During its earnings conference call Wednesday, State Street Corp. gave a glimpse into its plans for the capital infusion it received from the Treasury.
State Street, which announced its third-quarter results a week ahead of schedule after it was listed as one of nine financial companies that will receive capital injections from the government, said it will issue $2 billion of senior preferred shares to the Treasury along with warrants to buy common stock with a total price of about $300 million.
Ronald Logue, State Street's chief executive, said it was important to "accelerate" the release of the results "to get out as much clarity and information as fast as we could" after the Treasury's announcement Tuesday.
Mr. Logue said his company likely will be able to buy back the stock position from the Treasury any time after the three-year required waiting period ends.
"The intent here is to jump-start capital formation," he said on the call. "Obviously, as we go forward, the way we look at this is an opportunity in a difficult time to get strength. We need to continue to look at how to strengthen our balance sheet. We believe that we will pay this out within the given time."
Analysts said they expect State Street to be able to buy back from the government in the timeframe Mr. Logue anticipates. State Street's $2 billion investment is relatively small compared to the $25 billion some companies received but it is a sizable number when measured against the company's $20 billion market capitalization.
Under the program, the Boston company cannot raise its dividend or buy back stock without the agency's approval.
Given the state of the markets, analysts said it is doubtful State Street will have profit growth next year.
For its own part, State Street remains upbeat about its prospects, Mr. Logue said. He said he expects 2008 growth in operating earnings per share "to be approaching the high end of the 10% to 15% range, growth in operating revenue to be above the high end of the 14% to 17% range, and our operating return on equity to approach the high end of the 14% to 17% range."
During an interview Wednesday, he said the "general feeling" about next year "is that it will be slower-growth, but I think it will be positive for us."
"It is not a question of profitability, it is a question of how much profitability," he said.
State Street's net income rose 33%, to $477 million, or $1.09 a share, from a year earlier. Earnings included costs of 28 cents a share related to potential losses on loan collateral from Lehman Brothers Holdings Inc., which filed for bankruptcy last month.
Gerard Cassidy, an analyst with Royal Bank of Canada's RBC Capital Markets, said market volatility has forced many custodial customers "to move to more conservative positions, and this has them reassessing all of their vendors. I don't think customers will be running away from State Street, but I don't think they will be running towards them either."
Mr. Logue said during the conference call that State Street generated $280 billion of net new business in the third quarter. He said he expects it to continue to generate new business both domestically and throughout Europe.
He told American Banker that his company hopes to expand in Europe and is still expecting revenue from international markets to increase to 50% of its total, from 39% currently, within the next three to five years.
State Street's revenue rose 23%, to $2.77 billion, from a year earlier. This excludes the $350 million gain from its sale of CitiStreet in July, $8 million in net interest revenue from the Federal Reserve Board's asset-backed commercial paper money market liquidity facility and $98 million for a reduction of net interest revenue related to sale-in, lease-out transactions, operating revenue rose 12.4%, to $2.54 billion.
Expenses rose 14%, to $1.93 billion. Mr. Logue said in the interview that State Street has been able to control its costs better than it did in the previous quarter and that "expense discipline" will allow it "to be profitable in a slower-growth environment."
"It is all about how much we bring to the bottom line," he said. "We are generating positive operating leverage, and in this environment that is a hard thing to do."
Excluding some costs and gains, State Street earned $1.24 a share, beating analyst estimates by a nickel, according to Thomson Reuters. State Street said it might take a charge of $400 million to $450 million of distressed portfolios managed by its State Street Global Advisors unit.
Mr. Cassidy said that, though State Street posted "very respectable results in view of the volatility in the third quarter," bottom-line growth in 2009 will be a challenge in light of global market turmoil.
"The company's core business of winning new custody clients and winning new processing clients remains solid long-term," Mr. Cassidy said. "But unfortunately they are dealing with markets that went haywire, and that is going to affect their capital and their profitability."
Mr. Logue said that he expects growth from the company's passive funds and its exchange-traded funds.
He said the company does not plan to stop investing in its businesses. "You can never stop reinvesting, or you fall behind. Really, the question is, how you spend money rather than not spending money. It is an art, and we are learning how to do it pretty well."
"If it is a slower growth environment in the next year, that is fine, but we have to grow faster than the competition," he said. "Whether it be 10% or 12% or 15%, whatever it is, we have to continue to generate positive operating leverage. … The strategy for us is to capture new relationships and cross-sell into those relationships, and that will give us opportunities that we wouldn't have had if not for this situation."
State Street's shares have declined in recent weeks, leading some analysts to speculate that it and other custody banks, including Bank of New York Mellon Corp., might sell themselves. Mr. Logue said his company has survived by being prepared for choppy market conditions and will continue to do so.
"Over the last few weeks, we have focused on the risk environment," he said. "We have focused on protecting the franchise and our customers from all external events. From AIG to Wamu to Lehman to Wachovia, the effort here has been reaching out to customers and making sure they understood the risk environment. We wanted to be sure we were on solid footing so we could anticipate rather than react to issues in order to keep this company safe."