NTRS

Business Context and Reporting Period

Company: Northern Trust Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: September 30, 2004
Business Overview: Northern Trust is a financial services corporation providing trust, asset management, and banking services. The reporting period covers the third quarter and the first nine months of 2004. Results exclude the operations of Northern Trust Retirement Consulting (NTRC), which were classified as discontinued operations following its sale in June 2003.

Key Financial Metrics

Note: Revenue figures for the nine-month period are derived from the sum of Noninterest Income and Net Interest Income (FTE) as presented in the MD&A.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues (FTE) increased 4% in Q3 and 8% for the nine-month period compared to the prior year. This was driven by an 8% increase in Trust Fees (Q3) and a 13% increase for the nine-month period, attributed to new business and improved equity markets.
• Expense Increase: Noninterest expenses rose 9% in Q3 and 2% for the nine-month period. The Q3 increase was significantly impacted by a $17.0 million pre-tax charge for a proposed litigation settlement. Excluding this charge, expense growth was moderate.
• Asset Quality Improvement: The provision for credit losses was $0 in Q3 2004 compared to $5.0 million in Q3 2003. For the nine months, the company recorded a negative provision of $5.0 million (a release) compared to a $17.5 million charge in 2003, reflecting improved credit quality.
• Assets Under Administration: Reached a record $2.40 trillion at September 30, 2004, a 25% increase from September 30, 2003. Assets under management totaled $534.6 billion.
• Net Interest Margin: The net interest margin (FTE) decreased slightly to 1.66% in Q3 from 1.67% in the prior year, primarily due to lower yields on residential mortgage loans and growth in lower-margin money market assets.

Guidance, Outlook, and Risks

Management Commentary: Management highlighted strong performance in trust fees and asset growth. The company noted that a 10% rise or fall in equity markets would impact trust fees by approximately 4% and total revenues by 2%. The company continues to execute a share buyback program, purchasing 891,251 shares in Q3.

Contingencies and Risks:

• Litigation Settlement: A proposed settlement regarding a class action against Northern Trust Bank of California N.A. resulted in a $17.0 million pre-tax charge in Q3. The settlement amount is approximately $21 million pending court approval.
• Enron-Related Litigation: The company is a defendant in Enron-related class action suits and lawsuits filed by Enron as debtor-in-possession. Management intends to defend these actions vigorously but notes the inherent difficulty in predicting outcomes.
• Market Risks: The company is exposed to interest rate risk, foreign currency exchange rate fluctuations, and changes in securities market values. Management utilizes simulation and value-at-risk models to monitor these exposures.
• Regulatory Capital: Risk-based capital ratios remained strong at 11.3% for Tier 1 and 13.8% for Total Capital, well above regulatory minimums.

Investor Verification Checklist

• Litigation Impact: Verify the final court approval status and exact payout of the $21 million California trust fee settlement.
• Asset Quality Trends: Monitor the stability of the $64.2 million nonperforming loan balance and the continued low level of net charge-offs ($1.3 million in Q3).
• Fee Revenue Sensitivity: Assess the correlation between equity market performance and the company's trust fee revenue, given the stated 4% sensitivity to a 10% market move.
• Expense Management: Track the trajectory of "Other Operating Expenses" to ensure the $17.0 million litigation charge was a one-time event and not indicative of rising operational costs.
• Capital Deployment: Review the progress of the share buyback program (7.5 million shares remaining authorized) and dividend sustainability.