Northern Trust Corporation — Q2 2018 Form 10-Q
Business context and period: Northern Trust is a financial holding company providing wealth management, asset servicing, asset management and banking services. This unaudited report covers the quarter and six months ended June 30, 2018; comparisons are principally with the corresponding 2017 periods. Amounts are U.S. dollars unless stated otherwise.
Financial performance and position
- Q2 revenue and earnings: GAAP revenue was $1.506 billion, up 14% year over year. Net income was $390.4 million, up 46%; diluted EPS was $1.68, up from $1.12. Income before tax was $507.2 million.
- First-half results: Revenue was $2.982 billion, up 14%; net income was $772.0 million, up 42%; diluted EPS was $3.26, versus $2.21.
- Revenue mix: Q2 noninterest income rose 12% to $1.093 billion, led by servicing fees (+11%) and foreign exchange trading income (+58%). Net interest income rose 21% to $413.3 million. Higher client volumes and Treasury swap activity contributed to FX growth.
- Margins and returns: Q2 net interest margin was 1.48% on a fully taxable equivalent (FTE) basis, compared with 1.28% a year earlier; GAAP margin was 1.45%. Annualized return on average common equity was 16.5% (11.6% prior year), and return on average assets was 1.26% (0.91%).
- Costs and credit: Q2 noninterest expense increased 6% to $997.4 million, including higher compensation, benefits, outside services, and technology costs. Provision for credit losses was $1.5 million, versus a $7.0 million credit in Q2 2017. Net charge-offs were $0.1 million.
- Balance sheet and liquidity: June 30 assets were $135.1 billion, down 3% from year-end 2017; deposits were $106.5 billion, down 5%. Cash and due from banks was $4.9 billion, and Federal Reserve/other central bank deposits were $33.4 billion. Stockholders’ equity was $10.36 billion.
- Debt and capital: Balance-sheet funding included $7.6 billion of other borrowings, $3.2 billion of federal funds purchased, $1.5 billion of senior notes, $1.4 billion of long-term debt, and $0.28 billion of floating-rate capital debt. Regulatory capital ratios remained above “well-capitalized” minimums: Corporation CET1 was 13.3% (advanced approach) and 12.4% (standardized); total capital was 16.5% and 15.6%, respectively.
- Client assets: Assets under custody/administration were $10.71 trillion, approximately flat versus year-end and up 15% year over year. Assets under management were $1.149 trillion, down 1% from year-end and up 12% year over year. Q2 AUM had net outflows of $20.7 billion, partly offset by market performance and other factors.
Material changes and cash flows
- Q2 growth reflected higher servicing fees, FX income and net interest income. Fee growth was supported by favorable markets, new business, foreign exchange movements and the UBS Asset Management fund-administration acquisition in Luxembourg and Switzerland.
- The effective tax rate fell to 23.0% in Q2 from 31.4%, primarily reflecting the reduction in the U.S. corporate tax rate under the Tax Cuts and Jobs Act and a tax benefit related to sales of a non-strategic lease portfolio. First-half rate was 22.1%, versus 30.4%.
- For the first half, operating cash flow was negative $145.5 million, versus positive $312.6 million in 2017, primarily reflecting increased net collateral deposited with derivative counterparties and pension contributions. Investing activities provided $3.62 billion, while financing activities used $2.96 billion, including deposit declines and share repurchases.
- During the first half, Northern Trust repurchased 4.31 million shares for $453.8 million and declared $192.2 million of common dividends. The quarterly common dividend was $0.42 per share, up 11% year over year.
Outlook, risks and unusual items
- The filing provides no numerical earnings or revenue guidance. Management cited higher short-term rates as a driver of improved net interest margin, but also noted balance-sheet mix and deposit pricing assumptions affect results. A modeled 100-basis-point rate increase was estimated to add $31 million to next-12-month net interest income; a 50-basis-point decrease was estimated to reduce it by $55 million. These are scenario estimates, not forecasts.
- Net unrealized securities losses increased to $290.3 million from $160.8 million at year-end, primarily reflecting market-rate changes and, for some corporate debt, wider credit spreads. Management stated it did not intend to sell securities in loss positions and did not expect to be required to sell them before recovery or maturity.
- Nonperforming assets were $132.2 million, down from $166.7 million a year earlier. Residential real estate represented 84% of nonperforming loans and leases; the allowance assigned to loans and leases was 0.39% of loans.
- Management identified market and interest-rate volatility, client-asset values and flows, foreign exchange activity, cyber and operational risks, regulatory and compliance costs, competition, and Brexit-related uncertainty among forward-looking risk factors. The filing states that modeled interest-rate sensitivities are assumption-dependent and exclude potential management actions.
- Pending legal and regulatory matters: management estimated reasonably possible losses of zero to approximately $20 million in aggregate for a limited set of matters; other matters could not be reasonably estimated. A French appellate court acquitted Northern Trust’s subsidiary in an estate-tax case, but the prosecutor appealed to France’s highest court. The Bank was responding to a CFTC document request and addressing NFA examination findings.
- Other notable items include a $22.6 million first-half tax benefit from a change in software-development tax deduction accounting, partly offset by a $15.8 million adjustment to the initial TCJA estimate; a Visa Class B share swap liability valued at $36.1 million; and the June acquisition of Citadel Technology’s Omnium platform for $73 million.
- Adoption of the new revenue recognition standard reduced opening retained earnings by $4.0 million and changed certain gross-versus-net expense and revenue presentations. Management expected the forthcoming lease standard to significantly affect financial condition through lease assets and liabilities, but not significantly affect results of operations. The expected-credit-loss standard was still under assessment.
Important facts for investors to verify
- Whether revenue and margin growth persists as rates, deposit costs, client asset values, and AUM flows change.
- Whether expense growth—including acquisition, technology, benefits and servicing costs—remains controlled relative to revenue growth.
- The quality and trajectory of residential real estate and commercial credit exposures, nonperforming assets, and allowance coverage.
- The composition and funding implications of declining deposits, increased borrowings, and negative operating cash flow related in part to derivative collateral.
- Potential effects of securities valuation losses, Visa-related swap valuation, litigation and regulatory matters, and adoption of new accounting standards.
- Capital deployment: the filing states that the July 2018 capital plan permits up to $1.0 billion of common-stock repurchases through June 30, 2019; a new authorization allows repurchase of up to 25.0 million shares.