NTRS

Business Context and Reporting Period

Company: Northern Trust Corporation
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2005
Business Overview: Northern Trust is a financial services corporation providing trust, investment, and other servicing fees, foreign exchange trading, and treasury management. A significant event during the period was the acquisition of Baring Asset Management's Financial Services Group (FSG) on March 31, 2005, for approximately $475 million, expanding global fund administration and custody capabilities.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net income increased 15% year-over-year for the quarter, driven by a 17% increase in total revenues (FTE). Noninterest income rose 16%, primarily due to record trust and servicing fees ($402.1 million) and a 23% increase in net interest income.
• Acquisition Impact: The FSG acquisition contributed $36.3 million to revenues and $36.1 million to expenses in the second quarter. Adjusting for FSG, organic revenue growth was 11% and expense growth was 7%.
• Asset Growth: Total assets increased to $46.3 billion. Loans and leases grew to $20.0 billion, and assets under custody reached $2.7 trillion (up 22% from the prior year).
• Expense Management: Noninterest expenses increased 17% to $441.6 million. Compensation and employee benefits rose 17%, reflecting annual salary increases, higher performance-based compensation, and the addition of 800 FSG staff.
• Asset Quality: Nonperforming assets decreased significantly to $30.1 million from $67.9 million in the prior year. There was no provision for credit losses in the current quarter or the prior year quarter.

Guidance, Outlook, and Risks

• Acquisition Outlook: Management expects the FSG acquisition, including integration and transitional costs, to reduce earnings per share by approximately $0.04 to $0.06 in 2005.
• 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.
• Capital Position: Risk-based capital ratios remain strong, with Tier 1 capital at 9.8% and Total Capital at 12.7%, well above regulatory minimums.
• Share Repurchases: The company purchased 910,871 shares in the quarter for $41.5 million. Approximately 5.0 million shares remain authorized under the current buyback program.
• Legal and Regulatory Risks:
  • Enron Litigation: The company is a defendant in Enron-related class action suits and bankruptcy proceedings seeking recovery of commercial paper payments. Management intends to defend vigorously.
  • Tax Disputes: The IRS has challenged tax positions on 13 structured leasing transactions. Management believes its treatment is appropriate and has adequate reserves.
  • Market Risks: Exposure to interest rate risk, foreign currency fluctuations, and volatility in securities markets.

Investor Verification Checklist

• FSG Integration: Verify the timeline and cost of integrating FSG operations against the projected $0.04-$0.06 EPS dilution for 2005.
• Asset Quality Trends: Monitor the stability of the low nonperforming asset ratio (0.16% of domestic loans) and the adequacy of the $138.9 million credit loss reserve.
• Fee Revenue Sensitivity: Assess the impact of equity market fluctuations on trust and servicing fees, which management estimates at a 4% fee change for every 10% market move.
• Legal Exposure: Track developments in the Enron-related litigation and the IRS audit of structured leasing transactions for potential reserve adjustments.
• Capital Ratios: Confirm that capital ratios remain above regulatory thresholds following the FSG acquisition and ongoing share buybacks.