Northern Trust Corporation — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Unaudited consolidated results. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services through Corporate & Institutional Services (C&IS) and Wealth Management; Treasury and Other includes corporate funding, investment and unallocated items.
Financial performance and position
| Metric | Q2 2016 | Comparable period / change |
|---|---|---|
| Revenue (GAAP) | $1.317 billion | $1.256 billion; up 5% |
| Net interest income | $299.7 million | $251.2 million; up 19% |
| Net interest margin | 1.13% GAAP; 1.16% FTE | 0.97% GAAP; 1.00% FTE |
| Noninterest income | $1.017 billion | $1.005 billion; up 1% |
| Provision for credit losses | $3.0 million credit | $10.0 million credit |
| Noninterest expense | $925.0 million | $854.5 million; up 8% |
| Net income | $260.7 million | $269.2 million; down 3% |
| Diluted EPS | $1.09 | $1.10; down 1% |
| Return on average common equity / assets | 12.20% / 0.91% | 12.85% / 0.97% |
For the six months, revenue was $2.507 billion, up 5%; net income was $502.5 million, up 1%; and diluted EPS was $2.10, up 3%. Net interest income increased 19% to $607.5 million, while noninterest expense rose 7% to $1.754 billion. Six-month return on average common equity was 11.82%, versus 12.08%.
- Balance sheet at June 30: Assets were $121.5 billion, up 4% from year-end 2015; deposits were $99.1 billion, up 2%; loans and leases were $34.6 billion; and stockholders’ equity was $9.0 billion, up 3%.
- Funding and debt: Other borrowings were $6.0 billion, compared with $4.1 billion at year-end; senior notes were $1.5 billion, long-term debt $1.4 billion and floating-rate capital debt $277 million. These are selected reported balances, not a filing-stated total debt figure.
- Cash flows, first half: Operating activities used $513.1 million, investing activities used $4.930 billion, and financing activities provided $4.129 billion. Operating outflow primarily reflected increased net collateral deposited with counterparties; investing outflow chiefly reflected net securities purchases and loan growth. Cash and due from banks ended at $5.312 billion.
- Capital: Corporation CET1 ratios were 11.5% under the Advanced Approach and 10.6% under the Standardized Approach; management reported that applicable well-capitalized regulatory thresholds were exceeded.
- Client assets: Assets under custody/administration were $8.116 trillion, up 4% from December 2015; assets under management were $906.2 billion, down 4% year over year.
Material changes and segment results
- Higher net interest income reflected earning-asset growth and a higher margin. Average earning assets rose 3% year over year in Q2; FTE margin improved to 1.16% from 1.00%.
- Trust, investment and other servicing fees increased 3% in Q2. Foreign-exchange trading income fell 14%, generally reflecting lower client volumes.
- Expense growth reflected compensation, outside services and other operating costs. Excluding specified current- and prior-year items, Q2 expense increased 4%, primarily due to compensation and outside services.
- C&IS: Q2 net income fell 17% to $86.2 million, as higher net interest income and servicing fees were outweighed by higher expenses and lower foreign-exchange and other noninterest income.
- Wealth Management: Q2 net income rose 3% to $118.8 million, supported by higher net interest income and servicing fees.
- Treasury and Other: Q2 net income rose to $55.7 million from $49.7 million, including corporate and nonrecurring items.
- AUC growth year over year reflected new business and favorable fixed-income markets, partly offset by foreign-currency movements. AUM declined primarily because of sovereign wealth fund outflows, unfavorable equity markets and the loss of a passive institutional mandate.
Unusual items, outlook and risks
- Q2 included a $118.2 million Visa Class B share-sale gain net of valuation adjustment; a $46.5 million securities-lending litigation settlement charge, subject to court approval; $18.6 million of C&IS client contractual-modification charges; $17.5 million of severance and related charges; $14.1 million of charges tied to exiting part of a non-strategic loan and lease portfolio; and $7.5 million of aircraft and rail-car residual-value impairments. Management’s adjusted Q2 diluted EPS, net income and return on average common equity were $1.06, $252.7 million and 11.7%, respectively.
- The comparable 2015 quarter included a $99.9 million Visa gain, a $45.8 million contribution to certain constant-dollar NAV funds and $17.8 million of aircraft residual-value impairment. Adjusted Q2 2015 diluted EPS was $1.01.
- Management provided no specific earnings or revenue guidance in the supplied filing text. It described risks including market and interest-rate changes, equity-market effects on fee revenue, foreign-exchange activity, Brexit-related uncertainty, credit quality, litigation and regulatory matters, cybersecurity and operational risks, and the ability to control expenses and retain clients.
- Nonperforming assets were $166.4 million, down 24% year over year; residential real estate represented 65% of nonperforming loans and leases. The allowance for credit losses was $227.1 million, including $192.0 million assigned to loans and leases.
- Pending litigation and regulatory matters included securities-lending claims and an SEC investigation; the securities-lending settlement was not final. The filing estimated the upper end of reasonably possible losses for certain matters at approximately $90 million in aggregate, while noting other matters could not be reasonably estimated. A French criminal proceeding involving a subsidiary was scheduled for trial in September 2016.
- Visa-related uncertainty remained: the Second Circuit reversed approval of the covered-litigation settlement on June 30, 2016 and remanded the case. The ultimate resolution and timing for lifting restrictions on remaining Visa Class B shares were uncertain.
- Interest-rate simulations estimated next-12-month pretax earnings increases of $32 million for a 100-basis-point rise and $18 million for a 200-basis-point rise versus forward rates. Estimated economic-value-of-equity impacts were +$106 million and -$115 million, respectively. The filing cautions these models are assumption-dependent and not forecasts.
Key facts for investors to verify
- Whether the securities-lending settlement receives court approval and how the remaining litigation and SEC investigation develop.
- How much reported earnings growth depends on the Visa gain and other unusual items, versus recurring fee and net interest income.
- Whether rising compensation and technology/consulting costs can be contained as the business grows.
- Trends in AUM, client flows and market-sensitive servicing fees, including the effects of market performance and currency movements.
- Credit quality in residential real estate and the adequacy of the allowance; also track the planned exit from the non-strategic loan and lease portfolio.
- Funding and collateral movements, including higher other borrowings and operating cash outflows related to derivatives collateral.
- Capital levels, share repurchases and the impact of future regulatory requirements and accounting-standard adoption.