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Northern Trust Corporation / (NTRS – NASDAQ) / $108.45Note: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report:1Q18Earnings Update
Prev. Ed.: 4Q17and 2017 Earnings Update, Mar 12, 2018
Brokers’ Recommendations: Neutral: 58.3% (7 firms);Positive:33.3% (4); Negative: 8.4% (1) Prev. Ed.: 7; 4; 1
Brokers’ Target Price:$113.5 (↑$1.79 from the last edition; 11 firms) Brokers’ Average Expected Return:4.7%
Note: A Flash Update on 1Q18 Earnings was done on Apr 17, 2018.
Executive Summary
Northern Trust Companyis a multi-bank holding company headquartered in Chicago, IL.The company's lines of business include brokerage services, investment management, trust services and global investments. Northern Trust has offices in 19 U.S. states and 22 international locations.
Trend of Broker Opinions:Broker sentiment on the stock remains skewed toward a neutral stance, with58.3% of the firms in the Digest group rating the stock neutral, 33.3% rating it positive and the remaining 8.4%rating it negative.Target prices provided by the firms range from a low of $92.00 to a high of $123.00 per share. The average is$113.5, implying apositivereturn of 4.7%.
Chief Investment Considerations:
- Strong balance sheet and ample liquidity
- Cost management intitatives
- Ability to return capital to shareholders
- Manageable Eurozone exposure
- Easing Pressure on net interest margin (NIM)
- Lower commercial tax rate
- Regulatory issues
Neutral or equivalent outlook – Seven firms or 58.3% - These firms believe the company is in a sound position to gain from some strong long-term demographic trends.They believe, in the short term, the company will benefit from a below-average credit risk profile, strong capital levels and experienced management. For theupcoming quarters, these firms expect new business trends to remain positive, predominantly outside the U.S. Based on the company’s attractive competitive positioning and personal wealth management leadership, these firms believe that Northern Trust is positioned for strongtop-line growth. Furthermore, they believe that the company’s ability to take advantage of attractive secular trends will drive long-term earnings per share (EPS) growth.Nonetheless, firms believe the company has been unable to match growth in revenues and expenses. Further, firms are of the opinion that although the company’s “Value for Spend" initiative is accretive in the long term, it will not reap benefits in the shortterm.
Positive or equivalent outlook – Four firms or 33.3% - The firms believe Northern Trust is well diversified and has an enviable organic growth. Further, the company’s core business carries less credit risk than commercial banks. This provides a competitive advantage to the company. In addition, firms are encouraged by robust growth in its core businesses. Per the firms, the high asset sensitivity, greater personal wealth-management leadership and relatively small size will enable the company to achieve strong top-line growth. Firms are of the view that the company’s conservative balance sheet provides it with financial strength to consider new business opportunities. The firms believe the company’s shares should trade at a premium to the S&P 500.
Negative or equivalent outlook – One firm or 8.4% – According to the firm, Northern Trust shares have limited upside due to the absence of a near-term catalyst, owing to which they have maintained a negative stance. Further, despite its attractive Wealth Management franchise, Northern Trust’s performance was inconsistent in the last two years and therefore does not warrant a historical premium. Moreover, operating margin and earnings are expected to remain under pressure due to elevated regulatory costs.
May 21, 2018
Overview
Northern Trust Corporation is the holding company for its main subsidiary, Northern Trust Company, as well as a number of other banking and non-banking financial service subsidiaries. The company derives the majority of its revenues and earnings from the trust businessand provides a number of related banking and financial services.
The company’s main sources of revenues include two of its primary business units: Corporate and Institutional Services (C&IS) and Wealth Management (WM). Asset management and related services to WM and C&IS clients are provided primarily by its Asset Management business.
- The Corporate and Institutional Services unit provides asset servicing, asset management and related services to corporate and public retirement funds, foundations, endowments, fund managers, insurance companies and government funds; a full range of commercial banking services to large and mid-sized corporations and financial institutions; and foreign exchange services. As of Mar 31, 2018, total C&IS assets under custody (AUC) were $7.47 trillion,while assets under management (AUM) summed$878.3 billion.
