10-Q
Table of Contents




UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
Form 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2016

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 April 30, 2016 was 395,940,301.













 
 
 
 
 




STATE STREET CORPORATION
QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED
MARCH 31, 2016

TABLE OF CONTENTS
 
 
PART I. FINANCIAL INFORMATION
 
PART II. OTHER INFORMATION
 
 
 















ACRONYMS
 
 
 
 
 
 
 
 
2015 Form 10-K
State Street Corporation Annual Report on Form 10-K for the year ended December 31, 2015
FRBB
Federal Reserve Bank of Boston
ABS
Asset-backed securities
FSB
Financial Stability Board
AFS
Available-for-sale
FX
Foreign exchange
ALLL
Allowance for loan and lease losses
GAAP
Generally accepted accounting principals
AML
Anti-money laundering
G-SIB
Global systemically important banks
AOCI
Accumulated other comprehensive income (loss)
HQLA(1)
High-quality liquid assets
ASU
Accounting Standards Update
HTM
Held-to-maturity
AUCA
Assets under custody and administration
LCR(1)
Liquidity coverage ratio
AUM
Assets under management
MRAC
Management Risk and Capital Committee
BCBS
Basel Committee on Banking Supervision
NIR
Net interest revenue
CCAR
Comprehensive Capital Analysis and Review
OCI
Other comprehensive income (loss)
CD
Certificates of deposit
OFAC
Office of Foreign Assets Control
CET1(1)
Common equity tier 1
OTC
Over-the-counter
CLO
Collateralized loan obligations
OTTI
Other-than-temporary-impairment
CRE
Commercial real estate
Parent Company
State Street Corporation
CVA
Credit valuation adjustment
PCA
Prompt corrective action
Dodd-Frank Act
Dodd-Frank Wall Street Reform and Consumer Protection Act
P&L
Profit-and-loss
ECB
European Central Bank
RWA(1)
Risk-weighted assets
EPS
Earnings per share
SEC
Securities and Exchange Commission
ERISA
Employee Retirement Income Security Act
SERP
Supplemental executive retirement plans
ERM
Enterprise Risk Management
SIFI
Systemically important financial institutions
ETF
Exchange-Traded Fund
SLR(1)
Supplementary leverage ratio
EVE
Economic value of equity
SSGA
State Street Global Advisors
FASB
Financial Accounting Standards Board
State Street Bank
State Street Bank and Trust Company
FCA
Financial Conduct Authority
TMRC
Trading and Markets Risk Committee
FDIC
Federal Deposit Insurance Corporation
VaR
Value-at-risk
Federal Reserve
Board of Governors of the Federal Reserve System
VIE
Variable interest entity
FHLB
Federal Home Loan Bank of Boston
 
 
 
 
 
 
(1) As defined by the applicable U.S. regulations.



Table of Contents





STATE STREET CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

TABLE OF CONTENTS
 
 
 
 


















We use acronyms and other defined terms for certain business terms and abbreviations, as defined on the acronyms list following the table of contents to this Form 10-Q.

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


GENERAL
State Street Corporation, referred to as the parent company, is a financial holding company organized in 1969 under the laws of the Commonwealth of Massachusetts. Our executive offices are located at One Lincoln Street, Boston, Massachusetts 02111 (telephone (617) 786-3000). For purposes of this Form 10-Q, unless the context requires otherwise, references to “State Street,” “we,” “us,” “our” or similar terms mean State Street Corporation and its subsidiaries on a consolidated basis. The parent company is a source of financial and managerial strength to our subsidiaries. Through our subsidiaries, including our principal banking subsidiary, State Street Bank and Trust Company, referred to as State Street Bank, we provide a broad range of financial products and services to institutional investors worldwide, with $26.94 trillion of AUCA and $2.30 trillion of AUM as of March 31, 2016.
As of March 31, 2016, we had consolidated total assets of $243.69 billion, consolidated total deposits of $185.52 billion, consolidated total shareholders' equity of $21.50 billion and 32,527 employees. We operate in more than 100 geographic markets worldwide, including in the U.S., Canada, Europe, the Middle East and Asia.
Our operations are organized for management reporting purposes into 2 lines of business: Investment Servicing and Investment Management, which are defined based on products and services provided.
Investment Servicing provides services for institutional clients, including 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 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 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 March 31, 2016, and updates the Management's Discussion and Analysis in our 2015 Form 10-K 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 our 2015 Form 10-K. 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 U.S. GAAP. The preparation of financial statements in conformity with U.S. 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 include accounting for fair value measurements; other-than-temporary impairment of investment securities; impairment of goodwill and other intangible assets; and contingencies. 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 2015 Form 10-K. We did not change these significant accounting policies in the first quarter of 2016.
Certain financial information provided in this Form 10-Q, including this Management's Discussion and Analysis, is prepared on both a U.S. 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


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AND RESULTS OF OPERATIONS (Continued)

financial trends with respect to our normal ongoing business operations. We believe that operating-basis financial information, 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 our underlying financial performance and trends in addition to financial information prepared and reported in conformity with U.S. GAAP. We also believe that the use of certain non-GAAP measures in the calculation of identified regulatory capital ratios is useful in understanding our 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 U.S. GAAP. Any non-GAAP, or operating-basis, financial information presented in this Form 10-Q, including this Management’s Discussion and Analysis, is reconciled to its most directly comparable U.S. 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), summary results of semi-annual State Street-run stress tests which we conduct under the Dodd-Frank Act, and resolution plan disclosures required under the Dodd-Frank Act. These additional disclosures are accessible 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.
We use acronyms and other defined terms for certain business terms and abbreviations, as defined on the acronyms list following the table of contents to this Form 10-Q.
Forward-Looking Statements
This Form 10-Q, as well as other reports and proxy materials 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 the 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, expected outcomes of legal proceedings, 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,” "priority," “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, regulatory environment and 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, the valuation of the U.S. dollar relative to other currencies in which we record revenue or accrue expenses and the performance and volatility of securities, credit, currency and other markets in the U.S. and internationally;


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AND RESULTS OF OPERATIONS (Continued)

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, our ability to manage levels of such deposits and the relative portion of our deposits that are determined to be operational under regulatory guidelines and our ability to deploy deposits in a profitable manner 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 changes to the regulatory framework applicable to our operations, including implementation of the Dodd-Frank Act, the Basel III final rule and European legislation (such as the Alternative Investment Fund Managers Directive, Undertakings for Collective Investment in Transferable Securities Directives and Markets in Financial Instruments Directive II); among other consequences, these regulatory changes impact the levels of regulatory capital we must maintain, acceptable levels of credit exposure to third parties, margin requirements applicable to derivatives, and restrictions on banking and financial activities. In addition, our regulatory posture and related expenses have been and will continue to be affected by changes in regulatory expectations for global systemically important financial institutions applicable to, among other things, risk management, liquidity and capital planning and compliance programs, and changes in governmental enforcement approaches to perceived failures to comply with regulatory or legal obligations;
we may not successfully implement our plans to address the deficiencies jointly identified by the Federal Reserve and the FDIC in April 2016 with respect to our 2015 resolution plan, or those plans may not be considered to be sufficient by the Federal Reserve and the FDIC, due to a number of factors, including, but not limited to challenges we may experience in interpreting and addressing regulatory expectations, failure to implement remediation in a timely manner, the  complexities of development of a
 
comprehensive plan to resolve a global custodial bank and related costs and dependencies. If we fail to meet regulatory expectations to the satisfaction of the Federal Reserve and the FDIC in our resolution plan submission due on October 1, 2016 or in any future submission, we could be subject to more stringent capital, leverage or liquidity requirements, or restrictions on our growth, activities or operations;
adverse changes in the regulatory ratios that we are required or will be required to meet, whether arising under the Dodd-Frank Act or the Basel III final rule, 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 U.S. and non-U.S. regulators for the use, allocation or distribution of our capital or other specific capital actions or programs, including acquisitions, dividends and stock purchases, without which our growth plans, distributions to shareholders, share repurchase 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 develop and execute State Street Beacon, our multi-year transformation program to create cost efficiencies and to fully digitize our business to support the development of new solutions and capabilities for our clients, any failure of which, in whole or in part, may among other things, reduce our competitive position, diminish the cost-effectiveness of our systems and processes or provide an


