EXHIBIT 13.4
CONSOLIDATED STATEMENT OF CASH FLOWS
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STATE STREET BOSTON CORPORATION
NOTES TO FINANCIAL STATEMENTS
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STATE STREET BOSTON CORPORATION
NOTES TO FINANCIAL STATEMENTS
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STATE STREET BOSTON CORPORATION
NOTE A-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
State Street Boston Corporation ("State Street") is a financial services
corporation and provides banking, trust, investment management and securities
processing services to both domestic and global customers. State Street's
primary focus is servicing and managing financial assets on a global scale.
State Street has three lines of business:financial asset services, investment
management and commercial lending. Financial asset services are primarily
accounting, custody, banking and other services for large pools of assets such
as mutual funds and pension plans, participant recordkeeping for defined
contribution plans and corporate trusteeships. Financial asset services is State
Street's predominate line of business. Investment management is comprised of the
business components that manage financial assets worldwide, both institutional
investment management and personal trust services. Commercial lending activities
include regional middle market, specialized and trade finance lending as well
as asset-based finance and leasing.
The accounting and reporting policies of State Street and its
subsidiaries conform to generally accepted accounting principles. The
significant policies are summarized below.
BASIS OF PRESENTATION: The consolidated financial statements include the
accounts of State Street and its subsidiaries, including its principal
subsidiary, State Street Bank and Trust Company ("State Street Bank"). The
preparation of financial statements requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates. All
significant intercompany balances and transactions have been eliminated upon
consolidation. The results of operations of businesses purchased are included
from the date of acquisition. Investments in 50%-owned affiliates are accounted
for by the equity method. Certain previously reported amounts have been
reclassified to conform to the current method of presentation. For the
Consolidated Statement of Cash Flows, State Street has defined cash equivalents
as those amounts included in the Consolidated Statement of Condition caption,
"Cash and due from banks."
On January 31, 1995, State Street acquired Investors Fiduciary Trust
Company ("IFTC") in a transaction accounted for as a pooling of interests. The
financial information for prior periods has been restated to present the
combined financial condition and results of operations of both companies as if
the acquisition had taken place for all periods presented. See Note B -
Acquisition of Investors Fiduciary Trust Company.
RESALE AND REPURCHASE AGREEMENTS; SECURITIES BORROWED: State Street
enters into purchases of U.S. Treasury and Federal agency securities ("U.S.
Government securities") under agreements to resell the securities, which are
recorded as securities purchased under resale agreements, an asset in the
Consolidated Statement of Condition. These securities can be used as collateral
for repurchase agreements. It is State Street's policy to take possession or
control of the security underlying the resale agreement. The securities are
revalued daily to determine if additional collateral is necessary. State Street
enters into sales of U.S. Government securities under repurchase agreements,
which are treated as financings, and the obligations to repurchase such
securities sold are reflected as a liability in the Consolidated Statement of
Condition. The dollar amount of U.S. Government securities underlying the
repurchase agreements remains in investment securities.
Securities borrowed are recorded at the amount of cash collateral
deposited with the lender. State Street monitors daily its market exposure with
respect to securities borrowed transactions and requests that excess collateral
be returned or that additional securities be provided as needed.
SECURITIES: Debt securities are held in both the investment and trading
account portfolios. State Street accounts for debt and equity securities
classified as available for sale at fair value and the after-tax unrealized
gains and losses are reported as a separate component of stockholders' equity.
Securities classified as held to maturity are stated at cost, adjusted for
amortization of premiums and accretion of discounts. Gains or losses on sales of
available-for-sale securities are computed based on identified costs and
included in fee revenue. Trading account assets are held in anticipation of
short-term market movements and for resale to customers. Trading account assets
are carried at market value and the resulting adjustment is reflected in fee
revenue.
LOANS AND LEASE FINANCING: Loans are placed on a non-accrual basis when
they become 60 days past due as to either principal or interest, or when in the
opinion of management, full collection of principal or interest is unlikely.
When the loan is placed on non-accrual the accrual of interest is discontinued
and previously recorded but unpaid interest is reversed and charged against
current earnings.
