Despite a massive investor sell-off Tuesday, State Street Corp.'s top executive was upbeat in an interview, saying he expects to achieve "flat" results this year by cutting expenses and gaining asset servicing and management business.
The Boston company's shares fell 59%, to $14.89 in Tuesday trading — their biggest decline since 1984 — on concerns State Street would have to raise capital after bringing troubled investment vehicles onto its balance sheet.
But Ronald E. Logue, its chief executive officer, said during the interview that, despite a "broad desire in the marketplace for us to raise capital," he does not think it will be necessary.
"I can't predict what will happen, but I have to believe that all of the federal stimulus packages in place should have a positive effect," he said. Even if consolidating the troubled investment conduits on the balance sheet is needed, "we anticipate that we'll be able to handle [it] without raising capital."
State Street said after-tax, unrealized, mark-to-market losses in the investment portfolio rose to $6.3 billion in the fourth quarter, up $3 billion from the previous quarter. Losses in State Street-administered, asset-backed commercial paper conduits rose 63.6%, to $3.6 billion.
The conduits have been hit by the credit turmoil, and fear exists that State Street will have to consolidate the vehicles on its balance sheet.
"Obviously, the increases in the negative marks in our investment portfolio and in our conduits concern us," Mr. Logue said during the company's earnings call Tuesday. "But we still believe that they are, for the most part, a result of the lack of liquidity in the market and not a result of their credit quality."
He said State Street has considered raising capital. The company, which has a Tier 1 capital ratio of 20.49%, got $2 billion in the Treasury's Capital Purchase Program. It held talks with select institutional investors, he said, and "determined not to raise additional capital."
He said in the interview that despite difficult market conditions opportunities will exist for large trust banks like State Street, Bank of New York Mellon Corp., and Northern Trust Corp. to gain market share as they generate business from investment management companies, including hedge funds.
"There is certainly a flight to safety going on right now, and a lot of companies are interested in outsourcing," he said. "This flight to safety and reduction in administrative expenses is really playing to our strengths."
Mr. Logue touted the potential for big outsourcing deals, particularly from large hedge funds looking to "offload certain administrative services to third-party providers, like State Street."
"I believe that a certain amount of transparency is going to be mandated on the hedge fund world," he said. "Let's just call it the Madoff Effect."
Two months ago, Mr. Logue predicted that State Street would increase its operating earnings by 6% to 8% in 2009. But the company was forced to "change its tune," he said, after the Treasury announced that it would no longer buy troubled assets from banks. On Tuesday Mr. Logue changed his forecast to "flat."
Analysts said if he can achieve that and avoid having to raise capital it would be considered a "heroic" feat this year.
Andrew Marquardt, an analyst at Fox-Pitt Kelton Cochran Caronia Waller LLC, said in an interview: "It is not unreasonable for State Street to expect growth because they have good prospects for new business."
But other analysts were more skeptical, saying that State Street may face customer claims, financial losses, reputational damage, and regulatory scrutiny.
"I would say, clearly, the capital markets continue to deteriorate in 2009, and this is hampering State Street," said Gerard Cassidy, an analyst at Royal Bank of Canada's RBC Capital Markets Corp. "The company's success is hitched to the capital markets, and when the capital markets collapse, their day-to-day operations and their balance sheet suffer."
The key for State Street is to replenish equity, he said. "They can try to generate growth by adding new business, which takes time, or they can try to add capital, which can be dilutive. It is a tough spot."
State Street reported Tuesday that net income fell 71% in the quarter, to $65 million, or 15 cents a share, from a year earlier. The company's revenue grew 7.8%, to $2.67 billion, as net interest revenue surged 42% while cuts in the federal funds rate reduced funding costs.
The company's operating earnings fell 14.5%, to $1.18 per share. Analysts expected earnings of $1.14 a share on $2.42 billion in revenue, according to Thomson Reuters.
State Street's assets under custody fell 21%, to $12 trillion, and assets under management dropped 27%, to $1.44 trillion, but Mr. Logue described these results as leaving "room for optimism." He said the company generated "record" new business in the quarter —$400 billion in asset servicing and $34 billion in asset management.
State Street announced in December that it would reduce its global work force by about 6%, or 1,600 to 1,800 employees. During the earnings call, Mr. Logue said the company would freeze salaries this year.
During the interview, Mr. Logue said there are no plans for further job cuts. "We want to be sure we keep our service levels up, and since 75% of the current reductions are among vice presidents and above, we think we will be able to preserve our service levels," he said.
Mr. Logue said the company has no plan to divest businesses.
"Our business model is working," he said. "Our ability to generate revenue remains strong, and relative to what is happening in the economy, we will continue to perform. Perhaps not at the historic levels that we have set in the past, but we will grow."
Mr. Marquardt said capital remains a key issue. "This is not new, and it is not going away," he said. "I think this is something they need to address."
There are strategic alternatives for State Street to consider, including raising capital, cutting the dividend, divesting businesses, or shrinking the balance sheet, he said, but Mr. Logue said the company is not considering any of these options.
Despite skepticism in the market, Mr. Logue said, State Street continues to generate revenue. "Our complete product set is in a very specialized industry," he said. "We don't do loans or issue credit cards like banks. We are focused on the securities servicing industry, and we see a lot of opportunities for organic growth."
The company has no plan to acquire, he said.
"We are at a point, given the current market, that we want to grow organically," he said. "We think it would be hard to do an acquisition right now, given what is going on in the market. We want to focus on organic growth."
