State Street Sells $11 Billion in Securities to Meet Tigher Capital Rules

State Street Corp., the third-largest custody bank, sold $11 billion in mortgage-backed securities and other assets, a step more financial companies may take after global regulators agreed to tighten capital rules.

The transaction will reduce earnings by $350 million in the current quarter, the Boston-based company said today in a statement. Fitch Ratings raised its individual ratings on State Street and its bank subsidiary, State Street Bank & Trust, to B from B/C, saying the firm’s risk appetite is “more restrained.”

The Group of 20 nations last month endorsed rules, known as Basel III, increasing the level of the highest-quality capital that banks must hold to cushion against losses and avoid a repeat of the financial crisis. After the transaction, State Street’s Tier 1 common capital ratio, the most important regulatory measure of a bank’s financial health, will rise to 8.8 percent under the new rules, the bank estimated. The new minimum under the rules is 7 percent.

“This is quite favorable for the long-term investor,” Gerard Cassidy, an analyst at RBC Capital Markets in Portland, Maine, said in a telephone interview. “They’ve improved the integrity of the balance sheet at the expense of near-term earnings.”

State Street fell 44 cents, or 1 percent, to $45.74 at 4:15 p.m. in New York Stock Exchange composite trading. It has climbed 5.1 percent this year, compared with a 10 percent gain for Standard & Poor’s index of asset managers and custody banks.

Reducing Risk

Bank of America Corp., based in Charlotte, North Carolina, repackaged $13 billion of mortgage-linked securities into new bonds in the first half of the year, a technique that allowed the bank to reduce its assets by $5.2 billion.

State Street’s divestment will improve “capital ratios under evolving regulatory capital standards” and reduce risk from “certain assets,” the company said in the statement.

The transaction will reduce net interest income by $375 million in 2011, State Street said. The company reiterated a forecast for 2010 full-year operating profit to be “slightly” higher than the $3.32 a share reported in 2009.

The sale included U.S. non-agency mortgage-backed securities valued at $4.1 billion and asset-backed securities of $3.7 billion, as well as non-U.S. mortgage-backed and asset- backed securities of $3.1 billion, State Street said.

State Street plans to reinvest the proceeds from the sale mostly in asset-backed and mortgage-backed securities rated AAA and AA, the two highest levels, as well as U.S. Treasuries and agency securities, according to the statement. By replacing lower-rated holdings with less-risky assets, the bank improved its Tier 1 common ratio. The sale reduces State Street’s risk- weighted assets to $63.7 billion from $75.6 billion as of Sept. 30.

Capital Standards

The new capital standards, approved by the Basel committee in September, will more than double the ratio of capital banks must hold in relation to the amount of risk on their balance sheets. While the standards don’t phase in for eight years, banks may face restrictions on dividends or share buybacks from domestic regulators if they don’t reach compliance sooner, according to the New York-based brokerage firm KBW Inc.

Goldman Sachs Group Inc. in New York is offering U.S. home- loan bonds without government backing to investors after acquiring about $6 billion in a single trade this month, three people familiar with the matter said yesterday. State Street Corp. sold the notes, the people said.

Morgan Stanley, Barclays

Additional buyers also included New York’s Morgan Stanley and London-based Barclays Plc, others familiar with the transactions said.

Michael DuVally, a spokesman for Goldman Sachs, declined to comment, as did Mark Lane, a Barclays spokesman, and Mark Lake, a Morgan Stanley spokesman.

The new rules may increase the supply of securitized debt bought before the financial crisis, especially from European banks, though that will be tempered by the changes not taking effect for several years, said Scott Buchta, head of investment strategy at New York-based broker Braver Stern Securities.

A pick-up in sales of collateralized loan obligations, backed by high-yield, high-risk corporate debt, in London recently also may be a result of capital-rule changes, Buchta said. At the same time, a “recovery” in values may be even more of a driver of recent sales of securitized debt, he added.

State Street held $46 billion in structured securities within its $100 billion investment portfolio, as of Sept. 30, according to a company presentation. The overall portfolio held $281 million in after-tax, unrealized mark-to-market losses, down from $2.99 billion a year earlier.

‘Discount Accretion’

State Street wrote down the value of holdings in its investment portfolio by $3.7 billion in May 2009 to reflect market prices. As those holdings mature at face value, the firm recovers the amount written down and records that as “discount accretion” within net interest income.

Because of the sale, expected discount accretion in 2011 will fall to $175 million from $550 million.

Custody banks keep records, track performance and lend securities to institutional investors such as pension plans and hedge funds. State Street also manages mutual funds and institutional investor accounts.

To contact the reporters on this story: Christopher Condon in Boston at ccondon4@bloomberg.net; Jody Shenn in New York at jshenn@bloomberg.net

To contact the editors responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net; Alan Goldstein at agoldstein5@bloomberg.net

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