OREANDA-NEWS. Fitch Ratings has affirmed State Street Corporation's (STT) Long-Term Issuer-Default Ratings (IDR) at 'AA-'. The Rating Outlook remains Stable. A full list of rating actions follows at the end of this release.

These rating actions were taken in conjunction with Fitch's U. S. trust and processing bank peer review. A full list of rating actions is at the end of this release.

KEY RATING DRIVERS

IDRs, VRs AND SENIOR DEBT

The affirmation of STT's ratings reflects its strong franchise in asset custody and asset management, stable operating performance, and relatively conservative overall balance sheet posture. Additionally, Fitch believes that management's continued efforts to streamline the business via its Project Beacon will continue to drive operational excellence and lead to more significant positive operating leverage in a higher short-term interest rate environment.

STT's high ratings continue to be supported by the company's strong business model, which Fitch believes is characterized by high barriers to entry and sticky customer relationships. STT's ratings are further enhanced by the company's good funding profile, consisting mainly of institutional custody deposits that Fitch considers to be core in nature. These factors offset the comparatively weaker earnings performance for STT over the last several years.

STT's -- as well as its peer trust and processing banks -- overall earnings performance as measured by return on assets (ROA) and return on equity (ROE) has been challenged amid the protracted low interest rate environment of the last several years.

STT's annualized ROE in the first quarter of 2016 (1Q16) was 6.8%, down from 9.8% in full-year 2015. Notably, 1Q16 included some charges, specifically related to the company's Project Beacon efficiency program, but given the recurring nature of these charges Fitch includes them in its ROE calculations. Nevertheless these results are below STT's long-term averages as well as Fitch's range of estimates for the company's cost of equity of between 10% - 12% over an extended period.

The main operating driver of the lower earnings performance continues to be the low interest rate environment, which has compressed the company's net interest margin (NIM) relative to historical periods. As of 1Q16, STT's NIM improved to 1.15% due in large part to the Federal Reserve's 25 basis point rate hike in December 2015, though it continues to remain below historical averages. As such the contribution of net interest income (NII) to total revenue was 21% in 1Q16, lower than the company's 10-year averages. Given the slower than anticipated pace of short-term interest rate increases so far this year, Fitch expects NII to hover around this contribution amount in 2016.

Despite the challenging interest rate environment, STT has demonstrated good fee growth in both its world class asset custody and administration (AUCA) business and its strong and growing asset management business. This will likely be further boosted by the acquisition of General Electric's (GE) asset management business.

STT's fee growth has also been supported by episodic improvements in foreign exchange (FX) trading anytime FX volatility increases. However, at the same time revenue from securities lending continues to be challenging amid low interest rates and weak demand for securities.

Fitch believes STT's management has done a good job of controlling expenses and utilizing technology to drive efficiency and digitize its operations. However, this expense management has largely been offset by higher compliance and regulatory related expenses, which Fitch believes are likely to persist in 2016 as STT looks to remedy any deficiencies related to its resolution planning process.

However, at some point, Fitch believes STT has the potential to drive strong positive operating leverage once compliance related costs begin to level-off and should short-term rates begin to increase both more quickly and more meaningfully. STT remains the most interest rate sensitive of its peer trust and processing banks.

With meaningfully higher short-term interest rates, Fitch believes it is possible that STT's pre-tax operating margin to rise higher than historical levels of 30%. Fitch believes this could drive ROE to levels commensurate with its cost of equity range of 10% - 12%, even with the higher levels of equity that STT is now carrying relative to historical time periods.

Fitch believes that STT is appropriately capitalized, given the agency's view of the company's relatively low-risk balance sheet. STT's combined available-for-sale (AFS) and held-to-maturity (HTM) securities portfolio is considered to be relatively low risk and highly liquid. The majority of the portfolio is composed of U. S. agency securities, and consistently greater than 90% of the portfolio components carry a 'AAA' or 'AA' rating.

STT's estimated common equity Tier I (CETI) under Basel III (Advanced Approach Fully Phased-In) was 11.9% as of 1Q16 and under the standardized approach was 12.0% at 1Q16. The lower of these two ratios is binding, though Fitch notes there has been convergence amongst these two ratios as under the advanced approach operational risk-weight charges have continued to increase. Additionally, Fitch would note that STT's Basel III CET1 capital ratios compare favourably with both U. S. and international peers, particularly in the context of the company's lower risk and highly liquid balance sheet as noted above.

Fitch believes, however, that STT's binding constraint capital ratio is the Enhanced Supplementary Leverage Ratio (SLR). Under the Advanced Approach on a Fully Phased-In Pro-Forma basis, the SLR was 6.0% at the parent company and 6.2% at the main operating bank as of 1Q16, both already above regulatory minimums.

In order to maintain SLR compliance as well as to reduce the recently finalized Global Systemically Important Bank (GSIB) surcharge of 150 basis points, Fitch expects STT to continue to aggressively manage non-operational deposits. To this end, STT has begun charging clients fees to hold deposits on balance sheet in some geographic locations as well as pushing excess client deposits away from the balance sheet.

SUBSIDIARY AND AFFILIATED COMPANY

In May of 2015, Fitch upgraded the rating of STT's main operating bank, State Street Bank & Trust (SSBT), to a Long-Term IDR of 'AA' from 'AA-'. The Outlooks on the Long-Term IDRs are Stable. The upgrade of SSBT's rating to a notch above the parent company's LT IDR reflects the expected implementation of total loss absorbing capital (TLAC) requirements for U. S. Global Systemically Important Banks (GSIBs).

