Interest rate, stock market uncertainties weigh on Northern Trust outlook

By Harvard Zhang

Analysts covering Northern Trust Corp. are divided on the financial holding company’s year ahead thanks to a mix of unclear macroeconomic influencers, the corporation’s growth opportunities and its uncertain ability to wield the ax on expenses.

Clouds gather over the Chicago-based corporation’s outlook with unclear interest rate movements and a volatile equity market. On the other hand, analysts see bright spots in Northern Trust’s growing market share, burgeoning new businesses and its century-old goodwill.

“Even with the contraction in the first half of this year, they’ll still outperform their peers because they continue to gain market share,” said Marty Mosby, an analyst with Memphis, Tenn.-based brokerage Vining Sparks IBG LP.

Northern Trust manages and administers assets and provides custodian services for institutions and affluent families with a relatively conservative approach. The company has 16,500 employees in more than 20 locations globally.

A mix of uncertainties, expectations and tailwinds produce a wide variety of ratings of the stock: 13 out of 23 analysts polled by Bloomberg LP give a hold recommendation, while six say buy and four others sell.

Analysts expect the company’s stock price to rise 8.9 percent to $69.82 in a year from Wednesday’s close of $63.64. The shares have dropped 11.7 percent this year through March 9. In comparison, Standard & Poor’s 500 index declined 2.7 percent in that time frame, while S&P 500 Financials index dropped 8.5 percent.

Northern Trust’s stock price

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Northern Trust’s shares dropped 11.7 percent this year as of March 9, while the S&P 500 declined 2.7 percent. (Harvard Zhang/MEDILL)

Northern’s Wednesday stock price was more than 15 times the estimated per-share earnings this year, 27 percent above the price-earnings multiple of The Bank of New York Mellon Corp. and 35 percent more than State Street Corp., Northern’s most prominent competitors.

Northern improved its return on common equity – measuring the profitability of its shareholders’ investment – to 11.4 percent in 2015 from 9.9 percent a year ago.

However, analysts forecast a 2016 net income of $952.6 million, or per-share earnings of $4.06, up just a slight 1.9 percent from last year’s $935 million, or $3.99 per share.

Northern Trust’s net income

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Analysts forecast a 2016 net income of $952.6 million, up 1.9 percent from last year’s $935 million. (Harvard Zhang/MEDILL)

Interest rate hikes?

Analysts say an anticipated interest-rate increase by the Federal Reserve this year will do away with Northern’s tens of millions of money-market fee waivers, which are meant to avoid negative yields for investors reaping minuscule returns on the beaten-down money-market funds.

More than 40 percent of economists said the next interest-rate hike would be in June, a March Bloomberg LP survey of 44 economists found. The next Fed meeting takes place next week.

“One more rate hike of 25 basis points, and they should be able to do away with the negative waived fees they’ve got,” said Mosby of Vining Sparks, who gave a “strong buy” to the stock and a 12-month target price of $73. “You’ll start looking at net interest margin and interest they’ll generate from their assets going marginally higher, even though short-term interest rates can move very slowly, but surely to a higher level.”

Historically-low interest rates continue to weigh on Northern’s revenue, even though the $20.5-million money market mutual fund fees the company wrote off in the latest quarter was $12.5 million less than a year ago due to the December rate hike.

Yields on money-market mutual funds’ investments in such liquid obligations as Treasury bills and commercial paper quickly follow the Fed’s changes in the fed-funds rate.

Stock market fluctuation

The outlook for the firm’s colossal servicing fee revenues remain unclear, as the U.S. equity market hasn’t recovered the loss this year despite a three-week rally. Fees are based on the values of assets under management, so they rise and fall with stock prices.

The firm’s assets under management shrunk 6.3 percent to $875.3 million at the end of last year from $934.1 million a year ago.

“Northern and its peers have been struggling with relatively risk-off investor environment which is hard on their revenues,” said Jeffery Harte, a Chicago-based analyst at Sandler O’Neill & Partners LP, referring to investors’ pulling money out of the stock market and looking for less risky investments.

“It’ll get better if risk aversion backs off a bit so people start putting more money into equities and alternatives again,” said Harte, who gives Northern Trust a buy rating and a target price of $68.

Growth opportunities

Northern Trust has been grabbing a larger market share as it explores less price-sensitive areas like outsourced risk, IT and administrative management services for other financial firms, landing global deals and keeps attracting affluent families with its prudent investment strategies.

“Northern Trust has a kind of unique growth opportunity as compared to large peers like the Bank of New York and State Street,” Harte said. “It has enough skills to be significant, but still has a small enough market share that they can grow by getting market share.”

The corporation had $6.1 trillion of assets under custody at the end of 2015, only 6 percent of the custody-business market comparing with Bank of New York Mellon’s and State Street’s 30-percent share each, a Vining Sparks research showed.

Northern Trust has been growing its assets under custody at an annual pace of 9 percent compared with a market average growth rate of 5 percent for banks with custody assets.

Market shares: Assets under custody

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Northern Trust has been growing its assets under custody at an annual pace of 9 percent comparing with a market average growth rate of 5 percent for banks with custody assets. (Harvard Zhang/MEDILL)

The corporation has been winning affluent international clients and global custody mandates for pension plans. Non-U.S. revenue was $1.36 billion in 2015, or 28.9 percent of the total, up 38.5 percent in five years.

“They’ve found their niche to be able to work globally, and that’s where you started to see some growth,” Mosby of Vining Sparks said. “While State Street was getting business in Europe, Northern was able to go into Australia and help them set up a social security system.”

Curbing expenses

In addition to an unclear revenue outlook, the Chicago custodian firm finds it hard to cut spending on regulatory compliance, white-glove service for clients, and technology upgrades to improve efficiency and security.

Northern Trust CEO Frederick Waddell saw a modest pay increase in 2015 to $12.8 million from $12.4 million a year ago, the company’s March 9 proxy statement showed. Crain’s reported last month Northern froze the salaries of its U.S. and European staff until October.

The company’s expenses growth in the fourth quarter of 2015 from the year-earlier period was approximately 3 percentage points greater than the revenue growth, according to a research report by New York City-based Portales Partners LLC found.

“Expenses will be flat at best, and most likely higher in a year,” said Paul Gulberg, a Portales Partners analyst, in a phone interview. He  gives an underperform to Northern Trust stock, predicting it will trail the S&P Financials index by 5 percentage points in the next year.

“They’ve been cutting expenses so it’s hard to cut much further, and they have to spend more money on regulatory expenses and technology,” he said.

Photo at top: Northern Trust building on LaSalle Steet in downtown Chicago. Analysts are divided on the company’s year ahead. (Harvard Zhang/MEDILL)