Saturday, October 4, 2008

Is State Street safe?

They are custodial of over $15 trillion of assets. Let's look at what they have been doing.

Of the $75 billion of assets on their balance sheet, non of it is Level 1. They are all Level 2 and Level 3 assets.

They have a $27 billion asset-backed portfolio consisting of student loans, HELOC's, credit card and auto/equipment loans.

They have a $28 billion off balance sheet conduit, funded by commercial paper, and as of their last quarterly report, this off-balance sheet conduit had the following breakdown in it's assets:

Australian residential mortgage-backed securities $4.6 billion
European residential mortgage-backed securities $4.6 billion
U.S. residential mortgage-backed securities $3.8 billion
United Kingdom residential mortgage-backed securities $2.1 billion
Student loans $3.1 billion
Auto and equipment loans $3.2 billion
Credit cards $2.0 billion
CLO's, trade receivables, loans and other financial instruments where there is no transparency $5 billion

Anyone check the mortgage market in Australia? It's worse than the United States. Maybe that's why it is off-balance sheet. Auto loans? is that a good business now? Or student loans? CLO's? UK mortgages?

They had this to say about the financing on this conduit:

Basis risk arises when commercial paper funding costs move at a different rate than the comparable floating-rate asset benchmark rates (generally LIBOR). Basis risk is mitigated through the use of derivative financial instruments, principally basis swaps, which remove this variability from each conduit. Accordingly, basis risk is not a significant assumption in the financial model.

Anyone think that is accurate in today's environment?

Who backs up this $28 billion conduit if the commercial paper market is closed? That's right-State Street. Hey, maybe they'll lend out your securities to shorts, and use those fees to help offset their funding costs!

But how about State Street's estimates on this portfolio, of which half is still considered AAA? Last December, the unrealized loss was $850 million, in March is was $2.49 billion, in June it was $2.71 billion. Anyone want to hazard a guess at what the loss is now? Or is that just plain hazardous?

Remember a few months back, when State Street sold 35 million shares at 70? Wasn't that supposed to alleviate this mess?

They assure the markets that they don't have a problem. So did AIG. So did Lehman. And they are the custodian of over $15 trillion of securities.

This isn't old news. Here's what the NY Times had to say about STT back in January:

FORCED over the last five months to face icky truths about the credit crisis, investors seem to believe we are near the end of a disturbing interlude. How else to explain the 8.2 percent rally last Thursday in shares of the State Street Corporation after it said it would seek fresh capital and add $618 million in reserves to cover lawsuits over subprime mortgage investments it made for some clients?

Normally, the disclosures by State Street, custodian of $15.1 trillion in investor assets and manager of $2 trillion for clients, would not qualify as good news. Raising capital means diluting existing shareholders, after all. And most of the financial institutions that have had to seek capital recently have given their new investors hefty discounts.

It’s also not a positive sign that State Street is adding the reserves to settle lawsuits contending that it breached its fiduciary duties to clients for whom it bought subprime securities. Only last October, it said it would defend itself vigorously against one such lawsuit that the Prudential Retirement Insurance and Annuity Company filed against it in Federal District Court in Manhattan. Prudential contended that it lost $80 million after State Street Global Advisors and State Street Bank and Trust engaged in “deceptive, imprudent and incompetent” investing in two nominally conservative bond funds.

State Street said last week that it had changed its stance on such lawsuits to put the issue behind it. The stock hit a new 52-week high of $85.37 on the news. While it fell on Friday, closing at $81.82, it was up 1.4 percent on the week.

Remember the State Street Limited Duration Bond Fund? It was euphemistically "enhanced cash." It lost 37% of it's value last August, before it was swept under the rug.

Maybe they wanted these problems behind them, so everyone would quit digging at their balance sheet. Or their conduits.

But the digging continues. And the stock keeps on getting shellacked.

Maybe there is a causal relationship between the two.

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