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January 20, 2009 2:48 pm

State Street

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The stock market has not yet lost its capacity to be shocked. State Street – among the largest providers of stodgy but dependable custody services, and one of the “too big to fail” banks that first received federal bail-out money – was supposed to be safe. On Tuesday morning, however, its shares halved.

The rout followed fourth-quarter results that lowered this year’s earnings expectations. Investors also had the long weekend to digest a filing with the Securities and Exchange Commission. The 31-page form presented a list of risks that investors should consider, in effect bringing to their attention a variety of novel ways in which the company could lose money. State Street may be forced to bail out more money market funds that have “broken the buck” – that is when the net asset value of a cash vehicle falls below par. There is also a danger that mark-to-market losses on asset-backed securities may have to be recognised if impairments prove to be more than temporary. Unrecognised losses on instruments that State Street intends to hold to maturity now stand at $5.9bn.

Finally, there is the risk that State Street has to follow the route of UK and US peers by consolidating its off-balance-sheet conduits. Were it to do so, Barclays Capital calculates that tangible common equity would fall from the current 4.5 per cent to just 1.05 per cent of tangible assets, well below the 3 per cent level State Street targets as prudent. Closing the gap would require $2.7bn of new capital, about a third of the group’s dented market capitalisation. Yet State Street’s management, after talking to its largest shareholders, has decided not to raise new funds.

If it can protect and then rebuild its balance sheet, State Street will survive. Unless, of course, it is grabbed by a former investment bank hungry for ballast.

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