-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NBmQ3SVgbiMyVM3FBBjBaQi6pdySXvbQWlhoMFwKjfBd6XDvGficpiQ3Og/sgmE3 MBH+dqXyA574+ucuOgGR1g== 0000950131-99-001510.txt : 19990317 0000950131-99-001510.hdr.sgml : 19990317 ACCESSION NUMBER: 0000950131-99-001510 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 11 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990316 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NORTHERN TRUST CORP CENTRAL INDEX KEY: 0000073124 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 362723087 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-05965 FILM NUMBER: 99566057 BUSINESS ADDRESS: STREET 1: 50 S LASALLE ST CITY: CHICAGO STATE: IL ZIP: 60675 BUSINESS PHONE: 3126306000 FORMER COMPANY: FORMER CONFORMED NAME: NORTRUST CORP DATE OF NAME CHANGE: 19780525 10-K 1 FORM 10-K - -------------------------------------------------------------------------------- UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ---------------- FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _______________ Commission File Number 0-5965 Northern Trust Corporation (Exact name of registrant as specified in its charter) Delaware 36-2723087 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 50 South La Salle Street Chicago, Illinois 60675 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (312)630-6000 ---------------- Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $1.66 2/3 Par Value ---------------- Preferred Stock Purchase Rights ---------------- Floating Rate Capital Securities, Series A of NTC Capital I, and Series B of NTC Capital II Fully and Unconditionally Guaranteed by the Registrant ---------------- Floating Rate Junior Subordinated Debentures, Series A and Series B of the Registrant (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [_] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] At February 10, 1999, 111,366,724 shares of Common Stock, $1.66-2/3 par value, were outstanding, and the aggregate market value of the Common Stock (based upon the last sale price of the common stock at February 10, 1999, as reported by The Nasdaq Stock Market) held by non-affiliates was approximately $8,315,111,639. Determination of stock ownership by non-affiliates was made solely for the purpose of responding to this requirement and the registrant is not bound by this determination for any other purpose. Portions of the following documents are incorporated by reference: Annual Report to Stockholders for the Fiscal Year Ended December 31, 1998 - Part I and Part II 1999 Notice and Proxy Statement for the Annual Meeting of Stockholders to be held on April 20, 1999 - Part III - -------------------------------------------------------------------------------- [THIS PAGE INTENTIONALLY LEFT BLANK] Northern Trust Corporation FORM 10-K Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 TABLE OF CONTENTS
Page PART I Item 1 Business ............................................................... 4 Supplemental Item-Executive Officers of the Registrant ................. 22 Item 2 Properties ............................................................. 23 Item 3 Legal Proceedings ...................................................... 24 Item 4 Submission of Matters to a Vote of Security Holders .................... 24 PART II Item 5 Market for Registrant's Common Equity and Related Stockholder Matters .. 25 Item 6 Selected Financial Data ................................................ 25 Item 7 Management's Discussion and Analysis of Financial Condition and Results of Operations .................................................. 25 Item 7A Quantitative and Qualitative Disclosures About Market Risk ............. 25 Item 8 Financial Statements and Supplementary Data ............................ 25 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ................................................... 25 PART III Item 10 Directors and Executive Officers of the Registrant ..................... 26 Item 11 Executive Compensation ................................................. 26 Item 12 Security Ownership of Certain Beneficial Owners and Management ......... 26 Item 13 Certain Relationships and Related Transactions ......................... 26 PART IV Item 14 Exhibits, Financial Statement Schedules, and Reports on Form 8-K ....... 27 Signatures ....................................................................... 29 Exhibit Index .................................................................... 30
3 PART I Item 1--Business NORTHERN TRUST CORPORATION Northern Trust Corporation (Corporation) was organized in Delaware in 1971 and that year became the owner of all of the outstanding capital stock, except directors' qualifying shares, of The Northern Trust Company (Bank), an Illinois banking corporation headquartered in the Chicago financial district and the Corporation's principal subsidiary. The Corporation also owns banking subsidiaries in Arizona, California, Colorado, Florida and Texas, a Federal Savings Bank in Michigan, trust companies in Connecticut and New York and various other nonbank subsidiaries, including a securities brokerage firm, a registered investment adviser and a retirement services company. The Corporation expects that, although the operations of other subsidiaries will be of increasing significance, the Bank will in the foreseeable future continue to be the major source of the Corporation's assets, revenues and net income. Except where the context otherwise requires, the term "Northern Trust" refers to Northern Trust Corporation and its consolidated subsidiaries. At December 31, 1998, Northern Trust had consolidated total assets of approximately $27.9 billion and stockholders' equity of approximately $1.9 billion, and was the second largest bank holding company headquartered in Illinois and the 32nd largest in the United States. THE NORTHERN TRUST COMPANY The Bank was founded by Byron L. Smith in 1889 to provide banking and trust services to the public. Currently in its 110th year, the Bank's growth has come primarily from internal sources rather than through merger or acquisition. At December 31, 1998, the Bank had consolidated assets of approximately $23.3 billion and common equity capital of approximately $1.5 billion. At September 30, 1998, the Bank was the 2nd largest bank in Illinois and the 36th largest in the United States, based on consolidated total assets of approximately $23.9 billion on that date. The Bank currently has eighteen banking offices in the Chicago area and nine active wholly owned subsidiaries. The Northern Trust International Banking Corporation, located in New York, was organized under the Edge Act for the purpose of conducting international business. NorLease, Inc. conducts leasing and leasing-related lending activities. MFC Company, Inc. holds properties that are received from the Bank in connection with certain problem loans. Nortrust Nominees Ltd., located in London, is a U.K. trust corporation organized to hold U.K. real estate for fiduciary accounts. The Northern Trust Company U.K. Pension Plan Limited, located in London, was established in connection with the pension plan for the Bank's London Branch. The Northern Trust Company, Canada, located in Toronto, offers institutional trust products and services to Canadian entities. Northern Global Financial Services Limited, located in Hong Kong, provides securities lending and relationship servicing for large asset custody clients in Asia and the Pacific Rim. Northern Trust Trade Services Limited facilitates the issuance and processing of commercial letters of credit in Hong Kong. Northern Trust Fund Managers (Ireland) Limited was established to facilitate the offering of off-shore collective investment products to institutional clients. OTHER NORTHERN TRUST CORPORATION SUBSIDIARIES The Corporation's Florida banking subsidiary, Northern Trust Bank of Florida N.A., headquartered in Miami, at December 31, 1998 had twenty-four offices located throughout Florida and total assets of approximately $3.1 billion. The Corporation's Arizona banking subsidiary, Northern Trust Bank of Arizona N.A., is headquartered in Phoenix and at December 31, 1998 had total assets of approximately $587 million and served clients from seven office locations in Arizona. The Corporation's Texas banking subsidiary, Northern Trust Bank of Texas N.A., headquartered in Dallas, had seven office locations and total assets of approximately $587 million at December 31, 1998. The Corporation's California banking subsidiary, Northern Trust Bank of California N.A., is headquartered in Santa Barbara. At December 31, 1998, it had nine office locations and total assets of approximately $807 million. The Corporation's Colorado banking subsidiary, Northern Trust Bank of Colorado, was acquired in 1998. Its one location is in Denver and, at December 31, 1998, it had total assets of approximately $48 million. The Corporation's Federal Savings Bank subsidiary, Northern Trust Bank, FSB, commenced operations in Bloomfield Hills, Michigan in 1998. At December 31, 1998, it had total assets of approximately $14 million. 4 The Corporation has several nonbank subsidiaries. Among them is Northern Trust Securities, Inc. which provides full brokerage services to clients of the Bank and the Corporation's other banking and trust subsidiaries and selectively underwrites general obligation tax-exempt securities. Northern Trust Retirement Consulting, L.L.C. is a retirement benefit plan services company in Atlanta, Georgia. Northern Trust Global Advisors, Inc. in Stamford, Connecticut is an international provider of institutional investment management services, and the parent of The Northern Trust Company of Connecticut, and Northern Trust Quantitative Advisors, Inc. is a manager of index funds and quantitative investment products. Northern Investment Corporation holds certain investments, including a loan made to a developer of a property in which the Bank is the principal tenant. The Northern Trust Company of New York provides security clearance services for all nondepository eligible securities held by trust, agency, and fiduciary accounts administered by the Corporation's subsidiaries. Northern Trust Cayman International, Ltd. provides fiduciary services to clients residing outside of the United States. In 1998, Northern Trust exited from the futures brokerage business previously conducted by Northern Futures Corporation and sold all the assets of Berry, Hartell, Evers & Osborne, Inc., its San Francisco investment management firm. INTERNAL ORGANIZATION Northern Trust, under Chairman and Chief Executive Officer William A. Osborn, organizes client services around two principal business units: Corporate and Institutional Services and Personal Financial Services. Investment products are provided to the clients of those business units by Northern Trust Global Investments. Each of these three business units has a president who reports to President and Chief Operating Officer Barry G. Hastings. The Worldwide Operations and Technology business unit, which provides trust and banking operations and systems activities, also reports to Mr. Hastings. A Risk Management unit, which focuses on financial and risk management, reports directly to Mr. Osborn. The following is a brief summary of each unit's business activities. Corporate and Institutional Services (C&IS) Headed by Sheila A. Penrose, President - Corporate and Institutional Services, C&IS provides trust, commercial banking and treasury management services to corporate and institutional clients. Trust activities encompass custody services for owners of securities in the United States and foreign markets, as well as securities lending and asset management services. Services with respect to securities traded in foreign markets are provided primarily through the Bank's London Branch. Related foreign exchange services are rendered at the London and Singapore Branches as well as in Chicago. As measured by assets administered and by number of clients, Northern Trust is a leading provider of Master Trust and Master Custody services to three defined market segments: retirement plans, institutional clients and international clients. Master Trust and Custody includes a full range of state-of-the-art capabilities including: worldwide custody settlement and reporting, cash management, a wide range of investment products, securities lending, and performance analysis services. In addition to Master Trust and Master Custody, C&IS offers a comprehensive array of retirement consulting and recordkeeping services through Northern Trust Retirement Consulting, L.L.C. At December 31, 1998, total assets under administration, excluding personal trust assets, were $1.14 trillion. The Northern Trust Company of New York, The Northern Trust Company, Canada, Norlease, Inc., and The Northern Trust International Banking Corporation are also included in C&IS. C&IS offers a full range of commercial banking services through the Bank, placing special emphasis on developing institutional relationships in two target markets: large domestic corporations and financial institutions (both domestic and international). Treasury management services are provided to corporations and financial institutions and include a variety of other products and services to accelerate cash collections, control disbursement outflows and generate information to manage cash positions. Personal Financial Services (PFS) Services to individuals is another major dimension of the trust business. Headed by Mark Stevens, President - Personal Financial Services, PFS encompasses personal trust and investment management services, estate administration, banking and residential real estate mortgage lending. The Bank's personal financial services strategy includes targeting high net worth individuals in the metropolitan Chicago market and, through its Wealth Management Group, nationally. The Bank is one of the largest bank managers of personal trust assets in the United States, with $40.5 billion in assets under management and $77.0 billion in assets under administration at December 31, 1998. 5 PFS services are also delivered through a network of banking subsidiaries located in Arizona, California, Colorado, Florida and Texas, and a Federal Savings Bank subsidiary in Michigan. PFS is one of the largest bank managers of personal trust assets in the United States, with $73.4 billion in assets under management and $121.2 billion in assets under administration at December 31, 1998. Northern Trust Securities, Inc. is also part of PFS. Northern Trust Global Investments (NTGI) Headed by Stephen B. Timbers, President - Northern Trust Global Investments, NTGI, through various subsidiaries of the Corporation, provides investment products and services to clients of C&IS and PFS. NTGI activities include equity and fixed income research and portfolio management services. NTGI, through the Bank and Northern Trust Quantitative Advisors, Inc., provides investment advisory and related services to two families of proprietary mutual funds: the Northern Institutional Funds (formerly The Benchmark Funds), which are directed at corporate and institutional investors, and the Northern Funds, which are directed at individual and personal trust investors. Northern Trust Global Advisors, Inc. is also included in NTGI. Worldwide Operations and Technology Supporting all of Northern Trust's business activities is the Worldwide Operations and Technology Unit. Headed by Executive Vice President James J. Mitchell, this unit focuses on supporting sales, relationship management, transaction processing and product management activities for C&IS and PFS. These activities are conducted principally in the operations and technology centers in Chicago, Illinois and the Bank's London Branch. The Northern Trust Company of New York is also part of this unit. Risk Management The Risk Management Unit, headed by Senior Executive Vice President and Chief Financial Officer Perry R. Pero, includes the Credit Policy and Treasury functions. The Credit Policy function is described in the sections of this report referenced on page 18. The Treasury Department is responsible for managing the Bank's wholesale funding, capital position and interest rate risk, as well as the portfolio of interest rate risk management instruments under the direction of the Corporate Asset and Liability Policy Committee. It is also responsible for the investment portfolios of the Corporation and the Bank and provides investment advice and management services to the subsidiary banks. The Risk Management Unit also includes the Corporate Controller, Corporate Treasurer, Investor Relations and Economic Research functions. GOVERNMENT POLICIES The earnings of Northern Trust are affected by numerous external influences. Chief among these are general economic conditions, both domestic and international, and actions that the United States and foreign governments and their central banks take in managing their economies. These general conditions affect all of the Northern Trust's businesses, as well as the quality, value and profitability of their loan and investment portfolios. The Board of Governors of the Federal Reserve System is an important regulator of domestic economic conditions and has the general objective of promoting orderly economic growth in the United States. Implementation of this objective is accomplished by its open market operations in United States Government securities, its setting of the discount rate at which member banks may borrow from Federal Reserve Banks and its changes in the reserve requirements for deposits. The policies adopted by the Federal Reserve Board may strongly influence interest rates and hence what banks earn on their loans and investments and what they pay on their savings and time deposits and other purchased funds. Fiscal policies in the United States and abroad also affect the composition and use of Northern Trust's resources. COMPETITION Northern Trust's principal business strategy is to provide quality financial services to targeted market segments in which it believes it has a competitive advantage and favorable growth prospects. As part of this strategy, Northern Trust seeks to deliver a level of service to its clients that distinguishes it from its competitors. In addition, Northern Trust emphasizes the development and growth of recurring sources of fee-based income and 6 is one of a small group of major bank holding companies in the United States that generates more revenues from fee-based services than from net interest income. Northern Trust seeks to develop and expand its recurring fee-based revenue by identifying selected market niches and providing a high level of individualized service to its clients in those markets. Northern Trust also seeks to preserve its asset quality through established credit review procedures and by maintaining a conservative balance sheet. Finally, Northern Trust seeks to maintain a strong management team that includes senior officers having broad experience and long tenure. Active competition exists in all principal areas in which Northern Trust presently engages in business. C&IS and PFS compete with domestic and foreign financial institutions, trust companies, personal loan companies, mutual funds and investment advisers, brokerage firms and other financial services companies. Northern Trust is a leading provider of Master Trust and Master Custody services and has the leading market share in the Chicago area personal trust market and the second largest market share in the Florida personal trust market. Commercial banking and treasury management services compete with domestic and foreign financial institutions, finance companies and leasing companies. These products also face increased competition due to the general trend among corporations and other institutions to rely more upon direct access to the credit and capital markets (such as through the direct issuance of commercial paper) and less upon commercial banks and other traditional financial intermediaries. The chief local competitors of the Bank for trust and banking business are Bank of America, First National Bank of Chicago, Harris Trust and Savings Bank, and LaSalle National Bank. Competitive pressures within the custody market have resulted in consolidation in the industry, and the chief national competitors of the Bank for Master Trust/Master Custody services are now Mellon Bank Corporation, State Street Corporation, Bankers Trust New York Corporation, Chase Manhattan Corporation and The Bank of New York Company, Inc. REGULATION AND SUPERVISION The Corporation is a bank holding company subject to the Bank Holding Company Act of 1956, as amended (Act), and to regulation by the Board of Governors of the Federal Reserve System. The Act limits the activities which may be engaged in by the Corporation and its nonbanking subsidiaries to those so closely related to banking or managing or controlling banks as to be a proper incident thereto. Also, under section 106 of the 1970 amendments to the Act and subject to certain exceptions, subsidiary banks are prohibited from engaging in certain tie-in arrangements with nonbanking affiliates in connection with any extension of credit or provision of any property or services. The Act also prohibits bank holding companies from acquiring substantially all the assets of or owning more than 5% of the voting shares of any bank or nonbanking company which is not already majority owned without prior approval of the Board of Governors. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (Interstate Act) permits an adequately capitalized and adequately managed bank holding company to acquire, with Federal Reserve Board approval, a bank located in a state other than the bank holding company's home state, without regard to whether the transaction is permitted under any state law, except that a host state may establish by statute the minimum age of its banks (up to a maximum of 5 years) subject to acquisition by out-of-state bank holding companies. The Federal Reserve Board may not approve the acquisition if the applicant bank holding company, upon consummation, would control more than 10% of total U.S. insured depository institution deposits or more than 30% of the host state's total insured depository institution deposits except in certain cases. The Interstate Act also permits a bank, with the approval of the appropriate federal bank regulatory agency, to establish a de novo branch in a state, other than the bank's home state, in which the bank does not presently maintain a branch if the host state has enacted a law that applies equally to all banks and expressly permits all out-of-state banks to branch de novo into the host state. Banks having different home states may, with approval of the appropriate federal bank regulatory agency, merge across state lines, unless the home state of a participating bank opted-out of the Interstate Act prior to June 1, 1997. Two states opted out prior to that date: Montana and Texas. In addition, the Interstate Act permits any bank subsidiary of a bank holding company to receive deposits, renew time deposits, close loans, service loans and receive payments on loans and other obligations as agent for a bank or certain grandfathered thrift affiliates, whether such banks and thrifts are located in a different state or in the same state. 7 Under the Federal Deposit Insurance Act (FDIA), an insured depository institution which is commonly controlled with another insured depository institution shall generally be liable for any loss incurred, or reasonably anticipated to be incurred, by the Federal Deposit Insurance Corporation (FDIC) in connection with the default of such commonly controlled institution, or for any assistance provided by the FDIC to such commonly controlled institution, which is in danger of default. The term "default" is defined to mean the appointment of a conservator or receiver for such institution. Thus, any of the Corporation's banking subsidiaries could incur liability to the FDIC pursuant to this statutory provision in the event of a loss suffered by the FDIC in connection with any of the Corporation's other banking subsidiaries (whether due to a default or the provision of FDIC assistance). Such liability is subordinated in right of payment to deposit liabilities, secured obligations, any other general or senior liability and any obligation subordinated to depositors or other general creditors, other than obligations owed to any affiliate of the depository institution (with certain exceptions) and any obligations to shareholders in such capacity. Although neither the Corporation nor any of its nonbanking subsidiaries may be assessed for such loss under the FDIA, the Corporation has agreed to indemnify each of its banking subsidiaries, other than the Bank, for any payments a banking subsidiary may be liable to pay to the FDIC pursuant to these provisions of the FDIA. The Bank is a member of the Federal Reserve System, its deposits are insured by the FDIC, and it is subject to regulation by both these entities, as well as by the Illinois Office of Banks and Real Estate. The Bank is also a member of and subject to the rules of the Chicago Clearinghouse Association, and is registered as a government securities dealer in accordance with the Government Securities Act of 1986. As a government securities dealer its activities are subject to the rules and regulations of the Department of the Treasury. The Bank is registered as a transfer agent with the Federal Reserve and is therefore subject to the rules and regulations of the Federal Reserve in this area. State laws governing the Corporation's banking subsidiaries generally allow each bank to establish branches anywhere in its state. The national bank subsidiaries are members of the Federal Reserve System and the FDIC and are subject to regulation by the Comptroller of the Currency. Northern Trust Bank, FSB is a Federal Savings Bank which is not a member of the Federal Reserve System and is subject to regulation by the Office of Thrift Supervision and the FDIC. Northern Trust Bank of Colorado, a state chartered institution that also is not a member of the Federal Reserve System, is regulated by the FDIC and the Colorado Division of Banking. The Corporation's nonbanking affiliates are all subject to examination by the Federal Reserve. In addition, The Northern Trust Company of New York is subject to regulation by the Banking Department of the State of New York. Northern Trust Securities, Inc. is registered as a broker-dealer with the Securities and Exchange Commission and is a member of the National Association of Securities Dealers, Inc., and, as such, is subject to the rules and regulations of both these bodies. Northern Trust Retirement Consulting, L.L.C., Northern Trust Global Advisors, Inc., Northern Trust Quantitative Advisors, Inc., and Northern Trust Bank, FSB are each registered with the Securities and Exchange Commission under the Investment Advisers Act of 1940 and are subject to that Act and the rules and regulations of the Commission promulgated thereunder. In addition, Northern Trust Quantitative Advisors, Inc. is subject to regulation by the Illinois Office of Banks and Real Estate, and Northern Trust Retirement Consulting, L.L.C. is registered as a transfer agent with the Securities and Exchange Commission under the Securities Exchange Act of 1934 and is subject to that Act and the rules and regulations of the Commission promulgated thereunder. The Northern Trust Company of Connecticut is subject to regulation by the Connecticut Department of Banking. Two families of mutual funds for which the Bank acts as investment adviser are subject to regulation by the Securities and Exchange Commission under the Investment Company Act. The Bank also acts as investment adviser of an investment company which is subject to regulation by the Central Bank of Ireland under the Companies Act, 1990. Various other subsidiaries and branches conduct business in other states and foreign countries and are subject to their regulations and restrictions. The Corporation and its subsidiaries are affiliates within the meaning of the Federal Reserve Act so that the banking subsidiaries are subject to certain restrictions with respect to loans to the Corporation or its nonbanking subsidiaries and certain other transactions with them or involving their securities. Information regarding these restrictions, and dividend restrictions on banking subsidiaries, is incorporated herein by reference to Note 15 titled "Restrictions on Subsidiary Dividends and Loans or Advances" on page 60 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. 8 Under the FDIC's risk-based insurance assessment system, each insured bank is placed in one of nine risk categories based on its level of capital and other relevant information. Each insured bank's insurance assessment rate is then determined by the risk category in which it has been classified by the FDIC. There is currently a twenty-seven basis point spread between the highest and lowest assessment rates, so that banks classified as strongest by the FDIC are subject in 1999 to no insurance assessment, and banks classified as weakest by the FDIC are subject to an assessment rate of .27%. In addition to its insurance assessment, each insured bank is subject in 1999 to a debt service assessment of .0122%. The Federal bank regulators have adopted risk-based capital guidelines for bank holding companies and banks. The minimum ratio of qualifying total capital to risk-weighted assets, including certain off-balance sheet items (Total Capital Ratio), is 8%, and the minimum ratio of that portion of total capital that is comprised of common stock, related surplus, retained earnings, noncumulative perpetual preferred stock, minority interests and, for bank holding companies, a limited amount of qualifying cumulative perpetual preferred stock, less certain intangibles including goodwill (Tier 1 capital), to risk- weighted assets is 4%. The balance of total capital may consist of other preferred stock, certain other instruments, and limited amounts of subordinated debt and the loan and lease loss allowance. The Federal Reserve Board risk-based capital standards contemplate that evaluation of capital adequacy will take account of a wide range of other factors, including overall interest rate exposure; liquidity, funding and market risks; the quality and level of earnings; investment, loan portfolio, and other concentrations of credit; certain risks arising from nontraditional activities; the quality of loans and investments; the effectiveness of loan and investment policies; and management's overall ability to monitor and control financial and operating risks including the risks presented by concentrations of credit and nontraditional activities. In addition, the Federal Reserve has established minimum Leverage Ratio (Tier 1 capital to quarterly average total assets) guidelines for bank holding companies and banks. These guidelines provide for a minimum Leverage Ratio of 3% for bank holding companies and banks that meet certain specified criteria, including having the highest regulatory rating. All other banking organizations are required to maintain a Leverage Ratio of at least 3% plus an additional cushion of 100 to 200 basis points. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. Furthermore, the guidelines indicate that the Federal Reserve Board will continue to consider a "Tangible Tier 1 Leverage Ratio" in evaluating proposals for expansion or new activities. The Tangible Tier 1 Leverage Ratio is the ratio of Tier 1 capital, less intangibles not deducted from Tier 1 capital, to quarterly average total assets. As of December 31, 1998, the Federal Reserve had not advised the Corporation of any specific minimum Tangible Tier 1 Leverage Ratio applicable to it. At December 31, 1998, the Corporation had a Tangible Tier 1 Leverage Ratio of 6.9%. In addition to the effects of the provisions described above, the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) substantially revised the depository institution regulatory and funding provisions of the FDI Act and made revisions to several other federal banking statutes. Among other things, FDICIA requires the federal banking regulators to take prompt corrective action in respect to FDIC-insured depository institutions that do not meet minimum capital requirements. FDICIA establishes five capital tiers: "well capitalized," "adequately capitalized," "undercapitalized," "significantly undercapitalized" and "critically undercapitalized." A depository institution's capital tier will depend upon how its capital levels compare to various relevant capital measures and certain other factors, as established by regulation. Under applicable regulations, an FDIC-insured bank is defined to be well capitalized if it maintains a Leverage Ratio (Tier 1 capital to quarterly average total assets) of at least 5%, a Total Capital Ratio (qualifying total capital to risk- weighted assets, including certain off-balance sheet items) of at least 10% and a Tier 1 Capital Ratio (Tier 1 capital to risk-weighted assets) of at least 6% and is not otherwise in a "troubled condition" as specified by its appropriate federal regulatory agency. A bank is generally considered to be adequately capitalized if it is not defined to be well capitalized but meets all of its minimum capital requirements, i.e., if it has a Leverage Ratio of 4% or greater (or a Leverage Ratio of 3% or greater if the institution is rated composite 1 in its most recent report of examination, subject to appropriate federal banking agency guidelines), a Total Capital Ratio of 8% or greater and a Tier 1 Capital Ratio of 4% or greater. A bank will be considered undercapitalized if it fails to meet any minimum required measure, significantly undercapitalized if it is significantly below such 9 measure and critically undercapitalized if it maintains a level of tangible equity capital equal to or less than 2% of total assets. A bank may be reclassified to be in a capitalization category that is next below that indicated by its actual capital position if it receives a less than satisfactory examination rating by its examiners with respect to its assets, management, earnings or liquidity that has not been corrected, or it is determined that the bank is in an unsafe or unsound condition or engaged in an unsafe or unsound practice. At December 31, 1998, the Bank and each of the Corporation's other subsidiary banks met or exceeded the minimum regulatory ratios that are one of the conditions for them to be considered to be well capitalized. For further discussion of regulatory capital requirements and information about the capital position of the Corporation and the Bank, see pages 43 and 44 of "Management's Discussion and Analysis of Financial Condition and Results of Operations" and Note 29, titled "Regulatory Capital Requirements" on page 71 of the Corporation's Annual Report to Shareholders for the year ended December 31, 1998. FDICIA generally prohibits a depository institution from making any capital distribution (including payment of dividends) or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. Undercapitalized depository institutions are subject to growth limitations and are required to submit a capital restoration plan. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized. Under FDICIA, a bank that is not well capitalized is generally prohibited from accepting or renewing brokered deposits and offering interest rates on deposits significantly higher than the prevailing rate in its normal market area or nationally (depending upon where the deposits are solicited); in addition, "pass-through" insurance coverage may not be available for certain employee benefit accounts. Significantly undercapitalized depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets and cessation of receipt of deposits from correspondent banks. Critically undercapitalized depository institutions may be restricted from making payments of principal and interest on subordinated debt and are subject to appointment of a receiver or conservator. FDICIA also contains a variety of other provisions that affect the operations of a bank, including reporting requirements, regulatory standards for real estate lending, "truth in savings" provisions and a requirement that a depository institution give 90 days' prior notice to customers and regulatory authorities before closing any branch. STAFF Northern Trust employed 8,156 full-time equivalent officers and staff members as of December 31, 1998, approximately 6,033 of whom were employed by the Bank. 10 STATISTICAL DISCLOSURES The following statistical disclosures, included in the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, are incorporated herein by reference.
