision making, we have identified three management elements to aid in the compatibility and coordination of our capital adequacy strategies and processes:
Risk Management - identification, measurement, monitoring and forecasting of different types of risk and their combined impact on capital adequacy;
Capital Management - determination of optimal capital and liquidity levels; and
Business Management - strategic planning, budgeting, forecasting, and performance management.
We have a hierarchical structure supporting appropriate committee review of relevant risk and capital information. The ongoing responsibility for capital management rests with our Treasurer. The Capital Planning group within Global Treasury is responsible for capital policies, development of the capital plan, the management of global capital, capital optimization, and business unit capital management.
ALCCO has oversight of our management of regulatory capital, capital adequacy with respect to regulatory requirements, internal targets and the expectations of the major independent credit rating agencies. ALCCO’s roles and responsibilities are designed to work complementary to and in coordination with MRAC, which approves State Street’s balance sheet strategy and related activities. The Board’s RCC assists the Board in fulfilling its oversight responsibilities related to the assessment and management of risk and capital.
Regulatory Capital
As of December 31, 2013, we were subject to the generally applicable minimum regulatory capital requirements enforced by U.S. banking regulators, referred to as Basel I. In July 2013, U.S. banking regulators issued a final rule to implement the Basel


63

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

III framework in the U.S., referred to as the Basel III final rule, provisions of which become effective under a transition timetable which began on January 1, 2014, with full implementation required beginning on January 1, 2019. As provided in the Basel III final rule, banking organizations in their Basel II parallel run were required to complete a superseding parallel run under Basel III.
We were notified by the Federal Reserve on February 21, 2014 that we completed our Basel III parallel run and would be required to begin using the advanced approaches framework provided in the Basel III final rule in the determination of our risk-based capital requirements. Pursuant to this notification, we have begun to use the advanced approaches framework to calculate and disclose our regulatory capital ratios starting with the second quarter of 2014.
As required by the Dodd-Frank Act, State Street and State Street Bank, as advanced approaches banking organizations, are subject to a permanent "capital floor" in the calculation and assessment of their regulatory capital adequacy by U.S. banking regulators. Beginning on January 1, 2014, this capital floor is based on the provisions of Basel I, as adjusted by the final market risk capital rule issued by U.S. banking regulators in 2012.
Beginning on January 1, 2014, we became subject to the provisions of the Basel III final rule that govern our calculation of regulatory capital, including transitional, or phase-in, provisions. However, we calculated our risk-weighted assets in conformity with Basel I, as adjusted by the final market risk capital rule, for the first quarter of 2014.
Beginning with the second quarter of 2014 and ending with the fourth quarter of 2014, the lower of our regulatory capital ratios calculated under the advanced approaches provisions of the Basel III final rule and those ratios calculated under the transitional provisions of Basel III (capital calculated in conformity with Basel III and risk-weighted assets calculated in conformity with Basel I as described above) will apply in the assessment of our capital adequacy for regulatory purposes.
In conformity with the Basel III final rule, the minimum required regulatory capital ratios for 2014 are as follows:
common equity tier 1, or
tier 1 common, risk-based capital - 4%;
tier 1 risk-based capital - 5.5%;
total risk-based capital - 8%; and
tier 1 leverage capital - 4%.
As of January 1, 2019, the date that full implementation of Basel III is required, the minimum
 
required regulatory capital ratios, excluding the required capital conservation buffer of 2.5% (described below), will be as follows:
tier 1 common risk-based capital - 4.5%;
tier 1 risk-based capital - 6%;
total risk-based capital - 8%; and
tier 1 leverage capital - 4%.
Once the provisions of the standardized approach in the Basel III final rule are fully implemented effective January 1, 2015, the lower of the Basel III regulatory capital ratios calculated by us under the advanced approaches provisions of Basel III and the Basel III standardized approach will apply in the assessment of our capital adequacy for regulatory purposes. As a result, from January 1, 2015 going forward, our risk-based capital ratios for regulatory assessment purposes will be the lower of each ratio calculated under the advanced approaches and the standardized approach.
The methods for the calculation of our and State Street Bank's risk-based capital ratios will change as the provisions of the Basel III final rule related to the numerator (capital) and denominator (risk-weighted assets) are phased in, and as we begin calculating our risk-weighted assets using the advanced approaches. These ongoing methodological changes will result in differences in our reported capital ratios from one reporting period to the next that are independent of applicable changes to our capital base, our asset composition, our off-balance sheet exposures or our risk profile.
Under the Basel III final rule, a banking organization, subject to regulatory constraints, such as the review of capital plans, will be able to make capital distributions and discretionary bonus payments without specified limitations, as long as it maintains a required capital conservation buffer of 2.5% over each of the minimum tier 1 common, tier 1 and total risk-based capital ratios (plus any potentially applicable countercyclical capital buffer). Banking regulators will establish the minimum countercyclical capital buffer, which is initially set by banking regulators at zero, up to a maximum of 2.5% above the minimum ratios inclusive of the capital conservation buffer, under certain economic conditions.
The requirement for the capital conservation buffer will be phased in beginning on January 1, 2016, with full implementation by January 1, 2019. As of January 1, 2019, the minimum Basel III regulatory capital ratios, including the capital conservation buffer of 2.5% but assuming a countercyclical capital buffer of zero, will be as follows, in order for us to make capital distributions and discretionary bonus payments without limitation:


64

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

tier 1 common risk-based capital - 7.0%;
tier 1 risk-based capital - 8.5%; and
 
total risk-based capital - 10.5%.

The following table presents the regulatory capital structure and related regulatory capital ratios for State Street and State Street Bank as of the dates indicated. As a result of changes in the methodologies used to calculate our regulatory capital ratios from period to period as the provisions of the Basel III final rule are phased in, the ratios presented in the table for each period-end are not directly comparable. Refer to the footnotes following the table.
 
 
 
 
State Street
 
State Street Bank
(Dollars in millions)
 
 
 
Basel III Advanced Approach June 30, 2014(1)
 
Basel III Transitional June 30, 2014(2)
 
December 31, 2013(3)
 
Basel III Advanced Approach June 30, 2014(1)
 
Basel III Transitional June 30, 2014(2)
 
December 31, 2013(3)
  Common shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock and related surplus
 
 
 
$
10,269

 
$
10,269

 
$
10,280

 
$
10,832

 
$
10,832

 
$
10,786

Retained earnings
 
 
 
14,114

 
14,114

 
13,395

 
9,579

 
9,579

 
9,064

Accumulated other comprehensive income (loss)
 
 
 
328

 
328

 
215

 
299

 
299

 
209

Treasury stock, at cost
 
 
 
(4,405
)
 
(4,405
)
 
(3,693
)
 

 

 

Total
 
 
 
20,306

 
20,306

 
20,197

 
20,710

 
20,710

 
20,059

Regulatory capital adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and other intangible assets, net of associated deferred tax liabilities(4) 
 
 
 
(6,100
)
 
(6,100
)
 
(7,743
)
 
(5,816
)
 
(5,816
)
 
(7,341
)
Other adjustments
 
 
 
(41
)
 
(41
)
 

 
(126
)
 
(126
)
 

  Tier 1 common capital
 
 
 
14,165

 
14,165

 
12,454

 
14,768

 
14,768

 
12,718

Preferred stock
 
 
 
1,233

 
1,233

 
491

 

 

 

Trust preferred capital securities subject to phase-out from tier 1 capital
 
 
 
475

 
475

 
950

 

 

 

Other adjustments
 
 
 
(165
)
 
(165
)
 

 

 

 

  Tier 1 capital
 
 
 
15,708

 
15,708

 
13,895

 
14,768

 
14,768

 
12,718

Qualifying subordinated long-term debt
 
 
 
1,738

 
1,738

 
1,918

 
1,754

 
1,754

 
1,936

Trust preferred capital securities phased out of tier 1 capital
 
 
 
475

 
475

 
NA
 

 

 
NA
Other adjustments
 
 
 
3

 
3

 
(26
)
 

 

 
45

  Total capital
 
 
 
$
17,924

 
$
17,924

 
$
15,787

 
$
16,522

 
$
16,522

 
$
14,699

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit risk

 
 
$
71,093

 
$
86,928

 
$
78,864

 
$
64,617

 
$
83,524

 
$
76,197

Operational risk
 
 
 
35,985

 
NA
 
NA
 
35,566

 
NA
 
NA
Market risk
 
 
 
3,937

 
1,679

 
1,262

 
3,463

 
1,679

 
1,262

Total risk-weighted assets

 
 
$
111,015

 
$
88,607

 
$
80,126

 
$
103,646

 
$
85,203

 
$
77,459

Adjusted quarterly average assets
 
 
 
$
227,815

 
$
227,815

 
$
202,801

 
$
224,050

 
$
224,050

 
$
199,301

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Capital Ratios:
 
Minimum Requirements(5) 2014
Minimum Requirements(6) 2013
 
 
 
 
 
 
 
 
 
 
 
Tier 1 common risk-based capital
 
4.0
%
NA

12.8
%
 
16.0
%
 
15.5
%
 
14.2
%
 
17.3
%
 
16.4
%
Tier 1 risk-based capital
 
5.5

4.0
%
14.1

 
17.7

 
17.3

 
14.2

 
17.3

 
16.4

Total risk-based capital
 
8.0

8.0

16.1

 
20.2

 
19.7

 
15.9

 
19.4

 
19.0

Tier 1 leverage
 
4.0

4.0

6.9

 
6.9

 
6.9

 
6.6

 
6.6

 
6.4

 
 
 
 
NA: Not applicable.
(1) Tier 1 common capital, tier 1 capital and total capital ratios as of June 30, 2014 were calculated in conformity with the advanced approaches provisions of the Basel III final rule. Tier 1 leverage ratio as of June 30, 2014 was calculated in conformity with the Basel III final rule.
(2) Tier 1 common capital, tier 1 capital, total capital and tier 1 leverage ratios as of June 30, 2014 were calculated in conformity with the transitional provisions of the Basel III final rule. Specifically, these ratios reflect tier 1 common, tier 1 and total capital (the numerator) calculated in conformity with the provisions of the Basel III final rule, and total risk-weighted assets or, with respect to the tier 1 leverage ratio, quarterly average assets (in both cases, the denominator), calculated in conformity with the provisions of Basel I.
(3) Tier 1 common capital, tier 1 capital, total capital and tier 1 leverage ratios as of December 31, 2013 were calculated in conformity with the provisions of Basel I.
(4) Amounts for State Street and State Street Bank as of June 30, 2014 consisted of goodwill, net of associated deferred tax liabilities, and 20% of other intangible assets, net of associated deferred tax liabilities, the latter phased in as a deduction from capital, in conformity with the Basel III final rule.
(5) Minimum requirements will be phased in up to full implementation beginning on January 1, 2019; minimum requirements listed are as of June 30, 2014.
(6) Minimum requirements listed, governed by Basel I, are as of December 31, 2013.

65

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

The increases in State Street's tier 1 and total capital as of June 30, 2014 compared to December 31, 2013 were the result of the first-quarter 2014 issuance of preferred stock, the impact of the phase-in provisions of the Basel III final rule related to other intangible assets and the positive effect of year-to date net income, partly offset by declarations of common and preferred stock dividends and purchases by us of our common stock in the first six months of 2014.
State Street Bank's tier 1 and total capital increased, the result of the above-described phase-in provisions of the Basel III final rule related to other intangible assets and the positive effect of year-to-date net income, partly offset by the payment of dividends by State Street Bank to our parent company in the first six months of 2014.
The regulatory capital ratios for State Street and State Street Bank as of June 30, 2014, presented in the table above, differ from such ratios as of December 31, 2013. These differences are independent of applicable changes to our capital base, our asset composition, our off-balance sheet exposures or our risk profile, and resulted from changes in the methodologies, required by applicable regulatory requirements, used to calculate capital and risk-weighted assets. As a result, the ratios presented in the table for each period-end are not directly comparable. Beginning with the second quarter of 2014, we used both the advanced approaches provisions in the Basel III final rule, and the provisions of Basel I, to calculate our risk-weighted assets. For the fourth quarter of 2013, we used the provisions of Basel I to calculate our risk-weighted assets.
The regulatory capital ratios as of June 30, 2014 presented in the table above, calculated under the advanced approaches in conformity with the Basel III final rule, reflect calculations and determinations with respect to our capital and related matters as of June 30, 2014, based on State Street and external data, quantitative formulae, statistical models, historical correlations and assumptions, collectively referred to as “advanced systems,” in effect and used by State Street for those purposes as of the time we filed this Form 10-Q. Significant components of these advanced systems involve the exercise of judgment by us and our regulators, and our advanced systems may not accurately represent or calculate the scenarios, circumstances, outputs or other results for which they are designed or intended.
Due to the influence of changes in these advanced systems, whether resulting from changes in data inputs, regulation or regulatory supervision or interpretation, State Street-specific or market activities or experiences or other updates or factors,
 
we expect that our advanced systems and our capital ratios calculated in conformity with the Basel III final rule will change and may be volatile over time, and that those latter changes or volatility could be material as calculated and measured from period to period.
Models implemented under the Basel III final rule, particularly those implementing the advanced approach, remain subject to regulatory review and approval. The full effects of the Basel III final rule on State Street and State Street Bank are therefore subject to further evaluation and also to further regulatory guidance, action or rule-making.
Estimated Basel III Tier 1 Common Ratio
The following table presents our tier 1 common ratio as of June 30, 2014, calculated in conformity with the advanced approaches provisions of the Basel III final rule, and our estimated tier 1 common ratio as of June 30, 2014, calculated in conformity with the Basel III standardized approach. The Basel III tier 1 common ratio calculated in conformity with the standardized approach in the Basel III final rule is a preliminary estimate, based on our present interpretations of the Basel III final rule.
June 30, 2014
 
Basel III Final Rule Advanced Approach(1)
 
Basel III Final Rule Standardized Approach (Estimated)(2)
(Dollars in millions)
 
 
Tier 1 capital
 
$
15,708

 
$
15,708

Less:
 
 
 
 
   Trust preferred capital securities
 
475

 
475

   Preferred stock
 
1,233

 
1,233

Plus other adjustments
 
165

 
165

Tier 1 common capital
 
$
14,165

 
$
14,165

Total risk-weighted assets 
 
$
111,015

 
$
125,575

Tier 1 common ratio
 
12.8
%
 
11.3
%
Minimum tier 1 common ratio requirement, assuming full implementation on January 1, 2019
 
 
 
4.5

Capital conservation buffer, assuming full implementation on January 1, 2019
 
 
 
2.5

Minimum tier 1 common ratio requirement, including capital conservation buffer, assuming full implementation on January 1, 2019(3)
 
 
 
7.0

 
 
 
 
 
(1) The tier 1 common ratio was calculated in conformity with the provisions of the Basel III final rule; refer to previous table.
(2) As of June 30, 2014, for purposes of the calculations completed in conformity with the Basel III final rule, total risk-weighted assets under the standardized approach were calculated using State Street's estimates, based on the provisions of Basel III final rule. This tier 1 common ratio was calculated by dividing tier 1 common capital, calculated in conformity with the provisions of the Basel III final rule, by total risk-weighted assets, calculated in conformity with the standardized approach in the Basel III final rule. This estimated Basel III tier 1 common ratio is preliminary, and is based on our present interpretations of the Basel III final rule.
Under the standardized approach, total risk-weighted assets used in the calculation of the estimated tier 1 common ratio increased by $14.56 billion as a result of applying the provisions of the Basel III final rule to total risk-weighted assets of $111.02 billion as of


66

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

June 30, 2014 calculated in conformity with the advanced approaches provisions of the Basel III final rule.
(3) The minimum tier 1 common ratio requirement does not reflect the countercyclical capital buffer under the Basel III final rule, or the capital buffer for G-SIBs prescribed by the Basel Committee (refer to “Systemically Important Banks”); such countercyclical capital buffer, which is initially set at zero, would be established by banking regulators under certain economic conditions, and U.S. banking regulators have not yet issued a proposal to implement the prescribed capital buffer for systemically important financial institutions.
Supplementary Leverage Ratio Framework
On April 8, 2014, U.S. banking regulators issued a final rule enhancing the supplementary leverage ratio, or SLR, standards for certain bank holding companies, like State Street, and their insured depository institution subsidiaries, like State Street Bank. Under the April 2014 final rule, upon implementation on January 1, 2018, State Street Bank must maintain an SLR of at least 6% to be well capitalized under the U.S. banking regulators’ prompt corrective action provisions. The April 2014 final rule also provides that if State Street maintains an SLR of at least 5%, it is not subject to limitations on distributions and discretionary bonus payments under the April 2014 final rule.
On April 8, 2014, in addition to the April 2014 final rule, U.S. banking regulators published an NPR that would revise the denominator of the SLR that the regulators initially adopted as part of the Basel III final rule in July 2013. Specifically, the NPR would revise the treatment of on- and off-balance sheet exposures used in the calculation of total leverage exposure, and more closely align the regulators’ standards with respect to the calculation of total leverage exposure with the Basel Committee standards. The proposed rule would incorporate in total leverage exposure the effective notional principal amount of credit derivatives and other similar instruments through which a banking organization provides credit protection; modify the calculation of total leverage exposure for derivatives and repo-style transactions; and revise the credit conversion factors applied to certain off-balance sheet exposures. The NPR would also change the methodology used to calculate the supplementary leverage ratio, by requiring total leverage exposure to be calculated on a daily average basis.
Systemically Important Banks
We meet the criteria of a large bank holding company subject to enhanced supervision and prudential standards, commonly referred to as a “systemically important financial institution,” or SIFI, and we are one among a group of 29 institutions worldwide that have been identified by the Financial Stability Board, or FSB, and the Basel Committee as G-SIBs. Our designation as a G-SIB will require us to maintain an additional capital buffer, ranging between
 
1% and 2.5%, above the Basel III minimum tier 1 common ratio of 4.5%, based on a number of factors, as evaluated by banking regulators. Factors in this evaluation will include our size, interconnectedness, substitutability, complexity and cross-jurisdictional activities. In November 2013, the FSB maintained their designation of us as a category-1 organization, with a capital surcharge of 1%, although this designation and the associated additional capital buffer are subject to change. U.S. banking regulators have not yet issued a proposal to implement the G-SIB capital surcharge.
We expect these additional capital requirements for G-SIBs to be phased in beginning on January 1, 2016, with full implementation by January 1, 2019. Assuming completion of the phase-in period for the capital conservation buffer, and no countercyclical buffer, the minimum capital ratios as of January 1, 2019, including the capital conservation buffer and G-SIB capital surcharge, would be 8% for common equity tier 1 capital, 9.5% for tier 1 risk-based capital, and 11.5% for total risk-based capital, in order for State Street to make capital distributions and discretionary bonus payments without limitation. Not all of our competitors have similarly been designated as systemically important, and therefore some of our competitors may not be subject to the same additional capital requirements.
Capital Actions
Preferred Stock
In the first quarter of 2014, we issued 30 million depositary shares, each representing a 1/4,000th ownership interest in a share of State Street’s fixed-to-floating-rate non-cumulative perpetual preferred stock, Series D, without par value, with a liquidation preference of $100,000 per share (equivalent to $25 per depositary share), in a public offering. The aggregate proceeds from the offering, net of underwriting discounts, commissions and other issuance costs, were approximately $742 million.
In the second quarter of 2014, we declared a dividend on our non-cumulative perpetual preferred stock, Series D (represented by depositary shares, each representing a 1/4,000th ownership interest in a share of State Street’s fixed-to-floating-rate non-cumulative perpetual preferred stock, Series D) of $1,655 per share, or approximately $0.41 per depositary share, totaling approximately $12 million. We did not declare a dividend on our non-cumulative perpetual preferred stock, Series D, in the first quarter of 2014.
In the second quarter of 2014, we declared a dividend on our non-cumulative perpetual preferred stock, Series C (represented by depositary shares, each representing a 1/4,000th ownership interest in a


67

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

share of State Street’s non-cumulative perpetual preferred stock, Series C) of $1,313 per share, or approximately $0.33 per depositary share, totaling approximately $7 million. In the first six months of 2014, we declared aggregate dividends on our perpetual preferred stock, Series C, of $2,626 per share, or approximately $0.66 per depositary share, totaling approximately $13 million. In the second quarter and first six months of 2013, dividends on our perpetual preferred stock, Series C, totaled approximately $6 million and $13 million, respectively.
Common Stock
In the second quarter of 2014, under a purchase
program approved by our Board of Directors in March 2014 which authorizes us to purchase up to $1.70 billion of our common stock through March 31, 2015, we purchased approximately 6.3 million shares of our common stock at an average cost of $65.02 per share and an aggregate cost of approximately $410 million. We did not purchase any shares under this program in the first quarter of 2014. As of June 30, 2014, approximately $1.3 billion remained available for purchases of our common stock under the March 2014 program.
In the first quarter of 2014, we completed the $2.10 billion program authorized by the Board in March 2013 by purchasing approximately 6.1 million shares of our common stock, at an average price of $69.14 per share and an aggregate cost of approximately $420 million.
Under both programs, in the six months ended June 30, 2014, we purchased in the aggregate approximately 12.4 million shares of our common stock at an average per-share cost of $67.04 and an aggregate cost of approximately $830 million. Shares acquired in connection with our common stock purchase programs which remained unissued as of June 30, 2014 were recorded as treasury stock in our consolidated statement of condition as of June 30, 2014.
In the second quarter of 2014, we declared a quarterly common stock dividend of $0.30 per share, totaling approximately $128 million, which was paid in July 2014. In the first six months of 2014, we declared aggregate quarterly common stock dividends of $0.56 per share, totaling approximately $240 million, compared to aggregate common stock dividends of $0.52 per share, totaling approximately $235 million, declared in the first six months of 2013.
Federal and state banking regulations place certain restrictions on dividends paid by subsidiary banks to the parent holding company. In addition, banking regulators have the authority to prohibit bank holding companies from paying dividends. Information concerning limitations on dividends from our subsidiary banks is provided in “Related
 
Stockholder Matters” included under Item 5, and in note 15 to the consolidated financial statements, included in our 2013 Form 10-K.
Economic Capital
We define economic capital as the capital required to protect holders of our senior debt, and obligations higher in priority, against unexpected economic losses over a one-year period. Economic capital usage is one of several measures used by management and our Board to assess the adequacy of our capital levels in relation to State Street's risk profile. Due to the evolving nature of quantification techniques, we expect to periodically refine the methodologies, assumptions, and information used to estimate our economic capital requirements, which could result in a different amount of capital needed to support our business activities.
We quantify economic capital requirements for the risks inherent in our business activities and group them into categories that we broadly define for these purposes as follows:
Market risk: the risk of adverse financial impact due to fluctuations in market prices, primarily as they relate to our trading activities;
Interest-rate risk: the risk of loss in non-trading asset-and-liability management positions, primarily the impact of adverse movements in interest rates on the repricing mismatches that exist between the assets and liabilities carried in our consolidated statement of condition;
Credit risk: the risk of loss that may result from the default or downgrade of a borrower or counterparty;
Operational risk: the risk of loss from inadequate or failed internal processes and systems, human error, or from external events, which is generally consistent with the Basel III definition; and
Business risk: the risk of negative earnings resulting from adverse changes in business factors, including changes in the competitive environment, changes in the operational economics of our business activities, and the effect of strategic and reputational risks.
OFF-BALANCE SHEET ARRANGEMENTS
On behalf of clients enrolled in our securities lending program, we lend securities to banks, broker/dealers and other institutions. In most circumstances, we indemnify our clients for the fair market value of those securities against a failure of the borrower to return such securities. Though these transactions are collateralized, the substantial volume of these


68

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

activities necessitates detailed credit-based underwriting and monitoring processes. The aggregate amount of indemnified securities on loan totaled $363.06 billion as of June 30, 2014, compared to $320.08 billion as of December 31, 2013. We require the borrower to provide collateral in an amount in excess of 100% of the fair market value of the securities borrowed. We hold the collateral received in connection with these securities lending services as agent, and the collateral is not recorded in our consolidated statement of condition. We revalue the securities on loan and the collateral daily to determine if additional collateral is necessary or if excess collateral is required to be returned to the borrower. We held, as agent, cash and securities totaling $377.26 billion and $331.73 billion as collateral for indemnified securities on loan as of June 30, 2014 and December 31, 2013, respectively.
The cash collateral held by us as agent is invested on behalf of our clients. In certain cases, the cash collateral is invested in third-party repurchase agreements, for which we indemnify the client against loss of the principal invested. We require the counterparty to the indemnified repurchase agreement to provide collateral in an amount in excess of 100% of the amount of the repurchase agreement. In our role as agent, the indemnified repurchase agreements and the related collateral held by us are not recorded in our consolidated statement of condition. Of the collateral of $377.26 billion as of June 30, 2014 and $331.73 billion as of December 31, 2013 referenced above, $84.78 billion as of June 30, 2014 and $85.37 billion as of December 31, 2013 was invested in indemnified repurchase agreements. We or our agents held $90.06 billion and $91.10 billion as collateral for indemnified investments in repurchase agreements as of June 30, 2014 and December 31, 2013, respectively.
Additional information about our securities finance activities and other off-balance sheet arrangements is provided in notes 7 and 12 to the consolidated financial statements included in this Form 10-Q.
RECENT ACCOUNTING DEVELOPMENTS
Information with respect to recent accounting developments is provided in note 1 to the consolidated financial statements included in this Form 10-Q.


69

Table of Contents

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information provided under “Financial Condition - Market Risk Management” in Management’s Discussion and Analysis, included in this Form 10-Q, is incorporated by reference herein.
CONTROLS AND PROCEDURES
State Street has established and maintains disclosure controls and procedures that are designed to ensure that material information related to State Street and its subsidiaries on a consolidated basis required to be disclosed in its reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to State Street's management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. For the quarter ended June 30, 2014, State Street's management carried out an evaluation, with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of State Street's disclosure controls and procedures. Based on the evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that State Street's disclosure controls and procedures were effective as of June 30, 2014.
State Street has also established and maintains internal control over financial reporting as a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of consolidated financial statements for external purposes in conformity with GAAP. In the ordinary course of business, State Street routinely enhances its internal controls and procedures for financial reporting by either upgrading its current systems or implementing new systems. Changes have been made and may be made to State Street's internal controls and procedures for financial reporting as a result of these efforts. During the quarter ended June 30, 2014, no change occurred in State Street's internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, State Street's internal control over financial reporting.



