Northern Trust Corporation — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Financial statements are unaudited. Northern Trust provides wealth management, asset servicing, asset management and banking services through Corporate & Institutional Services (C&IS) and Wealth Management.
Financial performance and position
- Q2 revenue: $1.507 billion, essentially unchanged from $1.506 billion in Q2 2018. Net income was $389.4 million versus $390.4 million; diluted EPS increased 4% to $1.75 from $1.68.
- Six-month results: Revenue was $2.988 billion, up slightly from $2.982 billion. Net income declined 5% to $736.5 million from $772.0 million; diluted EPS was $3.23 versus $3.26.
- Net interest income and margin: Q2 GAAP net interest income rose 1% to $417.4 million; fully taxable equivalent (FTE) net interest margin rose to 1.61% from 1.48%. For the six months, GAAP net interest income increased 5% to $839.4 million and FTE margin was 1.59% versus 1.43%. Higher margins offset lower earning assets.
- Fees and expenses: Q2 noninterest income was $1.089 billion, down slightly, as lower foreign-exchange trading income offset higher servicing fees. Noninterest expense rose 1% to $1.006 billion. For the six months, noninterest income fell 2% to $2.148 billion and expenses rose 2% to $2.035 billion.
- Profitability: Q2 return on average common equity was 15.9% versus 16.5%; return on average assets was 1.34% versus 1.26%. Six-month figures were 15.0% versus 16.3% and 1.26% versus 1.25%, respectively.
- Credit: The Q2 provision was a $6.5 million credit, compared with a $1.5 million expense a year earlier. Nonperforming assets were $118.9 million, down from $132.2 million at June 30, 2018; residential real estate represented 87% of nonperforming loans and leases.
- Balance sheet and funding: Assets were $126.6 billion at June 30, down 4% from December 31, 2018; deposits were $100.2 billion, down 4%. Loans and leases were $31.0 billion, down from $32.5 billion. Stockholders’ equity was $10.8 billion, up 3%.
- Debt and capital: Period-end senior notes were $2.566 billion, long-term debt $1.148 billion, floating-rate capital debt $278 million and other borrowings $7.766 billion. The Corporation’s CET1 ratio was 13.6% under the Advanced Approach and 13.2% under the Standardized Approach; management said capital remained above “well-capitalized” minimums.
- Cash flows, six months: Operating activities provided $378.5 million, investing activities provided $7.331 billion and financing activities used $7.015 billion. Financing outflows primarily reflected lower deposits and repurchases. These cash-flow totals reflect banking balance-sheet movements and should not be read as free cash flow.
- Client assets: Assets under custody/administration were $11.322 trillion, up 12% from December 2018; assets under management were $1.180 trillion, up 10%. Compared with a year earlier, AUC/A rose 6% and AUM rose 3%; management cited favorable markets, partly offset by foreign-exchange effects and AUM net outflows.
Material changes and management commentary
- Q2 foreign-exchange trading income fell 23% to $60.5 million, attributed to lower swap activity, market volatility and client volumes. Servicing fees increased 1% to $955.5 million.
- For the six months, higher net interest income was offset in part by weaker foreign-exchange trading, securities commissions and trading, and treasury management fees. Interest expense increased substantially year over year, while the higher net interest margin reflected balance-sheet mix, higher short-term rates and lower FX swap volume.
- Wealth Management Q2 net income rose 2% to $200.4 million. C&IS net income fell 20% to $191.9 million; segment comparisons are affected by 2019 changes to funds-transfer-pricing and expense allocation, and prior periods were not recast.
- The Corporation repurchased 5.78 million shares for $528.6 million in the first six months and declared $264.6 million in common dividends. Its 2019 capital plan permits up to $1.4 billion of common-stock repurchases from after June 30, 2019 through June 30, 2020.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Its interest-rate sensitivity model estimates next-12-month net interest income increases of $75 million for a gradual 100-basis-point rise and $133 million for a 200-basis-point rise, and a decrease of $83 million for a 100-basis-point decline. Management cautions that these are estimates, depend on assumptions, and exclude potential mitigating actions.
- Northern Trust plans to adopt the expected-credit-loss standard (ASU 2016-13) on January 1, 2020. The adoption impact was not yet quantified and will depend, among other factors, on economic conditions and portfolio composition.
- Notable items include the $1.0 billion purchase of a bank-owned life-insurance program, which contributed to the lower earning-asset base and other operating income; a $500 million issuance of 3.15% senior notes due 2029; and adoption of lease accounting, which recognized $492 million of operating lease liabilities at June 30.
- Management identifies risks including market and FX volatility, interest rates, client-asset values and flows, credit quality, liquidity and funding, cybersecurity and operational controls, regulation, litigation, and geopolitical developments including Brexit. It reports no breach of Board-set interest-rate sensitivity tolerances and no actual trading loss above the daily VaR estimate during the period.
- Legal matters are ongoing. No material litigation or regulatory accruals were recorded; for a limited number of matters management estimated reasonably possible aggregate losses of $0 to approximately $25 million. Other matters could not be reasonably estimated. The Visa interchange litigation also leaves the timing and conversion rate for retained Visa Class B shares uncertain.
- Management concluded disclosure controls were effective as of June 30, 2019 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether higher net interest margins can persist as rates, funding costs, deposit balances and earning-asset levels change.
- Whether fee growth, client flows and market performance can offset FX trading and securities-lending weakness.
- The impact of 2019 segment-allocation changes on comparisons, particularly C&IS results and expense trends.
- Credit trends in residential real estate and other watch-list portfolios, and the eventual allowance impact of CECL adoption.
- Execution and capital effects of share repurchases, the new senior notes, and the $1.0 billion life-insurance investment.
- Updates on legal and regulatory matters, including the estimated loss range and Visa litigation developments.