1998 Annual Report Schedule Page - ------------------------------------------------------------ ------------- Foreign Outstandings....................................... 37 Nonperforming Assets and 90 Day Past Due Loans............. 37 Analysis of Reserve for Credit Losses...................... 38 Average Balance Sheet...................................... 76 Ratios..................................................... 76 Analysis of Net Interest Income............................ 78 - ------------------------------------------------------------ -------------
- -------------------------------------------------------------------------------- Additional statistical information on a consolidated basis is set forth below. Remaining Maturity and Average Yield of Securities Held to Maturity and Available for Sale (Yield on a taxable equivalent basis giving effect of the federal and state tax rates)
December 31, 1998 -------------------------------------------------------------------------------------------- One Year or Less One to Five Years Five to Ten Years Over Ten Years ----------------- ----------------- ------------------ ----------------- Average ($ in Millions) Book Yield Book Yield Book Yield Book Yield Maturity - ---------------------------------- --------- ----- -------- ----- -------- ----- -------- ----- -------- Securities Held to Maturity U.S. Government $ 55.3 6.42% $ - - % $ - - % $ - - % 6 mos. Obligations of States and Political Subdivisions 48.0 11.13 83.8 10.85 79.4 9.42 50.6 7.65 69 mos. Federal Agency 3.0 6.47 - - - - - - 7 mos. Other--Fixed 9.3 6.92 23.4 9.17 19.2 8.57 20.8 5.89 70 mos. --Floating .3 8.00 .8 7.06 1.5 6.07 77.1 6.63 118 mos. - ----------------------------------- -------- ----- -------- ------ -------- ----- -------- ----- -------- Total Securities Held to Maturity $ 115.9 8.42% $ 108.0 10.46% $ 100.1 9.21% $ 148.5 6.87% 70 mos. - ----------------------------------- -------- ----- -------- ------ -------- ----- -------- ----- -------- Securities Available for Sale U.S. Government $ 224.5 6.13% $ 35.5 5.85% $ - - % $ - - % 5 mos. Obligations of States and Political Subdivisions - - 3.7 9.82 30.9 8.95 231.5 7.02 149 mos. Federal Agency 4,422.2 5.35 272.4 5.56 .6 5.60 .2 6.73 6 mos. Other--Fixed .6 8.38 - - - - .1 - 33 mos. --Floating .4 5.54 12.0 6.78 1.2 5.52 139.4 6.07 105 mos. - ----------------------------------- -------- ----- -------- ----- ------- ---- -------- ----- -------- Total Securities Available for Sale $4,647.7 5.39% $ 323.6 5.69% $ 32.7 8.76% $ 371.2 6.66% 15 mos. - ----------------------------------- -------- ----- -------- ----- ------- ---- -------- ----- -------- December 31, 1997 -------------------------------------------------------------------------------------------- One Year or Less One to Five Years Five to Ten Years Over Ten Years ---------------- ----------------- ------------------ ----------------- Average ($ in Millions) Book Yield Book Yield Book Yield Book Yield Maturity - ---------------------------------- -------- ------ -------- ----- -------- ----- -------- ----- -------- Securities Held to Maturity U.S. Government $ 72.0 6.72% $ - - % $ - - % $ - - % 5 mos. Obligations of States and Political Subdivisions 38.9 10.99 113.8 11.02 93.6 10.07 30.4 8.50 59 mos. Federal Agency 8.3 6.00 6.0 7.12 - - - - 12 mos. Other--Fixed 4.5 4.19 7.2 5.40 2.9 2.76 19.9 6.00 86 mos. --Floating .2 8.00 .8 7.67 1.5 6.30 56.1 6.75 117 mos. - ---------------------------------- -------- ----- -------- ----- ------- ----- --------- ----- -------- Total Securities Held to Maturity $ 123.9 7.92% $ 127.8 10.49% $ 98.0 9.79% $ 106.4 7.11% 58 mos. - ---------------------------------- -------- ----- -------- ----- ------- ----- --------- ----- -------- Securities Available for Sale U.S. Government $ 207.6 6.15% $ 262.4 6.15% $ - - % $ - - % 11 mos. Obligations of States and Political Subdivisions - - .6 9.88 15.8 9.58 113.8 8.22 141 mos. Federal Agency 2,756.7 5.90 195.9 6.57 14.5 6.65 2.7 6.87 5 mos. Other--Fixed 13.4 5.66 - - - - - - 5 mos. --Floating 12.4 6.33 12.5 7.43 .8 6.22 124.2 6.00 105 mos. - ---------------------------------- -------- ----- -------- ----- ------- ----- --------- ----- -------- Total Securities Available for Sale $2,990.1 5.92% $ 471.4 6.36% $ 31.1 8.13% $ 240.7 7.06% 14 mos. - ---------------------------------- -------- ----- -------- ----- ------- ----- --------- ----- -------- - -----------------------------------------------------------------------------------------------------------------------------------
11
Securities Held to Maturity and Available for Sale December 31 ------------------------------------------------------------ (In Millions) 1998 1997 1996 1995 1994 - ------------------------------------------------- --------- --------- --------- --------- --------- Securities Held to Maturity U.S. Government $ 55.3 $ 72.0 $ 73.4 $ 116.1 $ 137.2 Obligations of States and Political Subdivisions 261.8 276.7 315.9 366.9 474.5 Federal Agency 3.0 14.3 18.2 22.2 -- Other 152.4 93.1 90.9 29.9 29.6 - ------------------------------------------------- --------- --------- --------- --------- --------- Total Securities Held to Maturity $ 472.5 $ 456.1 $ 498.4 $ 535.1 $ 641.3 - ------------------------------------------------- --------- --------- --------- --------- --------- Securities Available for Sale U.S. Government $ 260.0 $ 470.0 $ 906.7 $ 1,667.7 $ 801.3 Obligations of States and Political Subdivisions 266.1 130.2 117.0 70.2 -- Federal Agency 4,695.4 2,969.8 3,096.9 3,152.8 3,251.5 Other 153.7 163.3 191.1 245.6 355.0 - ------------------------------------------------- --------- --------- --------- --------- --------- Total Securities Available for Sale $ 5,375.2 $ 3,733.3 $ 4,311.7 $ 5,136.3 $ 4,407.8 - ------------------------------------------------- --------- --------- --------- --------- --------- Average Total Securities $ 7,470.8 $ 6,374.2 $ 6,363.8 $ 6,193.0 $ 5,000.9 - ------------------------------------------------- --------- --------- --------- --------- --------- Total Securities at Year-End $ 5,856.8 $ 4,198.2 $ 4,814.9 $ 5,760.3 $ 5,053.1 - ------------------------------------------------- --------- --------- --------- --------- --------- ================================================================================================================== Loans and Leases by Type December 31 ------------------------------------------------------------ (In Millions) 1998 1997 1996 1995 1994 - ------------------------------------------------- --------- --------- --------- --------- --------- Domestic Residential Real Estate $ 5,885.2 $ 5,186.7 $ 4,557.5 $ 3,896.4 $3,299.1 Commercial 3,937.9 3,734.8 3,161.4 3,202.1 2,672.0 Broker 147.6 170.1 389.1 304.0 274.6 Commercial Real Estate 677.1 582.1 557.7 512.6 494.1 Personal 1,463.4 1,207.2 989.8 758.9 662.1 Other 509.6 890.1 632.1 625.5 642.1 Lease Financing 528.3 347.0 267.8 202.3 159.9 - ------------------------------------------------- --------- --------- --------- --------- --------- Total Domestic 13,149.1 12,118.0 10,555.4 9,501.8 8,203.9 International 497.8 470.2 382.0 404.2 386.7 - ------------------------------------------------- --------- --------- --------- --------- --------- Total Loans and Leases $13,646.9 $12,588.2 $10,937.4 $9,906.0 $8,590.6 - ------------------------------------------------- --------- --------- --------- --------- --------- Average Loans and Leases $13,315.0 $11,812.9 $10,332.1 $9,136.0 $8,316.1 - ------------------------------------------------- --------- --------- --------- --------- --------- ================================================================================================================== Remaining Maturity of Selected Loans and Leases December 31, 1998 -------------------------------------------------------------------- One Year One to Over Five (In Millions) Total or Less Five Years Years - --------------------------------------------- -------- -------- ---------- ---------- Domestic (Excluding Residential Real Estate and Personal Loans) Commercial $3,937.9 2,942.1 740.9 254.9 Commercial Real Estate 677.1 211.7 289.6 175.8 Other 657.2 641.2 11.4 4.6 Lease Financing 528.3 45.5 77.5 405.3 - --------------------------------------------- -------- -------- ---------- ---------- Total Domestic 5,800.5 3,840.5 1,119.4 840.6 International 497.8 257.3 161.9 78.6 - --------------------------------------------- -------- -------- ---------- ---------- Total Selected Loans and Leases $6,298.3 4,097.8 1,281.3 919.2 - --------------------------------------------- -------- -------- ---------- ---------- Interest Rate Sensitivity of Loans and Leases Fixed Rate $4,648.0 2,831.0 1,010.8 806.2 Variable Rate 1,650.3 1,266.8 270.5 113.0 - --------------------------------------------- -------- -------- ---------- ---------- Total $6,298.3 4,097.8 1,281.3 919.2 - --------------------------------------------- -------- -------- ---------- ---------- ==================================================================================================================
12
Average Deposits by Type (In Millions) 1998 1997 1996 1995 1994 - ------------------------------------------------------ --------- --------- --------- --------- --------- Domestic Offices Demand and Noninterest-Bearing Individuals, Partnerships and Corporations $ 1,765.6 $ 1,754.6 $ 1,801.8 $ 1,651.1 $ 1,540.4 Correspondent Banks 87.2 92.8 115.2 129.8 192.2 Other 1,375.2 1,116.5 815.9 966.4 859.9 - ------------------------------------------------------ --------- --------- --------- --------- --------- Total $ 3,228.0 $ 2,963.9 $ 2,732.9 $ 2,747.3 $ 2,592.5 - ------------------------------------------------------ --------- --------- --------- --------- --------- Time Savings and Money Market $ 4,263.3 $ 3,895.4 $ 3,620.7 $ 3,312.4 $ 3,385.7 Savings Certificates less than $100,000 1,085.0 1,076.5 1,169.6 1,160.8 699.9 Savings Certificates $100,000 and more 1,059.5 959.3 892.8 839.5 529.7 Other Time 571.8 717.3 549.2 542.7 412.8 - ------------------------------------------------------ --------- --------- --------- --------- --------- Total $ 6,979.6 $ 6,648.5 $ 6,232.3 $ 5,855.4 $ 5,028.1 - ------------------------------------------------------ --------- --------- --------- --------- --------- Total Domestic Offices $10,207.6 $ 9,612.4 $ 8,965.2 $ 8,602.7 $ 7,620.6 - ------------------------------------------------------ --------- --------- --------- --------- --------- Foreign Offices Demand $ 503.8 $ 486.4 $ 347.8 $ 299.1 $ 361.7 Time 5,781.7 4,971.2 3,826.2 3,493.4 3,284.8 - ------------------------------------------------------ --------- --------- --------- --------- --------- Total Foreign Offices $ 6,285.5 $ 5,457.6 $ 4,174.0 $ 3,792.5 $ 3,646.5 - ------------------------------------------------------ --------- --------- --------- --------- --------- Total Deposits $16,493.1 $15,070.0 $13,139.2 $12,395.2 $11,267.1 - ------------------------------------------------------ --------- --------- --------- --------- --------- =======================================================================================================================
Average Rates Paid on Time Deposits by Type 1998 1997 1996 1995 1994 - ------------------------------------------------------ -------- ---------- --------- --------- --------- Time Deposits - Domestic Offices Savings and Money Market 3.31% 3.23% 3.16% 3.29% 2.52% Savings Certificates less than $100,000 5.79 5.86 5.85 6.08 4.77 Savings Certificates $100,000 and more 5.60 5.63 5.67 5.95 4.45 Other Time 5.35 5.50 5.44 5.81 4.50 - ------------------------------------------------------ -------- ---------- --------- --------- --------- Total Domestic Offices 4.21 4.25 4.23 4.46 3.20 - ------------------------------------------------------ -------- ---------- --------- --------- --------- Total Foreign Offices Time 4.95 4.82 4.82 5.21 4.18 - ------------------------------------------------------ -------- ---------- --------- --------- --------- Total Time Deposits 4.55% 4.49% 4.45% 4.74% 3.58% - ------------------------------------------------------ -------- ---------- --------- --------- --------- =======================================================================================================================
Remaining Maturity of Time Deposits $100,000 and more December 31, 1998 December 31, 1997 --------------------------------- --------------------------------- Domestic Offices Domestic Offices --------------------- --------------------- Certificates Other Foreign Certificates Other Foreign (In Millions) of Deposit Time Offices of Deposit Time Offices - --------------------------------------------- ------------ ----- -------- ------------ ----- -------- 3 Months or Less $ 872.7 $ .6 $6,464.3 $ 898.0 $ 2.0 $5,395.5 Over 3 through 6 Months 365.6 .7 45.5 265.9 3.2 50.0 Over 6 through 12 Months 265.4 5.0 11.1 239.5 5.4 5.6 Over 12 Months 261.9 7.0 11.0 234.0 2.4 4.3 - --------------------------------------------- ------------ ----- -------- ------------ ----- -------- Total $ 1,765.6 $13.3 $6,531.9 $ 1,637.4 $13.0 $5,455.4 - --------------------------------------------- ------------ ----- -------- ------------ ----- --------
13 Purchased Funds
Federal Funds Purchased (Overnight Borrowings) ($ in Millions) 1998 1997 1996 - ------------------------------------------------- --------- --------- -------- Balance on December 31 $ 2,025.1 $ 821.2 $ 653.0 Highest Month-End Balance 3,505.3 2,765.9 2,715.2 Year-Average Balance 2,620.6 1,690.2 1,842.2 -Average Rate 5.34% 5.47% 5.31% Average Rate at Year-End 4.43 5.64 6.03 - ------------------------------------------------- --------- -------- -------- Securities Sold under Agreements to Repurchase ($ in Millions) 1998 1997 1996 - ------------------------------------------------- --------- -------- -------- Balance on December 31 $ 2,114.9 $1,139.7 $ 966.1 Highest Month-End Balance 4,136.0 3,708.9 2,922.2 Year-Average Balance 1,506.0 1,519.9 1,973.3 -Average Rate 5.33% 5.38% 5.24% Average Rate at Year-End 4.59 5.43 5.69 - ------------------------------------------------- --------- -------- -------- Other Borrowings (Includes Treasury Tax and Loan Demand Notes and Term Federal Funds Purchased) ($ in Millions) 1998 1997 1996 - ------------------------------------------------- --------- -------- -------- Balance on December 31 $ 1,099.2 $2,876.6 $3,142.1 Highest Month-End Balance 7,122.8 5,528.4 4,953.6 Year-Average Balance 2,540.4 2,120.9 1,274.1 -Average Rate 5.21% 5.30% 5.07% Average Rate at Year-End 3.88 5.01 5.82 - ------------------------------------------------- --------- -------- -------- Total Purchased Funds ($ in Millions) 1998 1997 1996 - ------------------------------------------------- --------- -------- -------- Balance on December 31 $ 5,239.2 $4,837.5 $4,761.2 Year-Average Balance 6,667.0 5,331.0 5,089.6 -Average Rate 5.29% 5.38% 5.22% - ------------------------------------------------- --------- -------- -------- ============================================================================================ Commercial Paper ($ in Millions) 1998 1997 1996 - ------------------------------------------------- --------- -------- -------- Balance on December 31 $ 148.1 $ 146.8 $ 149.0 Highest Month-End Balance 149.6 149.9 153.0 Year-Average Balance 145.9 142.7 143.7 -Average Rate 5.51% 5.54% 5.40% Average Rate at Year-End 5.40 5.81 5.65 - ------------------------------------------------- --------- -------- --------
14 Changes in Net Interest Income
1998/97 1997/96 ------------------------ ----------------------- Change Due To Change Due To (Interest on a taxable equivalent basis) --------------- -------------- (In Millions) Volume Rate Total Volume Rate Total - ---------------------------------------------------- ------ ------ ------ ------ ----- ------ Increase (Decrease) In Interest Income Money Market Assets Federal Funds Sold and Resell Agreements $ 8.3 $ (1.2) $ 7.1 $ 27.1 $ 0.5 $ 27.6 Time Deposits with Banks 13.8 7.7 21.5 45.4 3.2 48.6 Other (.5) .2 (.3) .1 (.1) - Securities U.S. Government (26.9) .5 (26.4) (52.2) 3.4 (48.8) Obligations of States and Political Subdivisions 2.2 (2.1) .1 (.5) (2.2) (2.7) Federal Agency 84.8 (4.6) 80.2 50.7 2.8 53.5 Other 1.5 1.9 3.4 .9 .3 1.2 Trading Account .2 (.1) .1 .1 - .1 Loans and Leases 100.1 (12.3) 87.8 100.1 .8 100.9 - ---------------------------------------------------- ------ ------ ------ ------ ----- ------ Total $183.5 $(10.0) $173.5 $171.7 $ 8.7 $180.4 - ---------------------------------------------------- ------ ------ ------ ------ ----- ------ Increase (Decrease) In Interest Expense Deposits Savings and Money Market $ 12.3 $ 3.2 $ 15.5 $ 8.9 $ 2.6 $ 11.5 Savings Certificates 6.1 (1.2) 4.9 (1.5) (.4) (1.9) Other Time (7.8) (1.0) (8.8) 9.2 .3 9.5 Foreign Offices Time 40.1 6.5 46.6 55.2 .1 55.3 Federal Funds Purchased 49.6 (2.2) 47.4 (8.3) 2.8 (5.5) Repurchase Agreements (.7) (.8) (1.5) (24.4) 2.7 (21.7) Commercial Paper .2 (.1) .1 (.1) .2 .1 Other Borrowings 21.8 (1.9) 19.9 44.9 3.0 47.9 Senior Notes 6.4 (.8) 5.6 15.6 .9 16.5 Long-term Debt .7 (1.5) (.8) 5.6 (.4) 5.2 Debt-Floating Rate Capital Securities 2.6 (.2) 2.4 14.5 - 14.5 - ---------------------------------------------------- ------ ------ ------ ------ ----- ------ Total $131.3 $ - $131.3 $119.6 $11.8 $131.4 - ---------------------------------------------------- ------ ------ ------ ------ ----- ------ Increase (Decrease) In Net Interest Income $ 52.2 $(10.0) $ 42.2 $ 52.1 $(3.1) $ 49.0 - ---------------------------------------------------- ------ ------ ------ ------ ----- ------
Note: Changes not due only to volume changes or rate changes are included in the change due to rate column. 15 Analysis of Reserve for Credit Losses
(In Millions) 1998 1997 1996 1995 1994 - ---------------------------------- ------ ------ ------ ------ ------ Balance at Beginning of Year $147.6 $148.3 $147.1 $144.8 $145.5 - ---------------------------------- ------ ------ ------ ------ ------ Charge-Offs Residential Real Estate .8 .8 .2 .6 .1 Commercial 9.6 11.4 6.2 5.5 5.3 Commercial Real Estate .3 .7 7.4 3.6 4.1 Personal .8 1.3 1.5 1.2 1.2 Other .3 .2 .1 .2 - Lease Financing - - - - - International - - .2 .6 - - ---------------------------------- ------ ------ ------ ------ ------ Total Charge-Offs 11.8 14.4 15.6 11.7 10.7 - ---------------------------------- ------ ------ ------ ------ ------ Recoveries Residential Real Estate .2 .1 .2 - - Commercial .6 2.3 .5 2.1 1.0 Commercial Real Estate .7 1.6 1.9 2.3 1.1 Personal .3 .6 .6 .5 1.2 Other - .1 .1 .2 .2 Lease Financing - - - - .5 International - - .5 .7 - - ---------------------------------- ------ ------ ------ ------ ------ Total Recoveries 1.8 4.7 3.8 5.8 4.0 - ---------------------------------- ------ ------ ------ ------ ------ Net Charge-Offs 10.0 9.7 11.8 5.9 6.7 Provision for Credit Losses 9.0 9.0 12.0 6.0 6.0 Reserve Related to Acquisitions .2 - 1.0 2.2 - - ---------------------------------- ------ ------ ------ ------ ------ Net Change in Reserve (.8) (.7) 1.2 2.3 (.7) - ---------------------------------- ------ ------ ------ ------ ------ Balance at End of Year $146.8 $147.6 $148.3 $147.1 $144.8 - ---------------------------------- ------ ------ ------ ------ ------ - -------------------------------------------------------------------------------
International Operations (Based on Obligor's Domicile) See also Note 27 titled "Business Segments and Related Information" on page 70 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, which is incorporated herein by reference. Selected Average Assets and Liabilities Attributable to International Operations
(In Millions) 1998 1997 1996 1995 1994 - ----------------------------------- -------- -------- -------- -------- -------- Total Assets $3,883.9 $3,507.7 $2,365.5 $2,282.0 $2,820.5 - ----------------------------------- -------- -------- -------- -------- -------- Time Deposits with Banks 2,827.0 2,574.5 1,699.3 1,643.7 2,063.1 Other Money Market Assets - .1 .1 .1 .4 Loans 651.5 537.9 380.5 344.3 445.5 Customers' Acceptance Liability .7 .5 1.1 1.9 3.0 Foreign Investments 27.4 22.2 23.4 14.3 21.6 - ----------------------------------- -------- -------- -------- -------- -------- Total Liabilities $6,815.5 $5,960.7 $4,551.2 $4,163.5 $4,089.4 - ----------------------------------- -------- -------- -------- -------- -------- Deposits 6,640.9 5,747.2 4,435.7 3,992.2 4,010.6 Liability on Acceptances .7 .5 1.1 1.9 3.0 - ----------------------------------- -------- -------- -------- -------- --------
16
Percent of International Related Average Assets and Liabilities to Total Consolidated Average Assets 1998 1997 1996 1995 1994 - --------------------------------------- ---- ---- ---- ---- ---- Assets 14% 15% 11% 12% 16% - --------------------------------------- ---- ---- ---- ---- ---- Liabilities 25 25 22 21 23 - --------------------------------------- ---- ---- ---- ---- ---- ============================================================================================== Reserve for Credit Losses Relating to International Operations (In Millions) 1998 1997 1996 1995 1994 - --------------------------------------- ---- ---- ---- ---- ---- Balance at Beginning of Year $5.0 $3.6 $3.5 $4.7 $6.8 Charge-Offs - - (.2) (.6) - Recoveries - - .5 .7 - Provision for Credit Losses (1.4) 1.4 (.2) (1.3) (2.1) - --------------------------------------- ---- ---- ---- ---- ---- Balance at End of Year $3.6 $5.0 $3.6 $3.5 $4.7 - --------------------------------------- ---- ---- ---- ---- ---- The Securities and Exchange Commission requires the disclosure of the reserve for credit losses that is applicable to international operations. The above table has been prepared in compliance with this disclosure requirement and is used in determining international operating performance. The amounts shown in the table should not be construed as being the only amounts that are available for international loan charge-offs, since the entire reserve for credit losses is available to absorb losses on both domestic and international loans. In addition, these amounts are not intended to be indicative of future charge-off trends. ============================================================================================== Distribution of International Loans and Deposits by Type December 31 ---------------------------------------------------- Loans 1998 1997 1996 1995 1994 - -------------------------------------- ------ ------ ------ ------ ------ Commercial $298.3 $240.1 $226.6 $259.9 $233.8 Foreign Governments and Official Institutions 84.0 115.2 118.3 103.7 72.8 Banks 99.3 51.2 22.8 37.3 77.0 Other 16.2 63.7 14.3 3.3 3.1 - -------------------------------------- ------ ------ ------ ------ ------ Total $497.8 $470.2 $382.0 $404.2 $386.7 - -------------------------------------- ------ ------ ------ ------ ------ December 31 ---------------------------------------------------- Deposits 1998 1997 1996 - -------------------------------------- -------- -------- -------- Commercial $5,261.0 $4,473.3 $2,855.4 Foreign Governments and Official Institutions 1,098.8 782.1 708.6 Banks 481.1 443.4 350.7 Other Time 512.3 490.6 276.2 Other Demand 16.4 11.8 10.7 - -------------------------------------- -------- -------- -------- Total $7,369.6 $6,201.2 $4,201.6 - -------------------------------------- -------- -------- --------
17 CREDIT RISK MANAGEMENT For the discussion of Credit Risk Management, see the following information that is incorporated herein by reference to the Corporation's Annual Report to Stockholders for the year ended December 31, 1998:
1998 Annual Report Notes to Consolidated Financial Statements Page(s) - ---------------------------------------------------------------- ------------- 1. Accounting Policies F. Interest Risk Management Instruments............................. 50 G. Loans and Leases................................................. 51 H. Reserve for Credit Losses........................................ 51 L. Other Real Estate Owned.......................................... 52 5. Loans and Leases.................................................... 54 6. Reserve for Credit Losses........................................... 55 20. Contingent Liabilities.............................................. 63 21. Off-Balance Sheet Financial Instruments............................. 64-66 - ---------------------------------------------------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations - ---------------------------------------------------------------- Asset Quality and Credit Risk Management.................................... 35-40 - ---------------------------------------------------------------- -------------
In addition, the following schedules on pages 16 and 17 of this Form 10-K should be read in conjunction with the "Credit Risk Management" section: Analysis of Reserve for Credit Losses Reserve for Credit Losses Relating to International Operations Distribution of International Loans and Deposits by Type 18 INTEREST RATE SENSITIVITY ANALYSIS For the discussion of interest rate sensitivity, see the section entitled "Market Risk Management" on pages 40 to 43 of Management's Discussion and Analysis of Financial Condition and Results of Operations of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, which is incorporated herein by reference. 19 The following unaudited Consolidated Balance Sheet and Consolidated Statement of Income for The Northern Trust Company were prepared in accordance with generally accepted accounting principles and are provided here for informational purposes. These consolidated financial statements should be read in conjunction with the footnotes accompanying the consolidated financial statements, included in the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, and incorporated herein by reference on page 25 of this Form 10-K. The Northern Trust Company Consolidated Balance Sheet (unaudited)
December 31 -------------------- (In Millions) 1998 1997 - ---------------------------------------------------------- --------- --------- Assets Cash and Due from Banks $ 2,184.2 $ 1,568.8 Federal Funds Sold and Securities Purchased under Agreements to Resell 1,545.4 3,228.7 Time Deposits with Banks 3,264.2 2,282.4 Other Interest-Bearing 184.4 104.8 Securities Available for Sale 5,078.7 3,407.2 Held to Maturity (Fair Value - $438.2 in 1998 and $401.2 in 1997) 426.6 385.5 - ---------------------------------------------------------- --------- --------- Total Securities 5,505.3 3,792.7 - ---------------------------------------------------------- --------- --------- Loans Commercial and Other 6,389.2 6,224.8 Residential Mortgages 2,968.5 2,810.9 - ---------------------------------------------------------- --------- --------- Total Loans and Leases (Net of unearned income - $222.1 in 1998 and $149.8 in 1997) 9,357.7 9,035.7 - ---------------------------------------------------------- --------- --------- Reserve for Credit Losses (111.7) (118.2) Buildings and Equipment 260.3 235.0 Customers' Acceptance Liability 31.4 29.6 Trust Security Settlement Receivables 336.7 291.4 Other Assets 746.3 734.1 - ---------------------------------------------------------- --------- --------- Total Assets $23,304.2 $21,185.0 - ---------------------------------------------------------- --------- --------- Liabilities Deposits Demand and Other Noninterest-Bearing $ 3,281.8 $ 2,935.4 Savings and Money Market Deposits 2,524.2 2,672.1 Savings Certificates 1,281.7 1,276.7 Other Time 350.0 399.6 Foreign Offices--Demand 413.5 451.1 --Time 6,496.2 5,619.5 - ---------------------------------------------------------- --------- --------- Total Deposits 14,347.4 13,354.4 - ---------------------------------------------------------- --------- --------- Federal Funds Purchased 2,312.0 929.1 Securities Sold under Agreements to Repurchase 2,072.6 1,057.2 Other Borrowings 1,091.4 2,745.0 Senior Notes 700.0 785.0 Long-Term Debt 455.0 354.2 Liability on Acceptances 31.4 29.6 Other Liabilities 839.7 648.1 - ---------------------------------------------------------- --------- --------- Total Liabilities 21,849.5 19,902.6 - ---------------------------------------------------------- --------- --------- Stockholder's Equity Capital Stock--Par Value $60 213.8 213.8 Surplus 245.3 245.3 Undivided Profits 996.8 821.8 Net Unrealized Gain (Loss) on Securities Available for Sale (1.2) 1.5 - ---------------------------------------------------------- --------- --------- Total Stockholder's Equity 1,454.7 1,282.4 - ---------------------------------------------------------- --------- --------- Total Liabilities and Stockholder's Equity $23,304.2 $21,185.0 - ---------------------------------------------------------- --------- ---------
20 The Northern Trust Company Consolidated Statement of Income (unaudited)
For the Year Ended December 31 -------------------------------- (In Millions) 1998 1997 1996 - ------------------------------------------------------------------------------------ -------- -------- ------ Noninterest Income Trust Fees $ 522.9 $ 456.9 $397.8 Foreign Exchange Trading Profits 103.5 104.7 58.7 Treasury Management Fees 68.9 59.2 54.2 Security Commissions and Trading Income .6 .9 .9 Other Operating Income 39.6 42.0 36.8 Investment Security Gains 1.0 .7 .4 - ------------------------------------------------------------------------------------ -------- -------- ------ Total Noninterest Income 736.5 664.4 548.8 - ------------------------------------------------------------------------------------ -------- -------- ------ Interest Income Loans and Leases 597.9 548.6 489.3 Securities - Available for Sale 364.5 310.0 303.7 - Held to Maturity 24.8 26.5 26.1 - Trading Account - - .1 - ------------------------------------------------------------------------------------ -------- -------- ------ Total Securities 389.3 336.5 329.9 - ------------------------------------------------------------------------------------ -------- -------- ------ Time Deposits with Banks 155.0 133.5 84.8 Federal Funds Sold and Securities Purchased under Agreements to Resell and Other 83.3 71.9 36.7 - ------------------------------------------------------------------------------------ -------- -------- ------ Total Interest Income 1,225.5 1,090.5 940.7 - ------------------------------------------------------------------------------------ -------- -------- ------ Interest Expense Deposits 471.0 445.3 373.6 Federal Funds Purchased 141.0 93.3 99.0 Securities Sold under Agreements to Repurchase 76.8 77.4 99.1 Other Borrowings 130.2 107.8 60.9 Senior Notes 36.5 30.9 14.4 Long-Term Debt 29.0 24.4 19.5 - ------------------------------------------------------------------------------------ -------- -------- ------ Total Interest Expense 884.5 779.1 666.5 - ------------------------------------------------------------------------------------ -------- -------- ------ Net Interest Income 341.0 311.4 274.2 Provision for Credit Losses 3.0 5.6 7.4 - ------------------------------------------------------------------------------------ -------- -------- ------ Net Interest Income after Provision for Credit Losses 338.0 305.8 266.8 - ------------------------------------------------------------------------------------ -------- -------- ------ Income before Noninterest Expenses 1,074.5 970.2 815.6 - ------------------------------------------------------------------------------------ -------- -------- ------ Noninterest Expenses Compensation 370.4 322.7 258.3 Employee Benefits 68.3 58.0 52.3 Occupancy Expense 46.7 45.8 45.9 Equipment Expense 50.5 51.3 45.3 Other Operating Expenses 154.4 143.4 131.3 - ------------------------------------------------------------------------------------ -------- -------- ------ Total Noninterest Expenses 690.3 621.2 533.1 - ------------------------------------------------------------------------------------ -------- -------- ------ Income before Income Taxes 384.2 349.0 282.5 Provision for Income Taxes 130.6 117.4 90.5 - ------------------------------------------------------------------------------------ -------- -------- ------ Net Income $ 253.6 $ 231.6 $192.0 - ------------------------------------------------------------------------------------ -------- -------- ------ Dividends Paid to the Corporation $ 75.0 $ 50.0 $ 80.0 - ------------------------------------------------------------------------------------ -------- -------- ------
21 Supplemental Item--Executive Officers of the Registrant WILLIAM A. OSBORN Mr. Osborn became Chairman of the Board of the Corporation and the Bank in October 1995, and Chief Executive Officer of the Corporation and the Bank in June 1995. He held the title of President of the Corporation and the Bank from January 1994 to October 1995 and Chief Operating Officer from January 1994 through June 1995. Mr. Osborn, 51, began his career with the Bank in 1970. BARRY G. HASTINGS Mr. Hastings became President of the Corporation and the Bank in October 1995, and Chief Operating Officer of the Corporation and the Bank in June 1995. He held the title of Vice Chairman of the Corporation and the Bank from January 1994 through June 1995. Mr. Hastings, 51, began his career with the Corporation in 1974. DAVID L. EDDY Mr. Eddy became a Senior Vice President of the Corporation and the Bank and Treasurer of the Corporation in 1986. Mr. Eddy, 62, joined the Bank in 1960. JAMES J. MITCHELL Mr. Mitchell was appointed an Executive Vice President of the Bank in December 1987 and of the Corporation in October 1994, and is currently head of the Worldwide Operations and Technology business unit. Mr. Mitchell, 56, joined the Bank in 1964. SHEILA A. PENROSE Ms. Penrose became President - C&IS of the Corporation and of the Bank in January 1998, and has served as an Executive Vice President of the Bank since November 1993 and of the Corporation since November 1994. Ms. Penrose, 53, began her career with the Corporation in 1977. PERRY R. PERO Mr. Pero is Chief Financial Officer of the Corporation and the Bank and Cashier of the Bank. Mr. Pero is also head of the Risk Management Unit and Chairman of the Corporate Asset and Liability Policy Committee. He became a Senior Executive Vice President of the Corporation and the Bank in 1992. Mr. Pero, 59, joined the Bank in 1964. PETER L. ROSSITER Mr. Rossiter has served as Executive Vice President and General Counsel of the Corporation and the Bank since 1993. He also held the title of Secretary of the Corporation and the Bank from April 1993 through November 1997 and has served as an Assistant Secretary since then. Mr. Rossiter, 50, joined the Corporation in 1992, prior to which he was a partner in the law firm of Schiff Hardin & Waite. HARRY W. SHORT Mr. Short was appointed Senior Vice President and Controller of the Corporation and the Bank in October 1994. He joined the Corporation and the Bank in January 1990 and served as Senior Vice President and General Auditor. Mr. Short, 51, had been a partner in the accounting firm of KPMG Peat Marwick. JAMES M. SNYDER Mr. Snyder was appointed Executive Vice President of the Corporation and the Bank in November 1996 and is currently the Chief Investment Officer. He had been a Senior Vice President of the Bank from 1991 to 1996. Mr. Snyder, 52, joined the Bank in 1969. 22 MARK STEVENS Mr. Stevens became President - PFS of the Corporation and the Bank in January 1998, and has served as an Executive Vice President of the Corporation and the Bank since February 1996. He served as Chief Executive Officer of Northern Trust Bank of Florida N.A., from 1987 to 1996. Mr. Stevens, 51, joined the Corporation in 1979. STEPHEN B. TIMBERS Mr. Timbers joined Northern Trust in February 1998, when he was named President - NTGI and an Executive Vice President of the Corporation and the Bank. From January 1996 to December 1997, Mr.Timbers, 54, was President, Chief Executive Officer and Chief Investment Officer of Zurich Kemper Investments, Inc. (formerly Kemper Financial Services, Inc.), the investment adviser to the Kemper Funds and the parent organization of Zurich Investment Management, Inc. From January 1992 until January 1996, he served as President and Chief Operating Officer of Kemper Corporation. WILLIAM S. TRUKENBROD Mr. Trukenbrod was appointed an Executive Vice President of the Corporation and the Bank in February 1994, and is currently Chairman of the Credit Policy Committee. He had been a Senior Vice President of the Bank since 1980 and of the Corporation since 1992. Mr. Trukenbrod, 59, joined the Bank in 1962. The positions of Chairman of the Board, Chief Executive Officer, President and Vice Chairman are elected annually by the Board of Directors at the first meeting of the Board of Directors held after each annual meeting of stockholders. The other officers are appointed annually by the Board. Officers continue to hold office until their successors are duly elected or until their death, resignation or removal by the Board. Item 2--Properties The executive offices of the Corporation and the Bank are located at 50 South LaSalle Street in the financial district of Chicago. This Bank-owned building is occupied by various divisions of Northern Trust's business units. Financial services are provided by the Bank at this location. Adjacent to this building are two office buildings in which the Bank leases approximately 370,000 square feet of space principally for staff divisions of the business units. The Bank also leases approximately 40,000 square feet of a building at 125 South Wacker Drive in Chicago for banking operations and personal banking services. Financial services are also provided by the Bank at sixteen other Chicago metropolitan area locations, five of which are owned and eleven of which are leased. The Bank's trust and banking operations are located in a 465,000 square foot facility at 801 South Canal Street in Chicago. The building is leased by the Corporation under terms that qualify as a capital lease. In June 1997, the Bank entered into an agreement to purchase a building and adjacent land located across the street from the Chicago operations center in January 2000. The building, which is located at 840 South Canal Street and contains approximately 340,000 square feet of office space, houses the computer data center and will be used for future expansion. Prior to the purchase date, the Bank is leasing, in phases that began in November 1997, approximately two floors of this six-story building. Space for the Bank's London and Singapore Branches, Edge Act subsidiary and The Northern Trust Company, Canada are leased. The Corporation's other subsidiaries operate from sixty-five locations, fourteen of which are owned and fifty-one of which are leased. Detailed information regarding the addresses of all Northern Trust's locations can be found on pages 84 and 85 in the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, which is incorporated herein by reference. The facilities which are owned or leased are suitable and adequate for business needs. For additional information relating to properties and lease commitments, refer to Note 8 titled "Buildings and Equipment" and Note 9 titled "Lease Commitments" on page 55 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, which information is incorporated herein by reference. 23 Item 3--Legal Proceedings The information called for by this item is incorporated herein by reference to Note 20 titled "Contingent Liabilities" on page 63 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. Item 4--Submission of Matters to a Vote of Security Holders None. 24 PART II Item 5--Market for Registrant's Common Equity and Related Stockholder Matters The information called for by this item is incorporated herein by reference to the section of the Consolidated Financial Statistics titled "Common Stock Dividend and Market Price" on pages 80 and 81 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. Information regarding dividend restrictions of the Corporation's banking subsidiaries is incorporated herein by reference to Note 15 titled "Restrictions on Subsidiary Dividends and Loans or Advances" on page 60 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. Item 6--Selected Financial Data The information called for by this item is incorporated herein by reference to the table titled "Summary of Selected Consolidated Financial Data" on page 22 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. Item 7--Management's Discussion and Analysis of Financial Condition and Results of Operations The information called for by this item is incorporated herein by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 22 through 45 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. Item 7A--Quantitative and Qualitative Disclosures About Market Risk The information called for by this item is incorporated herein by reference to "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 40 through 43 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998. Item 8--Financial Statements and Supplementary Data The following financial statements of the Corporation and its subsidiaries included in the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, are incorporated herein by reference.
