State Street Corp., the third- largest custody bank, reported operating earnings that missed analysts' estimates as expenses rose faster than revenue. The shares fell by the most in a year.

Net income increased to $545 million, or $1.22 a share, in the fourth quarter, from $468 million, or $1, a year earlier, the Boston-based company said today in a statement. Profit on an operating basis was $1.15 a share, missing the $1.19 estimate of 20 analysts surveyed by Bloomberg.

State Street's operating costs rose in the quarter in part because of rising expenses tied to employee compensation, outweighing the benefits of a 30 percent rally in the Standard & Poor's 500 Index in 2013. Like competitors, State Street has also been hurt by record low interest rates. The firm, led by Joseph L. Hooley, said in a presentation accompanying earnings that it expects revenue to increase 3 percent to 5 percent in 2014 as interest rates rise and equity markets stay strong.

"Within the context of them making significant progress through the year, there's some year-end noise in the expense numbers that makes this quarter look like a hiccup," Marty Mosby, an analyst with Guggenheim Securities LLC in Hernando, Mississippi, said in a telephone interview.

Shares Fall

State Street fell 4.3 percent to $69.68 at 12:37 p.m. in New York, after earlier declining as much as 8.4 percent, the most since January 2012. The shares advanced 32 percent in the year ended yesterday, the best among the three biggest independent U.S. custody banks. Bank of New York Mellon Corp. rose 23 percent and Northern Trust Corp. increased 24 percent.

State Street allayed concerns over expenses in a conference call with analysts, according to James Shanahan, who covers the company at Edward Jones & Co. in St. Louis.

"It's important when you miss operating expenses to explain what is non-recurring," Shanahan said. "I am certainly more comfortable with the expense outlook post-call."

Certain costs related to sales promotions, litigation and securities processing are likely to drop in the current quarter, Chief Financial Officer Michael Bell said on the call.

Regulatory compliance expenses may continue to be higher than in the past because of U.S. rules and international banking standards, Bell said.

On a full-year basis, State Street increased revenue at a faster rate than expenses in 2013, adding 1.7 percentage points to the company's operating leverage from 2012, Hooley said in a telephone interview.

'Pretty Happy'

"I'm pretty happy with our ability to drive revenue and control expenses," said Hooley, the chairman and chief executive officer.

Operating revenue in the fourth quarter increased 2.6 percent from the same period a year earlier to $2.5 billion, helped by a 7.1 percent jump in custody fees and a 12 percent increase in management fees. Expenses climbed 2.7 percent as employee benefits rose and securities-processing costs increased. State Street said in its presentation that it expects benefits costs related to retirement and payroll taxes to rise in the current quarter.

State Street's assets under custody rose 15 percent to $20.4 trillion. The amount of money the firm managed for investors rose 12 percent to 2.3 trillion.

Hooley said adding technology remains a major focus for him. In State Street's core areas of custody services and transaction processing, he said that in 10 years the firm may be able to handle more business with fewer people than it employs now. He said he didn't expect headcount to drop in that time as the company will add workers in other areas.

Technology Focus

"What's possible with technology in displacing labor over time, I think we're in the early to middle innings," he said in the interview.

State Street, which employs about 30,000 globally, has eliminated almost 3,000 jobs in the past three years to reduce costs.

The firm spent about $560 million repurchasing 8 million shares in the fourth quarter at an average price of $69.98. The company has about $420 million remaining to spend in the repurchase program that expires March 31.

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.

BNY Mellon

BNY Mellon, the world's largest custody bank, said Jan. 17 that its fourth-quarter earnings fell 18 percent after it reported a $115 million investment loss. Net income declined to $513 million, or 44 cents a share, the New York-based bank said.

Northern Trust, based in Chicago, said Jan. 22 that fourth- quarter profit rose 1.1 percent, driven by stock-market gains.

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 totaled $31 million in the fourth quarter.

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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