- The Wealth Management division delivers customized investment management and trust services to high net worth individuals and families through a network of offices across 18 states of North America and Washington, D.C., as well as offices in London and Guernsey. As of Mar 31, 2018,total AUC was $645.2billion and total AUM was $287.4billion.
- Asset Management, through the company’s subsidiaries, provides a broad range of asset management and related services and other products to clients around the world, including clients of C&IS and WM. The segment’s activities also include overlay services and other risk management services.
Treasury and Other includes income and expense related to the wholesale funding activities and the investment portfolios of the Corporation and the Bank and nonrecurring items not allocated to C&IS and WM.
As of Mar 31, 2018, the company had total assets worth $129.7 billion, AUM of $1.17 trillion and AUC of $8.11 trillion
More details about the company are available on its website:
The key positive and negative arguments as identified by the analysts are outlined below:
Key Positive Arguments / Key Negative Arguments- Strong global franchise with solid long-term growth prospects
- Growth characteristics of the business sectors are attractive, specially in wealth management
- Acquisitions and new offices will likely lead to further business growth opportunities
- Strong capital base
- Cost cutting initiatives to act as a postitve catalyst
- Competitive pressure in the custody and related businesses
- Expense control has been a challenge and will need to be effectively and actively managed
Note: Northern Trust operates on a calendar-year basis.
May 21, 2018
Long-Term Growth
The firms believe that Northern Trust is a well-diversified, high-quality, large-cap financial institution with a relatively positive balance sheet. The company operates in two highly attractive businesses: global custody and private banking (including wealth management) andcarries considerably less credit risk than its bank peers. Global secular trends are encouragingfor the company and are supported by modern global pension plans, favorable demographics, and escalating cross-border investing and intricacy of investment strategies and products. The firms believethat growth over the next few years will be driven primarily by new prospects in Europe, China, India, and Emerging Asia. Moreover, the firms also believe that the company can leverage its financial strength to win more than its share of new business opportunities and can capitalize on positive secular trends to drive attractive long-term EPS growth. This will result in superior stock price performance.
In September 2014, Northern Trust announced the implementation of the Target2-Securities (T2S) strategy to provide better services to its clients in the form of improved liquidity as well as asset safety. T2S is an initiative undertaken by the European Central Bank (ECB) in 2008 to automate and standardize the current uneven settlement process throughout Europe by providing the market participants a single shared platform and legal framework for the settlement of securities. The T2S project is expected to result in reduction of risks and costs associated with cross-border settlements.The implementation of the T2S strategy with the support of Deutsche Bank and Euroclear will help Northern Trust improve efficiency and asset protection through synchronized Delivery-versus-Payment settlement in the ECB across European securities markets.
Over the long term, Northern Trust is expected to generate earnings growth on the back of investment in businesses. More investments in business will exploit growth opportunities globally for the company and drive earnings growth. Moreover, Northern Trust’s earnings are correlated to a rising interest rate environment, and therefore growth would accelerate after a significant rise in interest rates is experienced.
Based on a portfolio of initiatives, management anticipates realizing $250 million in expense run-rate savings by 2020. Over the last three quarters, the company has taken severance and restructuring charges of $47 million. On a combined basis, these charges will create approximately $35 million in annualized net savings and these savings are expected to be fully realized by the first quarter of 2019.
Some firmsare optimistic of Northern Trust’s attractive organic growth profile, conservative balance sheet and leverage to rising short-term rates.Therefore, the firms believe improvement in core businesses will enhance long-term value.
May 21, 2018
Target Price/Valuation
Provided below is a summary of valuations and ratings as compiled by Zacks Research Digest:
Rating DistributionPositive / 33.3%
Neutral / 58.3%
Negative / 8.4%
Average Target Price / $113.5↑
Maximum Upside from Current Price / 13.4%
Minimum Upside from Current Price / -15.2%
Upside from Current Price / 4.7%
Digest High / $123.00
Digest Low / $92.00
No. of Analysts with target price/total / 11/12
Risks to the target price include slower-than-expected economic recovery leading to reduced rate of growth in earnings, considerable deterioration in credit quality and persistent low interest rates.
