Northern Trust Corporation — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015. The unaudited filing covers a financial holding company providing asset servicing, fund administration, asset management, fiduciary and banking services. Its reporting segments are Corporate & Institutional Services (C&IS), Wealth Management, and Treasury and Other.
Financial results and key metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Noninterest income | $1,004.7 million | $835.1 million | $1,878.6 million | $1,629.9 million |
| Net interest income | $251.2 million | $246.6 million | $511.8 million | $492.3 million |
| Provision for credit losses | $(10.0) million | $0 | $(14.5) million | $3.0 million |
| Noninterest expense | $854.5 million | $811.0 million | $1,643.5 million | $1,579.0 million |
| Income before taxes | $411.4 million | $270.7 million | $761.4 million | $540.2 million |
| Net income | $269.2 million | $181.9 million | $499.9 million | $363.3 million |
| Diluted EPS | $1.10 | $0.75 | $2.04 | $1.50 |
- Q2 FTE revenue was $1.262 billion, up 16%; six-month FTE revenue was $2.403 billion, up 12%. FTE is a non-GAAP presentation.
- Q2 return on average common equity was 12.85% and return on average assets was 0.97%, versus 9.18% and 0.71%, respectively, a year earlier. Q2 FTE net interest margin was 1.00%, down from 1.06%.
- At June 30, assets were $119.9 billion, deposits $100.7 billion, loans and leases $33.0 billion, and stockholders’ equity $8.75 billion. At December 31, 2014, assets were $109.9 billion, deposits $90.8 billion, loans and leases $31.6 billion, and equity $8.45 billion.
- Six-month operating cash flow was $1.53 billion, investing cash flow $(7.66) billion, and financing cash flow $10.23 billion. Financing inflows primarily reflected deposit growth; investing outflows included securities purchases and growth in loans and other assets.
- Regulatory capital remained above “well-capitalized” thresholds. At June 30, Corporation CET1 was 12.0% under the Advanced Approach and 10.7% under the Standardized Approach; the Bank’s respective ratios were 11.6% and 10.1%.
- Assets under custody were $6.18 trillion, up 3% year over year; assets under management were $945.6 billion, up 2%.
Material changes versus comparable periods
- Q2 net income rose 48% and diluted EPS rose 47%. Growth included a $99.9 million pretax gain from selling 1.0 million Visa Class B shares. Excluding the gain and the $45.8 million NAV-fund contribution and $17.8 million aircraft lease impairment, management reported adjusted Q2 diluted EPS of $1.01 and net income of $246.7 million. These are management’s adjusted figures, not GAAP results.
- Noninterest income growth reflected the Visa gain, higher servicing fees and foreign-exchange trading income. Q2 foreign-exchange trading income rose 41% to $74.8 million, attributed primarily to greater currency volatility and client volumes.
- Q2 expenses increased 5%. The current period included the $45.8 million voluntary contribution to certain constant-dollar NAV funds; the prior-year quarter included $32.8 million in severance and real-estate charges and $9.5 million in software write-offs. Management said expenses increased 5% after excluding these items.
- Net interest income increased modestly despite lower margins. Earning-asset growth was partly offset by the aircraft lease impairment and weaker yields; excluding that impairment, management said Q2 FTE margin was 1.06%, unchanged year over year.
- Credit quality improved in several measures: nonperforming assets were $218.8 million, down from $241.9 million a year earlier; nonperforming loans and leases were 0.63% of total loans, versus 0.75%. Residential real estate remained the principal nonperforming exposure.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or revenue guidance. Management highlights risks from interest rates, financial markets, client asset values and flows, foreign exchange activity, credit quality, regulatory and legal developments, expense control, operational and cybersecurity risks, and the ability to grow and deploy deposits profitably.
- The $45.8 million contribution was made to bring four constant-dollar NAV funds to $1.00. The funds had $37.5 billion in net assets at quarter-end. Northern Trust said it was not required to consolidate them and had no current plans for further support; any future support would be discretionary.
- The $17.8 million aircraft residual-value impairment reduced interest income. Northern Trust’s leveraged-lease investment carrying amount was $507 million at quarter-end; its stated maximum exposure to loss is limited to carrying amounts.
- Northern Trust sold 1.0 million Visa Class B shares for a $99.9 million pretax gain and retained approximately 5.2 million shares. The shares’ eventual conversion ratio and removal of selling restrictions depend on resolution of covered litigation; the sale did not eliminate the conversion-ratio risk.
- For certain matters with reasonably possible losses, the estimated aggregate upper end of the loss range was approximately $125 million. Other matters could not be reasonably estimated. Management said pending litigation or regulatory matters were not expected to materially affect consolidated financial position or liquidity, though they could materially affect results in a particular period.
- Related proceedings include an SEC investigation into securities-lending activities and a French criminal charge against an indirect subsidiary concerning administration of two trusts; the subsidiary intends to contest the charge. A securities-lending settlement recorded in 2013 remained pending court approval, with other related claims still pending.
- Q2 share repurchases totaled $96.7 million; six-month repurchases totaled $203.9 million. The Board’s authorization allowed repurchase of up to 15 million shares, with 13.7 million remaining at June 30. The filing states the capital plan permitted up to $578.3 million of repurchases after June 30 through June 2016.
Most important facts for investors to verify
- How much earnings growth is sustainable after removing the Visa gain and accounting for the NAV-fund contribution and aircraft impairment.
- Whether margins can stabilize as the balance sheet and deposits grow, and how rate changes affect earnings and economic value. The filing estimates a $21 million pretax earnings decline under a 200-basis-point rate increase and a $436 million reduction in economic value of equity under that shock.
- Future support, if any, for the constant-dollar NAV funds, and the impact of such support on expenses, capital and consolidation conclusions.
- Developments in Visa covered litigation and the value and conversion terms of the remaining shares, along with the status and exposure of securities-lending and French proceedings.
- Residential real-estate credit performance: it represented 76% of nonperforming loans and leases; confirm trends in delinquencies, foreclosures, allowance coverage and recoveries.
- Cash-flow composition and funding: operating cash flow was substantially influenced by collateral movements, while financing cash flow was driven by deposit growth. Assess deposit stability and the use of short-term borrowings.