70


STATE STREET CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(UNAUDITED)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
(Dollars in millions, except per share amounts)
 
 
 
 
 
 
 
Fee revenue:
 
 
 
 
 
 
 
Servicing fees
$
1,288

 
$
1,201

 
$
2,526

 
$
2,376

Management fees
300

 
277

 
592

 
540

Trading services
260

 
304

 
513

 
593

Securities finance
147

 
131

 
232

 
209

Processing fees and other
44

 
58

 
100

 
110

Total fee revenue
2,039

 
1,971

 
3,963

 
3,828

Net interest revenue:
 
 
 
 
 
 
 
Interest revenue
650

 
700

 
1,305

 
1,387

Interest expense
89

 
104

 
189

 
215

Net interest revenue
561

 
596

 
1,116

 
1,172

Gains (losses) related to investment securities, net:
 
 
 
 
 
 
 
Net gains (losses) from sales of available-for-sale securities

 

 
15

 
5

Losses from other-than-temporary impairment

 
(6
)
 
(1
)
 
(6
)
Losses reclassified (from) to other comprehensive income
(2
)
 
(1
)
 
(10
)
 
(4
)
Gains (losses) related to investment securities, net
(2
)
 
(7
)
 
4

 
(5
)
Total revenue
2,598

 
2,560

 
5,083

 
4,995

Provision for loan losses
2

 

 
4

 

Expenses:
 
 
 
 
 
 
 
Compensation and employee benefits
978

 
917

 
2,135

 
1,952

Information systems and communications
244

 
235

 
488

 
472

Transaction processing services
193

 
186

 
384

 
366

Occupancy
115

 
114

 
229

 
230

Acquisition and restructuring costs
28

 
30

 
61

 
44

Professional services
116

 
103

 
221

 
182

Amortization of other intangible assets
54

 
54

 
108

 
107

Other
122

 
159

 
252

 
271

Total expenses
1,850

 
1,798

 
3,878

 
3,624

Income before income tax expense
746

 
762

 
1,201

 
1,371

Income tax expense
124

 
183

 
216

 
328

Net income
$
622

 
$
579

 
$
985

 
$
1,043

Net income available to common shareholders
$
602

 
$
571

 
$
958

 
$
1,026

Earnings per common share:
 
 
 
 
 
 
 
Basic
$
1.41

 
$
1.26

 
$
2.23

 
$
2.26

Diluted
1.38

 
1.24

 
2.19

 
2.22

Average common shares outstanding (in thousands):
 
 
 
 
 
 
 
Basic
427,824

 
452,176

 
429,215

 
453,240

Diluted
435,320

 
461,040

 
436,958

 
461,630

Cash dividends declared per common share
$
.30

 
$
.26

 
$
.56

 
$
.52




The accompanying condensed notes are an integral part of these consolidated financial statements.

71


STATE STREET CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(UNAUDITED)
 
Three Months Ended June 30,
(In millions)
2014
 
2013
Net income
$
622

 
$
579

Other comprehensive income (loss), net of related taxes:
 
 
 
Foreign currency translation, net of related taxes of $29 and ($29), respectively
46

 
(55
)
Net unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment and net of related taxes of $193 and ($507), respectively
306

 
(804
)
Net unrealized gains (losses) on available-for-sale securities designated in fair value hedges, net of related taxes of ($9) and $31, respectively
(13
)
 
45

Other-than-temporary impairment on held-to-maturity securities related to factors other than credit, net of related taxes of $3 and $3, respectively
4

 
5

Net unrealized gains (losses) on cash flow hedges, net of related taxes of $2 and $18, respectively
(54
)
 
30

Net unrealized gains (losses) on retirement plans, net of related taxes of ($8) and $4, respectively
12

 
5

Other comprehensive income (loss)
301

 
(774
)
Total comprehensive income (loss)
$
923

 
$
(195
)


 
Six Months Ended June 30,
(In millions)
2014
 
2013
Net income
$
985

 
$
1,043

Other comprehensive income (loss), net of related taxes:
 
 
 
Foreign currency translation, net of related taxes of $37 and ($93), respectively
73

 
(303
)
Net unrealized gains (losses) on available-for-sale securities, net of reclassification adjustment and net of related taxes of $355 and ($478), respectively
565

 
(753
)
Net unrealized gains (losses) on available-for-sale securities designated in fair value hedges, net of related taxes of ($15) and $40, respectively
(23
)
 
60

Other-than-temporary impairment on held-to-maturity securities related to factors other than credit, net of related taxes of $8 and $7, respectively
12

 
11

Net unrealized gains (losses) on cash flow hedges, net of related taxes of ($3) and $59, respectively
(61
)
 
94

Net unrealized gains (losses) on retirement plans, net of related taxes of ($5) and $6, respectively
18

 
8

Other comprehensive income (loss)
584

 
(883
)
Total comprehensive income
$
1,569

 
$
160


















The accompanying condensed notes are an integral part of these consolidated financial statements.

72


STATE STREET CORPORATION
CONSOLIDATED STATEMENT OF CONDITION
 
June 30, 2014
 
December 31, 2013
(Dollars in millions, except per share amounts)
(Unaudited)
 
 
Assets:
 
 
 
Cash and due from banks
$
6,247

 
$
3,220

Interest-bearing deposits with banks
98,386

 
64,257

Securities purchased under resale agreements
3,681

 
6,230

Trading account assets
941

 
843

Investment securities available for sale
98,546

 
99,174

Investment securities held to maturity (fair value of $18,864 and $17,560)
18,757

 
17,740

Loans and leases (less allowance for losses of $32 and $28)
16,767

 
13,458

Premises and equipment (net of accumulated depreciation of $4,620 and $4,417)
1,920

 
1,860

Accrued interest and fees receivable
2,221

 
2,123

Goodwill
6,037

 
6,036

Other intangible assets
2,247

 
2,360

Other assets
26,574

 
25,990

Total assets
$
282,324

 
$
243,291

Liabilities:
 
 
 
Deposits:
 
 
 
Noninterest-bearing
$
73,109

 
$
65,614

Interest-bearing—U.S.
27,584

 
13,392

Interest-bearing—non-U.S.
118,141

 
103,262

Total deposits
218,834

 
182,268

Securities sold under repurchase agreements
9,168

 
7,953

Federal funds purchased
14

 
19

Other short-term borrowings
4,322

 
3,780

Accrued expenses and other liabilities
19,249

 
19,194

Long-term debt
9,037

 
9,699

Total liabilities
260,624

 
222,913

Commitments, guarantees and contingencies (notes 7 and 8)

 

Shareholders’ equity:
 
 
 
Preferred stock, no par, 3,500,000 shares authorized:
 
 
 
Series C, 5,000 shares issued and outstanding
491

 
491

Series D, 7,500 shares issued and outstanding
742

 

Common stock, $1 par, 750,000,000 shares authorized:
 
 
 
503,881,095 and 503,882,841 shares issued
504

 
504

Surplus
9,765

 
9,776

Retained earnings
14,114

 
13,395

Accumulated other comprehensive income (loss)
489

 
(95
)
Treasury stock, at cost (78,910,844 and 69,754,255 shares)
(4,405
)
 
(3,693
)
Total shareholders’ equity
21,700

 
20,378

Total liabilities and shareholders’ equity
$
282,324

 
$
243,291







The accompanying condensed notes are an integral part of these consolidated financial statements.

73


STATE STREET CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
(Dollars in millions, except per share amounts, shares in thousands)
PREFERRED
STOCK
 
COMMON STOCK
 
Surplus
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
TREASURY STOCK
 
Total
Shares
 
Amount
 
Shares
 
Amount
 
Balance as of December 31, 2012
$
489

 
503,900

 
$
504

 
$
9,667

 
$
11,751

 
$
360

 
45,238

 
$
(1,902
)
 
$
20,869

Net income
 
 
 
 
 
 
 
 
1,043

 
 
 
 
 
 
 
1,043

Other comprehensive loss
 
 
 
 
 
 
 
 
 
 
(883
)
 
 
 
 
 
(883
)
Accretion of issuance costs
1

 
 
 
 
 
 
 
(1
)
 
 
 
 
 
 
 

Cash dividends declared:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Common stock - $.52 per share
 
 
 
 
 
 
 
 
(235
)
 
 
 
 
 
 
 
(235
)
Preferred stock
 
 
 
 
 
 
 
 
(13
)
 
 
 
 
 
 
 
(13
)
Common stock acquired
 
 
 
 
 
 
 
 
 
 
 
 
15,068

 
(920
)
 
(920
)
Common stock awards and options exercised, including related taxes of $32
 
 
(9
)
 
 
 
46

 
 
 
 
 
(4,807
)
 
174

 
220

Other
 
 
 
 
 
 
 
 
 
 
 
 
(3
)
 


 

Balance as of June 30, 2013
$
490

 
503,891

 
$
504

 
$
9,713

 
$
12,545

 
$
(523
)
 
55,496

 
$
(2,648
)
 
$
20,081

Balance as of December 31, 2013
$
491

 
503,883

 
$
504

 
$
9,776

 
$
13,395

 
$
(95
)
 
69,754

 
$
(3,693
)
 
$
20,378

Net income
 
 
 
 
 
 
 
 
985

 
 
 
 
 
 
 
985

Other comprehensive income
 
 
 
 
 
 
 
 
 
 
584

 
 
 
 
 
584

Preferred stock issued
742

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
742

Cash dividends declared:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock - $.56 per share
 
 
 
 
 
 
 
 
(240
)
 
 
 
 
 
 
 
(240
)
Preferred stock
 
 
 
 
 
 
 
 
(25
)
 
 
 
 
 
 
 
(25
)
Common stock acquired
 
 
 
 
 
 
 
 
 
 
 
 
12,380

 
(830
)
 
(830
)
Common stock awards and options exercised, including income tax benefit of $46
 
 
(2
)
 


 
(11
)
 
 
 
 
 
(3,221
)
 
118

 
107

Other
 
 
 
 
 
 


 
(1
)
 
 
 
(3
)
 
 
 
(1
)
Balance as of June 30, 2014
$
1,233

 
503,881

 
$
504

 
$
9,765

 
$
14,114

 
$
489

 
78,910

 
$
(4,405
)
 
$
21,700













The accompanying condensed notes are an integral part of these consolidated financial statements.

74


STATE STREET CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(UNAUDITED)
 
Six Months Ended June 30,
(In millions)
2014
 
2013
Operating Activities:
 
 
 
Net income
$
985

 
$
1,043

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
Deferred income tax expense
19

 
137

Amortization of other intangible assets
108

 
107

Other non-cash adjustments for depreciation, amortization and accretion, net
228

 
193

(Gains) losses related to investment securities, net
(4
)
 
5

Change in trading account assets, net
(98
)
 
(16
)
Change in accrued interest and fees receivable, net
(98
)
 
(85
)
Change in collateral deposits, net
(2,416
)
 
(3,596
)
Change in unrealized losses on foreign exchange derivatives, net
(121
)
 
(1,498
)
Change in other assets, net
(475
)
 
1,246

Change in accrued expenses and other liabilities, net
2,140

 
398

Other, net
178

 
305

Net cash provided by (used in) operating activities
446

 
(1,761
)
Investing Activities:
 
 
 
Net (increase) decrease in interest-bearing deposits with banks
(34,129
)
 
5,980

Net decrease (increase) in securities purchased under resale agreements
2,549

 
(553
)
Proceeds from sales of available-for-sale securities
2,842

 
4,817

Proceeds from maturities of available-for-sale securities
18,402

 
20,336

Purchases of available-for-sale securities
(19,624
)
 
(19,707
)
Proceeds from maturities of held-to-maturity securities
1,350

 
972

Purchases of held-to-maturity securities
(2,220
)
 
(5,022
)
Net increase in loans
(3,327
)
 
(4,156
)
Purchases of equity investments and other long-term assets
(133
)
 
(90
)
Purchases of premises and equipment
(234
)
 
(228
)
Other, net
46

 
66

Net cash (used in) provided by investing activities
(34,478
)
 
2,415

Financing Activities:
 
 
 
Net increase (decrease) in time deposits
9,841

 
(14,481
)
Net increase in all other deposits
26,725

 
16,820

Net increase (decrease) in short-term borrowings
1,752

 
(378
)
Proceeds from issuance of long-term debt, net of issuance costs

 
1,492

Payments for long-term debt and obligations under capital leases
(763
)
 
(13
)
Proceeds from issuance of preferred stock
742

 

Proceeds from exercises of common stock options
9

 
92

Purchases of common stock
(830
)
 
(920
)
Repurchases of common stock for employee tax withholding
(166
)
 
(135
)
Payments for cash dividends
(251
)
 
(242
)
Net cash provided by financing activities
37,059

 
2,235

Net increase
3,027

 
2,889

Cash and due from banks at beginning of period
3,220

 
2,590

Cash and due from banks at end of period
$
6,247

 
$
5,479





The accompanying condensed notes are an integral part of these consolidated financial statements.

75


STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



76


STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Note 1.    Basis of Presentation
The accounting and financial reporting policies of State Street Corporation conform to U.S. generally accepted accounting principles, referred to as GAAP. State Street Corporation, the parent company, is a financial holding company headquartered in Boston, Massachusetts. Unless otherwise indicated or unless the context requires otherwise, all references in these notes to consolidated financial statements to “State Street,” “we,” “us,” “our” or similar references mean State Street Corporation and its subsidiaries on a consolidated basis. Our principal banking subsidiary is State Street Bank and Trust Company, or State Street Bank.
We have two lines of business:
Investment Servicing provides services for mutual funds, collective investment funds and other investment pools, corporate and public retirement plans, insurance companies, foundations and endowments worldwide. Products include custody; product- and participant-level accounting; daily pricing and administration; master trust and master custody; record-keeping; cash management; foreign exchange, brokerage and other trading services; securities finance; deposit and short-term investment facilities; loans and lease financing; investment manager and alternative investment manager operations outsourcing; and performance, risk and compliance analytics to support institutional investors.
Investment Management, through State Street Global Advisors, or SSgA, provides a broad array of investment management, investment research and investment advisory services to corporations, public funds and other sophisticated investors. SSgA offers active and passive asset management strategies across equity, fixed-income and cash asset classes. Products are distributed directly and through intermediaries using a variety of investment vehicles, including exchange-traded funds, or ETFs, such as the SPDR® ETF brand.
The consolidated financial statements accompanying these condensed notes are unaudited. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair statement of the consolidated results of operations in these financial statements, have been made. Certain previously reported amounts presented in this Form 10-Q have been reclassified to conform to current-period presentation. Events occurring subsequent to the date of our consolidated statement of condition were evaluated for potential recognition or disclosure in our
 


consolidated financial statements through the date we filed this Form 10-Q with the SEC.
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions in the application of certain of our significant accounting policies that may materially affect the reported amounts of assets, liabilities, equity, revenue, and expenses. As a result of unanticipated events or circumstances, actual results could differ from those estimates. Amounts dependent on subjective or complex judgments in the application of accounting policies considered by management to be relatively more significant in this regard are those associated with our accounting for recurring fair-value measurements; other-than-temporary impairment of investment securities; and impairment of goodwill and other intangible assets. Among other effects, unanticipated events or circumstances could result in future impairment of investment securities, goodwill or other intangible assets.
Our consolidated statement of condition as of December 31, 2013 included in the accompanying consolidated financial statements was derived from the audited financial statements as of that date, but does not include all notes required by GAAP for a complete set of consolidated financial statements. The accompanying consolidated financial statements and these condensed notes should be read in conjunction with the financial and risk factors information included in our 2013 Annual Report on Form 10-K, which we previously filed with the SEC.
Recent Accounting Developments:
In June 2014, the FASB issued an amendment to GAAP for “repo-to-maturity” transactions and repurchase agreements executed as repurchase financings. The amendment requires enhanced disclosure for repurchase agreements and securities lending transactions accounted for as secured borrowings and for certain transfers of financial assets. The amendment is effective, for State Street, beginning on January 1, 2015. Our adoption of the amendment is not expected to have a material effect on our consolidated financial statements.
In May 2014, the FASB issued an amendment to GAAP that provides for a single comprehensive model to be applied in the accounting for revenue arising from contracts with clients. In applying this model, an entity would recognize revenue that represents the transfer of promised goods or services to clients in an amount that reflects the consideration


77

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

to which the entity expects to be entitled in exchange for those goods or services. The amendment supersedes most current revenue recognition guidance, including industry-specific guidance. The amendment is effective, for State Street, beginning on January 1, 2017, and must be applied retrospectively. Early adoption is prohibited. We are currently assessing the potential impact of this amendment on our consolidated financial statements.
In April 2014, the FASB issued an amendment to GAAP that revises the criteria for the treatment and disclosure of discontinued operations. The amendment allows entities to have significant continuing involvement and continuing cash flows with the discontinued operation, but requires additional disclosure for discontinued operations and disclosure for disposals deemed to be material that do not meet the definition of a discontinued operation. The presentation and disclosure requirements are effective, for State Street, beginning on January 1, 2015, and are required to be applied prospectively to discontinued operations occurring after that date.
In January 2014, the FASB issued an amendment to GAAP that allows an investor in an affordable housing project, if the project meets certain defined conditions, to amortize the cost of their investment in proportion to the tax credits and other tax benefits they receive, and reflect it as part of income tax expense rather than as revenue from operations. The amendment is effective, for State Street, for interim and annual periods beginning after December 15, 2014, with early adoption permitted, and must be applied retrospectively. At this time, we have not chosen to early-adopt the amendment as we continue to assess the potential impact of this amendment on our consolidated financial statements.
Note 2.    Fair Value
Fair-Value Measurements:
We carry trading account assets, investment securities available for sale and various types of derivative financial instruments at fair value in our consolidated statement of condition on a recurring basis. Changes in the fair values of these financial assets and liabilities are recorded either as components of our consolidated statement of income or as components of accumulated other comprehensive income, or AOCI, within shareholders' equity in our consolidated statement of condition.
We measure fair value for the above-described financial assets and liabilities in conformity with GAAP that governs the measurement of the fair value of financial instruments. Management believes that its valuation techniques and underlying assumptions
 
used to measure fair value conform to the provisions of GAAP. We categorize the financial assets and liabilities that we carry at fair value based on a prescribed three-level valuation hierarchy. The hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (level 1) and the lowest priority to valuation methods using significant unobservable inputs (level 3). If the inputs used to measure a financial asset or liability cross different levels of the hierarchy, categorization is based on the lowest-level input that is most significant to the fair-value measurement. Management's assessment of the significance of a particular input to the overall fair-value measurement of a financial asset or liability requires judgment, and considers factors specific to that asset or liability. The three levels of the valuation hierarchy are described below.
Level 1. Financial assets and liabilities with values based on unadjusted quoted prices for identical assets or liabilities in an active market. Fair value is measured using unadjusted quoted prices in active markets for identical securities. Our level-1 financial assets and liabilities primarily include positions in U.S. government securities and highly liquid U.S. and non-U.S. government fixed-income securities carried in trading account assets. We may carry U.S. government securities in our available-for-sale portfolio in connection with our asset-and-liability management activities. Our level-1 financial assets also include active exchange-traded equity securities and non-cash collateral received from counterparties in connection with our enhanced custody business.
Level 2. Financial assets and liabilities with values based on quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability. Level-2 inputs include the following:
Quoted prices for similar assets or liabilities in active markets;
Quoted prices for identical or similar assets or liabilities in non-active markets;
Pricing models whose inputs are observable for substantially the full term of the asset or liability; and
Pricing models whose inputs are derived principally from, or corroborated by, observable market information through correlation or other means for substantially the full term of the asset or liability.
Our level-2 financial assets and liabilities primarily include non-U.S. debt securities carried in trading account assets and various types of fixed-


78

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

income investment securities available for sale, as well as various types of foreign exchange and interest-rate derivative instruments.
Fair value for our investment securities available for sale categorized in level 2 is measured primarily using information obtained from independent third parties. This third-party information is subject to review by management as part of a validation process, which includes obtaining an understanding of the underlying assumptions and the level of market participant information used to support those assumptions. In addition, management compares significant assumptions used by third parties to available market information. Such information may include known trades or, to the extent that trading activity is limited, comparisons to market research information pertaining to credit expectations, execution prices and the timing of cash flows, and where information is available, back-testing.
Derivative instruments categorized in level 2 predominantly represent foreign exchange contracts used in our trading activities, for which fair value is measured using discounted cash-flow techniques, with inputs consisting of observable spot and forward points, as well as observable interest-rate curves. With respect to derivative instruments, we evaluate the impact on valuation of the credit risk of our counterparties and our own credit risk. We consider factors such as the likelihood of default by us and our counterparties, our current and potential future net exposures and remaining maturities in determining the fair value. Valuation adjustments associated with derivative instruments were not material to those instruments in the three and six months ended June 30, 2014 or 2013, respectively.
Level 3. Financial assets and liabilities with values based on prices or valuation techniques that require inputs that are both unobservable in the market and significant to the overall measurement of fair value. These inputs reflect management's judgment about the assumptions that a market participant would use in pricing the financial asset or liability, and are based on the best available information, some of which is internally developed. The following provides a more detailed discussion of our financial assets and liabilities that we may categorize in level 3 and the related valuation methodology.
The fair value of our investment securities categorized in level 3 is measured using information obtained from third-party sources, typically non-binding broker or dealer quotes, or through the use of internally-developed pricing models. Management has evaluated
 
its methodologies used to measure fair value, but has considered the level of observable market information to be insufficient to categorize the securities in level 2.
The fair value of foreign exchange contracts, primarily options, is measured using an option-pricing model. Because of a limited number of observable transactions, certain model inputs are not observable, such as implied volatility surface, but are derived from observable market information.
The fair value of certain interest-rate caps with long-dated maturities is measured using a matrix-pricing approach. Observable market prices are not available for these derivatives, so extrapolation is necessary to value these instruments, since they have a strike and/or maturity outside of the matrix.
Our level-3 financial assets and liabilities are similar in structure and profile to our level-1 and level-2 financial instruments, but they trade in less-liquid markets, and the measurement of their fair value is inherently more difficult. As of June 30, 2014, on a gross basis, we categorized in level 3 approximately 5% of our financial assets carried at fair value on a recurring basis. As of the same date and on the same basis, the percentage of our financial liabilities categorized in level 3 to our financial liabilities carried at fair value on a recurring basis was not significant. The fair value of investment securities categorized in level 3 that was measured using non-binding quotes and internally-developed pricing-model inputs composed approximately 98% and 2%, respectively, of the total fair value of our investment securities categorized in level 3 as of June 30, 2014.
The process used to measure the fair value of our level-3 financial assets and liabilities is overseen by a valuation group within Corporate Finance, separate from the business units that manage the assets and liabilities. This function, which develops and manages the valuation process, reports to State Street's Valuation Committee. The Valuation Committee, composed of senior management from separate business units, Enterprise Risk Management, a corporate risk oversight group, and Corporate Finance, oversees adherence to State Street's valuation policies.
The valuation group performs validation of the pricing information obtained from third-party sources in order to evaluate reasonableness and consistency with market experience in similar asset classes. Monthly analyses include a review of price changes relative to overall trends, credit analysis and other


79

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

relevant procedures (discussed below). In addition, prices for level-3 securities carried in our investment portfolio are tested on a sample basis based on unexpected pricing movements. These sample prices are then corroborated through price recalculations, when applicable, using available market information, which is obtained separately from the third-party pricing source. The recalculated prices are compared to market-research information pertaining to credit expectations, execution prices and the timing of cash flows, and where information is available, back-testing. If a difference is identified and it is determined that there is a significant impact requiring an adjustment, the adjustment is presented to the Valuation Committee for review and consideration.
Validation is also performed on fair-value measurements determined using internally-developed pricing models. The pricing models are subject to validation through our Model Assessment Committee, a corporate risk oversight committee that provides technical support and input to the Valuation Committee. This validation process incorporates a review of a diverse set of model and trade parameters across a broad range of values in order to evaluate the model's suitability for valuation of a particular financial instrument type, as well as the model's accuracy in reflecting the characteristics of the related financial asset or liability and its significant
 
risks. Inputs and assumptions, including any price-valuation adjustments, are developed by the business units and separately reviewed by the valuation group. Model valuations are compared to available market information including appropriate proxy instruments and other benchmarks to highlight abnormalities for further investigation.
Measuring fair value requires the exercise of management judgment. The level of subjectivity and the degree of management judgment required is more significant for financial instruments whose fair value is measured using inputs that are not observable. The areas requiring significant judgment are identified, documented and reported to the Valuation Committee as part of the valuation control framework. We believe that our valuation methods are appropriate; however, the use of different methodologies or assumptions, particularly as they apply to level-3 financial assets and liabilities, could materially affect our fair-value measurements as of the reporting date.
The following tables present information with respect to our financial assets and liabilities carried at fair value in our consolidated statement of condition on a recurring basis as of the dates indicated. No transfers of financial assets or liabilities between levels 1 and 2 occurred in the six months ended June 30, 2014 or the year ended December 31, 2013.


