Northern Trust Corporation — Q1 2013 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three months ended March 31, 2013. Northern Trust provides custody, asset servicing and management, fiduciary, and banking services through Personal Financial Services and Corporate & Institutional Services. Comparisons below are primarily with Q1 2012; balance-sheet comparisons are with December 31, 2012 where noted.
Financial and operating performance
- Revenue and earnings: GAAP revenue was $976.4 million, up 1% year over year. Net income was $164.0 million, up 2%; diluted EPS was $0.67 versus $0.66. Net income includes $12.4 million in fee-receivable write-offs and $1.8 million in restructuring and integration charges; together these reduced after-tax earnings by $8.9 million, or about $0.04 per share.
- Revenue mix: Noninterest income increased 6% to $750.3 million, led by trust, investment, and servicing fees, up 10% to $630.7 million. Net interest income declined 12% to $226.1 million. The filing also reports FTE revenue of $984.0 million; FTE is a non-GAAP presentation.
- Margins and returns: FTE net interest margin declined to 1.15% from 1.24%; average earning assets fell 5% to $82.2 billion. Return on average common equity was 8.82% versus 9.04%; return on average assets was 0.73% versus 0.68%.
- Expenses and credit: Noninterest expense rose 1% to $728.9 million. Provision for credit losses was $5.0 million, unchanged year over year; net charge-offs increased to $8.7 million from $5.8 million.
- Cash flow: Net cash from operating activities was $312.5 million, compared with $757.6 million in Q1 2012. Investing activities provided $4.44 billion and financing activities provided $4.67 billion, largely reflecting movements in financial assets, deposits, and other funding. Cash and due from banks ended at $3.77 billion. Banking cash-flow movements may not be comparable to those of nonfinancial companies.
- Balance sheet and funding: Total assets were $93.16 billion, down 4% from year-end; deposits were $75.82 billion, down 7%. Loans and leases were $28.86 billion, and stockholders’ equity was $7.61 billion. The balance sheet reports $5.31 billion in senior notes, long-term debt, and floating-rate capital debt combined; it also has other borrowing and federal funds funding.
- Capital and client assets: Corporation Tier 1 and total risk-based capital ratios were 13.3% and 14.7%, respectively, and the Tier 1 leverage ratio was 8.4%. Assets under custody rose 5% from year-end to $5.02 trillion; assets under management rose 7% to $810.2 billion.
Material changes versus comparable periods
- Servicing fees benefited from new business and stronger equity markets. Assets under custody and management were also higher year over year, while foreign-exchange trading income fell 4%, which management attributed to lower currency-market volatility.
- Lower asset yields and lower average earning assets weighed on net interest income and margin; management also cited persistently low short-term rates and money-market fee waivers.
- The $12.4 million fee-receivable write-off arose from correction of an accrual methodology used in prior years. Total noninterest expense increased modestly, with higher other operating costs partly offset by lower employee-benefit expense.
- Period-end nonperforming loans and leases were $251.7 million, down from $262.1 million a year earlier; nonperforming assets were $262.2 million. Residential real estate remained a key source of credit weakness.
Outlook, risks, contingencies, and unusual items
- Outlook: The filing provides no specific financial guidance or quantified forecast. Management identifies future results as dependent on economic conditions, markets, new-business generation, pricing and product mix, expense control, and regulatory developments.
- Key risks: The filing highlights interest-rate and liquidity risk, credit quality and allowance estimates, market and foreign-exchange volatility, operational and technology risks, regulatory and capital requirements, and the ability to attract and retain skilled personnel. Northern Trust said its interest-rate risk position and foreign-exchange VaR had not changed significantly since year-end.
- Credit and securities: Management said nonperforming assets remained elevated relative to historical levels. The residential real estate portfolio continued to show weakness. Investment securities had $25.5 million of unrealized losses at quarter-end; no other-than-temporary impairment losses were recorded in Q1 2013.
- Legal and contingent matters: The company estimated the upper end of reasonably possible losses for certain matters at approximately $126 million in aggregate, while noting that some potential losses cannot be reasonably estimated. Securities-lending litigation remains difficult to assess. A securities class action was dismissed in March 2013 with leave to amend. Management did not expect pending matters to materially affect consolidated financial position or liquidity, but said they could materially affect results in a particular period.
- Geographic exposure: Gross exposure to Irish obligors was approximately $885 million, less than 1% of consolidated assets; the filing reports no exposure to Portugal, Italy, Greece, Spain, or Cyprus, and no sovereign debt exposure to those countries.
- Capital returns: The company repurchased 1.40 million shares for $74.5 million during the quarter. After quarter-end, the board authorized a new program for up to 12 million shares. The Federal Reserve had also reviewed the capital plan without objection, allowing up to $400 million of repurchases after March 31, 2013 through March 31, 2014.
- Reporting note: The filing states that financial statements are unaudited. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether servicing-fee growth and higher client assets can offset continued pressure on net interest margin and interest income.
- How the fee-receivable methodology correction, any further write-offs, and associated controls affect subsequent results.
- Whether residential real estate credit weakness, nonperforming assets, charge-offs, and allowance levels improve or deteriorate.
- The status and potential financial exposure of securities-lending and other legal matters, including the estimated $126 million upper-end loss range.
- Actual pace of share repurchases and the effect of deposit outflows, funding mix, and evolving regulatory capital requirements on liquidity and capital.