DBRS Comments on Northern Trust Corporation’s 3Q13 Earnings – Senior at AA (low)

DBRS, Inc. (DBRS) has today commented on the 3Q13 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 $206.5 million in 3Q13, up from $191.1 million in 2Q13 and from $178.8 million a year ago. Excluding a $32.6 million pre-tax gain from the sale of an office building, net income would have been $186.2 million.

With the exception of higher equity markets, the operating environment in 3Q13 remained challenging with difficult bond market conditions, lower currency volatility and volumes, and very low short-term interest rates resulting in higher money market fee waivers sequentially. Overall, core revenues declined modestly, while expenses increased 1.5% sequentially resulting in negative operating leverage following the seasonally stronger second quarter. Excluding the office building gain, return on equity would have been 9.6%, which is below the lower end of the Company’s targeted range.

Bolstered by net new business wins, higher equity markets, and a favorable impact from currency translation; assets under custody increased 5% sequentially to $5.2 trillion. Meanwhile, assets under management also increased 5% to $846.2 billion benefiting from net new business and higher equity markets.

Consolidated revenue increased $26.7 million, or 3%, sequentially to $1.05 billion with both noninterest income and net interest income growing during the quarter. However, excluding the sale of the office building, total revenues would have declined by 1%. Specifically, core noninterest income declined by $22.8 million reflecting lower trust, investment, and other servicing fees, and lower foreign exchange trading income. Meanwhile, net interest income (FTE) increased $16.8 million to $244.8 million benefiting from both net interest margin expansion, as well as higher average earning assets. The margin benefited from lower premium amortization, as prepayment speeds slowed. DBRS notes that the low short-term rates seen in 3Q13 resulted in ever higher money market fee waivers, which totaled an aggregate $32.4 million compared to $22.7 million in 2Q13.

Following the seasonally higher international dividend season in 2Q13, securities lending revenue declined by 27% to $22.7 million driven by lower spreads. Meanwhile, foreign exchange trading income decreased by 12% to $62.8 million reflecting lower volatility and trading volumes. To improve depressed foreign exchange revenues, the Company has implemented a new front office trading platform and is looking to execute trades outside of its custody clients to grow volume.

Noninterest expenses increased 2% to $740.7 million primarily from higher consulting and technical service expense, including costs associated with growing regulatory and compliance demands, and higher equipment and software expense associated with the continued investment in technology related assets. The Company noted that consulting expenses doubled from 2Q13 to $15 million and should remain elevated. Positively, the Company continues to invest in its businesses including the Global Fund Services business and new offices have recently been opened in Frankfurt and Riyadh. Northern Trust’s objective remains to grow fee revenues at a faster rate than expenses, which the Company has achieved so far in 2013 and in 2012.

During the quarter, Northern Trust achieved over $70 million in pre-tax income benefit from its Driving Performance initiatives, an improvement of $5 million compared to 2Q13. For the first nine months, the Company has achieved approximately $190 million in pre-tax benefit and Northern Trust remains on track to exceed the 2013 $250 million pre-tax benefit target. Nonetheless, much of the benefit from Driving Performance has been used to absorb lower net interest income and foreign exchange trading, as well as dealing with elevated compliance and regulatory costs.

Asset quality remains strong although nonperforming assets increased modestly during the quarter to $284.0 million, or a still low 0.98% of loans and leases and OREO. Net charge-offs were relatively stable at $8.3 million, or 0.12% of average loans and leases annualized. The provision for credit losses remained at $5 million for the quarter. DBRS notes that the allowance completely covers nonperforming loans and leases and remains sufficient.

The Company noted that the average duration of the high quality securities portfolio is a bit over a year, which is quite conservative.

Capital ratios remain very sound with a tier 1 common equity ratio of 13.1%, up from 12.6% in 2Q13. During the quarter, Northern Trust repurchased 1.7 million shares at a cost of $97.3 million. The Company noted that its estimated Basel III tier 1 common capital ratio was a strong 13% on a fully phased-in basis under the advanced approach and approximately 11% under the standardized approach. Meanwhile, Northern Trust estimated its supplementary leverage ratio at approximately 5.5% at the holding company, which is already in compliance.

DBRS notes that the Company changed the name of its Personal Financial Services business to Wealth Management and its Northern Trust Global Investments business to Asset Management, to more accurately reflect the nature of the business units. The Corporate & Institutional Services and Technology business unit names remain unchanged.

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

[Amended on May the 23rd, 2014 to remove unnecessary disclosures.]