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AND RESULTS OF OPERATIONS (Continued)

insufficient return on our associated investment;
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 our review of our billing practices, including additional amounts we may be required to reimburse clients, as well as potential consequences of such review, including damage to our client relationships and adverse actions by governmental authorities;
the results of, and costs associated with, governmental or regulatory inquiries and investigations, litigation and similar claims, disputes, or civil or criminal proceedings;
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 depositary 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, 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;
our ability to expand our use of technology to enhance the efficiency, accuracy and reliability of our operations and our 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, manage expenses, attract and retain highly skilled people and raise the capital necessary to achieve our business goals and comply with regulatory requirements and expectations;
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 the amount of compensation we receive from clients 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 or liabilities 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 2015 Form 10-K. Forward-looking statements


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AND RESULTS OF OPERATIONS (Continued)

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 herein 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, financial condition or cash flows.
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
TABLE 1: OVERVIEW OF FINANCIAL RESULTS
 
 
Quarters Ended March 31,
 
(Dollars in millions, except per share amounts)
2016
 
2015
 
% Change
Total fee revenue
$
1,970

 
$
2,055

 
(4
)%
Net interest revenue
512

 
546

 
(6
)
Gains (losses) related to investment securities, net
2

 
(1
)
 
nm

Total revenue
2,484

 
2,600

 
(4
)
Provision for loan losses
4

 
4

 

Total expenses
2,050

 
2,097

 
(2
)
Income before income tax expense
430

 
499

 
(14
)
Income tax expense
62

 
94

 
(34
)
Net income
$
368


$
405


(9
)
Adjustments to net income:
 
 
 
 

Dividends on preferred stock(1)
(49
)
 
(31
)
 
58

Earnings allocated to participating securities(2)

 
(1
)
 
nm

Net income available to common shareholders
$
319

 
$
373

 
(14
)
Earnings per common share:
 
 
 
 
 
Basic
$
.80

 
$
.90

 
(11
)
Diluted
.79

 
.89

 
(11
)
Average common shares outstanding (in thousands):
 
 
 
 
 
Basic
399,421

 
412,225

 
 
Diluted
403,615

 
418,750

 
 
Cash dividends declared per common share
$
.34

 
$
.30

 
 
Return on average common equity
6.8
%
 
7.9
%
 
 
 
 
 
 
 
 
(1) Refer to Note 12 of the consolidated financial statements included in this Form 10-Q for additional information regarding our preferred stock dividends.
(2) Refer to Note 16 of the consolidated financial statements included in this Form 10-Q.
nm Not meaningful
 
The following “Highlights” and “Financial Results” sections provide information related to significant events, as well as highlights of our consolidated financial results for the quarter ended March 31, 2016 presented in Table 1: Overview of Financial Results. More detailed information about our consolidated financial results, including comparisons of our financial results for the quarter ended March 31, 2016 to those for the quarter ended March 31, 2015, is provided under “Consolidated Results of Operations,” which follows these sections. In this Management’s Discussion and Analysis, where we describe the effects of changes in foreign exchange rates, those effects are determined by applying applicable weighted average foreign exchange rates from the relevant 2015 period to the relevant 2016 results.
Highlights
We secured new asset servicing mandates of $263.9 billion in the first quarter of 2016; of that total, approximately $79.3 billion was installed prior to March 31, 2016, with the remaining balance expected to be installed in the remainder of 2016 or later.
Net inflows of AUM totaled $13 billion, which does not include $8 billion of new asset management business which was awarded to SSGA but not installed as of March 31, 2016.
We declared common stock dividends of $0.34 per share, totaling approximately $135 million in the first quarter of 2016.
In the first quarter of 2016, we purchased approximately 5.6 million shares of our common stock at an average per-share cost of $57.88 and an aggregate cost of approximately $325 million under our current program, approved by our Board in March 2015.
In the first quarter of 2016, we announced our agreement to acquire GE Asset Management in a cash transaction with a total purchase price of $435 million, subject to adjustments, with up to an additional $50 million tied to incremental opportunities with GE. Pending regulatory approvals and other customary closing conditions, the transaction is expected to be finalized early in the third quarter of 2016. As we integrate GE Asset Management into our business, we expect to incur merger and integration costs of approximately $70 million to $80 million through 2018.
In April 2016,
We sold the WM/Reuters branded foreign exchange benchmark


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AND RESULTS OF OPERATIONS (Continued)

business to Thomson Reuters. This sale will result in a gain of approximately $53 million ($40 million after-tax) in our results of operations for the second quarter of 2016.
We issued 20 million depositary shares, each representing 1/4,000th ownership interest in shares of State Street's fixed-to-floating rate non-cumulative perpetual preferred stock, Series G, without par value per share, 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 $494 million.
Additional information with respect to our common stock purchase program and stock dividends is provided under "Financial Condition - Capital" in this Management's Discussion and Analysis.
Financial Results
Total revenue in the first quarter of 2016 decreased 4% compared to the first quarter of 2015, primarily due to a 4% decrease in total fee revenue and a 6% decrease in net interest revenue.
Servicing fee revenue decreased 2% in the first quarter of 2016 compared to the first quarter of 2015, primarily due to lower global equity markets and the effect of the stronger U.S. dollar, partially offset by net new business.
Management fee revenue decreased 10% in the first quarter of 2016 compared to the first quarter of 2015, primarily due to lower global equity markets and decline in AUM, partially offset by lower money market fee waivers.
In the first quarter of 2016, we recorded restructuring charges of $97 million related to State Street Beacon, our multi-year transformation program to create cost efficiencies and to fully digitize our business to support the development of new solutions and capabilities for our clients. We are on track to generate at least $100 million in annualized pre-tax net run-rate savings in 2016, including the targeted staff reductions announced in the third quarter of 2015, compared to our full-year 2015 operating-basis expenses, all else being equal. The full effect of these savings will be felt in 2017.
 
Total expenses in the first quarter of 2016 decreased 2% compared to the first quarter of 2015, primarily driven by a decrease in other expenses and a decrease in securities processing costs, partially offset by an increase in restructuring costs and the effect of the stronger U.S. dollar.
Return on average common shareholders' equity decreased to 6.8% in the first quarter of 2016 compared to 7.9% in the first quarter of 2015.
CONSOLIDATED RESULTS OF OPERATIONS
This section discusses our consolidated results of operations for the quarter ended March 31, 2016 compared to the quarter ended March 31, 2015, and should be read in conjunction with the consolidated financial statements and accompanying condensed notes to the consolidated financial statements included in this Form 10-Q.
TOTAL REVENUE
TABLE 2: TOTAL REVENUE
 
Quarters Ended March 31,
 
 
(Dollars in millions)
2016
 
2015
 
%  Change
Fee revenue:
 
 
 
 
 
Servicing fees
$
1,242

 
$
1,268

 
(2
)%
Management fees
270

 
301

 
(10
)
Trading services:
 
 
 
 
 
Foreign exchange trading
156

 
203

 
(23
)
Brokerage and other trading services
116

 
121

 
(4
)
Total trading services
272

 
324

 
(16
)
Securities finance
134

 
101

 
33

Processing fees and other
52

 
61

 
(15
)
Total fee revenue
1,970

 
2,055

 
(4
)
Net interest revenue:
 
 
 
 
 
   Interest revenue
629

 
642

 
(2
)
   Interest expense
117

 
96

 
22

Net interest revenue
512

 
546

 
(6
)
Gains (losses) related to investment securities, net
2

 
(1
)
 
 
Total revenue
$
2,484

 
$
2,600

 
(4
)



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

FEE REVENUE
Table 2: Total Revenue, provides the breakout of fee revenue for the quarters ended March 31, 2016 and 2015.
Servicing and management fees collectively made up approximately 77% of our total fee revenue in the first quarter of 2016 compared to approximately 76% in the first quarter of 2015. 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, the geographical location in which services are provided and other factors, may have a significant effect on our servicing fee revenue.
Management fees are generally 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, as 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, 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, 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 include performance fee arrangements which are recorded when the performance period is complete. Performance fees are generated when the performance of certain managed portfolios 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 March 31, 2016 and assuming that all other factors remain constant, that:
A 10% increase or decrease in worldwide equity valuations, over the relevant periods for which our servicing and management fees are calculated, would result in a corresponding change in our total revenue of approximately 2%; and
A 10% increase or decrease in worldwide fixed income security valuations, over the relevant periods for which our servicing and management fees are calculated, would result in a corresponding change in our total revenue of approximately 1%.
See Table 3: Daily, Month-end and Quarter-end Indices, for 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.
Further discussion of fee revenue is provided under “Line of Business Information” in this Management's Discussion and Analysis.

