When management gurus talk about turning a negative into a positive, State Street Corp.'s experience with the Treasury Department's stress test could be a case study.
After passing the test with "flying colors," according to Ron Logue, the Boston custodial company's chairman and chief executive officer, it was able to arm itself with enough capital not just to repay federal funds, but also to be an acquirer next year.
Analysts have said the best thing the federal government did for custodial banking companies like State Street Corp., Northern Trust Corp. and Bank of New York Mellon Corp. was to subject them to the testing, because it illustrated to shareholders that the firms have suitable capital and can withstand difficult economic conditions.
Logue said State Street is the poster child for that line of thinking. He said the stress test proved to shareholders and analysts that it could raise capital, pay back the $2 billion it received from the Troubled Asset Relief Program and clean up an investment portfolio that had hampered its stock in previous quarters. "The survivors in the new world of financial services need strong capital bases," he said. "We knew we would be well positioned if we could raise capital sooner rather than later."
State Street had the highest Tier 1 capital ratio among of the 19 companies that underwent stress tests. It was not required to raise additional capital, though it elected to do so. "We were No. 1 because we don't make loans that can be stressed," Logue said.
It has raised enough capital to increase its Tier 1 ratio to 15.1% — more than twice the minimum requirement. Logue said starting early next year, there will be opportunities for State Street to buy asset management and asset servicing companies outside the United States. "I don't see many yet, but beginning next year, they will start to emerge," he said. "We have a strong goal of generating 50% of our revenue from outside of the United States. I think there will be opportunities."
In January the company's stock fell to as low as $14 a share. Nancy A. Bush of NAB Research LLC said there were some "serious concerns about where the company would be after the stress test." She said that the company, whose shares now trade at $48.95, came away from the stress test well positioned. "The world view of State Street had become so distorted in the past six months because of some of the fears surrounding their investment portfolio," she said. "I think the reality created by the stress test is more dramatic than anything BNY Mellon or Northern Trust has experienced."
On May 18 — 11 days after the test results were announced — State Street raised $2.3 billion by selling new stock to private investors. A day later it raised $500 million by selling debt not guaranteed by the government to position the company to pay back its Tarp funding as soon as possible.
Logue said that his company has sought Treasury approval to pay back the money, and that adding capital was one of the stipulations for companies that wanted to repay the government.
"We want to be among the first to pay it back," he said. "We will have more than twice the minimum capital ratio, and I believe that we are one of the only banks in the original nine that received funding that have raised more money than we were given."
To date 579 financial institutions have received Tarp funds, and two have repaid the Treasury. Old National Bancorp spent $100 million to buy back its preferred stock and $1.2 million for its warrants, and Iberiabank Corp. spent $90 million to buy back its preferred stock and $1.2 million for its warrants.
Other large companies, including JPMorgan Chase & Co. and American Express Co., have raised capital to pack back Tarp funds. Northern Trust and Bank of New York Mellon have also announced repayment plans.
Logue said State Street's decision to raise capital to repay its Tarp funds was not prompted by its competitors.
It raised the capital because "under the original Tarp rules, if you replaced all that you were given, you'd be forgiven 50% of the warrants," he said. "Also, it was clear that the window to raise such capital was going to close for a long time."
The stress test also examined State Street's exposure to $22.7 billion of asset-backed commercial paper conduits, Logue said. The conduits were originally intended to generate profits while remaining separate from State Street's balance sheet, but when credit markets slumped, the stock fell as investors worried the company would have to take what they perceived as troubled assets on to its balance sheet, he said.
The test affirmed the conduits "were money good," Logue said. "Coming out of the test, we proved even with the conduits we maintained very strong capital ratios."
When the company raised the capital, Logue said, it also consolidated the conduits on to its balance sheet.
Bush said the test encouraged State Street to consolidate its conduits and raise capital. "The company has really done a 180-degree turn in terms of how they are perceived in the market. I think it has realized that they weren't blameless. I think they have learned not to pursue risky strategies."
But Burton Greenwald of Philadelphia's BJ Greenwald Associates said State Street is not out of the woods yet; even after bringing the conduits on to its balance sheet, it will still have to contend with litigation issues surrounding them.
Given everything that has happened in the banking sector in the past 10 months, Logue said, State Street has learned its model works. "We provide asset servicing and asset management, and we don't make loans, and every one of our competitors does. That focus has emerged as a significant strength."
Currently, 35% to 40% of State Street's revenue are from foreign countries. Logue said there will be opportunities to acquire in Europe next year and add business in the Asia-Pacific region. "What you are going to see in the second half of this year is a lot of good-sized deals from us," Logue said. "A lot of traditional banks are reassessing their business model and deciding that asset servicing is not part of their core services."
