By John Spence

BOSTON (Dow Jones) -- State Street Corp., which has seen its shares dive on investor concerns over unrealized losses in its investment portfolio and off-balance-sheet vehicles, announced a plan Thursday to improve so-called tangible common equity, including cutting its dividend to a penny a share.

The Boston-based company (STT) said the plan includes "actions intended to increase organic capital growth and a reduction in the size of the company's balance sheet."

The giant custody bank and asset manager also lowered its outlook for 2009, while the quarterly dividend was cut to a penny a share from 24 cents.

Shares of State Street were up about 8% in midday trading Thursday.

The stock has plunged recently and investors have been worried that the company could suffer losses if it is forced to consolidate asset-backed commercial-paper conduits it administers onto its balance sheet.

Markets have also been closely following tangible common equity, or TCE, ratios during the credit crunch as a measure of a company's capital strength and ability to suffer losses before raising capital and diluting existing shareholders.

With many banks' common equity so low and balance sheets under pressure, shareholders are worried that more losses may wipe them out.

"State Street did not announce an equity offering," said Ladenburg Thalmann analyst Dick Bove in a note. "This is just as important as the other announcements that the company has made."

'Extraordinary times'

"These are extraordinary times that require swift action," said State Street Chief Executive Ronald Logue in a prepared statement Thursday.

"While our tangible common equity ratio will vary with the impact of the fixed-income markets on our investment portfolio and the conduit assets and our actual results, we currently anticipate that the steps we are announcing will result in a meaningful increase in our tangible common equity ratio during the first quarter and the full year," the CEO said.

In explaining its lower 2009 outlook, State Street cited a more conservative reinvestment plan affecting assets paying down and maturing in its investment portfolio. It lowered its view on U.S. stocks for 2009 and intends to cut expenses.

"As a result, we now expect our operating revenue to decline 8% to 12% from record levels in 2008; our operating earnings per share to decline 12% to 16% from the updated record level of $5.61 per share in 2008; and our return on common equity to approach the low end of our 14% to 17% long-term range," State Street said.

The financial-services giant said unrealized losses in the investment portfolio and in the conduit assets have improved. At the end of the fourth quarter, total assets outstanding in the four conduits that State Street sponsors were $23.9 billion, the company said. The unrealized loss in the conduit assets at the end of December was $3.56 billion.

The company was holding a meeting with investors and analysts on Thursday in New York.

Cutting bonuses

State Street updated its 2008 results to reflect a $278 million pre-tax reduction in incentive compensation as part of the plan to boost TCE. State Street eliminated 2008 incentive compensation for five executive officers and cut it by about 50% for the rest of the company.

"Given that we are asking our shareholders to make sacrifices through dividend reductions, we believe that we must also be willing to make our own sacrifices," Logue said.

State Street said its TCE ratio at Dec. 31 was 4.61%, while the pro forma TCE ratio, including consolidation of all assets and liabilities of the State Street-administered asset-backed commercial paper conduits, was 1.19%.

"Assuming market prices remain constant from January through the rest of 2009 and we execute on our plan, we expect TCE to be approximately 4.91% by the end of 2009," the company said.

Wall Street reacts

Standard & Poor's Ratings Services on Thursday said its rating on State Street was unaffected by the company's plan to increase TCE.

S&P said its recent ratings cut "addressed our concerns about the heightened business and market risks State Street is facing in the current global market crisis, evidenced by some large, surprising charges during the past five quarters."

The S&P analysts said they continue to be concerned "about reputational risks in State Street's large securities-lending and asset-management businesses, which could hurt profitability."

Shares of State Street lost nearly 60% on Jan. 20 after the company reported sharply lower fourth-quarter earnings and updated its risk factor disclosures in a regulatory filing.

"With the outlook for 2009 growing decidedly gloomier, State Street is trying to soothe investor concerns about its pressured TCE ratio -- one of Wall Street's new favorite metrics," said Isabel Schauerte, an analyst at Celent, a Boston-based financial research and consulting firm.

"Despite State Street's commitment to returning tangible capital to prior levels, it is questionable whether the measures taken will suffice to satisfy investors and rating agencies," Schauerte said.

"The main question is how much pressure management feels to raise new capital, and whether government actions could either help or hurt its efforts," Deutsche Bank analyst Mike Mayo wrote in a report this week.

"There is no doubt in our mind that State Street's core businesses benefit from a number of competitive advantages that form a wide economic moat," said Michael Kon at Morningstar in his latest analyst note on the company.

"However, the firm's investment endeavors have impaired the balance sheet to a degree that jeopardizes the rights of current shareholders to benefit from these competitive advantages in the future," Kon said. "We would reconsider our position if losses abate or the firm finds a solution that will lower the risk to shareholders."

Capital worries

Some analysts had expected State Street to announce steps to improve capital at Thursday's meeting to address investor concern over TCE levels, although the core business is holding up relatively well.

State Street has a conservative reputation, but its image has been tarnished somewhat recently by uncertainty over the conduits and big credit-related losses in some bond funds it oversees. The stock has been extremely volatile in recent months on fears State Street will need to raise equity by selling new shares.

State Street is among the banks that have received capital under the Treasury Department's Troubled Asset Relief Program, or TARP.