STT State Street Corporation

State Street Corporation’s (STT) first quarter 2011 operating earnings of 88 cents per share were ahead of the Zacks Consensus Estimate of 85 cents. The results also compare favorably with the prior quarter earnings of 87 cents and the prior-year quarter earnings of 75 cents.

Operating results, however, exclude certain discount accretion related to former conduit assets, restructuring charges related to reduction in staff and merger and integration costs.

On a GAAP basis, earnings for the quarter came in at 93 cents per share, compared with earnings of 16 cent in the prior quarter and 99 cents in the year-ago quarter.

Results in the quarter were aided primarily by growth in operating revenues and higher net interest margin, which were offset partly by higher operating expenses. The company’s capital ratios also continued to show improvement.

Quarter in Detail

State Street reported revenues of $2.4 billion in the quarter were up 20% sequentially and 3% year over year. Operating revenues of $2.33 billion rose 2.1% from $2.28 billion in the prior quarter and 10.1% from $2.12 billion in the year-ago quarter. The company’s operating revenues also surpassed the Zacks Consensus Estimate of $2.29 billion.

For the reported quarter, net interest income (NII) on an operating basis fell 0.7% sequentially but increased 13.5% year over year to $546 million. This increase was attributable to the impact of deposits added in connection with the Intesa acquisition and improvement in non-US Dollar rates.

Net interest margin (NIM) on an operating basis was 1.66% in the quarter, up 4 basis points (bps) year over year.

In the reported quarter, State Street reported a 3.2% growth in fee revenues compared with the prior quarter and 14.0% from prior-year quarter to $1.79 billion. Unrealized losses in the investment portfolio decreased to $352 million from $504 million in the prior quarter and $1.44 billion in the year-ago quarter.

On an operating basis, expenses surged 3.6% sequentially and 7.5% year over year to $1.68 billion in the quarter. The year-over-year hike was mainly due to higher salaries and employee benefits expenses, information systems and communications expenses and transaction processing services expenses, which were partly offset by a lower level of other expenses.

Total assets under custody and administration were $22.61 trillion as of March 31, 2011, up 18.7% year over year. Total assets under management as of March 31, 2011 totaled $2.12 trillion, up 7.7% year over year.

Profitability Ratios

The capital ratios continue to remain strong. As of March 31, 2011, State Street’s Tier 1 capital ratio was 19.6%, down from 20.5% as of December 31, 2010 but up from 18.0% as of March 31, 2010. Similarly, Tier 1 common ratio fell to 17.5% as of March 31, 2011 from 18.1% as of December 31, 2010 but improved from 15.9% as of March 31, 2010.

For the reported quarter, return on common equity (on an operating basis) came in at 9.9% compared with 9.8% in the prior quarter and 10.0% in the prior-year quarter.

Dividend and Share Repurchase

During the quarter, State Street got approval from the Federal Reserve to hike its quarterly dividend for the first time since the second quarter of 2007 to 18 cents per share from 1 cent. Furthermore, the company also announced that it would buy back $675 million stock in 2011, marking its first share repurchase program since January 2008.

Peer Performance

Among State Street’s competitors, KeyCorp.’s (KEY) first quarter earnings substantially outpaced the Zacks Consensus Estimates. Results primarily benefited from growth in non-interest income, lower non-interest expense and improvement in provision from credit losses.  However, lower NII and average earning assets were among the negatives.

Another peer, Comerica Incorporated (CMA) also reported first quarter results that surpassing the Zacks Consensus Estimate. The year over year improvement in the results reflected an increase in non-interest income and NIM, partially offset by higher non-interest expenses and lower NII. Also, a significant improvement in credit quality acted as a positive catalyst.

Our Take

We believe that the various restructuring programs, strong capital ratios along with well-off core servicing and investment management franchises will help State Street to offset the financial weakness caused by the sluggish economic recovery. Additionally, with company’s recent announcements regarding dividend and share repurchase, we view State Street as a sound asset for yield-oriented investors.

However, given the ongoing weakness in the mortgage market, we remain significantly concerned about the sizable amount of mortgage-backed and asset-backed securities exposure in State Street’s investment portfolio.

State Street currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Also, considering the fundamentals, we are maintaining our long-term Neutral recommendation on the shares.

 
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