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Morningstar | Tremendous Second-Quarter Results for Northern Trust; Raising Our Fair Value Estimate. See Updated Analyst Note from 18 Jul 2018

Wide-moat Northern Trust reported excellent second-quarter results that were again well ahead of our expectations for the firm. We are increasing our fair value estimate to $95 per share from $88 per share to reflect this, which is 2.4 times book value as of June and 12.9 times our 2019 earnings estimate. Northern Trust reported a return on average common equity of 16.5%, improving on the 16% level we saw last quarter. With management previously expecting a normalized return on equity range of 10%-15%, these were exceptional results. We had projected that the bank would hit 16% at some point after 2020, but now we are upping our long-term estimate to a 17% level. With more cost savings still left to realize, nicely expanding net interest margins, and solid growth for assets under management/custody and fee income, we expect Northern Trust will have even more quarters and years of strong performance ahead of it.

While markets were on a tear the past year, helping assets under custody/administration and assets under management increase 15% and 12% year over year, respectively, the quarter-over-quarter numbers were again a bit more subdued, at negative 1% overall growth for each. Trust, Investment, and other servicing fees were up 1% quarter over quarter, and noninterest income in total was roughly flat. Net interest income was the big driver during the quarter, up 8% quarter over quarter, with net interest margins expanding from 1.38% to 1.48%. We were again pleased with the expense control, with total noninterest expenses remaining essentially flat quarter over quarter, helping the firm realize operating leverage, although we note this was largely due to the gains in net interest income. Noninterest expense as a percentage of trust and investment fees remained flat in the quarter at 106%. Pretax FTE margins improved to 34.1%, the best results we have seen in years, and again largely driven by net interest income.

Northern Trust raised its quarterly dividend to $0.55 per share following the latest stress test results. Overall, given the bank's focus on maintaining excess capital as part of its business model, we don't expect the bank to significantly slim down its capital levels in the future.

For a more in-depth take on capital returns in the banking industry and the effects of changing stress-test regulations, please see our special report, "New Regulatory Proposals Will Change Stress Test Landscape," published on July 8.