Northern Trust Corporation — Q3 2009 Form 10-Q
Reporting period: Quarter ended September 30, 2009; filed October 30, 2009. Financial statements are unaudited. Northern Trust provides banking, custody, asset servicing and investment management services.
Financial performance
| Metric | Q3 2009 | Q3 2008 | Nine months 2009 | Nine months 2008 |
|---|---|---|---|---|
| Net income (loss) | $187.9 million | $(148.3) million | $663.9 million | $452.5 million |
| Diluted EPS | $0.77 | $(0.66) | $2.34 | $2.00 |
| Revenue, FTE basis | $927.6 million | $938.5 million | $2.88 billion | $3.18 billion |
| Net interest income, FTE basis | $248.2 million | $265.7 million | $796.0 million | $780.6 million |
| Net interest margin, FTE basis | 1.54% | 1.62% | 1.60% | 1.67% |
| Provision for credit losses | $60.0 million | $25.0 million | $175.0 million | $55.0 million |
- Q3 trust, investment and servicing fees rose 10% to $523.1 million, while foreign-exchange trading income fell 34% to $92.9 million. Lower currency volatility and client volumes weighed on FX revenue.
- Operating earnings, a company-defined non-GAAP measure excluding Visa-related adjustments, were $176.7 million ($0.72 per share) in Q3, versus an operating loss of $129.4 million ($0.58 per share) a year earlier. Nine-month operating earnings were $652.7 million ($2.29 per share), versus $317.9 million ($1.40 per share).
- Q3 operating expenses excluding Visa adjustments were $617.0 million, down sharply from the prior-year reported level, which included $561.5 million of client-support charges. Excluding those prior-year charges, expenses increased 10% year over year. Compensation and benefits rose, reflecting prior-year expense reductions and higher staffing.
Balance sheet, liquidity and capital
- At September 30, total assets were $77.9 billion, loans and leases $28.1 billion, securities $17.5 billion, deposits $55.3 billion and stockholders’ equity $6.2 billion. Total assets were $79.2 billion and deposits $62.4 billion at September 30, 2008.
- Cash and due from banks were $2.9 billion. Nine-month operating cash flow was $692.5 million, compared with $919.2 million in 2008; investing activities provided $3.0 billion and financing activities used $3.6 billion.
- Funding shifted: deposits declined $7.1 billion from year-end 2008, while federal funds purchased rose to $6.7 billion from $1.8 billion. Senior notes were $1.6 billion and long-term debt $2.9 billion at quarter-end.
- Regulatory capital remained above minimum requirements. The Corporation’s tier 1, total risk-based and leverage ratios were 13.3%, 15.7% and 9.0%, respectively; its tier 1 common equity ratio was 12.7%, up from 8.7% a year earlier.
- Assets under custody were $3.55 trillion, up 1% year over year; assets under management were $610.5 billion, down 6% year over year.
Material changes and unusual items
- Credit quality weakened: nonperforming loans rose to $292.3 million from $58.8 million a year earlier, equal to 1.04% of loans and leases. Q3 net charge-offs were $46.1 million, including $14.7 million from the sale of two nonperforming loans. The total credit-loss reserve was $333.0 million, versus $207.5 million a year earlier.
- The securities portfolio had $188.4 million of gross unrealized losses, down from $387.9 million at year-end 2008; $146.3 million related to residential mortgage-backed securities. The company recorded $5.3 million of Q3 credit-related impairment charges on residential mortgage-backed securities and $23.3 million for the first nine months.
- Securities-lending revenue included a favorable approximately $57 million mark-to-market adjustment in Q3, compared with a negative approximately $96 million adjustment in Q3 2008. Excluding these adjustments, the company reported lower underlying securities-lending fees due to reduced volumes and spreads.
- In 2009, Northern Trust issued common shares and repurchased its Treasury-issued preferred stock and warrant, completing its participation in the Capital Purchase Program. The share issuance contributed to higher equity; the warrant repurchase cost $87 million.
- Visa escrow funding reduced the Visa indemnification liability by $17.8 million in Q3. The remaining net liability was $56.1 million at September 30. Prior-year comparisons also include the $167.9 million Visa share-redemption gain in Q1 2008.
Outlook, risks and contingencies
- The filing provides no specific earnings or revenue guidance. Management cited continued economic weakness and low interest rates as pressures on credit costs and net interest margin. It estimated that a 10% change in equity markets could move trust, investment and servicing fees by about 4% and total revenue by about 2%.
- Two capital support agreements remained outstanding and were scheduled to expire November 6, 2009. Maximum exposure was $200.2 million; the recorded estimated liability was $126.1 million. Management did not consolidate the related investment funds.
- Standby letters of credit totaled $4.9 billion. Northern Trust also indemnified borrowers in securities-lending transactions covering $81.8 billion of client securities; management stated collateralization mitigated expected credit exposure.
- The IRS settlement over certain structured leases accelerated $88.6 million of tax payments but did not affect net income. $67.2 million of leveraged-lease-related uncertain tax positions remained at September 30. Management said future changes could materially affect a particular period’s results, though it did not expect a material effect on financial position or liquidity.
- Management could not estimate potential losses or timing for certain legal matters, including an ERISA class action concerning the company stock investment option in its employee plan. It did not believe pending matters would materially harm consolidated financial position or liquidity, but acknowledged possible material effects on results in a particular period.
- Management highlighted economic and market stress, securities valuations and impairment judgments, credit and liquidity risk, FX activity, securities-lending revenue, regulatory changes and potentially higher FDIC premiums as risks. It stated interest-rate and FX market-risk positions had not changed significantly since year-end 2008.
Investor verification priorities
- Track nonperforming loans, charge-offs, reserve adequacy and subsequent credit trends, particularly in residential real estate and commercial lending.
- Review the performance, impairment assessments and liquidity of mortgage-backed and other securities, including the below-double-A residential portfolio.
- Separate recurring securities-lending results from large mark-to-market movements; assess the sustainability of fee revenue and effects of markets on managed assets.
- Monitor deposits, short-term borrowing reliance, net interest margin and capital ratios as rates and funding conditions change.
- Confirm the expiration and final settlement of the remaining capital support agreements, and developments in Visa, tax and legal contingencies.