Northern Trust Corporation — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; interim financial statements are unaudited. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services through Corporate & Institutional Services (C&IS) and Wealth Management (WM), supported by Asset Management and Operations and Technology.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | Approximately $1.05 billion | Approximately $973 million | Approximately $3.04 billion | Approximately $2.93 billion |
| Net income | $206.5 million | $178.8 million | $561.6 million | $519.6 million |
| Diluted EPS | $0.84 | $0.73 | $2.29 | $2.12 |
| Net interest income (GAAP) | $237.0 million | $245.6 million | $683.2 million | $756.1 million |
| Noninterest income | $810.2 million | $726.9 million | $2.36 billion | $2.17 billion |
| Noninterest expense | $740.7 million | $696.4 million | $2.20 billion | $2.14 billion |
| Provision for credit losses | $5.0 million | $10.0 million | $15.0 million | $20.0 million |
Amounts are in U.S. dollars. Revenue figures are rounded as presented in management’s discussion; segment reporting uses fully taxable equivalent (FTE) net interest income and therefore differs from GAAP presentation.
- Profitability: Q3 return on average common equity was 10.6% versus 9.6%; return on average assets was 0.9% versus 0.8%. Nine-month figures were 9.8% versus 9.5% and 0.8% versus 0.7%, respectively.
- Net interest margin: FTE margin was 1.14% in Q3, down from 1.21%; nine-month FTE margin was 1.13%, down from 1.24%. Management attributed pressure mainly to lower asset yields in a low-rate environment.
- Client assets: Period-end assets under custody were $5.237 trillion, up 10% year over year; assets under management were $846.2 billion, up 13%.
- Balance sheet at September 30: Assets were $96.0 billion, deposits $78.2 billion, loans and leases $29.1 billion, and stockholders’ equity $7.8 billion. Compared with December 31, 2012, assets declined 2%, deposits declined 4%, and equity increased 4%.
- Capital: Corporation Tier 1 risk-based, total risk-based, and leverage ratios were 13.6%, 14.9%, and 8.3%, respectively. Management said the Corporation and Bank exceeded “well capitalized” minimums.
- Cash flow, nine months: Operating activities provided $960.9 million; investing activities provided $510.0 million; financing activities used $2.426 billion. Financing outflows primarily reflected lower deposits, partly offset by more short-term borrowings.
- Shareholder returns: Dividends declared were $0.31 per share for Q3. The company repurchased 1.72 million shares for $97.3 million in the quarter and 3.40 million shares for $187.1 million year to date.
Material changes versus comparable periods
- Q3 net income rose 15% and diluted EPS rose 15%; nine-month net income rose 8% and diluted EPS rose 8%.
- Q3 noninterest income increased 11%, led by servicing fees, foreign exchange trading income and other operating income. Foreign exchange trading income rose 43% for the quarter, reflecting higher currency-market volatility and trading volumes.
- Q3 net interest income fell 4%, while noninterest expense rose 6%. Higher outside services, equipment and software, and compensation costs contributed to the expense increase.
- Reported Q3 earnings included a $32.6 million pretax gain on the sale of an office building ($20.3 million after tax, or $0.08 per diluted share). Excluding it, management reported net income of $186.2 million, diluted EPS of $0.76 and return on average common equity of 9.6%.
- Nine-month results included the same building-sale gain. The prior-year nine-month period included $10.4 million of pretax restructuring, acquisition and integration charges.
- For the nine months, FTE net interest income declined 10%, reflecting lower margins and slightly lower average earning assets. WM’s Q3 FTE net interest income fell 13%; its margin declined to 2.40% from 2.71%.
- Deposits at period end decreased from year-end 2012, particularly U.S. demand deposits; management cited expiration of the FDIC Temporary Liquidity Guarantee Program as a contributing factor. Short-term other borrowings increased.
Outlook, risks and unusual items
- The filing provides no specific numerical earnings or revenue guidance. Management identifies ongoing technology investment, regulatory and compliance demands, expense management, client growth and interest-rate conditions as relevant business factors.
- Management said interest-rate exposure in a rising-rate scenario had increased, citing a higher-rate environment, projected sensitivity of non-U.S. deposit rates and longer securities portfolio duration. Foreign-exchange trading portfolio value-at-risk had not changed significantly since December 31, 2012.
- Credit quality remained mixed: nonperforming assets were $284.0 million, compared with $289.6 million a year earlier; nonperforming residential real estate loans remained a key concern. Residential real estate represented 70% of nonperforming loans and leases. The allowance for credit losses was $317.5 million, and its coverage of nonperforming loans and leases was 1.1 times.
- The investment portfolio had $55.9 million of net unrealized gains at September 30, 2013, with gross unrealized gains of $171.4 million and losses of $115.5 million. No other-than-temporary impairment losses were recognized in the 2013 quarter or nine-month period.
- Gross exposure to Irish obligors was approximately $1 billion, or 1% of consolidated assets; there was no exposure to obligors or sovereign debt in Portugal, Italy, Greece, Spain or Cyprus at quarter-end.
- Management estimated the upper end of reasonably possible losses for a limited set of legal matters at approximately $117 million in aggregate. It said some pending matters, including securities-lending class actions, could not be reasonably estimated; no material litigation or regulatory accruals were recorded.
- Other unusual item: the nine-month period included a $12.4 million write-off of certain fee receivables after correction of a prior-years accrual methodology.
Investor facts to verify
- Reconcile reported earnings with the building-sale gain and assess whether underlying fee and expense trends support continued earnings growth.
- Track net interest margin, asset yields, deposit mix and funding costs as rates and client balances change.
- Review residential real estate delinquencies, nonperforming loans, TDRs and allowance adequacy, especially given the concentration of nonperformers in residential real estate.
- Assess the sustainability of custody and management fee growth, including market-driven asset values and money-market mutual-fund fee waivers.
- Monitor deposit outflows, short-term borrowing levels, capital ratios, liquidity disclosures and the pace of share repurchases and dividends.
- Follow legal and regulatory developments, particularly securities-lending litigation and the estimated $117 million upper range of reasonably possible losses; the filing cautions that actual outcomes may differ materially.