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 77% of 3Q13 revenues. The ratings are also supported by a strong and conservative balance sheet. However, the low interest rate environment, increased regulatory costs, and still soft market-sensitive revenues continue to weigh on the Company’s financial performance. Primary risks remain reputational and operational in nature given the complexity of operating globally across numerous regulatory jurisdictions.

DBRS does not currently see positive rating pressure given the Company’s already high rating level and the current difficult operating environment. Negative rating implications could arise from diminished new business wins, sustained negative operating leverage, or an unexpected material loss which would invade capital.

Over the past year, net new business has remained at or near record levels, which clearly demonstrates that Northern Trust continues to compete effectively. Moreover, the Company’s pre-tax profit margin has been expanding over the past several years despite the difficult operating environment, as Northern Trust has been successfully executing on its ‘Driving Performance’ initiatives to enhance revenues and reduce expenses. Specifically, for the first nine months of 2013, the Company has achieved approximately $190 million in pre-tax benefit and Northern Trust remains on target to exceed the $250 million pre-tax benefit targeted for 2013. Nonetheless, much of the benefit from Driving Performance has been used to absorb lower net interest income and higher money market fee waivers, as well as dealing with elevated compliance and regulatory costs.

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 in 3Q13. Meanwhile, assets under management also increased 5% to $846.2 billion benefiting from net new business and higher equity markets.

For the nine months ended September 30, 2013, the Company reported net income of $561.6 million, an increase of $42.0 million, or 8%, compared to the similar time period in 2012. Excluding the sale of an office building and prior year restructuring, acquisition, and integration related charges, net income would have improved $28.5 million reflecting higher fee income and lower credit costs, which more than offset a 10% decline in net interest income (FTE). Meanwhile, expenses increased 3% primarily reflecting increased regulatory costs associated with such items as submitting a living will and being a first time CCAR bank. Positively, Northern Trust has managed to report modest positive operating leverage, but continued elevated spending in technology, risk management and regulatory compliance could pressure operating leverage for the full year.

Asset quality remains strong within the loan portfolio. Nonperforming loans and leases (NPLs) have been relatively stable over the past year at $270.1 million, or 0.93% of total loans and leases. DBRS notes that approximately 70% of all NPLs are related to residential real estate, which consists of residential mortgage loans, as well as equity credit lines. DBRS notes that these loans are extended to affluent clients, which helps mitigate losses. For the first nine months of 2013, Northern Trust has reported $25.1 million of net charge-offs, or a low 0.12% of average loans and leases annualized. Moreover, at $317.5 million, the allowance for credit losses more than covers total nonperforming assets.

The Company’s conservative and highly rated $30.6 billion securities portfolio represented 31.8% of total assets at quarter-end. Overall, the securities portfolio was in an unrealized gain position of $55.9 million and had an average duration of just over a year, which compares very favorably to most banks including the other trust banks. DBRS notes that Northern Trust has successfully avoided large losses within its securities portfolio even during the crisis unlike its two primary competitors.

Capital ratios remain very sound with a tier 1 common equity ratio of 13.1% in 3Q13, up from 12.6% in 2Q13. Through September 30, 2013, Northern Trust has repurchased 3.4 million shares at a cost of $187.1 million. At quarter-end, the Company noted that its estimated Basel III tier 1 common capital ratio was approximately 13% on a fully phased-in basis under the advanced approach and approximately 11% under the standardized approach. Meanwhile, Northern Trust estimated its supplemental leverage ratio at approximately 5.5% at the holding company, which is already in compliance with future regulations.

Positively, the Company does not believe that any current litigation (current or threatened) or regulatory matters could materially impact the financial strength of Northern Trust. At September 30, 2013, the Company estimated that the upper end of the range of reasonably possible losses for legal proceedings to be approximately $117 million. Current litigation includes legacy securities lending issues, but at present, management has not been able to assess the probability of an adverse outcome or reasonably estimate potential losses.

Northern Trust Corporation, a financial holding company headquartered in Chicago, reported $96.0 billion in assets at September 30, 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 Organisations. Other applicable methodologies include the DBRS Criteria: Intrinsic and Support Assessments and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities. These can be found can be found at: http://www.dbrs.com/about/methodologies

[Amended on June 16, 2014, to reflect actual methodologies used.]

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

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: 28 September 2012

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