DBRS Confirms Northern Trust Corporation at AA (low); Trend Stable

DBRS, Inc. (DBRS) has today confirmed the ratings of Northern Trust Corporation (Northern Trust or the Company) and its primary banking subsidiary, The Northern Trust Company (Bank), including Northern Trust’s Issuer & Senior Debt rating of AA (low). The trend for all ratings is Stable. The rating action follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

Northern Trust’s ratings and Stable trend reflect its premier personal trust business, as well as leading market positions in asset servicing and asset management. Collectively, these globally diverse fee-based businesses accounted for a very high 74% of 2Q12 revenues. The ratings are also supported by a strong and conservative balance sheet. Evidencing franchise strength, net new business wins remain robust demonstrating that the Company continues to compete effectively. Nonetheless, the low interest rate environment and global economic uncertainty continue to weigh on the Company’s earnings primarily through money market fee waivers, margin pressure, lower foreign exchange trading income, subdued securities lending results and client risk aversion. The ratings also take into account the elevated levels of operational and reputational risk that Northern Trust faces given its role servicing and managing client assets on a global basis.

To address declining profitability metrics, Northern Trust has launched a revenue enhancement and expense reduction program, Driving Performance, to bolster pre-tax income by $250 million by the end of 2013 with over half of this amount coming in 2012. Through the first half of the year, the Company has already achieved $60 million of its target even though the bulk of the process optimization savings are expected to be realized in 2013. On the revenue side, a new Personal Financial Services (PFS) pricing structure went into effect January 1, 2012, that provides greater transparency to clients. Positively, the new fee structure does not appear to have alienated clients. Indeed, the low level of lost business following the changes was consistent with previous quarters. Meanwhile in Corporate & Institutional Services (C&IS), the Company is going client-by-client to determine opportunities to deepen relationships and add incremental revenue growth. Overall, management noted they have been very pleased with client retention given the new pricing initiatives.

With higher market valuations, strong net new business wins and Driving Performance initiatives underway, earnings have improved, but remain below historical standards. Specifically, Northern Trust reported 1H12 net income of $340.8 million compared to $303.0 million in 1H11. Excluding various one-time items, net income would have increased $27.0 million, or 8%, to $345.7 million. Revenues of $1.95 billion were 6% higher, while non-interest expenses of $1.44 billion also increased 6% over the same timeframe. However, excluding one-time items, expenses would have increased 7% resulting in modest negative operating leverage. Nonetheless, with the Company making progress with its revenue and expense initiatives, DBRS views the Company as better positioned for the challenging global operating environment.

In the most recent quarter, both assets under custody (AUC) and assets under management (AUM) contracted during the quarter. Specifically, AUC declined 1% to $4.56 trillion, while AUM declined 2% to $704.3 billion, as net new business wins were more than offset by lower market valuations.

In DBRS’s view, asset quality remains strong and is improving. Specifically, nonperforming assets (NPAs) decreased to $265.1 million in 2Q12, or 0.89% of loans and leases and OREO, from $284.5 million, or 0.98%, in the first quarter. DBRS notes that residential real estate loans comprised 68% of total nonperforming loans at the end of the second 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 $10.0 million in 1H12, a $15.0 million improvement from 1H11. Moreover, the provision exceeded NCOs by $1.0 million. Improvements in commercial and industrial and commercial real estate loans more than offset continued weakness in residential real estate lending.

At $29.2 billion, total securities comprised almost 31% of total assets at June 30, 2012. The securities portfolio is conservatively managed and has allowed Northern Trust to avoid material securities losses unlike the other two major trust banks. Indeed, the Company has only recognized $3.1 million in OTTI charges in 2012 compared to $22.0 million in 1H11. Within the portfolio, 87% of the securities portfolio consists of U.S. Treasury and government sponsored agency securities and AAA-rated corporate notes, asset-backed securities, covered bonds, supranational bonds, auction rate securities, and obligations of states and political subdivisions. Of the remaining securities, 4% were rated AA, 1% were rated below AA and 8% were not rated (primarily comprised of negotiable certificates of deposits of banks with at least an ‘A’ rating). Overall, the securities portfolio remains in an unrealized gain position.

Capital remains strong. Indeed, Northern Trust’s tier 1 common equity ratio was a very sound 12.4% at June 30, 2012. Taking recent guidance into consideration, the Company’s estimated Basel III Tier 1 common ratio was 12.9%, which already exceeds anticipated requirements. Given the very conservative nature of the securities portfolio, the new guidance had little impact on Basel III capital calculations. DBRS notes that Northern Trust was one of only two major banks that maintained its dividend during the financial crisis.

Positively, Northern Trust has not disclosed any litigation that could have a material impact on the Company’s financial position. At June 30, 2012, the Company has estimated the upper end of reasonably possible litigation losses to be approximately $45 million, or 25% of 2Q12’s net income.

Northern Trust Corporation, a financial holding company headquartered in Chicago, reported $94.5 billion in assets at June 30, 2012.

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
Rating Committee Chair: 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.