Northern Trust Corporation — 2010 Third-Quarter Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010. The interim financial statements are unaudited. Dollar figures are in millions unless stated otherwise.
Business context and financial performance
Northern Trust provides corporate and institutional services, personal financial services, asset custody and management, and related banking services. Its results reflect fee income, securities lending, foreign-exchange activity, and net interest income.
- Third-quarter revenue: $899.0 on a fully taxable equivalent (FTE) basis, down 3% from $927.6 a year earlier. Trust, investment and other servicing fees were $518.7, down 1%; foreign-exchange trading income was $88.9, down 4%.
- Third-quarter earnings: Net income was $155.6 versus $187.9; diluted EPS was $0.64 versus $0.77. Annualized return on average equity was 9.23% and return on average assets was 0.83%, compared with 11.91% and 1.05%, respectively, in 2009.
- Interest income and margin: GAAP net interest income was $233.5, down 2%. FTE net interest income was $243.0, also down 2%; FTE net interest margin declined to 1.44% from 1.54%, principally due to the low-rate environment and compressed spreads.
- Expenses and credit costs: Noninterest expense rose 4% to $622.1. The provision for credit losses fell to $30.0 from $60.0; quarterly net charge-offs were $30.3 versus $46.1.
- Nine-month results: FTE revenue was $2,780.4, down 3%; net income was $512.4 versus $663.9, and diluted EPS was $2.10 versus $2.34. FTE net interest income was $725.5, down 9%, and FTE margin was 1.45% versus 1.60%. Provision for credit losses was $120.0 versus $175.0.
- Cash flows, nine months: Operating activities provided $919.4; investing activities provided $2,304.4; financing activities used $2,316.3. Cash and due from banks increased $997.7 to $3,489.5.
Balance sheet, funding and capital
- At September 30, total assets were $80.7 billion, compared with $77.9 billion a year earlier and $82.1 billion at December 31, 2009. Total loans and leases were $27.9 billion; securities were $20.7 billion; money-market assets were $22.9 billion.
- Total deposits were $58.4 billion, broadly unchanged from year-end 2009 and up from $55.3 billion a year earlier. Stockholders’ equity was $6.8 billion.
- Borrowings included $4.8 billion of federal funds purchased, $2.2 billion of other borrowings, $1.4 billion of senior notes, $2.8 billion of long-term debt, and $276.8 million of floating-rate capital debt.
- Reported capital ratios were 13.2% Tier 1, 15.3% total risk-based capital, and 9.3% leverage. Tier 1 common equity was $6.6 billion, or 12.7% of risk-weighted assets. The company said its U.S. subsidiary banks exceeded “well capitalized” thresholds.
Material changes and unusual items
- Third-quarter 2009 included a $17.8 million pre-tax benefit from reducing the Visa indemnification liability; excluding that benefit, 2009 operating earnings were $176.7 million, or $0.72 per share. Third-quarter 2010 had no comparable benefit.
- Nine-month comparisons also reflect unusual prior-year items: 2009 included a $121.8 million pre-tax expense reduction related to Capital Support Agreements and $111.1 million of preferred-stock dividends and discount accretion affecting common EPS.
- Corporate and Institutional Services’ quarterly net income fell 19% to $95.6 million, chiefly amid lower securities-lending revenue and weaker net interest income. Personal Financial Services’ net income rose 23% to $63.4 million, supported by stronger fees and margin.
- Assets under custody were $3.91 trillion, up 10% year over year; assets under management were $657.2 billion, up 8%.
- Gross unrealized securities losses were $94.9 million, down from $159.7 million at year-end 2009. Residential mortgage-backed securities accounted for $69.1 million of losses; the company recorded $14.0 million of credit-related impairment charges in the quarter.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management cited persistently low short-term interest rates, spread compression, economic weakness, and market volatility as factors affecting results. It estimated a 10% move in equity markets could change servicing fees by about 4% and total revenue by about 2%.
- Management said it expected to record a $20.3 million reduction in the Visa indemnification liability in fourth-quarter 2010 following an October 8 Visa escrow deposit. Further adjustments may follow; the ultimate resolution of Visa litigation remains uncertain.
- Credit quality remained a concern: nonperforming loans and leases were $327.3 million, or 1.17% of loans, and other real estate owned was $50.3 million. Total nonperforming assets were $377.6 million, up from $301.5 million a year earlier, despite a decline from the prior quarter.
- The securities-lending program faces participant lawsuits alleging imprudent investment of collateral; the company said it believes it acted prudently and was cooperating with an SEC investigation. A securities class action filed in August 2010 alleges inadequate commercial-real-estate credit provisions and disclosure concerning securities lending; a related derivative suit followed in September. Management said outcomes and potential losses could not be estimated, and no material accrual had been recorded for pending litigation or regulatory matters.
- The IRS continues to challenge tax treatment of certain structured leasing transactions. The company said it had reserves, but an adverse outcome could materially affect a particular period’s results. Management did not expect future changes to materially affect consolidated financial position or liquidity.
- Basel III standards had been announced but were not finalized or implemented in the United States. The company said it believed it was well positioned, while noting regulatory capital and liquidity requirements could change.
Important facts for investors to verify
- Whether the lower net interest margin and persistent low-rate environment continue to pressure earnings.
- Trends in nonperforming loans, real estate owned, charge-offs, and reserve adequacy, particularly in residential and commercial real estate.
- Resolution and financial effects of securities-lending litigation and the SEC investigation, and any related disclosures or accruals.
- The timing and amount of future Visa escrow-related liability adjustments and the value available to offset remaining obligations.
- Developments in the IRS structured-leasing dispute and the eventual U.S. implementation of Basel III requirements.