Northern Trust Corporation — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. Unaudited consolidated financial statements. Amounts are in U.S. dollars; financial statement figures are generally in millions unless stated otherwise.
Business context and results
Northern Trust provides custody, asset servicing and investment management, along with personal and commercial banking. Third-quarter results benefited from higher servicing fees and net interest income, while expenses rose and securities-lending revenue was materially below the prior-year quarter. Nine-month earnings were lower year over year.
Key financial metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue, GAAP basis | $971.5 | $889.5 | $2,814.3 | $2,751.6 |
| Net income | $170.4 | $155.6 | $473.4 | $512.4 |
| Diluted EPS | $0.70 | $0.64 | $1.93 | $2.10 |
| Net interest income, GAAP | $256.8 | $233.5 | $737.3 | $696.7 |
| Net interest margin, FTE | 1.25% | 1.44% | 1.26% | 1.45% |
| Provision for credit losses | $17.5 | $30.0 | $42.5 | $120.0 |
| Noninterest expense | $701.2 | $622.1 | $2,059.5 | $1,856.2 |
Q3 annualized ROE was 9.53% versus 9.23%; ROA was 0.72% versus 0.83%. Nine-month reported income included $30.6 million of restructuring, acquisition and integration charges ($25.0 million after tax, or $0.10 per share). Excluding Visa indemnification benefits, management reported nine-month operating earnings of $467.0 million, or $1.90 per share; this is a non-GAAP measure.
Balance sheet, liquidity and capital
- At September 30, total assets were $96.1 billion, up from $83.8 billion at December 31, 2010. Deposits were $78.5 billion, up from $64.2 billion.
- Loans and leases were $28.7 billion, compared with $28.1 billion at year-end; the allowance assigned to loans and leases was $298.3 million, down from $319.6 million.
- Cash and due from banks totaled $4.34 billion. Available-for-sale securities were $28.44 billion, versus $19.90 billion at year-end.
- Reported funding liabilities included $2.13 billion of senior notes, $2.14 billion of long-term debt, $0.82 billion of other borrowings, $0.74 billion of federal funds purchased, $0.34 billion of repurchase agreements and $0.28 billion of floating-rate capital debt.
- For the first nine months, operating cash flow was negative $137.0 million, investing cash flow negative $8.92 billion and financing cash flow positive $10.65 billion; cash and due from banks increased $1.52 billion. The filing identifies a $1.20 billion cash-flow adjustment for derivative fair value, including required collateral, and substantial securities purchases.
- At September 30, Corporation Tier 1 capital was 12.2%, total capital 13.9%, leverage 7.5%, and Tier 1 common equity 11.8%. Management said capital ratios remained above regulatory minimums and subsidiary banks were well capitalized.
Material changes versus comparable periods
- Q3 revenue increased 9% and net income increased 10%; nine-month revenue rose 2%, while net income declined 8% and diluted EPS fell from $2.10 to $1.93.
- Q3 servicing fees increased 7%, led by custody and fund administration, acquisitions, new business and improved markets. However, C&IS securities-lending fees fell 63% to $20.7 million, largely because the prior-year period included recovery of about $39 million of prior valuation losses. Nine-month securities-lending fees fell 62%, with a comparable prior-year recovery of about $114 million.
- Q3 FTE net interest income increased 10%, supported by average earning assets up 26% to $84.4 billion, but FTE margin contracted to 1.25% from 1.44%. Management attributed balance-sheet growth primarily to non-U.S. interest-bearing deposits invested in lower-yielding assets.
- Q3 noninterest expense increased 13%; management said the increase was 7% excluding acquisition-related operating expense and restructuring, acquisition and integration charges. Staffing was approximately 14,000 FTE, up 10% year over year.
- Credit indicators improved in some areas: nonperforming loans and leases were $307.5 million versus $333.0 million at December 2010, and total nonperforming assets were $337.9 million versus $378.5 million. Residential real estate nonperforming loans nevertheless increased to $181.9 million from $153.3 million at year-end.
- Assets under custody were $4.17 trillion, up 7% year over year but down 6% from the prior quarter. Assets under management were $644.2 billion, down 2% year over year and 6% sequentially.
Outlook, risks and unusual items
- The filing gives no specific numerical earnings or revenue guidance. Management noted persistent low short-term rates and related money-market fee waivers, and warned that market levels affect servicing fees; a 10% market move was estimated to change those fees by about 3% and total revenue by about 2%.
- Management said interest-rate risk exposure to rising rates had increased, reflecting somewhat longer securities duration and projected greater sensitivity of non-U.S. deposit rates. Foreign-exchange trading VaR was not materially changed from year-end 2010.
- Two acquisitions closed in 2011: Bank of Ireland Securities Services’ custody and related business for $84.4 million, and hedge-fund administrator Omnium LLC for $145.1 million. Both purchase prices include contingent consideration subject to performance adjustments.
- Investment securities had $74.0 million of gross unrealized losses at September 30. Non-agency residential mortgage-backed securities accounted for $32.4 million; the company recorded $23.3 million of credit-related OTTI losses for the first nine months. Auction-rate securities remained exposed to limited market liquidity.
- Legal matters include securities-lending-related litigation and an SEC investigation; management said it could not assess the probability of a material adverse outcome or reasonably estimate potential losses for that matter. For certain matters with estimable reasonably possible losses, the aggregate upper end was approximately $31 million; other matters could not be reasonably estimated. The company stated no material accruals had been recorded for pending litigation or regulatory matters.
- The IRS continues to dispute certain structured-leasing tax positions. The related uncertain tax position balance was $66.7 million at year-end 2010, unchanged in the filing; management anticipated settlement of remaining benefits by early 2012 and said a change could affect a particular period’s results.
- On August 22, 2011, Northern Trust issued $500 million of 3.375% unsecured senior notes due 2021 for general corporate purposes. The filing also describes $78.1 billion of client securities lending subject to indemnification; management considered credit exposure not significant given collateral and borrower controls and recorded no related liability.
Important facts for investors to verify
- Whether servicing-fee growth and acquisition contributions can offset securities-lending weakness, money-market fee waivers and market-driven asset fluctuations.
- Whether the lower net interest margin persists as deposits and earning assets grow, and how rising rates could affect deposit costs and securities values.
- Whether residential and commercial real estate credit quality, TDR balances and mortgage-backed security impairments worsen; review the allowance and nonperforming-asset trends.
- How much of the reported expense increase reflects ongoing staffing and technology costs versus acquisition and restructuring charges, and whether acquired businesses meet performance expectations.
- Developments in securities-lending litigation and the SEC investigation, IRS leasing disputes, Visa-related indemnifications and other contingencies.
- The drivers and sustainability of negative operating cash flow and large securities-related investing outflows, including derivative collateral movements.