July 17 (Bloomberg) -- State Street Corp., the third-largest custody bank, agreed to buy the hedge-fund administration unit of Goldman Sachs Group Inc. to boost growth as second-quarter revenue fell amid declining global markets and record-low interest rates.
State Street agreed to pay $550 million in cash for the Goldman Sachs unit to become the world’s largest servicer of alternative assets such as hedge funds, the Boston-based company said today. State Street fell 6.4 percent in New York, the most in seven months, as declining assets and fees spurred a 1.9 percent drop in revenue to $2.43 billion.
“Fee income was relatively stagnant due to the market correction, and while there were definitely expense savings in the quarter, they weren’t quite as much as we anticipated,” Marty Mosby, a Memphis, Tennessee-based analyst at Guggenheim Securities LLC, said in a telephone interview.
Custody banks have struggled to increase profits as the Federal Reserve has held interest rates near zero since December 2008 and falling stock markets worldwide have cut the assets that the firms oversee for clients. State Street Chief Executive Officer Joseph Hooley has cut more than 2,200 jobs in the past two years to contain expenses, raised the company’s dividend in April to boost shareholder returns and searched for acquisitions such as the Goldman Sachs unit to increase assets.
“We’re all grinding through this difficult environment,” Hooley said today in a telephone interview. “We’ve positioned ourselves in this cycle so that a combination of a less risky business model and higher capacity give us the opportunity to pounce on acquisitions when they make sense.”
State Street has reduced risk in its investment portfolio since 2009, when the firm was forced to write down the value of investments by $3.7 billion.
While he continues to approach the second half of 2012 with caution, Hooley said the increased global savings rate and “huge piles of cash sitting on the sidelines” made him optimistic.
State Street fell to $41.33 at 4:15 p.m. in New York. State Street’s shares have increased 2.5 percent this year, compared with the 9 percent gain by the Standard & Poor’s 20-company index of asset managers and custody banks.
State Street’s assets under custody fell 2.4 percent to $16.4 trillion and the money the firm invests for clients fell 9 percent to $1.9 trillion.
The acquisition of the Goldman Sachs’ hedge-fund servicing unit adds $200 billion in assets under custody, and gives State Street $877 billion in alternative funds under administration.
The company added $133 billion in custody assets through new client deals in the quarter. That’s down from an average of $327 billion in the previous five quarters.
Second-quarter profit rose 2.3 percent after the firm sold investment securities for an operating-basis gain of $19 million. Net income on an operating basis increased to $494 million, or $1.01 a share, from $483 million, or 96 cents, a year earlier.
State Street’s operating profit excludes money earned from the sale or maturing of bonds whose value was written down in May 2009, which the company records as “discount accretion” within net interest income. Discount accretion added $74 million to net income in the second quarter.
Using generally accepted accounting principles, or GAAP, State Street’s net income fell to $480 million, or 98 cents a share, from $502 million, or $1 a share, a year earlier.
State Street lost $46 million in the quarter when it sold its remaining Greek holdings. The company recorded that as a one-time item, excluding it from operating results.
“Greece seemed extraordinary to us,” Hooley said in the interview.
The MSCI ACWI Index of global stocks declined 8.7 percent in the year ended June 30. State Street’s custody fees in the second quarter fell 3.4 percent from a year earlier to $1.09 billion and investment-management fees dropped 1.6 percent to $246 million.
Operating basis expenses decreased 1.7 percent to $1.73 billion as employee compensation costs fell 6.6 percent.
Low interest rates hurt custody banks by trimming the return on their investments and lending. State Street has also waived some fees on money-market funds to keep client returns above zero. The Federal Reserve has held its benchmark interest rate at zero to 0.25 percent for more than three years in an attempt to stimulate lending and economic growth.
Custody banks keep records, track performance and lend securities for institutional investors including mutual funds, pension funds and hedge funds. State Street also manages investments for individuals and institutions.
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