DBRS Comments on Northern Trust Corporation’s 2Q12 Earnings – Senior at AA (low)

DBRS, Inc. (DBRS) has today commented on the 2Q12 earnings of Northern Trust Corporation (Northern Trust or the Company). DBRS rates the Company’s Issuer & Senior Debt at AA (low) with a Stable trend. The Company reported second quarter net income of $179.6 million, up from $161.2 million in 1Q12 and from $152.0 million a year ago. Excluding restructuring and integration charges, Northern Trust would have reported net income of $181.9 million compared to $163.8 million in 1Q12.

DBRS views the quarter as solid given the difficult operating environment. Positively, net new business continues to track well (C&IS net new business wins in 1H12 were the highest on record), Northern Trust noted success with improving profitability on both the Personal Financial Services (PFS) and Corporate & Institutional Services (C&IS) side, the Company’s initiative, “Driving Performance,” remains on track to bolster pre-tax income by $250 million by the end of 2013, the margin expanded, asset quality improved, and Northern Trust had modest loan growth. The Company also benefited from lower money market fee waivers. However, foreign exchange trading income was weaker than anticipated, net interest income declined, and clients became more risk adverse by increasing their exposures to fixed income securities. Overall, the Company delivered positive operating leverage in the seasonally stronger second quarter with revenues growing 2% while expenses declined by 1%.

Lower market valuations more than offset net new business with both assets under custody (AUC) and assets under management (AUM) declining during the quarter. Specifically, AUC declined 1% to $4.56 trillion, while AUM declined 2% to $704.3 billion.

Total revenue increased 2% to $988.5 million with noninterest income growth more than offsetting a modest decline in net interest income. Specifically, noninterest income grew 4% to $734.4 million driven by higher trust, investment and other servicing fees. Meanwhile, net interest income (FTE) declined by 1% to $264.3 million even with margin expansion, as earning assets contracted. Specifically, average earning assets decreased by 3%, while the margin improved by four basis points to 1.28%.

In PFS, a new fee structure was introduced in January and is contributing to revenue improvements. Meanwhile, in order to increase C&IS’ efficiency, the Company is going client-by-client to determine opportunities to deepen relationships and add incremental revenue growth, as well as eliminating services that the client does not value to become more efficient. Management noted they have been very pleased with client retention given the new pricing initiatives.

Securities lending benefited from the seasonally stronger second quarter increasing 43% to $30.7 million. Nonetheless, securities lending was down very modestly from a year ago. Moreover, borrower demand remains weak with securities lending collateral declining 3% to $93.7 billion. Meanwhile, foreign exchange trading income was down 4% to $59.4 million sequentially and was down 27% year-over-year reflecting lower volatility and volumes. Positively, money market fee waivers improved $8.4 million during the quarter totaling $17.0 million.

Noninterest expenses declined by $6.3 million, or 1%, to $717.3 million. However, first quarter expenses included seasonally higher stock option expenses, costs associated with the Northern Trust Open (golf tournament), as well as other seasonal expenses. The Company remains on track to achieve its target of enhancing pre-tax income by $250 million by the end of 2013 with over half of this amount coming in 2012. During the quarter, Northern achieved $35 million in improvements.

Loans grew 2% sequentially driven by commercial and industrial loans. In DBRS’s view, asset quality remains strong and is improving. Specifically, nonperforming assets (NPAs) decreased to $265.1 million, or 0.89% of loans and leases and OREO, from $284.5 million, or 0.98%. DBRS notes that residential real estate loans comprised 68% of total nonperforming loans at the end of the quarter. Meanwhile, net charge-offs (NCOs) were $3.2 million, or just 0.04% of average loans and leases, and included $13.0 million of recoveries. The provision for credit losses was stable at $5.0 million and the allowance for credit losses easily covers all NPAs.

The $29 billion securities portfolio is very conservatively managed with 87% of all securities composed of U.S. Treasury, government agency or AAA-rated securities. The portfolio is in an unrealized gain position and has an average maturity duration of approximately 2 years. During the quarter, Northern Trust offset $21.4 million of losses on the sale of auction rate securities with U.S. Treasury gains. DBRS notes that the Company has $107 million of auction rate securities remaining.

Taking recent guidance into consideration, the Company’s estimated Basel III Tier 1 common ratio was a strong 12.9%, which exceeds anticipated requirements. Given the very conservative nature of the securities portfolio, the new guidance had little impact on Basel III capital calculations. During the quarter, Northern Trust repurchased $36 million in shares under its share repurchase program and the dividend is now $0.30 per share. Under the capital plan submitted to the Federal Reserve, the Company received no objection to repurchase $240 million of stock through 1Q13, leaving approximately $190 million of shares left to be repurchased.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This is an unsolicited rating. This rating is based solely on publicly available information.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Michael Driscoll
Approver: Alan G. Reid
Initial Rating Date: 18 March 2010
Most Recent Rating Update: 5 July 2011

For additional information on this rating, please refer to the linking document under related research.