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Not only did all of the nation's larger commercial banks present at the recent Barclays Financial Services Conference, so did some of the nation's largest independent trust banks. I highlight “independent” because some large banks such as JPMorgan Chase (JPM) have large, fee based trust operations. But a trust bank obtains the bulk of its revenue from fee services.
As a banking operation, State Street (NYSE: STT) rates as the 11th largest commercial bank in the country by assets with almost $201 billion at the close of the second quarter. Despite that size, the organization has a loan portfolio of just $12 billion, and a whopping 14 branches, a mere two of which are in the United States.
Twice during the Barclays presentation, given by Chairman and CEO Joseph Hooley, State Street maintained three long term financial goals: (1) annual revenue growth of 8% to 12%; (2) annual earnings per share growth of 10% to 15%; and (3) annual returns on equity of 12% to 15%. Goals are good, I suppose, but it is highly unlikely these goals will be met any time soon. In State Street's second quarter, it posted earnings of $480 million, or $0.98 per share, down 4.4% from the second quarter of last year. Per share earnings dropped just two percent, due to State Street's share buyback program. Revenue actually fell almost three percent from the second quarter of 2011, and the annualized return on shareholder's equity was 10.3%.
State Street relies primarily on overall financial activity to drive its fee based model. Since the European Union remains a mess and the domestic economy is sluggish, State Street has a revenue problem. To counter that the bank plans to reduce expenses by $600 million by the end of 2015. It also gave its revenues a boost by acquiring Goldman Sach's (GS) hedge fund administration business in July. This deal, which will close in the fourth quarter of 2012, will vault State Street further ahead of its peers as the leading administrator of hedge fund operations in this country, with over $1 trillion in hedge fund assets.
One should not confuse State Street's exposure to hedge fund administration with any sort of excessive riskiness. State Street has extraordinary capitalization levels befitting a trust bank. Of the nineteen banks examined in the first round of the CCAR “Stress Test” earlier this year, State Street had the highest capitalization of the group. At the close of the second quarter, its Tier One Capital was 17.9%. Under anticipated Basel 3 standards, State Street's Tier One capital stood at 11%, comfortably above any anticipated minimum. State Street's regard for safety is also evidenced by the fact that at the close of the second quarter, 89% of its investment assets were in issues rated at least AA by ratings agencies.
Earlier this year State Street obtained Federal Reserve permission to raise its dividend 33% to its current quarterly $0.24 cents, for a current yield of 2.2%. State Street also has launched a $1.8 billion stock buyback that should help support the earnings per share in the next few quarters. Otherwise, earnings this year will not beat 2011, and growth in 2013 is likely to be unexceptional with prolonged low interest rates and sluggish economies. State Street has a five year PEG of 1.31, which seems awfully high for a company that has limited growth going forward.
Because of its exceptional capital levels, State Street is possibly suitable for very conservative investors seeking some financial exposure. Its returns for the next 12 to 18 months are unlikely to excite anyone.
Bank of New York Mellon (NYSE: BK) is essentially State Street's bigger brother, with just over $330 billion in assets at the close of the second quarter. Its CEO Tim Keaney and CFO Todd Gibbons, gave its presentation at the Barclays conference. It gave this presentation in the shadow of a poor second quarter. GAAP earnings in the quarter came to $466 million or $0.39 per share. Earnings were reduced by $212 million, or $0.18 per share due to a litigation settlement. But no matter how one slices earnings, compared to the year ago $735 million, or $0.59 per share, they were disappointing.
Without making any major acquisitions, Bank of New York is taking steps to grow its business by attracting new clients and setting up a new division specializing in the bank's burgeoning collateral services management work. Bank of New York is the world's largest trust bank, with $27.1 trillion in assets under custody, and another $9.6 trillion under management. At the close of the second quarter it held a 21% global share of assets under custody.
Looking ahead, Bank of New York is much more favorably priced than State Street. The two trust banks price to earnings ratios are virtually the same, but Bank of New York trades at a much more favorable 5 year PEG of 0.85. In the short term Bank of New York's stock may be undercut by lingering litigation concerning foreign currency trades. But over the longer one, I see Bank of New York as a winning play for most investors.
The third major independent trust bank in this country is Chicago based Northern Trust (NASDAQ: NTRS). While Northern Trust is less than half the size of State Street and less than one third the size of Bank of New York, it's still a sizable institution with about $95 billion in assets. And it is not as pure a trust bank as its larger siblings, as Northern Trust has 77 retail branches in this country, compared to the being able to count branches on the fingers of one hand with the larger two trust banks. Northern Trust did not present at the Barclays Conference.
Northern Trust had a big second quarter. Income rose in the quarter by 18% from the second quarter of 2011, to $152 million, or $0.67 per share. Yet the majority of that gain was due to an $19 million reduction in one time charges in the recent quarter versus the year ago quarter. Omitting those factors, non-GAAP earnings were six percent above the year ago quarter.
Northern Trust's stock price has spiked by 41% over the past twelve months, and in light of that some in the investment community are urging shareholders to take profits. As for a new investor, it is impossible for me to endorse a purchase in a financial selling at 18 times earnings as Northern Trust is. Its 5 year PEG of 1.18 also suggests it may be slightly overvalued. I would look for a price pullback before investing.
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