Forex Issues May Stifle Q4 Gains for State Street


For Boston-based State Street Corp. , the past year has been a struggle. Formerly lucrative enterprises have felt the pinch of depressed global markets, and cost containment has proven elusive. Now that fourth-quarter earnings are just around the corner, can investors expect more of the same?

Global weakness and problems in the forex arena
State Street began 2012 with a decidedly lackluster 2011 Q4 report, missing on both EPS and revenue estimates -- despite a rise in the latter of nearly 12% from the year previous. Management blamed softening global capital markets for the slip, a problem that it predicted would continue to dog the bank throughout the year. The bank did achieve some cost cutting wins, however, primarily through its exit from fixed-income trading.

Though the company reported some improvement in capital markets in Q1 , it lost ground on compensation costs, which increased 22%. This issue was a sore spot with shareholders, some of whom saw the bank's compensation ratio as too high. Revenue dropped by 2.6% year over year in Q2 and 3.2% in Q3, however, reflecting increasing lethargy in international markets.

The bank had some wins and losses in the acquisitions area during the past year. It agreed to purchase Goldman Sachs' hedge fund administration unit, which it expected to be almost immediately accretive to earnings after the closing in the latter part of the year.

State Street's effort to bolster its presence in the foreign exchange-traded funds market came to naught, however, as it lost its bid to buy Credit Suisse's $17 billion ETF arm to heavyweight BlackRock . The bank pulled out of the bidding process for the unit this past December -- it would have added 58 additional ETFs to its current 44 European funds -- ceding that prize to BlackRock's already massive 195 European ETF holdings.

Pricing pressures in Q4
A thorny issue reared its head in the fourth quarter, brought to bear by Fidelity Investments. Federal lawsuits alleging price-gouging by custody bank BNY Mellon led Fidelity to pressure that bank into giving the mutual fund giant a better deal on foreign currency trades. Though Fidelity deals primarily with BNY Mellon, State Street faces similar pricing pressures. Fidelity, perhaps because of this ongoing problem, has itself decided to throw its hat into the ETF ring , putting itself in direct competition with State Street.

What does this mean for Q4?
Investors should expect many of the last year's pressures to be apparent in the fourth quarter, though two bright spots might provide some relief. One is the Goldman purchase, which closed in October and may give a boost to State Street's bottom line. Another is a new fee structure that BNY Mellon and State Street initiated that same month for institutional investors that park their foreign currency with the two custodial banks for safekeeping. Will these two initiatives be enough to prop up earnings? Stay tuned.

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