STT State Street Corporation

State Street Corporation’s (STT) second quarter 2011 operating earnings of 96 cents per share were a penny behind the Zacks Consensus Estimate of 97 cents. However, the results compare favorably with the prior quarter earnings of 88 cents and the prior-year quarter earnings of 93 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 $1.00 per share, compared with earnings of 93 cent in the prior quarter and 87 cents in the year-ago quarter.

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

State Street reported revenues of $2.5 billion in the quarter, which were up 5.5% sequentially and 8% year over year. Operating revenues of $2.47 billion rose 6.1% from $2.33 billion in the prior quarter and 14.3% from $2.16 billion in the year-ago quarter. The company’s operating revenues surpassed the Zacks Consensus Estimate of $2.41 billion.

Quarter in Detail

For the reported quarter, net interest income (NII) on an operating basis increased 1.5% sequentially and 7.2% year over year to $554 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 1.61% in the quarter, down 5 basis points (bps) year over year.

In the quarter, State Street reported 5.6% growth in fee revenues compared with the prior quarter and 10.4% from the prior-year quarter to $1.89 billion. Improvement in non-interest income was mainly due to a rise in all fee-based revenue sources driven by global client demand.

Unrealized losses in the investment portfolio decreased to $94 million from $352 million in the prior quarter and $994 million in the year-ago quarter.

On an operating basis, expenses surged 4.4% sequentially and 30.6% year over year to $1.76 billion in the quarter. The hike was mainly due to higher salaries and employee benefits expenses, information systems and communications expenses and transaction processing services expenses.

Total assets under custody and administration were $22.76 trillion as of June 30, 2011, up 19.6% year over year. Total assets under management as of June 30, 2011 totaled $2.112 trillion, up 15.3% year over year.

Profitability Ratios

The capital ratios continue to remain strong. As of June 30, 2011, State Street’s Tier 1 capital ratio was 18.9%, down from 19.6% as of March 31, 2011 but up from 15.1% as of June 30, 2010. Similarly, Tier 1 common ratio fell to 16.8% as of June 30, 2011 from 17.5% as of March 31, 2011 but improved from 13.1% as of June 30, 2010.

For the reported quarter, return on common equity (on an operating basis) came in at 10.2% compared with 9.9% in the prior quarter and 11.8% in the prior-year quarter.

Share Repurchase

During the quarter, State Street repurchased 4.9 million shares. This is the part of the share buyback program that was announced by the company in the first quarter authorizing it to repurchase $675 million worth of common stock in 2011.

Peer Performance

One of State Street’s competitors, KeyCorp.’s (KEY) second quarter earnings outpaced the Zacks Consensus Estimates. Better-than-expected results were mainly due to lower credit cost and decline in non-interest expenses. However, lower net interest income and no-interest income were the downside.

Our Viewpoint

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. 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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