State Street's deal to create a custody banking giant may not go through

State Street's planned acquisition of Brown Brothers Harriman Investor Services is facing pushback from regulators that has put its completion in doubt.

The successful outcome of the deal to create the country's largest custody bank is "increasingly uncertain," State Street CEO Ronald O'Hanley said on a call with analysts Tuesday.

Boston-based State Street said it has come up with a number of modifications to the deal to appease regulators, including lowering the $3.5 billion purchase price. The alterations, if accepted, will likely decrease the deal's synergies and slow its path to accretion, executives said.

State Street - Brown Brothers Harriman
State Street originally expected its deal for Brown Brothers Harriman's investor services business would be completed by the end of 2021. Now executives say the acquisition may not be completed at all.
Bloomberg/Adobe Stock

"We believe there's still the possibility that we can structure the transaction in a way that will work for both shareholders and to achieve strategic objectives, but … the likelihood of that happening is going down," O'Hanley said.

State Street announced last September that it had agreed to acquire BBH's investor services business for $3.5 billion, a price tag many believed had been driven up by a bidding war.

When the deal was announced, it was seen as perhaps the last obvious acquisition in the world of custody banking — a paperwork-intensive business in which funds and securities are managed for safekeeping, and other administrative services, like debt and interest payments, are offered to clients.

Mergers between large financial institutions have faced greater obstacles since President Biden's 2021 executive order directing federal financial regulators to reassess their processes for proposed mergers. For several months at the end of last year, regulators didn't issue any approvals for big-bank deals.

Still, some deals have received approval. U.S. Bancorp said last week it had gotten green lights from all relevant U.S. regulators in its $8 billion bid for MUFG Union Bank.

When the State Street deal was announced last fall, the two companies said they were targeting a completion of the transaction at the end of 2021. But three months ago, State Street said it was renegotiating the deal. Tuesday's announcement made clear that regulators' hesitance to approve the deal is driving the companies to consider potential revisions.

"This really highlights the times in terms of heightened scrutiny on mergers," said Mike Mayo, managing director at Wells Fargo Securities.

O'Hanley expressed similar sentiments on Tuesday.

"The timing of our announcement of this deal probably couldn't have come at a worse time because many of the regulatory agencies were going through personnel changes," he said. "In some cases, it has driven a very significant change in philosophy."

The acquisition had been expected to provide State Street with coveted data-integration technology. It would have also expanded the company's geographic reach in key markets such as Japan.

State Street said Tuesday that it expects to know whether it will proceed with the deal or not by the end of the fourth quarter. The original terms included a provision that allowed either party to elect not to go forward at no penalty.

State Street executives said Tuesday that buybacks worth $1 million were planned for the fourth quarter. The size of the buyback is larger than executives originally expected, in part because of the lower proposed transaction price for the Brown Brothers Harriman unit, Chief Financial Officer Eric Aboaf said on a conference call with analysts. A new potential deal price has not been disclosed. 

The bank reported $690 million in third-quarter net income, a decrease of 3% from the same period last year. Higher interest rates pushed net interest income up 36% to $660 million.

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