Northern Trust Corporation — Q3 2018 Form 10-Q
Business context and period: Unaudited results for the quarter and nine months ended September 30, 2018. Northern Trust provides wealth management, asset servicing, asset management and banking services through Corporate & Institutional Services (C&IS) and Wealth Management; Treasury and Other captures corporate and funding items.
Financial performance
| Metric | Q3 2018 | Year-over-year change |
|---|---|---|
| Revenue (GAAP) | $1.474 billion | Up 10% |
| Net interest income | $408.2 million | Up 15% |
| Net income | $374.5 million | Up 26% |
| Diluted earnings per share | $1.58 | Up 32% |
| Net interest margin (FTE) | 1.47% | Up from 1.29% |
| Return on average common equity | 15.1% | Up from 12.2% |
| Return on average assets | 1.22% | Up from 0.98% |
Revenue growth reflected higher servicing fees and foreign exchange income, along with stronger net interest income. Noninterest expense rose 7% to $1.002 billion, driven mainly by compensation, benefits, outside services and technology costs. The credit-loss provision was a $9.0 million credit, versus a $7.0 million credit a year earlier. The effective tax rate declined to 22.1% from 28.4%.
For the first nine months, revenue was $4.456 billion, up 13%; net income was $1.147 billion, up 36%; and diluted EPS was $4.84, up 42%. FTE net interest margin was 1.44%, versus 1.31%.
Balance sheet, funding and capital
- At September 30, total assets were $132.4 billion, down 4% from year-end 2017; deposits were $104.9 billion, down 7%; and stockholders’ equity was $10.4 billion, up 1%.
- Loans and leases were $31.4 billion, down from $32.6 billion at year-end. Debt securities totaled $50.6 billion, up from $46.8 billion.
- Period-end cash and due from banks was $5.1 billion. Federal Reserve and other central bank deposits were $32.8 billion, compared with $40.5 billion at year-end.
- Borrowings included $7.7 billion of other borrowings, $2.0 billion of senior notes, $1.1 billion of long-term debt and $0.3 billion of floating-rate capital debt. The company issued $500 million of 3.65% senior notes due 2028 in August.
- Regulatory capital remained above well-capitalized minimums: Corporation CET1 was 13.4% (advanced approach) and 12.9% (standardized approach); total capital was 16.7% and 16.2%, respectively.
- Assets under custody/administration were $10.83 trillion, up 12% year over year; assets under management were $1.17 trillion, up 4%. AUC/A growth reflected markets and net inflows; AUM growth reflected favorable markets, partly offset by net outflows and foreign exchange effects.
Cash flow and capital returns
For the nine months, operating cash flow was $1.31 billion, investing cash flow was positive $5.35 billion, and financing cash flow was negative $5.90 billion. Investing inflows mainly reflected reductions in central-bank and bank deposits; financing outflows reflected lower deposits, repurchases and other funding changes.
The company repurchased $689.7 million of common stock and declared $315.6 million of common dividends during the nine-month period. The quarterly common dividend declared was $0.55 per share, up from $0.42.
Material changes, commentary and risks
- Servicing fees increased 8% in the quarter, supported by favorable markets, new business and the UBS Asset Management fund-administration acquisition. Foreign exchange trading income rose 46%, partly due to higher swap activity and client volumes.
- Expense growth included UBS-related costs and higher software amortization and disposition charges. Adoption of the new revenue-recognition standard changed gross-versus-net presentation for some items; management noted a corresponding increase in servicing fees and outside-services expense.
- Other operating income fell 48% to $20.9 million. Items included an $8.1 million impairment of a community-development equity investment and expenses related to Visa Class B share swaps.
- Tax expense benefited from the lower U.S. corporate tax rate under the Tax Cuts and Jobs Act; the company recorded a $5.5 million quarterly deferred-tax adjustment and a $22.6 million nine-month benefit from a change in software-development tax accounting. Management said the initial TCJA estimate may be refined.
- Net unrealized investment-security losses increased to $356.2 million from $160.8 million at year-end, primarily reflecting market-rate movements and, for some securities, wider credit spreads. Management said it did not intend to sell securities in unrealized-loss positions and did not expect to be required to sell them before recovery or maturity.
- Nonperforming assets were $124.9 million, down 14% year over year, but residential real estate represented 86% of nonperforming loans and leases. The allowance for credit losses was $140.5 million; 90-day-past-due loans still accruing rose to $27.5 million from $8.7 million a year earlier.
- Market-risk sensitivity estimates showed next-12-month net interest income impacts of approximately negative $1 million for a gradual 100-basis-point rise, negative $2 million for a 200-basis-point rise and negative $51 million for a 50-basis-point decline. Management noted these are model estimates, not forecasts, and reported no limit breaches.
- Contingencies include $25.1 billion of legally binding credit commitments and $2.6 billion of standby letters of credit. Management estimated reasonably possible litigation and regulatory losses at zero to approximately $20 million in aggregate for matters that could be estimated; other matters could not be reasonably estimated. The filing discusses a French appeal, CFTC/NFA compliance matters and uncertainty over the Visa litigation settlement and conversion rate for retained Visa Class B shares.
- No specific earnings or revenue guidance was provided. The company expects adoption of lease accounting in January 2019 to significantly affect reported financial condition through lease assets and liabilities, but not results of operations significantly. Expected effects of the new credit-loss standard remained under evaluation.
Key facts for investors to verify
- Whether fee growth and AUC/A gains persist, and whether AUM net outflows or foreign-exchange effects worsen.
- Whether rising funding costs, deposit declines and balance-sheet mix constrain net interest income as rates change.
- Whether expense growth from acquisitions, technology and benefits is offset by operating leverage.
- Trends in residential real-estate delinquencies, nonperforming assets and allowance adequacy.
- The impact of unrealized securities losses, the pending Visa litigation settlement and related swap valuations.
- Capital deployment, including repurchases and dividends, alongside the planned lease-accounting balance-sheet increase and eventual credit-loss-standard adoption.