Subsidiaries of State Street provide asset-based financing to customers
through a variety of lease arrangements. Leveraged leases are carried net of
nonrecourse debt. Revenue on leveraged leases is recognized on a basis
calculated to achieve a constant rate of return on the outstanding investment in
the leases, net of related deferred tax liabilities, in the years in which the
net investment is positive. Gains and losses on residual values of leased
equipment sold are included in fee revenue.
NOTE A-SUMMARY OF SIGNIfiCANT ACCOUNTING POLICIES (CONTINUED)
ALLOWANCE FOR LOAN LOSSES: The adequacy of the allowance for loan losses
is evaluated on a regular basis by management. Factors considered in evaluating
the adequacy of the allowance include previous loss experience, current economic
conditions and their effect on borrowers, and the performance of individual
credits in relation to contract terms. The provision for loan losses charged to
earnings is based upon management's judgment of the amount necessary to maintain
the allowance at a level adequate to absorb probable losses.
State Street adopted Statement of Financial Accounting Standards ("SFAS")
No. 114, "Accounting by Creditors for Impairment of a Loan" as amended by SFAS
No. 118 on January 1, 1995. SFAS No. 114 requires that the allowance for loan
losses related to certain loans be evaluated based on discounted cash flows
using the loan's initial effective interest rate or the fair value of the
underlying collateral for certain collateral dependent loans. Prior to January
1, 1995, the allowance for loan losses related to these loans was based on
undiscounted cash flows or the fair value of the collateral for collateral
dependent loans. The adoption of SFAS No. 114 did not have a material effect on
the financial statements of State Street.
PREMISES AND EQUIPMENT: Premises, equipment and leasehold improvements
are carried at cost less accumulated depreciation and amortization. Depreciation
and amortization charged to operating expenses are computed using the
straight-line method over the estimated useful life of the related asset or the
remaining term of the lease. In 1995, SFAS No. 121, "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,"
was issued. This statement addresses how long-lived assets and certain
identifiable intangibles held and used should be evaluated for impairment
whenever events or changes in circumstances indicate that the carrying amount of
the asset may not be recoverable. State Street will adopt this new statement in
1996, and it is not expected to have a material impact.
OTHER REAL ESTATE OWNED: Properties acquired in satisfaction of debt are
carried at the lower of cost or fair market value and included in other assets.
Reductions in carrying value are recognized through charges to other operating
expenses. The costs of maintaining and operating foreclosed properties are
expensed as incurred.
REVALUATION GAINS AND LOSSES ON FINANCIAL CONTRACTS: The gross amount of
unrealized gains and losses on foreign exchange and interest rate contracts are
reported separately as other assets and other liabilities, respectively, in the
Consolidated Statement of Condition, except where such gains and losses arise
from contracts covered by qualifying master netting agreements.
FOREIGN CURRENCY TRANSLATION: The assets and liabilities of foreign
operations are translated at month-end exchange rates, and revenue and expenses
are translated at average monthly exchange rates. Gains or losses from the
translation of the net assets of certain foreign subsidiaries, net of any
foreign currency hedges and related taxes, are credited or charged to retained
earnings. Gains or losses from other translations are included in fee revenue.
INTEREST RATE AND FOREIGN EXCHANGE CONTRACTS: State Street uses interest
rate contracts as part of its overall interest rate risk management. Gains and
losses on interest rate futures and option contracts that are designated as
hedges and effective as such are deferred and amortized over the remaining life
of the hedged assets or liabilities as an adjustment to interest revenue or
interest expense. Interest rate swap contracts that are entered into as part of
interest rate management are accounted for using the accrual method as an
adjustment to interest revenue or interest expense. Interest rate contracts
related to trading activities are adjusted to market value with the resulting
gains or losses included in fee revenue.
Foreign exchange trading positions are valued daily at prevailing
exchange rates, and the resulting gain or loss is included in fee revenue.
INCOME TAXES: The provision for income taxes includes deferred income
taxes arising as a result of reporting some items of revenue and expense in
different years for tax and financial reporting purposes.
EARNINGS PER SHARE: The computation of primary earnings per share is
based on the weighted average number of shares of common stock and common stock
equivalents outstanding during each period. Stock option grants are included
only in periods when the results are dilutive. The computation of fully diluted
earnings per share additionally includes the assumption that the convertible
debt had been converted as of the beginning of each period, with the elimination
of related interest expense less the income tax benefit.