80

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair-Value Measurements on a Recurring Basis
 
as of June 30, 2014
(In millions)
Quoted Market
Prices in Active
Markets
(Level 1)
 
Pricing Methods
with Significant
Observable
Market Inputs
(Level 2)
 
Pricing Methods
with Significant
Unobservable
Market Inputs
(Level 3)
 
Impact of Netting(1)
 
Total Net
Carrying Value
in Consolidated
Statement of
Condition
Assets:
 
 
 
 
 
 
 
 
 
Trading account assets:
 
 
 
 
 
 
 
 
 
U.S. government securities
$
20

 
$

 
$

 
 
 
$
20

Non-U.S. government securities
423

 

 

 
 
 
423

Other
78

 
420

 

 
 
 
498

Total trading account assets
521

 
420

 

 
 
 
941

Investment securities available for sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
Direct obligations
2,781

 
654

 

 
 
 
3,435

Mortgage-backed securities

 
22,043

 
96

 
 
 
22,139

Asset-backed securities:
 
 
 
 
 
 
 
 
 
Student loans

 
13,640

 
322

 
 
 
13,962

Credit cards

 
6,566

 

 
 
 
6,566

Sub-prime

 
1,101

 

 
 
 
1,101

Other

 
574

 
4,061

 
 
 
4,635

Total asset-backed securities

 
21,881

 
4,383

 

 
26,264

Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
Mortgage-backed securities

 
11,435

 

 
 
 
11,435

Asset-backed securities

 
3,694

 
506

 
 
 
4,200

Government securities

 
3,823

 

 
 
 
3,823

Other

 
5,242

 
515

 
 
 
5,757

Total non-U.S. debt securities

 
24,194

 
1,021

 
 
 
25,215

State and political subdivisions

 
10,576

 
41

 
 
 
10,617

Collateralized mortgage obligations

 
5,178

 
196

 
 
 
5,374

Other U.S. debt securities

 
4,833

 
9

 
 
 
4,842

U.S. equity securities

 
37

 

 
 
 
37

Non-U.S. equity securities

 
1

 

 
 
 
1

U.S. money-market mutual funds

 
615

 

 
 
 
615

Non-U.S. money-market mutual funds

 
7

 

 
 
 
7

Total investment securities available for sale
2,781

 
90,019

 
5,746

 

 
98,546

Other assets:
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
Foreign exchange contracts

 
6,627

 
10

 
$
(3,762
)
 
2,875

Interest-rate contracts

 
58

 

 
(56
)
 
2

Other derivative contracts

 
4

 

 
(2
)
 
2

Total derivative instruments

 
6,689

 
10

 
(3,820
)
 
2,879

Other
106

 

 

 

 
106

Total assets carried at fair value
$
3,408

 
$
97,128

 
$
5,756

 
$
(3,820
)
 
$
102,472

Liabilities:
 
 
 
 
 
 
 
 
 
Accrued expenses and other liabilities:
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$

 
$
6,346

 
$
10

 
$
(3,117
)
 
$
3,239

Interest-rate contracts

 
270

 

 
(55
)
 
215

Other derivative contracts

 
59

 
9

 
(2
)
 
66

Total derivative instruments

 
6,675

 
19

 
(3,174
)
 
3,520

Other
106

 

 

 

 
106

Total liabilities carried at fair value
$
106

 
$
6,675

 
$
19

 
$
(3,174
)
 
$
3,626

 
 
 
 
(1) Represents counterparty netting against level-2 financial assets and liabilities, where a legally enforceable master netting agreement exists between State Street and the counterparty. Netting also reflects asset and liability reductions of $860 million and $214 million, respectively, for cash collateral received from and provided to derivative counterparties.

81

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
 
Fair-Value Measurements on a Recurring Basis
 
as of December 31, 2013
(In millions)
Quoted Market
Prices in Active
Markets
(Level 1)
 
Pricing Methods
with Significant
Observable
Market Inputs
(Level 2)
 
Pricing Methods
with Significant
Unobservable
Market Inputs
(Level 3)
 
Impact of Netting(1)
 
Total Net
Carrying Value
in Consolidated
Statement of
Condition
Assets:
 
 
 
 
 
 
 
 
 
Trading account assets:
 
 
 
 
 
 
 
 
 
U.S. government securities
$
20

 
$

 
$

 
 
 
$
20

Non-U.S. government securities
399

 

 

 
 
 
399

Other
67

 
357

 

 
 
 
424

Total trading account assets
486

 
357

 

 
 
 
843

Investment securities available for sale:
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
Direct obligations

 
709

 

 
 
 
709

Mortgage-backed securities

 
22,847

 
716

 
 
 
23,563

Asset-backed securities:
 
 
 
 
 
 
 
 
 
Student loans

 
14,119

 
423

 
 
 
14,542

Credit cards

 
8,186

 
24

 
 
 
8,210

Sub-prime

 
1,203

 

 
 
 
1,203

Other

 
532

 
4,532

 
 
 
5,064

Total asset-backed securities

 
24,040

 
4,979

 
 
 
29,019

Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
Mortgage-backed securities

 
10,654

 
375

 
 
 
11,029

Asset-backed securities

 
4,592

 
798

 
 
 
5,390

Government securities

 
3,761

 

 
 
 
3,761

Other

 
4,263

 
464

 
 
 
4,727

Total non-U.S. debt securities

 
23,270

 
1,637

 
 
 
24,907

State and political subdivisions

 
10,220

 
43

 
 
 
10,263

Collateralized mortgage obligations

 
5,107

 
162

 
 
 
5,269

Other U.S. debt securities

 
4,972

 
8

 
 
 
4,980

U.S. equity securities

 
34

 

 
 
 
34

Non-U.S. equity securities

 
1

 

 
 
 
1

U.S. money-market mutual funds

 
422

 

 
 
 
422

Non-U.S. money-market mutual funds

 
7

 

 
 
 
7

Total investment securities available for sale

 
91,629

 
7,545

 
 
 
99,174

Other assets:
 
 
 
 
 
 
 
 
 
Derivatives instruments:
 
 
 
 
 
 
 
 
 
Foreign exchange contracts

 
11,892

 
19

 
$
(6,442
)
 
5,469

Interest-rate contracts

 
65

 

 
(59
)
 
6

Other derivative contracts

 
1

 

 

 
1

Total derivative instruments

 
11,958

 
19

 
(6,501
)
 
5,476

Other
97

 

 

 

 
97

Total assets carried at fair value
$
583

 
$
103,944

 
$
7,564

 
$
(6,501
)
 
$
105,590

Liabilities:
 
 
 
 
 
 
 
 
 
Accrued expenses and other liabilities:
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$

 
$
11,454

 
$
17

 
$
(5,458
)
 
$
6,013

Interest-rate contracts

 
331

 

 
(94
)
 
237

Other derivative contracts

 

 
9

 

 
9

Total derivative instruments

 
11,785

 
26

 
(5,552
)
 
6,259

Other
97

 

 

 

 
97

Total liabilities carried at fair value
$
97

 
$
11,785

 
$
26

 
$
(5,552
)
 
$
6,356

 
 
 
 
(1) Represents counterparty netting against level-2 financial assets and liabilities, where a legally enforceable master netting agreement exists between State Street and the counterparty. Netting also reflects asset and liability reductions of $1.93 billion and $979 million, respectively, for cash collateral received from and provided to derivative counterparties.

82

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present activity related to our level-3 financial assets and liabilities during the three and six months ended June 30, 2014 and 2013, respectively. Transfers into and out of level 3 are reported as of the beginning of the period presented. In the three and six months ended June 30, 2014 and
 
2013, respectively, transfers out of level 3 were mainly related to certain mortgage- and asset-backed securities, including non-U.S. debt securities, for which fair value was measured using prices for which observable market information became available.


 
Fair Value Measurements Using Significant Unobservable Inputs
 
Three Months Ended June 30, 2014
 
Fair Value  as of
March 31,
2014
 
Total Realized and
Unrealized Gains (Losses)
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30, 2014
 
Change in
Unrealized
Gains
(Losses)
Related to
Financial
Instruments
Held as of
June 30,
2014
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies, mortgage-backed securities
$
100

 
$

 
$

 
$

 
$

 
$

 
$
(4
)
 
$

 
$

 
$
96

 
 
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Student loans
333

 
1

 
2

 

 

 

 
(14
)
 

 

 
322

 
 
Other
4,304

 
13

 
(1
)
 

 

 

 
(255
)
 

 

 
4,061

 
 
Total asset-backed securities
4,637

 
14

 
1

 

 

 

 
(269
)
 

 

 
4,383

 
 
Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities
612

 
1

 
1

 

 

 

 
(56
)
 

 
(52
)
 
506

 
 
Other
462

 

 
1

 
55

 

 

 
(3
)
 

 

 
515

 
 
Total non-U.S. debt securities
1,074

 
1

 
2

 
55

 

 

 
(59
)
 

 
(52
)
 
1,021

 
 
State and political subdivisions
42

 

 

 

 

 

 
(1
)
 

 

 
41

 
 
Collateralized mortgage obligations
202

 

 

 

 

 

 
(6
)
 

 

 
196

 
 
Other U.S. debt securities
8

 

 
1

 

 

 

 

 

 

 
9

 
 
Total investment securities available for sale
6,063

 
15

 
4

 
55

 

 

 
(339
)
 

 
(52
)
 
5,746

 
 
Other assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments, Foreign exchange contracts
6

 
(6
)
 

 
11

 

 

 
(1
)
 

 

 
10

 
$
(4
)
Total derivative instruments
6

 
(6
)
 

 
11

 

 

 
(1
)
 

 

 
10

 
(4
)
Total assets carried at fair value
$
6,069

 
$
9

 
$
4

 
$
66

 
$

 
$

 
$
(340
)
 
$

 
$
(52
)
 
$
5,756

 
$
(4
)

83

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair-Value Measurements Using Significant Unobservable Inputs
 
Three Months Ended June 30, 2014
 
Fair Value  as of
March 31,
2014
 
Total Realized and
Unrealized (Gains) Losses
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30, 2014
 
Change in
Unrealized
(Gains)
Losses Related to
Financial
Instruments
Held as of
June 30,
2014
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued expenses and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$
8

 
$
(5
)
 
$

 
$

 
$
8

 
$

 
$
(1
)
 
$

 
$

 
$
10

 
$
(3
)
Other
9

 

 

 

 

 

 

 

 

 
9

 

Total derivative instruments
17

 
(5
)
 

 

 
8

 

 
(1
)
 

 

 
19

 
(3
)
Total liabilities carried at fair value
$
17

 
$
(5
)
 
$

 
$

 
$
8

 
$

 
$
(1
)
 
$

 
$

 
$
19

 
$
(3
)



84

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair-Value Measurements Using Significant Unobservable Inputs
 
Six Months Ended June 30, 2014
 
Fair Value  as of
December 31,
2013
 
Total Realized and
Unrealized Gains (Losses)
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30,
2014
 
Change in
Unrealized
Gains
(Losses)
Related to
Financial
Instruments
Held as of
June 30,
2014
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies, mortgage-backed securities
$
716

 
$

 
$

 
$

 
$

 
$

 
$
(9
)
 
$

 
$
(611
)
 
$
96

 
 
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Student loans
423

 
1

 
3

 

 

 

 
(26
)
 

 
(79
)
 
322

 
 
Credit cards
24

 

 

 

 

 

 
(24
)
 

 

 

 
 
Other
4,532

 
29

 
(6
)
 
6

 

 

 
(500
)
 

 

 
4,061

 
 
Total asset-backed securities
4,979

 
30

 
(3
)
 
6

 

 

 
(550
)
 

 
(79
)
 
4,383

 
 
Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
375

 

 

 

 

 

 

 

 
(375
)
 

 
 
Asset-backed securities
798

 
3

 
1

 

 

 

 
(120
)
 

 
(176
)
 
506

 
 
Other
464

 

 
1

 
54

 

 
(1
)
 
(3
)
 

 

 
515

 
 
Total non-U.S. debt securities
1,637

 
3


2


54




(1
)

(123
)


 
(551
)
 
1,021

 
 
State and political subdivisions
43

 

 
(1
)
 

 

 

 
(1
)
 

 

 
41

 
 
Collateralized mortgage obligations
162

 

 

 
80

 

 
(6
)
 
(13
)
 

 
(27
)
 
196

 
 
Other U.S. debt securities
8

 

 
1

 

 

 

 

 

 

 
9

 
 
Total investment securities available for sale
7,545

 
33

 
(1
)
 
140

 

 
(7
)
 
(696
)
 

 
(1,268
)
 
5,746

 
 
Other assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments, Foreign exchange contracts
19

 
(15
)
 

 
15

 

 

 
(9
)
 

 

 
10

 
$
(7
)
Total derivative instruments
19

 
(15
)
 

 
15

 

 

 
(9
)
 

 

 
10

 
(7
)
Total assets carried at fair value
$
7,564

 
$
18

 
$
(1
)
 
$
155

 
$

 
$
(7
)
 
$
(705
)
 
$

 
$
(1,268
)
 
$
5,756

 
$
(7
)


85

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair-Value Measurements Using Significant Unobservable Inputs
 
Six months ended June 30, 2014
 
Fair Value  as of
December 31,
2013
 
Total Realized and
Unrealized (Gains) Losses
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30,
2014
 
Change in
Unrealized
(Gains)
Losses
Related to
Financial
Instruments
Held as of
June 30,
2014
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued expenses and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$
17

 
$
(14
)
 
$

 
$

 
$
14

 
$

 
$
(7
)
 
$

 
$

 
$
10

 
$
(5
)
Other
9

 

 

 

 

 

 

 

 

 
9

 

Total derivative instruments
26

 
(14
)
 

 

 
14

 

 
(7
)
 

 

 
19

 
(5
)
Total liabilities carried at fair value
$
26

 
$
(14
)
 
$

 
$

 
$
14

 
$

 
$
(7
)
 
$

 
$

 
$
19

 
$
(5
)


86

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair Value Measurements Using Significant Unobservable Inputs
 
Three Months Ended June 30, 2013
 
Fair Value as of March 31,
2013
 
Total Realized and
Unrealized Gains (Losses)
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30, 2013
 
Change in
Unrealized
Gains
(Losses)
Related to
Financial
Instruments
Held as of
June 30,
2013
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies, mortgage-backed securities
$
798

 
$

 
$

 
$
92

 
$

 
$

 
$
(26
)
 
$

 
$

 
$
864

 
 
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Student loans
461

 
1

 
2

 

 

 

 
(8
)
 

 
(76
)
 
380

 
 
Credit cards
24

 

 

 

 

 

 

 

 

 
24

 
 
Other
3,872

 
15

 
9

 
385

 

 

 
(433
)
 

 

 
3,848

 
 
Total asset-backed securities
4,357

 
16

 
11

 
385

 

 

 
(441
)
 

 
(76
)
 
4,252

 
 
Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
331

 

 
(1
)
 

 

 

 
(2
)
 

 

 
328

 
 
Asset-backed securities
470

 
1

 
(2
)
 
183

 

 

 
(35
)
 
139

 

 
756

 
 
Other
276

 

 
1

 
 
 

 

 
4

 

 

 
281

 
 
Total non-U.S. debt securities
1,077

 
1

 
(2
)
 
183

 

 

 
(33
)
 
139

 

 
1,365

 
 
State and political subdivisions
47

 

 
(1
)
 

 

 

 
(1
)
 

 

 
45

 
 
Collateralized mortgage obligations
108

 

 

 
140

 

 

 
(10
)
 

 

 
238

 
 
Other U.S. debt securities
9

 

 

 

 

 

 

 

 

 
9

 
 
Total investment securities available for sale
6,396

 
17

 
8

 
800

 

 

 
(511
)
 
139

 
(76
)
 
6,773

 
 
Other assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments, Foreign exchange contracts
172

 
31

 

 
12

 

 

 
(94
)
 

 

 
121

 
$
34

Total derivative instruments
172

 
31

 

 
12

 

 

 
(94
)
 

 

 
121

 
34

Total assets carried at fair value
$
6,568

 
$
48

 
$
8

 
$
812

 
$

 
$

 
$
(605
)
 
$
139

 
$
(76
)
 
$
6,894

 
$
34



87

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair Value Measurements Using Significant Unobservable Inputs
 
Three Months Ended June 30, 2013
 
Fair Value as of March 31,
2013
 
Total Realized and
Unrealized (Gains) Losses
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair
Value as of
June 30,
2013
 
Change in
Unrealized
(Gains)
Losses
Related to
Financial
Instruments
Held as of
June 30,
2013
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued expenses and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$
153

 
$
24

 
$

 
$

 
$
10

 
$

 
$
(79
)
 
$

 
$

 
$
108

 
$
29

Other
9

 

 

 

 

 

 

 

 

 
9

 

Total derivative instruments
162

 
24

 

 

 
10

 

 
(79
)
 

 

 
117

 
29

Total liabilities carried at fair value
$
162

 
$
24

 
$

 
$

 
$
10

 
$

 
$
(79
)
 
$

 
$

 
$
117

 
$
29






88

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair-Value Measurements Using Significant Unobservable Inputs
 
Six Months Ended June 30, 2013
 
Fair Value  as of December 31,
2012
 
Total Realized and
Unrealized Gains (Losses)
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30,
2013
 
Change in
Unrealized
Gains
(Losses)
Related to
Financial
Instruments
Held as of
June 30,
2013
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment securities available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
$
825

 
$

 
$
1

 
$
92

 
$

 
$

 
$
(54
)
 
$

 
$

 
$
864

 
 
Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Student loans
588

 
1

 
8

 

 

 
(26
)
 
(16
)
 

 
(175
)
 
380

 
 
Credit cards
67

 

 

 

 

 

 
(43
)
 

 

 
24

 
 
Other
3,994

 
28

 
30

 
565

 

 
(10
)
 
(759
)
 

 

 
3,848

 
 
Total asset-backed securities
4,649

 
29

 
38

 
565

 

 
(36
)
 
(818
)
 

 
(175
)
 
4,252

 
 
Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
555

 

 

 

 

 

 
(19
)
 

 
(208
)
 
328

 
 
Asset-backed securities
524

 
3

 
1

 
234

 

 

 
(68
)
 
139

 
(77
)
 
756

 
 
Other
140

 

 
1

 
179

 

 

 
1

 

 
(40
)
 
281

 
 
Total non-U.S. debt securities
1,219

 
3

 
2

 
413

 

 

 
(86
)
 
139

 
(325
)
 
1,365

 
 
State and political subdivisions
48

 

 
(1
)
 

 

 

 
(2
)
 

 

 
45

 
 
Collateralized mortgage obligations
117

 

 

 
140

 

 

 
(19
)
 

 

 
238

 
 
Other U.S. debt securities
9

 

 

 

 

 

 

 

 

 
9

 
 
Total investment securities available for sale
6,867

 
32

 
40

 
1,210

 

 
(36
)
 
(979
)
 
139

 
(500
)
 
6,773

 
 
Other assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
113

 
134

 

 
32

 

 

 
(158
)
 

 

 
121

 
$
56

Total derivative instruments
113

 
134

 

 
32

 

 

 
(158
)
 

 

 
121

 
56

Total assets carried at fair value
$
6,980

 
$
166

 
$
40

 
$
1,242

 
$

 
$
(36
)
 
$
(1,137
)
 
$
139

 
$
(500
)
 
$
6,894

 
$
56


89

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Fair-Value Measurements Using Significant Unobservable Inputs
 
Six Months Ended June 30, 2013
 
Fair Value  as of December 31,
2012
 
Total Realized and
Unrealized (Gains) Losses
 
Purchases
 
Issuances
 
Sales
 
Settlements
 
Transfers
into
Level 3
 
Transfers
out of
Level 3
 
Fair Value  as of
June 30,
2013
 
Change in
Unrealized
(Gains)
Losses
Related to
Financial
Instruments
Held as of
June 30,
2013
(In millions)
Recorded
in
Revenue
 
Recorded
in Other
Comprehensive
Income
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accrued expenses and other liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
$
106

 
$
74

 
$

 
$

 
$
35

 
$

 
$
(107
)
 
$

 
$

 
$
108

 
$
42

Other
9

 

 

 

 

 

 

 

 

 
9

 

Total derivative instruments
115

 
74

 

 

 
35

 

 
(107
)
 

 

 
117

 
42

Total liabilities carried at fair value
$
115

 
$
74

 
$

 
$

 
$
35

 
$

 
$
(107
)
 
$

 
$

 
$
117

 
$
42


The following table presents total realized and unrealized gains and losses for the periods indicated that were recorded in revenue for our level-3 financial assets and liabilities:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
Total Realized and
Unrealized Gains
(Losses) Recorded
in Revenue
 
Change in
Unrealized Gains
(Losses) Related to
Financial
Instruments Held at
June 30,
 
Total Realized and
Unrealized Gains
(Losses) Recorded
in Revenue
 
Change in
Unrealized Gains
(Losses) Related to
Financial
Instruments Held at
June 30,
(In millions)
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trading services
$
(1
)
 
$
7

 
$
(1
)
 
$
5

 
$
(1
)
 
$
60

 
$
(2
)
 
$
14

Total fee revenue
(1
)
 
7

 
(1
)
 
5

 
(1
)
 
60

 
(2
)
 
14

Net interest revenue
15

 
17

 

 

 
33

 
32

 

 

Total revenue
$
14

 
$
24

 
$
(1
)
 
5

 
$
32

 
$
92

 
$
(2
)
 
$
14




90

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following table presents quantitative information, as of the dates indicated, about the valuation techniques and significant unobservable inputs used in the valuation of our level-3 financial assets and liabilities measured at fair value on a recurring basis for which we use internally-developed pricing models. The significant unobservable inputs
 
for our level-3 financial assets and liabilities whose fair value is measured using pricing information from non-binding broker or dealer quotes are not included in the table, as the specific inputs applied are not provided by the broker/dealer.

 
 
Quantitative Information about Level-3 Fair-Value Measurements
 
 
Fair Value
 
 
 
 
 
Weighted-Average
(Dollars in millions)
 
As of June 30, 2014
 
As of December 31, 2013
 
Valuation Technique
 
Significant
Unobservable Input
 
As of June 30, 2014
 
As of December 31, 2013
Significant unobservable inputs readily available to State Street:
 
 
 
 
 
 
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
Asset-backed securities, student loans
 
$
14

 
$
13

 
Discounted cash flows
 
Credit spread
 
2.2
%
 
3.5
%
Asset-backed securities, credit cards
 

 
24

 
Discounted cash flows
 
Credit spread
 

 
2.0

Asset-backed securities, other
 
76

 
92

 
Discounted cash flows
 
Credit spread
 
1.0

 
1.5

State and political subdivisions
 
41

 
43

 
Discounted cash flows
 
Credit spread
 
1.6

 
1.7

Derivative instruments, foreign exchange contracts
 
10

 
19

 
Option model
 
Volatility
 
6.0

 
11.4

Total
 
$
141

 
$
191

 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative instruments, foreign exchange contracts
 
$
10

 
$
17

 
Option model
 
Volatility
 
5.8

 
11.2

Derivative instruments, other(1)
 
9

 
9

 
Discounted cash flows
 
Participant redemptions
 
4.9

 
7.5

Total
 
$
19

 
$
26

 
 
 
 
 
 
 
 
 
 
 
 
(1) Relates to stable value wrap contracts; refer to the sensitivity discussion following the tables presented below, and to note 7.
The following tables present information with respect to the composition of our level-3 financial assets and
 
liabilities, by availability of significant unobservable inputs, as of the dates indicated:

June 30, 2014
 
Significant Unobservable Inputs Readily Available to State Street(1)
 
Significant Unobservable Inputs Not Developed by State Street and Not Readily Available(2)
 
Total Assets and Liabilities with Significant Unobservable Inputs
(In millions)
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
U.S. Treasury and federal agencies, mortgage-backed securities
 
$

 
$
96

 
$
96

Asset-backed securities, student loans
 
14

 
308

 
322

Asset-backed securities, other
 
76

 
3,985

 
4,061

Non-U.S. debt securities, asset-backed securities
 

 
506

 
506

Non-U.S. debt securities, other
 

 
515

 
515

State and political subdivisions
 
41

 

 
41

Collateralized mortgage obligations
 

 
196

 
196

Other U.S. debt securities
 

 
9

 
9

Derivative instruments, foreign exchange contracts
 
10

 

 
10

Total
 
$
141

 
$
5,615

 
$
5,756

Liabilities:
 
 
 
 
 
 
Derivative instruments, foreign exchange contracts
 
$
10

 
$

 
$
10

Derivative instruments, other
 
9

 

 
9

Total
 
$
19

 
$

 
$
19

 
 
 
 
 
(1) Information with respect to these model-priced financial assets and liabilities is provided above in a separate table.
(2) Fair value for these financial assets is measured using non-binding broker or dealer quotes.

91

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

December 31, 2013
 
Significant Unobservable Inputs Readily Available to State Street(1)
 
Significant Unobservable Inputs Not Developed by State Street and Not Readily Available(2)
 
Total Assets and Liabilities with Significant Unobservable Inputs
(In millions)
 
 
 
 
 
 
Assets:
 
 
 
 
 
 
U.S. Treasury and federal agencies, mortgage-backed securities
 
$

 
$
716

 
$
716

Asset-backed securities, student loans
 
13

 
410

 
423

Asset-backed securities, credit cards
 
24

 

 
24

Asset-backed securities, other
 
92

 
4,440

 
4,532

Non-U.S. debt securities, mortgage-backed securities
 

 
375

 
375

Non-U.S. debt securities, asset-backed securities
 

 
798

 
798

Non-U.S. debt securities, other
 

 
464

 
464

State and political subdivisions
 
43

 

 
43

Collateralized mortgage obligations
 

 
162

 
162

Other U.S. debt securities
 

 
8

 
8

Derivative instruments, foreign exchange contracts
 
19

 

 
19

Total
 
$
191

 
$
7,373

 
$
7,564

Liabilities:
 
 
 
 
 
 
Derivative instruments, foreign exchange contracts
 
$
17

 
$

 
$
17

Derivative instruments, other
 
9

 

 
9

Total
 
$
26

 
$

 
$
26

 
 
 
 
 
(1) Information with respect to these model-priced financial assets and liabilities is provided above in a separate table.
(2) Fair value for these financial assets is measured using non-binding broker or dealer quotes.

