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State Street Corporation’s (NYSE:STT) recent earnings announcement, at least at first glance, gave investors something to cheer about. The company reported Q3 earnings of $0.96 per share, easily outpacing consensus estimates of $0.88. This was largely driven by significant expense reductions that we have also seen from competitors such as BlackRock (NYSE:BLK). If that were the end of the story, STT shareholders would gladly take these results. However, the nature of these cost cuts and what they bode for the immediate future requires additional investigation.

Cost Cuts Look Good Now…

The bump in earnings, at least over consensus estimates, was largely due to two factors. One was omitting the discounting of some assets’ accretion and certain restructuring costs relative to staff reductions and M&A expenses.

The second factor was the aforementioned cost cuts. While expense reductions are now the norm in the industry, the nature of the cutbacks brings into question the long-term benefits to the company. The expense reductions were largely the result of cuts in salaries and employee benefits, investments in information systems and transaction processing services.

… But Could Have Negative Long-Term Impact

Not spending on infrastructure in an IT intensive industry, along with cutting salaries and benefits appear to be short-term solutions to what may be longer term concerns. This is particularly the case with State Street as 43% of the stock price is derived from Investment and Servicing Fees, an information technology driven business line.

Even taking the Q3 decrease in expenses into account, the company is spending nearly 13% more than in 2010, the impact of which is still unknown. The Q3 bump in net interest income is not enough to offset the quarter-over-quarter 2.5% decline in fee revenue, a significant piece of the State Street stock price.

(Chart created using Trefis' app)

Our price estimate for State Street’s stock remains unchanged at $46, but should the company plan to further cut investment we may revisit our long-term growth forecasts.

Disclosure: No positions