1998 Annual Report For Northern Trust Corporation and Subsidiaries: Page(s) - ------------------------------------------------------------------------------------------------------------- ------------- Consolidated Balance Sheet--December 31, 1998 and 1997....................................................... 46 Consolidated Statement of Income--Years Ended December 31, 1998, 1997 and 1996............................... 47 Consolidated Statement of Changes in Stockholders' Equity--Years Ended December 31, 1998, 1997 and 1996...... 48 Consolidated Statement of Cash Flows--Years Ended December 31, 1998, 1997 and 1996........................... 49 - ------------------------------------------------------------------------------------------------------------- ------------- For Northern Trust Corporation (Corporation Only) - ------------------------------------------------------------------------------------------------------------- ------------- Condensed Balance Sheet--December 31, 1998 and 1997.......................................................... 72 Condensed Statement of Income--Years Ended December 31, 1998, 1997 and 1996.................................. 72 Consolidated Statement of Changes in Stockholders' Equity--Years Ended December 31, 1998, 1997 and 1996...... 48 Condensed Statement of Cash Flows--Years Ended December 31, 1998, 1997 and 1996.............................. 73 - ------------------------------------------------------------------------------------------------------------- ------------- Notes to Consolidated Financial Statements................................................................... 50-73 - ------------------------------------------------------------------------------------------------------------- ------------- Report of Independent Public Accountants..................................................................... 74 - ------------------------------------------------------------------------------------------------------------- -------------
The section titled "Quarterly Financial Data" on pages 80 and 81 of the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, is incorporated herein by reference. Item 9--Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 25 PART III Item 10--Directors and Executive Officers of the Registrant The information called for by Item 10 relating to Directors and Nominees for election to the Board of Directors is incorporated herein by reference to pages 2 through 6 of the Corporation's definitive 1999 Notice and Proxy Statement filed on March 15, 1999 in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 20, 1999. The information called for by Item 10 relating to Executive Officers is set forth in Part I of this Annual Report on Form 10-K. The information called for by Item 10 relating to Item 405 disclosure of delinquent Form 3, 4 or 5 filers is incorporated by reference to page 9 of the Corporation's definitive 1999 Notice and Proxy Statement filed on March 15, 1999 in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 20, 1999. Item 11--Executive Compensation The information called for by this item is incorporated herein by reference to pages 8 and 9 and pages 12 through 23 of the Corporation's definitive 1999 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 20, 1999. Item 12--Security Ownership of Certain Beneficial Owners and Management The information called for by this item is incorporated herein by reference to pages 10 and 11 of the Corporation's definitive 1999 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 20, 1999. Item 13--Certain Relationships and Related Transactions The information called for by this item is incorporated herein by reference to pages 8 and 9 of the Corporation's definitive 1999 Notice and Proxy Statement filed in connection with the solicitation of proxies for the Annual Meeting of Stockholders to be held April 20, 1999. 26 PART IV Item 14-Exhibits, Financial Statement Schedules, and Reports on Form 8-K Item 14(a)(1) and (2)-Northern Trust Corporation and Subsidiaries List of Financial Statement and Fincancial Statement Schedules The following financial information is set forth in Item 1 for informational purposes only: Financial Information of The Northern Trust Company (Bank Only): Unaudited Consolidated Balance Sheet-December 31, 1998 and 1997. Unaudited Consolidated Statement of Income-Years Ended December 31, 1998, 1997 and 1996. The following consolidated financial statements of the Corporation and its subsidiaries are incorporated by references into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1998: Consolidated Financial Statements of Northern Trust Corporation and Subsidiaries: Consolidated Balance Sheet-December 31, 1998 and 1997. Consolidated Statement of Income-Years Ended December 31, 1998, 1997 and 1996. Consolidated Statement of Changes in Stockholders' Equity-Years Ended December 31, 1998, 1997 and 1996. Consolidated Statement of Cash Flows-Years Ended December 31, 1998, 1997 and 1996. The following financial information is incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1998: Financial Statements of Northern Trust Corporation (Corporation): Condensed Balance Sheet-December 31, 1998 and 1997. Condensed Statement of Income-Years Ended December 31, 1998, 1997 and 1996. Consolidated Statement of Changes in Stockholders' Equity-Years Ended December 31, 1998, 1997 and 1996. Condensed Statement of Cash Flows-Years Ended December 31, 1998, 1997 and 1996. The Notes to Consolidated Financial Statements as of December 31, 1998, incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1998, pertain to the Bank only information, consolidated financial statements and Corporation only information listed above. The Report of Independent Public Accountants incorporated by reference into Item 8 from the Corporation's Annual Report to Stockholders for the year ended December 31, 1998 pertains to the consolidated financial statements and Corporation only information listed above. Financial statement schedules have been omitted for the reason that they are not required or are not applicable. 27 Item 14(a)3-Exhibits The exhibits listed on the Exhibit Index beginning on page 30 of this Form 10-K are filed herewith or are incorporated herein by reference to other filings. Item 14(b)-Reports on Form 8-K In a report on Form 8-K dated October 20, 1998, Northern Trust incorporated by reference in Item 5 its October 19, 1998 press release, reporting on its earnings for the third quarter and nine months of 1998. The press release, with summary financial information, was filed as an exhibit pursuant to Item 7 of the Form 8-K. In a report on Form 8-K dated November 20, 1998, Northern Trust Corporation incorporated by reference in Item 7 an amendment of its 1989 Stockholder Rights Plan and an amendment of its 1998 Stockholder Rights Plan. 28 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Form 10-K Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized. Date: March 16, 1999 Northern Trust Corporation (Registrant) BY:/s/ William A. Osborn ---------------------- William A. Osborn Chairman of the Board and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Form 10-K Annual Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the date indicated. Signature Title --------- ----- /s/William A. Osborn Chairman of the Board, - ------------------------ William A. Osborn Chief Executive Officer and Director /s/ Perry R. Pero Senior Executive Vice President - --------------------- Perry R. Pero and Chief Financial Officer /s/ Harry W. Short Senior Vice President and Controller - --------------------- Harry W. Short (Chief Accounting Officer) Duane L. Burnham Director Dolores E. Cross Director Robert S. Hamada Director Barry G. Hastings Director Robert A. Helman Director BY: /s/ Peter L. Rossiter Arthur L. Kelly Director --------------------- Frederick A. Krehbiel Director Peter L. Rossiter William G. Mitchell Director Attorney-in-Fact Edward J. Mooney Director Harold B. Smith Director William D. Smithburg Director Bide L. Thomas Director Date: March 16, 1999 29 EXHIBIT INDEX The following Exhibits are filed herewith or are incorporated herein by reference.
Exhibit Incorporated By Reference to Exhibit of Same Name Exhibit in Prior Filing* Number Description or Filed Herewith - ----------- ----------------------------------- ---------------------- (3) Articles of Incorporation and By-laws (i) Restated Certificate of Incorporation of Northern Trust Corporation as amended to date .......................... (12) (ii) By-laws as amended to date............................... (16) (4) Instruments Defining the Rights of Security Holders (i) Form of The Northern Trust Company's Global Senior Bank Note (Fixed Rate)................................... (19) (ii) Form of The Northern Trust Company's Global Senior Bank Note (Floating Rate)................................ (19) (iii) Form of The Northern Trust Company's Global Subordinated Bank Note (Fixed Rate)...................... (19) (iv) Form of The Northern Trust Company's Global Subordinated Bank Note (Floating Rate)................... (19) (v) Junior Subordinated Indenture, dated as of January 1, 1997, between Northern Trust Corporation and The First National Bank of Chicago, as Debenture Trustee.................................................. (10) (10) Material Contracts (i) Northern Trust Corporation Amended Incentive Stock Plan, as amended May 20, 1986 **............................... (2) (1) Amendment dated November 1, 1996 .................... (9) (ii) Lease dated July 1, 1988 between American National Bank & Trust Company of Chicago as Trustee under Trust Agreement dated February 12, 1986 and known as Trust No. 66603 (Landlord) and Nortrust Realty Management, Inc. (Tenant)................................ (3) (iii) Restated Northern Trust Employee Stock Ownership Plan, dated January 1, 1989, as amended November 21, 1995 and April 26, 1996 ..................................... (9) (1) Amendments effective January 1, 1996 to the Northern Trust Employee Stock Plan for former employees of Tanglewood Bank, N.A................ (12) (2) Amendment effective September 30, 1996 to the Northern Trust Employee Stock Ownership Plan for certain former employees of First Chicago NBD Corporation.................................. (12) (3) Amendments effective January 1, 1997 to the Northern Trust Employee Stock Ownership Plan for former employees of Bent Tree National Bank ............................................ (12) (4) Amendment dated March 25, 1998 to the Northern Trust Employee Stock Ownership Plan ............. (15) (5) Amendment effective May 14, 1998 to the Northern Trust Employee Stock Ownership Plan ............. (18) (6) Amendment effective August 1, 1998 to the Northern Trust Employee Stock Ownership Plan ............................................ (18) (7) Amendment effective December 31, 1998 to the Northern Trust Employee Stock Ownership Plan ............................................ Filed Herewith
30
(iv) Trust Agreement between The Northern Trust Company and Citizens and Southern Trust Company (Georgia), N.A., (predecessor of NationsBank which, effective January 1, 1998, was succeeded by U.S. Trust Company, N.A.) dated January 26, 1989........................................................ (4) (1) Amendment dated February 21, 1995.............................................. (14) (2) Amendment dated January 2, 1998................................................ (15) (v) Form of Note Agreement dated January 26, 1989 between ESOP Trust and each of the institutional lenders, with respect to the 8.23% Notes of the ESOP Trust...................................................................... (4) (vi) Implementation Agreement dated June 26, 1996 between the Registrant, The Northern Trust Company, the ESOP Trust and NationsBank (South) N.A. as Trustee (effective January 1, 1998, U.S. Trust Company, N.A. as successor Trustee).......................................................... (8) (vii) Term Loan Agreement between the ESOP Trust and the Registrant dated June 28, 1996....................................................................... (8) (viii) Restated Trust Agreement dated June 18, 1996, between The Northern Trust Company and Harris Trust and Savings Bank regarding the Supplemental Employee Stock Ownership Plan for Employees of The Northern Trust Company, the Supplemental Thrift-Incentive Plan for Employees of The Northern Trust Company and the Supplemental Pension Plan for Employees of The Northern Trust Company**..................................................... (9) (ix) Supplemental Employee Stock Ownership Plan for Employees of The Northern Trust Company as amended and restated as of April 30, 1996**........................ (9) (x) Supplemental Thrift-Incentive Plan for Employees of The Northern Trust Company as amended and restated as of April 30, 1996**.............................. (9) (xi) Supplemental Pension Plan for Employees of The Northern Trust Company as amended and restated as of April 30, 1996**...................................... (9) (1) Amendment effective May 1, 1998................................................ (19) (xii) Rights Agreement, dated as of October 17, 1989, between Northern Trust Corporation and Harris Trust and Savings Bank (as succeeded by Norwest Bank Minnesota, N.A. as Rights Agent effective November 10, 1997)................... (5) (1) First Amendment to Rights Agreement dated as of September 17, 1997............. (13) (2) Second Amendment to Rights Agreement dated as of November 18, 1997............. (14) (3) Third Amendment to Rights Agreement dated as of July 21, 1998.................. (16) (4) Fourth Amendment to Rights Agreement dated as of November 18, 1998............. (20) (5) Fifth Amendment to Rights Agreement dated as of February 16, 1999.............. (21) (xiii) Rights Agreement, dated as of July 21, 1998, between Northern Trust Corporation and Norwest Bank Minnesota, N.A......................................... (17) (1) Amendment No. 1 to Rights Agreement dated as of November 18, 1998.............. (20) (2) Amendment No. 2 to Rights Agreement dated as of February 16, 1999.............. (21) (xiv) Lease dated August 27, 1985 between American National Bank & Trust Company of Chicago as Trustee under Trust Agreement dated April 5, 1990 and known as Trust No. 110513-07 (Landlord) and The Northern Trust Company (Tenant), as amended........................................................ (6) (1) First Amendment to Agreement of Lease dated August 15, 1986.................... (7) (2) Second Amendment to Agreement of Lease dated August 6, 1987.................... (7) (3) Third Amendment to Agreement of Lease dated May 20, 1988....................... (7) (4) Fourth Amendment to Agreement of Lease dated May 1, 1990....................... (7) (5) Fifth Amendment to Agreement of Lease dated January 12, 1995................... (7) (6) Sixth Amendment to Agreement of Lease dated November 30, 1995.................. (7) (7) Seventh Amendment to Agreement of Lease dated February 24, 1998................ (15)
31
(xv) Lease dated July 8, 1987 between American National Bank & Trust Company of Chicago as Trustee under Trust Agreement dated July 12, 1984 and known as Trust No. 61523 (Landlord) and The Northern Trust Company (Tenant), as amended.............................................................. (6) (1) First Amendment to Office Lease dated October 20, 1987....................... (11) (2) Second Amendment to Office Lease dated January 16, 1998...................... (15) (3) Third Amendment to Office Lease dated May 27, 1998........................... (19) (xvi) Amended 1992 Incentive Stock Plan**............................................... (12) (xvii) Northern Trust Corporation (1998) Management Performance Plan**................... (18) (xviii) Northern Trust Corporation (1998) Annual Performance Plan**....................... (15) (xix) Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors**....................................................................... Filed Herewith (xx) Northern Trust Corporation 1997 Deferred Compensation Plan for Non-Employee Directors As Amended**........................................... Filed Herewith (xxi) Form of Employment Security Agreement dated March 1, 1996 (and in one case February 23, 1998) entered into between Northern Trust Corporation and each of 8 executive officers - as amended**....................... (8) (xxii) Form of Employment Security Agreement dated May 21, 1996 entered into between Northern Trust Corporation and each of 28 officers**................. (8) (xxiii) Form of Employment Security Agreement dated May 21, 1996 entered into between Northern Trust Corporation and each of 11 officers**................. (8) (xxiv) Amended and Restated Trust Agreement of NTC Capital I, dated as of January 16, 1997, among Northern Trust Corporation, as Depositor, The First National Bank of Chicago, as Property Trustee, First Chicago Delaware, Inc., as Delaware Trustee, and the Administrative Trustees named therein............................................. (10) (xxv) Guarantee Agreement, dated as of January 16, 1997, relating to NTC Capital I, by and between Northern Trust Corporation, as Guarantor, and The First National Bank of Chicago, as Guarantee Trustee...................... (10) (xxvi) Amended and Restated Trust Agreement of NTC Capital II, dated as of April 25, 1997, among Northern Trust Corporation, as Depositor, The First National Bank of Chicago, as Property Trustee, First Chicago Delaware, Inc., as Delaware Trustee, and the Administrative Trustees named therein............................................. (12) (xxvii) Guarantee Agreement, dated as of April 25, 1997, relating to NTC Capital II, by and between Northern Trust Corporation, as Guarantor, and The First National Bank of Chicago, as Guarantee Trustee...................... (12) (xxviii) Northern Trust Corporation Deferred Compensation Plan dated as of May 1, 1998**............................................................... (18) (xxix) Deferred Compensation Plans Trust Agreement dated as of May 11, 1998 between Northern Trust Corporation and Harris Trust and Savings Bank as Trustee........................................................................ (18) (xxx) Agreement between Fiserv Solutions, Inc. and The Northern Trust Company dated as of October 20, 1998.............................................. Filed Herewith (13) 1998 Annual Report to Stockholders......................................................... Filed Herewith (21) Subsidiaries of the Registrant............................................................. Filed Herewith (23) Consent of Independent Public Accountants.................................................. Filed Herewith (24) Powers of Attorney......................................................................... Filed Herewith (27) Financial Data Schedule.................................................................... Filed Herewith (99) Description of Common Stock (filed for the purpose of updating the description of Common Stock contained in the registration statement for such securities)............................................................. Filed Herewith
32 * Prior Filings (File No. 0-5965, except as noted) (1) Quarterly Report on Form 10-Q for the quarter ended September 30, 1995 (2) Quarterly Report on Form 10-Q for the quarter ended September 30, 1986 (3) Annual Report on Form 10-K for the year ended December 31, 1988 (4) Form 8-K dated January 26, 1989 (5) Form 8-A dated October 27, 1989 (6) Annual Report on Form 10-K for the year ended December 31, 1990 (7) Annual Report on Form 10-K for the year ended December 31, 1995 (8) Quarterly Report on Form 10-Q for the quarter ended June 30, 1996 (9) Quarterly Report on Form 10-Q for the quarter ended September 30, 1996 (10) Form 8-K dated January 22, 1997 (11) Annual Report on Form 10-K for the year ended December 31, 1996 (12) Quarterly Report on Form 10-Q for the quarter ended March 31, 1997 (13) Quarterly Report on Form 10-Q for the quarter ended September 30, 1997 (14) Annual Report on Form 10-K for the year ended December 31, 1997 (15) Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 (16) Form 8-K dated July 24, 1998 (17) Form 8-A dated July 24, 1998 (18) Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (19) Quarterly Report on Form 10-Q for the quarter ended September 30, 1998 (20) Form 8-K dated November 20, 1998 (21) Form 8-K dated February 19, 1999 ** Denotes management contract or compensatory plan or arrangement Upon written request to Rose A. Ellis, Secretary, Northern Trust Corporation, 50 South LaSalle Street, Chicago, Illinois 60675, copies of exhibits listed above are available to Northern Trust Corporation stockholders by specifically identifying each exhibit desired in the request. Pursuant to Item 601(b)(4)(iii) of Regulation S-K, the Corporation hereby agrees to furnish the Commission, upon request, any instrument defining the rights of holders of long-term debt of the Corporation not filed as an exhibit herein. No such instrument authorizes long-term debt securities in excess of 10% of the total assets of the Corporation and its subsidiaries on a consolidated basis. 33 EX-10.(III)(7) 2 AMENDED EMPLOYEE STOCK OWNERSHIP PLAN Exhibit Number (10)(iii)(7) To 1998 Form 10-K AMENDMENT NUMBER SEVEN TO NORTHERN TRUST EMPLOYEE STOCK OWNERSHIP PLAN WHEREAS, The Northern Trust Company (the "Company") maintains the Northern Trust Employee Stock Ownership Plan, as amended and restated effective January 1, 1989 (the "Plan"); WHEREAS, by virtue and in exercise of the amending power reserved to the Company under Section 13.1 of the Plan, the Board of Directors authorized amendments to the Plan by resolutions dated dated February 18, 1997 and November 18, 1998; NOW THEREFORE, pursuant to the authority delegated by the Board of Directors to the undersigned officer by such resolutions, the Plan is hereby amended in the following particulars, effective December 31, 1998: 1. Section 2.1(vv) is modified by amended by adding the following sentence after the vesting schedule that appears therein: "Notwithstanding the foregoing, any Member identified in Exhibits 16.1 and 16.2 of the Payment System Services Agreement dated October 20, 1998, between The Company and Fiserv Solutions, Inc. who is employed by the Company on December 31, 1998, shall become fully vested in his or her Account as of such date." 2. Section 9.7(d)(3) of the Plan is amended in its entirety to read as follows: "(3) For purposes of subsection (d)(1), the Required Distribution Date means April 1 of the calendar year in which occurs the later of (A) the Member's attainment of age seventy and one-half (70-1/2), or (B) the Member's retirement (within the meaning of Code section 401(a)(9)), unless the Member is a Five Percent Owner (as defined in Section 416(i) of the Code) with respect to the Plan Year during which the Member attains age 70-1/2, in which case clause (B) shall not apply. Any Participant who attained age 70-1/2 on or before December 31, 1998 shall continue to receive distributions under the terms of the Plan as in effect on December 30, 1998." IN WITNESS WHEREOF, the Company has caused this amendment to be executed on its behalf by the undersigned officer this 30th day of December, 1998. /s/ Martin J. Joyce, Jr. - ------------------------------ Martin J. Joyce, Jr. Senior Vice President EX-10.(XIX) 3 STOCK PLAN FOR NON-EMPLOYEE DIRECTORS Exhibit Number (10)(xix) To 1998 Form 10-K NORTHERN TRUST CORPORATION 1997 STOCK PLAN FOR NON-EMPLOYEE DIRECTORS ------------------------------------------ 1. Purpose. The purpose of the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors ("the Plan") is to attract and retain well-qualified persons to serve as directors of Northern Trust Corporation (the "Corporation") and to provide incentive to such directors to work for the long-term best interests of the Corporation and its stockholders. 2. Eligibility. Participation in this Plan is limited to persons who serve as directors of the Corporation and who are not employees of the Corporation or any subsidiary of the Corporation ("Non-Employee Directors"). 3. Shares Subject to the Plan. Shares of Common Stock, $1.66 2/3 par value per share ("Common Stock") subject to the Plan shall be either authorized but unissued shares or treasury shares of the Corporation. The Corporation shall reserve such number of shares of Common Stock as may be issuable under the Plan. 4. Grants of Stock. On the date of each annual stockholder meeting of the Corporation to be held in 1997, 1998 and 1999, and without any further action of the Board of Directors, there shall be granted to each Non- Employee Director of the Corporation who is elected as a director by the stockholders of the Corporation at such meeting 500 shares of Common Stock of the Corporation. Subject to the provisions of The Northern Trust Corporation 1997 Deferred Compensation Plan for Non-Employee Directors, shares granted hereunder shall be registered in the name of the Non-Employee Director and certificates representing such shares shall be distributed promptly to each Non-Employee Director. 5. Adjustment Provisions. In the event of any change in the number or nature of outstanding shares of Common Stock of the Corporation by reason of a recapitalization, merger, consolidation, dividend, split, combination of shares or any other change in the corporate structure or shares of Common Stock of the Corporation, the Board of Directors of the Corporation will make appropriate adjustments in the number of shares available for distribution pursuant to the provisions of this Plan and the number of shares that may be awarded to each participant under the Plan. 6. No Obligation to Reelect. Nothing in this Plan shall be deemed to create an obligation on the part of the Board of Directors to nominate any director for reelection by the Corporation's stockholders or to fill a vacancy upon action of the Board of Directors. 7. Administration of the Plan. This Plan shall be administered by the Secretary of the Corporation. 8. Amendment or Termination of the Plan. The Corporation reserves the right to amend, modify or terminate this Plan by action of its Board of Directors, provided that no such amendment or modification shall be effected more often than once every six months, other than to comport with changes in the Internal Revenue Code, the Employee Retirement Income Security Act, or the rules thereunder, and provided further that no such amendment, modification, or termination shall adversely affect any rights of Non- Employee Directors with respect to grants of Common Stock made pursuant to this Plan prior to such action. 9. Taxes. A Non-Employee Director may pay any applicable taxes due with respect to any shares awarded under this Plan in cash or in stock, either by having the Corporation withhold a portion of the shares otherwise distributable or by delivering to the Corporation shares otherwise owned by the Non-Employee Director. 10. Applicable Law. All questions pertaining to the validity, construction and administration of the Plan and the shares of Common Stock granted hereunder shall be determined in conformity with the laws of the State of Delaware. EX-10.(XX) 4 AMENDED DEFERRED COMPENSATION PLAN/NON-EMPLOYEE DI Exhibit Number (10)(xx) To 1998 Form 10-K NORTHERN TRUST CORPORATION 1997 DEFERRED COMPENSATION PLAN FOR NON-EMPLOYEE DIRECTORS AS AMENDED 1. Name. This Plan shall be known as the "Northern Trust Corporation 1997 Deferred Compensation Plan for Non-Employee Directors As Amended" (the "Plan"). 2. Definitions. The following definitions shall apply in interpreting the Plan: (a) The term "Beneficiary" shall mean such individual, trustee, trust or other entity designated by a Non-Employee Director pursuant to Section 5(e). (b) The term "Board" shall mean the Board of Directors of the Corporation. (c) The term "Cash Account"shall have the meaning set forth in Section 4(b). (d) The term "Committee" shall mean the Compensation and Benefits Committee of the Board of Directors. (e) The term "Common Stock" shall mean the common stock, $1.66-2/3 par value per share, of the Corporation. (f) The term "Corporation" shall mean Northern Trust Corporation, a Delaware corporation. (g) The term "Election Form" shall have the meaning set forth in Section 3(b). (h) The term "Non-Employee Director" shall mean a person who is serving as a member of the Board and is not an employee of the Corporation or any subsidiary of the Corporation. (i) The term "Stock Unit Account" shall have the meaning set forth in Section 4(a). 3. Participation. (a) A Non-Employee Director may elect to defer receipt of the payment of all or any portion of: (i) the annual retainer fee payable for services as a Director, (ii) any cash fees payable for attendance at a Board committee meeting or for any other service provided to the Corporation, or (iii) the annual stock grant under the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors, in each case until the date on which the Non-Employee Director's service on the Board terminates for any reason. (b) Each election for a calendar year shall be set forth on an election form ("Election Form") provided by the Corporation. An Election Form effective for a calendar year shall be delivered to the Corporation prior to the first day of such calendar year. An Election Form shall remain in effect for subsequent calendar years until a written notice to revise the Election Form is delivered to the Corporation on or before the first day of the calendar year in which the revision is to become effective. Except as provided in Section 3(c) below, an initial Election Form or a revised Election Form shall only apply to compensation otherwise payable to a Non-Employee Director after the end of the calendar year in which such initial or revised Election Form is delivered to the Corporation. Any Election Form delivered by a Non-Employee Director shall be irrevocable with respect to any compensation covered by the election set forth therein. (c) Notwithstanding Section 3(b) above, (i) an election by a Non-Employee Director with respect to compensation payable on or after March 31, 1997 may be made pursuant to an Election Form delivered to the Corporation prior to March 31, 1997, and (ii) an election made by a Non-Employee Director in the calendar year in which the Non-Employee Director first becomes eligible to participate in the Plan may be made pursuant to an Election Form delivered to the Corporation within 30 days after the date on which the Non-Employee Director initially becomes eligible to participate, and such Election Form shall be effective with respect to compensation earned from and after the date such Election Form is delivered to the Corporation. 4. Deferral Accounts. (a) All cash compensation deferred by a Non-Employee Director pursuant to Section 3 shall be credited to a stock unit account ("Stock Unit Account") maintained by the Corporation on its books in the name of the participating Non- Employee Director and converted into stock units equivalent to full shares of the Corporation's Common Stock as of the last trading day of the calendar quarter for which the cash compensation would have been paid. The conversion shall be determined by dividing the dollar amount of the cash compensation as of such quarterly date by the mean of the high and low sale prices of the Corporation's Common Stock as reported by The Nasdaq Stock Market on such quarterly date. Any cash balance remaining after any such conversion shall be credited to the Cash Account of a Non-Employee Director as provided in Section 4(b) below. The shares of Common Stock representing a stock grant under the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors which are deferred by a Non-Employee Director pursuant to Section 3 shall be credited to a Stock Unit Account and converted into stock units as of the date of the annual meeting of stockholders on which the stock was granted. (b) The Corporation also shall maintain a cash account ("Cash Account") on its books in the name of each participating Non-Employee Director. Credits shall be made to a participating Non-Employee Director's Cash Account in dollar amounts equal to (i) the cash balance remaining after any conversion pursuant to Section 4(a) above, and (ii) the cash dividends (or the fair market value of dividends paid in property other than Common Stock) that the Non-Employee Director would have received had the Non-Employee Director been the owner on each record date of the number of shares of Common Stock equal to the number of stock units in such Non-Employee Director's Stock Unit Account on such date. Until the entire balance of a Cash Account has been paid to a Non-Employee Director, or to the Beneficiaries of a deceased Non-Employee Director, such balance shall 2 be increased on the last day of each calendar quarter to reflect accrued interest on such balance based on the rate of interest determined from time to time by the Committee. (c) In the case of a dividend in Common Stock or a Common Stock split, additional credits will be made to a Non-Employee Director's Stock Unit Account of a number of stock units equal to the number of full shares of Common Stock that the Non-Employee Director would have received had the Non-Employee Director been the owner on each record date of the number of shares of Common Stock equal to the number of stock units in such Non-Employee Director's Stock Unit Account on such date. (d) Amounts previously deferred by a participating Non-Employee Director under any prior deferred compensation plan maintained by the Corporation or any of its subsidiaries shall be transferred effective March 31, 1997 into the Stock Unit Account or the Cash Account as designated by the Non-Employee Director. (e) Each Stock Unit Account and each Cash Account shall be maintained on the books of the Corporation until full payment of the balance thereof has been made to the applicable Non-Employee Director or to the Beneficiaries of a deceased Non-Employee Director. No funds shall be set aside or earmarked for any Account, which shall be purely a bookkeeping device. 5. Distribution of Accounts. (a) The entire balance of a Non-Employee Director's Stock Unit Account and Cash Account shall be paid to such Non-Employee Director or to the Beneficiaries of a deceased Non-Employee Director (i) in a single lump sum as of a date selected by the Corporation not more than 90 days following the date the Non- Employee Director's service on the Board terminates for any reason, or (ii) in up to 10 annual installments beginning on a date selected by the Corporation not more than 90 days following the date the Non-Employee Director's service on the Board terminates for any reason, as designated by the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director. In the absence of a designation by a Non-Employee Director, the entire balance of the Non-Employee Director's Stock Unit Account and Cash Account shall be paid in a single lump sum. (b) Except as provided in Section 5(c) below, the balance of a Non- Employee Director's Stock Unit Account shall be distributed in cash. In the event of a single lump sum distribution in cash, the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director shall receive an amount in cash equal to the number of stock units in the Stock Unit Account multiplied by the mean of the high and low sales prices of the Common Stock as reported by the Nasdaq Stock Market on the fifth trading day prior to the distribution date. In the event of a distribution in cash in up to 10 annual installments, the cash amount determined in the manner provided in the immediately preceding sentence shall continue to accrue interest and shall be distributed to the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director on the distribution date in each year of the installment period in an amount equal to the then current cash balance in the Stock Unit 3 Account multiplied by a fraction, the numerator of which shall be one, and the denominator of which shall be the number of years remaining in the installment period. (c) Stock units in the Stock Unit Account representing the deferral of shares of Common Stock under the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors shall be distributed only in shares of Common Stock. In the event of a single lump sum distribution in Common Stock, a certificate representing the number of full shares of Common Stock equal to the number of such stock units in the Non-Employee Director's Stock Unit Account representing the deferral of shares of Common Stock under the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors, registered in the name of the Non- Employee Director or the Beneficiaries of a deceased Non-Employee Director, shall be distributed to the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director on the distribution date referred to in Section 5(a) above. In the event of a distribution in Common Stock in up to 10 annual installments, a certificate representing the number of full shares of Common Stock equal to a fraction (the numerator of which shall be the number of stock units in the Non-Employee Director's Stock Unit Account representing the deferral of shares of Common Stock under the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors, and the denominator of which shall be the number of annual installments designated by the Non-Employee Director), registered in the name of the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director, shall be distributed to the Non-Employee Director or the Beneficiary of a deceased Non-Employee Director on the distribution date in each year of the installment period, provided that the number of shares in each of the installments may be rounded to avoid fractional shares. (d) The balance of a Non-Employee Director's Cash Account shall be distributed in cash. In the event of a single lump sum distribution in cash, the entire balance of the Non-Employee Director's Cash Account shall be distributed to the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director on the distribution date described in Section 5(a) above. In the event of a distribution in cash in up to 10 annual installments, the balance of the Cash Account shall continue to accrue interest and shall be distributed to the Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director on the distribution date in each year of the installment period in an amount equal to the then current balance in the Cash Account multiplied by a fraction, the numerator of which shall be one, and the denominator of which shall be the number of years remaining in the installment period. (e) If a Non-Employee Director's service on the Board shall terminate by reason of death, or if a Non-Employee Director shall die after becoming entitled to distribution hereunder, but prior to receipt of the entire distribution, all cash or Common Stock then distributable hereunder with respect to such Non-Employee Director shall be distributed to such Beneficiaries as such Non-Employee Director shall have designated by an instrument in writing last filed with the Corporation prior to death, or in the absence of such designation or of any living Beneficiary, to his or her spouse, or if not then living, to his or her then-living descendants, per stirpes, or if none is then living, to the personal representative of the Non-Employee Director's estate, in the same manner as would have been distributed had the Non-Employee Director continued to live. 4 6. Amendment or Termination. ------------------------ (a) The Corporation intends the Plan to be permanent but reserves the right to amend or terminate the Plan when, in the sole opinion of the Corporation, such amendment or termination is advisable. Any such amendment or termination shall be made pursuant to a resolution of the Board and shall be effective as of the date of such resolution or such later date as the resolution may expressly state. (b) No amendment or termination of the Plan shall (i) directly or indirectly deprive any current or former Non-Employee Director or any Beneficiaries, of all or any portion of such Non-Employee Director's Stock Unit Account or Cash Account as determined as of the effective date of such amendment or termination, or (ii) directly or indirectly reduce the balance of any such Accounts held hereunder as of the effective date of such amendment or termination. Upon termination of the Plan, distribution of balances in all Accounts shall be made to the Non-Employee Directors or their Beneficiaries in the manner and at the time described in Section 5 as if each Non-Employee Director's service on the Board had then terminated. No additional deferrals shall be credited to the Accounts of Non-Employee Directors after termination of the Plan, but the Corporation shall continue to credit earnings, gains and losses to Accounts pursuant to Section 4 until the balances of such Accounts have been fully distributed to Non-Employee Directors or their Beneficiaries. 7. General Provisions. ------------------ (a) The Plan at all times shall be entirely unfunded and no provision shall at any time be made with respect to segregating any assets of the Corporation for payment of any benefits hereunder. The right of a Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director to receive a benefit hereunder shall be an unsecured claim against the general assets of the Corporation, and neither the Non-Employee Director nor such Beneficiaries shall have any rights in or against any specific assets of the Corporation. All amounts credited to Accounts shall constitute general assets of the Company. (b) Shares of Common Stock distributed under the Plan may be authorized but unissued shares or treasury shares of the Corporation. The Corporation shall reserve such number of shares of Common Stock as may be issuable under the Plan. (c) Nothing contained in the Plan shall constitute a guaranty by the Corporation, the Committee, or any other person or entity, that the assets of the Corporation will be sufficient to pay any benefit hereunder. No Non-Employee Director or the Beneficiaries of a deceased Non-Employee Director shall have any right to receive a distribution under the Plan except in accordance with the terms of the Plan. (d) Establishment of the Plan shall not be construed to give any Non- Employee Director the right to be retained as a member of the Board. 