We use internally-developed pricing models to measure the fair value of our level-3 financial assets and liabilities, which models incorporate discounted cash flow and option modeling techniques. Use of these techniques requires the determination of relevant inputs and assumptions, some of which represent significant unobservable inputs as indicated in the preceding table. Accordingly, changes in these unobservable inputs may have a significant impact on fair value.
Certain of these unobservable inputs will, in isolation, have a directionally consistent impact on the fair value of the instrument for a given change in that input. Alternatively, the fair value of the instrument may move in an opposite direction for a given change in another input. Where multiple inputs are used within the valuation technique of an asset or liability, a change in one input in a certain direction may be offset by an opposite change in another input, resulting in a potentially muted impact on the overall fair value of that particular instrument. Additionally, a change in one unobservable input may result in a change to another unobservable input (that is, changes in certain inputs are interrelated to one another), which may counteract or magnify the fair-value impact.
For recurring level-3 fair-value measurements for which significant unobservable inputs were readily available to State Street as of June 30, 2014, the
 
sensitivity of the fair-value measurement to changes in significant unobservable inputs, and a description of any interrelationships between those unobservable inputs, is described below; however, we rarely experience a situation in which those unobservable inputs change in isolation:
The significant unobservable input used in the measurement of the fair value of our asset-backed securities and municipal securities (state and political subdivisions) is the credit spread. Significant increases (decreases) in the credit spread would result in measurements of significantly lower (higher) fair value of these securities.
The significant unobservable input used in the measurement of the fair value of our foreign exchange option contracts is the implied volatility surface. A significant increase (decrease) in the implied volatility surface would result in measurements of significantly higher (lower) fair value of these contracts.


92

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The significant unobservable input used in the measurement of the fair value of our other derivative instruments, specifically stable value wrap contracts, is participant redemptions. Increased volatility of participant redemptions may result in changes to our measurement of fair value. Generally, significant increases (decreases) in participant redemptions may result in measurements of significantly higher (lower) fair value of this liability.
Fair Values of Financial Instruments:
Estimates of fair value for financial instruments not carried at fair value on a recurring basis in our consolidated statement of condition, as defined by GAAP, are generally subjective in nature, and are determined as of a specific point in time based on the characteristics of the financial instruments and relevant market information. Disclosure of fair-value estimates is not required by GAAP for certain items, such as lease financing, equity-method investments, obligations for pension and other post-retirement plans, premises and equipment, other intangible assets and income-tax assets and liabilities. Accordingly, aggregate fair-value estimates presented do not purport to represent, and should not be considered representative of, our underlying “market” or franchise value. In addition, because of potential differences in methodologies and assumptions used to estimate fair values, our estimates of fair value should not be compared to those of other financial institutions.
We use the following methods to estimate the fair values of our financial instruments:
For financial instruments that have quoted market prices, those quoted prices are used to estimate fair value.
For financial instruments that have no defined maturity, have a remaining maturity of 180 days or less, or reprice frequently to a market rate, we assume that the fair value of these instruments approximates their reported
 
value, after taking into consideration any applicable credit risk.
For financial instruments for which no quoted market prices are available, fair value is estimated using information obtained from independent third parties, or by discounting the expected cash flows using an estimated current market interest rate for the financial instrument.
The generally short duration of certain of our assets and liabilities results in a significant number of financial instruments for which fair value equals or closely approximates the amount recorded in our consolidated statement of condition. These financial instruments are reported in the following captions in our consolidated statement of condition: cash and due from banks; interest-bearing deposits with banks; securities purchased under resale agreements; accrued interest and fees receivable; deposits; securities sold under repurchase agreements; federal funds purchased; and other short-term borrowings.
In addition, due to the relatively short duration of certain of our net loans (excluding leases), we consider fair value for these loans to approximate their reported value. The fair value of other types of loans, such as senior secured bank loans, commercial real estate loans and purchased receivables, is estimated using information obtained from independent third parties or by discounting expected future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings for the same remaining maturities. Commitments to lend have no reported value because their terms are at prevailing market rates.
The following tables present the reported amounts and estimated fair values of the financial instruments defined by GAAP, excluding financial assets and liabilities carried at fair value on a recurring basis, as they would be categorized within the fair-value hierarchy, as of the dates indicated.


93

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
 
 
 
 
 
Fair-Value Hierarchy
June 30, 2014
 
Reported Amount 
 
Estimated Fair Value
 
Quoted Market Prices in Active Markets (Level 1)
 
Pricing Methods with Significant Observable Market Inputs (Level 2) 
 
Pricing Methods with Significant Unobservable Market Inputs (Level 3)
(In millions)
 
 
 
 
 
 
 
 
 
 
Financial Assets:
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
6,247

 
$
6,247

 
$
6,247

 
$

 
$

Interest-bearing deposits with banks
 
98,386

 
98,386

 

 
98,386

 

Securities purchased under resale agreements
 
3,681

 
3,681

 

 
3,681

 

Investment securities held to maturity
 
18,757

 
18,864

 

 
18,864

 

Net loans (excluding leases)
 
15,695

 
15,709

 

 
15,223

 
486

Financial Liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
     Noninterest-bearing
 
$
73,109

 
$
73,109

 
$

 
$
73,109

 
$

     Interest-bearing - U.S.
 
27,584

 
27,584

 

 
27,584

 

     Interest-bearing - non-U.S.
 
118,141

 
118,141

 

 
118,141

 

Securities sold under repurchase agreements
 
9,168

 
9,168

 

 
9,168

 

Federal funds purchased
 
14

 
14

 

 
14

 

Other short-term borrowings
 
4,322

 
4,322

 

 
4,322

 

Long-term debt
 
9,037

 
9,412

 

 
8,525

 
887

 
 
 
 
 
 
Fair-Value Hierarchy
December 31, 2013
 
Reported Amount 
 
Estimated Fair Value
 
Quoted Market Prices in Active Markets (Level 1)
 
Pricing Methods with Significant Observable Market Inputs (Level 2) 
 
Pricing Methods with Significant Unobservable Market Inputs (Level 3)
(In millions)
 
 
 
 
 
 
 
 
 
 
Financial Assets:
 
 
 
 
 
 
 
 
 
 
Cash and due from banks
 
$
3,220

 
$
3,220

 
$
3,220

 
$

 
$

Interest-bearing deposits with banks
 
64,257

 
64,257

 

 
64,257

 

Securities purchased under resale agreements
 
6,230

 
6,230

 

 
6,230

 

Investment securities held to maturity
 
17,740

 
17,560

 

 
17,560

 

Net loans (excluding leases)
 
12,363

 
12,355

 

 
11,908

 
447

Financial Liabilities:
 
 
 
 
 
 
 
 
 
 
Deposits:
 
 
 
 
 
 
 
 
 
 
     Noninterest-bearing
 
$
65,614

 
$
65,614

 
$

 
$
65,614

 
$

     Interest-bearing - U.S.
 
13,392

 
13,392

 

 
13,392

 

     Interest-bearing - non-U.S.
 
103,262

 
103,262

 

 
103,262

 

Securities sold under repurchase agreements
 
7,953

 
7,953

 

 
7,953

 

Federal funds purchased
 
19

 
19

 

 
19

 

Other short-term borrowings
 
3,780

 
3,780

 

 
3,780

 

Long-term debt
 
9,699

 
9,909

 

 
9,056

 
853



94

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 3.    Investment Securities

The following table presents the amortized cost and fair value, and associated unrealized gains and losses, of investment securities as of the dates indicated:
 
June 30, 2014
 
December 31, 2013
 
Amortized
Cost
 
Gross
Unrealized
 
Fair
Value
 
Amortized
Cost
 
Gross
Unrealized
 
Fair
Value
(In millions)
Gains
 
Losses
 
Gains
 
Losses
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Direct obligations
$
3,403

 
$
33

 
$
1

 
$
3,435

 
$
702

 
$
9

 
$
2

 
$
709

Mortgage-backed securities
22,067

 
235

 
163

 
22,139

 
23,744

 
211

 
392

 
23,563

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Student loans(1)
13,985

 
135

 
158

 
13,962

 
14,718

 
92

 
268

 
14,542

Credit cards
6,580

 
20

 
34

 
6,566

 
8,230

 
21

 
41

 
8,210

Sub-prime
1,172

 
3

 
74

 
1,101

 
1,291

 
3

 
91

 
1,203

Other
4,523

 
126

 
14

 
4,635

 
4,949

 
138

 
23

 
5,064

Total asset-backed securities
26,260

 
284

 
280

 
26,264

 
29,188

 
254

 
423

 
29,019

Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
11,231

 
207

 
3

 
11,435

 
10,808

 
230

 
9

 
11,029

Asset-backed securities
4,181

 
20

 
1

 
4,200

 
5,369

 
23

 
2

 
5,390

Government securities
3,819

 
4

 

 
3,823

 
3,759

 
2

 

 
3,761

Other
5,699

 
66

 
8

 
5,757

 
4,679

 
59

 
11

 
4,727

Total non-U.S. debt securities
24,930

 
297

 
12

 
25,215

 
24,615

 
314

 
22

 
24,907

State and political subdivisions
10,400

 
289

 
72

 
10,617

 
10,301

 
160

 
198

 
10,263

Collateralized mortgage obligations
5,321

 
83

 
30

 
5,374

 
5,275

 
70

 
76

 
5,269

Other U.S. debt securities
4,706

 
145

 
9

 
4,842

 
4,876

 
138

 
34

 
4,980

U.S. equity securities
29

 
8

 

 
37

 
28

 
6

 

 
34

Non-U.S. equity securities
1

 

 

 
1

 
1

 

 

 
1

U.S. money-market mutual funds
615

 

 

 
615

 
422

 

 

 
422

Non-U.S. money-market mutual funds
7

 

 

 
7

 
7

 

 

 
7

Total
$
97,739

 
$
1,374

 
$
567

 
$
98,546

 
$
99,159

 
$
1,162

 
$
1,147

 
$
99,174

Held to maturity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Direct obligations
$
5,119

 
$

 
$
237

 
$
4,882

 
$
5,041

 
$

 
$
448

 
$
4,593

Mortgage-backed securities
74

 
5

 

 
79

 
91

 
6

 

 
97

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Student loans(1)
1,900

 
6

 
1

 
1,905

 
1,627

 

 
10

 
1,617

Credit cards
897

 
3

 

 
900

 
762

 
1

 

 
763

Other
692

 
3

 
1

 
694

 
782

 
1

 
2

 
781

Total asset-backed securities
3,489

 
12

 
2

 
3,499

 
3,171

 
2

 
12

 
3,161

Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
4,274

 
200

 
21

 
4,453

 
4,211

 
150

 
48

 
4,313

Asset-backed securities
2,898

 
18

 

 
2,916

 
2,202

 
19

 

 
2,221

Government securities
2

 

 

 
2

 
2

 

 

 
2

Other
245

 

 
1

 
244

 
192

 

 

 
192

Total non-U.S. debt securities
7,419

 
218

 
22

 
7,615

 
6,607

 
169

 
48

 
6,728

State and political subdivisions
15

 

 

 
15

 
24

 
1

 

 
25

Collateralized mortgage obligations
2,641

 
151

 
18

 
2,774

 
2,806

 
176

 
26

 
2,956

Total
$
18,757

 
$
386

 
$
279

 
$
18,864

 
$
17,740

 
$
354

 
$
534

 
$
17,560

 
 
 
 
(1) Substantially composed of securities guaranteed by the federal government with respect to at least 97% of defaulted principal and
accrued interest on the underlying loans.

95

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Aggregate investment securities with carrying values of $45.99 billion and $46.99 billion as of June 30, 2014 and December 31, 2013, respectively, were designated as pledged for public and trust
 
deposits, short-term borrowings and for other purposes as provided by law.


The following tables present the aggregate fair values of investment securities that have been in a continuous unrealized loss position for less than 12 months, and those that have been in a continuous unrealized loss position for 12 months or longer, as of the dates indicated:
 
Less than 12 months
 
12 months or longer
 
Total
June 30, 2014
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
Direct obligations
$

 
$

 
$
127

 
$
1

 
$
127

 
$
1

Mortgage-backed securities
2,484

 
11

 
7,865

 
152

 
10,349

 
163

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Student loans
440

 
4

 
6,901

 
154

 
7,341

 
158

Credit cards
1,268

 
2

 
1,664

 
32

 
2,932

 
34

Sub-prime

 

 
1,046

 
74

 
1,046

 
74

Other
1,533

 
7

 
360

 
7

 
1,893

 
14

Total asset-backed securities
3,241

 
13

 
9,971

 
267

 
13,212

 
280

Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
580

 
1

 
215

 
2

 
795

 
3

Asset-backed securities
501

 
1

 

 

 
501

 
1

Other
1,992

 
3

 
295

 
5

 
2,287

 
8

Total non-U.S. debt securities
3,073

 
5

 
510

 
7

 
3,583

 
12

State and political subdivisions
308

 
3

 
2,263

 
69

 
2,571

 
72

Collateralized mortgage obligations
309

 
2

 
863

 
28

 
1,172

 
30

Other U.S. debt securities

 

 
405

 
9

 
405

 
9

Total
$
9,415

 
$
34

 
$
22,004

 
$
533

 
$
31,419

 
$
567

Held to maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
Direct obligations
$

 
$

 
$
4,765

 
$
237

 
$
4,765

 
$
237

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Student loans

 

 
160

 
1

 
160

 
1

Other
83

 
1

 

 

 
83

 
1

Total asset-backed securities
83

 
1

 
160

 
1

 
243

 
2

Non-U.S. mortgage-backed securities
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
460

 
1

 
732

 
20

 
1,192

 
21

Other
54

 
1

 

 

 
54

 
1

Total non-U.S. debt securities
514

 
2

 
732

 
20

 
1,246

 
22

Collateralized mortgage obligations
343

 
5

 
631

 
13

 
974

 
18

Total
$
940

 
$
8

 
$
6,288

 
$
271

 
$
7,228

 
$
279



96

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Less than 12 months
 
12 months or longer
 
Total
December 31, 2013
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
 
Fair
Value
 
Gross
Unrealized
Losses
(In millions)
 
 
 
 
 
Available for sale:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
Direct obligations
$
182

 
$
1

 
$
113

 
$
1

 
$
295

 
$
2

Mortgage-backed securities
10,562

 
316

 
2,389

 
76

 
12,951

 
392

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Student loans
1,930

 
16

 
7,252

 
252

 
9,182

 
268

Credit cards
3,714

 
30

 
161

 
11

 
3,875

 
41

Sub-prime

 

 
1,150

 
91

 
1,150

 
91

Other
1,896

 
12

 
439

 
11

 
2,335

 
23

Total asset-backed securities
7,540

 
58

 
9,002

 
365

 
16,542

 
423

Non-U.S. debt securities:
 
 
 
 
 
 
 
 
 
 
 
Mortgage-backed securities
868

 
2

 
258

 
7

 
1,126

 
9

Asset-backed securities
551

 
1

 
16

 
1

 
567

 
2

Other
1,655

 
9

 
150

 
2

 
1,805

 
11

Total non-U.S. debt securities
3,074

 
12

 
424

 
10

 
3,498

 
22

State and political subdivisions
3,242

 
113

 
1,268

 
85

 
4,510

 
198

Collateralized mortgage obligations
1,581

 
55

 
510

 
21

 
2,091

 
76

Other U.S. debt securities
1,039

 
25

 
58

 
9

 
1,097

 
34

Total
$
27,220

 
$
580

 
$
13,764

 
$
567

 
$
40,984

 
$
1,147

Held to maturity:
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
 
 
 
 
Direct obligations
$
4,571

 
$
448

 
$

 
$

 
$
4,571

 
$
448

Asset-backed securities:
 
 
 
 
 
 
 
 
 
 
 
Student Loans
1,352

 
10

 

 

 
1,352

 
10

Other
297

 
1

 
29

 
1

 
326

 
2

Total asset-backed securities
1,649

 
11

 
29

 
1

 
1,678

 
12

Non-U.S. mortgage-backed securities
834

 
3

 
878

 
45

 
1,712

 
48

Collateralized mortgage obligations
759

 
18

 
161

 
8

 
920

 
26

Total
$
7,813

 
$
480

 
$
1,068

 
$
54

 
$
8,881

 
$
534


97

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)



The following table presents contractual maturities of debt investment securities as of June 30, 2014:
(In millions)
Under 1
Year
 
1 to 5
Years
 
6 to 10
Years
 
Over 10
Years
Available for sale:
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
Direct obligations
$
2

 
$
783

 
$
2,079

 
$
571

Mortgage-backed securities
197

 
2,295

 
5,141

 
14,506

Asset-backed securities:
 
 
 
 
 
 
 
Student loans
378

 
6,718

 
4,219

 
2,647

Credit cards
1,650

 
3,261

 
1,655

 

Sub-prime
7

 
19

 
1

 
1,074

Other
506

 
1,224

 
1,187

 
1,718

Total asset-backed securities
2,541

 
11,222

 
7,062

 
5,439

Non-U.S. debt securities:
 
 
 
 
 
 
 
Mortgage-backed securities
2,055

 
5,053

 
403

 
3,924

Asset-backed securities
333

 
3,176

 
564

 
127

Government securities
2,233

 
1,590

 

 

Other
2,038

 
2,655

 
1,064

 

Total non-U.S. debt securities
6,659

 
12,474

 
2,031

 
4,051

State and political subdivisions
670

 
3,032

 
4,321

 
2,594

Collateralized mortgage obligations
397

 
1,403

 
1,113

 
2,461

Other U.S. debt securities
637

 
3,485

 
685

 
35

Total
$
11,103

 
$
34,694

 
$
22,432

 
$
29,657

Held to maturity:
 
 
 
 
 
 
 
U.S. Treasury and federal agencies:
 
 
 
 
 
 
 
Direct obligations
$

 
$

 
$
5,000

 
$
119

Mortgage-backed securities

 
18

 
13

 
43

Asset-backed securities
 
 
 
 
 
 
 
Student loans
9

 
182

 
385

 
1,324

Credit cards

 
335

 
562

 

Other
24

 
441

 
222

 
5

Total asset-backed securities
33

 
958

 
1,169

 
1,329

Non-U.S. debt securities:
 
 
 
 
 
 
 
Mortgage-backed securities
87

 
1,320

 
181

 
2,686

Asset-backed securities
7

 
2,513

 
378

 

Government securities
2

 

 

 

Other
165

 
80

 

 

Total non-U.S. debt securities
261

 
3,913

 
559

 
2,686

State and political subdivisions
12

 
3

 

 

Collateralized mortgage obligations
487

 
697

 
510

 
947

Total
$
793

 
$
5,589

 
$
7,251

 
$
5,124

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

98

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present gross realized gains and gross realized losses from sales of available-for-sale securities and the components of net impairment losses, included in net gains and losses related to investment securities, for the periods indicated:
 
Three Months Ended June 30,
(In millions)
2014
 
2013
Gross realized gains from sales of available-for-sale securities
$
1

 
$
30

Gross realized losses from sales of available-for-sale securities
(1
)
 
(30
)
Net impairment losses:
 
 
 
Gross losses from other-than-temporary impairment

 
(6
)
Losses reclassified (from) to other comprehensive income
(2
)
 
(1
)
Net impairment losses(1)
(2
)
 
(7
)
Gains related to investment securities, net
$
(2
)
 
$
(7
)
(1) Net impairment losses, recognized in our consolidated statement of income, were composed of the following:
 
 
 
Impairment associated with expected credit losses
$
(1
)
 
$

Impairment associated with management's intent to sell impaired securities prior to recovery in value

 
(6
)
Impairment associated with adverse changes in timing of expected future cash flows
(1
)
 
(1
)
Net impairment losses
$
(2
)
 
$
(7
)

 
 
Six Months Ended June 30,
(In millions)
2014
 
2013
Gross realized gains from sales of available-for-sale securities
$
16

 
$
87

Gross realized losses from sales of available-for-sale securities
(1
)
 
(82
)
Net impairment losses:
 
 
 
Gross losses from other-than-temporary impairment
(1
)
 
(6
)
Losses reclassified (from) to other comprehensive income
(10
)
 
(4
)
Net impairment losses(1)
(11
)
 
(10
)
Gains related to investment securities, net
$
4

 
$
(5
)
(1) Net impairment losses, recognized in our consolidated statement of income, were composed of the following:
 
 
 
Impairment associated with expected credit losses
$
(10
)
 
$

Impairment associated with management's intent to sell impaired securities prior to recovery in value

 
(6
)
Impairment associated with adverse changes in timing of expected future cash flows
(1
)
 
(4
)
Net impairment losses
$
(11
)
 
$
(10
)
The following table presents activity with respect to net impairment losses for the periods indicated:
 
Six Months Ended June 30,
(In millions)
2014
 
2013
Beginning balance
$
122

 
$
124

Plus losses for which other-than-temporary impairment was not previously recognized

 
6

Plus losses for which other-than-temporary impairment was previously recognized
11

 
4

Less previously recognized losses related to securities sold or matured
(2
)
 
(9
)
Less losses related to securities intended or required to be sold
(6
)
 

Ending balance
$
125

 
$
125



99

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Impairment:
We conduct periodic reviews of individual securities to assess whether other-than-temporary impairment exists. Impairment exists when the current fair value of an individual security is below its amortized cost basis. When the decline in the security's fair value is deemed to be other than temporary, the loss is recorded in our consolidated statement of income. In addition, for debt securities available for sale and held to maturity, impairment is recorded in our consolidated statement of income when management intends to sell (or may be required to sell) the securities before they recover in value, or when management expects the present value of cash flows expected to be collected from the securities to be less than the amortized cost of the impaired security (a credit loss).
 Our review of impaired securities generally includes:
the identification and evaluation of securities that have indications of potential other-than-temporary impairment, such as issuer-specific concerns, including deteriorating financial condition or bankruptcy;
the analysis of expected future cash flows of securities, based on quantitative and qualitative factors;
the analysis of the collectability of those future cash flows, including information about past events, current conditions and reasonable and supportable forecasts;
the analysis of the underlying collateral for mortgage- and asset-backed securities;
the analysis of individual impaired securities, including consideration of the length of time the security has been in an unrealized loss position, the anticipated recovery period, and the magnitude of the overall price decline;
discussion and evaluation of factors or triggers that could cause individual securities to be deemed other-than- temporarily impaired and those that would not support other-than-temporary impairment; and
documentation of the results of these analyses.
 
Factors considered in determining whether impairment is other than temporary include:
certain macroeconomic drivers;
certain industry-specific drivers;
the length of time the security has been impaired;
the severity of the impairment;
the cause of the impairment and the financial condition and near-term prospects of the issuer;
activity in the market with respect to the issuer's securities, which may indicate adverse credit conditions; and
our intention not to sell, and the likelihood that we will not be required to sell, the security for a period of time sufficient to allow for its recovery in value.
Substantially all of our investment securities portfolio is composed of debt securities. A critical component of our assessment of other-than-temporary impairment of these debt securities is the identification of credit-impaired securities for which management does not expect to receive cash flows sufficient to recover the entire amortized cost basis of the security.
Debt securities that are not deemed to be credit-impaired are subject to additional management analysis to assess whether management intends to sell, or, more likely than not, would be required to sell, the security before the expected recovery to its amortized cost basis.
The following provides a description of our process for the identification and assessment of other-than-temporary impairment, as well as information about other-than-temporary impairment recorded in the three and six months ended June 30, 2014 and 2013 and changes in period-end unrealized losses, for major security types.
U.S. Agency Securities
Our portfolio of U.S. agency direct obligations and mortgage-backed securities receives the implicit or explicit backing of the U.S. government in conjunction with specified financial support of the U.S. Treasury. We recorded no other-than-temporary impairment on these securities in the three and six months ended June 30, 2014 or 2013. The decline in the unrealized losses on these securities as of June 30, 2014 compared to December 31, 2013 was primarily attributable to narrowing spreads in the six months ended June 30, 2014.


100

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Asset-Backed Securities - Student Loans
Asset-backed securities collateralized by student loans are primarily composed of securities collateralized by Federal Family Education Loan Program, or FFELP, loans. FFELP loans benefit from a federal government guarantee of at least 97% of defaulted principal and accrued interest, with additional credit support provided in the form of over-collateralization, subordination and excess spread, which collectively total in excess of 100%. Accordingly, the vast majority of FFELP loan-backed securities are protected from traditional consumer credit risk.
We recorded no other-than-temporary impairment on these securities in the three and six months ended June 30, 2014 or 2013. The gross unrealized losses in our FFELP loan-backed securities portfolio as of June 30, 2014 were primarily attributable to the lower spreads on these securities relative to those associated with more current issuances. The decline in the unrealized losses on these securities as of June 30, 2014 compared to December 31, 2013 was primarily attributable to narrowing spreads in the six months ended June 30, 2014.
Our assessment of other-than-temporary impairment of these securities considers, among many other factors, the strength of the U.S. government guarantee, the performance of the underlying collateral, and the remaining average term of the FFELP loan-backed securities portfolio, which was approximately 4.7 years as of June 30, 2014.
Our total exposure to private student loan-backed securities was less than $800 million as of June 30, 2014. Our assessment of other-than-temporary impairment of private student loan-backed securities considers, among other factors, the impact of high unemployment rates on the collateral performance of private student loans. We recorded no other-than-temporary impairment on these securities in the three and six months ended June 30, 2014 or 2013.
Non-U.S. Mortgage- and Asset-Backed Securities
Non-U.S. mortgage- and asset-backed securities are primarily composed of U.K., Australian and Dutch securities collateralized by residential mortgages and German securities collateralized by automobile loans and leases. Our assessment of impairment with respect to these securities considers the location of the underlying collateral, collateral enhancement and structural features, expected credit losses under base-case and stressed conditions and the macroeconomic outlook for the country in which
 
the collateral is located, including housing prices and unemployment. Where appropriate, any potential loss after consideration of the above-referenced factors is further evaluated to determine whether any other-than-temporary impairment exists.
In the three and six months ended June 30, 2014, we recorded other-than-temporary impairment of $1 million on non-U.S. residential mortgage-backed securities in our consolidated statement of income, all associated with adverse changes in the timing of expected future cash flows from the securities. In the three and six months ended June 30, 2013, we recorded other-than-temporary impairment of $6 million on these securities in our consolidated statement of income, all associated with management's intent to sell the impaired security prior to its recovery in value. In addition, in the three and six months ended June 30, 2013, we recorded other-than-temporary impairment of $1 million and $4 million, respectively, on these securities in our consolidated statement of income, all associated with adverse changes in the timing of expected future cash flows from the securities.
Our aggregate exposure to Spain, Italy, Ireland and Portugal with respect to mortgage- and asset-backed securities totaled approximately $926 million as of June 30, 2014, composed of $197 million in Spain, $530 million in Italy, $119 million in Ireland and $80 million in Portugal. We had no direct sovereign debt exposure to any of these countries as of that date. As of June 30, 2014, these mortgage- and asset-backed securities had an aggregate pre-tax net unrealized gain of approximately $120 million, composed of gross unrealized gains of $122 million and gross unrealized losses of $2 million. We recorded the above-mentioned other-than-temporary impairment of $6 million on one of these securities in the three and six months ended June 30, 2013.
Our assessment of other-than-temporary impairment of these securities takes into account government intervention in the corresponding mortgage markets and assumes a conservative baseline macroeconomic environment for this region, factoring in slower economic growth and continued government austerity measures. Our baseline view assumes a recessionary period characterized by high unemployment and by additional housing price declines of between 2% and 15% across these four countries. Our evaluation of other-than-temporary impairment in our base case does not assume a disorderly sovereign-debt restructuring or a break-up of the Eurozone. In addition, we perform stress testing and sensitivity analysis in order to understand the impact of more severe assumptions on potential other-than-temporary impairment.


