State Street Stock Value is Highly Sensitive to Proprietary Investment Limits
State Street (NYSE:STT) provides investment servicing and investment management to large institutional investors. The firm’s primary competitors include Bank of America (NYSE:BAC), Citigroup (NYSE:C), and Barclays (NYSE:BCS), among others.
With assets under custody in excess of $19 trillion, State Street is the third largest custodian of assets globally. State Street also provides investment advisory services on assets in excess of $1.9 trillion.
We estimate that investment servicing fees on assets in custody constitutes 36% of our $56.38 Trefis price estimate for State Street ‘s stock. Asset management fees for equity, cash & money markets and fixed income investments together constitute another 6% of our estimate for State Street’s stock.
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What catches our attention, however, is the substantial portion of State Street’s stock value that is dependent upon proprietary investments. We estimate that this segment contributes roughly 35% to the company’s stock value.
State Street Leverages In-House Expertise Towards Proprietary Investments
State Street finances its proprietary investments primarily through consumer deposits and short-term debt, on which it incurs an interest expense. The firm invests in a variety of interest-bearing deposits, investment securities, private equity funds, etc.
While State Street’s core business includes investment servicing (asset custody along with allied value-added services) and investment management for institutional investors, proprietary investments are a means of leveraging its in-house expertise in investment research and transaction processing to yield higher returns for shareholders. The size of these proprietary investments effectively depends on the size of State Street’s overall operations, which in turn depends on the aggregate total of assets under its custody and management.
But, Here’s Our Concern…
The recent financial crisis resulted in widespread write-offs by banks and financial institutions. To limit future risk assumed by financial intermediaries, new regulatory reforms are imposing greater checks on proprietary investments, particularly in structured products, hedge funds and private equity funds.
The Volcker Rule proposed banning investments in hedge funds and private equity funds by banks but was later adjusted to limit investments in these to 3% of Tier 1 capital or 3% of a fund’s capital (whichever is less). [1] We expect similar restrictions to limit growth in proprietary investments in the future.
We currently estimate State Street’s proprietary investments will increase from $123 billion in 2009 to $150 billion in 2012, eventually reaching $195 billion by 2017. If stricter restrictions are imposed on a custodian’s proprietary investments, however, we can anticipate a more moderate increase towards $130 billion by 2012 and $144 billion by 2017. This scenario would generate a 9% downside to our current $56.38 price estimate for State Street’s stock, although still leaving our number ahead of market price.
The decline in proprietary investments would most likely lead to the same funds then being employed towards gradually reducing liabilities (debt), making the company leaner. But this might only partially mitigate the downside described above, given the high rate of return that State Street has previously seen in some of its alternative investments (including private equity and hedge fund investments).
See our full company breakdown and estimates for key drivers to State Street’s stock value in the display below.
You can see our detailed $56.38 Trefis price estimate of State Street’s stock here.
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