5 (e) No interest of any person or entity in, or right to receive a distribution under, the Plan, shall be subject in any manner to sale, transfer, assignment, pledge, attachment, garnishment, or other alienation or encumbrance of any kind; nor may such interest or right to receive a distribution be taken, either voluntarily or involuntarily, for the satisfaction of the debts of, or other obligations or claims against, such person or entity, including claims for alimony, support, separate maintenance and claims in bankruptcy proceedings. (f) The Plan shall be administered by the Secretary of the Corporation. (g) A Non-Employee Director may pay any applicable taxes due with respect to any shares distributed under the Plan in cash or in stock, either by having the Corporation withhold a portion of the shares otherwise distributable or by delivering to the Corporation shares otherwise owned by the Non-Employee Director. (h) The Plan shall be construed and administered under the laws of the State of Delaware except to the extent preempted by federal law. 6 EX-10.(XXX) 5 AGREEMENT DATED OCTOBER 20, 1998 Exhibit Number (10)(xxx) To 1998 form 10-K AGREEMENT between FISERV SOLUTIONS, INC. 255 Fiserv Drive Brookfield, WI 53045-5815 and THE NORTHERN TRUST COMPANY 50 South LaSalle Street Chicago, IL 60675-0002 Date: PAYMENTS SYSTEM SERVICES AGREEMENT ("Agreement") dated as of October [20], 1998 ("Agreement Date"), by and between THE NORTHERN TRUST COMPANY ("Northern Trust"), an Illinois banking corporation, and FISERV SOLUTIONS, INC. ("Fiserv"), a Wisconsin corporation. W I T N E S S E T H: WHEREAS, based on the proposal presented by Fiserv to Northern Trust on September 25, 1998, Northern Trust and Fiserv have engaged in extensive negotiations, discussions and due diligence culminating in the relationship described in this Agreement; WHEREAS, based on such proposal, Northern Trust desires to outsource its payments processing business to Fiserv pursuant to the terms hereof; WHEREAS, in connection with the foregoing transaction, Northern Trust desires to transfer to Fiserv certain assets used or useful in the conduct of the payments processing business in exchange for cash pursuant to the terms hereof; and WHEREAS, Fiserv intends to perform the services described in this Agreement reflecting appropriate new technologies for providing such services. NOW, THEREFORE, Fiserv and Northern Trust agree as follows: ARTICLE 1. DEFINITIONS. 1 The following defined terms have the meanings specified in the Agreement portion indicated below: TERM DEFINED IN Agreement Heading Agreement Date Heading Assets Section 13.1 Change Control Procedures Section 4.3 Change(s) Section 4.1 Completion Data Section 3.3 Conclusion Date Section 27.1 Contract Year Section 2.2 Conversion Section 3.3 Conversion Period Section 3.3 Credits Section 31.4 Critical Services Section 18.1 Data Tapes Section 17.6 Designated Fees Section 19.1 Designated Services Section 3.1 Designated Service Levels Section 5.1 Developed Software Section 11.2 Disaster Section 18.1 Disaster Recovery Plan Section 18.1 Discloser Section 22.2 Effective Date Section 2.1 Estimated Additional Fees Section 19.1 Estimated Designated Fees Section 19.1 Estimated Fees Section 19.1 Estimated Out-of-Pocket Expenses Section 19.1 Fees Section 19.4 Fiserv Heading Fiserv 401(k) Savings Plan Section 16.7 Fiserv Acquired Services Article 14 Fiserv Agent(s) Section 9.3 Fiserv Benefits Plans Section 16.6 Fiserv Credits Section 31.3 Fiserv Health Benefits Plan Section 16.8 Fiserv Information Section 22.1 Fiserv Project Manager Section 9.1 Fiserv Proprietary Software Section 11.3 Fiserv Software Section 11.3 Fiserv Systems Section 7.1 2 Fiserv Third Party Software Section 11.3 Force Majeure Event Section 18.2 General Assignment Section 13.1 Hearing Section 29.3 Implementation Consents Section 12.1 Improved Technology Section 3.4 Indemnifying Party Section 30.3 Indemnitee Section 30.3 Information Section 22.1 Initial Term Section 2.1 Insured Dependent(s) Section 16.8 Losses Section 30.1 Management Committee Section 10.2 Minimum Employment Period Section 16.5 New Service(s) Section 4.1 New Service Fees Section 19.4 New Service Levels Section 5.2 New Services Schedule Section 4.1 Northern Trust Heading Northern Trust Benefit Plans Section 16.6 Northern Trust Credits Section 31.4 Northern Trust Data Section 17.3 Northern Trust Health Benefits Plan Section 16.8 Northern Trust Information Section 22.1 Northern Trust Project Manager Section 9.2 Northern Trust Proprietary Software Section 11.1 Northern Trust Retained Agreements Section 3.2 Northern Trust Retained Responsibilities Section 3.2 Northern Trust Software Section 11.1 Northern Trust Systems Section 7.2 Northern Trust Third Party Software Section 11.1 Problem Section 10.5 Project Managers Section 9.2 Proposal Section 4.1 Recipient Section 22.1 Reconstruction Costs Section 32.17 Renewal Term(s) Section 2.2 Report(s) Section 17.1 Required Change Section 21.1 Required Consents Section 12.3 Residuals Section 22.3 Retained Responsibilities Service Levels Article 14 Securities Section 32.17 3 Service Levels Section 5.2 Service Location(s) Section 6.1 Services Section 4.1 Software Section 11.3 Start Date Section 16.3 Systems Section 7.2 Taxes Article 20 Term Section 2.2 Termination Assistance Period Section 27.1 Termination Assistance Services Section 27.1 Termination Consents Section 12.2 Termination for Convenience Section 25.1 Termination Losses Section 26.3 Termination Reasons Section 16.5 Third Party Resources Section 15.2 Third Party Resources Agreements Section 15.2 Third Party Resources Invoice(s) Section 15.4 Transitioned Employee(s) Section 16.2 Transition Period Section 16.1 Yearly Damage Cap Section 31.1 ARTICLE 2. TERM 2.1 Initial Term. The initial term of this Agreement shall commence on November 1, 1998 ("Effective Date") and shall continue until midnight Central Time on the last business day of October, 2008 ("Initial Term"), unless terminated earlier pursuant hereto. 2.2 Renewal Term. Upon Initial Term expiration, this Agreement shall automatically renew for three successive three-year terms (collectively, "Renewal Terms"; each, a "Renewal Term") unless terminated (1) earlier pursuant to Article 25; or (2) by either party upon at least 365 days' written notice to the other prior to Initial Term expiration or any Renewal Term expiration. (Initial Term and Renewal Terms collectively, "Term,") (each 12-month period commencing on the Effective Date during the Term, a "Contract Year".) ARTICLE 3. DESIGNATED SERVICES. 3.1 Designated Services. Fiserv shall provide Northern Trust and its designated affiliates the payments system processing services, including encoding, check 4 processing, controlled disbursement processing and advising, account reconcilement, statement rendition, totaling, verification, and sorting services, return item processing, investigations, hardware, software, software maintenance, software development, and related services performed in the ordinary course by Northern Trust prior to the Effective Date (a) listed in Exhibit 3.1; and (b) otherwise identified in this Agreement as being part of the designated services (collectively, "Designated Services"). Except for Northern Trust Retained Responsibilities, Fiserv shall assume full responsibility, including financial responsibility, for managing, administering, operating, and maintaining Northern Trust Service Locations, Northern Trust Systems, Northern Trust Software, and such other resources mutually agreed by the parties. Except as otherwise provided herein, Fiserv shall be the exclusive provider for Northern Trust with respect to accounts held by Northern Trust, its successors, and assigns of (i) Designated Services as such Designated Services were performed by Northern Trust immediately prior to the Effective Date; and (ii) any increases in volume of such Designated Services resulting from acquisition or otherwise with respect to accounts held by Northern Trust. Affiliates of Northern Trust may at their option and upon 60 days' notice to Fiserv during the term hereof, elect to use Fiserv for the provision of payments processing services on the same term and conditions as described herein, taking account of the fact that differing Services may need to be provided to such affiliates, upon such terms as may be mutually agreeable to the parties at such time. In such case, such affiliate will become an additional signatory to this Agreement. 3.2 Northern Trust Retained Services. Northern Trust shall have responsibility for (1) services described in Article 14 and such ancillary services in support of Designated Services as were performed by Northern Trust as of the Effective Date (respectively, "Northern Trust Retained Responsibilities" and "Fiserv Acquired Services"); and (2) pursuant to Article 15, agreements identified in Exhibit 15.2 ("Northern Trust Retained Agreements"). 3.3 Conversion. Commencing on the Effective Date and continuing until the date specified in Exhibit 3.3A ("Completion Date"), Fiserv shall convert the systems and data described in Exhibit 3.3A in accordance with the conversion plan set forth in Exhibit 3.3A ("Conversion;" the period commencing on the Effective Date until the Completion Date, "Conversion Period"). During the Conversion Period, (1) Fiserv shall provide Northern Trust with monthly reports on its progress in the format indicated in Exhibit 3.3B, and (2) Fiserv shall provide the Management Committee with regular reports of its progress. 3.4 Improved Technology. Fiserv shall use reasonable efforts to provide Northern Trust access to, for Northern Trust's evaluation and testing, new information technology developments relating to the financial and information services industries, relating to Designated Services ("Improved Technology"), providing such access is not 5 inconsistent with Fiserv's obligations of confidentiality to any unaffiliated third party. All fees and expenses associated with such evaluation and testing shall be borne by the parties as mutually agreed by the parties. Fiserv shall use reasonable efforts to adopt and implement at its cost any Improved Technology that becomes the industry standard for leading technology banking service institutions serving the large corporate market; provided however, that nothing herein shall be understood to mean that any Improved Technology proposed or implemented by Fiserv may not be a New Service hereunder, which New Service is governed by the provisions of Section 4.1 hereof. In addition, to the extent not inconsistent with Fiserv's obligations of confidentiality to any unaffiliated third party, Fiserv shall meet with Northern Trust at least once during every 180 day period to inform Northern Trust of any Improved Technology related to any item or information processing or imaging technology Fiserv is developing, or is considering developing, or is otherwise aware of, that relates to either the financial or information services industries. In general Fiserv covenants and agrees to use reasonable efforts to remain current with respect to new information technology developments relating to the Designated Services, such as investing in new hardware for image based item processing. Notwithstanding the foregoing but in furtherance thereof, the Management Committee shall adopt a plan each year for implementing Improved Technology. Compliance with the plan shall create a strong presumption that Fiserv's agreements with respect to Improved Technology contained in this Section 3.4 have been fully carried out. 3.5 Financial Reports and Other Information. Fiserv shall provide Northern Trust within (1) 90 days after Fiserv, Inc.'s fiscal year end, copies of Fiserv Inc.'s audited balance sheet and related audited statements of income, shareholders' equity, and cash flow, together with the notes, if any, relating thereto; and (2) 45 days after each of Fiserv Inc.'s quarter ends, copies of Fiserv, Inc.'s unaudited quarterly financial statements. The foregoing shall be prepared in accordance with generally accepted accounting principles. 3.6 Joint Verification. During the 180-day period after the Effective Date, Northern Trust and Fiserv each reserve the right to validate costs (as measured, calculated, and defined by Northern Trust during 1998), volume, composition, and service levels of Designated Services against the information set forth in Exhibit 3.1, Exhibit 5.1 and Exhibits 14A and 14B hereof. If any such information is inaccurate or incomplete, unless the parties otherwise agree, an equitable adjustment to the terms of this Agreement shall occur, as mutually agreed by the parties; provided, however, that no such adjustment shall be required with respect to inaccurate or incomplete information that has a de minimis financial effect. 3.7 Fiserv Proposals. Fiserv may from time to time propose that Fiserv perform services outside the scope of Services. At Fiserv's expense, any such proposal shall be submitted by Fiserv to Northern Trust for consideration and shall include the applicable terms, conditions, and fees, with an explanation of Fiserv's actual business case and a proposed business case justification on behalf of Northern Trust in respect of 6 such proposal. ARTICLE 4. REQUIRED SERVICES AND CHANGES 4.1 Required Services. Northern Trust may from time to time request that Fiserv perform services related to payments system processing (1) either in addition to or outside the scope of Designated Services; and (2) that require resources other than those required for performance of Designated Services or require additional start-up expenses not otherwise required for the performance of Designated Services, including (a) certain Software modifications; and (b) additions to a Designated Service ("New Services"), (New Services and Designated Services collectively, "Services")or (3) that materially change the (a) Systems; (b) the manner in which the Services are provided, delivered, or measured; (c) Services composition; or (d) Software ("Changes"). Fiserv agrees to provide 10,500 hours of maintenance, programming and consulting services per Contract Year with respect to New Services and/or Changes ("Required Services"), pursuant to the Management Committee's Required Services annual budget required by Section 10.2 hereof. Each annual budget for Required Services shall also include quarterly budgeting of the projects and hours to be spent upon such projects for each such quarter. The parties shall use their reasonable efforts to assure that all projects involving Required Services are completed without material variation from the time budgeted for such projects in the annual and quarterly budgets. At the end of every quarter, any amount of hours budgeted for Required Services for such quarter, other than immaterial amounts, shall not be carried over to the budget for Required Services for any subsequent quarter. If any proposed New Service is not a Required Service, which budget shall be in the form contained in Exhibit 4.1A hereto, Fiserv shall prepare and provide the Management Committee with a proposal in respect of such proposed New Service requested containing, at a minimum, (i) the time frame for delivery or performance of such New Service; (ii) if applicable, a description of such New Service's scope and functionality; (iii) fees to be paid with respect to such New Service ; and (iv) to the extent applicable, an estimate of the resource requirements necessary to develop and implement such New Service (each, a Proposal"). If (i) Northern Trust elects to have Fiserv perform such New Service not as a Required Service or (ii) both parties agree to a New Service after all the hours for Required Services for the Contract Year have been budgeted, Northern Trust and Fiserv shall execute an amendment to this Agreement in substantially the form set forth in Exhibit 4.1B for a New Service (a "New Services Schedule"). Northern Trust and Fiserv shall each respectively perform its responsibilities as required in the applicable New Services Schedule related to any New Service. Fiserv shall perform all Required Services without fees or other compensation in addition to the basic fees hereunder for performing Designated Services. 4.2 Changes. Subject to Section 4.1 hereof, Fiserv may propose to Northern Trust changes to any Services. A proposal shall contain, at a minimum, (i) the time 7 frame for delivery or performance of the Change; (ii) if applicable, a description of the Change's scope and functionality; (iii) fees to be paid with respect to the Change; and (iv) to the extent applicable, an estimate of the resource requirements necessary to develop and implement the Change. If Northern Trust agrees to the proposed Change, both parties shall execute an amendment to this Agreement in substantially the form set forth in Exhibit 4.1B. 4.3 Change Control Procedures. The parties shall agree on Change Control Procedures within 90 days of the date hereof, in written form ("Change Control Procedures"). Fiserv shall (1) schedule all projects and Changes so as not to unreasonably interrupt Northern Trust's business operations; (2) provide Northern Trust a monthly schedule for ongoing and planned Changes for the next 60 day period; (3) monitor and report the status of Changes against the applicable schedule; and (4) document and provide Northern Trust notice of all material Changes performed on a temporary basis to maintain Services continuity. Any changes to Change Control Procedures must contain the approval of each of Northern Trust and Fiserv. 4.4 Fiserv shall provide Northern Trust with monthly reports of the status of its progress in implementing Required Services and Changes. ARTICLE 5. SERVICE LEVELS. 5.1 Designated Service Levels. As of the Effective Date, Fiserv shall provide Designated Services at or better than the levels of service set forth in Exhibit 5.1, which Northern Trust represents and warrants are the corresponding levels of service as of the Effective Date (collectively, "Designated Service Levels"). Exhibit 5.1 shall designate the service levels which have client impact. Failure to meet those service levels will result in Fiserv paying Northern Trust in the form of Fiserv Credits, in the case of Designated Services performed by Fiserv hereunder, or Northern Trust will pay Fiserv in the form of Northern Trust Credits, in the case of Fiserv Acquired Services, all as described in Sections 31.3 and 31.4 hereof. 5.2 New Service Levels. Fiserv shall provide New Services at levels equal to or better than the levels of service (1) specified in the New Services Schedule; or (2) otherwise mutually established by Northern Trust and Fiserv (collectively, "New Service Levels;" Designated Service Levels and New Service Levels collectively, "Service Levels"). 5.3 Service Levels Adjustment. Every six months, the Management Committee shall review Service Levels for the preceding 6-month period. In respect of any Service Levels that require periodic adjustment or that are no longer appropriate because of a Change or technology that has been implemented to change or enhance Services, the Management Committee may recommend that such Service Levels be 8 adjusted for the subsequent Contract Year, and, upon mutual agreement of the parties hereto, such Service Levels shall be adjusted with expenses related thereto paid as mutually agreed. In addition, either Northern Trust or Fiserv may, at any time upon notice to the other party, initiate negotiations to review and adjust any Service Levels that such party in good faith believes are inappropriate at the time. 5.4 Service Reports. Fiserv shall provide Northern Trust with monthly reports in respect of Service Levels set forth in Exhibit 5.1, and any New Service Levels described in Section 5.2. 5.5 Float Policy. The Float Policy Fiserv shall observe in performing the Designated Services shall be as set forth in Exhibit 5.5. ARTICLE 6. SERVICE LOCATIONS AND RELATED PROCEDURES. 6.1 Service Locations. Fiserv and Northern Trust covenant and agree that they shall use reasonable efforts to relocate the main unit for provision of the Services out of the Northern Trust's Operations Center at 801 South Canal Street as promptly as practicable, to another location in the downtown Chicago area. Fiserv shall continue to lease space at 801 South Canal Street until such relocation has occurred. The terms and conditions, including fees, applicable to Fiserv's lease shall be specified in Exhibit 6.1A. Fiserv shall have the right to replace a Northern Trust Service Location with another service location selected by Fiserv, provided such new Service Location shall be operationally suitable to provision of Designated Services and is consented to in writing by Northern Trust. Northern Trust shall be permitted access to any locations used by Fiserv to perform the Services ("Service Locations") at all times and subject to any reasonable notice, security and confidentiality procedures in effect at such Service Location. Such access shall be for the purpose of auditing and verifying that the facility is in first-class operating condition and that work rules (including reasonable dress codes and satisfactory security procedures) are being enforced by on-site management. Fiserv specifically covenants and agrees that all such facilities will be maintained appropriately during normal business hours for tours by clients and prospective clients. Full access will also be provided so that banking regulators shall be allowed to examine all aspects of applicable laws and regulations, including, without limitation, Fiserv's data and system security. 6.2 Facilities Security Procedures. Fiserv shall implement, maintain, and enforce reasonable environmental and physical security standards and procedures at each Service Location. 6.3 Data and Systems Security. Fiserv shall (1) implement, maintain, and enforce data and systems security in respect of Fiserv Systems; and (2) maintain and enforce in respect of (a) Northern Trust Systems that Fiserv is responsible for as part of 9 Designated Services; and (b) Northern Trust Data, in each case on-line security standards and procedures at least as rigorous as those in effect at Northern Trust Service locations as of the Effective Date. 6.4 Lockbox Operation. The parties hereto shall facilitate the relocation, at Northern Trust's option and, if Northern Trust elects to pursue such relocation, at Northern Trust's expense, of Northern Trust's lockbox operations out of the Canal Center and to the main site for Fiserv's check processing operations for Northern Trust pursuant to this Agreement, at such time as Fiserv moves the payments processing unit out of such facility. Fiserv shall provide such space at cost in the new facility. The lockbox operation, which is under Northern Trust's ownership and control, may be moved to facilitate its continued functioning. Northern Trust shall notify Fiserv of its election concerning relocation of the lockbox operation prior to Fiserv finalizing arrangements for its new facility. Fiserv shall notify Northern Trust just prior to its finalizing such arrangements so that Northern Trust may make the foregoing election. ARTICLE 7. SYSTEMS. 7.1 Fiserv Systems. Except as provided in Article 11, any systems and related documentation and procedures and any modifications or enhancements to such systems or related documentation or procedures designed, developed, owned, acquired, or licensed by Fiserv or any of its affiliates related to Services ("Fiserv Systems") shall be the exclusive property of Fiserv or its third party licensor or lessor, as the case may be. Fiserv shall maintain Fiserv Systems in good working order, to the reasonable satisfaction of Northern Trust. Fiserv shall also maintain in good working order the interfaces the Fiserv Systems have with any systems, software or devices of Northern Trust. Fiserv will also cooperate with establishing and maintaining any interfaces it might have with third parties in providing the Services. Except as otherwise provided hereto, Northern Trust shall have no rights to or interests in Fiserv Systems. 7.2 Northern Trust Systems. Except as provided in Article 11, any systems and related documentation or procedures and any modifications or enhancements to such systems or related documentation or procedures designed, developed, owned, acquired, or licensed by Northern Trust or any of its affiliates related to Services ("Northern Trust Systems") shall be the exclusive property of Northern Trust or its third party licensor or lessor. Fiserv shall have no rights to or interests in Northern Trust Systems. (Fiserv Systems and Northern Trust Systems collectively, "Systems".) Fiserv shall maintain in good working order and shall not injure or compromise in any material way the portion of Northern Trust Systems that Fiserv uses or with which Fiserv interfaces in order to provide Services. 10 ARTICLE 8. OMITTED INTENTIONALLY ARTICLE 9. PROJECT TEAM. 9.1 Fiserv Project Manager. Fiserv shall appoint an individual who shall be in charge of implementing Services at Service Locations ("Fiserv Project Manager"). The initial Fiserv Project Manager shall be Mr. Kenneth P. True. 9.2 Northern Trust Project Manager. Northern Trust shall appoint an individual who shall be in charge of working with the Fiserv Project Manager related to Fiserv's implementing Services at Service Locations ("Northern Trust Project Manager"). The initial Northern Trust Project Manager shall be Mr. John Van Pelt. (The Fiserv Project Manager and Northern Trust Project Manager collectively, "Project Managers"). 9.3 Conduct of Fiserv Employees and Agents. While at Northern Trust Service Locations, Fiserv's employees, agents, contractors, and subcontractors (collectively, "Fiserv Agents") shall (1) comply with reasonable Northern Trust requests, rules, and regulations regarding personal and professional conduct (including the wearing of a particular uniform or business attire, identification badge or adhering to general security procedures) generally applicable to such Northern Trust Service Locations; (2) adhere to Northern Trust security procedures; and (3) otherwise conduct themselves in a businesslike manner. 9.4 Fiserv Employment Policies. Fiserv shall exercise due care and diligence in the selection and training of Fiserv Agents and shall take reasonable steps to assure that Services are provided only by persons who have not been convicted of a job-related criminal offense involving violence, dishonesty or any breach of trust. Fiserv shall include language on its employment application or in its subcontracts requiring prospective Fiserv Agents to attest to not having been so convicted. Each Fiserv Agent involved in providing Services shall be bondable and covered by the insurance required under Section 32.17. Fiserv will not discriminate against any of its employees or applicants for employment because of age, race, color, religion, sex, national origin, ancestry, disability, handicap, or veteran status or any other basis prohibited by applicable federal, state or local law, and will comply with all applicable requirements of the equal opportunity and affirmative action clauses set forth in Executive Order 11246 (applicable to subcontractors), as amended, in the regulations of the Department of Labor implementing the Vietnam Era Veterans Readjustment Act of 1974, and in the Rehabilitation Act of 1973, as amended, which, together with the implementing rules and regulations prescribed by the Secretary of Labor, are incorporated in this Agreement by reference. 11 ARTICLE 10. MANAGEMENT AND CONTROL. 10.1 Management Meetings. Monthly meetings of the Management Committee shall be held at a designated site or by conference call or video conference, as may be agreed by the members of the Management Committee to (a) review Fiserv's performance of Services; (b) resolve disputes arising pursuant to this Agreement; (c) track progress of special projects; and (d) coordinate and plan for any new hardware or software acquisitions, or the provision of New Services or Changes. 10.2 Management Committee. Within 10 days of the Effective Date, Northern Trust shall appoint 3 members of its management staff, and Fiserv shall appoint 3 members of its management staff to serve on a management committee ("Management Committee"). Once every Contract Year, the Management Committee shall designate one of its members to act as chairman. The first Contract Year, the chairman shall be one of the Northern Trust members; the second Contract Year, a Fiserv member; and shall continue to alternate each Contract Year. The Management Committee shall be authorized and responsible for (1) generally overseeing the performance hereof; (2) making recommendations relating to the achievement of Northern Trust strategic and tactical objectives in respect of the establishment, budgeting, and implementation of Northern Trust's priorities and plans for payments system processing and communications relating thereto; (3) monitoring and resolving disagreements regarding the provision of Services and Service Levels; and (4) approving an annual budget for the Required Services described in Section 4.1 hereof, and monitoring performance thereunder. Progress with respect to such Required Services budget shall be followed in a report not less than monthly which shall be one of the reports listed on Exhibit 17.1 hereof. The Management Committee shall identify major enhancements annually and determine which of those will be part of the Required Services for the year. 10.3 Management Committee Direction. Each party shall abide by the directions and plans of the Management Committee. The management process agreed to by the parties hereto shall be as described in Exhibit 10.3 hereto. 10.4 Other Fiserv Projects. Any Fiserv contract or project proposed to be entered into after the Effective Date with a party other than Northern Trust or its affiliates that anticipates using the Transferred Assets or the former Northern Trust employees working in the payment processing unit in connection with such contract or project shall be pre-approved by a majority of the Management Committee. 10.5 Problem Notification. In the event Fiserv becomes aware (either through notification by Northern Trust or otherwise) of a Systems, software, or Services event, occurrence, error, defect, or malfunction that Fiserv reasonably believes would materially 12 affect any of the Designated Services (each, a "Problem"), Fiserv shall promptly notify the Northern Trust Project Manager or designated alternate of such Problem. Fiserv shall treat such Problem as a priority and work diligently to avert any adverse effect such Problem may have on the Services. If the Problem is not corrected within 24 hours, Fiserv shall devote sufficient increased resources to either treat the Problem or provide a work around acceptable to Northern Trust. If the Problem has not been treated within two days, Fiserv shall pay damages to Northern Trust as determined by the Management Committee, with such damages to be governed pursuant to the provisions of this Agreement. If more than one Problem arises or occurs at one time, the Northern Trust Project Manager shall determine and inform Fiserv promptly as to the order of priority in which such Problems shall be addressed and resolved. 10.6 Infiteq Alliance. Fiserv shall fund Northern Trust's membership in this program. ARTICLE 11. SOFTWARE. 11.1 Northern Trust Software. (1) Subject to Article 12 hereof, Northern Trust hereby grants Fiserv during the term hereof, a non-exclusive, non-transferable right to have access to and to (a) operate and use as required to provide Services (i) Northern Trust proprietary software operated and used by Transition Employees or other Northern Trust employees prior to the Effective Date related to Designated Services, including the proprietary software listed in Exhibit 11; and (ii) to the extent mutually agreed, any Northern Trust proprietary software acquired by Northern Trust after the Effective Date for use related to Services (collectively, "Northern Trust Proprietary Software"); (b) operate and use as required to provide Services (i) the software licensed or leased by Northern Trust from a third party operational prior to the Effective Date related to Designated Services, including the licensed or leased software listed in Exhibit 11; and (ii) to the extent agreed upon by the parties, any software licensed or leased by Northern Trust from a third party after the Effective Date for use related to Services (collectively, "Northern Trust Third Party Software"); and (c) use any documentation related to Northern Trust Proprietary Software or Northern Trust Third Party Software in Northern Trust's possession on or after the Effective Date ((a), (b) and (c) collectively, "Northern Trust Software"). Northern Trust Software shall be the exclusive property of Northern Trust or its third-party licensor, and Fiserv shall have no rights to or interests in Northern Trust Software, except as described in this Section 11.1. Subject to Section 10.4, Fiserv may use the Northern Trust Software to provide services for any entity during the term of this Agreement. Nothing herein shall in any way affect Northern Trust's rights to the Northern Trust Software, which except as specifically described herein, remains absolute. Upon expiration or termination of this Agreement and upon payment by Fiserv to Northern Trust of the then current licensing 13 fee, if any (so long as the licensing fee is no higher than the amount charged to any other non-affiliated third party), Northern Trust shall deliver to Fiserv a copy of, and hereby grants, or shall cause to be granted to Fiserv, for so long as Fiserv is obligated to provide services to third parties under existing agreements, a non-exclusive, non-transferable license to use and operate, and to sublicense to a third party to have access to, operate, and use Northern Trust Software and Developed Software. Upon the expiration or termination of (i) this Agreement; and (ii) the license granted in the preceding sentence, the rights granted to Fiserv in this Section 11.1 shall immediately revert to Northern Trust. (2) Fiserv may sublicense to Fiserv Agents (each of whom must be specifically approved by Northern Trust) the right to have access to, operate, and use Northern Trust Software to the extent set forth in Section 11.1(1) and as may otherwise be mutually agreed. (3) Upon expiration or termination of this Agreement for any reason, Fiserv shall provide Northern Trust with all extant copies in its possession of Northern Trust Software. (4) Fiserv shall not reverse engineer or decompile Northern Trust Software. 11.2 Developed Software. Except as otherwise provided as part of a New Services Schedule in accordance with Article 4, (1) any enhancements or modifications to the Northern Trust Software shall be and shall remain the exclusive property of Northern Trust or the applicable third party licensor ("Developed Software"). Fiserv shall provide Northern Trust with documentation and source code for all Developed Software at the time the Developed Software goes into use. (2) In consideration of the payments made by Northern Trust, Fiserv hereby assigns to Northern Trust all right, title, and interest in Developed Software. (3) Northern Trust hereby grants to Fiserv during the term hereof, or until earlier termination, a non-exclusive, non-transferable right to have access to, operate, and use Developed Software. (4) Fiserv may sublicense to Fiserv Agents (each of whom shall be specifically approved by Northern Trust) the right to have access to, operate, and use Developed Software during the term of this Agreement and for so long thereafter as Fiserv is obligated to furnish services to third parties under existing agreements. (5) Upon expiration or termination of this Agreement for any reason, Fiserv shall deliver to Northern Trust all extant copies in its possession of Developed Software. 11.3 Fiserv Software. (1) All software and related documentation (a) (i) owned by Fiserv prior to the Effective Date or that Fiserv acquires ownership after the Effective Date, which is used related to Services, including software listed in Exhibit 13A; or (ii) developed by Fiserv after the Effective Date that is not Developed Software (collectively, "Fiserv Proprietary Software"); or (b) licensed or leased from a third party by Fiserv prior to or after the Effective Date that is used related to Services, including software listed in 14 Exhibit 13A ("Fiserv Third Party Software") ((a) and (b) collectively, "Fiserv Software") shall be the exclusive property of Fiserv or its third-party licensor, and Northern Trust shall have no rights to or interests in Fiserv Software except as described in this Section 11.3. (2) Fiserv shall operate and use Fiserv Software related to Services to provide the Designated Services at no additional cost to Northern Trust other than as expressly provided in this Agreement. (3) Northern Trust may sublicense to Northern Trust Agents (each of whom shall be specifically approved by Fiserv) the right to have access to, operate and use Fiserv Software. Upon expiration or termination of this Agreement and upon payment by Northern Trust to Fiserv of the then current licensing fee, if any (so long as the licensing fee is no higher than the amount charged to any other non-affiliated third party), Fiserv shall deliver to Northern Trust a copy of, and hereby grants, or shall cause to be granted to Northern Trust, a non-exclusive, non-transferable license to use and operate, and to sublicense to a third party to have access to, operate, and use Fiserv Software. Upon the expiration or termination of (i) this Agreement; and (ii) the license granted in the preceding sentence, the rights granted to Northern Trust in this Section 11.3 shall immediately revert to Fiserv. (Northern Trust Software, Developed Software, and Fiserv Software collectively, "Software.") ARTICLE 12. REQUIRED CONSENTS. 12.1 Implementation Consents. Northern Trust shall use its commercially reasonable efforts to obtain all consents, approvals, authorizations, notices, requests, and acknowledgments necessary to allow Fiserv and Fiserv Agents to use Northern Trust Software and Northern Trust Systems in order to provide Services to Northern Trust ("Implementation Consents"). 12.2 Termination Consents. Fiserv shall use its commercially reasonable efforts to obtain all consents, approvals, authorizations, notices, and acknowledgments necessary to allow Northern Trust and Northern Trust Agents to continue to use Fiserv Software and Fiserv Systems, and to allow Fiserv to assign or transfer third party agreements to Northern Trust pursuant to Article 28(4), upon expiration or termination of this Agreement for any reason ("Termination Consents"). The costs of obtaining the Termination Consents shall be the responsibility of the party or parties as set forth below: (1) in the event of a termination of this Agreement pursuant to Section 25.1, the costs of obtaining the Termination Consents shall be paid by Northern Trust; and (2) in the event of a termination of this Agreement pursuant to Section 25.2, the costs of obtaining the Termination Consents shall be paid by the defaulting party. 12.3 General Obligations. Each party shall cooperate with and, at the other's request, assist it in obtaining Implementation Consents and Termination Consents (collectively, "Required Consents"). Fiserv and Northern Trust shall each use 15 commercially reasonable efforts to mitigate the expense of obtaining Required Consents. In the event a party is unable to obtain any Required Consents, the parties shall cooperate with each other in implementing a reasonable work around. ARTICLE 13. ASSETS TRANSFERRED. 13.1 Assets Transferred. On the Closing Date (as hereinafter defined), Fiserv shall purchase from Northern Trust the assets specified in Exhibit 13A ("Assets"). The purchase price of each of the Assets shall be the net book value of the Asset, as reflected on the books of Northern Trust. In addition, Fiserv shall be responsible for and shall pay all sales, use, and other similar taxes related to such transfer. On or before December 31, 1998 or such other date as the parties may mutually agree (the "Closing Date"), Northern Trust shall assign and transfer to Fiserv good title to Assets free and clear of all liens by delivery of (1) a General Assignment and Bill of Sale in the form of Exhibit 13B ("General Assignment"), duly executed by each of Northern Trust and Fiserv; and (2) such other good and sufficient instruments of conveyance, assignment, and transfer to be prepared by Fiserv, in form and substance reasonably acceptable to Northern Trust, as shall be effective to vest good and marketable title to Assets in Fiserv. From and after the Effective Date, until the Closing Date, Fiserv shall lease from Northern Trust the Assets, for a rental payment equal to the book value depreciation of such Assets from and after the Effective Date to and including the Closing Date. 13.2 Joint Verification. During the six-month period following the Effective Date, Northern Trust and Fiserv each reserve the right to inventory and validate the information set forth in Exhibit 13A. If any such information should prove to be inaccurate or incomplete, an equitable adjustment to the terms of this Agreement shall occur, as mutually agreed by the parties; provided, however, that no such adjustment shall be required with respect to inaccurate or incomplete information that has a de minimis financial effect. ARTICLE 14. NORTHERN TRUST RETAINED RESPONSIBILITIES AND ACQUIRED SERVICES. Unless provided by Fiserv as a New Service, Northern Trust shall be responsible for the services set forth in Exhibit 14A, which shall be performed at the respective service levels set forth in Exhibit 5.1 ("Retained Responsibilities Service Levels"). Fiserv shall acquire the services and at the cost listed on Exhibit 14B from Northern Trust ("Fiserv Acquired Services"). The Parties by mutual agreement may also add to the list of Fiserv Acquired Services, and designate associated costs of such services, on Exhibit 14B hereafter. 