101

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

State and Political Subdivisions and Other U.S. Debt Securities
Our municipal securities portfolio primarily includes securities issued by U.S. states and their municipalities. A portion of this portfolio is held in connection with our tax-exempt investment program, more fully described in note 9. Our portfolio of other U.S. debt securities is primarily composed of securities issued by U.S. corporations. 
Our assessment of other-than-temporary impairment of these portfolios considers, among other factors, adverse conditions specifically related to the industry, geographic area or financial condition of the issuer; the structure of the security, including collateral, if any, and payment schedule; rating agency changes to the security's credit rating; the volatility of the fair value changes; and our intent and ability to hold the security until its recovery in value.  If the impairment of the security is credit-related, we estimate the future cash flows from the security, tailored to the security and considering the above-described factors, and any resulting impairment deemed to be other than temporary is recorded in our consolidated statement of income.  
We recorded no other-than-temporary impairment on these securities in the three and six months ended June 30, 2014 or 2013. The decline in the unrealized losses on these securities as of June 30, 2014 compared to December 31, 2013 was primarily attributable to the narrowing of spreads and U.S. Treasury rates in the six months ended June 30, 2014.
U.S. Non-Agency Residential Mortgage-Backed Securities
We assess other-than-temporary impairment of our portfolio of U.S. non-agency residential mortgage-backed securities using cash-flow models, tailored for each security, that estimate the future cash flows from the underlying mortgages, using the security-specific collateral and transaction structure. Estimates of future cash flows are subject to management judgment. The future cash flows and performance of our portfolio of U.S. non-agency residential mortgage-backed securities are a function of a number of factors, including, but not limited to, the condition of the U.S. economy, the condition of the U.S. residential mortgage markets, and the level of loan defaults, prepayments and loss severities. Management's estimates of future losses for each security also consider the underwriting and historical performance of each specific security, the underlying collateral type, vintage, borrower profile, third-party guarantees, current levels of subordination, geography and other factors.
 
We recorded no other-than-temporary impairment on these securities in the three and six months ended June 30, 2014 or 2013.
U.S. Non-Agency Commercial Mortgage-Backed Securities
With respect to our portfolio of U.S. non-agency commercial mortgage-backed securities, other-than-temporary impairment is assessed by considering a number of factors, including, but not limited to, the condition of the U.S. economy and the condition of the U.S. commercial real estate market, as well as capitalization rates. Management estimates of future losses for each security also consider the underlying collateral type, property location, vintage, debt-service coverage ratios, expected property income, servicer advances and estimated property values, as well as current levels of subordination. In the three and six months ended June 30, 2014, we recorded other-than-temporary impairment of $1 million and $10 million, respectively, on these securities in our consolidated statement of income, all associated with expected credit losses. We recorded no other-than-temporary impairment on these securities in the three and six months ended June 30, 2013.
*****
The estimates, assumptions and other risk factors utilized in our assessment of impairment as described above are used by management to identify securities which are subject to further analysis of potential credit losses. Additional analyses are performed using more stressful assumptions to further evaluate the sensitivity of losses relative to the above-described factors. However, since the assumptions are based on the unique characteristics of each security, management uses a range of estimates for prepayment speeds, default, and loss severity forecasts that reflect the collateral profile of the securities within each asset class. In addition, in measuring expected credit losses, the individual characteristics of each security are examined to determine whether any additional factors would increase or mitigate the expected loss. Once losses are determined, the timing of the loss will also affect the ultimate other-than-temporary impairment, since the loss is ultimately subject to a discount commensurate with the purchase yield of the security.
In the aggregate, we recorded other-than-temporary impairment of $2 million and $11 million in the three and six months ended June 30, 2014, respectively, compared to $7 million and $10 million in the three and six months ended June 30, 2013, respectively, as summarized below:



102

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Three and six months ended June 30, 2014:
$1 million in both periods (non-U.S. mortgage-backed securities) resulted from adverse changes in the timing of expected future cash flows from certain of the securities; and
$1 million and $10 million (U.S. non-agency commercial mortgage-backed securities), respectively, were both associated with expected credit losses.
Three and six months ended June 30, 2013:
$6 million in both periods was associated with management's intent to sell the impaired security prior to its recovery in value; and
$1 million and $4 million (non-U.S. mortgage-backed securities), respectively, resulted from adverse changes in the timing of expected future cash flows from certain of the securities.
After a review of the investment portfolio, taking into consideration current economic conditions, adverse situations that might affect our ability to fully collect principal and interest, the timing of future payments, the credit quality and performance of the collateral underlying mortgage- and asset-backed securities and other relevant factors, and excluding other-than-temporary impairment recorded in the six months ended June 30, 2014, management considers the aggregate decline in fair value of the investment securities portfolio and the resulting gross pre-tax unrealized losses of $846 million as of June 30, 2014, related to 1,645 securities, to be temporary, and not the result of any material changes in the credit characteristics of the securities.
 
Note 4.    Loans and Leases
The following table presents our recorded investment in loans and leases, by segment and class, as of the dates indicated:
(In millions)
June 30, 2014
 
December 31, 2013
Institutional:
 
 
 
Investment funds:
 
 
 
U.S.
$
10,131

 
$
8,695

Non-U.S.
2,705

 
1,718

Commercial and financial:
 
 
 
U.S.
2,109

 
1,372

Non-U.S.
318

 
154

Purchased receivables:
 
 
 
U.S.
187

 
217

Non-U.S.
14

 
26

Lease financing:
 
 
 
U.S.
338

 
339

Non-U.S.
734

 
756

Total institutional
16,536

 
13,277

Commercial real estate:
 
 
 
U.S.
263

 
209

Total loans and leases
16,799

 
13,486

Allowance for loan losses
(32
)
 
(28
)
Loans and leases, net of allowance for loan losses
$
16,767

 
$
13,458

Aggregate short-duration advances to our clients included in the institutional segment were $5.41 billion and $2.45 billion as of June 30, 2014 and December 31, 2013, respectively.
The commercial and financial class in the institutional segment presented in the table above included approximately $1.32 billion and $724 million of senior secured bank loans as of June 30, 2014 and December 31, 2013, respectively. These commercial and financial loans are included in the “speculative” category in the credit-quality-indicator tables presented below. As of June 30, 2014, our allowance for loan losses included approximately $20 million related to these loans.
The commercial real estate, or CRE, segment is composed of the loans acquired in 2008 pursuant to indemnified repurchase agreements with an affiliate of Lehman as a result of the Lehman Brothers bankruptcy. These loans, which are primarily collateralized by direct and indirect interests in commercial real estate, were recorded at their then-current fair value, based on management’s expectations with respect to future cash flows from the loans using appropriate market discount rates as of the date of acquisition. These cash flow estimates are updated quarterly to reflect changes in management’s expectations, which consider market conditions and other factors.


103

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present our recorded investment in each class of loans and leases by credit quality indicator as of the dates indicated:
 
Institutional
 
Commercial Real Estate
 
 
June 30, 2014
Investment
Funds
 
Commercial and Financial
 
Purchased
Receivables
 
Lease
Financing
 
Property Development
 
Other
 
Total
Loans and
Leases
(In millions)
 
 
 
 
Investment grade(1)
$
12,236

 
$
892

 
$
201

 
$
1,032

 
$

 
$
29

 
$
14,390

Speculative(2)
600

 
1,535

 

 
40

 
234

 

 
2,409

Total
$
12,836

 
$
2,427

 
$
201

 
$
1,072

 
$
234

 
$
29

 
$
16,799

 
Institutional
 
Commercial Real Estate
 
 
December 31, 2013
Investment
Funds
 
Commercial and Financial
 
Purchased
Receivables
 
Lease
Financing
 
Property Development
 
Other
 
Total
Loans and
Leases
(In millions)
 
 
 
 
 
Investment grade(1)
$
10,282

 
$
740

 
$
243

 
$
1,068

 
$

 
$
29

 
$
12,362

Speculative(2)
131

 
770

 

 
27

 
180

 

 
1,108

Special mention(3)

 
16

 

 

 

 

 
16

Total
$
10,413

 
$
1,526

 
$
243

 
$
1,095

 
$
180

 
$
29

 
$
13,486

 
 
 
 
(1) Investment-grade loans and leases consist of counterparties with strong credit quality and low expected credit risk and probability of default. Ratings apply to counterparties with a strong capacity to support the timely repayment of any financial commitment.
(2) Speculative loans and leases consist of counterparties that face ongoing uncertainties or exposure to business, financial, or economic downturns. However, these counterparties may have financial flexibility or access to financial alternatives, which allow for financial commitments to be met.
(3) Special mention loans and leases consist of counterparties with potential weaknesses that, if uncorrected, may result in deterioration of repayment prospects.
Loans and leases are categorized in the rating categories presented in the preceding table that align with our internal risk-rating framework. Management considers the ratings to be current as of June 30, 2014. We use an internal risk-rating system to assess our risk of credit loss for each loan or lease. This risk-rating process incorporates the use of risk-rating tools in conjunction with management judgment. Qualitative and quantitative inputs are captured in a systematic manner, and following a formal review and approval process, an internal credit rating based on our credit scale is assigned.

 
In assessing the risk rating assigned to each individual loan or lease, among the factors considered are the borrower's debt capacity, collateral coverage, payment history and delinquency experience, financial flexibility and earnings strength, the expected amounts and sources of repayment, the level and nature of contingencies, if any, and the industry and geography in which the borrower operates. These factors are based on an evaluation of historical and current information, and involve subjective assessment and interpretation. Credit counterparties are evaluated and risk-rated on an individual basis at least annually.

The following table presents our recorded investment in loans and leases, disaggregated based on our impairment methodology, as of the dates indicated:
 
June 30, 2014
 
December 31, 2013
(In millions)
Institutional
 
Commercial Real Estate
 
Total Loans and Leases
 
Institutional
 
Commercial Real Estate
 
Total Loans and Leases
Loans and leases:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$

 
$
130

 
$
130

 
$
26

 
$
180

 
$
206

Collectively evaluated for impairment(1)
16,536

 
133

 
16,669

 
13,251

 
29

 
13,280

Total
$
16,536

 
$
263

 
$
16,799

 
$
13,277

 
$
209

 
$
13,486

 
 
 
 
(1) As of June 30, 2014 and December 31, 2013, all of the allowance for loan losses of $32 million and $28 million, respectively, related to institutional loans collectively evaluated for impairment.

104

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present information related to our recorded investment in impaired loans and leases as of the dates, or for the periods, indicated:
 
June 30, 2014
 
December 31, 2013
(In millions)
Recorded Investment
 
Unpaid
Principal
Balance
 
Related Allowance(1)
 
Recorded Investment
 
Unpaid
Principal
Balance
 
Related Allowance(1)
With no related allowance recorded:
 
 
 
 
 
 
 
 
 
 
 
CRE—property development
$
130

 
$
143

 
$

 
$
130

 
$
143

 
$

CRE—property development—acquired credit-impaired

 
34

 

 

 
34

 

CRE—other—acquired credit-impaired

 
22

 

 

 
21

 

Total CRE
$
130

 
$
199

 
$

 
$
130

 
$
198

 
$

 
 
 
 
(1) As of June 30, 2014 and December 31, 2013, all of the allowance for loan losses of $32 million and $28 million, respectively, related to loans that were not impaired.
 
Three Months Ended June 30,
 
Average Recorded Investment
 
Interest Revenue Recognized
 
2014
 
2013
 
2014
 
2013
(In millions)
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
CRE—property development
$
130

 
$
148

 
$
3

 
$
10

Total CRE
$
130

 
$
148

 
$
3

 
$
10

 
Six Months Ended June 30,
 
Average Recorded Investment
 
Interest Revenue Recognized
 
2014
 
2013
 
2014
 
2013
(In millions)
 
 
 
 
 
 
 
With no related allowance recorded:
 
 
 
 
 
 
 
CRE—property development
$
130

 
$
166

 
$
5

 
$
14

Total CRE
$
130

 
$
166

 
$
5

 
$
14

 
As of both June 30, 2014 and December 31, 2013, we held an aggregate of approximately $130 million of CRE loans, presented in the preceding impaired loans and leases table, which were modified in troubled debt restructurings.
No impairment loss was recognized as a result of restructuring the loans, as the discounted cash flows of the modified loans exceeded the carrying amount of the original loans as of the modification date. In the six months ended June 30, 2014 and the year ended December 31, 2013, no loans were modified in troubled debt restructurings.


105

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present activity in the allowance for loan losses for the periods indicated:
 
Three Months Ended June 30,
 
2014
 
2013
(In millions)
Institutional
 
Commercial
Real Estate
 
Total Loans and Leases
 
Institutional
 
Commercial
Real Estate
 
Total Loans and Leases
Allowance for loan losses(1):
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
30

 
$

 
$
30

 
$
22

 
$

 
$
22

Charge-offs

 

 

 

 

 

Provisions
2

 

 
2

 

 

 

Recoveries

 

 

 

 

 

Ending balance
$
32

 
$

 
$
32

 
$
22

 
$

 
$
22


 
Six Months Ended June 30,
 
2014
 
2013
(In millions)
Institutional
 
Commercial
Real Estate
 
Total Loans and Leases
 
Institutional
 
Commercial
Real Estate
 
Total Loans and Leases
Allowance for loan losses(1):
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
28

 
$

 
$
28

 
$
22

 
$

 
$
22

Charge-offs

 

 

 

 

 

Provisions
4

 

 
4

 

 

 

Recoveries

 

 

 

 

 

Ending balance
$
32

 
$

 
$
32

 
$
22

 
$

 
$
22

 
 
 
 
(1) As of June 30, 2014, approximately $20 million of our allowance for loan losses was related to senior secured bank loans included in the institutional segment; the remaining $12 million was related to other commercial-and-financial loans in the institutional segment.
The provision of $2 million recorded in the three months ended June 30, 2014 was composed of a provision of $12 million associated with an increase in our estimates of credit losses on our portfolio of senior secured bank loans, as the portfolio continues to grow and become more seasoned, net of a negative provision of $10 million associated with the pay-down of an unrelated commercial and financial loan with speculative-rated credit quality. The provision of $4 million recorded in the six months ended June 30, 2014 included an additional provision of $2 million, recorded in the three months ended March 31, 2014, associated with senior secured bank
 
loans.
These loans are held in connection with our participation in loan syndications in the non-investment-grade lending market.
Loans and leases are reviewed on a regular basis, and any provisions for loan losses that are recorded reflect management's estimate of the amount necessary to maintain the allowance for loan losses at a level considered appropriate to absorb estimated incurred losses in the loan-and-lease portfolio.

Note 5.    Goodwill and Other Intangible Assets
The following table presents changes in the carrying amount of goodwill during the periods indicated:
 
Six Months Ended June 30,
 
2014
 
2013
(In millions)
Investment
Servicing
 
Investment
Management
 
Total
 
Investment
Servicing
 
Investment
Management
 
Total
Goodwill:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
5,999

 
$
37

 
$
6,036

 
$
5,941

 
$
36

 
$
5,977

Foreign currency translation and other, net
1

 

 
1

 
(52
)
 
(1
)
 
(53
)
Ending balance
$
6,000

 
$
37

 
$
6,037

 
$
5,889

 
$
35

 
$
5,924


106

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following table presents changes in the net carrying amount of other intangible assets during the periods indicated:
 
Six Months Ended June 30,
 
2014
 
2013
(In millions)
Investment
Servicing
 
Investment
Management
 
Total
 
Investment
Servicing
 
Investment
Management
 
Total
Other intangible assets:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
2,321

 
$
39

 
$
2,360

 
$
2,492

 
$
47

 
$
2,539

Amortization
(104
)
 
(4
)
 
(108
)
 
(102
)
 
(5
)
 
(107
)
Foreign currency translation and other, net
(5
)
 

 
(5
)
 
(24
)
 
(2
)
 
(26
)
Ending balance
$
2,212

 
$
35

 
$
2,247

 
$
2,366

 
$
40

 
$
2,406

The following table presents the gross carrying amount, accumulated amortization and net carrying amount of other intangible assets by type as of the dates indicated:
 
June 30, 2014
 
December 31, 2013
(In millions)
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Amount
Client relationships
$
2,700

 
$
(1,053
)
 
$
1,647

 
$
2,706

 
$
(975
)
 
$
1,731

Core deposits
715

 
(208
)
 
507

 
717

 
(191
)
 
526

Other
230

 
(137
)
 
93

 
234

 
(131
)
 
103

Total
$
3,645

 
$
(1,398
)
 
$
2,247

 
$
3,657

 
$
(1,297
)
 
$
2,360

Note 6.    Other Assets
The following table presents the components of other assets as of the dates indicated:
(In millions)
June 30, 2014
 
December 31, 2013
Collateral deposits, net
$
16,541

 
$
13,706

Unrealized gains on derivative financial instruments, net
2,879

 
5,476

Bank-owned life insurance
2,374

 
2,343

Investments in joint ventures and other unconsolidated entities
1,769

 
1,644

Accounts receivable
808

 
950

Receivable for securities settlement
507

 
195

Income taxes receivable
368

 
337

Prepaid expenses
315

 
286

Deferred tax assets, net of valuation allowance
244

 
263

Deposits with clearing organizations
185

 
177

Other(1)
584

 
613

Total
$
26,574

 
$
25,990

 
 
(1) 
Included other real estate owned of approximately $61 million and $59 million as of June 30, 2014 and December 31, 2013, respectively.
 
Note 7.    Commitments and Guarantees
Commitments:
We had unfunded off-balance sheet commitments to extend credit totaling $23.15 billion and $21.30 billion as of June 30, 2014 and December 31, 2013, respectively. The potential losses associated with these commitments equal the gross contractual amounts, and do not consider the value of any collateral. As of June 30, 2014, approximately 78% of our unfunded commitments to extend credit expire within one year. Since many of these commitments are expected to expire or renew without being drawn upon, the gross contractual amounts do not necessarily represent our future cash requirements.
Guarantees:
Off-balance sheet guarantees are composed of indemnified securities financing, stable value protection, unfunded commitments to purchase assets, and standby letters of credit. The potential losses associated with these guarantees equal the gross contractual amounts, and do not consider the value of any collateral. The following table presents the aggregate gross contractual amounts of our off-balance sheet guarantees as of the dates indicated. Amounts presented do not reflect participations to independent third parties. 


107

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

(In millions)
June 30, 2014
 
December 31, 2013
Indemnified securities financing
$
363,060

 
$
320,078

Stable value protection
24,310

 
24,906

Asset purchase agreements
4,234

 
4,685

Standby letters of credit
4,556

 
4,612

Indemnified Securities Financing
On behalf of our clients, we lend their securities, as agent, to brokers and other institutions. In most circumstances, we indemnify our clients for the fair market value of those securities against a failure of the borrower to return such securities. We require the borrowers to maintain collateral in an amount in excess of 100% of the fair market value of the securities borrowed. Securities on loan and the collateral are revalued daily to determine if additional collateral is necessary or if excess collateral is required to be returned to the borrower. Collateral received in connection with our securities lending services is held by us as agent and is not recorded in our consolidated statement of condition.
The cash collateral held by us as agent is invested on behalf of our clients. In certain cases, the cash collateral is invested in third-party repurchase agreements, for which we indemnify the client against loss of the principal invested. We require the counterparty to the indemnified repurchase agreement to provide collateral in an amount in excess of 100% of the amount of the repurchase agreement. In our role as agent, the indemnified repurchase agreements and the related collateral held by us are not recorded in our consolidated statement of condition.
The following table summarizes the fair values of indemnified securities financing and related collateral, as well as collateral invested in indemnified repurchase agreements, as of the dates indicated:
(In millions)
June 30, 2014
 
December 31, 2013
Aggregate fair value of indemnified securities financing
$
363,060

 
$
320,078

Aggregate fair value of cash and securities held by us, as agent, as collateral for indemnified securities financing
377,258

 
331,732

Aggregate fair value of collateral for indemnified securities financing invested in indemnified repurchase agreements
84,776

 
85,374

Aggregate fair value of cash and securities held by us or our agents as collateral for investments in indemnified repurchase agreements
90,063

 
91,097

 
In certain cases, we participate in securities finance transactions as a principal. As a principal, we borrow securities from the lending client and then lend such securities to the subsequent borrower, either a State Street client or a broker/dealer. Collateral provided and received in connection with such transactions is recorded in other assets and accrued expenses and other liabilities, respectively, in our consolidated statement of condition. As of June 30, 2014 and December 31, 2013, we had approximately $15.40 billion and $11.29 billion, respectively, of collateral provided and approximately $7.40 billion and $6.62 billion, respectively, of collateral received from clients in connection with our participation in principal securities finance transactions.
Stable Value Protection
In the normal course of our business, we offer products that provide book-value protection, primarily to plan participants in stable value funds managed by non-affiliated investment managers of post-retirement defined contribution benefit plans, particularly 401(k) plans. The book-value protection is provided on portfolios of intermediate investment grade fixed-income securities, and is intended to provide safety and stable growth of principal invested. The protection is intended to cover any shortfall in the event that a significant number of plan participants withdraw funds when book value exceeds market value and the liquidation of the assets is not sufficient to redeem the participants. The investment parameters of the underlying portfolios, combined with structural protections, are designed to provide cushion and guard against payments even under extreme stress scenarios.
These contingencies are individually accounted for as derivative financial instruments. The notional amounts of the stable value contracts are presented as “derivatives not designated as hedging instruments” in the table of aggregate notional amounts of derivative financial instruments provided in note 12. We have not made a payment under these contingencies that we consider material to our consolidated financial condition, and management believes that the probability of payment under these contingencies in the future, that we would consider material to our consolidated financial condition, is remote.
Note 8.    Contingencies
Legal and Regulatory Matters:
In the ordinary course of business, we and our subsidiaries are involved in disputes, litigation, and governmental or regulatory inquiries and


108

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

investigations, both pending and threatened. These matters, if resolved adversely against us or settled, may result in monetary damages, fines and penalties or require changes in our business practices. The resolution or settlement of these matters is inherently difficult to predict. Based on our assessment of these pending matters, we do not believe that the amount of any judgment, settlement or other action arising from any pending matter is likely to have a material adverse effect on our consolidated financial condition.  However, an adverse outcome in certain of the matters described below could have a material adverse effect on our consolidated results of operations for the period in which such matter is resolved, or an accrual is determined to be required on our consolidated financial condition, or on our reputation.
We evaluate our needs for accruals of loss contingencies related to legal proceedings on a case-by-case basis. When we have a liability that we deem probable and that we deem can be reasonably estimated as of the date of our consolidated financial statements, we accrue for our estimate of the loss. We also consider a loss probable and establish an accrual when we make or intend to make an offer of settlement. Once established, an accrual is subject to subsequent adjustment as a result of additional information. The resolution of proceedings and the reasonably estimable loss (or range thereof) are inherently difficult to predict, especially in the early stages of proceedings. Even if a loss is probable, due to many complex factors, such as speed of discovery and the timing of court decisions or rulings, a loss or range of loss might not be reasonably estimated until the later stages of the proceeding.
As of June 30, 2014, our aggregate accruals for legal loss contingencies and regulatory matters, net of anticipated insurance recoveries, totaled approximately $51 million. To the extent that we have established accruals in our consolidated statement of condition for probable loss contingencies, such accruals 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 financial statements. Except where otherwise noted below, we have not established accruals with respect to the claims discussed and do not believe that potential exposure is probable and can be reasonably estimated.
The following discussion provides information with respect to significant legal and regulatory matters.