NOTE B-ACQUISITION OF INVESTORS FIDUCIARY TRUST COMPANY
On January 31, 1995, State Street acquired IFTC in a transaction
accounted for as a pooling of interests. IFTC was acquired for 5,972,222 shares
of State Street common stock. IFTC provides custody and fund accounting services
to mutual funds, unit investment trusts, insurance portfolios and bank
portfolios.
NOTE C -INVESTMENT SECURITIES
Investment securities consisted of the following at December 31:
The amortized cost and fair value of available-for-sale and
held-to-maturity securities by maturity at December 31, 1995, were as follows:
The maturity of asset-backed securities is based upon the expected
principal payments. Securities carried at $2,226,579,000 and $4,246,809,000 at
December 31, 1995 and 1994, respectively, were designated as security for public
and trust deposits, borrowed funds and for other purposes as provided by law.
During 1995, gains of $17,414,000 and losses of $5,084,000 were realized
on sales of available-for-sale securities of $3,654,042,000. During 1994, gains
of $5,843,000 and losses of $4,136,000 were realized on sales of
available-for-sale securities of $1,524,662,000. During 1993, gains of
$16,630,000 and losses of $884,000 were realized on sales of available-for-sale
securities of $1,002,271,000.
The excess of fair value over the amortized cost of available-for-sale
securities on the January 1, 1994 adoption of SFAS No. 115 was $11,918,000 with
an after-tax increase to stockholders' equity of $7,030,000.
In November 1995, the Financial Accounting Standards Board issued a
Special Report, "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities." In accordance with
provisions in that Special Report, State Street chose to reclassify certain
securities from held to maturity to available for sale on December 1, 1995. At
the date of transfer, the amortized cost of those securities was $3,828,808,000
and the net unrealized gain on those securities was $2,684,000, which was
recorded net of tax in stockholders' equity at the date of transfer.
NOTE D-LOANS
The loan portfolio consisted of the following at December 31:
Changes in the allowance for loan losses for the years ended December 31
were as follows:
During 1995 and 1994, loans totaling $1,742,000 and $191,000 were
transferred to other real estate owned.
NOTE E-PREMISES AND EQUIPMENT
Premises and equipment consisted of the following at December 31:
State Street has entered into noncancelable operating leases for premises
and equipment. At December 31, 1995, future minimum payments under noncancelable
operating leases with initial or remaining terms of one year or more totaled
$572,925,000. This consisted of $45,340,000, $43,421,000, $37,042,000,
$34,011,000 and $30,660,000 for the years 1996 to 2000, respectively, and
$382,451,000 thereafter. The minimum rental commitments have been reduced by
sublease rental commitments of $5,659,000. Substantially all leases include
renewal options.
Total rental expense amounted to $41,782,000, $35,023,000 and $26,673,000
in 1995, 1994 and 1993, respectively. Rental expense has been reduced by
sublease revenue of $556,000, $1,083,000 and $2,149,000 in 1995, 1994 and 1993,
respectively.
NOTE F-INVESTMENT SECURITIES SOLD UNDER REPURCHASE AGREEMENTS
State Street enters into sales of U.S. Government securities under
repurchase agreements that are treated as financings, and the obligations to
repurchase such securities sold are reflected as a liability in the Consolidated
Statement of Condition. The dollar amount of U.S. Government securities
underlying the repurchase agreements remains in investment securities.
Information on these U.S. Government securities, and the related
repurchase agreements including accrued interest, is shown in the table below.
This table excludes repurchase agreements that are secured by securities
purchased under resale agreements and securities borrowed.
Information at December 31, 1995 was as follows:
NOTE G-NOTES PAYABLE
State Street Bank issues Bank Notes from time to time, in an aggregate
amount not to exceed $750,000,000 and with original maturities ranging from 14
days to five years.
The Bank Notes, which are not subject to redemption, represent unsecured
debt obligations of State Street Bank. The Bank Notes are neither obligations of
nor guaranteed by State Street and are recorded net of original issue discount.