TABLE 3: DAILY, MONTH-END AND QUARTER-END INDICES
 
Daily Averages of Indices
 
Averages of Month-End Indices
 
Quarter-End Indices
 
Quarters Ended March 31,
 
Quarters Ended March 31,
 
As of March 31,
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
 
2016
 
2015
 
% Change
S&P 500®
1,951

 
2,064

 
(5
)%
 
1,977

 
2,056

 
(4
)%
 
2,060

 
2,068

 
 %
NASDAQ®
4,614

 
4,825

 
(4
)
 
4,681

 
4,833

 
(3
)
 
4,870

 
4,901

 
(1
)
MSCI® EAFE®
1,594

 
1,817

 
(12
)
 
1,601

 
1,839

 
(13
)
 
1,652

 
1,849

 
(11
)
MSCI® Emerging Markets
757

 
969

 
(22
)
 
773

 
975

 
(21
)
 
837

 
975

 
(14
)

11


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

NET INTEREST REVENUE
See Table 2: Total Revenue, for the breakout of interest revenue and interest expense for the quarters ended March 31, 2016 and 2015.
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 interest-earning assets for the period. It is calculated by dividing fully taxable-equivalent net interest revenue by average interest-earning assets. 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.

TABLE 4: AVERAGE BALANCES AND INTEREST RATES - FULLY TAXABLE-EQUIVALENT BASIS
 
Quarters Ended March 31,
 
2016
 
2015
(Dollars in millions; fully taxable-equivalent basis)
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
 
Average
Balance
 
Interest
Revenue/
Expense
 
Rate
Interest-bearing deposits with banks
$
48,545

 
$
43

 
.36
%
 
$
71,568

 
$
54

 
.30
%
Securities purchased under resale agreements(1)
2,490

 
36

 
5.86

 
2,449

 
11

 
1.88

Trading account assets
860

 

 

 
1,117

 

 

Investment securities
100,899

 
488

 
1.94

 
112,656

 
544

 
1.93

Loans and leases
18,615

 
91

 
1.96

 
18,025

 
74

 
1.65

Other interest-earning assets
22,672

 
13

 
.22

 
20,544

 
3

 
.06

Average total interest-earning assets
$
194,081

 
$
671

 
1.39

 
$
226,359

 
$
686

 
1.23

Interest-bearing deposits:
 
 
 
 
 
 
 
 
 
 
 
U.S.
$
27,096

 
$
27

 
.40
%
 
$
30,174

 
$
10

 
.13
%
Non-U.S.
92,971

 
11

 
.05

 
103,831

 
16

 
.06

Securities sold under repurchase agreements
4,243

 

 

 
9,354

 

 

Federal funds purchased
15

 

 

 
24

 

 

Other short-term borrowings
1,688

 

 

 
4,448

 
1

 
.13

Long-term debt
11,027

 
61

 
2.20

 
9,707

 
62

 
2.55

Other interest-bearing liabilities
5,951

 
18

 
1.22

 
7,465

 
7

 
.41

Average total interest-bearing liabilities
$
142,991

 
$
117

 
.33

 
$
165,003

 
$
96

 
.24

Interest-rate spread
 
 
 
 
1.06
%
 
 
 
 
 
.99
%
Net interest revenue—fully taxable-equivalent basis
 
 
$
554

 
 
 
 
 
$
590

 
 
Net interest margin—fully taxable-equivalent basis
 
 
 
 
1.15
%
 
 
 
 
 
1.06
%
Tax-equivalent adjustment
 
 
(42
)
 
 
 
 
 
(44
)
 
 
Net interest revenue—GAAP basis
 
 
$
512

 
 
 
 
 
$
546

 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1) Reflects the impact of balance sheet netting under enforceable netting agreements.
Net interest revenue decreased 6% on a fully taxable-equivalent basis in the first quarter of 2016 compared to the first quarter of 2015. The decrease was generally the result of management actions taken towards the end of 2015 to better balance our clients' cash management needs with our economic and regulatory objectives. These actions contributed to a reduction of interest and non-interest bearing clients deposits of $24 billion as of March 31, 2016 compared to March 31, 2015. The first quarter 2016 reduction in net interest revenue also reflects our efforts to manage the size and composition of our investment portfolio as we seek to optimize our capital and liquidity positions in light of the evolving regulatory environment. Benefits during the first quarter of 2016 from the U.S. rate hike in December
 
2015 were partially offset by lower global interest rates that affected our revenue from certain floating-rate assets, the rate at which payments from the maturity or prepayment on portfolio holdings could be reinvested, and the effect of the stronger U.S. dollar.
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.
Average total interest-earning assets were lower for the quarter ended March 31, 2016 compared to the quarter ended March 31, 2015 as a result of the previously described management actions taken towards the end of 2015 to better balance our clients'


12


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

cash management needs with our economic and regulatory obligations which also reduced interest-earning assets by $32 billion compared to the first quarter of 2015.
The lower level of investment in interest-bearing deposits with banks during the quarter ended March 31, 2016 compared to the quarter ended March 31, 2015 resulted from management actions to reduce client deposits as part of our balance sheet management actions towards the end of 2015, while the increase in average loans and leases resulted from growth in municipal loans and our continued investment in senior secured loans, offset by a reduction in mutual fund lending.
Even though we have seen reductions in the overall level of excess deposits during the past year, our clients have continued to place elevated levels of deposits with us, as central bank actions have resulted in high levels of liquidity and low global interest rates. We evaluate deposits as either inherent in our relationship with our custodial clients, which we generally invest in our investment portfolio, or transient, or excess deposits, which we generally deposit with central banks. Deposits with central banks generate low returns. Consequently, the elevated levels of these transient deposits have contributed to a reduction of our net interest margin relative to historical levels.
The deposits with central banks are also included in our total consolidated assets, and lower deposit levels impact our regulatory leverage ratios. If global interest rates increase, we would expect to see some additional decreases in client deposits. In general, we continue to anticipate higher levels of client deposits when compared to longer-term historical trends, irrespective of the interest rate environment, particularly during periods of market stress. If ECB monetary policy continues to pressure European interest rates downward and the U.S. dollar remains strong or strengthens, the negative effects on our net interest revenue may continue or worsen.
The effect of the stronger U.S. dollar relative to other currencies, also negatively impacted our net interest revenue particularly the Euro, as we maintain a portion of our investment portfolio in Euro denominated securities.  The stronger U.S. dollar had the effect of reducing net interest revenue by approximately $4 million in the first quarter of 2016 compared to the first quarter of 2015.
We recorded aggregate discount accretion in interest revenue of $14 million in the first quarter of 2016 related to the assets we consolidated onto our balance sheet in 2009 from our asset-backed commercial paper conduits. Subsequent to the commercial paper conduit consolidation in 2009, we
 
have recorded total discount accretion in interest revenue as follows:
TABLE 5: TOTAL DISCOUNT ACCRETION IN INTEREST REVENUE
 
Discount Accretion in Interest Revenue
(In millions)
Twelve Months Ended December 31, 2009
$
621

Twelve Months Ended December 31, 2010
712

Twelve Months Ended December 31, 2011
220

Twelve Months Ended December 31, 2012
215

Twelve Months Ended December 31, 2013
137

Twelve Months Ended December 31, 2014
119

Twelve Months Ended December 31, 2015
98

Three Months Ended March 31, 2016
14

Total Discount Accretion
$
2,136

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 to our net interest revenue, though generally in declining amounts. Assuming that we hold them to maturity, all else being equal, we expect the remaining former conduit securities carried in our investment portfolio as of March 31, 2016 to generate aggregate discount accretion in future periods of approximately $201 million over their remaining terms, with approximately half of this discount accretion to be recorded over the next four years.
Interest-bearing deposits with banks averaged $48.55 billion for the quarter ended March 31, 2016 compared to $71.57 billion for the quarter ended March 31, 2015 and reflect management’s effort to reduce elevated client deposit levels as a component of our balance sheet management actions. These deposits reflected our maintenance of cash balances at the Federal Reserve, the ECB and other non-U.S. central banks both to satisfy regulatory reserve requirements, and elevated levels of client deposits and our investment of the excess deposits with central banks.