Recent Events
On Apr 17, 2018, Northern Trust announced 1Q18 results. Driven by top-line strength, the company reported earnings per share of $1.58, comparing favorably with $1.09 recorded in the year-ago quarter. The Zacks Consensus Estimate was $1.42.
Higher revenues and credit provisions were the positives. In addition, the quarter witnessed rise in AUC and AUM. Moreover, credit metrics marked a significant improvement. However, escalating operating expenses remained a major drag.
Net income came in at $381.6 million compared with $276.1 million recorded in the prior-year quarter.
Revenue
Total revenueswere $1.48billion in 1Q18, up15%year over year (y/y).
Net interest income(NII), stated on a fully taxable equivalent basis, was$392.7million, up8% y/y,driven by higher levels of average earning assets and higher net interest margin (NIM).
Net interest margin (NIM) was 1.38%, up3basis points (bps) from 1Q17,driven by higher short-term interest rates,partially offset by elevated levels of premium amortization and an unfavorable mix shift in balance sheet.
Non-interest incomegrew 17% y/y to$1.09billion. Increase in trust, investment and other servicing fees, foreign-exchange trading income, security commissions and trading incomewere the primary drivers for this improvement.These positives were partially offset by lower treasury management fees, other operating inocme and investment security losses.
Provision for credit losses wasa credit of $3 millioninthe reported quarter compared with a creditof $1millionin 1Q17.
Trust, investment and other servicing fees increased 16% y/y to $937.7 million. This upsideprimarily stemmed fromnew business, favorable movment in foreign currency exchange rates, conductive markets, along with a the adoption of the new revenue recognition standard, thatresulted in achange in presentation of certain fees.
Trust, investment and other servicing fees from Corporate & Institutional Services (C&IS)improved 18% y/yto $544.3 million.The largest component of C&IS fees is custody and fund administration fees, having increased 22% y/y to$373.9million,driven by new business, upbeat equity marketsand the favorable movements in foreign exchange rates.
C&IS investment management fees totaled $109.7 million, up17% y/y,reflecting new business andthe favorable impact of equity markets.Securities lending fees were $26 million in the quarter, up 9% y/y.
Trust, investment and other servicing fees from Wealth Management totaled $393.4million, up 14% from the prior-year quarter.The rise was mainly attributable to favorable equity markets, new business and adoption of new revenue recognition standard that resulted in a change in presentation of certain fees.
Foreign exchange trading income was $68.5 million, up 63% y/y, reflecting increased volumes and higher foreign exchange swaps relating to treasury.
Outlook
Manangemnt expects premium amortization in the $10-$12 million range on a quarterly basis, going forward.
Margins
Non-interest expenses in 1Q18were $995.3 million, 11% higher y/y.This was mainly due to an increase in all components of expenses.
Compensation expenses, the largest component of non-interest expenses, were $471.7 million in the quarter, 11%higher y/y.This increase was mainly due to higher salary expenses and severance charges, along with increased cash-based incentive accruals.
Employee benefit expenses totaled $91.7 million, reflecting an18% increase y/y.The rise was mainly due to elevated retirement plan expenses and expenses related to the UBS acquisition.
Provision for income taxestotaled $102.1 million compared with $114.8 million in 1Q17, primarily due toa reduction in U.S. corporate tax rates andtax benefits accruing on the back of changes in accounting of tax deductions for software development related expenses. This waspartially offset by an increase in income before income taxes, reduction in income-tax benefits from exercising stock options and vesting restricted stock units.Also, the company recorded adjustments on account of implementation ofthe TCJA, tax accounting changes in 2018.
Theeffective tax ratewas 21.1% compared with 29.4% in 1Q17.
Outlook
Management aims to realize $250 million in expense run-rate savings by 2020 from its value per spend initiative and a sustainable expense-management approach.
Additionaly, for 2Q18 compensation expenses, management anticipates $11 million of expenses relating to retirement-eligible employees and nearly $8 million due to base pay adjustments, effective Apr 1, 2018.
