Trian Fund Management, L.P. ("Trian" or “Trian Partners”), whose
investment funds and accounts managed by it currently beneficially
own approximately 3.3% of the outstanding shares of State Street
Corporation (“State Street”) (NYSE: STT), today made public a
letter it has sent to the State Street Board of Directors setting
forth its views as to why State Street has continued to
significantly underperform - - delivering negative shareholder
returns during each of the most recent ten, five, four, three, two
and one-year periods. Trian also made public its “White Paper”
which includes a detailed action plan that identifies operational
and strategic initiatives to be taken by State Street that Trian
believes can significantly improve State Street’s long-term
operating performance and enhance shareholder value. Trian believes
State Street’s share price, which closed on Friday, October 14,
2011 at $33.90, is significantly undervalued and that the implied
target value per share could be approximately $99 in 2014, assuming
the Company successfully executes Trian’s recommended action plan
and a modest re-rating to 13.5x forward earnings. Details of
Trian’s views and action plan for State Street have been posted at
www.trian-statestreet.com.
In its communication to State Street, Trian stated, among other
things:
- Trian believes State Street is an
exceptional franchise. The platform that has been assembled over
many years has leadership positions in attractive sectors and
geographies.
- Despite these leadership positions,
Trian believes State Street’s shareholders have lost money
subsidizing growth in revenue, compensation and assets at the
expense of profitability, return on invested capital (“ROIC”) and
total shareholder returns. In particular, Trian noted:
- Costs have grown faster than sales, despite
significant asset growth, implying negative economies of scale and
operating leverage.
- Acquisitions have been very expensive
(average price to forward earnings (“P/E”) multiple of 27.2x).
- Recurring “non-recurring” charges,
including restructurings, credit and legal are very high (30% of
earnings before tax (“EBT”) in each year since 2007).
- Earnings per share (“EPS”) have declined,
the valuation and multiple have contracted and shareholder returns
have been negative.
- State Street’s record of
underperformance aside, Trian believes that State Street has
significant potential that is ready to be unlocked and has outlined
Trian’s action plan to improve operational performance and enhance
shareholder value by:
- Redefining success as growth in
profitability and shareholder returns, not growth in revenue and
headcount.
- Setting an explicit long-term EBT margin
target of approximately 35% by 2014 as well as interim targets.
State Street announced a Business Operations and I/T Transformation
Program targeting $575-$625mm of savings in November 2010, which
followed Trian's August 2010 meeting with management and for which
management has indicated Trian served as a catalyst. However, Trian
believes the program lacks credibility in the absence of explicit
consolidated margin targets. Further, Trian believes management
must provide more transparency and detail around its savings plan
to assure shareholders a credible path to value creation and
positive operating leverage.
- Prioritizing returning capital to
shareholders over dilutive mergers and acquisitions.
- Eliminating non-recurring charges.
- Considering a separation of the Investment
Management and Investment Servicing divisions to unlock value.
- Improving State Street’s corporate
governance profile.
In its letter to the State Street Board, Trian stated that it
has been communicating privately with State Street's management for
over a year and provided its White Paper to management in June
2011. Despite assurances from management that Trian’s assessment of
the Company is consistent with the views of both management and the
Board, it has become clear that State Street has not been willing,
to date, to publicly commit to the actions Trian views as necessary
to enhance long-term shareholder value.
Trian remains willing to work closely and constructively with
State Street to create greater shareholder value. However, if
management and the Board fail to make progress, Trian may decide to
become significantly more active in evaluating its alternatives as
a large shareholder.
The October 16, 2011 letter that Trian sent to the State Street
Board of Directors is below and available with Trian’s White Paper
at www.trian-statestreet.com.
October 16, 2011
The Board of DirectorsState Street CorporationOne Lincoln
StreetBoston, MA 02111
Ladies and Gentlemen:
Investment funds and accounts managed by Trian Fund Management,
L.P. (collectively, “Trian” or “Trian Partners”) currently
beneficially own approximately 3.3% of the outstanding shares of
State Street Corporation (“State Street” or “the Company”). As you
know, Trian has engaged in a dialogue for more than a year with
State Street’s management around specific actions we believe can
significantly improve the Company’s financial performance. We have
expressed concern that State Street, despite being a leader in an
attractive industry, has generated negative shareholder returns
over each of the previous ten, five, four, three, two and one-year
periods. State Street now trades at a depressed multiple in-line
with traditional banks, despite State Street having a superior
balance sheet to most traditional banks (90% AAA / AA), having
significant excess capital, being more of a fee-driven business,
relying less on net interest income (23% of total net revenue
compared to around 65% for the average commercial bank) and having
delivered superior organic growth over time. We believe this
deterioration in shareholder value stems from a culture that has
prioritized growth over profitability and has led to dilutive
acquisitions, inadequate cost management and significant
non-recurring charges.