 
Securities Finance
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. In taking these actions, we believe that we acted in the best interests of all participants in the collateral pools. The two participants have asserted damages of $120 million, an amount that plaintiffs attribute to alleged deficiencies in the methodology that State Street used to construct the in-kind distribution and alleged errors in the pricing of the securities that plaintiffs received on or about August 2009. While management does not believe that such difference is an appropriate measure of damages, we have been informed that the participants liquidated these securities in June 2013, and we estimate the loss on those sales to be approximately $11 million. As of June 30, 2014, we had $10 million accrued in connection with this matter.
Foreign Exchange
We offer our custody clients and their investment managers the option to route foreign exchange transactions to our foreign exchange desk through our asset servicing operation. We record as revenue an amount approximately equal to the difference between the rates we set for those trades and indicative interbank market rates at the time of settlement of the trade. As discussed more fully below, claims have been asserted on behalf of certain current and former custody clients, and future claims may be asserted, alleging that our indirect foreign exchange rates (including the differences between those rates and indicative interbank market rates at the time we executed the trades) were not adequately disclosed or were otherwise improper, and seeking to recover, among other things, the full amount of the revenue we obtained from our indirect foreign exchange trading with them.
In October 2009, the Attorney General of the State of California 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


109

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

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 approximately $100 million for periods from 2001 to 2009 and seeks additional penalties, including treble damages. This action is in the discovery phase.
We provide custody and principal foreign exchange services to government pension plans in other jurisdictions. Since the commencement of the litigation in California, attorneys general and other government authorities from a number of jurisdictions, as well as U.S. Attorney's offices, the U.S. Department of Labor and the SEC, have requested information or issued subpoenas in connection with inquiries into the pricing of our foreign exchange services. We continue to respond to such inquiries and subpoenas.
We offer indirect foreign exchange services such as those we offer to the California state pension plans to a broad range of custody clients in the U.S. and internationally. We have responded and are responding to information requests from a number of clients concerning our indirect foreign exchange rates. In February 2011, a putative class action was filed in federal court in Boston seeking unspecified damages, including treble damages, on behalf of all custodial clients that executed certain foreign exchange transactions with State Street from 1998 to 2009. 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 under Massachusetts law and a breach of the duty of loyalty.
Two other putative class actions are currently pending in federal court in Boston alleging various violations of ERISA on behalf of all ERISA plans custodied with us that executed indirect foreign exchange transactions with State Street from 1998 onward. The complaints allege that State Street caused class members to pay unfair and unreasonable rates for indirect foreign exchange transactions with State Street. The complaints seek unspecified damages, disgorgement of profits, and other equitable relief.
We have not established an accrual with respect to any of the pending legal proceedings related to our indirect foreign exchange services. We cannot provide any assurance as to the outcome of the pending proceedings, or whether other proceedings might be commenced against us by clients or government authorities. We expect that plaintiffs will
 
seek to recover their share of all or a portion of the revenue that we have recorded from providing indirect foreign exchange services.
The following table summarizes our estimated total revenue worldwide from indirect foreign exchange trading services for the periods indicated:
(In millions)
 
Revenue from indirect foreign exchange trading
2008
 
$
462

2009
 
369

2010
 
336

2011
 
331

2012
 
248

2013
 
285

Six Months Ended June 30, 2014
 
128

We believe that the amount of our revenue from such services has been of a similar or lesser order of magnitude for many years prior to 2008. Our revenue calculations related to indirect foreign exchange trading services reflect a judgment concerning the relationship between the rates we charge for indirect foreign exchange execution and indicative interbank market rates near in time to execution. Our revenue from foreign exchange trading generally depends on the difference between the rates we set for indirect trades and indicative interbank market rates on the date trades settle.
We cannot predict the outcome of any pending matters or whether a court, in the event of an adverse resolution, would consider our revenue to be the appropriate measure of damages.
Shareholder Litigation
Three shareholder-related complaints are currently pending in federal court in Boston. One complaint purports to be a class action on behalf of State Street shareholders. The two other complaints purport to be class actions 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 allege various violations of the federal securities laws, common law and ERISA in connection with our public disclosures concerning our investment securities portfolio, our asset-backed commercial paper conduit program, and our foreign exchange trading business. In July 2014, we filed motions to approve a $60 million class settlement in the shareholder litigation and a $10 million class settlement in the two Salary Savings Program actions. A fourth complaint, a purported shareholder derivative action on behalf of


110

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

State Street, was dismissed in September 2013. We have entered into an agreement to settle that matter for nominal consideration. As of June 30, 2014, we had an accrual which, together with anticipated insurance recovery, will be sufficient to fund each of these proposed settlements.
Transition Management
In January 2014, we entered into a settlement with the U.K. Financial Conduct Authority pursuant to which we paid a fine of £22.9 million (approximately $37.8 million), as a result of our having charged six clients of our U.K. transition management business during 2010 and 2011 amounts in excess of the contractual terms. The SEC and the U.S. Attorney are conducting separate investigations into this matter. As of June 30, 2014, we had remaining accruals of approximately $3 million for indemnification costs associated with this matter.
Investment Servicing
State Street has been named as a defendant in related complaints by investment management clients of TAG Virgin Islands, Inc., or TAG, who hold or held custodial accounts with State Street. The complaints collectively have alleged various claims in connection with certain assets managed by TAG. In 2013, we entered into settlements with certain of the TAG account holders. As of June 30, 2014, two actions were pending (one of which was subsequently settled and voluntarily dismissed with prejudice as a result) and the dismissal of a third action was subject to a certiorari petition deadline, which has since expired. As of June 30, 2014, we had $4.6 million accrued with respect to these matters.
Income Taxes:
In determining our provision for income taxes, we make certain judgments and interpretations with respect to tax laws in jurisdictions in which we have business operations. Because of the complex nature of these laws, in the normal course of our business, we are subject to challenges from U.S. and non-U.S. income tax authorities regarding the amount of income taxes due. These challenges may result in adjustments to the timing or amount of taxable income or deductions or the allocation of taxable income among tax jurisdictions. We recognize a tax benefit when it is more likely than not that our position will result in a tax deduction or credit. Unrecognized tax benefits totaled approximately $156 million and $164 million as of June 30, 2014 and December 31, 2013, respectively.
The Internal Revenue Service, or IRS, is currently reviewing our U.S. income tax returns for the tax years 2010 and 2011. Management believes
 
that we have sufficiently accrued liabilities as of June 30, 2014 for tax exposures, including, but not limited to, exposures related to the review by the IRS of the tax years 2010 and 2011.
Note 9.    Variable Interest Entities
Asset-Backed Investment Securities:
We invest in various forms of asset-backed securities, which we carry in our investment securities portfolio. These asset-backed securities meet the GAAP definition of asset securitization entities, which are considered to be variable interest entities, or VIEs, as defined by GAAP. We are not considered to be the primary beneficiary of these VIEs, as defined by GAAP, since we do not have control over their activities. Additional information about our asset-backed securities is provided in note 3.
Tax-Exempt Investment Program:
In the normal course of our business, we structure and sell certificated interests in pools of tax-exempt investment-grade assets, principally to our mutual fund clients. We structure these pools as partnership trusts, and the assets and liabilities of the trusts are recorded in our consolidated statement of condition as investment securities available for sale and other short-term borrowings. We may also provide liquidity and re-marketing services to the trusts. As of June 30, 2014 and December 31, 2013, we carried investment securities available for sale, composed of securities related to state and political subdivisions, with a fair value of $2.32 billion and $2.33 billion, respectively, and other short-term borrowings of $1.92 billion and $1.95 billion, respectively, in our consolidated statement of condition in connection with these trusts.
We transfer assets to the trusts from our investment securities portfolio at adjusted book value, and the trusts finance the acquisition of these assets by selling certificated interests issued by the trusts to third-party investors and to State Street as residual holder. These transfers do not meet the de-recognition criteria defined by GAAP, and therefore, are recorded in our consolidated financial statements. The trusts had a weighted-average life of approximately 6.3 years as of June 30, 2014, compared to approximately 6.5 years as of December 31, 2013.
Under separate legal agreements, we provide standby bond-purchase agreements to these trusts and, with respect to certain securities, letters of credit. Our commitments to the trusts under these standby bond-purchase agreements and letters of credit totaled $1.94 billion and $684 million, respectively, as of June 30, 2014, none of which was utilized as of


111

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

that date. In the event that our obligations under these agreements are triggered, no material impact to our consolidated results of operations or financial condition is expected to occur, because the securities are already recorded at fair value in our consolidated statement of condition.
Interests in Sponsored Investment Funds:
In the normal course of business, we manage various types of sponsored investment funds through SSgA. The services we provide to these sponsored investment funds generate management fee revenue. From time to time, we may invest cash in the funds, which we refer to as seed capital, in order for the funds to establish a performance history for newly-launched strategies. These funds may be considered VIEs.
As of June 30, 2014, we were an investor in a sponsored investment fund, considered to be a VIE, which was initially launched on December 31, 2013. Given the extent of our exposure to the variability of the net assets of the fund, we were deemed to be the fund’s primary beneficiary, and as a result we include the fund in our consolidated financial statements. The fund's activities consist primarily of active trading in various equity, fixed-income, currency, commodity and futures markets. Such activities are included in our consolidated financial statements.
As of June 30, 2014, the aggregate assets and liabilities of this consolidated sponsored investment fund totaled $52 million and $2 million, respectively. As of December 31, 2013, the fund’s assets consisted solely of $50 million in cash.
As of June 30, 2014 our potential maximum total exposure associated with the consolidated sponsored investment fund totaled $50 million and represented the value of our economic ownership interest in the fund. In the aggregate, we expect any financial losses that we realize over time from these seed investments to be limited to the actual fair value of the amount invested in the consolidated fund, which is based on the fair value of the underlying investment securities held by the funds. However, in the event of a fund wind-down, gross gains and losses of the fund may be recognized for financial accounting purposes in different periods during the time the fund is consolidated but not wholly owned. Although we expect the actual economic loss to be limited to the amount invested, our losses in any period could exceed the value of our economic interests in the fund and could exceed the value of our initial seed capital investment.
Our conclusion to consolidate a sponsored investment fund may vary from period to period, most commonly as a result of fluctuation in our ownership
 
interest as a result of changes in the number of fund shares held by either us or by third parties. Given that the funds follow specialized investment company accounting rules which prescribe fair value, a de-consolidation generally would not result in gains or losses for us.
The net assets of any consolidated fund are solely available to settle the liabilities of the fund and to settle any investors’ ownership redemption requests, including any seed capital invested in the fund by State Street. We are not contractually required to provide financial or any other support to any of our sponsored investment funds. In addition, neither creditors nor equity investors in the sponsored investment funds have any recourse to State Street’s general credit.
As of June 30, 2014 and December 31, 2013, we managed certain sponsored investment funds, considered VIEs, in which we held a variable interest but for which we were not deemed to be the primary beneficiary. Our potential maximum loss exposure related to these unconsolidated funds totaled $24 million and $18 million as of June 30, 2014 and December 31, 2013, respectively, and represented the carrying value of our seed capital investment, which is recorded in either investment securities available for sale or other assets in our consolidated statement of condition. The amount of loss we may recognize during any period is limited to the carrying amount of our seed capital investment in the unconsolidated fund.
Note 10.    Shareholders’ Equity
Preferred Stock:
In the three months ended March 31, 2014, we issued 30 million depositary shares, each representing a 1/4,000th ownership interest in a share of State Street’s fixed-to-floating-rate non-cumulative perpetual preferred stock, Series D, without par value, with a liquidation preference of $100,000 per share (equivalent to $25 per depositary share), in a public offering. The aggregate proceeds from the offering, net of underwriting discounts, commissions and other issuance costs, were approximately $742 million.
On March 15, 2024, or any dividend payment date thereafter, the Series D preferred stock and corresponding depositary shares may be redeemed by us, in whole or in part, at a redemption price equal to $100,000 per share (equivalent to $25 per depositary share) plus any declared and unpaid dividends, without accumulation of any undeclared dividends. The Series D preferred stock and corresponding depositary shares may be redeemed


112

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

at our option in whole, but not in part, prior to March 15, 2024, upon the occurrence of a regulatory capital treatment event, as defined in the certificate of designation with respect to the Series D preferred stock, at a redemption price equal to $100,000 per share (equivalent to $25 per depositary share) plus any declared and unpaid dividends, without accumulation of any undeclared dividends.
In the three months ended June 30, 2014, we declared a dividend on our non-cumulative perpetual preferred stock, Series D (represented by depositary shares, each representing a 1/4,000th ownership interest in a share of State Street’s fixed-to-floating-rate non-cumulative perpetual preferred stock, Series D, without par value), of $1,655 per share, or approximately $0.41 per depositary share, totaling approximately $12 million. We did not declare a dividend on our non-cumulative perpetual preferred stock, Series D, in the three months ended March 31, 2014.
In the three months ended June 30, 2014, we declared a dividend on our non-cumulative perpetual preferred stock, Series C (represented by depositary shares, each representing a 1/4,000th ownership interest in a share of State Street's non-cumulative perpetual preferred stock, Series C), of $1,313 per share, or approximately $0.33 per depositary share, totaling approximately $7 million. In the six months ended June 30, 2014, we declared aggregate dividends on our non-cumulative perpetual preferred stock, Series C, of $2,626 per share, or approximately $0.66 per depositary share, totaling approximately $13 million. In the three months ended June 30, 2013, we declared a dividend on our non-cumulative perpetual preferred stock, Series C (represented by depositary shares, each representing a 1/4,000th ownership interest in a share of State Street's non-cumulative perpetual preferred stock, Series C), of $1,313 per share, or approximately $0.33 per depositary share, totaling approximately $6 million. In the six months ended June 30, 2013, we declared aggregate dividends on our non-cumulative perpetual preferred stock, Series C, of $2,626 per share, or approximately $0.66 per depositary share, totaling approximately $13 million.
Dividends on shares of both our Series C and Series D preferred stock are not mandatory and are not cumulative. If declared, dividends will be payable on the liquidation preference of $100,000 per share quarterly in arrears on March 15, June 15, September 15 or December 15 of each year at an annual rate of 5.25% and 5.90%, respectively. If we issue additional shares of our Series C or Series D preferred stock after the original issue date, dividend rights with respect to such shares will commence from the
 
original issue date of such additional shares. Dividends on our Series C and Series D preferred stock will not be declared to the extent that such declaration would cause us to fail to comply with applicable laws and regulations, including applicable federal regulatory capital guidelines.
On September 15, 2017, or any dividend payment date thereafter, the Series C preferred stock and corresponding depositary shares may be redeemed by us, in whole or in part, at a redemption price equal to $100,000 per share (equivalent to $25 per depositary share) plus any declared and unpaid dividends, without accumulation of any undeclared dividends. The Series C preferred stock and corresponding depositary shares may be redeemed at our option, in whole or in part, prior to September 15, 2017, upon the occurrence of a regulatory capital treatment event, as defined in the certificate of designation with respect to the Series C preferred stock, at a redemption price equal to $100,000 per share (equivalent to $25 per depositary share) plus any declared and unpaid dividends, without accumulation of any undeclared dividends.
Common Stock:
In March 2014, our Board of Directors approved a common stock purchase program authorizing the purchase of up to $1.70 billion of our common stock through March 31, 2015. In the three months ended June 30, 2014, we purchased approximately 6.3 million shares of our common stock under this program, at an average per-share cost of $65.02 and an aggregate cost of approximately $410 million. No shares were purchased under this program in the three months ended March 31, 2014.
In the three months ended March 31, 2014, we purchased approximately 6.1 million shares of our common stock at an average cost of $69.14 per share and an aggregate cost of approximately $420 million, under a previous program approved by the Board in March 2013. As of March 31, 2014, no shares remained available for purchase under the March 2013 program.
Under both programs, in the six months ended June 30, 2014, we purchased in the aggregate approximately 12.4 million shares of our common stock at an average per-share cost of $67.04 and an aggregate cost of approximately $830 million. Shares acquired in connection with our common stock purchase programs which remained unissued as of June 30, 2014 were recorded as treasury stock in our consolidated statement of condition as of June 30, 2014.
In the three months ended June 30, 2014, we declared a quarterly common stock dividend of $0.30


113

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

per share, totaling approximately $128 million. In the three months ended June 30, 2013, we declared a quarterly common stock dividend of $0.26 per share, totaling approximately $117 million. In the six months ended June 30, 2014, we declared aggregate common stock dividends of $0.56 per share, totaling approximately $240 million, compared to aggregate common stock dividends of $0.52 per share, totaling
 
approximately $235 million, declared in the six months ended June 30, 2013.
Accumulated Other Comprehensive Income (Loss):
The following table presents the after-tax components of AOCI as of the dates indicated:

(In millions)
June 30, 2014
 
December 31, 2013
Net unrealized gains on cash flow hedges
$
100

 
$
161

Net unrealized gains (losses) on available-for-sale securities portfolio
492

 
(56
)
Net unrealized losses related to reclassified available-for-sale securities
(54
)
 
(72
)
Net unrealized gains (losses) on available-for-sale securities
438

 
(128
)
Net unrealized losses on available-for-sale securities designated in fair value hedges
(120
)
 
(97
)
Other-than-temporary impairment on available-for-sale securities related to factors other than credit
3

 
4

Net unrealized losses on hedges of net investments in non-U.S. subsidiaries
(14
)
 
(14
)
Other-than-temporary impairment on held-to-maturity securities related to factors other than credit
(35
)
 
(47
)
Net unrealized losses on retirement plans
(185
)
 
(203
)
Foreign currency translation
302

 
229

Total
$
489

 
$
(95
)
In the six months ended June 30, 2014, we realized net gains of $15 million, or $9 million net of related taxes as presented in the tables that follow, from sales of available-for-sale securities. Unrealized pre-tax gains of $5 million were included in AOCI as of December 31, 2013, net of deferred taxes of $2 million, related to these sales. In the six months
 
ended June 30, 2013, we realized net gains of $5 million, or $3 million net of related taxes as presented in the tables that follow, from sales of available-for-sale securities. Unrealized pre-tax gains of $15 million were included in AOCI as of December 31, 2012, net of deferred taxes of $6 million, related to these sales.

The following tables present changes in AOCI by component, net of related taxes, for the periods indicated:
 
Six Months Ended June 30, 2014
(In millions)
Net Unrealized Gains (Losses) on Cash Flow Hedges
 
Net Unrealized Gains (Losses) on Available-for-Sale Securities
 
Net Unrealized Losses on Hedges of Net Investments in Non-U.S. Subsidiaries
 
Other-Than-Temporary Impairment on Held-to-Maturity Securities
 
Net Unrealized Losses on Retirement Plans
 
Foreign Currency Translation
 
Total
Beginning balance
$
161

 
$
(221
)
 
$
(14
)
 
$
(47
)
 
$
(203
)
 
$
229

 
$
(95
)
Other comprehensive income (loss) before reclassifications
(62
)
 
551

 

 
11

 
1

 
73

 
574

Amounts reclassified out of AOCI
1

 
(9
)
 

 
1

 
17

 

 
10

Other comprehensive income (loss)
(61
)
 
542

 

 
12

 
18

 
73

 
584

Ending balance
$
100

 
$
321

 
$
(14
)
 
$
(35
)
 
$
(185
)
 
$
302

 
$
489


114

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Six Months Ended June 30, 2013
(In millions)
Net Unrealized Gains (Losses) on Cash Flow Hedges
 
Net Unrealized Gains (Losses) on Available-for-Sale Securities
 
Net Unrealized Losses on Hedges of Net Investments in Non-U.S. Subsidiaries
 
Other-Than-Temporary Impairment on Held-to-Maturity Securities
 
Net Unrealized Losses on Retirement Plans
 
Foreign Currency Translation
 
Total
Beginning balance
$
69

 
$
519

 
$
(14
)
 
$
(65
)
 
$
(283
)
 
$
134

 
$
360

Other comprehensive income (loss) before reclassifications
92

 
(694
)
 

 
9

 
(2
)
 
(304
)
 
(899
)
Amounts reclassified out of AOCI
2

 
1

 

 
2

 
10

 
1

 
16

Other comprehensive income (loss)
94

 
(693
)
 

 
11

 
8

 
(303
)
 
(883
)
Ending balance
$
163

 
$
(174
)
 
$
(14
)
 
$
(54
)
 
$
(275
)
 
$
(169
)
 
$
(523
)

115

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present after-tax reclassifications out of AOCI for the periods indicated:
 
Three Months Ended June 30,
 
 
 
2014
 
2013
 
 
(In millions)
Amounts Reclassified out of AOCI
 
Affected Line Item in Consolidated Statement of Income
Cash flow hedges:
 
 
 
 
 
Interest-rate contracts, net of related tax benefit of $1
$

 
$
1

 
Net interest revenue
Available-for-sale securities:
 
 
 
 
 
Other-than-temporary impairment on available-for-sale securities related to factors other than credit, net of related tax benefit of $2

 
4

 
Losses reclassified (from) to other comprehensive income
Held-to-maturity securities:
 
 
 
 
 
Other-than-temporary impairment on held-to-maturity securities related to factors other than credit
1

 
1

 
Losses reclassified (from) to other comprehensive income
Retirement plans:
 
 
 
 
 
Amortization of actuarial losses, net of related taxes of ($8) and net of related tax benefits of $3, respectively
12

 
5

 
Compensation and employee benefits expenses
Foreign currency translation:
 
 
 
 
 
Sales of non-U.S. entities, net of related tax benefit of ($1)

 
(1
)
 
Processing fees and other revenue
Total reclassifications out of AOCI
$
13

 
$
10

 
 

 
Six Months Ended June 30,
 
 
 
2014
 
2013
 
 
(In millions)
Amounts Reclassified out of AOCI
 
Affected Line Item in Consolidated Statement of Income
Cash flow hedges:
 
 
 
 
 
Interest-rate contracts, net of related tax benefit of $1 and $1, respectively
$
1

 
$
2

 
Net interest revenue
Available-for-sale securities:
 
 
 
 
 
Net realized gains from sales of available-for-sale securities, net of related taxes of ($6) and ($2), respectively
(9
)
 
(3
)
 
Net gains (losses) from sales of available-for-sale securities
Other-than-temporary impairment on available-for-sale securities related to factors other than credit, net of related tax benefit of $2

 
4

 
Losses reclassified (from) to other comprehensive income
Held-to-maturity securities:
 
 
 
 
 
Other-than-temporary impairment on held-to-maturity securities related to factors other than credit, net of related tax benefit of $2 for 2013
1

 
2

 
Losses reclassified (from) to other comprehensive income
Retirement plans:
 
 
 
 
 
Amortization of actuarial losses, net of related taxes of ($5) and net of related tax benefits of $6, respectively
17

 
10

 
Compensation and employee benefits expenses
Foreign currency translation:
 
 
 
 
 
Sales of non-U.S. entities, net of related taxes of ($1)

 
1

 
Processing fees and other revenue
Total reclassifications out of AOCI
$
10

 
$
16

 
 


116

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 11.    Regulatory Capital
As of December 31, 2013, we were subject to the generally applicable minimum regulatory capital requirements enforced by U.S. banking regulators, referred to as Basel I. These requirements were based on a 1988 international accord developed by the Basel Committee on Banking Supervision, or Basel Committee.
In July 2013, U.S. banking regulators jointly issued a final rule to implement the Basel III framework in the U.S., referred to as the Basel III final rule, provisions of which become effective under a transition timetable which began on January 1, 2014, with full implementation required beginning on January 1, 2019. As provided in the Basel III final rule, banking organizations in their Basel II qualification period, or parallel run, were required to complete a superseding parallel run under Basel III.
We were notified by the Federal Reserve on February 21, 2014 that we completed our parallel run and would be required to begin using the advanced approaches framework in the Basel III final rule in the determination of our risk-based capital requirements. Pursuant to this notification, we have begun to use the advanced approaches to calculate and disclose our risk-based capital ratios starting with the three months ended June 30, 2014.
As required by the Dodd-Frank Wall Street Reform and Consumer Protection Act, or Dodd-Frank Act, enacted in 2010, State Street and State Street Bank, as advanced approaches banking organizations, are subject to a permanent "capital floor" in the calculation and assessment of their regulatory capital adequacy by U.S. banking regulators. Beginning on January 1, 2014, this capital floor is based on the provisions of Basel I, as adjusted by the final market risk capital rule issued by U.S. banking regulators in 2012.
Beginning on January 1, 2014, we became subject to the provisions of the Basel III final rule that govern our calculation of regulatory capital, including transitional, or phase-in, provisions. Beginning with the three months ended June 30, 2014 and ending
 

with December 31, 2014, the lower of our regulatory capital ratios calculated under the advanced approaches provisions of the Basel III final rule and those ratios calculated under the transitional provisions of Basel III (capital calculated in conformity with Basel III and risk-weighted assets calculated in conformity with Basel I as described above) will apply in the assessment of our capital adequacy for regulatory purposes.
As of June 30, 2014, the minimum required regulatory capital ratios are as follows:
common equity tier 1, or
tier 1 common, risk-based capital - 4%;
tier 1 risk-based capital - 5.5%;
total risk-based capital - 8%; and
tier 1 leverage - 4%
The methods for the calculation of our and State Street Bank's risk-based capital ratios will change as the provisions of the Basel III final rule related to the numerator (capital) and denominator (risk-weighted assets) are phased in, and as we begin calculating our risk-weighted assets using the advanced approaches. These ongoing methodological changes will result in differences in our reported capital ratios from one reporting period to the next that are independent of applicable changes to our capital base, our asset composition, our off-balance sheet exposures or our risk profile.
As of June 30, 2014, State Street and State Street Bank exceeded all regulatory capital adequacy requirements to which they were subject. As of June 30, 2014, State Street Bank was categorized as “well capitalized” under the applicable regulatory capital adequacy framework, and exceeded all “well capitalized” ratio guidelines to which it was subject. Management believes that no conditions or events have occurred since June 30, 2014 that have changed the capital categorization of State Street Bank.









117

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following table presents the regulatory capital structure, total risk-weighted assets and related regulatory capital ratios for State Street and State Street Bank as of the dates indicated. As a result of changes in the methodologies used to calculate our regulatory capital ratios from period to period as the provisions of the Basel III final rule are phased in, the ratios presented in the table for each period-end are not directly comparable. Refer to the footnotes following the table.
 