At December 31, 1995, there was a total of $175,218,000 of Bank Notes
outstanding. This included $126,868,000 with an average maturity of 45 days and
a weighted average interest rate of 5.79% and $48,350,000 of two year foreign
currency denominated notes due October 1997, with an interest rate of 1.05%.
NOTE H-LONG-TERM DEBT
Long-term debt, less unamortized original issue discount, consisted of
the following at December 31:
The 5.95% notes are unsecured obligations of State Street.
The 7.75% debentures are convertible to common stock at a price of $5.75
per share, subject to adjustment for certain events. The debentures are
redeemable, at State Street's option, at a price of approximately 101.6%,
declining annually to par by 1998. During 1995 and 1994, $148,000 and $563,000
of debentures were converted into 25,734 and 137,711 shares of common stock,
respectively. At December 31, 1995, 558,261 shares of authorized common stock
had been reserved for issuance upon conversion.
The 9.50% mortgage note was fully collateralized by property at December
31, 1995. The aggregate maturities of this mortgage note for the years 1996
through 2000 are $948,000, $1,042,000, $1,146,000, $1,260,000 and $1,385,000,
respectively.
In August 1993, a shelf registration statement became effective that
allows State Street to issue up to $250 million of unsecured debt securities. In
September 1993, State Street issued $100 million of 5.95% Notes due 2003, and
the remaining balance of $150 million at December 31, 1995, is available for
issuance.
NOTE I-STOCKHOLDERS' EQUITY
The Board of Directors has authorized the repurchase of up to three
million shares of State Street's common stock. Shares purchased under the
authorization could be used for employee benefit plans or general corporate
purposes. During the third quarter of 1995, the stock purchase program was
initiated and 416,200 shares of State Street's common stock were purchased for
employee benefit plans at an average cost of $41 per share through December 31,
1995.
State Street has a long-term incentive plan from which stock options,
stock appreciation rights (SARs) and performance units can be awarded. The
exercise price of non-qualified and incentive stock options may not be less
than fair value of such shares at date of grant and expire no longer than ten
years from date of grant. Performance units have been granted to officers at
the policy-making level. Performance units are earned over a performance period
based on achievement of goals. Payment for performance units is made in cash
equal to the fair market value of State Street's common stock after the
conclusion of each performance period. Compensation expense related to
performance units was $3,439,000, $333,000 and $2,126,000 for 1995, 1994 and
1993, respectively.
Under the 1994 Stock Option and Performance Unit Plan, options and SARs
covering 3,500,000 shares of common stock and 1,000,000 performance units may be
issued. State Street has stock options and performance shares outstanding from
previous plans under which no further grants can be made.
Option activity during 1995 and 1994 was as follows:
At December 31, 1995, 1,175,814 shares under options were exercisable and
2,391,366 shares under options and SARs were available for future grants. During
1993, 393,000 options were exercised at per share prices of $3.52 to $20.38.
In 1995, SFAS No. 123, "Accounting for Stock-Based Compensation," was
issued. This statement addresses financial accounting and reporting standards
for stock-based employee compensation plans. State Street plans to continue to
measure compensation cost for these plans using the intrinsic value-based method
of accounting prescribed by APB Opinion No. 25. State Street will adopt the new
disclosure requirements of this statement in 1996.
NOTE J-SHAREHOLDERS' RIGHTS PLAN
In 1988, State Street declared a dividend of one preferred share purchase
right for each outstanding share of common stock. Under certain conditions, a
right may be exercised to purchase one two-hundredths share of a series of
participating preferred stock at an exercise price of $75, subject to
adjustment. The rights become exercisable if a party acquires or obtains the
right to acquire 20% or more of State Street's common stock or after
commencement or public announcement of an offer for 20% or more of State
Street's common stock. When exercisable, under certain conditions, each right
also entitles the holder thereof to purchase shares of common stock, of either
State Street or of the acquiror, having a market value of two times the then
current exercise price of that right.
The rights expire in 1998 and may be redeemed at a price of $.005 per
right at any time prior to expiration or the acquisition of 20% of State
Street's common stock. Also, under certain circumstances, the rights may be
redeemed after they become exercisable and may be subject to automatic
redemption.