As a long-term shareholder that believes in State Street’s
enormous potential for value creation, we would have preferred to
continue to work privately with management and the Board, out of
the public eye. To that end, we first shared our views with
management regarding ways to improve the Company’s results in
August 2010. In June 2011, we shared our “White Paper” with
management, outlining why we believe State Street has
underperformed and proposing a detailed action plan to improve
long-term performance and enhance shareholder value. We believe we
have been patient as management repeatedly requested time to assess
our analysis and promised a response. We have been told by
management that our White Paper is “thoughtful” and that our
assessment of the Company is consistent with the views of both
management and the Board. We have also been told that our
recommendations influenced management’s thinking and that our
August 2010 meeting with management was a catalyst for the
Company’s November 2010 announcement of its Business Operations and
I/T Transformation Program, which targeted $575-$625mm of savings,
but which did not include sufficient detail on how the savings
would be achieved or specific margin targets.
Despite these assurances from management, it has become clear
that State Street has not been willing, to date, to publicly commit
to the actions we view as necessary to enhance long-term
shareholder value:
- Set an explicit long-term earnings
before tax (“EBT”) margin target of ~35% and outline clear interim
targets along the way.
- Prioritize returning capital to
shareholders over dilutive mergers and acquisitions.
- Put an end to non-recurring
charges.
- Consider a separation of Investment
Management (“SSgA”) and Investment Servicing to unlock value.
- Though we did not include as part of
our original White Paper, we believe the Board should make
improvements to State Street’s corporate governance profile.
Accordingly, we are now publicly presenting our vision for State
Street and what we believe should be done to capitalize on the
Company’s inherent strengths, improve operational and financial
performance and deliver increased shareholder value. We hope the
public dissemination of this plan will facilitate greater action by
management and the Board.
We have attached an updated copy of our White Paper and also
provide a brief summary of our views on State Street below.
I. State Street’s record of underperformance:
Inadequate cost management –
2006-2010:1
- Pro forma for the Investors Financial
Corp. acquisition and publicly targeted synergies, expenses grew
significantly faster than sales from 2006 to 2010. Pro forma net
revenue grew 21% since 2006; unfortunately, pro forma expenses grew
30% over this same period.
- Despite 21% growth in assets under
custody (“AUCA”), the Company experienced negative operating
leverage as EBT margins compressed 480 bps. We disagree with
management that margin deterioration was a result of mix shift away
from higher margin services to lower margin services. Net interest
revenue (an extremely high margin revenue stream) actually
increased from 18% of total revenue in 2006 to 24% in 2010. Other
capital markets revenue lines were generally stable during this
period (the real decline in capital markets revenue was from 2008
to 2010). Lower margin servicing and management fees decreased from
58% to 55% of total revenue from 2006 to 2010. On the whole, we
believe these trends should have been margin accretive.
- Compensation costs increased
dramatically while earnings per share (“EPS”) declined. As revenue
peaked in the frothy capital markets environment between 2006 and
2008, State Street allowed a massive run-up in compensation expense
(from $2.78bn to $3.84bn). This run-up was initially overshadowed
by strong EPS growth. When the cycle inevitably turned and EPS fell
even more than it had risen, management did not make proportionate
cuts to compensation. In 2010, State Street paid more in
compensation than in any year other than 2008 but generated the
lowest EPS in its recent history. Shareholders have subsidized
these increases in employee compensation.
- During this period, non-compensation
expense also grew significantly faster than revenue (a 34%
increase, from $2.07bn to $2.77bn, compared to a 21% increase in
pro forma revenue).
- State Street’s Investment Management
division generated a 28% adjusted operating margin in 2010, well
below average asset management operating margins of ~45%.
