Higher Expenses Drag State Street Earnings

State Street Corp. (STT) reported fourth-quarter operating earnings of $1.15 per share, missing the Zacks Consensus Estimate of $1.19 owing to higher non-interest expenses. However, the reported figure was up 3.6% from the prior-year quarter figure of $1.11.

Lower-than-expected results were due to a marginal fall in net interest income and higher-than-expected operating expenses, partially offset by growth in fee income. Further, deteriorating capital ratios was a dampener. However, improvement in asset position and profitability ratios were tailwinds.

After considering certain non-recurring items, net income applicable to common shareholders was $545 million, up 16.5% year over year.

For full-year 2013, operating earnings per share increased 14.9% year over year to $4.54. This, however, missed the Zacks Consensus Estimate of $4.59.

Performance in Detail

Revenues on an operating basis came in at $2.53 billion, up 2.6% from the prior-year quarter. Further, it beat the Zacks Consensus Estimate of $2.50 billion.

Net interest revenue on an operating basis dropped 0.7% from the previous-year quarter to $596 million. The fall was mainly due to lower yields on earning assets, partly offset by lower yields on interest bearing liabilities. Likewise, net interest margin was 1.30% in the quarter, down 6 basis points year over year.

Fee revenues came in at $1.93 billion, increasing 4.9% from the prior-year quarter. The rise was attributable to increase in servicing fees, management fees and securities finance fees, partially offset by fall in processing and other revenues as well as total trading services revenues.

On an operating basis, non-interest expenses increased 2.7% from the year-ago quarter to $1.76 billion. The increase was primarily driven by rise in compensation and employee benefits expenses as well as other expenses, which were partly offset by lower information systems and transaction processing service costs.

Total assets under custody and administration were $27.43 trillion as of Dec 31, 2013, up 12.5% year over year. Moreover, assets under management were $2.35 trillion, up 12.4% from the prior year.

Capital and Profitability Ratios

State Street’s capital ratios deteriorated, while profitability ratio improved. As of Dec 31, 2013, Tier 1 capital ratio was 17.3%, down from 19.1% as of Dec 31, 2012. Likewise, Tier 1 common to risk-weighted assets decreased to 15.5% as of Dec 31, 2013 from 17.1% as of Dec 31, 2012.

Further, under Jul 2013 Basel III final rule (Advanced approach), the estimated Tier 1 common ratio was 11.8% as of Dec 31, 2013.

Return on common equity (on an operating basis) came in at 10.3%, flat year over year.

Share Repurchase

During the reported quarter, State Street repurchased shares worth $560 million at an average price of $69.98 per share. This was part of the company’s buyback plan authorizing purchase of up to $2.1 billion worth of stock through Mar 13, 2014. As of Dec 31, 2013, the company had nearly $420 million remaining under stock repurchase program.

During 2013, the company brought back nearly 31.2 million shares at a total cost of roughly $2.04 billion at an average price of $65.30 per share.

Guidance

In 2014, management anticipates revenue to grow in the range of 3%–5% year over year. Moreover, the company expects to generate an incremental $130 million in total pre-tax expense savings from the Business Operations and IT Transformation program. Further, effective tax rate will likely remain unchanged from the 2013 level.

In first-quarter 2014, compensation and employee benefits expense related to retirement-eligible employees and payroll taxes are expected to increase from the year-ago quarter. Notably, incremental amount attributed to equity compensation for retirement-eligible employees and payroll taxes is expected to be nearly $150 million.

Performance of Other Major Regional Banks

Earnings for BB&T Corp. (BBT), KeyCorp. (KEY) and SunTrust Banks, Inc. (STI) outpaced the Zacks Consensus Estimate. The results benefited from prudent expense management and lower provision, partially offset by a fall in the top line.

Our Viewpoint

We anticipate State Street’s restructuring programs, along with stable core servicing and investment management franchises to help offset its financial weakness. In addition, the recent acquisitions will drive revenues further.

Moreover, enhanced capital deployment initiatives reinforce the company’s priority to enhance shareholders’ value. However, a low interest rate environment and declining net interest revenues are expected to hamper State Street’s top line in the coming quarters.

Currently, State Street carries a Zacks Rank #3 (Hold).

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