 
 
 
State Street
 
State Street Bank
(Dollars in millions)
 
 
 
Basel III Advanced Approach June 30, 2014(1)
 
Basel III Transitional June 30, 2014(2)
 
December 31, 2013(3)
 
Basel III Advanced Approach June 30, 2014(1)
 
Basel III Transitional June 30, 2014(2)
 
December 31, 2013(3)
  Common shareholders' equity:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common stock and related surplus
 
 
 
$
10,269

 
$
10,269

 
$
10,280

 
$
10,832

 
$
10,832

 
$
10,786

Retained earnings
 
 
 
14,114

 
14,114

 
13,395

 
9,579

 
9,579

 
9,064

Accumulated other comprehensive income (loss)
 
 
 
328

 
328

 
215

 
299

 
299

 
209

Treasury stock, at cost
 
 
 
(4,405
)
 
(4,405
)
 
(3,693
)
 

 

 

Total
 
 
 
20,306

 
20,306

 
20,197

 
20,710

 
20,710

 
20,059

Regulatory capital adjustments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Goodwill and other intangible assets, net of associated deferred tax liabilities(4) 
 
 
 
(6,100
)
 
(6,100
)
 
(7,743
)
 
(5,816
)
 
(5,816
)
 
(7,341
)
Other adjustments
 
 
 
(41
)
 
(41
)
 

 
(126
)
 
(126
)
 

  Tier 1 common capital
 
 
 
14,165

 
14,165

 
12,454

 
14,768

 
14,768

 
12,718

Preferred stock
 
 
 
1,233

 
1,233

 
491

 

 

 

Trust preferred capital securities subject to phase-out from tier 1 capital
 
 
 
475

 
475

 
950

 

 

 

Other adjustments
 
 
 
(165
)
 
(165
)
 

 

 

 

  Tier 1 capital
 
 
 
15,708

 
15,708

 
13,895

 
14,768

 
14,768

 
12,718

Qualifying subordinated long-term debt
 
 
 
1,738

 
1,738

 
1,918

 
1,754

 
1,754

 
1,936

Trust preferred capital securities phased out of tier 1 capital
 
 
 
475

 
475

 
NA
 

 

 
NA
Other adjustments
 
 
 
3

 
3

 
(26
)
 

 

 
45

  Total capital
 
 
 
$
17,924

 
$
17,924

 
$
15,787

 
$
16,522

 
$
16,522

 
$
14,699

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Risk-weighted assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Credit risk
 
 
 
$
71,093

 
$
86,928

 
$
78,864

 
$
64,617

 
$
83,524

 
$
76,197

Operational risk
 
 
 
35,985

 
NA
 
NA
 
35,566

 
NA
 
NA
Market risk
 
 
 
3,937

 
1,679

 
1,262

 
3,463

 
1,679

 
1,262

Total risk-weighted assets
 
 
 
$
111,015

 
$
88,607

 
$
80,126

 
$
103,646

 
$
85,203

 
$
77,459

Adjusted quarterly average assets
 
 
 
$
227,815

 
$
227,815

 
$
202,801

 
$
224,050

 
$
224,050

 
$
199,301

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Capital Ratios:
 
Minimum Requirements(5) 2014
Minimum Requirements(6) 2013
 
 
 
 
 
 
 
 
 
 
 
Tier 1 common risk-based capital
 
4.0
%
NA

12.8
%
 
16.0
%
 
15.5
%
 
14.2
%
 
17.3
%
 
16.4
%
Tier 1 risk-based capital
 
5.5

4.0
%
14.1

 
17.7

 
17.3

 
14.2

 
17.3

 
16.4

Total risk-based capital
 
8.0

8.0

16.1

 
20.2

 
19.7

 
15.9

 
19.4

 
19.0

Tier 1 leverage
 
4.0

4.0

6.9

 
6.9

 
6.9

 
6.6

 
6.6

 
6.4

 
 
 
 
NA: Not applicable.
(1) Tier 1 common capital, tier 1 capital and total capital ratios as of June 30, 2014 were calculated in conformity with the advanced approaches provisions of the Basel III final rule. Tier 1 leverage ratio as of June 30, 2014 was calculated in conformity with the Basel III final rule.
(2) Tier 1 common capital, tier 1 capital, total capital and tier 1 leverage ratios as of June 30, 2014 were calculated in conformity with the transitional provisions of the Basel III final rule. Specifically, these ratios reflect tier 1 common, tier 1 and total capital (the numerator) calculated in conformity with the provisions of the Basel III final rule, and total risk-weighted assets or, with respect to the tier 1 leverage ratio, quarterly average assets (in both cases, the denominator), calculated in conformity with the provisions of Basel I.
(3) Tier 1 common capital, tier 1 capital, total capital and tier 1 leverage ratios as of December 31, 2013 were calculated in conformity with the provisions of Basel I.
(4) Amounts for State Street and State Street Bank as of June 30, 2014 consisted of goodwill, net of associated deferred tax liabilities, and 20% of other intangible assets, net of associated deferred tax liabilities, the latter phased in as a deduction from capital, in conformity with the Basel III final rule.
(5) Minimum requirements will be phased in up to full implementation beginning on January 1, 2019; minimum requirements listed are as of June 30, 2014.
(6) Minimum requirements listed, governed by Basel I, are as of December 31, 2013.

118

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 12.    Derivative Financial Instruments
We use derivative financial instruments to support our clients' needs and to manage our interest-rate and currency risk. In undertaking these activities, we assume positions in both the foreign exchange and interest-rate markets by buying and selling cash instruments and using derivative financial instruments, including foreign exchange forward contracts, foreign exchange and interest-rate options and interest-rate swaps, interest-rate forward contracts and interest-rate futures. Our derivative positions include derivative contracts held by a consolidated sponsored investment fund (refer to note 9).
Interest-rate contracts involve an agreement with a counterparty to exchange cash flows based on the movement of an underlying interest-rate index. An interest-rate swap agreement involves the exchange of a series of interest payments, at either a fixed or variable rate, based on the notional amount without the exchange of the underlying principal amount. An interest-rate option contract provides the purchaser, for a premium, the right, but not the obligation, to receive an interest rate based upon a predetermined notional amount during a specified period. An interest-rate futures contract is a commitment to buy or sell, at a future date, a financial instrument at a contracted price; it may be settled in cash or through the delivery of the contracted instrument.
Foreign exchange contracts involve an agreement to exchange one currency for another currency at an agreed-upon rate and settlement date. Foreign exchange contracts generally consist of foreign exchange forward and spot contracts, option contracts and cross-currency swaps. Future cash requirements, if any, related to foreign exchange contracts are represented by the gross amount of currencies to be exchanged under each contract unless we and the counterparty have agreed to pay or to receive the net contractual settlement amount on the settlement date.
Derivative financial instruments involve the management of interest-rate and foreign currency risk, and involve, to varying degrees, market risk and credit and counterparty risk (risk related to repayment). Market risk is defined by U.S. banking regulators as the risk of loss that could result from broad market movements, such as changes in the general level of interest rates, credit spreads, foreign exchange rates or commodity prices. We use a variety of risk management tools and methodologies to measure, monitor and manage the market risk associated with our trading activities, which trading
 
activities include our use of derivative financial instruments. One such risk-management measure is Value-at-Risk, or VaR. VaR is an estimate of potential loss for a given period within a stated statistical confidence interval. We use a risk-measurement system to measure VaR daily. We have adopted standards for measuring VaR, and we maintain regulatory capital for market risk in accordance with currently applicable regulatory market risk requirements.
Derivative financial instruments are also subject to credit and counterparty risk, which is defined as the risk of financial loss if a borrower or counterparty is either unable or unwilling to repay borrowings or settle a transaction in accordance with the underlying contractual terms. We manage credit and counterparty risk by performing credit reviews, maintaining individual counterparty limits, entering into netting arrangements and requiring the receipt of collateral. Collateral requirements are determined after a review of the creditworthiness of each counterparty, and these requirements are monitored and adjusted daily. Collateral is generally held in the form of cash or highly liquid U.S. government securities. We may be required to provide collateral to the counterparty in connection with our entry into derivative financial instruments. Cash collateral received from and provided to counterparties in connection with derivative financial instruments is recorded in accrued expenses and other liabilities and other assets, respectively, in our consolidated statement of condition. As of June 30, 2014 and December 31, 2013, we had recorded approximately $1.13 billion and $2.58 billion, respectively, of cash collateral received from counterparties and approximately $1.34 billion and $3.36 billion, respectively, of cash collateral provided to counterparties in connection with derivative financial instruments in our consolidated statement of condition.
We enter into master netting agreements with many of our derivative counterparties, and we have elected to net derivative assets and liabilities, including cash collateral received or deposited, which are subject to those agreements. Certain of these agreements contain credit risk-related contingent features in which the counterparty has the right to declare State Street in default and accelerate cash settlement of our net derivative liabilities with the counterparty in the event that our credit rating falls below specified levels. The aggregate fair value of all derivative instruments with credit risk-related contingent features that were in a net liability position as of June 30, 2014 totaled approximately $571 million, against which we posted aggregate collateral


119

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

of approximately $14 million, with the latter amount due to timing differences with respect to the mark-to-market valuation of the collateral. If State Street’s credit rating were downgraded below levels specified in the agreements, the maximum additional amount of payments related to termination events that could have been required pursuant to these contingent features as of June 30, 2014 was approximately $557 million. Such accelerated settlement would not affect our consolidated results of operations.
Derivatives Not Designated as Hedging Instruments:
In connection with our trading activities, we use derivative financial instruments in our role as a financial intermediary and as both a manager and servicer of financial assets, in order to accommodate our clients' investment and risk management needs. In addition, we use derivative financial instruments for risk management purposes as economic hedges, which are not formally designated as accounting hedges, in order to contribute to our overall corporate earnings and liquidity. These activities are designed to generate trading services revenue and to manage volatility in our net interest revenue. The level of market risk that we assume is a function of our overall objectives and liquidity needs, our clients' requirements and market volatility.
With respect to cross-border investing, our clients often enter into foreign exchange forward contracts to convert currency for international investments and to manage the currency risk in their international investment portfolios. As an active participant in the foreign exchange markets, we provide foreign exchange forward contracts and options in support of these client needs, and also act as a dealer in the currency markets. As part of our trading activities, we assume positions in both the foreign exchange and interest-rate markets by buying and selling cash instruments and using derivative financial instruments, including foreign exchange forward contracts, foreign exchange and interest-rate options and interest-rate swaps, interest-rate forward contracts, and interest-rate futures. In the aggregate, we seek to match positions closely with the objective of minimizing related currency and interest-rate risk.
We offer products that provide book-value protection primarily to plan participants in stable value funds managed by non-affiliated investment managers of post-retirement defined contribution benefit plans, particularly 401(k) plans. We account for the associated contingencies, more fully described in note 7, individually as derivative financial instruments. These contracts are valued quarterly
 
and unrealized losses, if any, are recorded in other expenses in our consolidated statement of income.
In 2013 and 2014, we granted deferred cash awards to certain of our employees as part of our employee incentive compensation plans. We account for these awards as derivative financial instruments, as the underlying referenced shares are not equity instruments of State Street. The fair value of these derivatives is referenced to the value of units in State Street-sponsored investment funds or funds sponsored by other unrelated entities. We re-measure these derivatives to fair value quarterly, and record the change in value in compensation and employee benefits expenses in our consolidated statement of income.
Derivatives Designated as Hedging Instruments:
In connection with our asset-and-liability management activities, we use derivative financial instruments to manage our interest-rate risk. Interest-rate risk, defined as the sensitivity of income or financial condition to variations in interest rates, is a significant non-trading market risk to which our assets and liabilities are exposed. We manage our interest-rate risk by identifying, quantifying and hedging our exposures, using fixed-rate portfolio securities and a variety of derivative financial instruments, most frequently interest-rate swaps and options (for example, interest-rate caps and floors). Interest-rate swap agreements alter the interest-rate characteristics of specific balance sheet assets or liabilities. When appropriate, forward-rate agreements, options on swaps, and exchange-traded futures and options are also used. Our hedging relationships are formally designated, and qualify for hedge accounting, as fair value or cash flow hedges.
 Fair value hedges
Derivatives designated as fair value hedges are utilized to mitigate the risk of changes in the fair values of recognized assets and liabilities. Differences between the gains and losses on fair value hedges and the gains and losses on the asset or liability attributable to the hedged risk represent hedge ineffectiveness. We use interest-rate or foreign exchange contracts in this manner to manage our exposure to changes in the fair value of hedged items caused by changes in interest rates or foreign exchange rates.
We have entered into interest-rate swap agreements to modify our interest revenue from certain available-for-sale investment securities from a fixed rate to a floating rate. The hedged securities had a weighted-average life of approximately 6.3 years as of June 30, 2014, compared to 6.5 years as


120

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

of December 31, 2013. These securities are hedged with interest-rate swap contracts of similar maturity, repricing and fixed-rate coupons. The interest-rate swap contracts convert the interest revenue from a fixed rate to a floating rate indexed to LIBOR, thereby mitigating our exposure to fluctuations in the fair value of the securities attributable to changes in the benchmark interest rate.
We have entered into interest-rate swap agreements to modify our interest expense on two senior notes and one subordinated note from fixed rates to floating rates. The senior notes mature in 2018 and 2023 and pay fixed interest at annual rates of 1.35% and 3.70%, respectively. The subordinated note matures in 2023 and pays fixed interest at a 3.10% annual rate. The senior and subordinated notes are hedged with interest-rate swap contracts with notional amounts, maturities and fixed-rate coupon terms that align with the hedged notes. The interest-rate swap contracts convert the fixed-rate coupons to floating rates indexed to LIBOR, thereby mitigating our exposure to fluctuations in the fair values of the senior and subordinated notes stemming from changes in the benchmark interest rates.
We have entered into forward foreign exchange contracts to hedge the change in fair value attributable to foreign exchange movements in the funding of non-functional currency-denominated investment securities. These forward contracts convert the foreign currency risk to U.S. dollars, thereby mitigating our exposure to fluctuations in the fair value of the securities attributable to changes in foreign exchange rates. Generally, no ineffectiveness is recorded in earnings, since the notional amount of the hedging instruments is aligned with the carrying value of the hedged securities. The forward points on the hedging instruments are considered to be a hedging cost, and accordingly are excluded from the evaluation of hedge effectiveness and recorded in net interest revenue.
 
Cash flow hedges
Derivatives categorized as cash flow hedges are utilized to offset the variability of cash flows to be received from or paid on a floating-rate asset or liability. Ineffectiveness of cash flow hedges is defined as the extent to which the changes in fair value of the derivative exceed the variability of cash flows of the forecast transaction.
We have entered into an interest-rate swap agreement to modify our interest revenue from an available-for-sale debt security from a floating rate to a fixed rate. The hedged security had a remaining life of approximately 4 months as of June 30, 2014, compared to approximately 10 months as of December 31, 2013. The security is hedged with an interest-rate swap contract of similar maturity, repricing and other characteristics. The interest-rate swap contract converts the interest revenue from a floating rate to a fixed rate, thereby mitigating our exposure to fluctuations in the cash flows of the security attributable to changes in the benchmark interest rate.  
We have entered into foreign exchange contracts to hedge the change in cash flows attributable to foreign exchange movements in the funding of non-functional currency-denominated investment securities. These foreign exchange contracts convert the foreign currency risk to U.S. dollars, thereby mitigating our exposure to fluctuations in the cash flows of the securities attributable to changes in foreign exchange rates. Generally, no ineffectiveness is recorded in earnings, since the critical terms of the hedging instruments and the hedged securities are aligned.
For cash flow hedges, any changes in the fair value of the derivative financial instruments remain in AOCI, and are generally recorded in our consolidated statement of income in future periods when earnings are affected by the variability of the hedged cash flow.


121

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following table presents the aggregate contractual, or notional, amounts of derivative financial instruments entered into in connection with our trading and asset-and-liability management activities as of the dates indicated:
(In millions)
June 30,
2014
 
December 31,
2013
Derivatives not designated as hedging instruments:
 
 
 
Interest-rate contracts:
 
 
 
Swap agreements and forwards
$
898

 
$
1,023

Options and caps purchased
15

 
27

Options and caps written
15

 
27

Futures
4,063

 
3,282

Foreign exchange contracts:
 
 
 
Forward, swap and spot
1,260,080

 
1,124,355

Options purchased
2,486

 
1,666

Options written
1,631

 
1,423

Credit derivative contracts:
 
 
 
Credit swap agreements
165

 
141

Total return swap agreements(1)
431

 

Commodity and equity contracts:
 
 
 
Commodity(1)
14,800

 
2

Equity(1)
27

 
1

Other:
 
 
 
Stable value contracts
24,310

 
24,906

Deferred cash awards(2)
239

 
42

Derivatives designated as hedging instruments:
 
 
 
Interest-rate contracts:
 
 
 
Swap agreements
5,222

 
5,221

Foreign exchange contracts:
 
 
 
Forward and swap
2,703

 
2,783

 
 
(1) Primarily composed of positions held by a consolidated sponsored investment fund, more fully described in note 9.
(2) Represents grants of deferred cash awards to employees; refer to discussion in this note under "Derivatives Not Designated as Hedging Instruments."

122

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

In connection with our asset-and-liability management activities, we have entered into interest-rate contracts designated as fair value and cash flow hedges to manage our interest-rate risk. The following table presents the aggregate notional amounts of these interest-rate contracts and the related assets or liabilities being hedged as of the dates indicated:
 
June 30, 2014
 
December 31, 2013
(In millions)
Fair
Value
Hedges
 
Cash
Flow
Hedges
 
Total
 
Fair
Value
Hedges
 
Cash
Flow
Hedges
 
Total
Investment securities available for sale
$
2,585

 
$
137

 
$
2,722

 
$
2,589

 
$
132

 
$
2,721

Long-term debt(1)
2,500

 

 
2,500

 
2,500

 

 
2,500

Total
$
5,085

 
$
137

 
$
5,222

 
$
5,089

 
$
132

 
$
5,221

 
 
 
 
 
(1) As of June 30, 2014, these fair value hedges increased the carrying value of long-term debt presented in our consolidated statement of condition by $40 million. As of December 31, 2013, these fair value hedges decreased the carrying value of long-term debt presented in our consolidated statement of condition by $35 million.
The following tables present the contractual and weighted-average interest rates for long-term debt, which include the effects of the fair value hedges presented in the table above, for the periods indicated:
 
Three Months Ended June 30,
 
2014
 
2013
 
Contractual
Rates
 
Rate Including
Impact of Hedges
 
Contractual
Rates
 
Rate Including
Impact of Hedges
Long-term debt
3.53
%
 
2.73
%
 
3.40
%
 
2.65
%
 
Six Months Ended June 30,
 
2014
 
2013
 
Contractual
Rates
 
Rate Including
Impact of Hedges
 
Contractual
Rates
 
Rate Including
Impact of Hedges
Long-term debt
3.46
%
 
2.66
%
 
3.57
%
 
2.83
%
The following tables present the fair value of derivative financial instruments, excluding the impact of master netting agreements, recorded in our consolidated statement of condition as of the dates indicated. The impact of master netting agreements is disclosed in note 2.  
 
Derivatives - Assets
 
Balance Sheet
Location
 
Fair Value
(In millions)
 
 
June 30, 2014
 
December 31, 2013
Derivatives not designated as hedging instruments:
 
 
 
 
 
Foreign exchange contracts
Other assets
 
$
6,346

 
$
11,552

Interest-rate contracts
Other assets
 
19

 
29

Other derivative contracts
Other assets
 
4

 
1

Total
 
 
$
6,369

 
$
11,582

Derivatives designated as hedging instruments:
 
 
 
 
 
Foreign exchange contracts
Other assets
 
$
291

 
$
359

Interest-rate contracts
Other assets
 
39

 
36

Total
 
 
$
330

 
$
395


123

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Derivatives - Liabilities
 
Balance Sheet
Location
 
Fair Value
(In millions)
 
 
June 30, 2014
 
December 31, 2013
Derivatives not designated as hedging instruments:
 
 
 
 
 
Foreign exchange contracts
Other liabilities
 
$
6,322

 
$
11,428

Other derivative contracts
Other liabilities
 
68

 
23

Interest-rate contracts
Other liabilities
 
20

 
29

Total
 
 
$
6,410

 
$
11,480

Derivatives designated as hedging instruments:
 
 
 
 
 
Interest-rate contracts
Other liabilities
 
$
250

 
$
302

Foreign exchange contracts
Other liabilities
 
34

 
43

Total
 
 
$
284

 
$
345

 
The following tables present the impact of our use of derivative financial instruments on our consolidated statement of income for the periods indicated:
 
Location of Gain (Loss) on
Derivative in Consolidated
Statement of Income
 
Amount of Gain (Loss) on Derivative Recognized
in Consolidated Statement of Income
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In millions)
 
 
2014
 
2013
 
2014
 
2013
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Foreign exchange contracts
Trading services revenue
 
$
144

 
$
169

 
$
278

 
$
314

Interest-rate contracts
Trading services revenue
 
(1
)
 
2

 
(1
)
 
3

Other derivative contracts
Processing fees and other revenue
 

 

 
(1
)
 

Total
 
 
$
143

 
$
171

 
$
276

 
$
317


 
Location of (Gain) Loss on
Derivative in Consolidated
Statement of Income
 
Amount of (Gain) Loss on Derivative Recognized
in Consolidated Statement of Income
 
 
 
Three Months Ended June 30
 
Six Months Ended June 30,
(In millions)
 
 
2014
 
2013
 
2014
 
2013
Derivatives not designated as hedging instruments:
 
 
 
 
 
 
 
 
Other derivative contracts
Compensation and employee benefits
 
$
(22
)
 
$
3

 
$
(70
)
 
$
6

Total
 
 
$
(22
)
 
$
3

 
$
(70
)
 
$
6


 
Location of Gain (Loss) on Derivative in Consolidated Statement of Income
 
Amount of Gain
(Loss) on Derivative
Recognized in
Consolidated
Statement of Income
 
Hedged Item in Fair Value Hedging Relationship
 
Location of Gain (Loss) on Hedged Item in Consolidated Statement of Income
 
Amount of Gain
(Loss) on Hedged
Item Recognized in
Consolidated
Statement of Income
(In millions)
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
 
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
Derivatives designated as fair value hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-rate contracts
Processing fees and
other revenue
 
$
47

 
$
96

 
Long-term debt
 
Processing fees and
other revenue
 
$
(44
)
 
$
(89
)
Interest-rate contracts
Processing fees and
other revenue
 
(24
)
 
(41
)
 
Available-for-sale securities
 
Processing fees and
other revenue(1)
 
22

 
38

Foreign exchange contracts
Processing fees and
other revenue
 
18

 
60

 
Investment securities
 
Processing fees and
other revenue
 
(18
)
 
(60
)
Total
 
 
$
41

 
$
115

 
 
 
 
 
$
(40
)
 
$
(111
)

124

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Location of Gain (Loss) on Derivative in Consolidated Statement of Income
 
Amount of Gain
(Loss) on Derivative
Recognized in
Consolidated
Statement of Income
 
Hedged Item in Fair Value Hedging Relationship
 
Location of Gain (Loss) on Hedged Item in Consolidated Statement of Income
 
Amount of Gain
(Loss) on Hedged
Item Recognized in
Consolidated
Statement of Income
(In millions)
 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
 
 
 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
Derivatives designated as fair value hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Foreign exchange contracts
Processing fees and
other revenue
 
$
(159
)
 
$
(155
)
 
Investment securities
 
Processing fees and
other revenue
 
$
159

 
$
155

Interest-rate contracts
Processing fees and
other revenue
 
(117
)
 
(132
)
 
Long-term debt
 
Processing fees and
other revenue
 
105

 
121

Interest-rate contracts
Processing fees and
other revenue
 
20

 
21

 
Available-for-sale securities
 
Processing fees and
other revenue(1)
 
(20
)
 
(22
)
Total
 
 
$
(256
)
 
$
(266
)
 
 
 
 
 
$
244

 
$
254

 
 
 
 
 
(1) Represents amounts reclassified out of other comprehensive income, or OCI. For the three and six months ended June 30, 2014, $13 million and $23 million, respectively, of unrealized losses on available-for-sale securities designated in fair value hedges were recognized in OCI. For the three and six months ended June 30, 2013, $45 million and $60 million, respectively, of unrealized gains on available-for-sale securities designated in fair value hedges were recognized in OCI.

Differences between the gains (losses) on the derivative and the gains (losses) on the hedged item,
 
excluding any amounts recorded in net interest revenue, represent hedge ineffectiveness.


 
Amount of Gain
(Loss) on Derivative
Recognized in Other
Comprehensive
Income
 
Location of Gain (Loss) Reclassified from OCI to Consolidated Statement of Income
 
Amount of Gain
(Loss) Reclassified
from OCI to
Consolidated
Statement of Income
 
Location of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income
 
Amount of Gain
(Loss) on Derivative
Recognized in
Consolidated
Statement of Income
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-rate contracts
$
(1
)
 
$
(2
)
 
Net interest revenue
 
$
(1
)
 
$
(2
)
 
Net interest revenue
 
$
1

 
$
2

Foreign exchange contracts
(52
)
 
(64
)
 
Net interest revenue
 

 

 
Net interest revenue
 
1

 
2

Total
$
(53
)
 
$
(66
)
 
 
 
$
(1
)
 
$
(2
)
 
 
 
$
2

 
$
4


 
Amount of Gain
(Loss) on Derivative
Recognized in Other
Comprehensive
Income
 
Location of Gain (Loss) Reclassified from OCI to Consolidated Statement of Income
 
Amount of Gain
(Loss) Reclassified
from OCI to
Consolidated
Statement of Income
 
Location of Gain (Loss) on Derivative Recognized in Consolidated Statement of Income
 
Amount of Gain
(Loss) on Derivative
Recognized in
Consolidated
Statement of Income
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
(In millions)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as cash flow hedges:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-rate contracts
$
(1
)
 
$
11

 
Net interest revenue
 
$
(1
)
 
$
(2
)
 
Net interest revenue
 
$
1

 
$
2

Foreign exchange contracts
48

 
153

 
Net interest revenue
 

 

 
Net interest revenue
 
2

 
5

Total
$
47

 
$
164

 
 
 
$
(1
)
 
$
(2
)
 
 
 
$
3

 
$
7

 


125

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 13. Offsetting Arrangements
 We manage credit and counterparty risk by entering into enforceable netting agreements and other collateral arrangements with counterparties to derivative contracts and secured financing transactions, including resale and repurchase agreements, and principal securities borrowing and lending agreements. These netting agreements mitigate our counterparty credit risk by providing for a single net settlement with a counterparty of all financial transactions covered by the agreement in an event of default as defined under such agreement. In limited cases, a netting agreement may also provide for the periodic netting of settlement payments with respect to multiple different transaction types in the normal course of business.
Certain of our derivative contracts are executed under either standardized netting agreements or, for exchange-traded derivatives, the relevant contracts for a particular exchange which contain enforceable netting provisions. In certain cases, we may have cross-product netting arrangements which allow for netting and set-off of a variety of types of derivatives with a single counterparty. A derivative netting arrangement creates an enforceable right of set-off that becomes effective, and effects the realization or settlement of individual financial assets and liabilities, only following a specified event of default. Collateral requirements associated with our derivative contracts are determined after a review of the creditworthiness of each counterparty, and the requirements are monitored and adjusted daily, typically based on net exposure by counterparty. Collateral is generally in the form of cash or highly liquid U.S. government securities.
In connection with secured financing transactions, we enter into netting agreements and other collateral arrangements with counterparties, which provide for the right to liquidate collateral in the event of default. Collateral is generally required in the form of cash, equity securities or fixed-income securities. Default events may include the failure to make payments or deliver securities timely, material adverse changes in financial condition or insolvency, the breach of minimum regulatory capital
 
requirements, or loss of license, charter or other legal authorization necessary to perform under the contract.
In order for an arrangement to be eligible for netting, we must have a reasonable basis to conclude that such netting arrangements are legally enforceable. The analysis of the legal enforceability of an arrangement differs by jurisdiction, depending on the laws of that jurisdiction. In many jurisdictions, specific legislation exists that provides for the enforceability in bankruptcy of close-out netting under a netting agreement, typically by way of specific exception from more general prohibitions on the exercise of creditor rights.
When we have a basis to conclude that a legally enforceable netting arrangement exists between us and the derivative counterparty and the relevant transaction is the type of transaction that is recorded in our consolidated statement of condition, we offset derivative assets and liabilities, and the related collateral received and provided, in our consolidated statement of condition. We also offset assets and liabilities related to secured financing transactions with the same counterparty or clearinghouse which have the same maturity date and are settled in the normal course of business on a net basis.
Collateral that we receive in the form of securities in connection with secured financing transactions and derivative contracts can be transferred or re-pledged as collateral in many instances to enter into repurchase agreements or securities finance or derivative transactions. The securities collateral received in connection with our securities finance activities is recorded at fair value in other assets in our consolidated statement of condition, with a related liability to return the collateral, if we have the right to transfer or re-pledge the collateral. As of June 30, 2014 and December 31, 2013, the fair value of securities received as collateral where we are permitted to transfer or re-pledge the securities totaled $2.47 billion and $5.64 billion, respectively, and the fair value of the portion that had been transferred or re-pledged as of the same date was $474 million and $1.77 billion, respectively.