Dilutive capital allocation
decisions:2
- While State Street spent ~$14bn of
shareholder capital from 2006 to 2010 on acquisitions,
integrations, restructurings, capital expenditures and realized
conduit losses (~80% of the current market capitalization), EPS
declined 7%.
- $8bn was spent on acquisitions at an
average forward earnings multiple of 27.2x.3
- $900mm was spent on integrations and
restructurings aimed at improving margins and delivering
synergies.
- $2bn was spent on capital expenditures.
Despite these investments, both compensation and non-compensation
expenses increased as a percentage of revenue from 2006 to
2010.
- After initially guiding to $850mm of
realized conduit losses, we believe State Street ultimately
recognized approximately $3-$3.5bn of losses. These losses related
to a $6.1bn pre-tax charge associated with the consolidation of
conduit assets, a portion of which was recovered through accretion.
As a result of these conduit charges and strained capital ratios,
State Street executed two equity offerings that permanently diluted
shareholders.
- From January 2007 to January 2011,
shareholders have been diluted 50% as shares outstanding have
increased from 334mm to 502mm.
“Non-recurring” charges have been a
recurring problem:4
- Over $3bn of non-recurring charges from
2006-2010 excluding conduit losses (~18% of the current market
capitalization).
- State Street’s gross non-recurring
charges have represented more than 30% of EBT in each year since
2007.
Negative total shareholder
returns:5
- Total Shareholder Return:
- Ten-Years: -16%
- Five-Years: -45%
- Four-Years: -51%
- Three-Years: -30%
- Two-Years: -37%
- One-Year: -16%
II. Trian’s proposed action plan:
We urge State Street to take the following actions to
demonstrate that management is on track to deliver improvements in
the business and that the Board is committed to holding management
accountable and increasing shareholder value:
1. Set an explicit long-term EBT margin target of ~35%
by 2014 and outline clear interim targets along the way.
Provide greater transparency around cost savings
initiatives.
When we first met with management in August 2010, we shared our
view that State Street had a cost problem. Management initially
disagreed. Over the course of several ensuing meetings, we
presented a detailed analysis of State Street’s historical
financials, highlighting that costs had grown faster than revenue
and that misguided capital deployment had destroyed shareholder
value. Several months later, in November 2010, we were encouraged
when State Street announced a $575-$625mm savings plan through 2014
(simplistically, a 24-26% improvement in EBT). Though we believe
there is potential for even greater savings, State Street’s plan
represents progress. However, we have expressed our reservations
regarding the execution of that plan in subsequent conversations
with management. First, we do not believe management has provided
enough transparency and detail on how it will realize its targets.
This concern is magnified by the fact that we believe ~$300mm of
the anticipated savings involve adaptation of new technologies,
such as cloud computing, while only ~$300mm represent traditional
cost cutting. Between 2006 and 2010, we know that existing costs
such as compensation and non-compensation expense ballooned by
$1.44bn.6 Just as these existing costs escalated dramatically, we
believe they must be brought back in-line. We believe there is room
to cut much more than the $300mm of traditional costs that
management has identified.
We also believe State Street’s savings plan lacks credibility in
the absence of explicit consolidated margin targets. Management’s targeted savings represent a 700 bps
improvement in margin based on 2010 sales levels. This
implies a mid-30% margin by 2014, which we believe is achievable.
Management argues it cannot set specific targets because
fluctuations in key revenue streams (e.g., net interest margin) are
outside of their control. However, we believe that every company in
the S&P 500 has sources of revenue and expense that are outside
of their control, whether they are interest rates, commodity costs
or even the weather. The best companies set decisive targets and
flex their cost structure to achieve them. If they miss by a small
amount because of factors outside of management’s control,
shareholders can evaluate accordingly. But without long-term profit
targets, how do companies budget and how are incentives aligned?
How did State Street make acquisitions historically and solve for
an appropriate return on investment? How will the Board hold
management accountable for delivering on its promises? And how can
shareholders evaluate performance and measure progress?
