DBRS: Northern Trust’s Strong 2Q: Positive Operating Leverage & Improving Metrics

Summary:
• Excluding one-time items, Northern Trust reported 2Q net income of $246.7 million, higher both QoQ and YoY.
• Northern Trust once again delivered positive operating leverage primarily reflecting strong new business and higher markets.
• DBRS rates Northern Trust Corporation Issuer & Senior Debt at AA (low) with a Stable trend.

DBRS, Inc. (DBRS) views Northern Trust Corporation’s (Northern Trust or the Company) 2Q15 results as strong even when excluding one-time items that bolstered net income. Higher markets, strong new business, better-than-peer foreign exchange trading, and well managed expenses all contributed to positive operating leverage both quarter-over-quarter (QoQ) and year-over-year (YoY). While securities lending improved sequentially benefiting from the international dividend season, revenues were down YoY, as new fee arrangements have decreased Northern Trust’s share from clients due to competitive pressures.

The quarter included three unusual items, including a large gain on sale of Visa shares, a $45.8 million charge related to voluntary cash contributions to four constant dollar net asset value (NAV) funds that had previously sustained losses in the crisis that brought their respective NAVs back to approximately $1, and a lease impairment. In aggregate, these items resulted in a net benefit of $36.3 million, or $22.5 million after tax.

Assets under custody increased modestly sequentially, but assets under management contracted by 2%, as two sovereign wealth funds moved out of equities mandates. Positively, Northern Trust announced several new custody business wins, and momentum remains strong on the wealth management side.

Net interest revenue (FTE and excluding the lease impairment) grew 3% reflecting solid earning asset growth that more than offset core net interest margin pressure. Meanwhile, trust, investment, and other servicing fees had strong growth driven by new business and favorable equity markets. DBRS notes that foreign exchange trading improved during the quarter, while other banks reporting to date have seen declines. Expenses remain well managed, especially considering investments being made to support growth and increase efficiencies. Adjusting for the one-time items, the Company’s pre-tax profit margin and return on equity were 32.3% and 11.8%, respectively, both of which were five-year highs.

The Company’s strong balance sheet remains supportive of the ratings. On a fully phased in basis, Northern Trust estimated its common equity tier 1 ratio was 10.4% under the standardized approach. Meanwhile, management noted that Northern Trust is already compliant with the fully phased in Liquidity Coverage Ratio. Northern Trust has seen opportunities to expand relationships with potential clients looking to move large amounts of deposits, as it is not leverage constrained like some of its larger competitors. Nonetheless, the Company will be selective on a case by case basis preferring to sell additional products and services in return for balance sheet usage.

DBRS rates Northern Trust Corporation Issuer & Senior Debt at AA (low) with a Stable trend.

Note:
All figures are in U.S. Dollars unless otherwise noted.