13


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

We expect to continue to invest deposits we deem as elevated in investment securities or short-term assets, including central bank deposits, depending on our assessment of the underlying characteristics of the deposits.
TABLE 6: U.S. AND NON-U.S. SHORT-DURATION ADVANCES
 
Quarters Ended March 31,
(In millions)
2016
 
2015
Average U.S. short-duration advances
$
2,230

 
$
2,364

Average non-U.S. short-duration advances
1,264

 
1,520

Average total short-duration advances
$
3,494

 
$
3,884

Average short-duration advances to average loans and leases
19
%
 
22
%
The decline in the proportion of average daily short-duration advances to average loans and leases is primarily due to growth in the other segments of the loan and lease portfolio. Short-duration advances provide liquidity to clients in support of their investment activities.
Average other interest-earning assets increased to $22.67 billion for the quarter ended March 31, 2016 from $20.54 billion for the quarter ended March 31, 2015. Growth in our enhanced custody business, which is our principal securities financing business for our custody clients, contributed to this increase. Our average other interest-earning assets, largely associated with our enhanced custody business, comprised approximately 12% of our average total interest-earning assets for the quarter ended March 31, 2016 compared to approximately 9% for the quarter ended March 31, 2015. The enhanced custody business supports our overall profitability by generating securities finance revenue. The net interest earned on these transactions is generally lower than the interest earned on other alternative investments.
Aggregate average interest-bearing deposits decreased to $120.07 billion for the quarter ended March 31, 2016 from $134.01 billion for the quarter ended March 31, 2015. The lower levels in the first quarter of 2016 were primarily the result of managements actions to reduce both U.S. and non-U.S. transaction accounts, offset by increases in time deposits. Future deposit levels will be influenced by the underlying asset servicing business, client deposit behavior, as well as market conditions, including the general levels of U.S. and non-U.S. interest rates.
Average other short-term borrowings declined to $1.69 billion for the quarter ended March 31, 2016 from $4.45 billion for the quarter ended March 31, 2015. The decrease was the result of State Street phasing-out its commercial paper program during 2015, consistent with the objectives of its 2015 recovery and resolution plan developed pursuant to the requirements of the Dodd-Frank Act.
 
Average long-term debt increased to $11.03 billion for the quarter ended March 31, 2016 from $9.71 billion for the quarter ended March 31, 2015. The increase primarily reflected the issuance of $3.0 billion of senior debt issued in August 2015 which was offset by a $900 million extendible note called at the end of February 2015 and the maturities of $200 million of senior debt in December 2015, $400 million of senior debt in January 2016 and $1.0 billion of senior debt in March 2016.
Average other interest-bearing liabilities decreased to $5.95 billion for the quarter ended March 31, 2016 from $7.47 billion for the quarter ended March 31, 2015, primarily the result of higher levels of cash collateral received from clients in connection with our enhanced custody business, which is presented on a net basis in accordance with enforceable netting agreements.
Average loans and leases also include short-duration advances. Average short-duration advances remained relatively flat for the quarter ended March 31, 2016 compared to the quarter ended March 31, 2015.
Several factors could affect future levels of our net interest revenue and margin, including the volume and 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; the yields earned on securities purchased compared to the yields earned on securities sold or matured; and changes in our enhanced custody business.
Based on market conditions and other factors, including regulatory requirements, 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, municipal 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, the implementation of regulatory standards, 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.


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

EXPENSES
TABLE 7: EXPENSES
 
 
 
 
 
 
Quarters Ended March 31,
 
 
(Dollars in millions)
2016
 
2015
 
% Change
Compensation and employee benefits
$
1,107

 
$
1,087

 
2
 %
Information systems and communications
272

 
247

 
10

Transaction processing services
200

 
197

 
2

Occupancy
113

 
113

 

Acquisition costs
7

 
5

 
40

Restructuring charges, net
97

 
1

 
nm

Other:
 
 
 
 
 
Professional services
93

 
96

 
(3
)
Amortization of other intangible assets
49

 
50

 
(2
)
Securities processing costs
4

 
20

 
(80
)
Regulatory fees and assessments
20

 
34

 
(41
)
Other
88

 
247

 
(64
)
Total other
254

 
447

 
(43
)
Total expenses
$
2,050

 
$
2,097

 
(2
)
Number of employees at quarter-end
32,527

 
30,495

 
 
 
 
nm Not meaningful
Compensation and employee benefits expenses increased 2% in the first quarter of 2016 compared to the first quarter of 2015. The increase in costs was primarily due to additional staffing to support regulatory initiatives and new business, partially offset by the effect of the stronger U.S. dollar and decreases in incentive compensation and benefits.
Compensation and employee benefits expenses in the first quarter of 2016 and the first quarter of 2015 included approximately $122 million and $137 million, respectively, of seasonal deferred incentive compensation expense for retirement-eligible employees and payroll taxes.
Information systems and communications expenses increased 10% in the first quarter of 2016 compared to the first quarter of 2015. The increase was primarily related to new software and systems going into production for corporate and regulatory initiatives and maintenance and new business, as well as additional related depreciation costs supporting these investments.
Other expenses decreased 43% in the first quarter of 2016 compared to the first quarter of 2015. The decrease was primarily due to legal accruals of $150 million in the first quarter of 2015. No such costs related to legal proceedings were accrued in the first quarter of 2016. The decrease was also driven by lower levels of professional services and lower insurance expenses related to lower assessment fees from the FDIC. The legal accrual is further discussed under "Legal and Regulatory Matters" in Note 10 to the consolidated financial statements included in this Form 10-Q.
 
Our compliance obligations have increased 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 regulatory compliance programs. We anticipate that these evolving and increasing regulatory compliance requirements and expectations, including our efforts to address the deficiencies identified in our resolution plan submitted to the Federal Reserve and FDIC on July 1, 2015 as discussed within the Liquidity Risk Management section included within this Form 10-Q, 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 first quarter of 2016, we recorded acquisition costs of $7 million, compared to $5 million in the first quarter of 2015. These amounts related to previously announced acquisitions.
Restructuring Charges
In the first quarter of 2016, we announced State Street Beacon, our multi-year transformation program to create cost efficiencies and to fully digitize our business to support the development of new solutions and capabilities for our clients.
To implement State Street Beacon, we expect to incur aggregate future pre-tax restructuring charges of approximately $300 million to $400 million beginning in 2016 through December 31, 2020. We estimate those charges will include approximately $250 million to $300 million in severance and benefits costs associated with targeted staff reductions (a substantial portion of which will result in future cash expenditures) and approximately $50 million to $100 million in information technology application rationalization and real estate actions.
In the first quarter of 2016, we recorded net restructuring charges of $97 million compared to $1 million in the first quarter of 2015. Increases in costs were primarily due to State Street Beacon, consisting of approximately $86 million of employee-related expenses and approximately $11 million of other restructuring costs.


