NTRS

Business Context and Reporting Period

Company: Northern Trust Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2005
Business Overview: Northern Trust is a financial services firm specializing in trust, investment, and other servicing fees, as well as banking and asset management. The quarter concluded with the acquisition of Baring Asset Management's Financial Services Group (FSG) on March 31, 2005, expanding global fund administration and custody capabilities.

Key Financial Metrics

Key Ratios:
- Return on Average Common Equity (ROE): 17.06% (vs. 16.74% in Q1 2004)
- Return on Average Assets (ROA): 1.29% (vs. 1.30% in Q1 2004)
- Net Interest Margin (FTE): 1.79% (vs. 1.73% in Q1 2004)
- Tier 1 Capital Ratio: 9.6% (vs. 11.0% at Dec 31, 2004)

Material Changes vs. Prior Period

• Profitability: Net income increased 9% to a record $139.1 million, driven by a 13% increase in net interest income and a 9% rise in trust and servicing fees.
• Revenue Growth: Total revenues (FTE) rose 7% to $621.1 million. Trust, investment, and other servicing fees reached a record $357.2 million, accounting for 58% of total revenue.
• Expense Management: Noninterest expenses increased 5% to $395.0 million, primarily due to higher compensation and employee benefits, including the integration of 785 new staff from the FSG acquisition.
• Asset Quality: Nonperforming assets decreased significantly to $34.1 million (from $72.1 million in Q1 2004). The provision for credit losses was $0, compared to a negative provision of $5.0 million in the prior year.
• Balance Sheet Expansion: Total assets grew 19% year-over-year to $47.8 billion, fueled by a 23% increase in average earning assets and a 17% increase in interest-related deposits.

Guidance, Outlook, and Risks

Acquisition Impact: The acquisition of FSG (approx. $500 million cost) is expected to reduce earnings per share by approximately $0.04 to $0.06 in 2005 due to integration costs and amortization of intangible assets. No FSG operating results are included in the current quarter.

Accounting Changes: The company anticipates adopting SFAS No. 123(R) regarding share-based payment effective January 1, 2006. This is expected to increase pre-tax compensation expense by approximately $5 million in 2006, reducing EPS by roughly $0.02.

Risks and Contingencies:

• Legal Proceedings: The company is defending against Enron-related class action suits and a settled California trust fee class action ($21 million paid in Q3 2004). Management does not believe pending litigation will have a material adverse effect on financial position.
• Tax Matters: The IRS has challenged the tax position on $425 million of structured leasing transactions.
• Market Risks: Exposure to interest rate fluctuations and foreign currency exchange rates, though hedging strategies are in place. A 10% change in equity markets is estimated to impact trust fees by approximately 4%.

Investor Verification Checklist

• FSG Integration: Verify the timeline and cost of integrating the Financial Services Group and the realization of projected revenue synergies.
• Stock-Based Compensation: Monitor the impact of the SFAS No. 123(R) adoption in 2006 on future earnings and EPS.
• Asset Quality Trends: Confirm the stability of the low nonperforming asset ratio ($34.1 million) and the adequacy of the $139.7 million credit loss reserve.
• Capital Ratios: Review the impact of the FSG acquisition and new debt issuance on Tier 1 and Total Capital ratios relative to regulatory minimums.
• Legal Exposure: Track developments in the Enron-related litigation and the IRS challenge regarding structured leases.