Fitch Ratings has affirmed the ratings of State Street Corp. on news that it is acquiring Investors Financial Services Corp., and it has placed Investors Financial on rating watch positive.

Institutional investment manager State Street has agreed to buy Investors Financial for about US$4.5 billion in stock. Boston-based Investors Financial provides investment services for US$2.2 trillion in assets.

The rating agency says that State Street’s stable rating outlook reflects Fitch’s belief that the company can absorb the acquisition without pressuring its existing ratings. Fitch expects to align the rationgs of Investors Financial with those of State Street at consummation, and therefore has placed debt and issuer ratings on Rating Watch Positive.

The transaction, when consummated, will expand State Street’s scale and reach in the asset servicing business, it says. State Street will be the second largest asset servicer in the world, behind only the Bank of New York/Mellon combination. It will also become the largest global servicer of hedge funds, a rapidly growing sector of the custodial business. The transaction, which is scheduled to close in third quarter-2007, is expected to be neutral to GAAP earnings in 2008 and accretive thereafter, assuming that client retention goals and cost save targets are reached.

Still, the deal poses several challenges, Fitch says. “The projected cost saves are relatively high, at approximately 50% of IFIN’s expense base. Fitch notes that the degree of difficulty is reduced by the degree of overlap between State Street’s and IFIN’s operations,” it says.

Client retention is a second challenge, Fitch suggests. Many of IFIN’s clients are mutual funds that compete with State Street’s investment management subsidiary, State Street Global Advisors. The largest IFIN client, Barclays Global Investors, provides 18% of IFIN’s revenue and competes directly with SSgA in exchange traded funds and indexed funds, it notes. “State Street may find it difficult to avoid attrition of IFIN’s revenue base, whether through client losses or contract renegotiations,” it says.

The third challenge will be systems integration as State Street management plans to migrate many of IFIN’s customers onto its existing service platforms.

On the positive side, Fitch notes that State Street has recent experience in integrating a major custodial acquisition with its 2003 purchase of the Global Securities Servicing division of Deutsche Bank. Fitch also notes that IFIN’s expertise of servicing complex pooled funds is already a core product of State Street. Tangible common equity will decline to about 4.25% at closing, near the bottom end of management’s target range. However, this level will be rebuilt by amortization of intangibles going forward, and will also be supplemented by new issues of high equity content trust preferred securities, it says.