15


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

INCOME TAX EXPENSE
Income tax expense was $62 million in the first quarter of 2016 compared to $94 million in the first quarter of 2015. Our effective tax rate in the first quarter of 2016 was 14.4% compared to 18.8% for the same period in 2015. The decrease in the tax rate is primarily due to additional alternative energy investments and foreign tax credits, as well as the effects of a non-deductible legal accrual in the first quarter of 2015.
LINE OF BUSINESS INFORMATION
Our operations are organized for management reporting purposes into two lines of business: Investment Servicing and Investment Management, which are defined based on products and services provided. 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. For information about our two lines of business, as well as the revenues, expenses and capital allocation methodologies associated with them, refer to Note 24 to the consolidated financial statements included in our 2015 Form 10-K.
Investment Servicing
TABLE 8: INVESTMENT SERVICING LINE OF BUSINESS RESULTS
 
Quarters Ended March 31,
 
 
(Dollars in millions, except where otherwise noted)
2016
 
2015
 
% Change
Servicing fees
$
1,242

 
$
1,268

 
(2
)%
Trading services
262

 
315

 
(17
)
Securities finance
134

 
101

 
33

Processing fees and other
45

 
59

 
(24
)
Total fee revenue
1,683

 
1,743

 
(3
)
Net interest revenue
511

 
545

 
(6
)
Gains (losses) related to investment securities, net
2

 
(1
)
 
nm

Total revenue
2,196

 
2,287

 
(4
)
Provision for loan losses
4

 
4

 

Total expenses
1,687

 
1,836

 
(8
)
Income before income tax expense
$
505

 
$
447

 
13

Pre-tax margin
23
%
 
20
%
 
 
 
 
 
nm- Not meaningful
Total revenue in the first quarter of 2016 for our Investment Servicing line of business, presented in Table 8: Investment Servicing Line of Business Results, decreased 4% compared to the first quarter of 2015. Total fee revenue decreased 3% in the first quarter of 2016 compared to the first quarter of 2015.
Net interest revenue decreased 6% in the first quarter of 2016 compared to the first quarter of 2015. The decrease was generally the result of our efforts to optimize our capital position, lower yields on interest-earning assets, as well as lower global interest rates, which affect our revenue from floating-
 
rate assets, and the effect of the stronger U.S. dollar, partially offset by the benefit of higher levels of interest-earning assets. A discussion of net interest revenue is provided under “Net Interest Revenue” in “Total Revenue” in this Management's Discussion and Analysis.
Total expenses decreased 8% in the first quarter of 2016 compared to the first quarter of 2015. The decrease primarily resulted from expenses for a legal accrual recorded in first quarter of 2015 in connection with management's intention to seek to resolve some, but not all, of the outstanding and potential claims arising out of our indirect FX client activities recorded in the first quarter of 2015.
In December 2015, we announced a review of the manner in which we invoiced certain expenses to certain of our Investment Servicing clients, primarily in the United States, during a period going back to 1998. We have informed our clients that we will pay to them the expenses we concluded were incorrectly invoiced to them, plus interest. In conjunction with that review, we are evaluating other aspects of invoicing relating to billing our Investment Servicing clients, including calculation of asset-based fees. See Note 10 to the consolidated financial statements included in this Form 10-Q.
Servicing Fees
Servicing fees decreased 2% in the first quarter of 2016 compared to the first quarter of 2015, primarily due to lower global equity markets and the effect of the stronger U.S. dollar, partially offset by net new business.
Servicing fees generated outside the U.S. were approximately 41% of total servicing fees in the quarters ended March 31, 2016 and 2015.
TABLE 9: COMPONENTS OF ASSETS UNDER CUSTODY AND ADMINISTRATION
(In billions)
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
Mutual funds
 
$
6,728

 
$
6,768

 
$
7,073

Collective funds
 
7,000

 
7,088

 
7,113

Pension products
 
5,197

 
5,510

 
5,745

Insurance and other products
 
8,018

 
8,142

 
8,560

Total
 
$
26,943

 
$
27,508

 
$
28,491

TABLE 10: COMPOSITION OF ASSETS UNDER CUSTODY AND ADMINISTRATION
(In billions)
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
Equities
 
$
14,433

 
$
14,888

 
$
15,660

Fixed-income
 
9,199

 
9,264

 
9,157

Short-term and other investments
 
3,311

 
3,356

 
3,674

Total
 
$
26,943

 
$
27,508

 
$
28,491



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

TABLE 11: GEORGRAPHIC MIX OF ASSETS UNDER CUSTODY AND ADMINISTRATION(1)
(In billions)
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
North America
 
$
20,505

 
$
20,842

 
$
21,554

Europe/Middle East/Africa
 
5,159

 
5,387

 
5,590

Asia/Pacific
 
1,279

 
1,279

 
1,347

Total
 
$
26,943

 
$
27,508

 
$
28,491

 
 
(1) Geographic mix is based on the location in which the assets are serviced.
Asset levels as of March 31, 2016 did not reflect the estimated $401.8 billion of new business in assets to be serviced, which was awarded to us in the first quarter of 2016 and prior periods but not installed prior to March 31, 2016. 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.
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.
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.
Trading Services
TABLE 12: TRADING SERVICES REVENUE
 
Quarters Ended March 31,
 
 
(Dollars in millions)
2016
 
2015
 
% Change
Foreign exchange trading:
 
 
 
 
 
Direct sales and trading
$
90

 
$
135

 
(33
)%
Indirect foreign exchange trading
66

 
68

 
(3
)
Total foreign exchange trading
156

 
203

 
(23
)
Brokerage and other trading services:
 
 
 
 
 
Electronic foreign exchange services
44

 
48

 
(8
)
Other trading, transition management and brokerage
62

 
64

 
(3
)
Total brokerage and other trading services
106

 
112

 
(5
)
Total trading services revenue
$
262

 
$
315

 
(17
)
Trading services revenue is composed of revenue generated by FX trading, as well as revenue generated by brokerage and other trading services. We primarily 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,” “indirect FX trading” and “electronic FX services.” With respect to electronic FX services, 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.
Our FX trading revenue is influenced by multiple factors, including: the volume and type of client FX transactions and related spreads; currency volatility, reflecting market conditions; and our management of exchange rate, interest rate and other market risks associated with our foreign exchange activities. The relative impact of these factors on our total FX trading revenues often differs from period to period. For example, assuming all other factors remain constant, increases or decreases in volumes or spreads across product mix tend to result in increases or decreases, as the case may be, in client-related FX revenue. Revenue earned from direct sales and trading and indirect FX trading is recorded in FX trading revenue.
Total FX trading revenue decreased 23% in the first quarter of 2016 compared to the first quarter of 2015, primarily due to lower volumes and volatility.
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” and it includes many transactions for funds serviced by third party custodians or prime brokers, as well as those funds under custody at State Street. Direct sales and trading revenue represented 58% of total foreign exchange trading revenue in the first quarter of 2016 compared to 67% in the first quarter of 2015.
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 trading” and, in all cases, we are the funds' custodian. We execute indirect FX trades as a principal at rates disclosed to our clients. Estimated indirect sales and trading revenue represented 42% of total foreign exchange trading revenue in the first quarter of 2016 as compared to 33% in the first quarter of 2015. We calculate revenue for indirect FX trading using an attribution methodology. This methodology takes into consideration estimated mark-ups/downs and


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

observed client volumes. Direct sales and trading revenue is all other FX trading revenue other than the revenue attributed to indirect FX trading.
Our clients that utilize indirect FX trading can, in addition to executing their FX transactions through dealers not affiliated with us, transition from indirect FX trading to either direct sales and trading execution, including our “Street FX” service, or to one of our electronic trading platforms. Street FX, in which we continue to act as a principal market-maker, enables our clients to define their FX execution strategy and automate the FX trade execution process, both for funds under custody with us as well as those under custody at another bank.
Our direct sales and trading revenue decreased 33% in the first quarter of 2016 as compared to the first quarter of 2015. The decrease primarily resulted from lower volumes and volatility. Our estimated indirect FX trading revenue decreased 3% in the first quarter of 2016 compared to the first quarter of 2015. The decrease mainly resulted from lower volume.
We continue to expect that some clients may choose, over time, to reduce their level of indirect FX trading transactions in favor of other execution methods, including either direct sales and trading transactions or electronic FX services 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 decreased 5% in the first quarter of 2016 compared to the first quarter of 2015. The decrease was primarily due to a one-time gain recorded in the first quarter of 2015.
Our clients may choose to execute FX transactions through one of our electronic trading platforms. These transactions generate revenue through a “click” fee. Revenue from such electronic FX services decreased 8% in the first quarter of 2016 compared to the first quarter of 2015, mainly due to declines in client volumes.
Other trading, transition management and brokerage revenue decreased 3% in the first quarter of 2016 compared to the first quarter of 2015, primarily due to a decrease in transition management revenue, partially offset by an increase in other trading revenue.
In recent years, our transition management revenue was adversely affected by compliance issues in our U.K. business during 2010 and 2011. The reputational and regulatory impact of those compliance issues continues and may adversely affect our revenue in future periods. See Note 10 to the consolidated financial statements included in this Form 10-Q.
 
