Business Context and Reporting Period
Company: Northern Trust Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2006
Business Overview: Northern Trust is a financial services firm specializing in asset servicing, asset management, and personal financial services. The company operates primarily through Corporate and Institutional Services (C&IS) and Personal Financial Services (PFS) segments.
Key Financial Metrics
| Metric ($ in Millions) | Q3 2006 | Q3 2005 | 9M 2006 | 9M 2005 |
|---|---|---|---|---|
| Net Income | $163.7 | $147.7 | $494.6 | $436.8 |
| Diluted EPS | $0.74 | $0.67 | $2.23 | $1.97 |
| Total Revenue (FTE) | $749.6 | $685.2 | $2,284.7 | $1,993.7 |
| Noninterest Income | $551.1 | $501.7 | $1,696.8 | $1,458.7 |
| Net Interest Income (FTE) | $198.5 | $183.5 | $588.1 | $535.0 |
| Noninterest Expenses | $477.0 | $441.6 | $1,442.3 | $1,278.2 |
| Provision for Credit Losses | $6.0 | $2.5 | $13.0 | $2.5 |
| Total Assets | $55,200.9 | $48,427.4 | - | - |
| Stockholders' Equity | $3,936.0 | $3,529.0 | - | - |
| Return on Average Equity (ROE) | 16.96% | 16.83% | 17.73% | 17.24% |
| Return on Average Assets (ROA) | 1.23% | 1.27% | 1.28% | 1.28% |
Material Changes vs. Prior Period
- Revenue Growth: Net income increased 11% in Q3 2006 compared to Q3 2005. Total revenues (FTE) rose 9% in the quarter and 15% year-to-date, driven by a 10% increase in trust, investment, and servicing fees and a 14% increase in foreign exchange trading income.
- Asset Expansion: Total assets grew to $55.2 billion, a 10% increase from the prior year. Assets under custody reached $3.31 trillion (up 16% YoY), and assets under management totaled $667.2 billion (up 10% YoY).
- Expense Increases: Noninterest expenses rose 8% in the quarter, primarily due to higher compensation costs (driven by staff increases and annual raises) and the adoption of SFAS No. 123(R) for stock-based compensation, which added $2.4 million in expense for the quarter.
- Net Interest Margin: The net interest margin (FTE) declined slightly to 1.73% from 1.81% in the prior year quarter, impacted by growth in lower-margin short-term assets and rising deposit rates.
- Credit Quality: The provision for credit losses increased to $6.0 million from $2.5 million, reflecting growth in the commercial loan portfolio and migration of certain loans to higher risk ratings. Nonperforming assets remained stable at $32.5 million.
Guidance, Outlook, Risks, and Unusual Items
- Accounting Changes: The company adopted SFAS No. 123(R) on January 1, 2006, requiring fair-value accounting for stock-based compensation. This increased pre-tax compensation expense by $15.3 million for the nine months ended September 30, 2006. Future adoption of SFAS No. 158 (pension accounting) is expected to reduce stockholders' equity by approximately $150 million to $160 million in 2006.
- Legal Proceedings: The company settled the Enron-related class action lawsuit (Tittle v. Enron Corp.) for $37.5 million, fully covered by insurance. The company continues to defend against Enron bankruptcy estate lawsuits regarding commercial paper buybacks and an IRS investigation into structured leasing transactions.
- Capital Management: The Board increased the common stock buy-back authorization to allow for the purchase of up to 12 million shares. During Q3, the company repurchased 446,149 shares at an average price of $56.76.
- Risk Factors: Key risks include the health of the U.S. and international economies, changes in securities markets, foreign currency exchange rate fluctuations, and regulatory developments. Management notes that a 10% change in equity markets would impact trust fees by approximately 4%.
Investor Verification Checklist
- Fee Revenue Sensitivity: Verify the correlation between equity market performance and the company's primary revenue stream (trust and servicing fees), which represents 58% of total revenue.
- Stock-Based Compensation Impact: Monitor the ongoing impact of SFAS No. 123(R) on compensation expenses and diluted EPS, estimated at an $18 million increase for the full year 2006.
- Credit Provision Trends: Review the migration of commercial loans to higher risk ratings and the adequacy of the reserve for credit losses ($149.4 million) relative to the growing loan portfolio.
- Regulatory Capital Ratios: Confirm that Tier 1 and Total Capital ratios remain well above regulatory minimums (Tier 1: 10.2%; Total: 12.5% as of Sept 30, 2006).
- Legal Contingencies: Track the status of the IRS investigation into structured leasing transactions and the Enron bankruptcy estate litigation, which could result in future adjustments to tax liabilities or legal settlements.