State Street Corp (STT)

This 'pig' may still be able to find a few truffles. STT mints money in a downward rate environment on their securites lending business. What drives sec lending? Bearish sentiment for one: this encourages borrowers to short stocks held by long term institutional holders that have their securities custodied at STT. These borrowers get paid a reduced rebate rate in a low Fed Rate environment which means thicker gravy for STT. This is just one aspect of STT's varied business in addition to their much publicized(sp?) asset management segment. People seem to forget STT's primary business is selling picks and shovels: they hold and service or 'custody' assets held by other institutions. Sure, in a volatile market custody revenues may be hit, but as long as firms are out there trading and trying to make a buck, STT will be right there selling them picks and shovels (i.e., custody services) in pure Levi Strauss fashion. Also, Soverign Wealth Funds are awash in assets and you can bet STT has been racking up a lot of frequent flier miles.

Regarding the 7-8% pop on the announcment of major problems in STT's fixed income department: tough to read, but the market may well have been astute enough to recognize the competency of a resolute CEO who will excise any potential malignancy with extreme prejudice and put entire divisions on notice that performance is weighed on a risk-adjusted basis; not to mention earnings and revenues topped forecasts exclusive of the charge. Question: How were client investment mandates violated under a competent CEO? Answer: The CEO no doubt asked himself the same question and you can bet it won't be happening again.

The big issue is the potential for STT's SIV liabilities to make an appearance on the balance sheet. STT has huge exposure to these vehicles and if they are unable to fund themselves through short term commercial paper issuance STT is mandated to provide funding via its own balance sheet. Truly a frightening but nevertheless relatively far-fetched proposition as most financial firms will enable a line of credit to add liquidity to struggling funds. If such a line is enabled expect a knee-jerk SledgeHammer of the Gods type smack-down that has short sellers salivating but could provide a steady entry point.

If you plan on investing in STT you had better have your time-frame nailed down tight. This ship might list a bit in the near future, but expect a slow and steady ride as it rights itself from any trouble and returns to its conservative New England upbringing, leaving a steady trail of cash in its wake.