Securities Finance
Our securities finance business consists of three components: (1) 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, (2) an agency lending program for third-party investment managers and asset owners, which we refer to as the agency lending funds and (3) security lending transactions which we enter into as principal, which we refer to as our enhanced custody business.
See Table 8: Investment Servicing Line of Business Results, for the comparison of securities finance revenue for the quarters ended March 31, 2016 and 2015.
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.
As principal, our enhanced custody business borrows securities from the lending client and then lends such securities to the subsequent borrower, either a State Street client or a broker/dealer. We act as principal when the lending client is unable to, or elects not to, transact directly with the market and execute the transaction and furnish the securities. In our role as principal, we provide support to the transaction through our credit rating. While we source a significant proportion of the securities furnished by us in our role as principal 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 increased 33% in the first quarter of 2016 compared to the first quarter of 2015. The increase was primarily the result of growth in our enhanced custody business and higher agency lending.
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, the constantly evolving regulatory environment 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 includes diverse types of fees and revenue, including fees from our structured products business, fees from software licensing and maintenance, equity income from our joint venture investments, gains and losses


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AND RESULTS OF OPERATIONS (Continued)

on sales of leased equipment and other assets, and amortization of our tax-advantaged investments.
Processing fees and other revenue, presented in Table 8: Investment Servicing Line of Business Results, decreased 24% in the first quarter of 2016 compared to the first quarter of 2015, primarily due to lower income from equity method investments.
Investment Management
TABLE 13: INVESTMENT MANAGEMENT LINE OF BUSINESS RESULTS
 
Quarters Ended March 31,
 
 
(Dollars in millions, except where otherwise noted)
2016
 
2015
 
% Change
Management fees
$
270

 
$
301

 
(10
)%
Trading services
10

 
9

 
11

Processing fees and other
7

 
2

 
nm

Total fee revenue
287

 
312

 
(8
)
Net interest revenue
1

 
1

 

Total revenue
288

 
313

 
(8
)
Total expenses
256

 
256

 

Income before income tax expense
$
32

 
$
57

 
(44
)
Pre-tax margin
11
%
 
18
%
 
 
 
 
nm Not meaningful
Total revenue for our Investment Management Line of Business, presented in Table 13: Investment Management Line of Business Results, decreased 8% in the first quarter of 2016 compared to the first quarter of 2015. Total fee revenue decreased 8% in the first quarter of 2016 compared to the first quarter of 2015.
Total expenses were flat in the first quarter of 2016 compared to the first quarter of 2015 resulting from increases in regulatory and compliance costs, offset by declines in other operating expenses.
Management Fees
Through SSGA, we provide a broad range of investment management strategies, specialized investment management advisory services and other financial services for corporations, public funds, and other sophisticated investors. SSGA offers an array of investment management strategies, including passive and active, such as enhanced indexing, using quantitative and fundamental methods for both U.S. and global equity and fixed income securities. SSGA also offers ETFs, such as the SPDR® ETF brand. While certain management fees are directly determined by the values of assets under management and the investment strategies employed, management fees reflect other factors as well, including our relationship pricing for clients who
 
use multiple services, and the benchmarks specified in the respective management agreements related to performance fees.
Management fees decreased $31 million, or 10%, in the first quarter of 2016 compared to the first quarter of 2015 primarily due to lower global equity markets and net outflows, partially offset by lower money market fee waivers.
Management fees generated outside the U.S. were approximately 36% of total management fees in the first quarter of 2016 compared to 34% in the first quarter of 2015.
TABLE 14: ASSETS UNDER MANAGEMENT BY ASSET CLASS AND INVESTMENT APPROACH(1)
 
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
(In billions)
 
 
 
 
 
 
Equity:
 
 
 
 
 
 
   Active
 
$
32

 
$
32

 
$
38

   Passive
 
1,295

 
1,294

 
1,434

Total Equity
 
1,327

 
1,326

 
1,472

Fixed-Income:
 
 
 
 
 
 
   Active
 
17

 
18

 
17

   Passive
 
310

 
294

 
306

Total Fixed-Income
 
327

 
312

 
323

Cash(1)
 
381

 
368

 
393

Multi-Asset-Class Solutions:
 
 
 
 
 
 
   Active
 
17

 
17

 
31

   Passive
 
92

 
86

 
84

Total Multi-Asset-Class Solutions
 
109

 
103

 
115

Alternative Investments(2):
 
 
 
 
 
 
   Active
 
18

 
17

 
17

   Passive
 
134

 
119

 
123

Total Alternative Investments
 
152

 
136

 
140

Total
 
$
2,296

 
$
2,245

 
$
2,443

 
 
(1) Includes both floating- and constant-net-asset-value portfolios held in commingled structures or separate accounts.
(2) 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.
TABLE 15: EXCHANGE - TRADED FUNDS BY ASSET CLASS(1)(2)
 
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
(In billions)
 
 
 
 
 
 
Alternative Investments(2)
 
$
45

 
$
34

 
$
40

Cash
 
3

 
3

 
1

Equity
 
349

 
350

 
356

Fixed-income
 
46

 
41

 
43

Total Exchange-Traded Funds
 
$
443

 
$
428

 
$
440

 
 
(1) ETFs 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.


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AND RESULTS OF OPERATIONS (Continued)

TABLE 16: GEOGRAPHIC MIX OF ASSETS UNDER MANAGEMENT(1)
 
 
March 31, 2016
 
December 31, 2015
 
March 31, 2015
(In billions)
 
 
 
 
 
 
North America
 
$
1,491

 
$
1,452

 
$
1,549

Europe/Middle East/Africa
 
496

 
489

 
566

Asia/Pacific
 
309

 
304

 
328

Total
 
$
2,296

 
$
2,245

 
$
2,443

 
 
(1) Geographic mix is based on client location or fund management location.

