By John Spence

BOSTON (Dow Jones) -- State Street Corp.'s stock was down 50% on Tuesday on concerns the company may have to bring troubled investment vehicles onto its balance sheet, a move that could force it to raise capital and potentially dilute shareholders.

The financial-services firm reported sharply lower fourth-quarter earnings and updated its risk factor disclosures in a regulatory filing.

State Street (STT) shares were under pressure after the Boston-based company said its quarterly net income fell 71% from the year-ago period to $65 million, or 15 cents a share. Analysts surveyed by Thomson Reuters had forecast profit of $1.14 a share, on average.

Reflecting "ongoing illiquidity in the markets," the company said after-tax, unrealized mark-to-market losses in the investment portfolio rose to $6.3 billion at the end of the fourth quarter, up $3 billion from the end of the third quarter. Losses in State Street-administered asset-backed commercial paper conduits rose $1.4 billion to $3.6 billion.

The conduits have been hit by the credit turmoil and there are fears State Street will have to consolidate the vehicles on its balance sheet.

"We continue to believe that the asset quality of both our investment portfolio and the conduit program remains strong," said State Street Chief Executive Ronald Logue in the earnings release.

State Street lowered its 2009 outlook and now sees flat growth in revenue and operating earnings.

The company said after recent discussions with investors, it has "determined not to raise equity capital in this turbulent market."

On Tuesday's analyst call, Logue said State Street's capital and leverage ratios are strong, but said he understands that investors are concerned about the mark-to-market impact of conduit consolidation.

"Obviously, the increases in the negative marks in our investment portfolio and in our conduits concern us," the CEO said. "But we still believe that they are for the most part a result of the lack of liquidity in the market and not a result of their credit quality."

New risk factors

State Street in a filing Friday updated its risk factor disclosures, which helped fuel the sell-off in the shares.

The company said it may be exposed to customer claims, financial loss, reputational damage and regulatory scrutiny as a result of transacting purchases and redemptions relating to the unregistered cash collateral pools underlying its securities lending program "at a net asset value of $1.00 per unit rather than a lower net asset value based upon market value of the underlying portfolios."

"This relates to the company's decision to protect its clients in the securities lending business from loss related to their cash float," said Ladenburg Thalmann analyst Richard Bove in a research note. "The assumption had been that State Street had paid out the monies in question and no new funds would be exposed. This new risk provision raises questions as to whether this assumption is correct or not."

State Street warned it could recognize a material charge to earnings and see its capital ratios hurt if all or a significant portion of the unrealized losses in its portfolio of investment securities "were determined to be other-than-temporarily impaired."

Finally, its business activities, including the unconsolidated asset-backed commercial paper conduits its administers, expose it to liquidity and interest-rate risk.

Bove said the last new risk factor raises the question as to whether State Street has changed its mind about not needing to consolidate its off-balance-sheet conduits. Such a move could force the company to raise capital by selling new equity, the analyst said.

"In sum, nothing has outwardly changed at State Street," Bove wrote. "However the acknowledgement of these issues at this time needs to be explained by the company quickly."

"The main question is if and when State Street will need to issue more capital," said Deutsche Bank analysts in a note to clients Tuesday.

State Street in December said it planned to cut roughly 6% of its global workforce in an effort to reduce costs amid the economic downturn.

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