16 ARTICLE 15. THIRD PARTY CONTRACTS 15.1 Transferred Contracts. On the Effective Date, Northern Trust shall transfer or assign Fiserv the agreements, including all rights and responsibilities thereunder, for assets and facilities leased or licensed by Northern Trust or an affiliate and third party services identified in Exhibit 15.1. During the six-month period following the Effective Date, Northern Trust and Fiserv each reserve the right to inventory and validate the information set forth in Exhibit 15.1. If such information should prove to be inaccurate or incomplete, an equitable adjustment to the terms of this Agreement shall occur, as mutually agreed by the parties; provided, however, that no such adjustment shall be required with respect to inaccurate or incomplete information that has a de minimis effect. 15.2 Fiserv Administration. Except as provided in Section 15.6, Fiserv shall be responsible, as of the Effective Date, for managing (including paying any fees or expenses due under such agreements to Northern Trust or the applicable third party vendor, as the case may be), administering, and maintaining agreements for assets and facilities leased or licensed by Northern Trust or an affiliate and third party services that Northern Trust has not assigned to Fiserv pursuant to Section 15.1 and that are (1) identified in Exhibit 15.2; (2) reasonably necessary to provide Designated Services to Northern Trust; and (3) retained by Northern Trust or an affiliate in Northern Trust's or such affiliate's name ("Third Party Resources"). Fiserv shall provide Northern Trust with updates to Exhibit 15.2 periodically during the Term. Fiserv shall provide Northern Trust with reasonable notice of any renewal, termination, or cancellation dates and fees in respect of Third Party Resources. Fiserv may, to the extent permitted by the agreements in respect of Third Party Resources ("Third Party Resources Agreements"), modify, terminate, or cancel any such Third Party Resources Agreements. Any modification, termination, or cancellation fees or charges imposed upon Northern Trust related to any such modification, termination, or cancellation shall be paid by Fiserv. 15.3 Performance Under Third Party Resources Agreements. Northern Trust and Fiserv shall each promptly inform the other of any breach, misuse, or fraud related to any Third Party Resources Agreements of which it becomes aware and shall cooperate with the other party to prevent or stay any such breach, misuse, or fraud. Each party shall pay all amounts due for any penalties or charges (including amounts due to a third party as a result of such party's failure to promptly notify the other party pursuant to the preceding sentence, legal expenses, and other incidental expenses) incurred by such party as a result of such party's performance or nonperformance of its obligations with respect to Third Party Resources Agreements. 15.4 Third Party Invoices. Except as otherwise directed by Northern Trust, 17 Fiserv shall (1) receive all invoices submitted by third parties related to Third Party Resources ("Third Party Resources Invoices"); (2) review and correct any errors in Third Party Resources Invoices in a timely manner; and (3) pay Third Party Resources Invoices prior to the due date. Fiserv shall be responsible for any late fees in respect of Third Party Resources Invoices. 15.5 Appointment as Agent. To the extent permitted by Third Party Resources Agreements, Northern Trust hereby appoints Fiserv as its sole, limited purpose agent for all matters pertaining to such Third Party Resources Agreements. 15.6 Northern Trust Retained Responsibilities. Northern Trust shall retain all rights and responsibilities in and to those agreements for assets and facilities leased or licensed by Northern Trust or an affiliate and third party services identified in Exhibit 15.6. Upon Northern Trust's request, and at Northern Trust's expense with Northern Trust's prior approval and solely to the extent such information and cooperation requires resources other than those provided related to Services, Fiserv shall (1) provide Northern Trust with information relating to the agreements identified in Exhibit 15.6; and (2) cooperate as reasonably required by Northern Trust or its affiliates in order for Northern Trust or its affiliates or Northern Trust's or its affiliates' customers to conduct business in the ordinary course. ARTICLE 16. HUMAN RESOURCES. 16.1 Transition Period. Commencing on the Effective Date and continuing through December 31, 1998, ("Transition Period"), Northern Trust shall be responsible for all costs and expenses relating to Transitioned Employees, who are listed on Exhibit 16.1, incurred or accrued prior to the Effective Date. Fiserv shall be responsible for all costs and expenses related to Transitioned Employees incurred or accrued from and after the Effective Date, as described in Section 16.4 hereof. From the Agreement Date until the Effective Date, Northern Trust shall not, without Fiserv's prior written consent, enter into any new written or oral employment agreement with any Transitioned Employee. Fiserv and Northern Trust shall cooperate during the Transition Period to facilitate salary reviews and appropriate increases for non-officer employees. 16.2 Transitioned Employees. Fiserv shall take over the employment relationship with respect to those individuals listed in (1) Exhibit 16.1 who are active employees of Northern Trust or its affiliates as of January 1, 1999; and (2) Exhibit 16.2 who are on a granted leave (paid or unpaid) from active employment with Northern Trust (which entailed performing services that are Designated Services hereunder) for reasons (e.g., leave of absence or disability) other than layoff ("Transitioned Employees"), as of the Start Date (as defined in Section 16.3 hereof) for each such Transitioned Employee. Fiserv shall offer each Transitioned Employee for the period on and after the Start Date a 18 comparable position (a) requiring comparable skills and job responsibilities; (b) with substantially equivalent hours and shifts; and (c) with a title comparable to that held by such Transitioned Employees as of the Effective Date. Such offer shall be for employment at will. Each employment offer shall include (i) an initial base salary equal to the salary paid to such Transitioned Employee by Northern Trust as of the Effective Date, with such salary to be increased as of the Start Date to compensate for any premium increase such Transitioned Employees may incur when electing comparable medical and/or dental coverage under the 1999 Fiserv plans as compared to the 1999 Northern Trust plans, (ii) additional compensation under rate structures for overtime and shift differential equivalent to Northern Trust rates as of the Effective Date, if any; (iii) an employment designation for such Transitioned Employee to either (x) the Northern Trust Service Location where the Transitioned Employee performed services as of the Effective Date; or (y) a Service Location within the downtown Chicago area; and (iv) with respect to Transitioned Employees, the benefits package described in Section 16.6 applicable to such Transitioned Employees. Northern Trust shall provide Fiserv with the 1998 salary plan and performance review dates, if any, after the Effective Date for each Transitioned Employee. 16.3 Hiring Requirements. Fiserv shall hire on the terms and conditions contained in this Article 16 (1) those Transitioned Employees listed in Exhibit 16.1 who transition to Fiserv as of January 1, 1999 and (2) those Transitioned Employees listed in Exhibit 16.2 who accept an offer no later than 30 days after the date they would otherwise be reinstated by Northern Trust in the absence of this Agreement. Transitioned Employees who accept an employment offer with Fiserv shall become Fiserv employees on the Start Date, which shall mean either (a)January 1, 1999; or (b) with respect to any Transitioned Employee listed in Exhibit 16.2 who returns to active status with Northern Trust and accepts the Fiserv offer, the later of (i)January 1, 1999; (ii) the Fiserv offer acceptance date; or (iii) the return date to active status. Notwithstanding anything else contained herein, Fiserv shall not have to offer employment to any employee who is not able to start employment with Fiserv by July 1, 1999. Except as provided in Section 16.4, Fiserv shall have no responsibilities with respect to Transitioned Employees who decline employment with Fiserv. 16.4 Transition Period Responsibilities. During the Transition Period, Transitioned Employees shall perform their duties related to this Agreement under Northern Trust's direction. Fiserv shall reimburse Northern Trust, by applying credits against Designated Fees pursuant to Section 19.9 for an amount equal to 124% of the applicable salary expenses incurred by Northern Trust, together with reimbursing Northern Trust for all shift differentials, overtime, and all associated accrued bonus expense incurred by Northern Trust for Transitioned Employees after the Effective Date. 16.5 Minimum Employment Period. Those Transitioned Employees who accept an employment offer from Fiserv (1) shall not be terminated by Fiserv prior to 19 January 1, 1999 ("Minimum Employment Period"); provided, however, that nothing herein shall limit Fiserv's right to modify pay, benefit and terms and conditions of employment, or to terminate a Transitioned Employee's employment for reasons based on cause or unsatisfactory performance or conduct ("Termination Reasons"), to be determined in Fiserv's reasonable discretion; and (2) may be reassigned during the Conversion Period to a Service Location or any other location in the downtown Chicago area. Notwithstanding the foregoing, if an employee is terminated by Fiserv (other than for Termination Reasons) during the Minimum Employment Period, Fiserv shall pay such employee severance in an amount equal to the greater of (i) the severance benefits payable under any Fiserv severance plan or arrangement applicable to the employee at such time and (ii) the severance benefits payable to such employee under the applicable Northern Trust severance guidelines as of the Effective Date. 16.6 Benefits Generally. As of the Start Date for each Transitioned Employee, Fiserv shall provide such Transitioned Employee with coverage under benefit plans, programs, policies, and arrangements maintained by Fiserv for its employees generally ("Fiserv Benefits Plans"), including those set forth in Exhibit 16.6. Fiserv reserves the right to implement changes in Fiserv Benefit Plans. As of the Start Date for each Transitioned Employee, Fiserv shall provide credit for each Transitioned Employee's service with Northern Trust as such actual service may be recognized for such Transitioned Employee under the benefit plans, programs, policies, and arrangements maintained by Northern Trust for its employees ("Northern Trust Benefits Plans") immediately prior to their Start Date for purposes of eligibility, participation, vesting of, and qualification for benefits under Fiserv Benefits Plans; provided, however, that with respect to Fiserv's sabbatical plan each Transitioned Employee shall be credited with 25% of such Transitioned Employee's actual service with Northern Trust, up to a limit of five years of total credit toward the Fiserv sabbatical plan. In addition, Fiserv shall make available to Transitioned Employees immediate coverage under Fiserv's life insurance and disability plans as of the Transitioned Employee's Start Date, without any waiting period, and Fiserv shall waive application of any preexisting conditions provisions under said plans. Fiserv shall be required to waive such preexisting conditions provisions only for the level of coverage elected at Northern Trust immediately prior to the Transitioned Employee's Start Date, subject to the maximum level of coverage under Fiserv Benefits Plan. 16.7 401(k) Plan. Each offer to Transitioned Employees shall include participation in the Fiserv 401(k) Savings Plan, subject to Fiserv's 401(k) Savings Plan's eligibility criteria identified in Exhibit 16.6 ("Fiserv 401(k) Savings Plan"); provided, however, that Transitioned Employees' service with Northern Trust set forth in Exhibit 16.1 shall be added to such employees' length-of-service with Fiserv when calculating eligibility and vesting for such Transitioned Employees under the Fiserv 401(k) Savings Plan. Fiserv shall cause the Fiserv 401(k) Savings Plan to accept a direct rollover of cash or the equivalent of the vested account balance under The Northern Trust 20 Company Thrift-Incentive Plan (other than Northern Trust Corporation Common Stock and after-tax contributions made by a Transitioned Employee) and vested accrued benefit under The Northern Trust Company Pension Plan of each Transitioned Employee wishing to make such a rollover, to the extent permissible under applicable law. Fiserv will provide a one-time 401(k) loan rollover opportunity when distributions from The Northern Trust Company's TIP plan are no longer limited by the "same desk" rule. Northern shall assist Fiserv in the transition of such loans by combining the employee rollover requests for a single submission of all such requests to the administrator of the Fiserv 401(k) Savings Plan at the agreed upon time. Fiserv shall provide Northern Trust with any information that Northern Trust reasonably requests (such as a Transitional Employee's date of termination of employment with Fiserv) to enable Northern to administer The Northern Trust Company Thrift-Incentive Plan in compliance with the requirements applicable to section 401(k) plans under the Internal Revenue Code. 16.8 Health Benefits. Each offer to Transitioned Employees shall include for such Transitioned Employee and any insured dependents participating in Northern Trust health benefits plan ("Northern Trust Health Benefits Plan"), the ability to participate in the health, dental, and vision benefits package identified in Exhibit 16.6 ("Fiserv Health Benefits Plan") immediately as of the Start Date, without any waiting period. Fiserv shall waive application of any preexisting conditions provision under Fiserv Health Benefits Plan to any Transitioned Employee or covered dependents under such plans ("Insured Dependents") as of the Start Date for each Transitioned Employee provided such Transitioned Employee, or Insured Dependents, are participating in the Northern Trust Health Benefit Plan. Northern Trust shall retain all liability under the Northern Trust Health Benefits Plan with respect to claims incurred by each Transitioned Employee or Insured Dependents prior to the Start Date for such Transitioned Employee. For this purpose, a claim is deemed to have been incurred when the medical or other service giving rise to the claim is performed. In the event any Transitioned Employee or Insured Dependent is hospitalized on or prior to the Start Date for such Transitioned Employee, then to the extent Northern Trust Health Benefits Plan would otherwise have covered hospital-related claims through the date of such individual's discharge, Northern Trust shall be responsible for such claims and Fiserv shall have no liability with respect thereto. 16.9 Vacation. Fiserv shall provide each Transitioned Employee annual vacation days at the greater of (1) the number of days such Transitioned Employee would be eligible for under Fiserv's vacation policy determined by using aggregate service of such Transitioned Employee at Northern Trust and Fiserv; and (2) the annual vacation allotment that each such Transitioned Employee would have been entitled to receive under the Northern Trust vacation plan as of the Start Date for each Transitioned Employee. Notwithstanding the foregoing, no Transitioned Employee shall receive more than four weeks of annual vacation from Fiserv from and after such time as such employee becomes eligible for a sabbatical under the Fiserv sabbatical plan. 21 16.10 Tuition. As of the Start Date, Fiserv shall reimburse Transitioned Employees who meet requirements for reimbursement under Northern Trust's tuition plan for all course work of a Transitioned Employee approved by Northern Trust prior to the Effective Date (1) then in progress; or (2) paid for by the Transitioned Employee, but not yet commenced. The amount of such reimbursement shall be reduced by the amount of any outstanding tuition advance made by Northern Trust to such Transitioned Employee. The amount so reimbursed to a Transitioned Employee by Fiserv shall be repaid to Fiserv by Northern Trust. For each Transitioned Employee who, for any course work approved by Northern Trust prior to the Effective Date, has not submitted completed course work documentation to Northern Trust as of the Start Date, Northern Trust will furnish Fiserv with the approved education memorandum and the amount of all tuition advanced outstanding with respect to such course work. For courses that were approved by Northern Trust prior to the Effective Date, Fiserv shall (a) provide to Northern Trust copies of all required documentation provided by Transitioned Employees of grades received and the bursar's receipt; and (b) promptly notify Northern Trust of any Transitioned Employee who (i) has a tuition advance and leaves employment with Fiserv; or (ii) notifies Fiserv that he or she has not met the requirements for reimbursement. Commencing on the Effective Date and subject to the Transitioned Employee accepting Fiserv's employment offer, Fiserv shall be responsible for (x) approving all courses subject to tuition reimbursement; and (y) with respect to any courses so approved by Fiserv, paying any tuition reimbursement requests in accordance with Fiserv's tuition plan. 16.11 Human Resource Information. Fiserv and Northern Trust shall provide the other, on a continuing basis without charge, such information regarding Transitioned Employees as reasonably requested in order to permit proper administration of various benefit plans applicable to Transitioned Employees. Northern Trust shall provide Fiserv with the salary, last salary increase date, and amount, shift, shift differentials, job function, date of performance evaluations, health insurance coverage, numbers of supplemental life insurance levels elected under Northern Trust plans (if any), corporate title (if any), and Northern Trust (equated) hire date for each Transitioned Employee who accepts an employment offer with Fiserv pursuant to Section 16.3. The parties hereto acknowledge and agree that all personnel files, with the exception of current discipline documentation and the employee's latest performance appraisal for each of the Transitioned Employees representing their period of employment with Northern Trust are and remain the property of Northern Trust. On or prior to the Start Date, Northern Trust will take possession of such files, and Fiserv specifically covenants and agrees to cooperate in such project. 16.12 No Hiring. Except as otherwise provided under this Agreement, neither Northern Trust nor Fiserv shall, without the other party's consent, for a period of 24 months after the Effective Date, solicit or hire then-current employees of the other party that (1) performed services under or participated in the negotiations with respect to this 22 Agreement; and (2) had significant direct contact with the soliciting or hiring party while performing such Services. This restriction shall not apply to any employees who are given employment termination notices by the other party or to persons responding to general, published solicitations of employment. ARTICLE 17. REPORTS AND DATA. 17.1 Reports. Fiserv shall provide Northern Trust those reports (1) prepared by Northern Trust as of the Effective Date; and (2) described in Exhibit 17.1 (collectively, "Reports"). Reports shall be prepared by Fiserv and provided to Northern Trust according to the schedules set forth in Exhibit 17.1 and in substantially the same form as in effect as of the Effective Date unless otherwise mutually agreed. 17.2 Inspection of Reports. Northern Trust shall (1) inspect and review Reports; and (2) provide Fiserv with a notice of any errors or inaccuracies in (a) daily and weekly Reports within 5 days of receipt; and (b) in monthly or other Reports within 10 days of receipt. 17.3 Northern Trust Data Ownership. All data and information, including checks, drafts, check issuance files, stop payment instructions, and other instruments and items, submitted to Fiserv by Northern Trust or Northern Trust customers in connection with Services ("Northern Trust Data") is and shall remain Northern Trust's or its affiliates' property or property of their respective customers, as applicable. Northern Trust Data shall not be (1) used by Fiserv and Fiserv Agents other than in connection with providing Services; (2) sold, assigned, or leased to third parties by Fiserv and Fiserv Agents; or (3) commercially exploited by or on Fiserv's or Fiserv Agents' behalf. 17.4 Errors Correction. Fiserv shall promptly correct at its expense any errors or inaccuracies in Northern Trust Data and Reports caused by Fiserv or Fiserv Agents. At Northern Trust's expense, Fiserv shall promptly correct (a) any other errors or inaccuracies in Northern Trust Data and Reports; and (b) any errors or inaccuracies identified by Northern Trust after the applicable review period expiration described in Section 17.2. Northern Trust is responsible for (i) Northern Trust Data accuracy and completeness; and (ii) any errors or inaccuracies in and with respect to data obtained from Fiserv or Fiserv Agents because of any inaccurate or incomplete Northern Trust Data. Fiserv is responsible for all of the completeness of the Reports and any errors or inaccuracies in its data or Reports. 17.5 Return of Data. Except to the extent that Northern Trust's request requires resources other than those provided related to Designated Services, in which case the time and material charges set forth in Exhibit 19.1 shall apply, Fiserv shall on (1) Northern Trust's request at any time; and (2) upon Termination Assistance Services cessation, (a) promptly return to Northern Trust, in the format and on the media mutually 23 agreed, all or part of Northern Trust Data; and (b) erase or destroy all or part of Northern Trust Data in Fiserv's possession prior to Termination Assistance Services cessation after successfully returning Northern Trust Data pursuant to this Section 17.5. Archival tapes containing any Northern Trust Data shall be used solely for back-up purposes. Fiserv shall be relieved of its obligations to provide Services (except for any Termination Assistance Services to the extent such Termination Assistance Services can be provided without such Northern Trust Data) should Northern Trust require Fiserv to erase or destroy all Northern Trust Data in its possession prior to cessation of all Termination Assistance Services. 17.6 Data Retention. Fiserv and Northern Trust shall each make and maintain tapes or other medium containing copies of any Northern Trust Data then residing on Systems ("Data Tapes") in accordance with the Data Retention Schedule set forth in Exhibit 17.6. On request, authorized Fiserv and Northern Trust personnel shall be permitted access at any time to any facilities used to store Data Tapes during normal business hours and subject to any reasonable security and confidentiality procedures or other restrictions in effect at such facilities. Fiserv and Northern Trust shall each maintain Data Tapes copies for at least the period specified in Exhibit 17.6 from the date each such Data Tape was made. Fiserv shall maintain its Data Tape copies at locations other than the Service Locations. ARTICLE 18. CONTINUED PROVISION OF SERVICES. 18.1 Disaster Recovery Plan. Fiserv shall (1) maintain during the applicable Site Conversion Period and, in the event of a disaster, implement the on-site and off-site disaster recovery procedures in effect at each Northern Trust Service Location as of the Effective Date; (2) implement disaster recovery procedures in respect of Fiserv Service Locations; and (3) implement disaster recovery procedures in respect of the Northern Trust Service Locations after the Conversion Period (collectively, "Disaster Recovery Plan"); (4) periodically update and test twice a year, with Northern Trust's participation, Disaster Recovery Plan operability; (5) provide Northern Trust with a current Disaster Recovery Plan copy; (6) certify the Disaster Recovery Plan is fully operational at least once every Contract Year; (7) implement the Disaster Recovery Plan upon the occurrence of a disaster (a) at any Service Location; or (b) otherwise affecting Services provision or receipt (a "Disaster"); (8) consult with Northern Trust regarding Services priority during pendency of a Disaster ; and (9) gain Northern Trust's written approval to the Disaster Recovery Plan not less often than every six months during the Term of the Agreement. In the event of a Disaster and as part of the Disaster Recovery Plan, Fiserv shall restore those services designated in the Disaster Recovery Plan as critical services ("Critical Services") in accordance with the Disaster Recovery Plan. After the Effective Date, Fiserv may, upon approval of Northern Trust, modify or change the Disaster Recovery Plan at any time; provided, however, that such change or modification shall not adversely 24 affect Fiserv's obligation to restore Services in accordance with this Section 18.1, Article 4, and Section 18.2. The Northern Trust Disaster Recovery Plan is set forth in Exhibit 18.1. 18.2 Force Majeure. Neither Northern Trust nor Fiserv shall be liable for a failure or delay in the performance of its obligations pursuant to this Agreement, including in the event of failure or delay in respect of providing Services, (1) provided that such failure or delay (a) could not have been prevented by reasonable precautions; and (b) cannot reasonably be circumvented by the non-performing party through the use of alternate sources, work around plans, or other means; and (2) if such failure or delay is caused, directly or indirectly, by fire, flood, earthquake, elements of nature or acts of God, acts of war, terrorism, riots, civil disorders, rebellions or revolutions in the United States, strikes, lockouts or labor difficulties, or any other similar causes beyond the reasonable control of such party ("Force Majeure Event"). Upon the occurrence of a Force Majeure Event, the non-performing party shall be excused from any further performance of those of its obligations pursuant to this Agreement affected by the Force Majeure Event for as long as (i) such Force Majeure Event continues; and (ii) such party continues to use commercially reasonable efforts to recommence performance. The party delayed by a Force Majeure Event shall (x) promptly notify the other party by telephone (to be confirmed in writing within 5 days of the inception of such delay) of the occurrence of a Force Majeure Event; and (y) describe in reasonable detail the circumstances causing the Force Majeure Event. ARTICLE 19. PAYMENTS TO FISERV. 19.1 Designated Fees. In consideration of Fiserv providing Designated Services, Northern Trust shall pay Fiserv the fees based on unit prices and volume of each item processing Service as set forth in Exhibit 19.1 ("Designated Fees"). The fee for Services in any month Services are performed shall be the product of volume of items processed in that month multiplied by the applicable unit price set forth in Exhibit 19.1 (as such unit prices may be amended from time to time pursuant to this Agreement). Fiserv shall submit to Northern Trust monthly invoices on the 15th day of each month for the following month in respect of each Service containing (a) estimated Designated Fees applicable to such Service ("Estimated Designated Fees"); (b) estimated postage for the following month and other estimated direct, out-of-pocket disbursements for such following month that are payable by Fiserv for Northern Trust's account pursuant to this Agreement ("Estimated Out-of-Pocket Expenses"), and, if applicable, any estimated New Service Fees and Development Fees, as defined in Exhibit 19.1, (collectively, "Estimated Additional Fees"). (Estimated Designated Fees, Estimated Out-of-Pocket Expenses, and Estimated Additional Fees collectively, "Estimated Fees".) During the first quarter of the first Contract Year, Estimated Designated Fees per month shall be $2,046,083 and Estimated Out-of- Pocket Expenses per month shall be $76,000. (3) (a) Estimated 25 Designated Fees and Estimated Out-of-Pocket Expenses for every other month during the Term; and (b) all Estimated Additional Fees shall be agreed upon by Northern Trust and Fiserv annually and shall be based on the actual volume of Additional Fees during the preceding 6-month period (adjusted appropriately to reflect known or anticipated changes in such volumes). Unless Northern Trust disputes in good faith Estimated Fees within 30 days of receipt of the applicable invoice, Northern Trust shall pay the invoice provided to Northern Trust pursuant to this Section 19.1 by direct deposit to an account designated by Fiserv on the later of (i) 30 days from Northern Trust's receipt of such invoice; or (ii) the 15th day of the month for which such estimate is provided. Within 30 days after the end of the applicable month, Fiserv shall reconcile Estimated Fees paid by Northern Trust for Services provided by Fiserv for the month and Fees actually due to Fiserv based on Northern Trust's actual Services volume for such month and adjust the next invoice by such amount by either application of a credit or addition of Fees. Northern Trust shall notify Fiserv within 10 days of Northern Trust's receipt of the next invoice and accompanying Fee Reconciliation Statement as to whether Northern Trust approves or disapproves of the credit or additional Fees and other amounts owed or credited set forth in such next invoice. In the event Northern Trust disapproves of any such amount or additional Fees or other amounts owed or credited set forth in a subsequent invoices, Northern Trust shall provide Fiserv with a list of any such amount or additional Fees of which Northern Trust disapproves within 20 days of Northern Trust's receipt of such invoice, together with Northern Trust's reason for such disapproval, and shall pay to Fiserv within 30 days of Northern Trust's receipt of such subsequent invoice any undisputed amounts. Fiserv shall adjust the next invoice to reflect the changes agreed on by Northern Trust and Fiserv. At the end of every 6-month period of the Term, Northern Trust and Fiserv shall review the volume of the Services during the preceding 6 months to determine whether a sufficient change in volume has occurred to warrant an adjustment to the Estimated Fees. If an adjustment is warranted, Northern Trust and Fiserv shall adjust the Estimated Fees. 19.2 Fee Schedules During the Initial Term. The fee schedules as set forth in Exhibit 19.1 shall remain fixed for the first three Contract Years. Thereafter, the Fees shall be adjusted no more often than annually as follows. First, such Fees shall be subject to adjustment only for such Contract Years that occur after a preceding calendar year (or years, as the case may be) with respect to which the increase in the Consumer Price Index for Urban Consumers, published monthly by the U.S. Department of Labor, or any successor index, was greater than 1%. Second, such Fees shall be adjusted only in accordance with the following formula: 77%, such percent determined in Exhibit 19.2, multiplied by the applicable annual increase in the CPI less 1% per annum. Any such adjustment in the Fees shall be for the following period, until the next adjustment, if any. 19.3 Fee Schedules During Renewal Term. Prior to any Renewal Term, the parties shall negotiate in good faith to adjust the fee schedules which will apply to the Renewal Term. If the parties cannot agree to these adjusted Fees prior to the beginning 26 of such Renewal Term, this Agreement will remain in effect, with fee schedules unchanged, for an additional Contract Year; and at the end of such Contract Year, this Agreement will terminate without payment of any termination fees or Termination Losses. 19.4 New Service Fees. In consideration of Fiserv providing any New Service, Northern Trust shall pay Fiserv fees in the amount and manner mutually agreed in accordance with Article 4 ("New Service Fees"). (Designated Fees and New Service Fees collectively, "Fees".) 19.5 Most Favored Customer. Fiserv's charges to Northern Trust for the Services shall be at least as low as Fiserv's lowest charges for such services to any of Fiserv's other customers for (1) similar volumes and (2) similar scope of service and (3) similar performance standards, in each case subject to appropriate adjustments (a) to reflect the geographic area in which services are delivered and (b) to reflect any tradeoffs made between profit sharing, base prices, subsidies and assumption of existing operations. Upon request, Fiserv shall provide to Northern Trust a written certificate, signed by an officer of Fiserv, certifying that this Section 19.5 has not been contradicted by any transaction entered into, including any renewal or amendment of an existing agreement, by Fiserv since the later of (i) the Effective Date or (ii) the date of the most recent certification provided by Fiserv pursuant to this Section 19.5. If Fiserv is unable to provide such certificate because of any such transaction entered into by Fiserv contradicting this Section 19.5, Fiserv shall offer to Northern Trust an adjustment to the financial and other terms of this Agreement, including, if appropriate, the lowest total charges included in any such transaction. 19.6 Detailed Invoices. On Northern Trust's request, Fiserv shall provide mutually agreeable invoices with varying degree of detail (e.g., per unit, department, project). 19.7 Time of Payment. Any sum due Fiserv or Northern Trust pursuant to this Agreement that is not being disputed in good faith by the other party and for which payment is not otherwise specified shall be due and payable 30 days after receipt by either party of an invoice or demand for payment. If either party does not make payment when due for items not in dispute, the other party may assess a late fee of 1 1/2% per month on the outstanding balance. 19.8 Payment of Termination Fees. Upon receipt by Fiserv of a termination notice pursuant to Section 25.1, Fiserv shall calculate and notify Northern Trust of the fixed termination fee amount payable to Fiserv pursuant to Section 26.1 as a result of the termination. This amount shall be payable to Fiserv on the date Fiserv ceases providing the Services. The termination fee portions covering documented losses related to closing down Service Locations shall be payable by Northern Trust on the date the Service 27 Location is shut down. Northern Trust may conduct or, at its option and expense, engage a certified public accounting firm to conduct, within 60 days, an examination of the termination fee payable pursuant to Section 26.1, including the portion relating to Fiserv's documented losses from closing down Service Locations in order to determine the accuracy of such termination fee (or portion thereof). In the event that such audit reveals an error (other than a de minimis error) in such termination fee amount payable pursuant to Article 26, including the portion covering documented Losses, Fiserv shall pay the cost of such audit or shall reimburse Northern Trust for the amount previously paid for such audit unless contested by Fiserv pursuant to Article 29. 19.9 Set-Off Rights. (1) With respect to any amount payable to Northern Trust by Fiserv pursuant to this Agreement, including any occupancy-related charges owed to Northern Trust by Fiserv, in the event that earlier payment dates are not specified for such amounts, or Fiserv has not paid such amounts when due, Fiserv shall credit such amounts against Estimated Fees and Fees in the month for which such amounts owed to Northern Trust were incurred by Fiserv or as soon thereafter as such amounts are known. (2) With respect to any amount not credited to Northern Trust pursuant to Section 19.9(1) that (a) was not accounted for in an invoice; and (b) Northern Trust in good faith determines should be reimbursed or is owed to Northern Trust, Northern Trust may, upon notice to Fiserv, deduct the entire amount owed against Fees otherwise payable to Fiserv under this Agreement until such time as the entire amount owed to Northern Trust is paid. 19.10 Unused Credits. Any unused credits or charges against payments or credits or charges owed to Northern Trust by Fiserv pursuant to this Agreement that were not credited to Northern Trust pursuant to Section 19.9 or accounted for in an invoice shall be paid to Northern Trust by Fiserv within 30 days of the expiration or termination hereof for any reason. 19.11 Services Provided to Third Parties. Other than with respect to clients of Fiserv that are such clients on the date hereof, if Fiserv provides services to third parties at any Service Location, any volume for such services shall be added to Northern Trust volumes for purposes of determining applicable unit prices charged to Northern Trust. If after the Effective Date, any new client relationship results in added volume for Fiserv at its Service Locations, and if the efforts of Northern Trust have been material to gaining such new relationship, Fiserv shall pay to Northern Trust an amount based upon the profitability to Fiserv of such new relationship, as the parties shall hereafter agree upon. ARTICLE 20. TAXES. (1) Northern Trust shall pay or reimburse and indemnify Fiserv, for any sales, use or excise taxes imposed in connection with Fiserv's provision of Services hereunder. (2) 28 Northern Trust and Fiserv shall cooperate to segregate Fees into the following separate payment streams: (a) those for taxable Services; (b) those for nontaxable Services; (c) those for which a sales, use, or similar Tax has already been paid by Fiserv; and (d) those for which Fiserv functions merely as a Northern Trust paying agent in receiving goods, supplies, or services (including leasing and licensing arrangements) that otherwise are nontaxable or were previously subject to tax. (3) Fiserv and Northern Trust also agree that in the event any Fees for Services that were nontaxable become taxable, or are asserted to be taxable by any taxing authority, Fiserv will take all commercially reasonably possible steps to restructure provision of those Services in a manner reasonably acceptable to Northern Trust that would cause those Services not to be taxable, or subject to any taxing authority's assertion that those Services are taxable. (4) For purposes of this Article 20, "Taxes" shall mean all sales, use, transfer, ad valorem, gross receipts, or excise taxes and any other similar taxes, fees, duties, or imposts, plus any interest and penalties imposed thereon, and all expenses incurred by Northern Trust related to payment or settlement of or defense against any claim for such taxes. ARTICLE 21. AUDITS AND REGULATORY EXAMINATIONS. 21.1 Processing. On notice from Northern Trust, Fiserv shall provide such internal auditors, external auditors, and inspectors as Northern Trust or any regulatory authority may designate, with reasonable access to Service Locations to perform audits or inspections of Northern Trust's business (including Fiserv's provision of Services). Fiserv shall provide such auditors and inspectors any assistance that they may reasonably require. If any audit by an auditor designated by Northern Trust or a regulatory authority having jurisdiction over Northern Trust or Fiserv results in Fiserv being notified that it is not in compliance with banking laws, regulations, policies, or interpretations thereof promulgated by any regulatory authority, any generally accepted accounting principles, or other audit requirements relating to Services, Fiserv shall, within a reasonable period of time comply with such audit or regulatory authority, with Northern Trust's approval and at Northern Trust's expense; provided, however, that Fiserv shall bear such expense if it fails to comply with procedures existing prior to the Effective Date, fails to follow any relevant laws, regulations, or generally accepted accounting principles, or fails to follow procedures in accordance with Designated Services. If Fiserv is required to make changes or take corrective action as a result of such audit or regulatory examination, (1) Northern Trust will invite Fiserv to participate in the Northern Trust response team discussions (without such auditor or regulator); and (2) Northern Trust will invite Fiserv to offer alternative solutions to such auditor or regulatory authority or participate in discussions with such auditor or regulatory authority. If a change is required by banking laws, regulations, policies, or interpretations thereof promulgated by any regulatory authority (a "Required Change"), such change that is a New Service shall be at Northern Trust's expense and a Change that is a modification to a Designated Service shall be at Fiserv's expense.. In the event that either Northern Trust or Fiserv is audited and a 29 regulatory change is required, both parties shall engage in cooperative behavior in order to implement such change. 