TABLE 17: ACTIVITY IN ASSETS UNDER MANAGEMENT BY PRODUCT CATEGORY
(In billions)
Equity
 
Fixed-Income
 
Cash(2)
 
Multi-Asset-Class Solutions
 
Alternative Investments(3)
 
Total
Balance as of March 31, 2015
$
1,472

 
$
323

 
$
393

 
$
115

 
$
140

 
$
2,443

Long-term institutional inflows(1)
210

 
43

 

 
41

 
24

 
318

Long-term institutional outflows(1)
(297
)
 
(52
)
 

 
(35
)
 
(27
)
 
(411
)
Long-term institutional flows, net
(87
)
 
(9
)
 

 
6

 
(3
)
 
(93
)
ETF flows, net
4

 
1

 
1

 

 
(3
)
 
3

Cash fund flows, net

 

 
(24
)
 

 

 
(24
)
Total flows, net
(83
)
 
(8
)
 
(23
)
 
6

 
(6
)
 
(114
)
Market appreciation(2)
(61
)
 
(2
)
 
(1
)
 
(18
)
 
5

 
(77
)
Foreign exchange impact(2)
(2
)
 
(1
)
 
(1
)
 

 
(3
)
 
(7
)
Total market/foreign exchange impact
(63
)
 
(3
)
 
(2
)
 
(18
)
 
2

 
(84
)
Balance as of December 31, 2015
1,326

 
312

 
368

 
103

 
136

 
2,245

Long-term institutional inflows(1)
63

 
17

 

 
12

 
2

 
94

Long-term institutional outflows(1)
(67
)
 
(20
)
 

 
(9
)
 
(3
)
 
(99
)
Long-term institutional flows, net
(4
)
 
(3
)
 

 
3

 
(1
)
 
(5
)
ETF flows, net
(4
)
 
4

 

 

 
7

 
7

Cash fund flows, net

 

 
11

 

 

 
11

Total flows, net
(8
)
 
1

 
11

 
3

 
6

 
13

Market appreciation
(1
)
 
9

 

 
2

 
7

 
17

Foreign exchange impact
10

 
5

 
2

 
1

 
3

 
21

Total market/foreign exchange impact
9

 
14

 
2

 
3

 
10

 
38

Balance as of March 31, 2016
$
1,327

 
$
327

 
$
381

 
$
109

 
$
152

 
$
2,296

 
 
(1) Amounts represent long-term portfolios, excluding ETFs.
(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.
The positive net flows of approximately $13 billion in AUM as of March 31, 2016 compared to December 31, 2015 presented in the preceding table did not include approximately $8 billion of new asset management business, which was awarded to SSGA but not installed as of March 31, 2016. 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 AUM as of March 31, 2016 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.


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

FINANCIAL CONDITION
The structure of our consolidated statement of condition is primarily driven by the liabilities generated by our Investment Servicing and Investment Management lines of business. Our clients' needs and our operating objectives determine balance sheet volume, mix, and currency denomination. As our clients execute their worldwide cash management and investment activities, they utilize deposits and short-term investments that constitute the majority of our liabilities. These liabilities are generally in the form of interest-bearing transaction account deposits, which are denominated in a variety of currencies; non-interest-bearing demand deposits; and repurchase agreements, which generally serve as short-term investment alternatives for our clients.
Deposits and other liabilities resulting from client initiated transactions are invested in assets that generally have contractual maturities significantly longer than our liabilities; however, we evaluate the operational nature of our deposits and seek to maintain appropriate short-term liquidity of those liabilities that are not operational in nature and maintain longer-termed assets for our operational deposits. Our assets consist primarily of securities held in our available-for-sale or held-to-maturity portfolios and short-duration financial instruments, such as interest-bearing deposits with banks and securities purchased under resale agreements. The actual mix of assets is determined by the characteristics of the client liabilities and our desire to maintain a well-diversified portfolio of high-quality assets.
 
TABLE 18: AVERAGE STATEMENT OF CONDITION(1) 
 
Quarters Ended March 31,
 
2016
 
2015
(In millions)
Average Balance
 
Average Balance
Assets:
 
 
 
Interest-bearing deposits with banks
$
48,545

 
$
71,568

Securities purchased under resale agreements
2,490

 
2,449

Trading account assets
860

 
1,117

Investment securities
100,899

 
112,656

Loans and leases
18,615

 
18,025

Other interest-earning assets
22,672

 
20,544

Average total interest-earning assets
194,081

 
226,359

Cash and due from banks
2,690

 
2,397

Other noninterest-earning assets
26,852

 
30,297

Average total assets
$
223,623

 
$
259,053

Liabilities and shareholders’ equity:
 
 
 
Interest-bearing deposits:
 
 
 
U.S.
$
27,096

 
$
30,174

Non-U.S.
92,971

 
103,831

Total interest-bearing deposits
120,067

 
134,005

Securities sold under repurchase agreements
4,243

 
9,354

Federal funds purchased
15

 
24

Other short-term borrowings
1,688

 
4,448

Long-term debt
11,027

 
9,707

Other interest-bearing liabilities
5,951

 
7,465

Average total interest-bearing liabilities
142,991

 
165,003

Noninterest-bearing deposits
45,001

 
55,066

Other noninterest-bearing liabilities
14,053

 
17,767

Preferred shareholders’ equity
2,703

 
1,961

Common shareholders’ equity
18,875

 
19,256

Average total liabilities and shareholders’ equity
$
223,623

 
$
259,053

 
 
(1) 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.


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AND RESULTS OF OPERATIONS (Continued)

Investment Securities
TABLE 19: CARRYING VALUES OF INVESTMENT SECURITIES
(In millions)
March 31, 2016
 
December 31, 2015
Available for sale:
 
 
 
U.S. Treasury and federal agencies:
Direct obligations
$
6,342

 
$
5,718

Mortgage-backed securities
18,234

 
18,165

Asset-backed securities:
 
 
 
Student loans(1) 
6,817

 
7,176

Credit cards
1,368

 
1,341

Sub-prime
388

 
419

Other
1,813

 
1,764

Total asset-backed securities
10,386

 
10,700

Non-U.S. debt securities:
 
 
 
Mortgage-backed securities
7,612

 
7,071

Asset-backed securities
2,704

 
3,267

Government securities
5,070

 
4,355

Other
5,009

 
4,834

Total non-U.S. debt securities
20,395

 
19,527

State and political subdivisions
10,026

 
9,746

Collateralized mortgage obligations
2,938

 
2,987

Other U.S. debt securities
2,231

 
2,624

U.S. equity securities
40

 
39

Non-U.S. equity securities
3

 
3

U.S. money-market mutual funds
473

 
542

Non-U.S. money-market mutual funds
18

 
19

Total
$
71,086

 
$
70,070

 
 
 
 
Held to maturity:
 
 
 
U.S. Treasury and federal agencies:
Direct obligations
$
22,603

 
$
20,878

Mortgage-backed securities
588

 
610

Asset-backed securities:
 
 
 
Student loans(1) 
1,544

 
1,592

Credit cards
897

 
897

Other
277

 
366

Total asset-backed securities
2,718

 
2,855

Non-U.S. debt securities:
 
 
 
Mortgage-backed securities
2,147

 
2,202

Asset-backed securities
1,109

 
1,415

Government securities
273

 
239

Other
217

 
65

Total non-U.S. debt securities
3,746

 
3,921

State and political subdivisions

 
1

Collateralized mortgage obligations
1,557

 
1,687

Total
$
31,212

 
$
29,952

 
 
(1) Primarily 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 that we consider to be operational deposits 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.
Approximately 93% of the carrying value of the portfolio was rated “AAA” or “AA” as of March 31, 2016 and 92% as of December 31, 2015.
TABLE 20: INVESTMENT PORTFOLIO BY EXTERNAL CREDIT RATING
 
March 31, 2016
 
December 31, 2015
AAA(1)
80
%
 
80
%
AA
13

 
12

A
4

 
5

BBB
2

 
2

Below BBB
1

 
1

 
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 March 31, 2016, the investment portfolio of 12,862 securities was diversified with respect to asset class. Approximately 49% of the aggregate carrying value of the portfolio as of March 31, 2016 was composed of mortgage-backed and asset-backed securities, compared to 51% as of December 31, 2015. The asset-backed securities portfolio, of which approximately 92% of the carrying value as of both March 31, 2016 and December 31, 2015 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 Volcker rule. The Volcker rule will, over time, prohibit banking entities, including us and our affiliates, from engaging in certain prohibited proprietary trading activities, as defined in the final Volcker rule regulations, subject to exemptions for market making-related activities, risk-mitigating hedging, underwriting and certain other activities. The Volcker rule will also require banking entities to either restructure or divest certain ownership interests in, and relationships with, covered funds (as such terms are defined in the final Volcker rule regulations).
The Volcker rule became effective in July 2012, and the final implementing regulations became


