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Morningstar | Northern Trust Not Immune To Market Movements, Core Businesses Still Look Strong

Wide-moat Northern Trust reported fourth-quarter results that were well within our expectations for the firm. Northern Trust was not immune to the tougher market environment in the fourth quarter, although the declines weren’t quite as bad as some peers.  While we do not expect to be making drastic changes to our current fair value estimate based on our initial reaction to earnings, we may lower it slightly as we more fully incorporate the results into our model. This would be primarily due to factoring in current and future market pressures.

Northern Trust reported a return on average common equity of 17% in the quarter, a high for the year. This brought the full year return on average common equity to 16.2%, above management’s previous goal range. Revenues (on a fully taxable equivalent basis) were up 5% for the quarter compared to last year’s fourth quarter, largely driven by net interest income (up 9%), while fee income was up 4%. Net interest margins increased to 1.52% in the quarter, up from 1.47% just last quarter, while average earning assets were down slightly for the year. We continue to see some additional rate sensitivity for the bank, even without any rate hikes in 2019. Based on management’s comments regarding deposit pricing, as well as the fact that portions of the balance sheet have yet to reprice, we could see a few additional basis points in NIM in 2019, albeit at a much slower pace than in the past.

Assets under management were down 8% year over year, with bigger declines in the corporate and institutional services segment (down 9%) versus the wealth management segment (down 4%). These declines came entirely in the fourth quarter. Due to lagged pricing effects, we could see additional fee pressure in the first quarter from the declines in assets in the fourth quarter. Assets under custody and administration were down 6% for the year. Despite these declines, total C&IS fees were down 1% compared with the third quarter (although some of this should flow through into the first because of pricing lags), while wealth management fees were flat. These results do support the thesis that, while Northern Trust is certainly market-sensitive, it is not quite a one-to-one effect. Further, management provided interesting color around the pricing pressure they are seeing, which sounded less drastic than what at least one peer has noted. This could be partially due to Northern Trust’s focus on more complex clients on the asset servicing side, and the bank’s high-net-worth and ultra-high-net-worth clients also tend to be stickier and more complex, giving opportunities to add more value. We don't see this dynamic changing.

Management stuck to their overall organic fee growth goals of 4%-5%, despite the more difficult environment, and stated that there is still room to manage organic expense growth within a similar range. We like Northern Trust’s conservative balance sheet, holding significant capital, as well as the bank’s ability to further control expenses in the face of a tougher fee environment. We also think that Northern Trust’s less dire commentary, and the lack of a need to drastically alter operations related to the expense base, show that the bank has been well-run. We don’t foresee much of an increase in sustainable return on equity levels for the bank from here, and the bank remains sensitive to overall market movements, but its core businesses still look healthy.

For a more detailed view of our expectations regarding interest rates and their effects on banking profitability, please see our December 2018 Observer, "The Return of the Bank: Net Interest Margins Reach a Turning Point--Funding Advantages and Net Interest Income."