Northern Trust Corporation — Q1 2018 Form 10-Q
Business context and reporting period. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services. This unaudited report covers the three months ended March 31, 2018, compared with Q1 2017 for operating results and December 31, 2017 for period-end balance-sheet comparisons. Its reporting segments are Corporate & Institutional Services (C&IS), Wealth Management, and Treasury and Other.
Key financial results
| Metric | Q1 2018 | Prior period / change |
|---|---|---|
| Revenue (GAAP) | $1,476.0 million | $1,284.4 million; up 15% |
| Net interest income (GAAP) | $384.0 million | $353.5 million; up 9% |
| Net interest margin | 1.38% FTE; 1.35% GAAP | 1.35% FTE; 1.32% GAAP |
| Noninterest income | $1,092.0 million | $930.9 million; up 17% |
| Provision for credit losses | $3.0 million credit | $1.0 million credit |
| Noninterest expense | $995.3 million | $894.5 million; up 11% |
| Net income | $381.6 million | $276.1 million; up 38% |
| Diluted EPS | $1.58 | $1.09; up 45% |
| Return on average common equity / assets | 16.0% / 1.24% | 11.6% / 0.96% |
| Cash dividends declared per common share | $0.42 | $0.38; up 11% |
Balance sheet and capital at March 31, 2018. Assets were $129.7 billion, down 6% from year-end; deposits were $105.2 billion, down 6%; and stockholders’ equity was $10.2 billion, essentially unchanged. Loans and leases totaled $32.1 billion, versus $32.6 billion at year-end. Cash and due from banks was $6.1 billion; Federal Reserve and other central bank deposits were $29.4 billion. Debt and borrowing balances included $7.0 billion of other borrowings, $1.5 billion of senior notes, $1.4 billion of long-term debt and $0.3 billion of floating-rate capital debt. The filing reports regulatory capital ratios of 13.0% CET1 under the advanced approach and 12.3% under the standardized approach; management said capital remained above well-capitalized minimums.
Cash flow. Operating activities used $477.8 million, compared with $784.7 million provided in Q1 2017, mainly reflecting higher net collateral deposited with derivative counterparties and other operating changes. Investing activities provided $11.2 billion, while financing activities used $9.2 billion, primarily due to deposit and federal funds declines, partly offset by higher short-term borrowings. Period-end cash and due from banks was $6.1 billion.
Material changes and management commentary
- Revenue growth reflected higher servicing fees and foreign-exchange trading income, alongside higher net interest income. Trust, investment and other servicing fees rose 16% to $937.7 million; FX trading income rose 63% to $78.5 million.
- Average earning assets rose 6% year over year to $115.7 billion. The FTE margin increased to 1.38%, primarily due to higher short-term rates; higher premium amortization and balance-sheet mix partly offset the benefit.
- Expenses increased 11%, including higher compensation, employee benefits, outside services, and equipment and software costs. The UBS Asset Management fund-administration acquisition in Luxembourg and Switzerland contributed to higher costs. Compensation included $6.1 million of severance charges.
- Net income benefited from a lower effective tax rate: 21.1%, versus 29.4% in Q1 2017. The lower U.S. federal corporate rate under the Tax Cuts and Jobs Act contributed; the quarter also included a $22.6 million tax benefit from a change in the timing of software-development tax deductions and a $15.8 million net provision for tax adjustments.
- Client assets grew year over year: assets under custody/administration were $10.79 trillion, up 21%, and assets under management were $1.17 trillion, up 16%. Management attributed growth principally to favorable markets, new business, currency effects, and net inflows in selected AUM categories. Quarterly AUM net inflows were $6.6 billion.
- C&IS net income rose 62% to $234.2 million; Wealth Management net income rose 50% to $190.1 million. Treasury and Other reported a $42.7 million net loss, compared with $4.5 million net income, including lower segment net interest income.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management describes exposure to market levels and client-asset values, interest and foreign-exchange movements, deposit pricing, client flows, and expense execution.
- Interest-rate simulations estimate a next-12-month net interest income increase of $71 million for a gradual +100-basis-point move and $110 million for +200 basis points; a −50-basis-point move estimates a $64 million decrease. Estimated market value of equity effects are +$228 million at +100 basis points, +$10 million at +200, and −$352 million at −50. The company cautions these are model estimates, omit potential management actions, and depend on assumptions; it did not exceed its stated sensitivity limits.
- Asset quality improved year over year: nonperforming assets were $128.9 million, down 31%; nonperforming loans and leases were 0.39% of total loans. Net charge-offs were $3.0 million. Residential real estate represented 91% of nonperforming loans and leases.
- Investment securities had net unrealized losses of $272.3 million at quarter-end, versus $160.8 million at year-end. Management attributed most losses to market rates, credit spreads, or liquidity, and stated it did not intend to sell loss-position securities and was not likely to be required to sell before recovery or maturity.
- Contingencies include $25.7 billion of legally binding loan commitments and $2.9 billion of standby letters of credit. Management estimated reasonably possible litigation and regulatory losses at zero to approximately $20 million in aggregate for matters where an estimate was possible; other matters could not be reasonably estimated. A French appellate ruling concerning a subsidiary was expected in June 2018. The company also reported a CFTC document request and NFA examination findings involving its swap-dealer compliance program.
- Other notable items: the company repurchased 2.52 million shares at a total cost of $263.2 million and declared $96.4 million of common dividends. Adoption of the new revenue-recognition standard reduced retained earnings by $4.0 million and changed some gross-versus-net presentation; comparisons with prior periods are therefore not fully presentation-consistent. The company expected the forthcoming lease standard to significantly affect financial condition, primarily through operating-lease assets and liabilities.
Important facts for investors to verify
- Whether servicing-fee growth and elevated client-asset levels persist, including the effect of market returns, currency movements, flows, and fee recognition timing.
- Whether revenue growth continues to outpace expense growth, particularly costs associated with the UBS acquisition, technology, compensation and regulatory compliance.
- How rising rates, deposit repricing, balance-sheet mix, and premium amortization affect net interest margin and funding costs.
- Whether credit trends remain favorable, especially in residential real estate, and whether allowance levels remain appropriate as the expected-credit-loss standard approaches.
- The development of unrealized securities losses, capital and liquidity levels, and the effect of planned repurchases and dividends.
- Updates on the French appeal, CFTC/NFA matters, other litigation and regulatory proceedings, and any changes to the disclosed range of possible losses.