126

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present information about the offsetting of assets related to derivative contracts and secured financing transactions, as of the dates indicated:
Assets:
 
June 30, 2014
 
December 31, 2013
(In millions)
 
Gross Amounts of Recognized Assets(1)
 
Gross Amounts Offset in Statement of Condition(2)
 
Net Amounts of Assets Presented in Statement of Condition
 
Gross Amounts of Recognized Assets(1)
 
Gross Amounts Offset in Statement of Condition(2)
 
Net Amounts of Assets Presented in Statement of Condition
Derivatives:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
6,637

 
$
(2,923
)
 
$
3,714

 
$
11,911

 
$
(4,514
)
 
$
7,397

Interest-rate contracts
 
58

 
(35
)
 
23

 
65

 
(59
)
 
6

Other derivative contracts
 
4

 
(2
)
 
2

 
1

 

 
1

Cash collateral netting
 

 
(860
)
 
(860
)
 

 
(1,928
)
 
(1,928
)
Total derivatives
 
$
6,699

 
$
(3,820
)
 
$
2,879

 
$
11,977

 
$
(6,501
)
 
$
5,476

Other financial instruments:
 
 
 
 
 
 
 
 
Resale agreements and securities borrowing(3)
 
$
48,284

 
$
(29,208
)
 
$
19,076

 
$
48,221

 
$
(30,700
)
 
$
17,521

Total derivatives and other financial instruments
 
$
54,983

 
$
(33,028
)
 
$
21,955

 
$
60,198

 
$
(37,201
)
 
$
22,997

 
 
 
 
 
(1) Amounts include all transactions regardless of whether or not they are subject to an enforceable netting arrangement.
(2) Amounts subject to netting arrangements which have been determined to be legally enforceable.
(3) Included in the $19,076 million as of June 30, 2014 were $3,681 million of resale agreements and $15,395 million of collateral provided related to securities borrowing. Included in the $17,521 million as of December 31, 2013 were $6,230 million of resale agreements and $11,291 million of collateral provided related to securities borrowing. Resale agreements and collateral provided related to securities borrowing were recorded in securities purchased under resale agreements and other assets, respectively, in our consolidated statement of condition. Refer to note 7 for additional information with respect to principal securities finance transactions.
 
 
June 30, 2014
 
December 31, 2013
 
 
 
 
Gross Amounts Not Offset in Statement of Condition(1)
 
 
 
 
 
Gross Amounts Not Offset in Statement of Condition(1)
 
 
(In millions)
 
Net Amount of Assets Presented in Statement of Condition
 
Counterparty Netting
 
Collateral Received
 
Net Amount(2)
 
Net Amount of Assets Presented in Statement of Condition
 
Counterparty Netting
 
Collateral Received
 
Net Amount(2)
Derivatives
 
$
2,879

 
$

 
$
(199
)
 
$
2,680

 
$
5,476

 
$

 
$
(181
)
 
$
5,295

Resale agreements and securities borrowing
 
19,076

 
(163
)
 
(17,600
)
 
1,313

 
17,521

 
(131
)
 
(14,983
)
 
2,407

Total
 
$
21,955

 
$
(163
)
 
$
(17,799
)
 
$
3,993

 
$
22,997

 
$
(131
)
 
$
(15,164
)
 
$
7,702

 
 
 
 
 
(1) Amounts subject to netting arrangements which have been determined to be legally enforceable.
(2) Includes amounts secured by collateral not determined to be subject to enforceable netting arrangements.

127

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

The following tables present information about the offsetting of liabilities related to derivative contracts and secured financing transactions, as of the dates indicated:
Liabilities:
 
June 30, 2014
 
December 31, 2013
(In millions)
 
Gross Amounts of Recognized Liabilities(1)
 
Gross Amounts Offset in Statement of Condition(2)
 
Net Amounts of Liabilities Presented in Statement of Condition
 
Gross Amounts of Recognized Liabilities(1)
 
Gross Amounts Offset in Statement of Condition(2)
 
Net Amounts of Liabilities Presented in Statement of Condition
Derivatives:
 
 
 
 
 
 
 
 
Foreign exchange contracts
 
$
6,356

 
$
(2,923
)
 
$
3,433

 
$
11,471

 
$
(4,514
)
 
$
6,957

Interest-rate contracts
 
270

 
(35
)
 
235

 
331

 
(59
)
 
272

Other derivative contracts
 
68

 
(2
)
 
66

 
9

 

 
9

Cash collateral netting
 

 
(214
)
 
(214
)
 

 
(979
)
 
(979
)
Total derivatives
 
$
6,694

 
$
(3,174
)
 
$
3,520

 
$
11,811

 
$
(5,552
)
 
$
6,259

Other financial instruments:
 
 
 
 
 
 
 
 
Repurchase agreements and securities lending(3)
 
$
45,772

 
$
(29,208
)
 
$
16,564

 
$
45,273

 
$
(30,700
)
 
$
14,573

Total derivatives and other financial instruments
 
$
52,466

 
$
(32,382
)
 
$
20,084

 
$
57,084

 
$
(36,252
)
 
$
20,832

 
 
 
 
 
(1) Amounts include all transactions regardless of whether or not they are subject to an enforceable netting arrangement.
(2) Amounts subject to netting arrangements which have been determined to be legally enforceable.
(3) Included in the $16,564 million as of June 30, 2014 were $9,168 million of repurchase agreements and $7,395 million of collateral received related to securities lending. Included in the $14,573 million as of December 31, 2013 were $7,953 million of repurchase agreements and $6,620 million of collateral received related to securities lending. Repurchase agreements and collateral received related to securities lending were recorded in securities sold under repurchase agreements and accrued expenses and other liabilities, respectively, in our consolidated statement of condition. Refer to note 7 for additional information with respect to principal securities finance transactions.
 
 
June 30, 2014
 
December 31, 2013
 
 
 
 
Gross Amounts Not Offset in Statement of Condition(1)
 
 
 
 
 
Gross Amounts Not Offset in Statement of Condition(1)
 
 
(In millions)
 
Net Amount of Liabilities Presented in Statement of Condition
 
Counterparty Netting
 
Collateral Provided
 
Net Amount(2)
 
Net Amount of Liabilities Presented in Statement of Condition
 
Counterparty Netting
 
Collateral Provided
 
Net Amount(2)
Derivatives
 
$
3,520

 
$

 
$
(11
)
 
$
3,509

 
$
6,259

 
$

 
$
(6
)
 
$
6,253

Repurchase agreements and securities lending
 
16,564

 
(163
)
 
(14,758
)
 
1,643

 
14,573

 
(131
)
 
(13,036
)
 
1,406

Total
 
$
20,084

 
$
(163
)
 
$
(14,769
)
 
$
5,152

 
$
20,832

 
$
(131
)
 
$
(13,042
)
 
$
7,659

 
 
 
 
 
(1) Amounts subject to netting arrangements which have been determined to be legally enforceable.
(2) Includes amounts secured by collateral not determined to be subject to enforceable netting arrangements.




128

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 14.    Net Interest Revenue
The following table presents the components of interest revenue and interest expense, and related net interest revenue, for the periods indicated:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In millions)
2014
 
2013
 
2014
 
2013
Interest revenue:
 
 
 
 
 
 
 
Deposits with banks
$
51

 
$
31

 
$
85

 
$
62

Investment securities:
 
 
 
 
 
 
 
U.S. Treasury and federal agencies
164

 
183

 
327

 
377

State and political subdivisions
44

 
54

 
115

 
105

Other investments
318

 
339

 
637

 
680

Securities purchased under resale agreements
10

 
12

 
19

 
25

Loans and leases
61

 
79

 
119

 
135

Other interest-earning assets
2

 
2

 
3

 
3

Total interest revenue
650

 
700

 
1,305

 
1,387

Interest expense:
 
 
 
 
 
 
 
Deposits
18

 
27

 
33

 
61

Short-term borrowings(1)
(12
)
 
15

 
3

 
31

Long-term debt
64

 
54

 
127

 
110

Other interest-bearing liabilities
19

 
8

 
26

 
13

Total interest expense
89

 
104

 
189

 
215

Net interest revenue
$
561

 
$
596

 
$
1,116

 
$
1,172

 
 
(1) The negative interest expense for the three months ended June 30, 2014 was associated with a reclassification of certain derivative contracts that hedge our interest-rate risk on certain assets and liabilities. This reclassification reduced total interest revenue and total interest expense for the three months ended June 30, 2014.
Note 15.    Expenses
Severance Costs:
We recorded $76 million of severance costs in the six months ended June 30, 2014, composed of $4 million in the three months ended June 30, 2014 and $72 million in the three months ended March 31, 2014. These severance costs were the result of staff reductions associated with the realignment of our cost base, and were recorded in compensation and employee benefits expenses in our consolidated statement of income.
 
Acquisition and Restructuring Costs:
The following table presents net acquisition and restructuring costs recorded in the periods indicated: 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(In millions)
 
2014
 
2013
 
2014
 
2013
Acquisition costs
 
$
15

 
$
19

 
$
36

 
$
34

Restructuring charges, net
 
13

 
11

 
25

 
10

Total acquisition and restructuring costs
 
$
28

 
$
30

 
$
61

 
$
44

Acquisition Costs
Acquisition costs recorded in the three and six months ended June 30, 2014 and the three and six months ended June 30, 2013 were related to previously disclosed acquisitions.
Restructuring Charges
Information with respect to our Business Operations and Information Technology Transformation program and our 2012 expense control measures, including charges, employee reductions and aggregate activity in the related accruals, is provided in the two sections that follow.
Business Operations and Information Technology Transformation Program
In November 2010, we announced a global multi-year Business Operations and Information Technology Transformation program. The program includes operational, information technology and targeted cost initiatives, including plans related to reductions in both staff and occupancy costs. To date, we have recorded aggregate restructuring charges of $400 million in our consolidated statement of income, composed of $156 million in 2010, $133 million in 2011, $67 million in 2012, $25 million in 2013 and $19 million in the six months ended June 30, 2014.
The charges related to the program included costs related to severance, benefits and outplacement services, as well as costs which resulted from actions taken to reduce our occupancy costs through the consolidation of leases and properties. The charges also included costs related to information technology, including transition fees associated with the expansion of our use of third-party service providers associated with components of our information technology infrastructure and application maintenance and support.


129

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

In 2010, in connection with the program, we initiated the involuntary termination of 1,400 employees, or approximately 5% of our global workforce, which we completed by the end of 2011. In addition, in connection with our announcement in 2011 of the expansion of our use of third-party service providers associated with our information technology infrastructure and application maintenance and support, as well as the continued execution of the business operations transformation component of the program, we identified 1,554 additional involuntary terminations. As of June 30, 2014, we eliminated 1,437 of these positions.
Expense Control Measures
In December 2012, in connection with expense control measures designed to better align our
 
expenses to our business strategy and related outlook for 2013, we identified additional targeted staff reductions. As a result of these actions, we have recorded aggregate pre-tax restructuring charges of $133 million in 2012, $3 million in 2013 and $6 million in the six months ended June 30, 2014 in our consolidated statement of income. Employee-related costs included severance, benefits and outplacement services. Costs for asset and other write-offs were primarily related to contract terminations. We originally identified involuntary terminations of 960 employees (630 positions after replacements).  As of March 31, 2014, we substantially completed these reductions.

Aggregate Restructuring-Related Accrual Activity
The following table presents aggregate activity associated with accruals that resulted from the charges associated with the Business Operations and Information Technology Transformation program and expense control measures: 
(In millions)
Employee-
Related
Costs
 
Real Estate Consolidation
 
Asset and Other Write-Offs
 
Total
Balance as of December 31, 2013
$
50

 
$
49

 
$
7

 
$
106

Additional accruals for Business Operations and Information Technology Transformation program
16

 
3

 

 
19

Additional accruals for 2012 expense control measures

 

 
6

 
6

Payments and adjustments
(26
)
 
(29
)
 
(4
)
 
(59
)
Balance as of June 30, 2014
$
40

 
$
23

 
$
9

 
$
72


130

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 16.    Earnings Per Common Share
The following tables present the computation of basic and diluted earnings per common share for the periods indicated:
 
Three Months Ended June 30,
(Dollars in millions, except per share amounts)
2014
 
2013
Net income
$
622

 
$
579

Less:
 
 
 
Preferred stock dividends
(19
)
 
(6
)
Dividends and undistributed earnings allocated to participating securities(1)
(1
)
 
(2
)
Net income available to common shareholders
$
602

 
$
571

Average common shares outstanding (in thousands):
 
 
 
Basic average common shares
427,824

 
452,176

Effect of dilutive securities: common stock options and common stock awards
7,496

 
8,864

Diluted average common shares
435,320

 
461,040

Anti-dilutive securities(2)
1,508

 
2,330

Earnings per Common Share:
 
 
 
Basic
$
1.41

 
$
1.26

Diluted(3)
1.38

 
1.24

 
Six Months Ended June 30,
(Dollars in millions, except per share amounts)
2014
 
2013
Net income
$
985

 
$
1,043

Less:
 
 
 
Preferred stock dividends
(25
)
 
(13
)
Dividends and undistributed earnings allocated to participating securities(1)
(2
)
 
(4
)
Net income available to common shareholders
$
958

 
$
1,026

Average common shares outstanding (in thousands):
 
 
 
Basic average common shares
429,215

 
453,240

Effect of dilutive securities: common stock options and common stock awards
7,743

 
8,390

Diluted average common shares
436,958

 
461,630

Anti-dilutive securities(2)
1,506

 
2,409

Earnings per Common Share:
 
 
 
Basic
$
2.23

 
$
2.26

Diluted(3)
2.19

 
2.22

 
 
(1) Represented the portion of net income available to common equity allocated to participating securities, composed of fully vested deferred director stock and unvested restricted stock that contain non-forfeitable rights to dividends during the vesting period on a basis equivalent to dividends paid to common shareholders.
(2) Represented common stock options and other equity-based awards outstanding but not included in the computation of diluted average common shares, because their effect was anti-dilutive.
(3) Calculations reflect allocation of earnings to participating securities using the two-class method, as this computation is more dilutive than the treasury stock method.
 
Note 17.    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 revenues, expenses and capital allocation methodologies associated with them, is provided in note 25 to the consolidated financial statements included in our 2013 Form 10-K.
The following tables provide a summary of our line-of-business results for the periods indicated. The “Other” column for three and six months ended June 30, 2014 included severance costs associated with staff reductions of $4 million and $76 million, respectively, as well as net acquisition and restructuring costs of $28 million and $61 million, respectively. In addition, the six months ended June 30, 2014 included net provisions for litigation exposure and other costs of $6 million. The “Other” column for three and six months ended June 30, 2013 included net acquisition and restructuring costs of $30 million and $44 million, respectively, as well as net provisions for litigation exposure and other costs of $15 million for both periods. The amounts in the “Other” columns were not allocated to State Street's business lines. Results for the 2013 periods reflect reclassifications, for comparative purposes, related to management changes in methodologies associated with allocations of revenue and expenses reflected in line-of-business results for 2014.

  


131

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

 
Three Months Ended June 30,
 
Investment
Servicing
 
Investment
Management
 
Other
 
Total
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
(Dollars in millions,
except where otherwise noted)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicing fees
$
1,288

 
$
1,201

 
$

 
$

 
$

 
$

 
$
1,288

 
$
1,201

Management fees

 

 
300

 
277

 

 

 
300

 
277

Trading services
249

 
287

 
11

 
17

 

 

 
260

 
304

Securities finance
147

 
131

 

 

 

 

 
147

 
131

Processing fees and other
42

 
58

 
2

 

 

 

 
44

 
58

Total fee revenue
1,726


1,677

 
313

 
294

 

 

 
2,039

 
1,971

Net interest revenue
545

 
571

 
16

 
25

 

 

 
561

 
596

Gains (losses) related to investment securities, net
(2
)
 
(7
)
 

 

 

 

 
(2
)
 
(7
)
Total revenue
2,269


2,241

 
329

 
319

 

 

 
2,598

 
2,560

Provision for loan losses
2

 

 

 

 

 

 
2

 

Total expenses
1,593

 
1,549

 
225

 
204

 
32

 
45

 
1,850

 
1,798

Income before income tax expense
$
674


$
692

 
$
104

 
$
115

 
$
(32
)
 
$
(45
)
 
$
746

 
$
762

Pre-tax margin
30
%
 
31
%
 
32
%
 
36
%
 
 
 
 
 
29
%
 
30
%
Average assets (in billions)
$
231.3

 
$
203.6

 
$
3.4

 
$
4.1

 
 
 
 
 
$
234.7

 
$
207.7

 
Six Months Ended June 30,
 
Investment
Servicing
 
Investment
Management
 
Other
 
Total
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
 
2014
 
2013
(Dollars in millions,
except where otherwise noted)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fee revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Servicing fees
$
2,526

 
$
2,376

 
$

 
$

 
$

 
$

 
$
2,526

 
$
2,376

Management fees

 

 
592

 
540

 

 

 
592

 
540

Trading services
490

 
552

 
23

 
41

 

 

 
513

 
593

Securities finance
232

 
209

 

 

 

 

 
232

 
209

Processing fees and other
97

 
105

 
3

 
5

 

 

 
100

 
110

Total fee revenue
3,345

 
3,242

 
618

 
586

 

 

 
3,963

 
3,828

Net interest revenue
1,083

 
1,128

 
33

 
44

 

 

 
1,116

 
1,172

Gains (losses) related to investment securities, net
4

 
(5
)
 

 

 

 

 
4

 
(5
)
Total revenue
4,432

 
4,365

 
651

 
630

 

 

 
5,083

 
4,995

Provision for loan losses
4

 

 

 

 

 

 
4

 

Total expenses
3,266

 
3,139

 
469

 
426

 
143

 
59

 
3,878

 
3,624

Income before income tax expense
$
1,162

 
$
1,226

 
$
182

 
$
204

 
$
(143
)
 
$
(59
)
 
$
1,201

 
$
1,371

Pre-tax margin
26
%
 
28
%
 
28
%
 
32
%
 
 
 
 
 
24
%
 
27
%
Average assets (in billions)
$
221.8

 
$
204.0

 
$
3.4

 
$
4.0

 
 
 
 
 
$
225.2

 
$
208.0


132

Table of Contents
STATE STREET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)
(UNAUDITED)

Note 18.    Non-U.S. Activities
We generally define our non-U.S. activities as those revenue-producing business activities that arise from clients domiciled outside the U.S. Due to the integrated nature of our business, precise segregation of our U.S. and non-U.S. activities is not possible. Subjective estimates and other judgments are applied to quantify the financial results and assets related to our non-U.S. activities, including our application of funds transfer pricing, our asset-and-liability management policies and our allocation of certain indirect corporate expenses. Interest expense allocations are based on our internal funds transfer pricing methodology.
The following table presents our non-U.S. financial results for the periods indicated.
 
Three Months Ended June 30,
(In millions)
2014
 
2013
Total fee revenue
$
838

 
$
811

Net interest revenue
341

 
295

Gains (losses) related to investment securities, net
(1
)
 
(7
)
Total revenue
1,178

 
1,099

Expenses
813

 
740

Income before income taxes
365

 
359

Income tax expense
87

 
85

Net income
$
278

 
$
274

 
Six Months Ended June 30,
(In millions)
2014
 
2013
Total fee revenue
$
1,626

 
$
1,576

Net interest revenue
666

 
568

Gains (losses) related to investment securities, net
5

 
(10
)
Total revenue
2,297

 
2,134

Expenses
1,652

 
1,493

Income before income taxes
645

 
641

Income tax expense
152

 
154

Net income
$
493

 
$
487








 

The following table presents the significant components of our non-U.S. assets as of the dates indicated, based on the domicile of the underlying counterparties:
(In millions)
June 30, 2014
 
December 31, 2013
Interest-bearing deposits with banks
$
15,969

 
$
9,584

Investment securities
32,642

 
31,522

Other assets
16,111

 
16,778

Total non-U.S. assets
$
64,722

 
$
57,884



133

Table of Contents

REVIEW REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Shareholders and Board of Directors of
State Street Corporation
We have reviewed the consolidated statement of condition of State Street Corporation (the “Corporation”) as of June 30, 2014, and the related consolidated statements of income and comprehensive income for the three- and six-month periods ended June 30, 2014 and 2013 and changes in shareholders' equity and cash flows for the six-month periods ended June 30, 2014 and 2013. These financial statements are the responsibility of the Corporation's management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statement of condition of State Street Corporation as of December 31, 2013, and the related consolidated statements of income, comprehensive income, changes in shareholders' equity, and cash flows for the year then ended, not presented herein, and in our report dated February 21, 2014, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying consolidated statement of condition of the Corporation as of December 31, 2013, is fairly stated, in all material respects, in relation to the consolidated statement of condition from which it has been derived.
/s/ Ernst & Young LLP
Boston, Massachusetts
August 8, 2014


134

Table of Contents

FORM 10-Q PART I CROSS-REFERENCE INDEX
The information required by the items presented below is incorporated herein by reference from the “Financial Information” section of this Form 10-Q.
 
 
 
PART I. FINANCIAL INFORMATION
 
Item 1.
Financial Statements
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.

PART II. OTHER INFORMATION

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(c) In March 2014, our Board of Directors approved a new common stock purchase program authorizing the purchase by us of up to $1.70 billion of our common stock through March 31, 2015.


 



The following table presents purchases of our common stock under this program and related information for each of the months in the quarter ended June 30, 2014. We may employ third-party broker/dealers to acquire shares on the open market in connection with our common stock purchase programs.

(Dollars in millions, except per share amounts, shares in thousands)
 
Total Number of Shares Purchased Under Publicly Announced Program
 
Average Price Paid Per Share
 
Approximate Dollar Value of Shares Purchased Under Publicly Announced Program
 
Approximate Dollar Value of Shares Yet to be Purchased Under Publicly Announced Program
 
Period:
 
 
 
 
 
 
 
 
 
April 1 - April 30, 2014
 
409

 
$
63.96

 
$
26

 
$
1,674

 
May 1 - May 31, 2014
 
4,105

 
64.40

 
264

 
1,410

 
June 1 - June 30, 2014
 
1,792

 
66.68

 
120

 
1,290

 
Total
 
6,306

 
$
65.02

 
$
410

 
$
1,290

 
ITEM 6.    EXHIBITS
The exhibits listed in the Exhibit Index following the signature page of this Form 10-Q are filed herewith or are incorporated herein by reference to other SEC filings.

135

Table of Contents

SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. 
 
 
 
 
 
STATE STREET CORPORATION
 
 
 
 
 
(Registrant)
 
 
 
 
 
 
Date:
August 8, 2014
 
By:
 
/s/ MICHAEL W. BELL
 
 
 
 
 
Michael W. Bell,
 
 
 
 
 
Executive Vice President, Chief Financial Officer and Chief Accounting Officer (Principal Financial Officer and Principal Accounting Officer)
 
 
 
 
 
 

136

Table of Contents

EXHIBIT INDEX
 
 
10.1†
 
Description of compensation arrangements for non-employee directors
 
 
 
 
 
12
 
Ratios of earnings to fixed charges
 
 
 
 
 
15
 
Letter regarding unaudited interim financial information
 
 
 
 
 
31.1
 
Rule 13a-14(a)/15d-14(a) Certification of Chairman, President and Chief Executive Officer
 
 
 
 
 
31.2
 
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer
 
 
 
 
 
32
 
Section 1350 Certifications
 
 
 
 
*
101.INS
 
XBRL Instance Document
 
 
 
 
*
101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
 
*
101.CAL
 
XBRL Taxonomy Calculation Linkbase Document
 
 
 
 
*
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
 
*
101.LAB
 
XBRL Taxonomy Label Linkbase Document
 
 
 
 
*
101.PRE
 
XBRL Taxonomy Presentation Linkbase Document
 
 
 
 
 
Denotes management contract or compensatory plan or arrangement
*
 
Submitted electronically herewith
Attached as Exhibit 101 to this report are the following formatted in XBRL (Extensible Business Reporting Language): (i) consolidated statement of income for the three and six months ended June 30, 2014 and 2013, (ii) consolidated statement of comprehensive income for the three and six months ended June 30, 2014 and 2013, (iii) consolidated statement of condition as of June 30, 2014 and December 31, 2013, (iv) consolidated statement of changes in shareholders' equity for the six months ended June 30, 2014 and 2013, (v) consolidated statement of cash flows for the six months ended June 30, 2014 and 2013, and (vi) condensed notes to consolidated financial statements.


137