The Viability Ratings (VRs) remain equalized between STT and its material operating subsidiaries, namely SSBT. The common VR of STT and its operating companies reflects the correlated performance, or failure rate between STT and these subsidiaries.

SUPPORT RATING AND SUPPORT RATING FLOOR

Additionally in May of 2015 Fitch downgraded the support ratings of SSBT and State Street Corporation (STT) to be in line with the agency's view of sovereign support. The Support Ratings (SR) of '5' and Support Rating Floors (SRF) of 'No Floor' reflect Fitch's view that senior creditors can no longer rely on receiving full extraordinary support from the sovereign in the event that State Street becomes non-viable.

In Fitch's view, implementation of the Dodd Frank Orderly Liquidation Authority legislation is now sufficiently progressed to provide a framework for resolving banks that is likely to require holding company senior creditors participating in losses, if necessary, instead of or ahead of the company receiving sovereign support.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

Subordinated debt and other hybrid capital issued by STT and by various issuing vehicles are all notched down from STT's or its bank subsidiaries' VRs in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles.

Subordinated debt is notched one notch down from the VR and preferred stock is notched down five notches from the VR. Capital trust securities have been notched down four notches from the VR.

LONG - AND SHORT-TERM DEPOSITS

With the upgrade of SSBT's Long-Term IDR in May of 2015, Fitch also upgraded SSBT's Long-Term Deposit ratings to 'AA+. The upgrade of SSBT's deposit ratings is based on the upgrade of their IDRs. Deposit ratings are one notch higher than senior debt reflecting the deposits' superior recovery prospects in case of default given depositor preference in the U. S.

RATING SENSITIVITIES

IDRs, VRs AND SENIOR DEBT

Given that STT's ratings are already near the top of Fitch's global rated bank universe, Fitch views limited potential for upwards ratings momentum.

Fitch believes that the main threat to STT's business model and ratings would result from a large idiosyncratic technological or operational loss resulting in reputational damage that causes clients to flee the firm. STT has been making significant investments in its technology systems over the past several years, which the agency believes helps to reduce potential idiosyncratic events that are prone to cause large losses.

Fitch believes these operational risks have been well monitored and controlled, but also acknowledges that they are inherently difficult to predict and quantify. As such, a large occurrence such that it causes a revenue loss of 5% or greater would likely prompt Fitch to review ratings to determine if a negative rating action was appropriate.

Additionally, should certain regulatory rules cause STT's management to aggressively expand its currently small leveraged loan portfolio such that in Fitch's opinion it alters the agency's view of STT's risk appetite this could, over time, result in negative ratings pressure.

Currently, Fitch does not expect the affirmative BREXIT vote to overly impact STT's business; however, it may change the way that STT conducts business with some of its foreign clients.

Finally, Fitch also notes that STT and its peer trust and processing banks are beginning to face risk of potential technological disruption to its business, though this is likely over a very long-term time horizon.

Blockchain, or distributed ledger, is an electronic means of settling, reconciling, and reporting on transactions, which is the core of STT and its peer banks' businesses. While Fitch believes that it is highly probable that STT and its peer trust and processing banks jointly work to harness this technology to drive efficiencies across their respective platforms, it's also possible that over a long period of time a technology company offers an alternative blockchain solution that in Fitch's view could potentially disrupt the trust banks business. At present, Fitch views this risk as well outside of the Rating Outlook horizon.

SUPPORT RATING AND SUPPORT RATING FLOOR

Any upward revision to the SR and SRF would be contingent on a positive change in the U. S.'s propensity to support its banks. While not impossible, Fitch views this as highly unlikely.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

STT's subordinated debt ratings are broadly sensitive to the same considerations that might affect STT's VR.

SUBSIDIARY AND AFFILIATED COMPANIES

Given that SSBT's and STT's VRs remain equalized, SSBT's ratings are broadly sensitive to the same considerations that might affect STT's VR.

LONG - AND SHORT-TERM DEPOSITS

The ratings of long - and short-term deposits issued by STT and its subsidiaries are primarily sensitive to any change in the State Street's IDR. This means that should a Long-Term IDR be downgraded, deposit ratings could be similarly impacted.

The rating actions are as follows:

Fitch has affirmed the following ratings:

State Street Corporation

--Long-Term IDR at 'AA-'; Outlook Stable;

--Short-Term IDR at 'F1+';

--Support at '5';

--Support Rating Floor at 'NF';

--Viability rating at 'aa-';

--Junior subordinated debt at 'BBB+';

--Commercial paper at 'F1+';

--Preferred stock at 'BBB';

--Long-Term senior debt at 'AA-';

--Long-Term subordinated notes at 'A+';

State Street Bank and Trust Company

--Long-Term IDR at 'AA'; Outlook Stable;

--Short-Term IDR at 'F1+';

--Support at '5';

--Support Rating Floor at 'NF';

--Viability rating at 'aa-';

--Short-Term deposits at 'F1+';

--Long-Term deposits at 'AA+';

--Long-Term subordinated at 'A+'.

State Street Capital Trust I

State Street Capital Trust IV

--Trust Preferred Securities at 'BBB+'.