Northern Trust Upgraded to Neutral - Analyst Blog

We are upgrading our recommendation on Northern Trust Corporation (NTRS) to Neutral from Underperform based on the company's solid capital ratios, a competitive dividend yield and an attractive business model.

Northern Trust's third quarter earnings of 64 cents per share were below the Zacks Consensus Estimate of 72 cents, attributed to low interest rate environment and lingering economic recovery. The company reported earnings of 82 cents both in the prior quarter and prior-year quarter.

Northern Trust exhibits strong risk-based capital ratios as of September 30, 2010, with Tier 1 capital ratio of 13.2%, total risk-based capital ratio of 15.3% and leverage ratio of 9.3%, exceeding the regulatory requirements of 6%, 10%, and 5%, respectively. This classifies Northern Trust as a well-capitalized institution. The ratio of Tier 1 common equity to risk-weighted assets, a non-GAAP financial measure, was 12.7% as of September 30, 2010, in line with the prior-year period. 

Volatile equity market has been impacting the value of client assets in both Assets Under Management (AUM) and Assets Under Custody (AUC). However, after falling for four straight quarters, Northern Trust's AUM and AUC witnessed an increase since the second quarter of 2009. The turnaround in the equity markets is expected to benefit the company's AUM and AUC in the upcoming quarters.

In September 2010, the Basel III norms were established for a strong set of capital requirements. At the current level, the impact of Basel III on the company or its bank subsidiaries cannot be estimated as it has not yet been finalized and implemented by the federal banking agencies. However, based on the current Basel III regulations, the capital strength, balance sheet and business model of Northern Trust position it well for the near future.

Credit quality is a major concern for Northern Trust at this point. The company continues to suffer from the weakness in the broader economic environment. Further, Northern Trust's net interest margin (NIM) has been shrinking for the past seven quarters.

NIM is expected to remain under pressure due to the low interest rate environment amid weakening industry-wide credit trends. Equity markets deteriorated and low interest rates and spreads are expected to impact several revenue sources.

Further, the recession is phasing out, bringing in uncertain prospects, changes within the financial services industry and regulatory measures. The Dodd-Frank Act, among other things, may affect the company's leverage limits and elevate risk-based capital and liquidity requirements. Until the regulations of the Dodd-Frank Act fall in place, the company will not be able to fully assess the impact on its businesses.

We maintain our long-term Neutral recommendation on Northern Trust. Also, the company currently retains a Zacks #3 Rank, which translates into a short-term Hold rating.