State Street Corporation (NYSE:STT) announced today that it will record a net charge, after taxes, in the fourth quarter of 2007 of $279 million, or $0.71 per share. The purpose of the charge is to establish a reserve to address legal exposure and other costs associated with the underperformance of certain active fixed-income strategies managed by State Street Global Advisors (SSgA), the company’s investment management arm, and customer concerns as to whether the execution of these strategies was consistent with the customers’ investment intent. As a consequence of the unprecedented events in the credit markets over the past six months, these strategies were adversely impacted by exposure to, and the lack of liquidity in, sub-prime mortgage markets. In aggregate, the reserve will be $618 million on a pre-tax basis. The impact to earnings of the net charge, after taking into account the tax effect of the reserve and associated lower incentive compensation cost, will be $279 million
State Street also announced that James S. Phalen, currently executive vice president and head of international operations for investment servicing and investment research and trading, is returning to SSgA as interim president and chief executive officer. Phalen, age 57, succeeds William W. Hunt who has resigned from State Street. Phalen will report to Ronald E. Logue, chairman and chief executive officer of State Street. The company has initiated a global search for SSgA’s new CEO, which will focus on both internal and external candidates.
Logue said, “We have reviewed the actively managed fixed-income strategies at SSgA that contained investments backed by sub-prime mortgages. Based on our review and discussions with certain customers who were invested in these strategies, we have established this reserve to address legal exposure and other costs relating to these strategies.”
Logue continued, “State Street values its reputation as a trusted fiduciary to institutions around the world and recognizes the critical importance of preserving this reputation with its customers. Some of our customers that were invested in the active fixed-income strategies have raised concerns that we intend to address. Nevertheless, we will continue to defend ourselves vigorously against inappropriate claims, including those that seek recovery of investment losses arising solely from changes in market conditions. With this reserve, SSgA can continue its focus on delivering the highest quality of service to its customers and on steadily expanding its business.”
Earnings per share for 2007 are expected to be between $3.42 and $3.45 per share, and return on equity is expected to be approximately 13%, all on a GAAP basis.
On an operating basis, which excludes the impact of the charge announced today, the merger and integration costs associated with State Street’s acquisition of Investors Financial in July 2007, and, for 2006, the effect of 2006 tax adjustments of $65 million, or $0.20 per share, 2007 earnings per share is expected to be between $4.54 and $4.57 per share and return on equity is expected to be approximately 17.5%. Both operating earnings per share and return on equity for 2007 are expected to be above the ranges provided on October 16, 2007. This outlook for full-year earnings per share on an operating basis compares to 2006 results of $3.46 per share. The company continues to expect to exceed the year-over-year revenue growth range of 20% to 22% provided on October 16, 2007.
“Our business continues to be very strong, with revenue growth expected to be in excess of 30 percent in 2007 compared to 2006. We also continue to expect to exceed our ranges for operating earnings per share and return on equity,” said Logue. “We remain committed to the active investment management business and have made changes to the investment teams to address the underperformance experienced in the active fixed income strategies exposed to sub-prime mortgages. We are very fortunate to have an experienced executive like Jim Phalen to step in and lead the business and work alongside SSgA’s strong management team. His deep understanding of State Street’s customers will allow a seamless transition in his interim role.”
In his current role, Phalen is responsible for State Street's investment services and investment research and trading operations outside of North America and is a member of State Street’s Operating Group, the company's most senior strategy and policy-making team. He spent more than five years at SSgA as a member of its Executive Management Group managing significant portions of SSgA’s business. In 2000, having overseen the combination of SSgA and Citigroup’s retirement business to form CitiStreet, he became CitiStreet’s CEO.
He returned to State Street in 2005 and was appointed head of State Street’s investment servicing business in North America before assuming his international role in 2007.
“I welcome this opportunity to return to SSgA and to work directly again with many of my longstanding colleagues,” said Phalen. “SSgA has an exceptional team of professionals, and I look forward to helping them continue to build on their track record of growth and industry innovation.