Northern Trust Corporation — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015; financial statements are unaudited. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services through Corporate & Institutional Services (C&IS) and Wealth Management.
Financial results and key metrics
- Quarter: Net income was $234.6 million, up 15% from $204.5 million; diluted EPS was $0.96, up 14% from $0.84. GAAP revenue, comprising net interest income and noninterest income, was approximately $1.16 billion, up 7%. Pretax income was $353.2 million.
- Nine months: Net income was $734.5 million, up 29%; diluted EPS was $3.00, up 28%. GAAP revenue was approximately $3.55 billion, up about 11%.
- Revenue drivers: Q3 noninterest income rose 7% to $886.6 million, led by servicing fees (+4%), foreign exchange trading income (+36%) and security commissions and trading income (+44%). Net interest income rose 8% to $268.9 million. Noninterest expense increased 5% to $812.3 million.
- Margins and returns: Q3 fully taxable equivalent (FTE) net interest margin was 1.08%, versus 1.05% a year earlier; annualized return on average common equity was 10.9%, versus 10.1%. Nine-month FTE margin was 1.06%, versus 1.08%; annualized return on average common equity was 11.7%, versus 9.5%.
- Balance sheet at September 30: Assets were $120.0 billion, deposits $99.9 billion, loans and leases $33.4 billion, and stockholders’ equity $8.8 billion. Compared with December 31, 2014, assets and deposits each rose 9%; equity rose 4%. Cash, bank deposits and Federal Reserve deposits totaled approximately $41.9 billion.
- Debt and funding: Reported liabilities included $4.1 billion of other borrowings, $1.5 billion of senior notes, $1.4 billion of long-term debt and $277 million of floating-rate capital debt. Deposits remained the principal funding source. The filing does not provide a single aggregate debt measure or a liquidity coverage ratio in the summarized data.
- Cash flow, first nine months: Operating activities provided $483.8 million, down from $1.27 billion in 2014; investing activities used $10.51 billion, versus $9.07 billion; financing activities provided $11.57 billion, versus $7.49 billion. Investing outflows chiefly reflected Federal Reserve deposits, securities purchases and loan growth; deposit growth was the main financing source.
- Credit and capital: The provision for credit losses was a credit of $10.0 million in Q3 and $24.5 million for nine months, reflecting improved credit quality. Nonperforming assets were $207.5 million, down 10% year over year; residential real estate represented 77% of nonperforming loans and leases. Corporation capital ratios were 12.4% CET1 and 14.8% total under the Advanced Approach; management said applicable ratios exceeded “well capitalized” thresholds.
- Client assets: Assets under custody were $5.96 trillion, roughly flat versus year-end 2014 and up 1% year over year. Assets under management were $886.8 billion, down 5% versus year-end and 4% year over year.
Material changes and unusual items
- Nine-month earnings included a $99.9 million pretax gain on selling 1.0 million Visa Class B shares, a $45.8 million pretax voluntary contribution to constant-dollar NAV funds, and a $17.8 million impairment of aircraft leveraged-lease residual values. Excluding these items, management reported diluted EPS of $2.91 and net income of $712.1 million.
- Management reported higher Q3 costs for outside services, compensation, and equipment and software. Regulatory-related consulting and technical services, as well as software costs, contributed to expense growth. FTE headcount was approximately 16,000, up 5% year over year.
- Nine-month other operating income rose sharply, primarily because of the Visa share-sale gain. Other operating expense included the $45.8 million fund contribution. Excluding those items, management said other operating income was broadly unchanged and other operating expense rose 3%.
- Q3 AUM declined from June, reflecting market movements; year-over-year consolidated AUC growth reflected institutional net new business, while AUM was lower mainly due to reduced equity and fixed-income assets.
Outlook, risks and contingencies
- The filing gives no specific near-term earnings or revenue guidance. Management’s commentary emphasizes sensitivity of fee income to asset values, market activity and client flows, and of net interest income to earning-asset growth, funding costs and interest rates.
- Interest-rate scenarios estimated a $17 million increase in next-12-month pretax earnings for a 100-basis-point rise, but a $2 million decrease for a 200-basis-point rise. A 100- and 200-basis-point immediate rate shock was estimated to reduce economic value of equity by $38 million and $286 million, respectively. Management cautions these models are assumption-based and not forecasts.
- Legal and regulatory matters include securities-lending litigation and an SEC investigation; a French subsidiary has been charged with complicity in estate-tax fraud and plans to contest the charge. Management said pending matters were not expected to materially affect consolidated financial position or liquidity, though they could affect results in a particular period. No material litigation accruals were recorded; the estimated upper end of reasonably possible losses for certain matters was approximately $125 million, excluding matters whose loss range could not be estimated.
- Other stated risks include financial-market and counterparty disruption, interest-rate and foreign-exchange movements, credit and investment-security losses, regulatory and compliance costs, operational and cybersecurity risks, and the ability to retain clients, grow fee-generating assets and control expenses.
Most important facts for investors to verify
- How much of nine-month earnings growth persists after the Visa gain and other unusual charges are excluded.
- Whether servicing-fee growth, institutional net new business and AUC trends offset lower AUM and market-sensitive fee pressure.
- Whether deposit growth can be deployed profitably while maintaining liquidity, and how interest-rate changes affect net interest margin and economic value.
- Whether nonperforming residential real estate loans, the allowance and charge-offs continue to improve; residential real estate remained the largest source of nonperforming loans.
- Developments and potential financial exposure from securities-lending claims, the SEC investigation, the French criminal proceeding and other contingencies.
- Capital, dividends and buybacks: Q3 common dividend declared was $0.36 per share; the Corporation repurchased 1.91 million shares for $140.5 million during the quarter.