State Street Falls After Missing Revenue Estimates

State Street Corp., the third-largest custody bank, fell the most in more than a year after low interest rates reduced earnings on the company’s investments.

Operating revenue rose 3.4 percent from a year earlier to $2.47 billion, the Boston-based company said today in a statement, missing the $2.54 billion average estimate of 14 analysts surveyed by Bloomberg. The shares fell as much as 4.3 percent, the most since July 2012. They traded 3.6 percent lower at $67.47 at 12:21 p.m. in New York.

Chief Executive Officer Joseph Hooley cut costs and returned capital to shareholders more aggressively than his rivals over the past three years as custody banks struggled to increase profits amid rates that have hovered near zero since the end of 2008. Low rates in the third quarter offset the impact of higher assets, cost savings from earlier job cuts and investments in technology.

While State Street demonstrated “decent expense containment,” the outlook for the revenue the company earns investing and lending deposits “will likely concern some investors,” Luke Montgomery, an analyst in New York with Sanford C. Bernstein & Co., wrote in a research note published today.

Net-interest revenue fell 9.5 percent from a year earlier to $553 million. Fees for custody and investing assets each jumped by 10 percent as the MSCI ACWI Index of global stocks rose 7.4 percent in the three months and 15 percent in the nine months ended Sept. 30.

Treasury Yields

State Street doesn’t expect the recent increase in 10-year treasury yields to have a noticeable impact on its net-interest revenue, Michael W. Bell, chief financial officer, said in a conference call with analysts. Bell said higher short-term rates would be necessary to benefit the firm’s investment portfolio.

Assets under custody rose 1.7 percent in the quarter and 11 percent from a year earlier to $19.2 trillion. The amount of money State Street invests for clients rose 4.4 percent in the quarter and 8.5 percent from a year earlier to $2.24 trillion

Operating expenses rose at a slower pace than operating revenue, increasing 1.4 percent to $1.69 billion. The largest expense component, compensation and benefits, declined 1.4 percent to $903 million.

Net income on an operating basis increased 14 percent to $537 million, or $1.19 a share, from $473 million, or 99 cents, a year earlier. Excluding certain items, 21 analysts surveyed by Bloomberg expected earnings of $1.18 a share on average.

Discount Accretion

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 $28 million to net income in the third quarter

Using generally accepted accounting principles, or GAAP, State Street’s net income fell 19 percent to $531 million, or $1.17 a share, from $654 million, or $1.36, a year earlier.

GAAP earnings in the third quarter of 2012 included a net, after-tax benefit of 35 cents a share, most of which relates to claims associated with the 2008 bankruptcy of Lehman Brothers Holdings Inc.

State Street won new business in the quarter, adding $200 billion to custody assets. It lost $15 billion in investment withdrawals in the quarter.

Debt Ceiling Scare

State Street spent the first half of October preparing for a possible crisis as the U.S. government approached its borrowing limit and a debt default, according to Hooley.

“We were hoping that nobody panicked and started shorting short-term Treasuries,” Hooley said in a telephone interview. “The market could have cascaded into something pretty harmful, and it could have happened before we hit the debt ceiling.”

Republican Party leaders in Congress agreed Oct. 16 not to block a measure to end a government shutdown and lift the borrowing limit that Treasury officials said they would reach the next day. The accord with President Barack Obama sets a Dec. 13 date for completing talks that opened yesterday on a broader budget deal. It funds government operations through Jan. 15 and suspends the debt limit through Feb. 7.

Hooley said a wider budget compromise by lawmakers in Washington would avoid not only another scare over the debt ceiling but could also help the economy grow.

“I think the U.S. economy is in recovery, but we need to unleash the business-level confidence to achieve that next level,” he said.

Share Buyback

State Street said it repurchased about $560 million of common stock in the quarter at an average price of $68.57 a share.

Bank of New York Mellon Corp., the world’s largest custody bank, said Oct. 16 its third-quarter profit rose 34 percent to $967 million, helped by stock market gains and a tax court ruling.

Northern Trust Corp., on the same day, said third-quarter profit rose 15 percent as cost cuts combined with rising stocks pushed revenue higher.

State Street’s shares had advanced 49 percent this year through yesterday, the best among the three biggest U.S. custody banks. BNY Mellon had risen 23 percent this year and Chicago-based Northern Trust had increased 12 percent.

Low interest rates hurt custody banks by reducing the returns they make on lending and on their own investments. The U.S. Federal Reserve has held its benchmark interest rate at zero to 0.25 percent since December 2008 in an attempt to stimulate borrowing 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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