DBRS Confirms State Street Corporation’s Senior Debt at AA (low); Trend Negative

DBRS has today confirmed the ratings of State Street Corporation (State Street or the Company) including its Issuer & Senior Debt rating of AA (low). At the same time the trend on all ratings, except for the Company’s Short-Term Instruments rating, have been placed on Negative trend from Stable.

For Q4 2008, State Street reported strong revenues of $2.67 billion (up 8% compared with the prior year’s quarter), but constrained earnings of $87 million (down from $223 million in the prior year’s quarter) and income before provisions and taxes of $84 million compared to $306 million in Q4 2007. While Q4 2008 results were weaker than expected, DBRS notes that State Street’s overall 2008 performance was strong and resulted in record revenues, net income and income before provisions and taxes. The weaker Q4 2008 earnings were negatively impacted by various one-time charges including a $450 million charge to bolster State Street Global Advisors Stable Value Funds, $306 million in restructuring charges related to workforce reductions and $27 million in merger and integration costs related to the 2007 acquisition of Investors Financial Services Corp.

The rating confirmation is based on State Street’s large-scale, broad-range and global nature of its well-respected financial services offerings. With $12.0 trillion in assets under custody (down 21% from Q3 2008) and $1.44 trillion in assets under management (down 27% from Q3 2008) as of December 31, 2008, State Street is one of the world’s leading providers of financial services to institutional investors. In addition to servicing and managing investments, the Company provides trading platforms for a broad range of securities and other financial instruments and also provides financing for securities. The Company has a good pipeline of new business in process and has been a beneficiary of a flight to quality. These strengths underpin State Street’s sustainable strong operating performance and business momentum.

The Negative trend reflects DBRS’s view that the Company’s tangible capital ratios are being pressured from mark-to-market valuations of its investment portfolio and conduit securities that widened significantly in Q4 2008. Moreover, earnings from servicing fees are constrained due to the decline in asset values at a time when unexpected expenses arise and may be somewhat volatile. The Company may also be subject to legal risk or business loss from securities lending customers who may face valuation issues from $122 billion in its commingled cash collateral pools. There is also the likely potential of consolidating its conduits on balance sheet at the beginning of 2010 (based on proposed accounting guidelines). This is all occurring at a time of unprecedented stress in the capital markets, which has reduced financial flexibility for financial institutions seeking capital.

Even with its strong internal capital generation capability and the shrinking of its conduits, DBRS would view favorably any common equity issuance and/or dividend reduction to address the weakened tangible common equity ratios. Lack of progress in addressing the tangible common equity in 2009, a significant revenue decline, or large realized losses could result in a ratings downgrade. Conversely, a return of tangible capital to prior levels (above the adjusted 3.5% range) assuming the conduit consolidation, stable revenue generation and asset values could return the trend to Stable.

DBRS is mindful that State Street has a $78.8 billion investment portfolio that carries an unrealized mark-to-market loss of $6.3 billion (after-tax) at December 31, 2008, up significantly from $3.3 billion at September 30, 2008. DBRS continues to believe that the Company’s intent and ability to hold these securities to maturity somewhat mitigates the risk implied in the unrealized loss. Moreover, State Street has assembled this high-quality portfolio using conservative investment guidelines and has a robust surveillance capability to monitor the underlying cash flows and project each security’s expected performance. The Company’s unrealized mark-to-market loss on its asset-backed commercial paper conduits has increased to $3.6 billion at December 31, 2008, from $2.1 billion at September 30, 2008. State Street did not transfer any conduit assets on to the balance sheet in the quarter.

State Street provided support to stable value portfolios managed by State Street Global Advisors that have entered into contracts with third-party financial institutional guarantors. These portfolios have come under pressure because of lack of market liquidity for the underlying securities. The decision to support these accounts resulted in a Q4 2008 pre-tax charge of $450 million. In the fourth quarter, the Company also took a $306 million pre-tax charge for a reduction in force of approximately 6% of its global workforce. The reductions of approximately 1,600 to 1,800 positions began early in December and will be mostly completed by the end of the first quarter of 2009.

Regulatory capital ratios are some of the highest in the industry, with a Tier 1 ratio of 20.5% and a total capital ratio of 21.9%. The capital ratios improved from the sale of $2 billion in Preferred Stock through the TARP Capital Purchase Program. The adjusted tangible common equity ratio declined to 4.46% at December 31, 2008, from 4.8% at September 30, 2008 but is projected to be a very weak 1.05%, assuming the consolidation of conduits onto the balance sheet.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The applicable methodology is Rating Banks and Bank Holding Companies Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.