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AND RESULTS OF OPERATIONS (Continued)

effective in April 2014. We were required to bring our activities and investments into conformance with the Volcker rule and its final regulations by July 21, 2015. In December 2014, the Federal Reserve issued an order, the 2016 conformance period extension, extending the Volcker rule’s general conformance period until July 21, 2016 for investments in and relationships with covered funds and certain foreign funds that were in place on or prior to December 31, 2013, referred to as legacy covered funds. Under the 2016 conformance period extension, all investments in and relationships with investments in a covered fund made or entered into after December 31, 2013 by a banking entity and its affiliates, and all proprietary trading activities of those entities, were required to be in conformance with the Volcker rule and its final implementing regulations by July 21, 2015. The Federal Reserve stated in the 2016 conformance period extension that it intends to grant a final one-year extension of the general conformance period, to July 21, 2017, for banking entities to conform ownership interests in and relationships with legacy covered funds.
Whether certain types of investment securities or structures such as CLOs constitute covered funds, as defined in the final Volcker rule regulations, and do not benefit from the exemptions provided in the Volcker rule, and whether a banking organization's investments therein constitute ownership interests remain subject to (1) market, and ultimately regulatory, interpretation, and (2) the specific terms and other characteristics relevant to such investment securities and structures.
As of March 31, 2016, we held approximately $2.10 billion of investments in CLOs. As of the same date, these investments had an aggregate pre-tax net unrealized gain of approximately $29 million, composed of gross unrealized gains of $36 million and gross unrealized losses of $7 million. Comparatively, as of December 31, 2015, we held approximately $2.10 billion of investments in CLOs which had an aggregate pre-tax net unrealized gain of approximately $43 million, composed of gross unrealized gains of $46 million and gross unrealized losses of $3 million. In the event that we or our banking regulators conclude that such investments in CLOs, or other investments, are covered funds under the Volker rule, we may be required to divest of such investments. 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 of 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 or on our consolidated financial condition in the period in which such a divestiture occurs.
 
The final Volcker rule regulations also require banking entities to establish extensive programs designed to ensure compliance with the restrictions of the Volcker rule. We have established a compliance program which we believe complies with the final Volcker rule regulations as currently in effect. Such compliance program restricts our ability in the future to service certain types of funds, in particular covered funds for which SSGA acts as an advisor and certain types of trustee relationships. Consequently, Volcker rule compliance entails both the cost of a compliance program and loss of certain revenue and future opportunities.
Non-U.S. Debt Securities
Approximately 24% of the aggregate carrying value of our investment securities portfolio was non-U.S. debt securities as of March 31, 2016 compared to approximately 23% as of December 31, 2015.
TABLE 21: NON-U.S. DEBT SECURITIES
(In millions)
March 31, 2016
 
December 31, 2015
Available for sale:
 
 
 
United Kingdom
$
5,664

 
$
5,754

Australia
3,473

 
3,316

Canada
2,612

 
2,400

Netherlands
1,877

 
1,839

Japan
1,445

 
1,348

South Korea
1,103

 
1,052

France
943

 
954

Germany
892

 
990

Italy
592

 
389

Norway
582

 
524

Finland
305

 
319

Belgium
245

 
234

Sweden
222

 
123

Hong Kong
123

 

Other(1)
317

 
285

Total
$
20,395

 
$
19,527

Held to maturity:
 
 
 
United Kingdom
$
973

 
$
1,067

Australia
900

 
917

Germany
730

 
832

Netherlands
691

 
684

Singapore
158

 
129

Spain
111

 
108

Italy
59

 
59

Ireland
11

 
10

Other(2)
113

 
115

Total
$
3,746

 
$
3,921

 
 
(1) Included approximately $272 million and $205 million as of March 31, 2016 and December 31, 2015, respectively, related to Portugal, Ireland, Austria and Spain, all of which were related to mortgage-backed securities and auto loans.
(2) Included approximately $32 million and $31 million as of March 31, 2016 and December 31, 2015, respectively, of securities related to Portugal, all of which were mortgage-backed securities.
Approximately 88% and 89% of the aggregate carrying value of these non-U.S. debt securities was rated “AAA” or “AA” as of March 31, 2016 and December 31, 2015, respectively. The majority of these securities comprised senior positions within the


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AND RESULTS OF OPERATIONS (Continued)

security structures; these positions have a level of protection provided through subordination and other forms of credit protection. As of March 31, 2016 and December 31, 2015, approximately 69% and 70%, respectively, of the aggregate carrying value of these non-U.S. debt securities was floating-rate, and accordingly, we consider these securities to have minimal interest-rate risk.
As of March 31, 2016, our non-U.S. debt securities had an average market-to-book ratio of 100.6%, and an aggregate pre-tax net unrealized gain of approximately $136 million, composed of gross unrealized gains of $214 million and gross unrealized losses of $78 million. These unrealized amounts included a pre-tax net unrealized gain of $62 million, composed of gross unrealized gains of $105 million and gross unrealized losses of $43 million, associated with non-U.S. debt securities available for sale.
As of March 31, 2016, the underlying collateral for non-U.S. 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 and covered bonds. The securities listed under “France” were composed of automobile loans, prime mortgages, and corporate debt and covered bonds. 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.
Additional information on our exposures relating to Spain, Italy, Ireland and Portugal as of March 31, 2016 is provided under "Financial Condition - Cross-Border Outstandings" in this Management's Discussion and Analysis.
Municipal Obligations
We carried approximately $10.03 billion of municipal securities classified as state and political subdivisions in our investment securities portfolio as of March 31, 2016 as shown in Table 19: Carrying Values of Investment Securities. Substantially all of these securities were classified as AFS, with the remainder classified as HTM. As of the same date, we also provided approximately $8.79 billion of credit and liquidity facilities to municipal issuers.
 
TABLE 22: STATE AND MUNICIPAL OBLIGORS (1)
(Dollars in millions)
Total  Municipal
Securities
 
Credit and
Liquidity 
Facilities(2)
 
Total
 
% of Total Municipal
Exposure
March 31, 2016
 
 
 
 
 
 
State of Issuer:
 
 
 
 
 
 
Texas
$
1,342

 
$
1,743

 
$
3,085

 
16
%
California
487

 
2,241

 
2,728

 
15

New York
817

 
1,101

 
1,918

 
10

Massachusetts
934

 
900

 
1,834

 
10

Maryland
490

 
413

 
903

 
5

Total
$
4,070

 
$
6,398

 
$
10,468

 
 
 
 
 
 
 
 
 
 
December 31, 2015
 
 
 
 
 
 
State of Issuer:
 
 
 
 
 
 
Texas
$
1,250

 
$
1,962

 
$
3,212

 
17
%
California
444

 
2,220

 
2,664

 
14

New York
817

 
1,259

 
2,076

 
11

Massachusetts
927

 
731

 
1,658

 
9

Maryland
454

 
413

 
867

 
5

Total
$
3,892

 
$
6,585

 
$
10,477

 
 
 
 
 
 
(1) Represented 5% or more of our aggregate municipal credit exposure of approximately $18.81 billion and $18.50 billion across our businesses as of March 31, 2016 and December 31, 2015, respectively.
(2) Includes municipal loans which are also presented within Table 24.
Our aggregate municipal securities exposure presented in Table 22: State and Municipal Obligors, was concentrated primarily with highly-rated counterparties, with approximately 91% of the obligors rated “AAA” or “AA” as of March 31, 2016. As of that date, approximately 58% and 37% of our aggregate municipal securities exposure was associated with general obligation and revenue bonds, respectively. In addition, we had no exposures associated with 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.
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 AFS and HTM debt securities, 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).


24


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

The increase in the net unrealized gain position as of March 31, 2016 as compared to December 31, 2015, presented in Table 23: Amortized Cost, Fair Value and Net Unrealized Gains (Losses) of Investment Securities, was primarily attributable to the decline in interest rates during the quarter.
TABLE 23: AMORTIZED COST, FAIR VALUE AND NET UNREALIZED GAINS (LOSSES) OF INVESTMENT SECURITIES
 
March 31, 2016
 
December 31, 2015
(In millions)
Amortized Cost
 
Net Unrealized Gains(Losses)
 
Fair Value
 
Amortized Cost
 
Net Unrealized Gains(Losses)<