Northern Trust Corporation — Q2 2012 Form 10-Q
Business context and period. Northern Trust provides asset servicing, investment management, fiduciary and banking services through Personal Financial Services (PFS) and Corporate & Institutional Services (C&IS). This unaudited quarterly report covers the three and six months ended June 30, 2012; comparisons are primarily with the corresponding 2011 periods.
Financial performance and condition
| Metric | Q2 2012 | Change vs. Q2 2011 | Six months 2012 | Change vs. 2011 |
|---|---|---|---|---|
| Revenue | $988.5 million | Up 5% | $1.95 billion | Up 6% |
| Net income | $179.6 million | Up 18% | $340.8 million | Up 12% |
| Diluted earnings per share | $0.73 | Up 18% | $1.39 | Up 12% |
| Net interest income, GAAP | $254.1 million | Up 3% | $510.5 million | Up 6% |
| Net interest margin, FTE | 1.28% | 1.23% prior year | 1.26% | 1.27% prior year |
| Provision for credit losses | $5.0 million | Down 50% | $10.0 million | Down 60% |
| Noninterest expense | $717.3 million | Up 2% | $1.44 billion | Up 6% |
FTE means fully taxable equivalent, a non-GAAP presentation. Q2 return on average common equity was 9.9% and return on average assets was 0.8%, compared with 8.8% and 0.7%, respectively, a year earlier. The six-month figures were 9.5% and 0.7%.
- Revenue drivers: Trust, investment and other servicing fees rose 9% to $605.8 million in Q2, supported by new business and the full-period contribution from 2011 acquisitions. Foreign exchange trading income fell 27% to $59.4 million amid lower currency volatility and client volumes. Q2 investment security results were a $0.5 million gain versus a $16.6 million loss a year earlier.
- Expenses: Q2 equipment and software expense rose 20% to $99.4 million, including a $10.5 million software write-off. Restructuring, acquisition and integration charges were $3.6 million in Q2, versus $22.6 million in Q2 2011. For the six months, expense also reflects a $15.1 million software write-off; the prior-year period included a $10.1 million Visa indemnification benefit.
- Balance sheet and funding: At June 30, total assets were $94.5 billion, deposits $77.0 billion, loans and leases $29.6 billion, securities $29.2 billion and stockholders’ equity $7.39 billion. Since December 31, 2011, assets declined 6%, deposits 7%, and equity increased 4%. Q2 average noninterest-bearing deposits increased substantially year over year, while average interest-bearing deposits declined.
- Cash flow: For the first six months, operating activities provided $539.3 million, investing activities provided $4.61 billion, and financing activities used $5.88 billion. Cash and due from banks decreased $721.0 million to $3.59 billion. Investing flows included significant securities purchases and maturities/redemptions and movements in interest-bearing deposits; cash-flow movements should be considered alongside the balance-sheet changes.
- Capital and shareholder returns: Corporation regulatory ratios at June 30 were 12.9% Tier 1 capital, 14.4% total capital and 8.0% leverage; the company reported itself and its bank subsidiary as well-capitalized. Six-month share repurchases totaled 1.13 million shares for $50.4 million. The company authorized up to 9.2 million additional shares after June 30. First-half dividends declared were $0.58 per common share.
- Client assets: Period-end assets under custody were $4.56 trillion and assets under management $704.3 billion, up 7% and 6%, respectively, from year-end 2011; both were 3% above June 2011.
Material changes, outlook and risks
- Q2 PFS net income increased 39% to $98.0 million, while C&IS net income increased 10% to $81.2 million. PFS benefited from strong new business and lower expenses; C&IS fee growth was partly offset by lower foreign exchange income and higher expenses.
- Management provided no specific earnings or revenue guidance in the supplied filing text. It cited persistent low short-term interest rates and related money-market fee waivers, market sensitivity of servicing fees, and the need to manage costs and technology investment. Management estimated that a 10% rise or fall in equity markets would change servicing fees by approximately 3% and total revenue by approximately 2%.
- Credit quality improved overall: nonperforming loans and leases declined to $239.8 million from $328.0 million a year earlier. Residential real estate remained a relative weakness, representing 68% of nonperforming loans. The allowance for credit losses was $329.9 million; the allowance assigned to loans and leases equaled 1.01% of loans.
- Investment portfolio risks include $44.9 million of gross unrealized losses at June 30, including $18.3 million on non-agency residential mortgage-backed securities. Auction-rate securities were valued using Level 3 inputs; their fair value was $105.2 million. The filing describes valuation assumptions and sensitivity to market liquidity, credit and housing conditions.
- Gross exposure to Portugal, Italy, Ireland, Greece and Spain was approximately $933 million, or 1% of consolidated assets; there was no sovereign debt exposure. $201 million of Spanish bank deposits matured and were repaid in full in July 2012 and were not renewed.
- Legal proceedings include securities-lending litigation and a securities class action for which management could not assess the likelihood or estimate potential loss. For a limited set of other matters, the estimated upper end of reasonably possible losses was approximately $45 million in aggregate. Management stated that pending matters were not expected to materially affect consolidated financial position or liquidity, but could materially affect results in a particular period.
- Other notable items include the July 13, 2012 Visa interchange-fee settlement memorandum of understanding; Northern Trust said the value of its remaining Visa shares was expected to offset any remaining indemnification obligations, while final resolution and timing remained uncertain. Market, credit, liquidity, operational, regulatory, litigation and acquisition-integration risks remain relevant. Management reported no material change in the prior-year Form 10-K risk factors.
Important facts for investors to verify
- Whether fee growth from new business and acquisitions can offset weaker foreign-exchange revenue, market-sensitive fees and continuing low-rate fee waivers.
- Whether equipment, software and other operating costs—including the software write-offs—remain elevated, and how expense growth compares with recurring revenue growth.
- Trends in residential real-estate delinquencies, nonperforming loans, charge-offs and allowance coverage, including the adequacy of reserves under weaker economic scenarios.
- Valuation, liquidity and impairment assumptions for non-agency mortgage-backed and auction-rate securities, and the potential effects of market stress.
- Developments in securities-lending and securities-class-action litigation, the stated $45 million aggregate estimate for certain reasonably possible losses, and remaining Visa-related obligations.
- Capital and liquidity after deposit outflows, debt repayments, dividends and the additional share-repurchase authorization; the filing text does not provide a single standalone liquidity ratio.