NOTE K-FEE REVENUE-OTHER
The Other category of fee revenue consisted of the following for the
years ended December 31:
NOTE L-OPERATING EXPENSES-OTHER
The Other category of operating expenses consisted of the following for
the years ended December 31:
NOTE M-QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a tabulation of the unaudited quarterly results of
operations:
NOTE N-EMPLOYEE BENEfiT PLANS
RETIREMENT PLANS
State Street and nearly all of its U.S. subsidiaries participate in a
noncontributory cash balance defined benefit plan covering employees based on
age and service. The plan provides individual account accumulations that are
increased annually based on salary, service and interest credits. State Street
uses the projected unit credit method as its actuarial valuation method. It is
State Street's funding policy to contribute annually the maximum amount that can
be deducted for Federal income tax purposes. Employees in non-U.S. offices
participate in local plans, and the cost of these plans is not material.
The following table sets forth the primary plan's funded status,
actuarial assumptions and amounts recognized in the Consolidated Financial
Statements as of and for the years ended December 31:
State Street has unfunded, non-qualified supplemental retirement plans
that provide certain officers with defined pension benefits in excess of
limits imposed by Federal tax law. At December 31, 1995, 1994 and 1993, the
projected benefit obligation of these plans was $15,259,000, $5,168,000 and
$2,790,000, and the related pension expense was $2,224,000, $436,000 and
$430,000, respectively.
Total pension expense for all plans was $8,300,000, $4,546,000 and
$2,050,000 for 1995, 1994 and 1993, respectively.
Employees of State Street Bank and certain subsidiaries with one or more
years of service are eligible to contribute a portion of their pre-tax salary to
a 401(k) Salary Savings Plan. State Street matches a portion of these
contributions, and the related expenses were $8,572,000, $7,456,000 and
$7,034,000 for 1995, 1994 and 1993, respectively.
POSTRETIREMENT PLAN
State Street Bank and certain subsidiaries provide health care and life
insurance benefits for retired employees. Upon adoption of SFAS No. 106, State
Street elected to amortize the accumulated postretirement benefit obligation
(APBO), which at the date of adoption was $22,100,000, over a 20-year period.
State Street continues to fund medical and life insurance benefit costs on a
pay-as-you-go basis.
The following table sets forth the financial status of the plan and
amounts recognized in the Consolidated Financial Statements as of and for the
years ended December 31:
The discount rate used in determining the APBO was 8.00% and 8.75% for
1995 and 1994, respectively. The assumed health care cost trend rate used in
measuring the APBO was 6.00% for 1996 and thereafter. If the health care trend
rate assumptions were increased by 1%, the APBO would have increased by 6.0%, as
of December 31, 1995, and the aggregate of service and interest costs for 1995
would have increased by 8.0%.
NOTE O-INCOME TAXES
The provision for income taxes included in the Consolidated Statement of
Income consisted of the following:
Current and deferred taxes for 1994 and 1993 have been reclassified to
reflect the tax returns as actually filed. Income tax benefits of $1,845,000,
$4,949,000 and $3,603,000 in 1995, 1994 and 1993, respectively, related to
certain employee stock option exercises were recorded directly to stockholders'
equity and are not included in the table above. Income tax expense related to
net securities gains were $5,142,000, $573,000 and $6,782,000 for 1995, 1994 and
1993, respectively.
Pre-tax income attributable to operations located outside the United
States was $66,712,000, $75,655,000 and $51,823,000 in 1995, 1994 and 1993,
respectively.
Significant components of the deferred tax liabilities and assets at
December 31 were as follows:
At December 31, 1995, State Street had non-U.S. carryforward tax losses
of $27,260,000 and U.S. tax credit carryforwards of $10,606,000. If not
utilized, $12,100,000 of the losses will expire in the years 1998-2002. The tax
credits and the remaining tax losses carry forward indefinitely.
A reconciliation of the differences between the U.S. statutory income tax
rate and the effective tax rates based on income before taxes is as follows:
For years beginning on or after January 1, 1995, the Commonwealth of
Massachusetts reduced the tax rate applicable to financial institutions and
permitted apportionment of income. The change in tax law resulted in a
revaluation of the deferred tax assets and liabilities which existed at the
beginning of 1995. This revaluation and the reduction of current year state tax
expense reduced the 1995 provision for state taxes. In addition, during 1995 a
settlement of prior years' state taxes resulted in a net $3.6 million reduction
in taxes. The settlement resolved a claim over the taxability of interest
revenue on certain Massachusetts bonds.