21.2 Federal Reserve Examinations. The performance of some or all Services is subject to regulation and examination by the Federal Reserve. Fiserv shall submit to regulations and examinations by the Federal Reserve to the same extent Northern Trust would submit to regulations and examinations by the Federal Reserve if such regulations and examinations were performed by the Federal Reserve on Northern Trust premises. ARTICLE 22. CONFIDENTIALITY. 22.1 Definition. (1) Northern Trust Information. "Northern Trust Information" means: (a) confidential plans, customer lists, information, and other Northern Trust proprietary material and (b) any information and data concerning the business and financial records of Northern Trust's customers. (2) Fiserv Information. "Fiserv Information" means: (a) confidential plans, information, research, development, trade secrets, business affairs (including that of any Fiserv customer, supplier, or affiliate), and other Fiserv proprietary material; and (b) Fiserv's proprietary computer programs, including custom software modifications, software documentation and training aids, and all data, code, techniques, algorithms, methods, logic, architecture, and designs embodied or incorporated therein (whether or not any such information is marked with a restrictive legend). (3) Information. "Information" means Northern Trust Information and Fiserv Information. No obligation of confidentiality applies to any Information that the receiving party ("Recipient") (a) already possesses without obligation of confidentiality; (b) develops independently; or (c) rightfully receives without obligation of confidentiality from a third party. No obligation of confidentiality applies to any Information that is, or becomes, publicly available without breach of this Agreement. 22.2 Obligations. Recipient agrees to hold as confidential all Information it receives from the disclosing party ("Discloser"). All Information shall remain the property of Discloser or its suppliers and licensors. Information will be returned to Discloser at the termination or expiration of this Agreement. Recipient will use the same care and discretion to avoid disclosure of Information as it uses with its own similar information that it does not wish disclosed, but in no event less than a reasonable standard of care. However, Northern Trust's customer information shall be kept confidential as provided by 205 ILCS 5/48.1. Recipient may use Information for any purpose that does not violate such obligation of confidentiality. Recipient may disclose 30 Information to (a) employees and employees of affiliates who have a need to know; and (b) any other party with Discloser's written consent. Before disclosure to any of the above parties, Recipient will have a written agreement with such party sufficient to require that party to treat Information in accordance with this Agreement. Recipient may disclose Information to the extent required by law. However, Recipient agrees to give Discloser prompt notice so that it may seek a protective order. The provisions of this Section 22.2 survive any termination or expiration of this Agreement. 22.3 Residuals. Nothing contained in this Agreement shall restrict Recipient from the use of any ideas, concepts, know-how, or techniques contained in Information that are related to Recipient's business activities ("Residuals"), provided that in so doing, Recipient does not breach its obligations under this Article 22. However, this does not give Recipient the right to disclose the Residuals except as set forth elsewhere in this Agreement. 22.4 Systems. Each party's Systems contain information and computer software that are proprietary and confidential information of, its suppliers, and licensors. Each party agrees not to attempt to circumvent the devices employed by the other to prevent unauthorized access to a system, including, but not limited to, alterations, decompiling, disassembling, modifications, and reverse engineering thereof. 22.5 Confidentiality of this Agreement. Fiserv and Northern Trust agree to keep confidential the prices, terms and conditions of this Agreement, without disclosure to third parties (except upon the request of bank regulators and as required by law). 22.6 Injunctive Relief. Recipient recognizes that disclosure of Information in respect of Discloser may give rise to irreparable injury to the other party and acknowledges that remedies other than injunctive relief may not be adequate. Accordingly, Discloser has the right to seek equitable and injunctive relief without implementing dispute resolution procedures described in Article 29 to prevent unauthorized possession, use, disclosure, or knowledge of any Information, as well as to such damages or other relief as is occasioned by such unauthorized possession, use, disclosure, or knowledge. 22.7 Legal Action. Recipient shall not commence any legal action or proceeding in respect of any unauthorized possession, use, or knowledge, or attempt thereof, of Discloser's Information by any person or entity, which action or proceeding directly or indirectly identifies Discloser or its Information without Discloser's prior written consent. ARTICLE 23. REPRESENTATIONS AND WARRANTIES. 31 23.1 By Northern Trust. Northern Trust represents and warrants that: (1) it is an Illinois state bank; (2) it has all requisite power and authority to execute, deliver, and perform its obligations hereunder; (3) the execution, delivery, and performance of this Agreement are duly authorized; (4) any approval, authorization, or consent of any government or regulatory agency, or notice or filing required to be obtained or made by it in order for it to enter into and perform its obligations under this Agreement shall be obtained or filed prior to the Effective Date, or immediately upon notice that such approval, authorization, consent, notice, or filing is required; (5) it shall comply with all applicable Federal, state, and local laws and regulations, and shall obtain all applicable permits and licenses in connection with its obligations under this Agreement; (6) as of the Effective Date, it has not disclosed any Fiserv Information; (7) as of Conversion, Designated Services shall not, and Northern Trust Proprietary Software does not, infringe any third party proprietary rights; (8) no outstanding litigation, arbitration, or other dispute to which Northern Trust is a party exists that, if decided unfavorably to Northern Trust, would have a material adverse effect on Northern Trust's ability to fulfill its obligations under this Agreement; (9) it shall not incorporate into any Northern Trust Software or Developed Software any (a) automatic shut-off devices or "time bombs"; or (b) computer viruses or coding intended to corrupt, delete, or otherwise render Fiserv Systems inaccessible; (10) to the knowledge of Northern Trust, no circumstances of non-compliance by Northern Trust with any external audit or regulatory authority exist as of the Effective Date; (11) Northern Trust will not incur any additional costs or expenses in connection with its performance of Designated Services from the Agreement Date to the Effective Date, except (a) in the ordinary course of business consistent with past practice; or (b) as otherwise provided under this Agreement; and (12) contracts and agreements listed in Exhibit 15.1, Exhibit 15.2, and Exhibit 15.6 represent all of the contractual arrangements used by Northern Trust as of the Effective Date in order to perform services that are Designated Services under this Agreement, other than contractual arrangements that (a) involve the payment by Northern Trust of less than $10,000 annually; (b) can be terminated within 30 days after giving notice of termination, without resulting in any material cost to Fiserv; (c) are specifically identified as not being assigned to Fiserv; or (d) are incidental to occupancy of Northern Trust Service Locations; (13) the assets transferred to Fiserv hereunder are substantially all the assets used by Northern Trust in rendering the Designated Services as of the Effective Date; (14) the personnel information concerning Transitioned Employees provided to Fiserv hereunder is true and accurate in all material respects; and (15) the services performed by Northern Trust prior to the date hereof corresponding to the Services hereunder conform in all material respects to the descriptions of such Services set forth in Exhibit 3.1. 23.2 By Fiserv. Fiserv represents and warrants that: (1) it is a Wisconsin corporation, duly organized, validly existing, and in good standing under the laws of Wisconsin; (2) it has all requisite power and authority to execute, deliver, and perform its obligations hereunder; (3) the execution, delivery, and performance of this Agreement are duly authorized; (4) it shall comply with all applicable Federal, state, and local laws and 32 regulations, and shall obtain all applicable permits and licenses, in connection with its obligations under this Agreement; (5) as of the Effective Date it has not disclosed any Northern Trust Information; (6) New Services, Fiserv Systems, and Developed Software shall not, and Fiserv Software does not and shall not, infringe any third party proprietary rights; (7) it shall not incorporate into any Developed Software any (a) automatic shut-off devices or "time bombs"; or (b) computer viruses or coding intended to corrupt, delete, or otherwise render inaccessible Northern Trust Data or Northern Trust Systems; (8) Services shall conform in all material respects to the descriptions set forth in Exhibit 3.1, as may be amended from time to time; (9) any approval, authorization, or consent of any government or regulatory agency, or notice or filing required to be obtained or made by it in order for it to enter into and perform its obligations under this Agreement shall be obtained prior to the Effective Date, or immediately upon notice that such approval, authorization, consent, filing, or notice is required; (10) the knowledge of Fiserv, no circumstances of material non-compliance by Fiserv with any external audit or regulatory authority exists as of the Effective Date; and (11) no outstanding litigation, arbitration, or other dispute to which Fiserv is a party that, if decided unfavorably to Fiserv, would have a material adverse effect on Fiserv's ability to fulfill its obligations under this Agreement. 23.3 Year 2000. Fiserv represents and warrants that the Services, the Fiserv Systems, the Fiserv Software and any software interfaces developed by Fiserv is or shall be Millennium Compliant. Northern Trust represents and warrants that the Northern Trust Systems, Northern Trust Software and any software interfaces developed by or on behalf of (other than by Fiserv) Northern Trust is or shall be Millennium Compliant by the Effective Date, except for the Pegasus System. Each party covenants and agrees with the other that it shall not cause any such Systems, Software or software interfaces received from the other to fail to be Millennium Compliant. Millennium Compliant means that they shall consistently function in the same manner after December 31, 1999 as they were warranted to work before such date and shall correctly process dates falling after December 31, 1999. Any modifications of Northern Trust Software made to become Millennium Compliant shall be made by Fiserv as part of the Required Services. Northern Trust shall have the right to review Fiserv's plan and progress towards Millennium Compliance. In addition, upon reasonable request by Northern Trust, Fiserv shall cooperate with Northern Trust in testing (including integration testing with Northern Trust and Federal Reserve Testing) to verify that it is Millennium Compliant as part of the Required Services. Fiserv agrees to abide by the guidelines established by the Federal Financial Institutions Examination Counsel (FFIEC) issued in connection with Year 2000. ARTICLE 24. DISCLAIMER OF WARRANTIES. EXCEPT AS SPECIFIED IN THIS AGREEMENT, NEITHER FISERV NOR NORTHERN TRUST MAKES ANY OTHER WARRANTIES IN RESPECT OF 33 SERVICES, SYSTEMS OR SOFTWARE, AND EACH EXPLICITLY DISCLAIMS ALL WARRANTIES, EXPRESS OR IMPLIED, INCLUDING IMPLIED WARRANTIES OF MERCHANTABILITY AND FITNESS FOR A SPECIFIC PURPOSE. ARTICLE 25. TERMINATION. 25.1 Termination for Convenience. Northern Trust may in its sole discretion terminate this Agreement, in whole or in part, at any time with respect to any period after the third Contract Year, without cause, upon at least one year's notice to Fiserv (a "Termination for Convenience"). 25.2 Termination for Cause. (1) If either party (a) fails to perform any of its material obligations; or (b) breaches any of its material representations under this Agreement and any such failure or breach is not cured within 30 days after notice is given to the breaching party specifying the nature of the breach (unless the defaulting party has demonstrated to the satisfaction of the other party, acting reasonably, that it is proceeding with all due diligence to cure or cause to be cured such breach), the non-breaching party may, upon further notice given within 6 months after the end of the 30 day period to the breaching party terminate this Agreement, in whole or in part, as of the date specified in such notice of termination. (2) If (a) either party repeatedly fails to perform any of its obligations or repeatedly breaches any of its representations under this Agreement; and (b) such repeated failures or breaches taken together are material in the aggregate as of the date of the most recent such failure or breach even though cured, then (c) the non-breaching party may, upon notice given within 6 months terminate this Agreement, in whole or in part, as of the date specified in such notice of termination. (3) In the event of a termination pursuant to Section 25.2(2), Northern Trust or Fiserv, as the case may be, may only terminate (i) those parts of the Agreement that relate to such failures or breaches; and (ii) such other parts of the Agreement that are affected adversely or have become less effective or more costly, whether taken alone or together with the terminated portions, and, therefore, would be rendered ineffective or unpracticable as a result of terminating only those parts of the Agreement that relate to such failures or breaches. 25.3 Early Termination. If the Agreement is terminated for cause under Section 25.2 hereof at a time when the Designated Services are still being performed predominantly at Northern Trust's existing location at the Canal Center, 801 South Canal Street, Chicago, Illinois, then Northern Trust, at its option exercised in writing at the time of such for cause termination, may treat such termination as an early termination (the "Early Termination"), with the consequences described herein. An Early Termination shall entail the re- transfer of the check processing business back to Northern Trust. All employees of the business will be transferred back to Northern Trust, and all assets used or useful in the business will be transferred back from Fiserv to Northern Trust at the 34 price Fiserv paid for such assets, deducting any interim depreciation. Early Termination shall not foreclose either party from seeking any other remedies available to such party for breach of this Agreement or otherwise with respect to the subject transaction. The parties shall cooperate with each other in case of an Early Termination, using reasonable efforts to transfer the check processing business back to Northern Trust as expeditiously and smoothly as possible. ARTICLE 26. TERMINATION FEES. 26.1 Termination for Convenience in Whole. In the event of a termination of this Agreement in whole pursuant to Section 25.1, Northern Trust shall pay to Fiserv a termination fee in an amount equal to applicable fees set forth in Exhibit 26.1 for Termination for Convenience; and (2) Termination Losses, as defined in Section 26.3 hereof. 26.2 Termination for Convenience in Part. In the event Northern Trust terminates this Agreement in part pursuant to Section 25.1, Northern Trust shall pay to Fiserv a termination fee in an amount equal to applicable fees set forth in Exhibit 26.1 multiplied by a percentage equal to the percent by which Designated Fees will be reduced as a result of such partial termination and partial Termination Losses applicable thereto. 26.3 No Additional Fees. In the event of a termination of this Agreement (except pursuant to Section 25.2 as a result of a breach by Northern Trust), Northern Trust shall not pay to Fiserv any fees or charges other than the applicable termination fees set forth in Section 26.1, Section 26.2, or Section 27.1. In the event of a termination other than pursuant to Section 25.1 or Section 25.2 as a result of a breach by Northern Trust, Fiserv shall be responsible for Termination Losses. "Termination Losses" shall mean any documented losses directly incurred in connection with closing down Service Locations as a result of such termination, including the unamortized portion of any equipment and start-up costs incurred by Fiserv, severance with respect to Fiserv Agents employed as of the date of notice of such termination, lease buy- outs contained in contracts in effect as of the date of notice of such termination for equipment, and documented losses directly incurred on leases or sublets in effect as of the date of notice of such termination or required to be renewed or entered into to provide services through the date of termination; provided, however, (i) Fiserv uses its commercially reasonable efforts to mitigate, and permits Northern Trust to mitigate, any Termination Losses payable by Northern Trust pursuant to Section 26.1(2); (ii) Fiserv appoints Northern Trust as its agent under any contracts pursuant to which Termination Losses are incurred under Section 26.1(2) to mitigate any such Termination Losses; (iii) leases entered into after the Effective Date for any affected Service Location include customary sublet provisions; and (iv) prior to incurring any such losses, the parties execute a written Termination Plan, that seeks to organize the process of termination and, to the extent 35 possible, minimize the losses resulting from such termination. ARTICLE 27. TERMINATION ASSISTANCE. 27.1 Termination Assistance Services. On notice from Northern Trust to Fiserv after a determination that an expiration or termination of this Agreement will occur, Fiserv shall (1) on request by Northern Trust, cooperate with Northern Trust in effecting the orderly Services transfer to a third party or Services resumption by Northern Trust; (2) continue to perform those Designated Services until the effective date of expiration or termination of this Agreement ("Conclusion Date"); (3) continue to perform those Designated Services requested by Northern Trust after the Conclusion Date; and (4) perform such New Services as may be requested by Northern Trust pursuant to Article 4 ("Termination Assistance Services"). As specified and requested by Northern Trust on notice to Fiserv, in the event of expiration or termination of this Agreement, subject to price adjustments based on reductions in volumes, Fiserv shall continue to provide Services, and Northern Trust shall pay applicable Fees for provision of Termination Assistance Services (a) for up to one year after the Conclusion Date ("Termination Assistance Period") at the rates set forth in Exhibit 19.1; and (b) for up to one year from Termination Assistance Period expiration at 150 percent of rates set forth in Exhibit 19.1. 27.2 Facilities, Assets, and Personnel. In the event of termination of this Agreement pursuant to Article 25, other than pursuant to Section 25.1 or Section 25.2 as a result of a breach by Northern Trust, Northern Trust shall have the right to (1) at any or all Service Locations, acquire the assets required to provide Services at such Service Locations, including facilities and equipment, at the then-current asset book value, unless otherwise agreed upon by the parties at the time of such termination; (2) subject to the provisions of Article 11 hereof, use the Fiserv Software; and (3) offer employment to any Fiserv staff working on Northern Trust's behalf. In the event a facility is being used by Fiserv for the provision of services to customers in addition to Northern Trust, Northern Trust and Fiserv shall cooperate to provide ongoing services to Fiserv customers serviced at Service Locations for a reasonable period of time, and in accordance with the terms of such customers' agreements and pricing arrangement. Northern Trust and Fiserv shall cooperate to ensure a smooth transition for the relevant workforce. ARTICLE 28. EXIT PLAN. Upon the expiration of this Agreement or termination of this Agreement: (1) Fiserv shall provide Termination Assistance Services in accordance with Section 27.1; 36 (2) Northern Trust shall have the rights set forth in Section 27.2; (3) each party shall have the rights specified in Article 11 in respect of Software; (4) on Northern Trust's request with respect to any contracts applicable solely to services being provided to Northern Trust for maintenance, disaster recovery services, and other necessary third party services (other than subcontractor services) being used by Fiserv to perform Services as of the expiration or termination, Fiserv shall transfer or assign such agreements to Northern Trust or its designee, on terms and conditions acceptable to both parties; and (5) the parties shall pay the costs of obtaining Termination Consents as set forth in Article 12. ARTICLE 29. DISPUTE RESOLUTION. 29.1 Project Managers. All disputes shall initially be referred to the Project Managers. If the Project Managers are unable to resolve the dispute within 4 business days after referral to them, the parties shall submit the dispute to the Management Committee. 29.2 Management Committee. The Management Committee shall meet at least once every 30 days (or at such other time as either party may designate in a notice to the other party) in person, by conference call, or video conference for the purpose of resolving disputes that may arise under this Agreement. The Management Committee shall consider disputes in the order such disputes are brought before it. In the event the Management Committee is unable to resolve a dispute within 5 business days of the meeting date during which such dispute was considered, the Management Committee shall notify senior management of each party pursuant to Section 29.3. 29.3 Senior Management. Either party may, upon notice and within 15 days of receipt of a notice from the Management Committee pursuant to Section 29.2, elect to utilize a non-binding resolution procedure whereby each presents its case at a hearing ("Hearing") before a panel consisting of 2 senior executives of each party and, if such executives can agree upon such an individual, a mutually acceptable neutral advisor. If either party elects to use the procedure set forth in this Section 29.3, the other party shall participate. The Hearing will occur no more than ten days after a party serves notice to use the procedure set forth in this Section 29.3. Each party may be represented at the Hearing by lawyers. If the matter cannot be resolved at such Hearing by such senior executives, the neutral advisor, if one has been agreed upon, may be asked to assist such senior executives in evaluating the strengths and weaknesses of each party's position on the dispute merits. Thereafter, such senior executives shall meet and try again to resolve 37 the matter. If the matter cannot be resolved at such meeting, such senior executives shall inform their respective senior management and each party may, but shall not be obligated to, submit to binding arbitration as provided for in Section 29.4; the proceedings occurring pursuant to this Section 29.3 will be without prejudice to either party's legal position. Except as set forth in Section 29.4, no arbitration or litigation may commence concerning the dispute until 10 business days have elapsed from the last day of the Hearing. The parties shall each bear their respective costs incurred in connection with the procedure set forth in this Section 29.3, except that they shall share equally the fees and expenses of the neutral advisor, if any, and the Hearing facility cost. 29.4 Arbitration. If a dispute is not resolved pursuant to Section 29.3, the parties may agree, but shall not be obligated, within 60 business days after the completion of the procedures set forth in Section 29.1, Section 29.2, and Section 29.3, as appropriate, upon notice, to submit the dispute to formal binding arbitration in accordance with this Section 29.4. If a party commences litigation regarding such dispute, no arbitration may be commenced by the other party regarding such dispute. If the parties agree to formal binding arbitration, the following procedures shall apply: (1) The arbitration shall be held in Chicago, Illinois before a panel of 3 arbitrators. Either Northern Trust or Fiserv may, by notice to the other party, demand arbitration by serving on the other party a statement of dispute, controversy, or claim and the facts relating or giving rise thereto, in reasonable detail, and the name of the arbitrator selected by it. (2) Within 30 days after receipt of such notice, the other party shall (a) deny the request for arbitration or; (b) name its arbitrator. The two arbitrators named by the parties shall, within 10 days after the date of such notice, select the third arbitrator. (3) The arbitration shall be governed by the Commercial Arbitration Rules of the American Arbitration Association, as may be amended from time to time, except as expressly provided in this Section 29.4; provided, however, that the arbitration shall be administered by any organization agreed upon by the parties. The arbitrators may not amend or disregard any provision of this Section 29.4. (4) The arbitrators shall allow such discovery as is appropriate for the purposes of arbitration in accomplishing fair, speedy, and cost-effective resolution of disputes. The arbitrators shall reference the rules of evidence of the Federal Rules of Civil Procedure then in effect in setting the scope and direction of such discovery. The arbitrators shall not be required to make findings of fact or render opinions of law. (5) The decision of and award rendered by the arbitrators shall be final and binding on the parties. Judgment on the award may be entered and enforced by any court of competent jurisdiction. The arbitrators shall have no authority to award damages in 38 excess of or in contravention of Article 31. Except (a) for an action to seek injunctive relief to prevent a stay or breach of Article 11, Article 22, or Section 29.6; or (b) any action necessary to enforce the arbitrators' award, if submitted to arbitration, the provisions of this Section 29.4 are a complete defense to any suit, action, or other proceeding instituted in any court or before any administrative tribunal with respect to any dispute, controversy, or claim related to this Agreement or the creation, validity, interpretation, breach, or termination of this Agreement. 29.5 Critical Disputes. In the event either party determines that the resolution of a dispute is critical to its business, such party may at any time proceed directly to the stage described in Section 29.3 prior to the commencement of an arbitration or litigation in respect of such dispute. 29.6 Continuity of Services. Northern Trust and Fiserv each acknowledges that the provision of Services is critical to their respective business and operations. Accordingly, in the event of a dispute between Northern Trust and Fiserv pursuant to which Northern Trust believes in good faith it is entitled to withhold payment and during the pendency of an arbitration pursuant to Section 29.4 or litigation, Fiserv shall continue to provide Services, and Northern Trust shall continue to pay any undisputed amounts to Fiserv, in accordance with Section 19.1, except that termination fees pursuant to Article 25 shall not be covered by the foregoing ability to withhold payment. Northern Trust hereby authorizes Fiserv to withhold all Termination Assistance and to retain all Northern Trust property pending payment in full of termination fees payable under Article 25. ARTICLE 30. INDEMNIFICATION. 30.1 By Northern Trust. Northern Trust shall indemnify Fiserv, Fiserv Agents, and Fiserv's officers, employees and directors from, and defend Fiserv, Fiserv Agents, and Fiserv's officers, employees and directors against, any losses, liabilities, and damages (including taxes and related penalties) and all related costs and expenses, including, reasonable attorneys' fees and expenses and costs of litigation, settlement, judgment, appeal, interest, and penalties as relates to either party ("Losses") arising out of or relating to (1) any claim by a third party that Northern Trust Proprietary Software, Developed Software developed by Northern Trust or Northern Trust Agents, or Northern Trust Systems infringe on any third party's proprietary rights (except as may have been caused by a modification by Fiserv or Fiserv Agents); (2) any claim by a third party in respect of services or systems provided by Northern Trust to such third party; (3) any claim based on a Northern Trust act or omission in its capacity as an employer and arising out of or relating to (a) Federal, state, or other laws or regulations for the 39 protection of persons or members of a protected class or category of persons; (b) sexual discrimination or harassment; (c) work-related injury or death; (d) accrued employee benefits, including (i) income, disability, withholding, and other employment taxes; and (ii) medical benefit premiums, vacation pay, sick pay, or other fringe benefits not expressly assumed by Fiserv; and (e) any other employment relationship aspect between Northern Trust and such employee, or the termination of such employment relationship (including claims for breach of an express or implied contract employment) that, in all such cases, are attributable to the period when the person asserting the claim was a Northern Trust employee; (4) any claim based on the personal injury (including death) or damage to property received or sustained (a) by reason of any act or omission, whether negligent or otherwise, to the extent caused by Northern Trust or Northern Trust Agents; and (b) at any Northern Trust locations, including premises owned or leased by Northern Trust, or other Northern Trust property to the extent not licensed or sublet to Fiserv or otherwise used by Fiserv; (5) except as may arise pursuant to Section 30.2(1), any claim against Fiserv by a third party arising out of Northern Trust's or Northern Trust Agents' use of any Northern Trust Third Party Software; (6) any costs incurred by Fiserv resulting from a breach of a Northern Trust representation or warranty in this Agreement; and (7) fees and expenses incurred in enforcement of this indemnity by Fiserv. 30.2 By Fiserv. Fiserv shall indemnify Northern Trust, Northern Trust Agents, and Northern Trust's officers, employees and directors from, and defend Northern Trust, Northern Trust Agents, and Northern Trust's officers, employees and directors against, any Losses arising out of or relating to (1) any claim by a third party that Services, Developed Software developed by Fiserv or Fiserv Agents, Fiserv Software, or Systems infringe on any third party's proprietary rights (except as may have been caused by modification by Northern Trust or Northern Trust Agents); (2) any claim by a third party in respect of services or systems provided by Fiserv to such third party; (3) any claim based on a Fiserv act or omission in its capacity as an employer and arising out of or relating to (a) Federal, state, or other laws or regulations for the protection of persons or members of a protected class or category of persons; (b) sexual discrimination or harassment; (c) work-related injury or death; (d) accrued employee benefits, including (i) income, disability, withholding, and other employment taxes; and (ii) medical benefit premiums, vacation pay, sick pay, or other fringe benefits not retained by Northern Trust; and (e) any other employment relationship aspect between Fiserv and such employee (including Fiserv's hiring procedures from and after the Effective Date in respect of Transitioned Employees), or the termination of such employment relationship (including claims for breach of an express or implied contract of employment) that, in all such cases, are attributable to the period when the person asserting the claim (i) was a Fiserv employee; and (ii) the claim arose on or after the Effective Date; (4) any claim by a Northern Trust Agent based on a Fiserv act or omission during the Transition Period arising out of or relating to (a) Federal, state, or other laws or regulations for the protection of persons or members of a protected class or category of persons; (b) sexual discrimination or harassment; and (c) work-related injury or death; (5) any claim by a 40 Transitioned Employee based on a violation or alleged violation by Fiserv or a Fiserv Agent during the Transition Period of a Northern Trust employment practice, policy, or procedure contained in Northern Trust's manual for employees, as set forth in Exhibit 30.2; (6) any claim based on the personal injury (including death) or damage to property received or sustained (a) by reason of any act or omission, whether negligent or otherwise, to the extent caused by Fiserv or Fiserv Agents; and (b) at any Fiserv locations including premises owned, leased, licensed, subleased, or sublicensed by Fiserv, or other Fiserv property; (7) except as may arise pursuant to Section 30.1(1), any claim against Northern Trust by a third party arising out of the use by Northern Trust, Northern Trust Agents, Fiserv, or Fiserv Agents of any Fiserv Third Party Software (except as may be caused by Northern Trust's or Northern Trust Agents' use of Fiserv Third Party Software in violation of Fiserv Third Party Software licenses); (8) any costs incurred by Northern Trust resulting from a Fiserv breach of a representation or warranty in this Agreement; (9) any claim based on the disclosure by Northern Trust to Fiserv, and the use by Fiserv, of any personnel information with respect to Transitioned Employees including, without limitation, any information with respect to employee demographics, job performance, compensation, or benefits; and (10) fees and expenses incurred in enforcement of this indemnity by Northern Trust. 30.3 Indemnification Procedures. If any third party makes a claim covered by Section 30.1 or Section 30.2 against any indemnitee (an "Indemnitee") with respect to which such Indemnitee intends to seek indemnification under Section 30.1 or Section 30.2, such Indemnitee shall give notice of such claim to the indemnifying party (under Section 30.1 or Section 30.2) ("Indemnifying Party") including a brief description of the amount and basis therefore, if known. Upon giving such notice, the Indemnifying Party shall be obligated to defend such Indemnitee against such claim, and shall be entitled to assume control of claim defense with counsel chosen by the Indemnifying Party. The Indemnitee shall cooperate fully with, and assist, the Indemnifying Party in its defense against such claim. The Indemnifying Party shall keep the Indemnitee fully apprised at all times as to status of the defense. Notwithstanding the foregoing, the Indemnitee shall have the right to employ its own separate counsel in any such action, but the fees and expenses of such counsel shall be at such Indemnitee's expense; provided, however, (1) if the parties agree that it is advantageous to the defense for the Indemnitee to employ its own counsel; or (2) in the reasonable judgment of the Indemnitee, based upon an opinion of counsel that shall be provided to the Indemnifying Party, a conflict of interest exists with respect to such claim, then reasonable fees and expenses of the Indemnitee's counsel shall be at the Indemnifying Party's expense as the Indemnitee accrues such fees and expenses, provided that the Indemnifying Party approves such counsel. Neither the Indemnifying Party nor any Indemnitee shall be liable for or bound by any settlement of any action or claim effected without its consent. Notwithstanding the foregoing, the Indemnitee shall retain, assume, or resume sole control over any and all expenses relating to every aspect of defense that it believes 41 is not the subject of the indemnification provided for in Section 30.1 or Section 30.2. Until both (1) the Indemnitee receives notice from the Indemnifying Party that it will defend; and (2) the Indemnifying Party assumes such defense, the Indemnitee may, at any time after 10 days from the date notice of claim is given to the Indemnifying Party by the Indemnitee, resist or otherwise defend the claim or, after consultation with and consent of the Indemnifying Party, settle or otherwise compromise or pay the claim. The Indemnifying Party shall pay all Indemnitee costs related to that defense and any such settlement, compromise, or payment. The Indemnitee shall keep the Indemnifying Party fully apprised at all times as to status of the defense. Following indemnification as provided in Section 30.1 or Section 30.2, the Indemnifying Party shall be subrogated to all rights, subject to Section 30.4, of the Indemnitee with respect to the matters for which indemnification has been made. 30.4 Contribution. Notwithstanding anything to the contrary contained in this Agreement, Northern Trust and Fiserv shall contribute to amounts paid or payable as a result of any Losses referred to in Section 30.1(2) or Section 30.2(2) in such proportion as is appropriate to reflect the relative fault of Northern Trust, on the one hand, and Fiserv, on the other hand, in connection with actions or omissions that resulted in such Losses, as well as any other relevant equitable considerations. Northern Trust and Fiserv agree that it would not be just and equitable if contributions pursuant to this Section 30.4 were to be determined by any method of allocation that does not take account of the equitable considerations referred to in the first sentence of this Section 30.4. 30.5 18 Month Limitation on Certain Claims. Notwithstanding anything else contained herein, any claim for indemnification hereunder relating to representations or warranties must be made within 18 months of the date hereof. ARTICLE 31. DAMAGES AND LIMITATION OF LIABILITY. 