Northern Trust Corporation — Q2 2014 Form 10-Q
Business context and reporting period
Quarterly report for the three and six months ended June 30, 2014; financial statements are unaudited. Northern Trust provides asset servicing, fund administration, asset management, fiduciary and banking services through Wealth Management and Corporate & Institutional Services, supported by Operations & Technology.
Key financial metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue (FTE basis) | $1,088.5 million | $1,028.4 million | $2,137.7 million | $2,012.4 million |
| Net interest income (GAAP) | $246.6 million | $220.1 million | $492.3 million | $446.2 million |
| Net interest margin (FTE) | 1.06% | 1.10% | 1.09% | 1.13% |
| Net income | $181.9 million | $191.1 million | $363.3 million | $355.1 million |
| Diluted EPS | $0.75 | $0.78 | $1.50 | $1.45 |
| Noninterest expense | $811.0 million | $729.7 million | $1,579.0 million | $1,458.6 million |
- For Q2, reported return on average common equity was 9.18% and return on average assets was 0.71%, versus 10.02% and 0.83% a year earlier. Six-month returns were 9.23% and 0.72%, respectively.
- Q2 trust, investment and other servicing fees grew 8% to $706.9 million; foreign-exchange trading income fell 26% to $52.9 million. Six-month servicing fees rose 8% to $1,386.4 million, while FX income declined 21% to $103.0 million.
- Average earning assets rose 15% year over year in Q2 to $95.5 billion. Volume growth lifted net interest income, but lower asset yields reduced the FTE margin to 1.06% from 1.10%.
- At June 30, total assets were $105.8 billion, deposits $88.9 billion, loans and leases $30.7 billion, and stockholders’ equity $8.0 billion. Assets under custody were $6.0 trillion and assets under management $924.4 billion; these are client assets, not balance-sheet assets.
- Q2 provision for credit losses was zero, versus $5.0 million a year earlier; six-month provision was $3.0 million, versus $10.0 million. Net charge-offs were $5.9 million in Q2 and $7.4 million for six months.
- For the six months, operating cash flow was $1.54 billion, investing cash flow was negative $3.08 billion, and financing cash flow was positive $2.22 billion. Operating cash flow benefited substantially from a $527.9 million reduction in net collateral deposited with derivative counterparties. Financing cash flow reflected deposit growth, partly offset by lower borrowings and debt repayments.
- Regulatory capital at June 30: Corporation common equity Tier 1 ratio 12.7% under both Advanced and Standardized approaches; total capital ratios were 14.9% and 15.4%, respectively. The Northern Trust Company’s respective total ratios were 13.7% and 14.0%. The company stated applicable well-capitalized thresholds were exceeded.
Material changes versus comparable periods
- Q2 revenue increased 6%, but net income fell 5% as expenses rose 11%; six-month revenue increased 6%, expenses rose 8%, and net income increased 2%.
- Q2 expenses included $42.3 million of pre-tax severance charges, office-space reduction charges and software write-offs. Excluding these items, management reported Q2 net income of $209.8 million, diluted EPS of $0.87 and return on average common equity of 10.6%. On the same basis for the six-month period, it reported net income of $391.1 million, diluted EPS of $1.61 and return on average common equity of 9.9%.
- The principal expense items were $25.5 million severance-related compensation charges, $1.9 million employee-benefit charges, $1.1 million outside-services charges, $9.5 million software write-offs and $4.3 million occupancy charges.
- Assets under custody increased 20% and assets under management 15% year over year. Fee growth reflected new business and higher equity markets, partly offset by higher money-market fund fee waivers. Q2 fee waivers totaled $30.7 million across the two principal client businesses, versus $22.7 million a year earlier.
- Corporate & Institutional Services Q2 net income decreased 15% to $85.0 million; Wealth Management net income decreased 8% to $88.8 million. Treasury and Other reported net income of $8.1 million, versus a $5.5 million loss, benefiting from higher internal net interest income and currency-hedging gains.
- Nonperforming loans and leases decreased to $229.3 million from $266.7 million a year earlier; nonperforming assets were $241.9 million. Residential real estate remained the principal area of credit weakness.
Outlook, risks, contingencies and unusual items
- The filing provides no specific earnings or revenue guidance. Management cited persistent low short-term rates, lower earning-asset yields, FX-market volatility and expense control as important business factors.
- SEC money-market reform rules approved July 23, 2014 will require institutional prime money-market funds to use a floating net asset value and allow redemption restrictions in certain circumstances. Northern Trust said the ultimate business impact was uncertain.
- Management described securities-lending lawsuits alleging imprudent investment of collateral and disclosed an SEC subpoena received in April 2014 seeking documents on securities-lending activities; Northern Trust said it was cooperating. A proposed settlement for two lawsuits remains subject to documentation and court approval; other cases remain pending.
- The company estimated the upper end of reasonably possible losses for certain legal matters at approximately $130 million in aggregate, while noting that other matters’ losses could not be reasonably estimated. It had recorded no material accruals for pending litigation or regulatory matters. Management did not expect pending matters to materially affect consolidated financial position or liquidity, but said they could materially affect results in a particular period.
- Six-month investment-security results included $3.9 million of impairment charges on certain CRA-eligible securities. The portfolio had $81.4 million of gross unrealized losses at June 30; management said it did not intend to sell affected securities and was not more likely than not to be required to sell before recovery.
- Gross cross-border exposure to Ireland was approximately $690 million, less than 1% of consolidated assets; the filing reported no exposure to sovereign debt of the identified stressed European countries and no cross-border exposure to Italy, Portugal, Greece, Spain, Cyprus or Slovenia.
- The company repurchased 3.86 million shares for $237.9 million during the first half and declared dividends of $0.64 per share. A $500 million fixed-rate senior note matured during Q2. Basel III capital-ratio reporting changed in Q2 after the company exited its parallel run; comparisons across approaches and periods therefore require care.
Important facts for investors to verify
- Whether servicing-fee and client-asset growth persists, and how much reflects market appreciation versus new business and net flows.
- Whether margins continue to decline as asset yields and money-market fee waivers pressure earnings, and whether FX trading income recovers.
- Whether expense growth moderates after the $42.3 million of Q2 charges and write-offs, including technology and staffing costs.
- Whether residential real-estate credit quality improves; monitor nonperforming loans, allowance coverage and charge-offs.
- Developments in securities-lending litigation and the SEC inquiry, including potential losses beyond the estimated $130 million range.
- The financial and client impact of money-market reforms, and the comparability of capital ratios following the Basel III methodology transition.