Margin targets are even more imperative at State Street given
its history of poor cost management. When State Street bought
Investors Financial Corp. for $4.4bn in 2007, management promised
$345-$365mm in synergies. Management subsequently confirmed that
those synergies were realized. Nevertheless, five years later,
expenses have grown faster than sales, margins have contracted and
EPS has declined. Where were the synergies? One thing shareholders
know for certain – State Street has recognized hundreds of millions
of dollars in integration and restructuring charges during this
period. State Street’s latest savings initiative comes with a
similarly large $400-450mm restructuring tab. Without appropriate
margin targets, how can shareholders ensure that three years from
now management won’t claim success on the savings front while we
are left to foot the bill and have nothing to show for it on the
bottom-line?
2. Prioritize returning capital to shareholders over
dilutive mergers and acquisitions. Eliminate non-recurring
charges.
Trian appreciates the platform that State Street has assembled
over the past five years. But State Street’s shareholders paid a
high price subsidizing the growth in revenue and assets at the
expense of profitability, return on invested capital and
shareholder returns. With over $22tn in AUCA and $2tn in assets
under management (“AUM”), State Street has scale. Now the Company
must make that scale work by delivering attractive organic growth,
controlling costs and growing EPS.
In the meantime, State Street currently enjoys a very strong
capital position (11.8% Tier 1 Common Ratio; $4.50 per share of
excess capital under Basel III assuming the most onerous SIFI
buffer (7.0% + 2.5% buffer)). State Street also trades at a
severely depressed multiple of only 8.0x 2011 consensus earnings.7
We believe there is no better investment that State Street can make
today than buying its own stock.
Clearly the Company is constrained by regulatory uncertainty
while we await new capital guidelines. But we also believe that
State Street must better explain to regulators, as well as
investors, how its business model is superior to that of
traditional banks (fee income represents a much higher percentage
of revenue; net interest income represents a much lower percentage
of revenue) as well as the details of its superior capital
position. We have told management that we believe State Street
failed to secure an appropriate capital plan this year to the
detriment of shareholders and that, going forward, State Street
must be more successful in optimizing its capital deployment
program. For example, State Street has a Tier 1 Common Ratio of
11.8% and was authorized by the regulators to repurchase $675mm of
stock, representing 33% of its 2011 expected capital generation and
4.0% of its market capitalization. In comparison, JPMorgan Chase
has a Tier 1 Common Ratio of 7.7% and was authorized to repurchase
$8bn of stock, representing 40% of its expected 2011 capital
generation and 6.4% of its current market capitalization. Given
State Street’s superior capital position, more stable business
model and lower anticipated SIFI buffer, this hardly seems
justifiable. As the regulatory process evolves, we view it as
imperative that State Street set a target capital ratio and commit
to return the vast majority of excess capital above that level plus
the majority of future years’ capital generation to
shareholders.
State Street must also commit to eliminating “non-recurring”
charges. When these charges are taken every year and are included
as add-backs in “adjusted earnings,” investors rightfully question
earnings quality and risk controls. We believe these factors have
contributed to State Street’s record of disappointing shareholder
returns and its depressed valuation multiple. We have received
assurances from management that steps are being taken to shore up
risk management and eliminate these charges from future periods. We
believe it is imperative that these efforts be successful.
3. Consider a separation of Investment Management and
Investment Servicing to unlock value.
We believe that management should actively consider a separation
of the Investment Management and Investment Servicing divisions. We
have proposed a tax-free spin of SSgA or a Reverse Morris Trust
transaction with a complementary publicly traded asset management
company. A separation would optimize focus and allow two standalone
management teams to improve performance and margins within both
divisions. Shareholders would benefit, as asset managers typically
trade at higher multiples than custody banks. Furthermore, a
separation would unlock the strategic value inherent in State
Street's fast-growing passive investment management franchise.
BlackRock purchased Barclay's Global Investors, another leading
passive franchise, in 2009 for $13.5bn. SSgA could likewise become
an attractive acquisition candidate.
Management has told us that the Board considered a separation of
SSgA but concluded there was too much overlap in the client bases
of the Investment Servicing and Investment Management divisions.
They were concerned that certain accounts would be lost following a
separation. We are skeptical of this conclusion and believe overlap
between Investment Servicing and SSgA’s clients is mostly a
function of these businesses being ubiquitous among the world’s
leading financial institutions. Furthermore, our due diligence has
led us to conclude there are minimal cross-selling synergies
between the two divisions and that both could thrive as standalone
public companies.
4. Improve State Street’s corporate governance
profile.