31.1 Direct Damages. Northern Trust and Fiserv each shall be liable to the other party for any direct damages relating to its performance or breach of any of its representations or warranties under this Agreement; provided, however, that the liability of each party relating to all claims for damages pursuant to this Section 31.1 arising in a particular Contract Year shall not exceed $4,000,000 ("Yearly Damage Cap"), so long as Fiserv shall keep in full force and effect commercial insurance insuring against damages greater than $4 million in any Contract Year suffered by anyone from errors and omissions of its employees. The premium for such insurance shall be divided equally by the parties hereto. (1) The following shall be considered Northern Trust direct damages, and Fiserv shall not assert that they are indirect, incidental, special, or consequential damages or lost 42 profits or otherwise not recoverable pursuant to Section 31.2 to the extent they result from Fiserv's failure to provide Services in accordance with this Agreement: (a) costs of recreating or restoring any Northern Trust Data or information lost or damaged; (b) costs of implementing a work around in respect of a failure to provide all or a portion of Services; (c) costs of replacing lost or damaged Northern Trust Systems, Northern Trust Software, Developed Software, and materials; (d) costs incurred by Northern Trust to procure Services from an alternate source, to the extent that such costs exceed the amount that would have been owed or paid, as may be applicable, by Northern Trust to Fiserv for such services; (e) fines or penalties imposed on Northern Trust by any government or regulatory agency as a result of such failure to the extent that such fine or penalty is not a result of Services performed in a manner (i) required by Northern Trust; or (ii) consistent with the procedures and practices in place as of the Effective Date; (f) costs of remedying processing errors and processing delays, including costs of reconstructing lost, damaged, or destroyed cash letters and other items; (g) liability to bank customers or other financial institutions under the Uniform Commercial Code or the Electronic Funds Transfer Act or under any other regulation or statute for any errors in providing the Services, including without limitation liability for the loss of use of any funds incurred by reason of any error or omission calculated at the applicable Federal Funds rate at the time of such error or omission; and (h) straight time, overtime, or related expenses incurred by Northern Trust, including wages and salaries of additional employees, travel expenses, overtime expenses, telecommunication charges, and similar charges, due to Fiserv's failure to provide all or a portion of Services or incurred in connection with (a) through (g) above. (2) The following shall be considered Fiserv direct damages, and Northern Trust shall not assert that they are indirect, incidental, special, or consequential damages or lost profits or otherwise not recoverable pursuant to Section 31.2 to the extent that they result from Northern Trust's failure to provide Northern Trust Retained Services in accordance with this Agreement: (a) costs of recreating or restoring any Fiserv data or information lost or damaged; 43 (b) costs of implementing a work around in respect of a failure to provide all or a portion of Northern Trust Retained Services; (c) costs of replacing lost or damaged Fiserv equipment, Fiserv Systems, Fiserv Software, Developed Software, and materials; (d) costs and expenses incurred by Fiserv to procure from an alternate source the services provided by Northern Trust as part of Northern Trust Retained Responsibilities and services provided under Northern Trust Retained Agreements, to the extent such services are necessary to provide Services; (e) costs of remedying processing errors and processing delays, including cost of reconstructing lost, damaged, or destroyed documents and other items; and (f) straight time, overtime, or related expenses incurred by Fiserv, including wages and salaries of additional employees, travel expenses, overtime expenses, telecommunication charges, and similar charges, due to Northern Trust's failure to provide all or a portion of services provided by Northern Trust as part of Northern Trust Retained Responsibilities and services provided under Northern Trust Retained Agreements or incurred in connection with (a) through (f) above. (3) Intentionally Omitted (4) If, at any time, either Northern Trust or Fiserv has received damages from the other party pursuant to this Section 31.1, and recovers funds, payments, and costs from a third party relating to damages for which the other party is liable, the amounts so recovered (less the costs of recovery and amounts paid to the other party) shall be remitted to the other party. A party liable pursuant to this Section 31.1 shall seek recovery in respect of any insured liability from its insurance carrier to the greatest extent pursuant to this Agreement and as promptly as possible. The proceeds of such insurance shall be used to reimburse the other party for any damages sustained by the other party in excess of those reimbursed pursuant to the first paragraph of Section 31.1. When insurance proceeds are received, the party who has sustained damages shall be paid in addition to any amount previously paid with respect to such damages no more than the amount of insurance proceeds paid covering such damages. (5) For purposes of Section 31.1(1) and Section 31.1(2), actions taken during a given month or on or prior to a particular date shall mean actions taken with respect to items processed or Services rendered by Fiserv or Northern Trust during such month or on or prior to such date, as the case may be, regardless of when resolved or written off. Actions shall include any acts or omissions of Fiserv or Fiserv Agents or Northern Trust or Northern Trust Agents in performing Services. 44 31.2 Consequential Damages. Neither Fiserv nor Northern Trust shall be liable for any indirect, incidental, special, or consequential damages or lost profits of the other party relating to either party's performance under this Agreement. 31.3 Fiserv Credits. In the event Fiserv fails to provide Services in accordance with Service Levels (as defined in Exhibit 5.1), the Management Committee will determine the amount of charges to be incurred by Fiserv ("Fiserv Credits") against Estimated Fees and Fees owed to Fiserv in the month in which such Fiserv Credits were incurred. In determining such Fiserv Credits, consideration must be given to the impact on Northern Trust and its customers of such failure, the severity of such failure (including the dollar value, volume effect, duration, and number of customers affected by such failure), and such other measures as may be relevant under the circumstances. The amount of such Credits should be a percentage of Estimated Fees and Fees paid for the particular Service that was not performed as required pursuant to this Agreement. Such Credits will be in addition to any Damages for which Fiserv may be liable to Northern Trust pursuant to Section 31.1. 31.4 Northern Trust Credits. In the event Northern Trust provides the Northern Trust Retained Services in such a way that it adversely affects Fiserv's ability to perform the Services, fails to provide Northern Trust Retained Services at Retained Responsibilities Service Levels or fails to provide Fiserv Acquired Services at Acquired Services Service Levels, the Management Committee will determine the amount of charges to be incurred by Northern Trust and payable to Fiserv as additional Fees ("Northern Trust Credits") in the month in which such Northern Trust Credits were incurred. (Fiserv Credits and Northern Trust Credits collectively, "Credits"). In determining such Northern Trust Credits, consideration must be given to the impact on Fiserv of such failure, the severity of such failure (including the dollar value, volume effect, duration, and number of customers affected by such failure), and such other measures as may be relevant under the circumstances. The amount of such Credits shall be a percentage of Fiserv's incremental costs (other than those paid as damages pursuant to Section 31.1) as a result of Northern Trust not performing the particular Northern Trust Retained Service as required pursuant to this Agreement. Such Credits will be in addition to any damages for which Northern Trust may be liable to Fiserv pursuant to Section 31.1. 31.5 Exclusions. The limitations or exculpations of liability set forth in Section 31.1 and Section 31.2 are not applicable to (1) the failure of either party to make payments or issue Credits; (2) a breach of Article 22; or (3) liability resulting from a party's bad faith, gross negligence, or willful misconduct. 31.6 Acknowledgment. Fiserv acknowledges that Fiserv Credits, and Northern Trust acknowledges that termination fees set forth in Article 26 and Northern Trust Credits, are each liquidated damages for loss of the bargain, are not a penalty, and are a 45 reasonable approximation of Northern Trust's and Fiserv's liquidated damages under the circumstances as can best be determined as of the Effective Date. Northern Trust and Fiserv each acknowledge that the limitations and exclusions contained in this Article 31 are the subject of active and complete negotiation between the parties and represent the parties' agreement based upon the level of risk to Northern Trust and Fiserv associated with their respective obligations under the Agreement. ARTICLE 32. MISCELLANEOUS. 32.1 Assignment and Subcontractors. Fiserv shall not, without Northern Trust's consent, assign this Agreement or any amounts payable pursuant to this Agreement. Northern Trust agrees that Fiserv may subcontract any Services to be performed hereunder. Any such subcontractors shall be required to comply with all applicable terms and conditions. Northern Trust's consent to any assignment or subcontracting shall not relieve Fiserv of any of its obligations whatsoever under this Agreement. This Agreement shall be binding on the parties and their respective successors and permitted assigns. Any assignment in contravention of this Section 32.1 shall be void. 32.2 Notices. All notices, requests, approvals, consents, and other communications required or permitted under this Agreement shall be in writing and shall be sent by telecopy to the telecopy number specified below and the party sending such notice shall telephone to confirm receipt. A copy of any such notice shall also be sent by registered express mail or courier with capacity to verify receipt of delivery on the date such notice is transmitted by telecopy to the address specified below: In the case of Fiserv: Mr. Kenneth R. Jensen Chief Financial Officer Fiserv Solutions, Inc. 255 Fiserv Drive Brookfield, WI 53045 Telecopy No.: 414-879-5245 With a copy to: Charles W. Sprague, Esq. General Counsel Fiserv, Inc. 255 Fiserv Drive Brookfield, WI 53045 Telecopy No.: 414-879-5532 46 In the case of Northern Trust: John Van Pelt Vice President The Northern Trust Company 50 South LaSalle Street Chicago, Illinois 60675 Telecopy No.: (312) With a copy to: James I. Kaplan, Esq. Associate General Counsel The Northern Trust Company 50 South LaSalle Street, M-9 Chicago, Illinois 60675 Telecopy No.: (312) 444-4134 Telecopy No.: Either party may change its address or telecopy number for notification purposes by giving the other party notice of the new address or telecopy number and the date upon which it will become effective. 32.3 Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one single agreement between the parties. 32.4 Headings. The Article and Section headings and the table of contents are for reference and convenience only and shall not be considered in the interpretation of this Agreement. 32.5 Relationship. Except as otherwise provided in this Agreement, Fiserv's performance of its duties and obligations under this Agreement shall be that of an independent contractor. Nothing contained in this Agreement shall create or imply an agency relationship between Fiserv and Northern Trust, nor shall this Agreement be deemed to constitute a joint venture or partnership between the parties. The parties agree that they will file all Federal, state, and local income tax returns in a manner consistent with the fact the parties are not partners in a partnership for income tax purposes. 32.6 Consents, Approval, and Requests. Except as specifically set forth in this Agreement, all consents, approvals, acceptance, or similar actions to be given by either party under this Agreement shall not be unreasonably withheld or delayed and each party 47 shall make only reasonable requests under this Agreement. 32.7 Severability. If any provision of this Agreement is held to be unenforceable or invalid, the other provisions shall continue in full force and effect. 32.8 Waiver. Either party's failure to insist on strict performance of any of the provisions hereunder shall not be construed as the waiver of any subsequent default of a similar nature. 32.9 Publicity. Each party shall submit to the other all advertising, written sales promotion, press releases, and other publicity matters relating to this Agreement in which the other party's name or mark is mentioned or language from which the connection of said name or mark may be inferred or implied, and shall not publish or use such advertising, sales promotion, press releases, or publicity matter without the other party's approval. Whenever required by reason of legal, accounting, or regulatory requirements, a party may disclose all or any part of this Agreement following reasonable notice to the other party, and after satisfying all reasonable means for masking, deleting, or otherwise protecting all or portions of this Agreement. Notwithstanding the foregoing, each party may disclose the existence and general relationship by this Agreement but not the terms and conditions of this Agreement. 32.10 Entire Agreement. This Agreement, including its Exhibits, which are expressly incorporated herein by reference, constitutes the complete and exclusive statement of the agreement between the parties as to the subject matter hereof and supersedes all previous agreements with respect thereto. No amendment to, or change, waiver, or discharge of, any provision of this Agreement shall be valid unless in writing and signed by an authorized party representative against which such amendment, change, waiver, or discharge is sought to be enforced. Each party hereby acknowledges that it has not entered into this Agreement in reliance upon any representation made by the other party not embodied herein. 32.11 Interpretation of Documents. In the event of a conflict between this Agreement and any New Services schedule, the terms of such New Services Schedule shall prevail. 32.12 Governing Law. This Agreement shall be governed by the substantive laws of the State of Illinois, without reference to provisions relating to conflict of laws. 32.13 Survival. All rights and obligations of the parties under this Agreement that, by their nature, do not terminate with the expiration or termination of this Agreement shall survive the expiration or termination of this Agreement. 32.14 Third Party Beneficiaries. Each party intends that this Agreement shall 48 not benefit or create any right or cause of action in or on behalf of any person or entity other than Northern Trust and Fiserv. 32.15 Covenant of Further Assurances. Northern Trust and Fiserv each agree that, subsequent to the execution and delivery of this Agreement and without any additional consideration, Northern Trust and Fiserv each shall execute and deliver any further legal instruments and perform any acts that are or may become necessary to effectuate the purposes of this Agreement and to establish or confirm Northern Trust's or Fiserv's ownership of Developed Software. 32.16 Interpretation of Certain Terms. All usage of the word "including" or the phrase "e.g.," in this Agreement shall mean "including, without limitation," throughout this Agreement. 32.17 Insurance. During the Term, Fiserv shall maintain at its sole expense the following insurance with financially sound and reputable insurers. Within a reasonable period of time after the Conversion Period, and annually thereafter, Northern Trust and Fiserv shall review the amounts of insurance coverage required pursuant to this Agreement. Consideration shall be given to Fiserv's performance and changes of volume, dollar value, mix of Services, and processing risks (based on the use of such technology), in determining whether recalibration of coverage is required. (1) Insurance covering all risks of loss or damage to any checks and other items and data (including Reconstruction Costs) from any cause while in Fiserv's or Fiserv Agents' possession in an amount not less than $5 million per occurrence. For the purposes hereof, "Reconstruction Costs" includes actual market value of lost, damaged, or destroyed Securities at the close of business on the business day immediately preceding the day on which the loss is discovered, or for more than the actual cost of replacing Securities, whichever is less, plus the cost to post any required Lost Instrument Bonds. Such costs shall be paid by Fiserv's insurance carrier. Valuation shall also include the cost of blank books, pages, tapes, or other blank materials to replace lost or damaged books of account or other records; the actual cash value at time of loss of other lost, damaged, or destroyed property or for more than the actual cost of repairing or replacing the property with property of similar quality and value, whichever is less. For purposes hereof, "Securities" means all negotiable and non-negotiable instruments or contracts representing either money or other property, including Northern Trust Data, revenue, and other stamps in current use, tokens and tickets, but not including money. (2) Worker's Compensation Insurance as mandated or allowed by the laws of the state in which the services are being performed, including at least $500,000 coverage for Employer's Liability. (3) Commercial General Liability Insurance in an amount not less than $1 million 49 per occurrence for claims arising out of bodily injury and property damage, personal injury, and Broad Form Contractual Liability Insurance to insure against any liability arising out of this Agreement. (4) Automobile Liability and Property Damage insurance on vehicles, if any, used to transport Northern Trust Data or other items in an amount not less than $1 million per occurrence for bodily injury and property damage, including vehicles for hire coverage. (5) Commercial Crime Insurance, including fidelity, transit, and premises, in an amount not less than $5 million per occurrence, which shall respond to any loss involving Northern Trust Data under Fiserv's care, custody, and control. (6) Errors and Omissions/Professional Liability Insurance in an amount not less than $5 million per occurrence, which shall include coverage for claims for loss or liability to third parties (including customers of Northern Trust) arising out of Fiserv's performance of, or failure to perform, its obligation to Northern Trust under this Agreement. Simultaneously with Fiserv's execution of this Agreement and annually thereafter Fiserv shall deliver to Northern Trust original certificates issued by the insurers evidencing the coverage required by this Section 32.17. Each certificate must unequivocally specify that at least 60 days' notice shall be given to Northern Trust in the event of any material change or cancellation of coverage for any reason. 32.18 Marketing Assistance. Fiserv shall assist Northern Trust in marketing the Services to potential clients. Northern Trust will contact the Fiserv Project Manager to assist Northern Trust in retaining existing clients and assisting in new business development, including working with designated Northern Trust employees to respond to Request for Proposals, develop marketing materials and standard proposal documentation. Fiserv will respond to all client or prospect proposals within 5 business days of a Northern Trust request, with either the requested materials or a plan to provide such materials within a reasonable time period. Fiserv, at the request of Northern Trust, will attend client and prospect meetings to make presentations on Fiserv capabilities. Northern Trust will contact the Fiserv Project Manager to make available Fiserv conducted tours of its facilities during normal business hours. IN WITNESS WHEREOF, the parties have caused this Agreement to be executed by their duly authorized representatives as of the date indicated below. For Northern Trust: For Fiserv: THE NORTHERN TRUST COMPANY FISERV SOLUTIONS, INC. 50 By: By: ------------------------------ ---------------------------- Name: James J. Mitchell Name: Leslie M. Muma Title: Executive Vice President Title: President Date: October 20, 1998 Date: October 20, 1998 51 EX-13 6 1998 ANNUAL REPORT TO STOCKHOLDERS EXHIBIT NUMBER (13) TO 1998 FORM 10-K NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Northern Trust Corporation (Corporation) is a bank holding company organized in 1971 to hold all of the outstanding capital stock of The Northern Trust Company (Bank), an Illinois banking corporation with its headquarters located in the Chicago financial district. The Corporation also owns banks in Florida, Arizona, California, Texas, Colorado and Michigan and various other nonbank subsidiaries, including a securities brokerage firm, an international investment consulting firm and a retirement services company. Although the operations of other subsidiaries will be of increasing significance, it is expected that the Bank will continue to be the major source of the consolidated assets, revenues and net income in the foreseeable future. All references to "Northern Trust" refer to Northern Trust Corporation and its subsidiaries on a consolidated basis. The Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Northern Trust's Consolidated Financial Statements and Consolidated Financial Statistics included herein. RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- OVERVIEW. Net income for 1998 totaled a record $353.9 million, a 14.4% increase from the $309.4 million earned in 1997 which in turn was 19.5% greater than the $258.8 million earned in 1996. The record 1998 net income performance produced a return on average common stockholders' equity of 20.5% compared with 20.2% in 1997 and 18.6% in 1996. The return on average assets was 1.30% in 1998 compared with 1.29% in 1997 and 1.23% in 1996. 1998 marks the eleventh consecutive year of record earnings. Trust fees, net interest income and treasury management fees were all at record levels, while trust assets under administration reached $1.26 trillion at December 31, 1998, up $180.4 billion from a year ago. Strength in all of Northern Trust's diversified revenue sources produced a 13% increase in revenues while operating expenses increased by 12%, resulting in a record productivity ratio of 159%. Stockholders' equity grew to $1.94 billion, as compared to $1.74 billion at December 31, 1997 and $1.54 billion at December 31, 1996, primarily through the retention of earnings, offset in part by the repurchase of common stock pursuant to the Corporation's share buyback program. The Board of Directors increased the quarterly dividend per common share 14.3% in November 1998, to $.24 from $.21, for a new annual rate of $.96. This is the twelfth consecutive year in which the dividend rate has been increased. The Board's action reflects a policy of increasing the dividend rate with increased profitability while retaining sufficient earnings to allow for strategic expansion and the maintenance of a strong balance sheet and capital ratios. Northern Trust's strategy will continue to focus on growing its two sharply defined businesses: Corporate and Institutional Services (C&IS) and Personal Financial Services (PFS). C&IS focuses on administering and managing domestic and global investment pools for corporate and institutional clients worldwide. PFS provides financial services to individuals and closely held businesses through a unique seven-state personal financial services franchise. An important element in this strategy is increasing the penetration of the C&IS and PFS target markets with investment products and services provided by a third business unit, Northern Trust Global Investments (NTGI). In executing this strategy,
SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA - ------------------------------------------------------------------------------ (In Millions Except Per Share Information) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------ Noninterest Income Trust Fees $ 816.3 $ 689.2 $ 594.4 $ 505.3 $ 453.4 Other Noninterest Income 255.3 245.3 185.6 173.1 180.0 Net Interest Income 477.2 438.2 388.3 357.6 334.6 Provision for Credit Losses 9.0 9.0 12.0 6.0 6.0 Noninterest Expenses 997.1 891.8 768.9 709.5 700.5 Provision for Income Taxes 188.8 162.5 128.6 100.5 79.3 - ------------------------------------------------------------------------------ Net Income $ 353.9 $ 309.4 $ 258.8 $ 220.0 $ 182.2 - ------------------------------------------------------------------------------ Net Income Applicable to Common Stock $ 349.0 $ 304.4 $ 253.9 $ 211.5 $ 174.9 - ------------------------------------------------------------------------------ Per Common Share Net Income Basic $ 3.15 $ 2.74 $ 2.27 $ 1.91 $ 1.62 Diluted 3.04 2.66 2.21 1.86 1.58 Dividends Declared .87 .75 .65 .55 .46 - ------------------------------------------------------------------------------ Average Total Assets $27,191 $24,052 $20,964 $19,409 $17,886 Senior Notes at Year-End 700 785 305 17 547 Long-Term Debt at Year-End 458 440 428 335 245 Debt-Floating Rate Capital Securities at Year-End 267 267 -- -- --
22 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Northern Trust emphasizes service quality through a high level of personal service complemented by the effective use of technology. Operating support for these business units is provided through the Worldwide Operations and Technology business unit (WWOT). Expense growth and capital expenditures are closely monitored to ensure that short- and long-term business strategies and performance objectives are effectively balanced. NONINTEREST INCOME. Noninterest income represented 68% of total taxable equivalent revenue in 1998, compared with 66% one year ago. Noninterest income totaled $1.1 billion in 1998, $934.5 million in 1997, and $780.0 million in 1996. TRUST FEES. Trust fees accounted for 76% of total noninterest income and 52% of total taxable equivalent revenue in 1998. Trust fees for 1998 increased 18% to $816.3 million from $689.2 million in 1997 which was up 16% from $594.4 million in 1996. Trust fees have increased at a compound growth rate of 15% for the past five years. Total trust assets under administration at December 31, 1998 were $1.26 trillion compared to $1.08 trillion a year ago, an increase of 17%. Trust assets under management, included in the above, increased 20% to $236.0 billion, from $196.6 billion at the end of 1997. Trust fees are based on the market value of assets managed and administered, the volume of transactions, securities lending volume and spreads, and fees for other services rendered. Asset-based fees are typically determined on a sliding scale so that as the value of a client portfolio grows in size, North- ern Trust receives a smaller percentage of the increasing value as fee income. Therefore, market value or other changes in a portfolio's size do not typi- cally have a proportionate impact on the level of trust fees. In addition, C&IS trust relationships are increasingly priced to reflect earnings from ac- tivities such as custody-related deposits and foreign exchange trading which are not included in trust fees. Custody-related deposits maintained with bank subsidiaries and foreign branches are primarily interest-bearing and aver- aged $6.0 billion in 1998 and $5.4 billion in 1997. Northern Trust's fiduciary business encompasses Master Trust, Master Custody, investment management and retirement services for corporate and institutional asset pools, as well as a complete range of estate planning, fiduciary and asset management services for individuals. Fees from these services are fairly evenly distributed between Northern Trust's two principal business units, C&IS and PFS. A discussion of each of these business units and NTGI follows. Corporate and Institutional Services. Trust fees in C&IS increased 17% in 1998 to $426.0 million from $364.8 million in 1997 which was up 16% from $314.8 million in 1996. These fees are derived from the full range of Master Trust and Master Custody services that Northern Trust provides to retirement plans and institutional clients worldwide. Northern Trust's products include worldwide custody, settlement, reporting and investment management. Investment services includes cash management, securities lending, performance analysis, risk management and a full range of active and passive investment products provided through NTGI. In addition to these services, Northern Trust offers its clients a comprehensive array of retirement consulting and recordkeeping services. All services provided by C&IS contributed to the $61.2 million increase in fees. Fees from custody services increased 9% as a result of new business and accounted for 20% of the growth in C&IS trust fees. Domestic and international securities lending fees were strong, increasing $16.4 million or 24% to $85.4 million as a result of both higher volumes and spreads earned on the investment of collateral. The cash and other assets that have been deposited by investment firms as collateral for securities they have borrowed from trust clients are invested by Northern Trust and are included in trust assets under administration as managed assets. The collateral totaled $65.2 billion and $57.9 billion at December 31, 1998 and 1997, respectively. New business drove a 21% increase in retirement services and recordkeeping and consulting fees. C&IS trust fees also benefited from new asset management business, demonstrating continued success in introducing both passive and actively managed investment products to trust and banking clients. Northern Trust Quantitative Advisors, Inc. (NTQA) contributed $14.1 million in fees during the year, reflecting the successful integration and strong momentum of this December 31, 1997 acquisition. Excellent new business, together with strong investment results, drove a 15% increase in fees from other investment products. Total C&IS trust assets under administration increased 16% from December 31, 1997 to $1.14 trillion at December 31, 1998. Of the C&IS trust assets under administration, $162.6 billion is managed by Northern Trust, up 18% from December 31, 1997. Trust assets under administration included approximately $200 billion of global custody assets. Net new C&IS business sold and transitioned in 1998 was approximately $70 million in annualized trust fees, up 10% from 1997. Approximately 40% of the new business sold came from existing clients and 60% from new relationships. Personal Financial Services. Northern Trust has positioned itself in markets having significant concentrations of wealth and growth potential. With the establishment or acquisition of new offices in Michigan and Colorado and the addition of three other new offices in 1998, Northern Trust's unique network of Personal Financial Services offices includes 67 locations in 23 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
CONSOLIDATED TRUST ASSETS UNDER ADMINISTRATION - -------------------------------------------------------------------------------- Five-Year Compound Percent Growth December 31 Change Rate - -------------------------------------------------------------------------------- ($ In Billions) 1998 1997 1996 1995 1994 1998/97 - -------------------------------------------------------------------------------- Corporate & Institutional $ 162.6 $ 138.1 $ 83.7 $ 67.2 $ 51.5 18% 28% Personal 73.4 58.5 46.6 38.3 30.8 25 19 - -------------------------------------------------------------------------------- Total Managed Trust Assets 236.0 196.6 130.3 105.5 82.3 20 25 - -------------------------------------------------------------------------------- Corporate & Institutional 975.9 845.3 618.2 483.4 395.7 15 21 Personal 47.8 37.4 30.4 25.0 20.6 28 20 - -------------------------------------------------------------------------------- Total Non-Managed Trust Assets 1,023.7 882.7 648.6 508.4 416.3 16 21 - -------------------------------------------------------------------------------- Consolidated Trust Assets Under Administration $1,259.7 $1,079.3 $778.9 $613.9 $498.6 17% 21%
Illinois, Florida, Arizona, California, Texas, Colorado and Michigan. PFS also includes the Wealth Management Group, which provides customized products and services to meet the complex financial needs of families throughout the country with assets typically exceeding $100 million. At December 31, 1998 trust assets under administration in PFS totaled $121.2 billion, an increase of 26% from $95.9 billion at December 31, 1997, reflecting record new business development in all states and strong growth in securities markets. Of the personal trust assets under administration, $73.4 billion was managed by Northern Trust at December 31, 1998 as compared to $58.5 billion at December 31, 1997. PFS trust fees also reached record levels, increasing 20% to $390.3 million for the year compared to $324.4 million in 1997 and $279.6 million in 1996. Every state recorded trust fee increases of 15% or more, with Florida, Arizona and Texas particularly strong. The Wealth Management Group also had solid performance with trust fees increasing 18% and now administers $38.4 billion for significant family asset pools nationwide, up 39% from last year. Net recurring new business sold and transitioned in 1998 totaled $40 million in annualized trust fees, up 27% from 1997. Northern Trust Global Investments. Northern Trust formalized and strengthened the focus on its investment management business in 1998 by bringing together the investment activities of the C&IS and PFS businesses in a newly created business unit, Northern Trust Global Investments. NTGI brings together Northern Trust's registered and bank investment advisers to integrate portfolio management, research and trading with client servicing, sales, marketing and product management, while continuing to emphasize Northern Trust's overall relationship orientation. NTGI's strategic focus on investment management, branding, product management, distribution and client servicing supported Northern Trust's strong growth in assets under management during 1998. Despite the year's turbulent financial markets, Northern Trust achieved strong investment results across asset classes. As of year-end, 22 of 27 capital market mutual funds advised by Northern Trust earned top one-year rankings ("A" or "B") by Lipper Analytical Services, a respected mutual fund rating agency. The PFS Investment group's equity performance placed Northern Trust among the leading professional active managers, demonstrating the consistency of NTGI's investment process. On the institutional side, Northern Trust's leading equity products also demonstrated strong performance during this volatile market period. Northern Trust's core growth composite exceeded the S&P 500, and placed Northern Trust among the leading institutional active equity managers. New capabilities were added to Northern Trust's core array of short duration, fixed income, index, domestic growth equity and international products in 1998. The scale and breadth of passive management services, was significantly expanded and now more than 80 different equity and fixed income index products across the capital market spectrum are being offered. Northern Trust's institutional and retail mutual funds continued to enjoy significant growth, reaching $21 billion in assets by year-end. Northern Trust's competitive investment results, combined with new product offerings and improvements to investment sales and client servicing, provided the foundation for another year of strong growth in assets under management. By year-end, Northern Trust managed $236.0 billion for personal and institutional clients, up from $196.6 billion at year-end 1997. FOREIGN EXCHANGE TRADING PROFITS. Foreign exchange trading profits totaled $103.5 million, compared to last year's record performance of $104.8 million which was up 78% from $58.8 million in 1996. The profits reflect increased volatility in certain currency markets offset by decreased volatility in the European Monetary Union currencies and lower client portfolio holdings in emerging markets. A substantial component of foreign exchange profits continued to result from 24 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- transactions associated with the growing global custody business. As custodian, Northern Trust provides foreign exchange services in the normal course of business. Active management of currency positions, within conservative limits, also contributes to trading profits. TREASURY MANAGEMENT FEES. The fee portion of treasury management revenues totaled $69.9 million in 1998, a 16% increase from the $60.2 million reported in 1997 compared with $55.3 million in 1996. Total treasury management revenues, which, in addition to fees, include the computed value of compensating deposit balances, increased 6% to $97.0 million from $91.6 million in 1997 compared to $86.0 million in 1996, reflecting the continued growth of new business in both paper- and electronic-based products. The fee portion of treasury management revenues also benefited in 1998 by a higher percentage of clients choosing to pay for services through fees versus compensating balances and certain accounting changes made for fee accruals. SECURITY COMMISSIONS AND TRADING INCOME. Security commissions and trading income totaled $28.0 million in 1998, compared with $26.1 million in 1997 and $23.9 million in 1996. This income is primarily generated from securities brokerage services provided by Northern Trust Securities, Inc. (NTSI). Additional revenue is provided from underwriting selected general obligation tax-exempt securities and interest risk management activities with clients. The 1998 results reflect strong growth in securities brokerage activities, up 22%, offset in part by a decline in futures commissions resulting from Northern Trust's exit from the futures business in the second quarter of the year. OTHER OPERATING INCOME. Other operating income includes loan, letter of credit and deposit-related service fees and other miscellaneous income from asset sales. Other operating income in 1998 totaled $52.6 million compared with $53.5 million in 1997 and $47.2 million in 1996. Included in the 1997 results was $11.1 million resulting from settlements reached with Illinois banking regulators concerning the disposition of certain unclaimed balances accumulated over a number of years. Nonrecurring gains in 1998 totaled $3.8 million and included sales of exchange membership seats owned by Northern Futures Corporation, a sale of mortgage loans and the sale of Northern Trust's small California investment management subsidiary, Berry, Hartell, Evers & Osborne, Inc. Other operating income in 1996 reflects a $4.0 million gain from the sale of the Bank's merchant charge card business. Excluding nonrecurring items, the increase in other operating income in 1998 is primarily attributable to higher fees from trust deposit activities and banking services. INVESTMENT SECURITY GAINS AND LOSSES. Net security gains totaling $1.3 million were realized in 1998. This compares with net gains of $.7 million in 1997 and $.4 million in 1996. NET INTEREST INCOME. Net interest income is defined as the total of interest income and amortized fees on earning assets less interest expense on deposits and borrowed funds, adjusted for the impact of off-balance sheet hedging activity. Earning assets, which consist of securities, loans and money market assets, are financed by a large base of interest-bearing funds, including retail deposits, wholesale deposits, short-term borrowings, senior notes and long-term debt. Earning assets are also funded by net noninterest-related funds. Net noninterest-related funds consist of demand deposits, the reserve for credit losses and stockholders' equity, reduced by nonearning assets including cash and due from banks, items in process of collection, buildings and equipment and other nonearning assets. Variations in the level and mix of earning assets, interest-bearing funds and net noninterest-related funds, and their relative sensitivity to interest rate movements, are the dominant factors affecting net interest income. In addition, net interest income is impacted by the level of nonperforming assets and client use of compensating deposit balances to pay for services. Net interest income for 1998 was a record $477.2 million, up 9% from $438.2 million in 1997, which was up 13% from $388.3 million in 1996. When adjusted to a fully taxable equivalent (FTE) basis, yields on taxable, nontaxable and partially taxable assets are comparable, although the adjustment to a FTE basis has no impact on net income. Net interest income on a FTE basis for 1998 was a record $513.1 million, an increase of $42.2 million or 9% from $470.9 million in 1997 which in turn was up 12% from $421.9 million in 1996. Through steady asset growth and conservative interest rate risk management, Northern Trust has been successful in generating year over year improvement in net interest income as evidenced by the fact that 1998 represents the fifteenth consecutive year of record performance. The increase in FTE net interest income in 1998 was driven by higher levels of loans, money market assets and short-term federal agency securities and a 10% increase in noninterest-related funding sources. The net interest margin declined to 2.08% from 2.18% last year. The decline in the margin is attributable to the growth in low-spread money market assets and federal agency securities. Earning assets averaged $24.6 billion, up 14% from the $21.6 billion reported in 1997, which was up from $18.8 billion in 1996. The $3.0 billion growth in average earning assets reflects a 13% or $1.5 billion increase in loans, a 17% or $1.1 billion increase in securities, and a 12% or $396 million increase in money market assets. 25 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
ANALYSIS OF NET INTEREST INCOME (FTE) - ----------------------------------------------------------------------------- Percent Change - ----------------------------------------------------------------------------- ($ In Millions) 1998 1997 1996 1998/97 1997/96 - ----------------------------------------------------------------------------- Interest Income $ 1,503.1 $ 1,332.8 $ 1,151.5 12.8% 15.7% FTE Adjustment 35.9 32.7 33.6 9.8 (2.7) - ----------------------------------------------------------------------------- Interest Income-FTE 1,539.0 1,365.5 1,185.1 12.7 15.2 Interest Expense 1,025.9 894.6 763.2 14.7 17.2 - ----------------------------------------------------------------------------- Net Interest Income-FTE $ 513.1 $ 470.9 $ 421.9 9.0% 11.6% - ----------------------------------------------------------------------------- Average Volume Earning Assets $24,624.5 $21,629.7 $18,779.4 13.8% 15.2% Interest-Related Funds 20,940.7 18,292.6 15,920.0 14.5 14.9 Noninterest-Related Funds 3,683.8 3,337.1 2,859.4 10.4 16.7 - ----------------------------------------------------------------------------- Change in Percentage - ----------------------------------------------------------------------------- Average Rate Earning Assets 6.25% 6.32% 6.31% (.07) .01 Interest-Related Funds 4.90 4.89 4.79 .01 .10 Interest Rate Spread 1.35 1.43 1.52 (.08) (.09) Total Source of Funds 4.17 4.14 4.06 .03 .08 - ----------------------------------------------------------------------------- Net Interest Margin 2.08% 2.18% 2.25% (.10) (.07)