NOTE P-CONTINGENT LIABILITIES
State Street provides custody, securities processing, accounting and
information services to mutual fund, master trust/master custody/global custody,
corporate trust and defined contribution plan customers; and investment
management services to institutions and individuals. Assets under custody and
management, held by State Street in a fiduciary or custody capacity, are not
included in the Consolidated Statement of Condition since such items are not
assets of State Street. Management conducts regular reviews of its
responsibilities for these services and considers the results in preparing its
financial statements. In the opinion of management, there are no contingent
liabilities at December 31, 1995 that would have a material adverse effect on
State Street's financial position or results of operations.
State Street is subject to pending and threatened legal actions that
arise in the normal course of business. In the opinion of management, after
discussion with counsel, these can be successfully defended or resolved without
a material adverse effect on State Street's financial position or results of
operations.
NOTE Q-CASH, DIVIDEND, LOAN AND OTHER RESTRICTIONS
During 1995, subsidiary banks of State Street were required by the
Federal Reserve Bank to maintain average reserve balances of $271,684,000.
State Street's principal source of funds for the payment of cash
dividends to stockholders and purchase of its common stock is from dividends
paid by State Street Bank. Federal and state banking regulations place certain
restrictions on dividends paid by subsidiary banks to State Street. At December
31, 1995, State Street Bank had $426,266,000 of retained earnings available for
distribution to State Street in the form of dividends.
The Federal Reserve Act requires that extensions of credit by State
Street Bank to certain affiliates, including State Street, be secured by
specific collateral, that the extension of credit to any one affiliate be
limited to 10% of capital and surplus (as defined), and that extensions of
credit to all such affiliates be limited to 20% of capital and surplus.
At December 31, 1995, consolidated retained earnings included $13,417,000
representing undistributed earnings of 50%-owned affiliates.
State Street has a committed line of credit amounting to $50,000,000 to
support its commercial paper program.
NOTE R-OFF-BALANCE SHEET FINANCIAL INSTRUMENTS, INCLUDING DERIVATIVES
State Street uses various off-balance sheet financial instruments,
including derivatives, to satisfy the financing and risk management needs of
customers, to manage interest rate and currency risk and to conduct trading
activities. In general terms, derivative instruments are contracts or agreements
whose value can be derived from interest rates, currency exchange rates and
financial indices. Derivative instruments include forwards, futures, swaps,
options and other instruments with similar characteristics. These instruments
generate fee, interest or trading revenue. Associated with these instruments are
market and credit risks that could expose State Street to potential losses.
Market risk relates to the possibility that financial instruments may
change in value due to future fluctuations in market prices. There may be
considerable day-to-day variation in market-risk exposure because of changing
expectations of future currency values or interest rates. State Street actively
manages its market-risk exposure.
Credit risk relates to the possibility that a loss may occur from the
failure of another party to perform according to the terms of a contract. The
credit risk associated with off-balance sheet financial instruments is managed
in conjunction with State Street's balance sheet activities. State Street
minimizes its credit risk by performing credit reviews of counterparties or by
conducting activities through organized exchanges. Historically, credit losses
with respect to these instruments have been immaterial.
State Street uses derivative financial instruments in trading and
balance sheet management activities. The objectives of trading activities are to
act as an intermediary in arranging transactions for customers and to assume
positions in interest rate or foreign currency markets based upon expectations
of future market movements. The objective of balance sheet management activities
is to utilize derivatives in minimizing the risk inherent in State Street's
asset and liability structure from interest rate and currency exchange
movements.
The following table summarizes the contractual or notional amounts of
derivative financial instruments held or issued by State Street at December 31:
Interest rate contracts involve an agreement with a counterparty to
exchange cash flows based on the movement of an underlying interest rate index.
A swap agreement involves the exchange of a series of interest payments, either
at a fixed or variable rate, based upon the notional amount without the
exchange of the underlying principal amount. An option contract provides the
purchaser, for a premium, the right but not the obligation to buy or sell the
underlying financial instrument at a set price at or during a specified period.