Currently Jay Hooley serves as Chairman of the Board and CEO. We
believe the best corporate governance practice is for State
Street’s Chairman to be an independent director. The role of the
board is to provide independent oversight of management and the
CEO. An independent Chairman helps minimize potential conflicts and
promotes risk oversight. A separate Chairman also frees the CEO to
manage the company and optimize results.
State Street also currently requires a 40% threshold of the
outstanding voting stock to call a special meeting of shareholders.
We believe this threshold is too high as it makes it extremely
difficult for shareholders to garner the required votes to call a
meeting to vote for change. We would like to see the threshold
reduced to 20%, which we believe strikes an appropriate balance
between enhancing shareholder rights and protecting against the
risk that a small minority could trigger a special meeting that
leads to needless expense and business interruption.
III. Significant upside potential at State
Street.
Trian believes there is significant opportunity for value
creation at State Street. Whereas State Street historically traded
at a high-teens forward earnings multiple, in-line with faster
growth financial services firms, the Company currently trades at a
depressed multiple of only 8.0x 2011 consensus earnings, more
closely aligned with traditional banks. We believe this multiple is
too low as State Street has a superior balance sheet to most
traditional banks that is easier to understand (90% AAA / AA), has
significant excess capital (~$4.50 per share), is more of a
fee-driven business, relies less on net interest income (23% of
total net revenue compared to around 65% for the average commercial
bank) and has delivered superior organic growth over time.
At the same time, we believe State Street’s low multiple is also
a referendum on management’s performance, the Board’s oversight and
the market’s lack of confidence in the Company’s strategy and level
of execution. As a result, we strongly encourage State Street to
adopt Trian’s action plan. By committing to and delivering on our
proposed margin targets, prudently returning capital to
shareholders, maintaining strong capital levels and assuming a
modest re-rating to 13.5x forward earnings, we arrive at an implied
target value per share for State Street of approximately $99 in
2014, compared to the closing price per share of $33.90 on Friday,
October 14, 2011. Separating Investment Management could create
even more value.
If management and the Board fail to make progress on their
initiatives and the plans we have laid out, Trian may decide to
become significantly more active in evaluating our alternatives as
a large shareholder.
As noted above, attached to this letter is an updated copy of
our White Paper. We have decided to make this letter public, along
with the White Paper, so that all shareholders can understand the
vision we have for this great company. As always, we are prepared
to meet with you to further discuss State Street’s plans and our
suggested initiatives to enhance shareholder value.
Sincerely,
Nelson Peltz
Chief Executive Officer
Founding Partner
Peter May
President
Founding Partner
Ed Garden
Chief Investment Officer
Founding Partner
About Trian Fund Management, L.P.
Founded in 2005 by Nelson Peltz, Peter May and Ed Garden, Trian
seeks to work closely with the management of those companies in
which it invests to enhance shareholder value through a combination
of strategic redirection, improved operational execution, more
efficient capital allocation and stronger focus.
THE VIEWS EXPRESSED IN THIS PRESS RELEASE REPRESENT THE OPINIONS
OF TRIAN FUND MANAGEMENT, L.P. AND THE FUNDS AND ACCOUNTS IT
MANAGES (COLLECTIVELY, “TRIAN PARTNERS”), AND ARE BASED ON PUBLICLY
