State Street Is Exposed to Conduit-Backed Assets

State Street Is Exposed to Conduit-Backed Assets

Vehicles Have Caused Headaches in Europe; Bond Fund Loses Value

By JENNIFER LEVITZ and TOM LAURICELLA

Shares of State Street Corp. fell on concerns it could face liabilities from four off-balance sheet "conduit" entities that it backs, and reports that funds it manages have taken sharp losses in the credit-market turmoil.

The 4.3% share-price drop came despite reassurances from credit-ratings firm Standard & Poor's that the Boston-based company's debt ratings weren't affected by its links to the conduits, which issue commercial paper to buy other types of debt, and are offered to investors as a way of earning attractive short-term yields. Several European banks have been hit in recent weeks by exposure to conduits that held securities backed by residential U.S. mortgages.

This month, State Street disclosed in filings to the Securities and Exchange Commission that it provides lines of credit and other backup financing totaling $28.81 billion to four conduits. The credit lines could be tapped if the funds were unable to issue commercial paper, a type of short-term IOU that some companies have had trouble selling in recent weeks, which would leave the bank holding their assets.

Arlene Roberts, a State Street spokeswoman, said "there isn't an issue" with the conduits, and said the company was "just baffled" by interest in them.

"State Street's conduit program was established at the request of our clients and has been in place since 1992. The credit quality of the assets is very good -- primarily AAA/AA assets," Ms. Roberts said. "The commercial paper continues to be sold daily." She said that the conduits hold credit-card, auto-loan debt and mortgages, but no subprime mortgages, which are made to high-credit risk borrowers.

Separately, market concerns focused on State Street's management of bond and short-term debt funds that hold asset-backed securities including subprime mortgages. One, the Limited Duration Bond Fund, sold privately to institutional investors, has fallen by 37% through the first three weeks of August, the Boston Globe reported yesterday. The fund had dropped 11% in July, when it had about $2.8 billion in assets. Ms. Roberts declined to comment on the fund or its performance.

Both Bear Stearns Cos. and Goldman Sachs Group Inc. stepped in to bail out in-house hedge funds in an attempt to curb the reputation risk should they fail.

A State Street mutual fund sold to individual investors, SSgA Yield Plus fund, is down 7.6% in the last three months, according to mutual-fund watcher Morningstar Inc. Other ultra-short funds run by other fund companies are also down, but only by about 1%, because they put only small portions in asset-backed and mortgage securities, said Lawrence Jones, an analyst for Morningstar. Mr. Jones said the drop "raises questions" about State Street's "credit research process...they underestimated the risk of these asset-backed securities."

The Limited Duration Bond Fund in the past appears to have been included in 401(k) and other retirement-plan offerings through State Street's Target Date Funds offerings, including to State Street's own employees, according to a State Street document dated in 2006. Target-date funds are portfolios designed for retirement plans that tailor investments according to an investor's age.

As part of these offerings, some of the Target Date Funds would allocate a percentage of their assets to Limited Duration Bond Fund. For example, State Street 2010 Target Date Fund would have put 19.2% of its assets in Limited Duration Bond Fund, according to the State Street document. Its Income Fund -- aimed at those in retirement -- would have allocated 40%. In April, State Street appears to have removed Limited Duration Bond Fund from the Target Date offerings, according to a brochure on the Web site of the California Public Employees' Retirement System, which offers a number of State Street's funds.

--Shefali Anand contributed to this article.
wsj.com