State Street Corporation’s (STT) third quarter operating earnings of $1.05 per share were 5 cents ahead of the Zacks Consensus Estimate. Operating results for the quarter exclude $11 million in pre-tax merger and integration costs associated with the Investors Financial Services Corp. acquisition. However, the results were down 15.3% from $1.24 per share in the prior-year quarter.

On a GAAP basis, earnings for the quarter came in at $1.04 per share. This compares unfavorably with earnings of $1.09 in the year-ago quarter.

The year-over-year decrease in earnings was due primarily to an increase in shares outstanding and decrease in revenue, partially offset by reduced expenses.

Revenue for the quarter increased 5.4% sequentially but decreased 19.3% year-over-year to $2.8 billion. Operating revenue for the quarter was down 10.6% year-over-year to $2.3 billion.

Operating expenses for the quarter decreased 13.2% year-over-year to $1.5 billion. Operating revenue and expense represent 260 basis points (bps) of positive operating leverage compared to the prior-year quarter.

Net interest revenue on an operating basis increased 18.0% year-over-year to $754 million. The increase was due primary to a $279 million of discount accretion on securities in the investment portfolio, recorded after the consolidation of the ABCP conduits. However, this increase was partially offset by lower rates negatively affecting the yield on floating-rate assets, and both lower volumes and spreads on customer deposits.

Fully taxable-equivalent net interest margin increased 54 bps sequentially and 64 bps year-over-year to 2.47%. Excluding discount accretion, the net interest margin would have been 1.56%.

Expenses on an operating basis decreased 13.0% year-over-year to $1.5 billion, primarily as a result of a 20.0% reduction in salaries and benefits expense due to the effect of a reduction in force as well as a lower level of incentive compensation.

State Street’s regulatory capital ratios continue to be strong as of Sept. 30, 2009, with Tier-1 capital ratio at 15.6% and leverage ratio at 8.2%.

Total assets under custody and administration were $17.9 trillion at Sept. 30, 2009, down 2.8% from $18.4 trillion at Sept. 30, 2008. Total assets under management at Sept. 30, 2009 were $1.7 trillion, up 2.9% compared to $1.7 trillion at Sept. 30, 2008.

Outlook for 2009 – State Street has reduced its outlook for 2009. Citing the slow pace of economic recovery, the company now expects operating revenue to decline about 16% from the last year’s record level and operating earnings per share to be between $4.13 and $4.17. Operating return on equity is expected to be between 14% and 17%, in line with the company’s long-term outlook.

Based in Boston, State Street Corporation is a financial holding company that offers a range of products and services to investors worldwide. It offers an array of services for managing financial assets, including investment management and investment research services, primarily for institutional investors.

We think that State Street Corporation remains well positioned due to its significant leverage to global capital markets volumes and less risky credit profile. Also, the company is expected to perform well as margin improvement provides a significant support to net interest income. However, higher credit losses and changes in capital structure could be a potential threat for the company’s earnings as well as its capital. As such, we maintain our Neutral recommendation on the shares of State Street Corporation.
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