Northern Trust Corporation — Q2 2011 Form 10-Q
Business context and reporting period. The unaudited filing covers the quarter and six months ended June 30, 2011, with comparisons to the corresponding 2010 periods. Northern Trust provides custody, asset servicing, investment management, banking and wealth-management services. Amounts below are in millions of dollars unless otherwise noted.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Change |
|---|---|---|---|
| Revenue, GAAP basis | $944.8 | $964.2 | Down 2% |
| Net interest income | $246.1 | $232.8 | Up 6% |
| Noninterest income | $698.7 | $731.4 | Down 4% |
| Provision for credit losses | $10.0 | $50.0 | Lower by $40.0 |
| Noninterest expense | $705.3 | $614.4 | Up 15% |
| Net income | $152.0 | $199.6 | Down 24% |
| Diluted EPS | $0.62 | $0.82 | Down $0.20 |
| FTE net interest margin | 1.23% | 1.47% | Down 24 basis points |
| Annualized ROE / ROA | 8.76% / 0.66% | 12.23% / 1.08% | Lower |
For the six months, revenue was $1.84 billion versus $1.86 billion; net income was $303.0 million versus $356.8 million; diluted EPS was $1.24 versus $1.46. FTE net interest income rose 4% to $501.5 million, while the FTE margin declined to 1.27% from 1.46%.
- Balance sheet and liquidity: At June 30, total assets were $97.4 billion, up from $83.8 billion at December 31, 2010. Deposits were $77.5 billion, compared with $64.2 billion; cash and due from banks were $5.1 billion. Management attributed much of balance-sheet expansion to higher client deposits and funds placed in lower-yielding short-term assets.
- Loans and credit: Loans and leases totaled $28.6 billion, up from $28.1 billion at year-end; the allowance assigned to loans and leases was $311.3 million. Nonperforming loans and leases were $328.0 million, or 1.15% of loans, and nonperforming assets totaled $359.1 million.
- Debt and capital: Reported senior notes were $1.9 billion, long-term debt $2.4 billion and other borrowings $2.3 billion. Total liabilities were $90.4 billion and stockholders’ equity $7.0 billion. The Corporation reported Tier 1 capital of 12.8%, total capital of 14.5%, leverage of 7.7% and Tier 1 common equity of 12.3%.
- Cash flow: For the first six months, operating activities provided $563.2 million, investing activities used $11.1 billion and financing activities provided $12.7 billion. Cash and due from banks increased $2.3 billion to $5.1 billion. The investing and financing movements principally reflect securities activity and deposit growth.
Material changes versus comparable periods
- Lower foreign-exchange trading income was a major revenue headwind: Q2 fell 30% to $80.8 million, which management attributed to reduced market volatility. Trust, investment and servicing fees rose 3% to $557.8 million.
- Q2 net interest income increased with higher average earning assets, but the FTE margin contracted amid low rates, weaker loan demand and increased funding from interest-bearing deposits. Average earning assets rose 27% year over year to $83.7 billion.
- Expenses increased, including compensation, outside services, and equipment and software. Q2 included $22.6 million of restructuring, acquisition and integration costs, including $18.4 million of severance charges. Excluding these charges and the prior-year Visa benefit, expenses rose 9%.
- Credit costs improved: Q2 provision was $10.0 million versus $50.0 million, and net charge-offs were $15.0 million versus $38.3 million. Management cited improvement in commercial and institutional lending, partially offset by continued weakness in commercial real estate and residential real estate.
- Investment-security losses were $16.6 million in Q2, including $16.9 million of credit-related impairment on residential mortgage-backed securities. Six-month security losses were $22.1 million.
- Assets under custody reached $4.42 trillion, up 24% year over year; assets under management were $684.1 billion, up 13%. Reported custody and management assets exclude the recently acquired Bank of Ireland Securities Services business.
Outlook, management commentary and risks
- The filing gives no specific earnings or revenue guidance. Management describes margin pressure from low interest rates, lower-yielding balance-sheet growth and a greater proportion of interest-bearing funding; it also notes money-market fee waivers related to persistently low short-term rates.
- Northern Trust completed its acquisition of Bank of Ireland Securities Services on June 1 for $84.4 million, including $13.4 million of contingent consideration. On July 29, after quarter-end, it completed its acquisition of Omnium LLC, a hedge-fund administrator.
- Management said interest-rate risk exposure to rising rates increased, reflecting a moderate extension in securities-portfolio duration and projected higher sensitivity of non-U.S. deposit rates. Foreign-exchange trading portfolio VaR had not changed significantly since year-end.
- Investment risks include mortgage-backed securities: 80% of the fair value of non-agency residential mortgage-backed securities was rated below double-A, and related unrealized losses were $31.4 million. Total securities unrealized losses were $63.2 million, down from $99.5 million at year-end.
- Contingencies include securities-lending litigation and an SEC investigation, an ERISA plan lawsuit, securities class and derivative actions, and unresolved IRS disputes over structured leasing transactions. Management reported an estimated upper end of approximately $29 million for reasonably possible losses in matters where it could estimate a range; other matters could not be reasonably estimated. It said pending matters could materially affect results in a particular period, though it did not expect a material adverse effect on consolidated financial position or liquidity.
- Standby letters of credit outstanding were $4.4 billion. Securities loaned subject to indemnification were $82.8 billion; management reported no related liability, citing collateralization and borrower credit quality. The net Visa indemnification liability was $13.0 million.
Key facts investors should verify
- Whether custody and servicing fee growth, including acquisition contributions, can offset continued foreign-exchange and securities-lending revenue weakness.
- Whether the net interest margin stabilizes as asset growth, deposit mix and interest rates evolve.
- Whether higher operating expenses and acquisition integration costs moderate, and how the acquisitions affect earnings and fee growth.
- Whether commercial real estate and residential mortgage credit quality, nonperforming assets and mortgage-security impairments improve or deteriorate.
- How the securities-lending, securities class-action and tax disputes develop, including any changes to estimated exposure.
- Capital and liquidity trends, including the effect of deposit flows, short-term funding, share repurchases and regulatory changes.