Earnings per Share
Northern Trust reported net income of $381.6 million or $1.58 per share in 1Q18compared with $276.1 million or $1.09in 1Q17.
Outlook
Some firms increasedtheir2018and 2019 EPS estimateson the company’s robust performance in 1Q18.
Balance Sheet/ Capital Structure/Others
Balance Sheet
As of Mar 31, 2018, total assetswere $129.6billion, up7% y/y.Loans and leaseswere $32.1billion, down 4%from the prior-year quarter.
Total Federal Reserve deposits were $29.4billionat the end of the quarter, up13% on a y/y basis.Total securitiesincreased 12%y/y and came in at $49.6 billion.
Capital Structure
Total stockholders' equityaveraged $10.1billion, up4% y/y, driven by earnings, partially offset by the repurchase of common stock pursuant to the company’s share-buyback program and the declaration of dividends.
Northern Trust's risk-based capital ratios remained solid as of Mar 31, 2018.
Under the standardized approach, Tier 1 capital ratiowas 13.6%, total capital ratiowas15.6% and leverage ratiowas7.6% compared with13.4%, 15% and 8.2%, respectively, as of Mar 31, 2017. These ratios exceeded regulatory requirements.
Return on average common equity was 16%,up from 11.6% in1Q17.Return on average assets was 1.24% compared with 0.96% in the prior-yearquarter.
Credit Quality
As of Mar 31, 2018,net charge-offstotaled $3 million, up 50% from $2 million in the prior-year quarter.
Nonperforming loans and leasesslumped 30.6% y/y to $124.7 million.The ratio of non-performing loans and leases to total loans and leases was 0.40% compared with 0.50% in 1Q17.
Nonperforming assets were $128.9 million, plunging 31% y/y.Total allowance for credit losses was $147.8million, down 22% y/y.
Capital Deployment
During 1Q18, the company repurchased 2.5 million shares for $263.2 million at an average price of $104.51 per share. This includes shares related to share-based compensation.
On Apr 18, 2018, Northern Trust announced a quarterly cash dividend of 42 cents per share on common stock. The dividend will be paid on Jul 1 to shareholders of record as of Jun 8.
Other
On Mar 21, 2018, Northern Trust raised its prime lending rate from 4.50% to 4.75%, effective Mar 22, 2018. Previously in December 2017, the bank had increased the rate to 4.50% from 4.25%.
On Jan 11, 2018,Northern Trustentered into an agreement with Citadel to acquire its Omnium technology platform. The transaction, which is expected to be completed by the first half of 2018, will provide Northern Trust with greater control over technological enhancements.
Notably, the software development rights of the technology platform will also be acquired by Northern Trust.
Once the team of key development professionals from Citadel collaborate with Northern Trust’s operations professionals, they will together be able to come up with more innovative solutions for alternative fund managers, asset managers, institutional investors and family offices.
Peter Cherecwich, president of Northern Trust Corporate & Institutional Services, noted, “We are excited to have the opportunity to bring this technology development team to Northern Trust. Their deep expertise has been a key contributor to our growth, and has been critical to our success in delivering solutions to our clients – which are among the world’s most sophisticated asset managers and institutional investors.”
Earlier in 2011, Northern Trust had acquired the Omnium hedge fund administration business of Citadel. After the acquisition, the business began to be known as Northern Trust Hedge Fund Services, which now provides services for hedge funds and large institutional investors, and offers middle office and administration services, including trade processing, asset servicing, valuation and profit and loss reporting, cash and collateral management etc.
Northern Trust Hedge Fund Services has now become a company with more than $350 billion in assets under administration, growing from $70 billion in assets under administration when it had been acquired.
While entering into this new agreement with Northern Trust, Gerald Beeson,chief operating officer of Citadel, said, “Citadel and Northern Trust have transformed the hedge fund administration industry through a combination of operational excellence and Citadel’s world-class technology. This change in our technology relationship with Northern Trust will enable each organization to better focus on their core strategies as both firms continue to experience significant growth.”
May 21, 2018