DBRS Comments on Northern Trust Corporation’s 3Q12 Earnings – Senior at AA (low)

DBRS, Inc. (DBRS) has today commented on the 3Q12 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 net income of $178.8 million in the third quarter compared to $179.6 million in 2Q12 and $170.4 million a year ago.

Despite strong asset growth in both the custody and asset management businesses and solid expense control, the low interest rate environment, muted market activity and less volatility continue to pressure results. Positively, net new business wins remain strong with year-to-date C&IS net new business wins at record levels, while PFS net new business wins have been very solid. DBRS is mindful that this performance was recorded even with clients being reluctant to make commitments given the economic and political uncertainty. Overall, assets under custody grew 4% to $4.8 trillion while assets under management increased 6% to $749.7 billion.

Total revenues declined $16 million, or 2% to $972.5 million during the quarter with both non-interest income and net interest income contracting in the third quarter. The decline in non-interest income was primarily from lower market-sensitive revenues. Specifically, securities lending revenues were down 22% following the seasonally stronger international dividend season in 2Q12, while foreign exchange trading income declined a significant $15.4 million, or 26%, to $44.0 million. Meanwhile, net interest income (FTE) declined 3% to $256.9 million with continued margin pressure more than offsetting average earning asset growth. Specifically, the margin contracted seven basis points to 1.21% during the quarter.

With the majority of trust and investment management fees based off lagged market values, the weaker second quarter market valuations had an adverse effect on fees. Positively, net new business wins were able to keep these fee levels relatively stable. Continued net new business wins and the higher market valuations seen in 3Q12 should contribute to higher fees in 4Q12.

Non-interest expenses declined $20.9 million, or 3%, to $696.4 million. However, adjusting for restructuring, acquisition and integration related charges and the software write-off in 2Q12, core expenses were down 1.4%. Positively, the Company’s revenue enhancement and expense initiative, Driving Performance, delivered a $45 million pretax benefit in 3Q12 (approximately $100 million since inception) and the Company remains on track to achieve its target of $250 million by the end of 2013. DBRS notes that Driving Performance has helped Northern Trust improve its pre-tax profit margin to 28.2%, the highest reported level since 2Q10.

The provision for credit losses, nonperforming assets (NPAs) and net charge-offs (NCOs) all increased during the quarter, but asset quality metrics remain strong. Specifically, NPAs increased $24.5 million to $289.6 million, or 0.98% of loans and leases and OREO. DBRS notes that increases in residential mortgages nonaccruals, as well as commercial real estate loans contributed to the increase. Meanwhile, NCOs increased $8.7 million to $11.9 million, or a still very manageable 0.16% of average loans and leases. While gross charge-offs were stable, Northern Trust’s recoveries were down significantly. Overall, the allowance for credit losses assigned to loans remains sufficient at 1.01%.

The Company’s $30 billion securities portfolio remains very conservatively managed and highly liquid. Indeed, 91% of the portfolio is composed of U.S. Treasury, government sponsored agency and AAA-rated securities and has a modest, albeit increasing, average maturity duration of approximately two years. Moreover, the portfolio remains in an unrealized gain position.

Capital remains strong and helps underpin the rating. Specifically, Northern Trust’s tier 1 common equity ratio was relatively stable at 12.3%. Moreover, the Company’s estimated Basel III tier 1 common ratio was a very strong 13.1%. During the quarter, the Company repurchased common stock totaling $49.6 million and may repurchase an additional $140 million of common stock through March 2013.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. 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: Roger Lister
Initial Rating Date: 18 March 2010
Most Recent Rating Update: 28 September 2012

For additional information on this rating, please refer to the linking document under Related Research.