Investor frustration grows at State Street

At a bank like State Street, which has a collection of good businesses, plenty of capital and a shareholder roster packed with names of asset managers that share its Boston heritage, dissent does not build quickly.

However, the share price, at a little over $41, is in the same place that it started in 2009. Boston institution Fidelity, the group’s fifth-largest shareholder, cut its holdings by a quarter earlier this year, to $700m.

It is also exactly a year since Trian, the activist investor group run by Nelson Peltz and Edward Garden, published a white paper detailing its ideas for improvements at the custody bank. Fidelity and Trian declined to comment.

The activists proposed a mix of cost cutting, capital returns and restructuring focused on margins. In essence, costs at the bank had grown faster than revenues since 2006, and the Trian plan was to reverse that process, to focus on profitability rather than growth.

With other actions, including a possible spin-out of State Street Global Advisors, the world’s third-largest investment manager judged by assets, Trian proposed a modest target for the bank’s share price of $99.

After the plan was published Joseph “Jay” Hooley, State Street’s chief executive, met his top 10 shareholders and told them that he agreed with 70 per cent of what Trian had said, according to people who attended the meetings.

He saw no need for a spin-out, but a plan to save $600m by 2015, through an extensive programme of restructuring and improvements to the group’s technological infrastructure, was promised.

The lender, one of the most highly capitalised US banks, also said in March after it passed the Federal Reserve stress tests that it would repurchase $1.8bn of shares over the following year.

Yet frustration is building among shareholders at the slow pace of progress so far, antagonised by what they see as other persistent faults in the way the bank uses its capital and presents its financial information.

A Trian criticism, that the group overpays for acquisitions, was not helped when State Street announced the $550m purchase of Goldman Sachs’ hedge fund administration business in July, at their second-quarter earnings. “They overpaid and communicated terribly, even though the deal does make sense strategically,” says one large investor.

He also points to a writedown on holdings of Greek government debt, announced at the same time, but taken as a non-operating expense, as another persistent annoyance. “Investor frustration with the way State Street announce their numbers is incredibly high.”

There is a recognition that the group faces slow growth in several of its fee-based businesses, as hedge fund use of leverage remains low and currency trading volatility remains subdued. Like all banks, low interest rates also limit the profits available from lending activities.

Yet that only goes so far. “As shareholders we don’t just want management to wait around. They are paid to deal with the circumstances now,” says one.

Indeed, a frequent comment is that executives “pay themselves too much”. Mr Hooley earned $16.2m last year, up 25 per cent on 2010. One top 20 investor says he voted in favour of Mr Hooley’s pay this year and remained supportive of the cost-cutting programme, “but he is on the watchlist”.

While discontent has started to be voiced to a board that says it is supportive of Mr Hooley, who was made chief operating officer in 2008 and promoted to the top job two years later, others are prepared to give him more time for the cost-cutting plan to work. Instead Edward Resch, chief financial officer since 2002, appears to be a lightning rod for criticism.

“It would benefit from new blood, it doesn’t have to be the chief executive,” says one investor. Another says Mr Hooley missed an opportunity to replace Mr Resch when he became chief executive.

The five top 20 investors who spoke to the Financial Times on condition of anonymity all said that State Street stock, which is valued at about nine times expected earnings, was cheap. “The stock could be up a ton, it just requires some gumption on the part of management,” says one.