Northern Trust Corporation — Q2 2013 Form 10-Q
Business context and reporting period
Northern Trust provides asset servicing, investment management, fiduciary and banking services through its Corporate & Institutional Services (C&IS) and Personal Financial Services (PFS) businesses. This unaudited quarterly report covers the three and six months ended June 30, 2013; comparisons are generally with the corresponding 2012 periods.
Financial performance and key metrics
| Metric | Q2 2013 | Change year over year |
|---|---|---|
| Revenue | $1.02 billion | Up 3% |
| Net income | $191.1 million | Up 6% |
| Diluted EPS | $0.78 | Up 7% |
| Noninterest income | $800.4 million | Up 9% |
| Net interest income, GAAP | $220.1 million | Down 13% |
| Net interest income, fully taxable equivalent (FTE) | $228.0 million | Down 14% |
| Noninterest expense | $729.7 million | Up 2% |
| Provision for credit losses | $5.0 million | Unchanged |
| Net interest margin, FTE | 1.10% | Down from 1.28% |
| Return on average common equity | 10.02% | Up from 9.91% |
For the six months ended June 30, revenue was $2.00 billion, up 2%; net income was $355.1 million, up 4%; and diluted EPS was $1.45, versus $1.39. FTE net interest income declined 13% to $461.7 million, with FTE margin at 1.13% versus 1.26%. The six-month return on average common equity was 9.43%, compared with 9.48%.
Servicing fees and foreign-exchange income supported growth: Q2 trust, investment and other servicing fees rose 8% to $657.3 million, and foreign-exchange trading income rose 20% to $71.3 million. Assets under custody were $4.99 trillion, up 9% year over year; assets under management were $803.0 billion, up 14%.
Balance sheet, cash flow and capital
- At June 30, assets were $97.2 billion, deposits $76.5 billion, and stockholders’ equity $7.72 billion. Deposits fell 6% from December 31, 2012; total assets were approximately unchanged.
- Loans and leases totaled $28.8 billion, down from $29.5 billion at year-end 2012. The allowance for credit losses was $320.7 million, including $290.4 million assigned to loans and leases.
- Six-month operating cash flow was negative $1.28 billion, principally reflecting increased collateral posted with derivative counterparties. Investing activities provided $2.71 billion and financing activities used $436.5 million. These cash-flow movements reflect banking and client-related balance changes and should not be read as operating cash flow alone.
- Corporation capital ratios were 13.1% Tier 1 risk-based capital, 14.4% total capital, and 8.4% leverage; each exceeded the stated well-capitalized thresholds. The Tier 1 common equity ratio was 12.6%.
- Share repurchases were $89.8 million for the first half, and dividends declared were $0.61 per common share. A new authorization permits repurchases of up to 12.0 million shares.
Material changes, outlook and risks
- Management attributed higher servicing fees mainly to favorable equity markets and new business, and stronger FX trading income to greater currency-market volatility and trading volumes. Continued low short-term rates contributed to money-market fee waivers and lower net interest margins.
- The principal earnings headwind was margin compression: lower yields on earning assets outweighed reduced funding costs. Average earning assets were broadly flat in Q2 versus the prior-year quarter; average loans and leases declined 2%.
- Credit quality remains a concern, particularly residential real estate. Nonperforming loans and leases rose 11% year over year to $266.7 million; residential real estate accounted for 66% and commercial real estate 23% of that total. Net charge-offs were $8.1 million in Q2 versus $3.2 million a year earlier.
- Other operating income for the first half included a $12.4 million write-off of fee receivables following correction of an accrual methodology used in prior years. The prior-year comparison also included a $15.1 million equipment and software write-off.
- Cash flows were affected by derivative collateral movements. The filing reports no significant change in measured interest-rate risk or FX trading VaR since December 31, 2012. It identifies economic and market volatility, interest rates, credit quality, client and market activity, regulation, operations, cybersecurity, and litigation as risks; it gives no specific earnings or revenue guidance.
- At June 30, gross exposure to Irish obligors was approximately $1.2 billion, about 1% of consolidated assets; the filing reports no exposure to Portugal, Italy, Greece, Spain or Cyprus obligors.
- Management estimated the upper end of reasonably possible losses for a limited set of legal matters at approximately $120.4 million in aggregate, subject to significant uncertainty. Some matters, including securities-lending litigation, could not be reasonably estimated. The securities class action was dismissed with prejudice in May 2013.
- Subsequent to quarter-end, Northern Trust and co-owners sold a Miami office building on July 15, 2013; the company expected to recognize an approximately $30 million pretax gain in Q3.
Important facts for investors to verify
- Whether fee and asset growth can offset continued pressure on FTE net interest margin and higher money-market fee waivers.
- Trends in residential and commercial real-estate nonperforming loans, charge-offs, allowance coverage and troubled-debt restructurings.
- The drivers and persistence of deposit outflows, increased short-term borrowing, and collateral-related operating cash outflows.
- Whether the estimated $120.4 million upper range of reasonably possible legal losses changes, and developments in securities-lending litigation and Visa-related obligations.
- The actual Q3 gain on the Miami property sale and execution of the share repurchase authorization.