AVAILABLE INFORMATION WITH RESPECT TO STATE STREET CORPORATION (THE
"ISSUER") AND THE OTHER COMPANIES REFERRED TO HEREIN. THERE IS NO
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RESULTS OR PERFORMANCE OF THE ISSUER WILL NOT DIFFER, AND SUCH
DIFFERENCES MAY BE MATERIAL. TRIAN PARTNERS RESERVES THE RIGHT TO
CHANGE ANY OF ITS OPINIONS EXPRESSED HEREIN AT ANY TIME AS IT DEEMS
APPROPRIATE. TRIAN PARTNERS DISCLAIMS ANY OBLIGATION TO UPDATE THE
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SUCH FUNDS OR ACCOUNTS FROM TIME TO TIME TO SELL ALL OR A PORTION
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THIS PRESS RELEASE CONTAINS FORWARD-LOOKING STATEMENTS. ALL
STATEMENTS CONTAINED IN THIS PRESS RELEASE THAT ARE NOT CLEARLY
HISTORICAL IN NATURE OR THAT NECESSARILY DEPEND ON FUTURE EVENTS
ARE FORWARD-LOOKING, AND THE WORDS “ANTICIPATE,” “BELIEVE,”
“EXPECT,” “POTENTIAL,” “OPPORTUNITY,” “ESTIMATE,” “PLAN,” AND
SIMILAR EXPRESSIONS ARE GENERALLY INTENDED TO IDENTIFY
FORWARD-LOOKING STATEMENTS. THE PROJECTED RESULTS AND STATEMENTS
CONTAINED IN THIS PRESS RELEASE THAT ARE NOT HISTORICAL FACTS ARE
BASED ON CURRENT EXPECTATIONS, SPEAK ONLY AS OF THE DATE OF THIS
PRESS RELEASE AND INVOLVE RISKS, UNCERTAINTIES AND OTHER FACTORS
THAT MAY CAUSE ACTUAL RESULTS, PERFORMANCE OR ACHIEVEMENTS TO BE
MATERIALLY DIFFERENT FROM ANY FUTURE RESULTS, PERFORMANCE OR
ACHIEVEMENTS EXPRESSED OR IMPLIED BY SUCH PROJECTED RESULTS AND
STATEMENTS. ASSUMPTIONS RELATING TO THE FOREGOING INVOLVE JUDGMENTS
WITH RESPECT TO, AMONG OTHER THINGS, FUTURE ECONOMIC, COMPETITIVE
AND MARKET CONDITIONS AND FUTURE BUSINESS DECISIONS, ALL OF WHICH
ARE DIFFICULT OR IMPOSSIBLE TO PREDICT ACCURATELY AND MANY OF WHICH
ARE BEYOND THE CONTROL OF TRIAN PARTNERS. ALTHOUGH TRIAN PARTNERS
BELIEVES THAT THE ASSUMPTIONS UNDERLYING THE PROJECTED RESULTS OR
FORWARD-LOOKING STATEMENTS ARE REASONABLE, ANY OF THE ASSUMPTIONS
COULD BE INACCURATE AND, THEREFORE, THERE CAN BE NO ASSURANCE THAT
THE PROJECTED RESULTS OR FORWARD-LOOKING STATEMENTS INCLUDED IN
THIS PRESS RELEASE WILL PROVE TO BE ACCURATE. IN LIGHT OF THE
SIGNIFICANT UNCERTAINTIES INHERENT IN THE PROJECTED RESULTS AND
FORWARD-LOOKING STATEMENTS INCLUDED IN THIS PRESS RELEASE, THE
INCLUSION OF SUCH INFORMATION SHOULD NOT BE REGARDED AS A
REPRESENTATION AS TO FUTURE RESULTS OR THAT THE OBJECTIVES AND
PLANS EXPRESSED OR IMPLIED BY SUCH PROJECTED RESULTS AND
FORWARD-LOOKING STATEMENTS WILL BE ACHIEVED. TRIAN PARTNERS WILL
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THE RESULTS OF ANY REVISIONS THAT MAY BE MADE TO ANY PROJECTED
RESULTS OR FORWARD-LOOKING STATEMENTS IN THIS PRESS RELEASE TO
REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE OF SUCH PROJECTED
RESULTS OR STATEMENTS OR TO REFLECT THE OCCURRENCE OF ANTICIPATED
OR UNANTICIPATED EVENTS.
1 Source: SEC filings. FY 2006 financials are State Street’s and
Investors Financial Corp.’s combined financial statements, pro
forma for management’s publicly targeted synergies.
2 Source: SEC filings.
3 Source: SEC filings, earnings calls and investor
presentations. Represents the weighted average acquisition forward
earnings multiple of Investors Financial Corp. and Intesa
Sanpaolo’s securities services business, including capital support
and intangible amortization for Intesa.
4 Source: SEC filings.
5 Source: Bloomberg. Total shareholder returns include
dividends.
6 Source: SEC filings. FY 2006 financials are State Street’s and
Investors Financial Corp.’s combined financial statements, pro
forma for management’s publicly targeted synergies.
7 Based on 2011 consensus EPS estimates. Adjusts share price for
$4.50 of excess capital assuming a 9.5% Basel III Tier I Common
Ratio.
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