DBRS Initiates Coverage of Northern Trust Corporation–Issuer & Senior Debt at AA (low), Trend Stable

DBRS has today initiated coverage of Northern Trust Corporation(Northern Trust or the Company) and its primary banking subsidiary, The Northern Trust Company (Bank). DBRS has assigned an Issuer & Senior Debt rating of AA (low) to Northern Trust and a Deposits & Senior Debt rating of AA to the Bank. At the same time, Northern Trust has been assigned a Short-Term Instruments rating of R-1 (middle), while the Bank has been assigned a Short-Term Instruments rating of R-1 (high). The trend on all ratings is Stable.

The ratings are underpinned by Northern Trust’s premier personal trust business, as well as leading market positions in asset servicing and asset management. These globally diverse fee-based businesses provide stable, recurring revenue streams that are less capital-intensive. The ratings are further supported by a conservative management team that has demonstrated a firm commitment to maintaining a strong balance sheet throughout all types of cycles. Indeed, the Company’s capital, liquidity and asset quality are among the best in the industry. The ratings also take into account the elevated levels of operational and reputational risk that Northern Trust faces given its role servicing and managing client assets on a global basis. Today’s low interest rate environment has produced several revenue headwinds including reduced securities lending spreads and a pressured net interest margin (NIM). Nonetheless, DBRS believes the Company is well-positioned to continue to deliver strong operating results while maintaining its sound balance sheet.

With $3.7 trillion in assets under custody (AUC) and $627.2 billion in assets under management (AUM), Northern Trust is a major player in custody and asset management. The Company’s three primary business lines all have attractive growth prospects, especially outside of the U.S. where wealth creation and capital market activities are increasing at a faster rate.

Northern Trust’s Personal Financial Services (PFS) business boasts the largest personal trust company in the U. S. by assets. DBRS notes that PFS clients typically have at least $1 million in investable assets, while its successful Wealth Management Group targets families with over $200 million in investable assets. Within the U.S., the Company has 79 offices in 18 states that are within a 45 minute drive of over 50% of all millionaires and has particularly dominant positions within Illinois and Florida. Currently, Northern Trust is evaluating opportunities to increase client penetration rates in the Northeast, mid-Atlantic and West Coast regions.

Corporate & Institutional Services (C&IS), which provides a wide range of asset servicing products and services to corporate and institutional clients, has 18 locations worldwide and clients in 41 countries.

In total, Northern Trust has $3.7 trillion in AUC, with 53% being global in nature. While AUC trails the industry leader by a wide margin, the Company has a solid market position, has sufficient scale to be competitive and continues to win its fair share of new business.

Clients of both of these businesses are supported by Northern Trust Global Investments (NTGI), the Company’s asset management arm, which is the 13th largest investment manager in the world.

For the sixth consecutive year, the Company reported record net income. Specifically, operating net income, which excludes the impact of Visa (the IPO gain and the reductions of indemnification liability), increased 33% to $853.0 million from $641.3 million in 2008. Positively, both AUC and AUM saw double digit increases primarily from improving market valuations, as well as new business wins. However, both foreign exchange trading and securities lending, two very important earnings drivers, remain under pressure. Indeed, foreign exchange (FX) trading revenues declined $170.5 million, or 28%, driven by lower volatility and weaker volumes. Meanwhile, securities lending (excluding certain adjustments made to a mark-to-market investment fund) fell approximately $302 million suffering from lower spreads and reduced volumes. DBRS expects these two businesses to remain important revenue drivers for the Company despite recent weakness. Securities lending in particular should benefit from increasing interest rates and should rebound in the near term, especially once rates increase. In 2009, fee-based revenues represented a very high 73% of total revenues with trust, investment and other servicing fee contributing over half of all revenues.

DBRS notes that 2008 results were negatively impacted by significant client support related pre-tax charges of $536.3 million, which exemplify the operating and reputational risks of the business. While under no contractual obligation to do so, Northern Trust incurred these significant charges to support their clients. DBRS notes that these actions caused a 3Q08 quarterly loss, but should benefit revenues in the long-term by not only retaining existing clients, but attracting new clients as well.

Besides having strong capital generation abilities, Northern Trust’s business model is highly focused on its clients and is very scalable. DBRS notes that the Company has an impressive track record of delivering positive operating leverage from year to year. Specifically, Northern Trust has had positive or neutral operating leverage in 18 of the past 22 years, an impressive feat.

The balance sheet is one of the strongest in the industry and is conservatively managed. Indeed, management has demonstrated a commitment to building capital and maintaining a fortress balance sheet. In 2Q09, Northern Trust raised $834.1 million in common equity to bolster its capital position and help repay TARP funds. Capital metrics remain robust with a 13.0% Tier 1 common equity to risk-weighted assets ratio and the Company’s tangible common equity ratio remains above 7%. As a result of its strong balance sheet, DBRS notes that the Company was one of the few banks to maintain its dividend level throughout the economic downturn.

While Northern Trust has avoided the securities issues of its major competitors, the Company does have moderately higher credit risk through a larger loan portfolio. Indeed, loans represented 34% of period end assets compared to 17% at the next closest trust bank. That being said, asset quality remains relatively strong, as clients tend to be solid companies or wealthy individuals. Northern Trust uses its balance sheet in order to win other fee-based business from these clients. Nonperforming assets (NPAs) increased modestly during 4Q09 reaching a relatively strong 1.11% of total loans + OREO. Meanwhile, net charge-offs (NCOs) declined during the fourth quarter to $32.4 million, or a manageable 0.46% of average loans. DBRS notes that the loan loss reserve more than covers nonperforming loans. Given potential issues within the commercial real estate portfolio, which represents 11% of total loans, management was not ready to call a peak in credit issues.


Notes:
All figures are in U.S. dollars unless otherwise noted.

This rating is based on public information.

The applicable methodologies are Global Methodology for Rating Banks and Banking Organisations, and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.

For more information on this credit or on this industry, visit www.dbrs.com or contact us at info@dbrs.com.

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