Northern Trust Corporation — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services through Corporate & Institutional Services (C&IS) and Wealth Management. Financial statements are unaudited.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Change |
|---|---|---|---|
| Revenue (GAAP) | $1,345.2 million | $1,213.7 million | +11% |
| Net interest income | $354.2 million | $303.1 million | +17% |
| Noninterest income | $991.0 million | $910.6 million | +9% |
| Noninterest expense | $935.6 million | $843.0 million | +11% |
| Provision for credit losses | Credit of $7.0 million | Credit of $3.0 million | |
| Net income | $298.4 million | $257.6 million | +16% |
| Diluted earnings per share | $1.20 | $1.08 | +11% |
| Net interest margin (FTE) | 1.29% | 1.14% | +15 basis points |
| Return on average common equity | 12.2% | 11.7% | |
| Return on average assets | 0.98% | 0.88% |
For the first nine months, revenue was $3.95 billion, up 6%; net income was $842.4 million, up 10%; and diluted EPS was $3.41, up 6%. Net interest margin (FTE) was 1.31%, versus 1.17%. Nine-month return on average common equity was 11.8% versus 11.9%, while return on average assets was 0.95% versus 0.89%.
Balance sheet, cash flow and capital
- At September 30, 2017, assets were $131.4 billion, deposits $105.8 billion, loans and leases $33.3 billion, and stockholders’ equity $10.2 billion. Assets, deposits and equity increased 6%, 4% and 4%, respectively, from December 31, 2016.
- Cash and due from banks was $5.3 billion; Federal Reserve and other central bank deposits were $34.1 billion. Deposits were the main funding source. Period-end borrowings included $6.1 billion of other borrowings, $2.1 billion of federal funds purchased, $1.5 billion of senior notes and $1.7 billion of long-term debt.
- For the nine months, operating cash flow was $869.7 million, investing cash outflow was $6.0 billion and financing cash inflow was $4.8 billion. Investing outflows primarily reflected increased central-bank and bank deposits; financing inflows primarily reflected deposits and short-term funding.
- Corporation regulatory capital ratios were 13.3% CET1 and 16.4% total capital under the Advanced Approach, and 12.3% and 15.4%, respectively, under the Standardized Approach. Management said capital remained strong and above “well-capitalized” minimums.
- Common dividends declared were $0.42 per share for Q3. The company repurchased approximately 1.37 million shares in the quarter for $124.8 million; nine-month repurchases totaled $352.5 million.
Material changes and business drivers
- Higher servicing fees and net interest income drove quarterly revenue growth. Trust, investment and other servicing fees rose 10%, supported by favorable markets and new business. Assets under custody/administration increased 14% year over year to $9.70 trillion, and assets under management rose 19% to $1.13 trillion.
- Net interest income benefited from higher short-term rates and 4% growth in average earning assets. Average earning-asset yields and funding costs both rose; deposit interest expense increased substantially year over year.
- Expenses grew 11% in Q3, with increases in compensation, outside services, equipment and software, and other operating expense. Compensation included $6.0 million of severance-related charges for the quarter.
- C&IS Q3 net income increased 25% to $164.8 million; Wealth Management net income increased 9% to $148.0 million. Treasury and Other recorded a $14.4 million net interest expense for the quarter, versus $7.8 million of net interest income a year earlier.
- Year-to-date noninterest income growth was partly offset by comparison with the prior-year $118.2 million net Visa share-sale gain. The prior-year period also included securities-lending litigation and client-contract modification charges; current-period expense included $29.8 million of severance and related charges.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management’s discussion identifies sensitivity to markets, interest rates, client asset values, foreign exchange activity and deposit deployment; these are risks and drivers, not quantified forecasts.
- Management recognized $17.6 million of federal and state research tax credits in Q3 after completing a study of technology spending for 2013–2016, partly offset by a $4.3 million increase in the Illinois deferred-tax reserve. The nine-month effective tax rate was 29.7%, versus 32.1% in 2016.
- Nonperforming assets were $145.5 million, down from $181.0 million a year earlier. Residential real estate represented 88% of nonperforming loans and leases; the allowance for credit losses was $173.4 million.
- Management reported no material accruals for pending litigation or regulatory matters. For a limited set of matters, the estimated aggregate reasonably possible loss ranged from zero to approximately $30 million; other matters could not be reasonably estimated. The French tax-fraud case involving a subsidiary was appealed after the subsidiary’s acquittal.
- Interest-rate simulations estimated that a gradual 100-basis-point increase could raise next-12-month net interest income by $21 million; a 200-basis-point increase by $38 million. These are model estimates, depend on assumptions and exclude possible management actions.
- On October 1, 2017, the company completed its acquisition of UBS Asset Management fund-administration businesses in Luxembourg and Switzerland for $199.4 million, including $19.4 million of contingent consideration; the purchase price remained subject to adjustment.
- Key disclosed risks include market and economic conditions, cyber and operational risks, regulatory and compliance changes, litigation, credit quality, technology investment and competition. Management stated disclosure controls were effective and reported no material quarter changes to internal control over financial reporting.
Investor verification priorities
- Reconcile reported GAAP results with management’s FTE non-GAAP revenue, net interest income and margin measures.
- Assess whether fee growth from markets and new business can continue, and monitor AUC/A and AUM flows, market sensitivity and foreign-exchange revenue.
- Track expense growth—especially compensation, technology and software—and separate recurring costs from severance, facility-exit and timing-related items.
- Review deposit mix, funding costs, borrowings, liquidity and capital ratios, including the effect of rising rates on both assets and funding.
- Monitor residential real estate nonperforming loans, allowance adequacy, legal contingencies, the Visa litigation-related exposure and the acquired business’s final purchase-price adjustment.