A futures contract is a commitment to buy or sell at a future date a financial
instrument at a contracted price and may be settled in cash or through the
delivery of the contracted instrument.
Foreign exchange contracts involve an agreement to exchange the currency
of one country for the currency of another country at an agreed upon rate and
settlement date. Foreign exchange contracts consist of swap agreements, and
forward and spot contracts.
State Street's exposure from these interest rate and foreign exchange
contracts results from the possibility that one party may default on its
contractual obligation or from movements in exchange or interest rates. Credit
risk is limited to the positive market value of the derivative financial
instrument, which is significantly less than the notional value. The notional
value provides the basis for determining the exchange of contractual cash flows.
The exposure to credit loss can be estimated by calculating the cost on a
present value basis to replace at current market rates all profitable contracts
at year-end. The estimated aggregate replacement cost of derivative financial
instruments in a net positive position was $658,000,000 and $413,000,000 at
December 31, 1995 and 1994, respectively.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR TRADING
The following table represents the fair value and average fair value of
financial instruments held or issued for trading purposes as of and for the
years ended December 31, 1995 and 1994. The following amounts have been reduced
by offsetting balances with the same counterparty where a master netting
agreement exists:
State Street is an active participant in the global foreign exchange
market in support of a large institutional customer base engaged in
international investing. Trading is conducted through eight treasury centers
located in major financial centers throughout the world serving the needs of
investment managers and their customers in the region. State Street operates in
the spot and forward markets in over 30 currencies today as investors expand
their horizons. State Street is also active in the foreign exchange interbank
market where it trades with approximately 300 counterparty banks globally to
facilitate customer transactions.
State Street Bank uses interest rate futures and, to a lesser extent,
options on interest rate futures, to minimize the impact of the market valuation
of a portion of the bank's trading securities portfolio and to take positions on
interest rate movements.
Foreign exchange contracts and other contracts used in trading activities
are carried at fair value. The fair value of the instruments is recorded in the
balance sheet as part of other assets or other liabilities. Net trading gains
and (losses) recognized in other fee revenue related to foreign exchange
contracts totaled $141,000,000 and $114,000,000 and for other financial
instrument contracts totaled ($1,000,000) and $1,000,000 in 1995 and 1994,
respectively. Future cash requirements, if any, related to foreign currency
contracts are represented by the gross amount of currencies to be exchanged
under each contract unless State Street and the counterparty have agreed to pay
or receive the net contractual settlement amount on the settlement date. Future
cash requirements on other financial instruments are limited to the net amounts
payable under the agreements.
FINANCIAL INSTRUMENTS HELD OR ISSUED FOR BALANCE SHEET MANAGEMENT
State Street enters into various interest rate and foreign exchange
contracts in managing its balance sheet risk. State Street utilizes interest
rate swaps and caps to manage interest rate risk and foreign exchange contracts
to minimize currency translation risk. Interest rate derivative contracts are
used to convert short-term floating rate liabilities into longer term fixed rate
liabilities corresponding to long-term balance sheet assets. Income or expense
on financial instruments used to manage interest rate exposure is recorded on
an accrual basis as an adjustment to the yield of the related interest-earning
asset or interest-bearing liability over the period covered by the contracts.
Foreign exchange contracts are utilized to minimize the exposure to
currency loss from balance sheet investments denominated in foreign currencies.
The foreign exchange contracts and the currency translation of the investment
are marked to market, and the unrealized gain or loss is recorded in other fee
revenue.
CREDIT-RELATED FINANCIAL INSTRUMENTS
Credit-related financial instruments include commitments to extend
credit, standby letters of credit, letters of credit and indemnified securities
lent. The maximum credit risk associated with credit-related financial
instruments is measured by the contractual amounts of these instruments.
The following is a summary of the contractual amount of State Street's
credit-related, off-balance sheet financial instruments at December 31:
In conjunction with its lending activities, State Street enters into
various commitments to extend credit and issues letters of credit. Loan
commitments (unfunded loans and unused lines of credit), standby letters of
credit and letters of credit are issued to accommodate the financing needs of
State Street's customers. Loan commitments are essentially agreements by State
Street to lend monies at a future date, so long as there are no violations of
any conditions established in the agreement. Standby letters of credit and
letters of credit commit State Street to make payments on behalf of customers
when certain specified events occur.
