STT State Street Corporation

State Street Corporation (STT) reported its second quarter 2012 operating earnings per share of $1.01, marginally surpassing the Zacks Consensus Estimate of 99 cents. This also compares favorably with the previous-quarter earnings of 84 cents and the year-ago earnings of 96 cents.

After considering certain non-recurring items such as acquisition costs, restructuring expenses, litigation settlement costs, loss on sale of securities as well as discount accretion related to former conduit securities, net income for the quarter came in at $480 million or 98 cents per share.

Though this compares favorably with the prior-quarter net income of $417 million or 85 cents per share, it came in below the year-ago net income of $502 million or $1.00.

The sequential improvement came on the back of enhanced net interest revenue and reduced operating expenses. The capital ratios of the company also remained strong in the quarter. However lower fee revenue was the headwind.

State Street’s net income available to shareholders was $494.0 million on an operating basis, up 20.5% from $410 million in the prior quarter and 2.3% from $483 million in the prior-year quarter.

Quarter in Detail

Revenue for the quarter was $2.42 billion, which almost remained unchanged sequentially. Revenue on an operating basis came in at $2.43 billion, up almost 1% from $2.40 billion in the prior quarter. Operating revenue was slightly lower than the Zacks Consensus Estimate of $2.44 billion.

For the reported quarter, net interest revenue on an operating basis grew 3.6% sequentially to $629 million. The improvement from the prior quarter was primarily due to lower funding costs along with increases in investments, which were partially offset by reduced asset yields.

Net interest margin was 1.72% in the quarter, up 8 basis points (bps) from 1.64% in the prior quarter.

Fee revenues came in at $1.78 million, slightly down by 0.4% from the prior quarter. The sequential decline can be attributed to lower trading service fees along with lower processing and other fees, partially offset by higher service fees, management fees and securities finance fees.

On an operating basis, non-interest expenses were $1.73 billion, declining 3.9% sequentially. The fall was due to lower compensation and employee benefits, reduced transaction processing service costs as well as occupancy costs, partially mitigated by higher information systems and communication expenses and other costs.

Asset Position

Total assets under custody and administration were $22.42 trillion as of June 30, 2012, down 3.4% sequentially and 1.5% on a year-over-year basis. Moreover, State Street’s total assets under management stood at $1.91 billion, down 3.6% from the prior quarter and 9.0% from the year-ago quarter.

Capital and Profitability Ratios

State Street’s capital ratios remained strong. As of June 30, 2012, Tier 1 capital ratio was 19.9%, up from 19.1% as of March 31, 2012, and 18.9% as of June 30, 2011. Likewise, Tier 1 common to risk-weighted assets increased to 17.9% as of June 30, 2012 from 17.2% as of March 31, 2012, and 16.9% as of June 30, 2011.

For the reported quarter, return on common equity (on an operating basis) came in at 10.3% compared with 8.6% in the prior quarter and 10.2% in the prior-year quarter.

Share Repurchase

In March, State Street, after receiving the approval for its capital plan, had announced a new share repurchase program authorizing the purchase of up to $1.8 billion of stock through the first quarter of 2013.

During the reported quarter, State Street bought back shares worth $480 million at an average price of $43.26 per share.

Acquisition

Concurrent with the earnings release, State Street announced the acquisition of Goldman Sachs Administration Services (GSAS) – a leading hedge fund administrator – from The Goldman Sachs Group, Inc. (GS). It is an all-cash deal worth $550 million.

The deal is subject to regulatory approvals and is expected to close in the last quarter of 2012. The acquisition will further strengthen State Street’s hedge fund business.

Our Viewpoint

We anticipate State Street’s restructuring programs along with well-off core servicing and investment management franchises to help offset the weakness caused by the slow economic recovery. However, given the ongoing weakness in the mortgage market, we remain concerned about the considerable amount of mortgage-backed and asset-backed securities in its investment portfolio.

State Street currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Considering the fundamentals, we maintain a long-term Neutral recommendation on the shares.

Among State Street’s peers, BB&T Corporation (BBT) is scheduled to report the first-quarter earnings on July 19, while SunTrust Banks Inc. (STI) will report on July 20.

 
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