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State Street Misses, Revs Up

Zacks Equity Research

State Street Corporation (STT) reported first quarter 2012 operating earnings per share of 84 cents, marginally below the Zacks Consensus Estimate of 86 cents. This compares unfavorably with the previous quarter earnings of 93 cents and the prior-year quarter earnings of 88 cents.

The year-over-year results were negatively impacted by lower fee income and a rise in expenses. However, these were partly offset by higher net interest revenue. Moreover, capital ratios were stable during the quarter.

After considering certain non-recurring items such as acquisition costs, restructuring expenses, litigation settlement costs as well as discount accretion related to former conduit securities, earnings for the quarter came in at 85 cents per share. Though this compared favorably with the prior-quarter earnings of 76 cents, it is below the year-ago quarter’s earnings of 93 cents.

State Street recorded net income of $410 million on an operating basis, down 10% from $454 million in the prior quarter and 7% from $439 million in the prior-year quarter.

During the quarter, State Street, after getting the approval for its capital plan, increased its quarterly cash dividend to 24 cents per share. The company also announced a new share repurchase program authorizing the purchase of up to $1.8 billion of stock through the first quarter of 2013.

Behind the Headlines

State Street reported revenue of $2.42 billion in the quarter, up 5% sequentially and 3% year over year. Operating revenue of $2.40 billion improved from $2.29 billion in the prior quarter and $2.33 billion in the year-ago quarter. Operating revenue was slightly higher than the Zacks Consensus Estimate of $2.3 billion.

For the reported quarter, net interest revenue on an operating basis grew 5% sequentially and 11% year over year to $607 million. The improvement from the prior-year quarter was primarily due to an increase in investment portfolio volume and higher yields on floating-rate securities, partially mitigated by a fall in yield in the fixed-income portfolio.

Net interest margin on an operating basis (excluding the excess deposits) was 1.64% in the quarter, up from 1.55% in the prior quarter, but down from 1.85% in the prior-year quarter.

State Street reported 7% sequential rise in fee revenues during the quarter to $1.8 billion. However, fee revenue declined marginally from the year-ago quarter. The year-over-year drop was mainly due to a fall in trading services fees.

On an operating basis, non-interest expenses were $1.8 billion, growing 10% sequentially and 6.9% year over year. The rise from the prior-year quarter was primarily the result of higher salaries and employee benefits expenses.

Total assets under custody and administration were $23.21 trillion as of March 31, 2012, up 2.6% year over year. However, State Street’s total assets under management stood at $2.0 billion, down 6% from the year-ago quarter.

Capital and Profitability Ratios

State Street’s capital ratios remain strong. As of March 31, 2012, Tier 1 capital ratio was 19.1%, slightly up from 18.8% as of December 31, 2011, but down from 19.6% as of March 31, 2011. Likewise, Tier 1 common to risk-weighted assets increased to 17.19% as of March 31, 2012 from 16.8% as of December 31, 2011, but decreased from 17.5% as of March 31, 2011.

For the reported quarter, return on common equity (on an operating basis) came in at 8.6% compared with 9.5% in the prior quarter and 9.9% in the prior-year quarter.

Our Viewpoint

We anticipate the company’s restructuring programs along with well-off core servicing and investment management franchises to help offset the weakness caused by the sluggish economic recovery. However, given the ongoing weakness in the mortgage market, we remain concerned about the sizable amount of mortgage-backed and asset-backed securities in its investment portfolio. Despite these concerns, investors’ confidence is expected to get enhanced as the company has announced an improved capital deployment program.

Among State Street’s peers, BB&T Corp. (BBT) is scheduled to report the first-quarter earnings on April 19 while SunTrust Banks Inc. (STI) will report on April 23.

State Street currently retains a Zacks #3 Rank, which translates into a short-term ‘Hold’ rating.

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