Northern Trust Corporation — Q1 2012 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2012; unaudited. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services. Its principal businesses are Corporate & Institutional Services (C&IS) and Personal Financial Services (PFS).
Financial performance and condition
- Revenue: GAAP revenue was $965.4 million, up 8% year over year. Noninterest income rose 7% to $709.0 million; servicing fees increased 12% to $575.2 million. Net interest income increased 9% to $256.4 million.
- Profit: Net income was $161.2 million, up 7%; diluted EPS was $0.66 versus $0.61. Pretax income rose 3% to $236.8 million. Effective tax rate was 31.9%, compared with 34.3%.
- Margins and returns: Fully taxable equivalent (FTE) net interest margin declined to 1.24% from 1.32%, despite FTE net interest income rising 9% to $266.3 million. Return on average common equity was 9.04% versus 8.94%; return on average assets was 0.68% versus 0.74%.
- Costs and credit: Noninterest expense increased 11% to $723.6 million, outpacing revenue growth. Provision for credit losses fell to $5.0 million from $15.0 million; net charge-offs were $5.8 million versus $21.6 million.
- Cash flow: Operating cash flow was $757.6 million versus $72.9 million. Investing activities provided $7.9 billion, while financing activities used $8.8 billion, including an $8.7 billion net decrease in deposits. These large cash-flow movements reflect balance-sheet and deposit activity and should be interpreted in the context of a bank’s operations.
- Balance sheet and liquidity: Total assets were $91.6 billion at quarter-end, down from $100.2 billion at December 31, 2011; average assets increased 14% year over year to $95.1 billion. Deposits were $73.9 billion, down from $82.7 billion at year-end. Cash and due from banks were $4.3 billion, interest-bearing deposits with banks $18.9 billion, and securities $31.6 billion.
- Debt and capital: Senior notes were $2.12 billion, long-term debt $1.79 billion (down 16% from year-end), and floating-rate capital debt $277 million. Corporation Tier 1 capital, total capital and leverage ratios were 12.4%, 14.0% and 7.6%, respectively; the filing states capital remained above well-capitalized thresholds.
- Client assets and shareholder returns: Assets under custody were $4.60 trillion, up 5% year over year; assets under management were $716.5 billion, up 8%. The declared dividend was $0.58 per share versus $0.28. The company repurchased 328,687 shares for $14.5 million during the quarter.
Material changes versus the prior comparable period
- Servicing-fee growth was supported by new business, revised fee structures and acquisitions completed in June and July 2011. C&IS servicing fees rose 17%, while PFS fees rose 6%.
- Foreign-exchange trading income fell 27% to $61.9 million, which management attributed to lower market volatility and client trading volumes.
- Expense growth reflected acquisition-related costs, higher equipment and software expense, and increased staffing. Equipment and software expense rose 24%, including a $4.6 million software write-off.
- The prior-year quarter included a $10.1 million pretax Visa indemnification benefit; no such benefit was recorded in Q1 2012. Current-quarter restructuring and integration charges were $3.9 million pretax, compared with $3.8 million in the prior year.
- C&IS net income declined 17% to $68.0 million, while PFS net income increased 36% to $85.9 million.
- Nonperforming loans declined to $262.1 million from $325.1 million a year earlier. Commercial and commercial real estate credit measures improved, while residential real estate weakness persisted.
Outlook, risks, contingencies and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management identifies low short-term interest rates as a factor contributing to money-market fund fee waivers and pressure on investment yields and margins.
- Management’s stated risks include economic and market uncertainty, particularly in Europe; interest-rate, foreign-exchange, credit, liquidity and operational risks; regulatory changes; acquisition integration; expense control; and securities-lending and investment-securities risks.
- Gross exposure to obligors in Portugal, Italy, Ireland, Greece and Spain was approximately $610 million, less than 1% of consolidated assets, mainly Ireland exposure. Management said risk controls limited exposure to higher-risk European financial and sovereign entities.
- Investment securities had $66.8 million of gross unrealized losses at quarter-end, including $23.9 million on residential mortgage-backed securities. Q1 credit-related other-than-temporary impairment charges were $3.1 million.
- The company estimated the upper end of reasonably possible losses for certain legal matters at approximately $39 million in aggregate; other matters could not be reasonably estimated. Securities-lending-related litigation remains pending and potential losses were not estimable. In April 2012, SEC staff advised that its securities-lending investigation was complete and it did not intend to recommend enforcement action.
- The quarter included a $26.7 million reduction in the postretirement health-care liability following the decision to join a government waiver program beginning in 2013. This affected benefit accounting, including a $0.9 million increase in amortization of an actuarial gain during the quarter.
Investor verification points
- Reconcile GAAP revenue of $965.4 million with the segment table’s FTE revenue presentation of $975.3 million.
- Assess whether servicing-fee and asset growth can continue to offset lower foreign-exchange revenue, fee waivers and margin pressure.
- Review expense trends, including acquisition integration, technology spending, software write-offs and staffing growth.
- Track deposit movements, funding mix, liquidity and capital ratios; period-end deposits fell materially from year-end.
- Monitor residential real estate credit quality, nonperforming loans, allowance adequacy and unrealized losses in mortgage-backed and auction-rate securities.
- Follow securities-lending litigation and other contingencies, including the limits of management’s loss estimates.