These loan and letter-of-credit commitments are subject to the same
credit policies and reviews as loans on the balance sheet. Collateral, both the
amount and nature, is obtained based upon management's assessment of the credit
risk. Approximately 70% of the loan commitments expire in one year or less from
the date of issue. Since many of the extensions of credit are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements.
On behalf of its customers, State Street lends their securities to
creditworthy brokers and other institutions. In certain circumstances, State
Street indemnifies its customers for the fair market value of those securities
against a failure of the borrower to return such securities. State Street
requires the borrowers to provide collateral in an amount equal to or in excess
of 102% of the fair market value of the securities borrowed. The borrowed
securities are revalued daily to determine if additional collateral is
necessary. State Street held as collateral, cash and U.S. Government securities
totaling $30.2 billion and $23.3 billion for indemnified securities at December
31, 1995 and 1994, respectively.
NOTE S-FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107 requires the calculation and disclosure of the fair value of
financial instruments. State Street uses the following methods to estimate the
fair value of financial instruments.
For financial instruments that have quoted market prices, those quotes
were used to determine fair value. Financial instruments that have no defined
maturity, have a remaining maturity of 180 days or less, or reprice frequently
to a market rate, are assumed to have a fair value that approximates reported
book value, after taking into consideration any applicable credit risk. If no
market quotes were available, financial instruments were valued by discounting
the expected cash flow(s) using an estimated current market interest rate for
the financial instrument. For off-balance sheet derivative instruments, fair
value is estimated as the amounts that State Street would receive or pay to
terminate the contracts at the reporting date, taking into account the current
unrealized gains or losses on open contracts.
The short maturity of State Street's assets and liabilities results in
having a significant number of financial instruments whose fair value equals or
closely approximates reported balance sheet value. Such financial instruments
are reported in the following balance sheet captions: Cash and due from banks;
Interest-bearing deposits with banks; Securities purchased under resale
agreements and securities borrowed; Federal funds sold; Deposits; Federal funds
purchased; Securities sold under repurchase agreements; and Other short-term
borrowings. Fair value of trading activities equals its balance sheet value. In
1995, the fair value of interest rate contracts used for balance sheet
management would be a payable of $4 million; in 1994, the fair value of such
interest rate contracts would be a receivable of $6 million. There is no cost
for loan commitments.
The reported value and fair value for other balance sheet captions at
December 31 are as follows:
NOTE T-FOREIGN ACTIVITIES
Foreign activities, as defined by the Securities and Exchange
Commission, are considered to be those revenue-producing assets and transactions
that arise from customers domiciled outside the United States.
Due to the nature of the Corporation's business, it is not possible to
segregate precisely domestic and foreign activities. The determination of
earnings attributable to foreign activities requires internal allocations for
resources common to foreign and domestic activities. Subjective judgments have
been used to arrive at these operating results for foreign activities. Interest
expense allocations are based on the average cost of short-term domestic
borrowed funds. Allocations for operating expenses and certain administrative
costs are based on services provided and received.
The following data relates to foreign activities, based on the domicile
location of customers, for the years ended and as of December 31:
NOTE U-FINANCIAL STATEMENTS OF STATE STREET BOSTON CORPORATION (PARENT ONLY)
Statement of Income
Statement of Condition
Statement of Cash Flows
REPORT OF INDEPENDENT AUDITORS
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STATE STREET BOSTON CORPORATION
The Stockholders and Board of Directors
State Street Boston Corporation
We have audited the accompanying consolidated statements of condition of
State Street Boston Corporation as of December 31, 1995 and 1994, and the
related consolidated statements of income, cash flows and changes in
stockholders' equity for each of the three years in the period ended December
31, 1995. These financial statements are the responsibility of the Corporation's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the consolidated financial position of State
Street Boston Corporation at December 31, 1995 and 1994, and the consolidated
results of its operations and its cash flows for each of the three years in the
period ended December 31, 1995 in conformity with generally accepted accounting
principles.
Boston, Massachusetts
January 10, 1996
/S/ ERNST & YOUNG LLP