Northern Trust Corporation — Q3 2012 Form 10-Q
Business context and reporting period
Quarter ended September 30, 2012; comparisons are primarily with Q3 2011, and year-to-date figures cover the nine months ended September 30. Northern Trust provides custody, asset servicing, asset management, fiduciary and banking services through Personal Financial Services (PFS) and Corporate & Institutional Services (C&IS), supported by Treasury and Operations & Technology. Interim financial statements are unaudited.
Key financial metrics
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Revenue, GAAP | $972.5 million | $971.5 million | Approximately $2.93 billion | Approximately $2.81 billion |
| Net income | $178.8 million | $170.4 million | $519.6 million | $473.4 million |
| Diluted EPS | $0.73 | $0.70 | $2.12 | $1.93 |
| Net interest income, GAAP | $245.6 million | $256.8 million | $756.1 million | $737.3 million |
| Net interest margin, FTE | 1.21% | 1.25% | 1.24% | 1.26% |
| Provision for credit losses | $10.0 million | $17.5 million | $20.0 million | $42.5 million |
| Noninterest expense | $696.4 million | $701.2 million | $2.14 billion | $2.06 billion |
Q3 annualized return on average common equity was 9.6% (9.5% prior year); return on average assets was 0.8% (0.7%). Nine-month effective tax rate was 32.4%, versus 33.5%.
At September 30, assets were $93.6 billion, deposits $76.9 billion, loans and leases $29.5 billion, and stockholders’ equity $7.5 billion. Assets and deposits were each down 7% from December 31, 2011; equity was up 6%. Cash and due from banks was $3.4 billion, with $19.3 billion in interest-bearing deposits at banks. Regulatory capital ratios were strong: Tier 1 capital 12.8%, total capital 14.3%, and leverage 8.1%; the Corporation and its bank subsidiary exceeded well-capitalized thresholds.
Nine-month cash flow from operating activities was $791.2 million, compared with cash used of $137.0 million in 2011. Investing activities provided $5.33 billion and financing activities used $7.05 billion. Ending cash and due from banks was $3.40 billion. Northern Trust issued $500 million of 2.375% senior notes due 2022 in August.
Material changes versus prior periods
- Q3 revenue was nearly flat, while net income rose 5%. Higher servicing fees were substantially offset by foreign-exchange trading income falling 49% and net interest income falling 4%.
- For the first nine months, revenue increased 4% and net income 10%. Trust, investment and servicing fees grew 10%; foreign-exchange trading income fell 35% amid reduced currency volatility and client volumes.
- Period-end assets under custody increased 12% year over year to $4.76 trillion and assets under management increased 13% to $749.7 billion.
- Q3 noninterest expense declined 1%; nine-month expense increased 4%, reflecting technology spending, software write-offs and the full-period costs of 2011 acquisitions. Equipment and software expense rose 19% year to date.
- Credit costs improved year over year: nine-month provision fell to $20.0 million from $42.5 million, and net charge-offs declined to $20.9 million from $65.2 million. However, Q3 nonperforming loans rose from $239.8 million at June 30 to $269.0 million, mainly from additions in commercial and residential real estate.
- Q3 PFS net income increased 42% to $96.0 million; C&IS net income declined 18% to $68.3 million. The filing attributes the C&IS decline chiefly to lower foreign-exchange revenue and higher allocated expenses.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or revenue guidance. Management discusses continuing sensitivity to low interest rates, market levels and volatility, client activity, fee waivers, and expense and technology investment.
- Management estimates that a 10% rise or fall in overall equity markets would change trust, investment and servicing fees by approximately 3% and total revenue by approximately 2%.
- Q3 included a $5.3 million gain on foreign-exchange contracts hedging certain foreign-currency investments. The quarter also included a $5.1 million adjustment from amortization of premiums on certain investment securities; without it, Q3 FTE net interest margin would have been 1.19% rather than 1.21%.
- Nine-month results included $10.4 million of restructuring, acquisition and integration charges; the comparable 2011 period included $30.6 million of such charges and a $10.1 million Visa indemnification benefit. Current-year equipment and software expense included $15.1 million of software write-offs.
- Management identifies economic and market uncertainty, especially in Europe, counterparty and credit risk, securities valuation and impairment, interest-rate and liquidity risk, foreign-exchange activity, operational and technology risks, regulation, and acquisition integration as factors that could affect future results. It reported no material changes to the risk factors in the 2011 Form 10-K.
- Gross exposure to Irish obligors was approximately $474 million, less than 1% of consolidated assets; there was no exposure to Portugal, Italy, Greece or Spain and no sovereign debt exposure to those countries. The securities portfolio had $31.8 million of gross unrealized losses, including $13.3 million on non-agency residential mortgage-backed securities.
- Legal proceedings include securities-lending-related claims and securities class and derivative actions. Management said it could not assess the probability or estimate potential losses for certain matters; for a limited group of matters it could estimate, the aggregate upper end of reasonably possible losses was approximately $40 million. No material litigation or regulatory accruals had been recorded.
- Visa announced a settlement agreement on October 19, 2012, after quarter-end. Northern Trust said it expected the value of its remaining Visa shares to be adequate to offset any remaining indemnification obligations, while noting resolution and timing remained uncertain.
- During the first nine months, the company repurchased approximately 2.20 million shares for $100 million. Its capital plan permitted up to $140 million of additional repurchases after September 30 through March 2013.
Important facts for investors to verify
- Whether servicing-fee and client-asset growth can continue to offset weaker foreign-exchange revenue and pressure on net interest margin.
- Whether recent increases in quarterly nonperforming loans, particularly in commercial and residential real estate, require higher provisions or allowance coverage.
- The sustainability and cash cost of technology investment, software write-offs, acquisition-related expense and planned share repurchases.
- Developments in securities-lending litigation, other legal matters, and the Visa settlement and any resulting indemnification exposure.
- Liquidity and valuation risks in investment securities, including non-agency mortgage-backed and auction-rate securities, and the effects of market and regulatory changes.