Refer to page 78 for detailed analysis of net interest income. Loan volume for the year averaged $13.3 billion with the majority of the growth reflected in the domestic portfolio while international loans increased $114 million on average. The domestic growth came principally from residential mortgage activities, up $672 million, and commercial and industrial loans, up $512 million. Reflected in the total loan growth are noninterest bearing domestic and international overnight advances related to processing certain trust client investments, which averaged $767 million in 1998, up from $708 million a year ago. Securities averaged $7.5 billion in 1998, up 17% from $6.4 billion a year ago resulting primarily from higher levels of federal agency securities. Money market assets averaged $3.8 billion in 1998 versus $3.4 billion in 1997. The increase was principally driven by a higher level of foreign office time deposits resulting from growth in global custody activities, and more active short-term investment of noninterest-bearing balances previously held with global subcustodians. The increase in average earning assets of $3.0 billion was funded through growth in interest-bearing deposits, other interest-related funding sources, and noninterest-related funds. The deposit growth was concentrated primarily in foreign office time deposits, up $811 million resulting from increased global custody activity, and higher levels of savings and money market deposits. Other interest-related funds averaged $8.2 billion, up $1.5 billion, principally from federal funds purchased (up $930 million) and other borrowings (up $420 million). Average net noninterest-related funds increased $347 million, mainly due to higher demand deposits, noninterest-bearing time deposits, and stockholders' equity. Stockholders' equity for the year averaged $1.8 billion, an increase of $195 million or 12% from 1997, principally due to the strong earnings performance, offset in part by the repurchase of common stock pursuant to the Corporation's share buyback program. PROVISION FOR CREDIT LOSSES. Asset quality remained strong as reflected by the low level of nonperforming assets which totaled $35.2 million at year-end. The provision for credit losses was $9.0 million in 1998, unchanged from 1997 which was down from $12.0 million in 1996. For a discussion of the reserve for credit losses, refer to pages 38 through 40. NONINTEREST EXPENSES. Noninterest expenses for 1998 totaled $997.1 million, up $105.3 million or 12% from $891.8 million in 1997, which was up 16% from $768.9 million in 1996. Included in the 1998 results were $16.0 million of incremental expenses related to acquisitions and $11.5 million of project costs related to Year 2000 initiatives. Total expenses for 1997 included $10.1 million in charges relating to Year 2000 initiatives and $3.5 million in costs associated with the planned relocation of Northern Trust's computer data facility. Expense increases during 1998 reflect a variety of growth initiatives, including staff additions and higher operating expenses necessary to support new business and growing transaction volumes, investments in technology and PFS office expansion. Performance-based compensation also increased, resulting from excellent new business results, improved client investment portfolio performance, strong corporate earnings and the price increase in Northern Trust Corporation common stock. 26 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
AVERAGE EARNING ASSETS AND SOURCE OF FUNDS - ------------------------------------------------------------------------------------------------- Percent Change - ------------------------------------------------------------------------------------------------- ($ In Millions) 1998 1997 1996 1998/97 1997/96 - ------------------------------------------------------------------------------------------------- Average Earning Assets Money Market Assets $ 3,838.7 $ 3,442.6 $ 2,083.5 11.5% 65.2% Securities U.S. Government 374.2 822.9 1,702.0 (54.5) (51.7) Obligations of States and Political Subdivisions 434.0 408.8 414.1 6.2 (1.3) Federal Agency 6,385.0 4,890.1 4,010.7 30.6 21.9 Other 265.8 243.4 228.2 9.2 6.7 Trading Account 11.8 9.0 8.8 31.1 1.5 - ------------------------------------------------------------------------------------------------- Total Securities 7,470.8 6,374.2 6,363.8 17.2 .2 - ------------------------------------------------------------------------------------------------- Loans and Leases-Domestic 12,663.6 11,275.1 9,951.6 12.3 13.3 -International 651.4 537.8 380.5 21.1 41.4 - ------------------------------------------------------------------------------------------------- Total Loans and Leases 13,315.0 11,812.9 10,332.1 12.7 14.3 - ------------------------------------------------------------------------------------------------- Total Earning Assets $24,624.5 $21,629.7 $18,779.4 13.8% 15.2% - ------------------------------------------------------------------------------------------------- Average Source of Funds Deposits-Savings and Money Market $ 4,263.3 $ 3,895.4 $ 3,620.7 9.4% 7.6% -Savings Certificates 2,144.5 2,035.8 2,062.4 5.3 (1.3) -Other Time 571.8 717.3 549.2 (20.3) 30.6 -Foreign Offices Time 5,781.7 4,971.2 3,826.2 16.3 29.9 - ------------------------------------------------------------------------------------------------- Total Deposits 12,761.3 11,619.7 10,058.5 9.8 15.5 Federal Funds Purchased 2,620.6 1,690.2 1,842.2 55.0 (8.3) Securities Sold under Agreements to Repurchase 1,506.0 1,519.9 1,973.3 (.9) (23.0) Commercial Paper 145.9 142.7 143.7 2.2 (.7) Other Borrowings 2,540.4 2,120.9 1,274.1 19.8 66.5 Senior Notes 653.3 539.3 267.5 21.1 101.6 Long-Term Debt 445.8 435.8 360.7 2.3 20.8 Debt-Floating Rate Capital Securities 267.4 224.1 -- 19.3 -- - ------------------------------------------------------------------------------------------------- Total Interest-Related Funds 20,940.7 18,292.6 15,920.0 14.5 14.9 Noninterest-Related Funds, net 3,683.8 3,337.1 2,859.4 10.4 16.7 - ------------------------------------------------------------------------------------------------- Total Source of Funds $24,624.5 $21,629.7 $18,779.4 13.8% 15.2%
The increase in 1997 noninterest expenses from 1996 reflects the impact of the nonrecurring charges described above, incremental expenses resulting from acquisitions, investments in technology, PFS office expansion, the opening of a Singapore office, higher performance-based compensation, and staff additions and related costs necessary to support new business and transaction volumes. The productivity ratio, defined as total revenue on a taxable equivalent basis divided by noninterest expenses, reached an all-time high of 159% for 1998 compared with 158% in 1997 and 156% in 1996. The improvement in the productivity ratio over the past two years reflects Northern Trust's success in growing revenues while at the same time controlling expenses. COMPENSATION AND BENEFITS. Compensation and benefits, which represent 61% of total noninterest expenses, increased 16% to $609.4 million in 1998 from $527.3 million in 1997, which was up 19% from $441.3 million in 1996. Compensation costs, the largest component of noninterest expenses, totaled $518.1 million, up $69.8 million or 16% from $448.3 million a year ago. The increase in 1998 was primarily attributable to staff additions, higher performance-based compensation and salary increases. Performance-based compensation expense was up $23.6 million in 1998 and $35.5 million in 1997 reflecting the impact of record corporate earnings, excellent new business results, client investment portfolio performance and the price increase in Northern Trust Corporation common stock. Staff on a full-time equivalent basis averaged 7,844 in 1998 compared with 7,198 in 1997 and 6,665 in 1996. The increase in staff levels during 1998 was required to support growth initiatives and strong new business in both C&IS and PFS. Staff on a full-time equivalent basis at December 31, 1998, totaled 8,156, an increase of 8% from 7,553 at the end of last year. Employee benefit costs for 1998 totaled $91.3 million, up $12.3 million or 16% from $79.0 million in 1997 which was 9% higher than the $72.5 million in 1996. The increase in employee benefits primarily reflects higher payroll taxes, medical and dental plan costs, and retirement plan benefits resulting from staff growth. The 27 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- increase in 1997 employee benefit costs resulted from higher payroll taxes and retirement plan benefits, partially offset by favorable medical plan experience as more employees elected coverage through managed care plans. OCCUPANCY EXPENSE. Net occupancy expense totaled $67.9 million, up 2% or $1.2 million from $66.7 million in 1997, which was up 10% from $60.7 million in 1996. The principal components of the 1998 increase were higher building operating and maintenance costs, partially offset by lower real estate taxes. The increase in 1997 resulted from higher rental costs, real estate taxes and building depreciation expense. EQUIPMENT EXPENSE. Equipment expense, which includes depreciation, rental, and maintenance costs, totaled $62.2 million in 1998, unchanged from the prior year, which was up 11% from $56.0 million in 1996. The 1998 results reflect higher levels of hardware depreciation expense, computer and equipment maintenance charges and leasing of data lines, offset by lower rental costs of computers and equipment. Included in the 1997 results were $2.6 million of technology-related special charges. The remainder of the increase in 1997 resulted from planned increases in equipment and computer depreciation and related costs to support trust and banking business expansion. OTHER OPERATING EXPENSES. Other operating expenses for 1998 totaled $257.6 million, up 9% from $235.6 million in 1997, which was up 12% from $210.9 million in 1996. The increase in the 1998 expense level was principally the result of continued investment in technology, expansion of the personal trust and banking office network, and higher operating expenses necessary to support business growth. These initiatives resulted in increases in technical and consulting service fees, business development efforts, telecommunications, amortization of goodwill and other intangible assets and higher costs associated with legal claims and processing errors. Investments in technology are designed principally to support and enhance the transaction processing and securities handling capability of the trust and banking businesses. Additional capital expenditures planned for systems technology will result in future expenses for the depreciation of hardware and amortization of software. Depreciation and software amortization are charged to equipment and other operating expenses, respectively. PROVISION FOR INCOME TAXES. The provision for income taxes was $188.8 million in 1998 compared with $162.5 million in 1997 and $128.6 million in 1996. The effective tax rate was 35% for 1998 compared with 34% for 1997 and 33% for 1996. The increase reflects the continued growth in income from taxable sources while tax-exempt municipal interest has remained relatively stable. BUSINESS SEGMENTS - -------------------------------------------------------------------------------- Northern Trust Corporation, under Chairman and Chief Executive Officer William A. Osborn, organizes client services around two principal business units, C&IS and PFS. Investment products are provided to the clients of these business units by NTGI. Each of these three business units has a president who reports to President and Chief Operating Officer Barry G. Hastings. Also reporting to Mr. Hastings is the WWOT business unit. For management reporting purposes, the operations of NTGI and WWOT are allocated to the other business units. The Risk Management Unit includes the Treasury Department and reports directly to Mr. Osborn. Mr. Osborn has been identified as the chief operating decision maker because he has final authority over resource allocation decisions and performance assessment. The results of the major business units are presented in order to promote a greater understanding of their financial performance. The information, presented on an internal management reporting basis, is derived from internal accounting systems that support the strategic objectives and management structure. Management has developed accounting systems to allocate revenue and expenses related to each segment, as well as certain corporate support services, worldwide operations and system development expenses. The management reporting systems also incorporate processes for allocating assets, liabilities and the applicable interest income and expense. Tier 1 and tier 2 capital is allocated based on the federal risk-based capital guidelines at a level that is consistent with Northern Trust's consolidated capital ratios, coupled with management's judgment of the operational risks inherent in the business. Allocations of capital and certain corporate expenses may not be representative of levels that would be required if the segments were independent entities. The accounting policies used for management reporting are the same as those described in "Accounting Policies," in the Notes to Consolidated Financial Statements. Transfers of income and expense items are recorded at cost; there is no intercompany profit or loss on sales or transfers between business units. Northern Trust's presentations are not necessarily consistent with similar information of other financial institutions. For management reporting purposes, certain corporate income and expense items are not allocated to the business units and are presented as part of "Treasury and Other." These items include the impact of long-term debt, preferred equity, holding company investments, and corporate operating expenses. The following tables reflect the earnings contribution of Northern Trust's business segments for the years ended December 31, 1998, 1997 and 1996 on the basis described above. 28 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Corporate and Institutional Services - ------------------------------------------------------------------------------- ($ In Millions) 1998 1997 1996 - ------------------------------------------------------------------------------- Noninterest Income Trust Fees $ 426.0 $ 364.8 $ 314.8 Other 197.2 183.2 130.5 Net Interest Income after Provision for Credit Losses* 151.4 126.9 114.2 Noninterest Expenses 507.3 435.6 376.3 - ------------------------------------------------------------------------------- Income before Income Taxes* 267.3 239.3 183.2 Provision for Income Taxes* 105.2 94.3 72.4 - ------------------------------------------------------------------------------- Net Income $ 162.1 $ 145.0 $ 110.8 - ------------------------------------------------------------------------------- Percentage Net Income Contribution 46% 47% 43% - ------------------------------------------------------------------------------- Average Assets $11,841.5 $10,246.3 $7,905.9 Personal Financial Services - ------------------------------------------------------------------------------- ($ In Millions) 1998 1997 1996 - ------------------------------------------------------------------------------- Noninterest Income Trust Fees $ 390.3 $ 324.4 $ 279.6 Other 52.0 45.4 43.1 Net Interest Income after Provision for Credit Losses* 332.1 316.0 270.7 Noninterest Expenses 456.4 410.6 372.5 - ------------------------------------------------------------------------------- Income before Income Taxes* 318.0 275.2 220.9 Provision for Income Taxes* 126.2 109.5 88.1 - ------------------------------------------------------------------------------- Net Income $ 191.8 $ 165.7 $ 132.8 - ------------------------------------------------------------------------------- Percentage Net Income Contribution 54% 53% 51% - ------------------------------------------------------------------------------- Average Assets $10,124.5 $ 8,931.9 $7,858.0 Treasury and Other - ------------------------------------------------------------------------------- ($ In Millions) 1998 1997 1996 - ------------------------------------------------------------------------------- Noninterest Income Trust Fees $ -- $ -- $ -- Other 6.1 16.7 12.0 Net Interest Income after Provision for Credit Losses* 20.6 19.0 25.0 Noninterest Expenses 33.4 45.6 20.1 - ------------------------------------------------------------------------------- Income before Income Taxes* (6.7) (9.9) 16.9 Provision for Income Taxes* (6.7) (8.6) 1.7 - ------------------------------------------------------------------------------- Net Income $ -- $ (1.3) $ 15.2 - ------------------------------------------------------------------------------- Percentage Net Income Contribution --% --% 6% - ------------------------------------------------------------------------------- Average Assets $ 5,224.7 $ 4,873.5 $5,200.4
Consolidated - -------------------------------------------------------------------------- ($ In Millions) 1998 1997 1996 - -------------------------------------------------------------------------- Noninterest Income Trust Fees $ 816.3 $ 689.2 $ 594.4 Other 255.3 245.3 185.6 Net Interest Income after Provision for Credit Losses* 504.1 461.9 409.9 Noninterest Expenses 997.1 891.8 768.9 - -------------------------------------------------------------------------- Income before Income Taxes* 578.6 504.6 421.0 Provision for Income Taxes* 224.7 195.2 162.2 - -------------------------------------------------------------------------- Net Income $ 353.9 $ 309.4 $ 258.8 - -------------------------------------------------------------------------- Percentage Net Income Contribution 100% 100% 100% - -------------------------------------------------------------------------- Average Assets $27,190.7 $24,051.7 $20,964.3
*Stated on a fully taxable equivalent basis (FTE). Total includes $35.9 million, $32.7 million and $33.6 million of FTE adjustment for 1998, 1997 and 1996, respectively. Note: Certain reclassifications have been made to 1997 and 1996 financial information to conform to the current year's presentation. CORPORATE AND INSTITUTIONAL SERVICES. C&IS, headed by Sheila A. Penrose, President, provides trust, commercial banking and treasury management services to corporate and institutional clients. Trust activities encompass custody services for securities in the United States and foreign markets, as well as securities lending and asset management. Foreign exchange services, which primarily relate to global custody activities, are also part of C&IS. A full range of commercial banking services is also offered by C&IS. Treasury management services are provided to corporations and financial institutions and include a variety of products and services to accelerate cash collections, control disbursement outflows and generate information to manage cash products. Net income for C&IS increased 12% in 1998 and totaled $162.1 million compared to $145.0 million in 1997 which was up 31% from the $110.8 million in 1996. The growth in net income was primarily driven by 17% growth in trust fees, which represent 55% of C&IS's revenues in 1998. Northern Trust, through C&IS, is a leading provider of Master Trust and Master Custody services to three targeted markets: retirement plans, institutional clients, and international clients. Retirement plans include the large corporate market, middle market and public and union retirement funds. Institutional clients include insurance companies, foundations and endowments and correspondent trust services. International clients include asset pools domiciled outside the U.S. and group trusts. For management reporting purposes the activities of Northern Trust Global Advisors (NTGA), an international provider of institutional asset management services, and NTQA, a manager of index funds and 29 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- quantitative investment products, are included in C&IS. A summary of C&IS trust fees and trust assets for each market together with the revenues and trust assets from NTGA and NTQA follows: CORPORATE AND INSTITUTIONAL SERVICES SUMMARY OF TRUST FEES - --------------------------------------------------------------------------------
(In Millions) 1998 1997 1996 - --------------------------------------------------------------------------- Domestic Retirement Plans $ 248.8 $222.7 $190.8 Institutional 65.1 59.7 53.2 International 62.3 50.2 43.0 NTGA* 35.7 32.2 27.8 NTQA 14.1 -- -- - --------------------------------------------------------------------------- Total Trust Fees $ 426.0 $364.8 $314.8 *Investment management expenses paid to sub-advisers totaled $17.5 million, $16.1 million and $13.3 million in 1998, 1997 and 1996, respectively. CORPORATE AND INSTITUTIONAL SERVICES SUMMARY OF TRUST ASSETS UNDER ADMINISTRATION - --------------------------------------------------------------------------- December 31 - --------------------------------------------------------------------------- (In Billions) 1998 1997 1996 - --------------------------------------------------------------------------- Domestic Retirement Plans $ 634.0 $535.6 $383.2 Institutional 227.0 202.0 164.2 International 170.7 150.2 105.4 NTGA 10.2 6.6 5.7 NTQA 30.9 30.8 -- Securities Lending/Other 65.7 58.2 43.4 - --------------------------------------------------------------------------- Total Trust Assets $1,138.5 $983.4 $701.9
The growth in other noninterest income resulted from a 23% increase in treasury management fees reflecting a higher percentage of clients choosing to pay for services through fees, continued growth in new business from both new and existing clients and certain accounting changes made to fee accruals. Total treasury management revenues, which, in addition to fees, include the computed value of compensating deposit balances, increased 6% in 1998. Foreign exchange profits, also included in other noninterest income, were essentially unchanged in 1998 but were up $45.9 million or 79% in 1997 when compared to 1996. Net interest income after provision for credit losses on a FTE basis increased 19% in 1998 and 11% in 1997. The increase in 1998 was driven by a 17% increase in earning assets, with loans increasing 11% and money market assets increasing 16%. Earning assets in 1997 were up 32% from 1996 primarily the result of a 45% increase in money market assets. The increase in money market assets was driven by the investment of deposit funds obtained through the rapid growth in global custody activities. Total expenses of C&IS, which include both the direct expenses of the business unit and indirect expense allocations from NTGI and WWOT for product and operating support, increased 16% in both 1998 and 1997. The growth in expenses is attributable to increases in compensation and employee benefits and higher operating costs to support business growth. PERSONAL FINANCIAL SERVICES. PFS, headed by Mark Stevens, President, encompasses personal trust and investment management services, estate administration, banking and residential real estate mortgage lending offered through the Bank in Illinois and affiliates in six other states. The personal financial services strategy includes targeting high net worth individuals in each banking subsidiary's target market and through its Wealth Management Group nationally. NTSI is also part of PFS. PFS net income totaled $191.8 million in 1998, an increase of 16% from 1997 which in turn was 25% above the net income achieved in 1996. Growth in trust activities continued to be the driver of the record performance for the business unit with trust fees increasing 20% as a result of record new business throughout Northern Trust's PFS network and favorable securities markets. A summary of trust fees and trust assets broken down by state and Wealth Management follows: PERSONAL FINANCIAL SERVICES SUMMARY OF TRUST FEES - --------------------------------------------------------------------------------
(In Millions) 1998 1997 1996 - -------------------------------------------- Illinois $148.2 $126.5 $115.9 Florida 116.8 93.2 77.3 California 50.3 43.6 39.5 Arizona 23.4 18.8 15.4 Texas 13.8 10.4 8.6 Wealth Management 37.7 31.9 22.9 Other .1 -- -- - -------------------------------------------- Total Trust Fees $390.3 $324.4 $279.6 PERSONAL FINANCIAL SERVICES SUMMARY OF TRUST ASSETS UNDER ADMINISTRATION - -------------------------------------------- December 31 - -------------------------------------------- (In Billions) 1998 1997 1996 - -------------------------------------------- Illinois $ 36.9 $ 32.6 $ 26.4 Florida 24.5 18.4 15.3 California 11.4 9.6 7.3 Arizona 4.6 3.9 2.6 Texas 3.6 2.9 2.3 Wealth Management 38.4 27.6 22.6 Other 1.8 .9 .5 - -------------------------------------------- Total Trust Assets $121.2 $ 95.9 $ 77.0
A significant portion of PFS growth has come from expansion into attractive markets within its seven-state network. These markets include approximately 20% of 30 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- the nation's high net worth households, defined as those with at least $1 million of investable assets. Over the next five years, Northern Trust will seek to continue this expansion and also to expand into markets with promising demographics in other states. The goal is to build the PFS national network to approximately 100 offices within as many as fifteen states in targeted markets where approximately 40% of all U.S. high net worth households are located. The growth in other noninterest revenues in both 1998 and 1997 reflects strong growth in brokerage commissions at NTSI. Driven by growth in residential mortgage loans, net interest income after provision for credit losses increased 5% in 1998 and totaled $332.1 million. In 1997, net interest income totaled $316.0 million and increased 17% over 1996. PFS noninterest expenses, which include both the direct expenses of the business unit and indirect expense allocations from NTGI and WWOT for product and operating support, increased 11% in 1998 and 10% in 1997. The increase in 1998 primarily reflects merit increases and staff growth to support record new business. Reflecting successful new business development and portfolio management results, performance-based compensation for PFS was up 39% and business promotion costs rose 20%. TREASURY AND OTHER. The Risk Management Unit, headed by Perry R. Pero, Senior Executive Vice President and Chief Financial Officer, includes the treasury function. The Treasury Department is responsible for managing the Bank's wholesale funding, capital position and interest rate risk, as well as the portfolio of interest rate risk management instruments. It is also responsible for the investment portfolios of the Corporation and the Bank and provides investment advice and management services to the subsidiary banks. "Other" corporate income and expenses represent items that are not allocated to the business units and generally represent certain nonrecurring items and certain executive level compensation. Other operating income in 1997 included $11.1 million resulting from settle- ments reached with Illinois banking regulators concerning the disposition of certain unclaimed balances. One-time gains in 1998 included $1.6 million realized on the sale of exchange membership seats owned by Northern Futures Corporation. The slight growth in net interest income reflects a $6.3 million increase relating to the management of the Bank's investment and money market asset portfolios offset by higher levels of unallocated corporate level funding costs. The higher level of operating expenses in 1997 is largely attributable to special technology-related charges associated with the Year 2000 project and costs associated with the relocation of Northern Trust's computer data facility. NORTHERN TRUST GLOBAL INVESTMENTS. NTGI, headed by Stephen B. Timbers, President, provides investment products and services to clients of C&IS and PFS through registered and bank investment managers. NTGI activities include equity and fixed income research and portfolio management services. NTGI also acts as the investment adviser to the Corporation's two families of proprietary mutual funds, Northern Funds and Northern Institutional Funds. NTGA and NTQA are also included in NTGI, although for management reporting purposes, these subsidiaries are included in C&IS. The other revenues and expenses of this business unit are fully allocated to C&IS and PFS. WORLDWIDE OPERATIONS AND TECHNOLOGY. Worldwide Operations and Technology, headed by James J. Mitchell, Executive Vice President, supports sales, relationship management, transaction processing and product management activities for C&IS and PFS. The expenses of this business unit are fully allocated to other business units. SUBSEQUENT IMPLEMENTATION OF ACCOUNTING STANDARDS - -------------------------------------------------------------------------------- In March 1998, the Accounting Standards Executive Committee (AcSEC) of the American Institute of Certified Public Accountants issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 requires the capitalization of certain external and internal costs of computer software developed or obtained for internal use. SOP 98-1 is effective for Northern Trust in 1999. Northern Trust's current accounting policy is to expense internal costs of computer software developed for internal use as incurred. It is estimated that salary and related costs of approximately $11 million, relating to currently planned software development projects, will be capitalized in 1999 following Northern Trust's adoption of SOP 98-1. In April 1998, the AcSEC issued SOP 98-5, "Reporting on the Costs of Start- Up Activities." SOP 98-5 requires all nongovernmental entities to expense costs of start-up activities as those costs are incurred. The term "start-up activities" is broadly defined and includes pre-operating, pre-opening and organization activities. SOP 98-5 is effective for financial statements for fiscal years beginning after December 15, 1998, with early adoption permitted. Northern Trust adopted SOP 98-5 on January 1, 1999. Northern Trust has typically expensed such costs as incurred and, therefore, adoption of this SOP will not have a material effect on Northern Trust's results of operations. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards 31 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement, and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. A company may elect to implement SFAS No. 133 at the start of any quarter, but must adopt the new statement by January 1, 2000. SFAS No. 133 cannot be applied retroactively. Northern Trust has not yet quantified the impact of adopting Statement No. 133 on its financial statements and has not determined the timing or method of its adoption. CAPITAL EXPENDITURES - ------------------------------------------------------------------------------- Northern Trust's Management Committee reviews and approves proposed capital expenditures which exceed $500,000. This process assures that the major projects to which Northern Trust commits its resources produce benefits compatible with corporate strategic goals. The Northern Trust continued to enhance its hardware and software capabilities during 1998. Significant improved capabilities were added to trust systems both from a client access and operational efficiency basis. Continued expansion of the state of the art and highly flexible trust platform provided new product capabilities to clients in risk and performance measurement and in other investment services. Major improvements to Northern Trust's suite of retirement services products were implemented during the year including a Web- based participant servicing system. In addition, development was completed to provide full euro capability in all applicable product lines. Work focused on operational improvements has increased the breadth and depth of the data available regarding assets held for clients and has enabled Northern Trust to take advantage of efficiencies of straight-through processing wherever available. A major initiative to consolidate banking systems on one platform was completed in the fourth quarter. This has positioned Northern Trust well to continue to move into additional markets and further enhance our offering of banking services for both personal and corporate clients. Another Web-based product, a positive pay capability, was introduced and increases the controls over checking account disbursements for corporate banking clients. To support the growing computing needs of clients and employees in a cost effective manner and enhance disaster recovery capabilities, Northern Trust moved into a new data center in the first half of 1998. The unamortized capitalized cost of corporate-wide software development projects as of December 31, 1998 was $172.8 million, of which $48.2 million represented the book value of the trust management system. During 1999, Northern Trust will continue to invest in computer hardware and software to remain in the forefront in the markets in which it competes. Improvements in the range and functionality of product offerings to both personal and commercial clients are planned with continued emphasis on the use of Web delivery where appropriate. Continued expansion of the reliability and efficiency of worldwide delivery of products and services will remain a priority. The technology initiatives in future periods will also include the capitalization of internal costs of computer software development in accordance with new accounting requirements. Capital expenditures in 1998 also included the leasehold improvements and furnishings associated with the opening of new offices in Illinois, California and Michigan, as well as expansion or remodeling in several existing offices. Capital expenditures for 1998 totaled $147.0 million of which $17.6 million was for building and leasehold improvements, $8.3 million for furnishings, $52.3 million for computer hardware and machinery and $68.8 million for software. During 1999, in addition to its technology initiatives, Northern Trust will continue to invest in the expansion of the seven-state network of Personal Financial Services offices. YEAR 2000 PROJECT. "Year 2000" issues stem from the fact that computer programmers and other designers of equipment that use microprocessors have long abbreviated dates by eliminating the first two digits of the year. As the Year 2000 approaches, many systems may be unable to distinguish years beginning with 20 from years beginning with 19, and so may not accurately process certain date-based information, which could cause a variety of operational problems for businesses. Northern Trust data processing software and hardware provide essential support to virtually all of its businesses. Failure to complete Year 2000 renovation of the critical systems used by Northern Trust on a timely basis could have a materially adverse affect on its operations and financial performance, as could Year 2000 problems experienced by others on whom Northern Trust relies or with whom it otherwise does business. Because of the range of possible issues and the large number of variables involved, it is impossible to quantify the potential cost of problems should Northern Trust's remediation efforts or the efforts of those with whom it does business 32 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- not be successful. Failure to make satisfactory progress toward Year 2000 readiness or take other agency-mandated steps could also result in action by state or federal regulators that could adversely affect Northern Trust's business. Northern Trust has a dedicated Year 2000 Project Team whose members have significant experience with Northern Trust's banking and trust applications. The scope of the Project Team's work has been reduced by the fact that Northern Trust has been developing systems using four digit years since the mid-1980s, and the work has proceeded more efficiently because Northern Trust has licensed a number of software tools that help automate the process of identifying and making needed changes. The information technology portion of Northern Trust's Year 2000 Project is proceeding in phases, although the phases overlap in some cases. In the awareness and assessment phases, which are now completed, the project was defined and application software, systems software and hardware were systematically inventoried and assessed for importance to Northern Trust's business. Northern Trust has used an inclusive definition of "mission critical" items, with approximately 90% of Northern Trust's core applications included in this category. The other phases of the Year 2000 Project include: . Renovation, which involves reviewing programming code and altering it where necessary to deal appropriately with years after 1999. . Validation, in which systems and software are tested. Both renovated sys- tems and systems that do not require renovation undergo Year 2000 testing, to verify that accurate results are produced using key dates (including the leap year date) in the new century. Renovated systems are also tested to make sure that other functions have not been affected. Any needed follow-up renovation is then performed. Hardware is similarly tested and either up- graded or replaced. . Implementation, in which test results are reviewed by user groups and docu- mented and systems or applications returned to production, follows valida- tion. Renovation has been completed for all mission critical information technology systems, including those provided by third parties. Validation has been completed for all internally developed mission critical information technology systems, with implementation to be completed by the end of the first quarter of 1999. Validation and implementation of mission critical systems provided by third parties were substantially completed by year-end, with validation and implementation of the only two systems not yet completed expected to be completed by the end of the first quarter of 1999. Northern Trust has also commenced integration testing, which will continue through 1999. This testing is designed to assure that logically related systems work with each other and that each system can run on compliant versions of hardware and operating system software. With respect to non-mission critical applications, including non-critical desktop software, Northern Trust's target for completion of Year 2000 work is June 1999. Northern Trust has also established a Year 2000 Business Issues Task Force, consisting of senior managers from across the Corporation's businesses and support functions, in order to systematically address issues that are not directly related to information technology. The Task Force and the Year 2000 Project Team provide regular reports to the Corporation's Management Committee and Board of Directors. The Business Issues Task Force is coordinating a review of various infrastructure issues, such as checking elevators and heating, ventilation and air-conditioning equipment, some of which include embedded systems, to verify that they will function in the Year 2000. The assessment phase of this task has been completed. Renovation, validation and implementation have been completed for most of the equipment needing renovation. Some building alarm and employee access systems will be renovated and tested in 1999. Contingency plans are also being developed for Northern Trust's important locations, to allow critical functions to continue in the event of infrastructure problems. The Task Force is also monitoring programs to contact important vendors and suppliers to verify their Year 2000 readiness. For example, during 1998, Northern Trust again reviewed the Year 2000 preparedness of its subcustodians, and completed on-site due diligence visits with subcustodians who account for most of Northern Trust's global securities processing--approximately 95% as measured by market value of holdings and 86% as measured by number of transac- tions. The great majority of these subcustodians appear to be making adequate progress, although Northern Trust has determined to transition its business to another subcustodian in one market. On-site visits to additional subcustodians will take place in the first half of 1999, along with follow-up work with those already visited. Northern Trust will continue to monitor subcustodians' Year 2000 work throughout the year and develop contingency plans where neces- sary and feasible. Northern Trust also relies on entities such as the Federal Reserve System, Depository Trust Company, Participants Trust Company, Society for Worldwide Interbank Financial Telecommunications (SWIFT), and the Clearing House Interbank Payment Systems (CHIPS) in its securities processing and banking businesses, as do other financial services providers in similar businesses. Testing with these organizations is underway and is expected to be completed by March 31, 1999. 33 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- Northern Trust also plans to test for certain key dates in the new century with critical third party service providers, although it may be necessary to rely on proxy testing in some cases. The majority of this work is expected to be done in the first half of 1999. Northern Trust will offer testing opportunities to its clients for some of its products and services. In appropriate circumstances, Northern Trust will make available testing documentation, including test results, to clients instead of conducting actual tests. Although Northern Trust is attempting to monitor and validate the efforts of other parties, it cannot control the success of these efforts. Northern Trust has not tried to predict the severity of the various malfunctions that may occur, alone or in combination with other external or internal problems. Instead, Northern Trust is developing contingency plans where practical to provide alternatives in situations where an entity furnishing a critical product or service experiences significant Year 2000 difficulties that will affect Northern Trust or internal problems develop. For example, the Task Force is coordinating a review of the Year 2000 status of power and telecommunications providers at each important location, as these services are critical to Northern Trust's business. The contingency plan for Northern Trust's critical Chicago data and operations complex calls for back-up generators to be used in the event of extended power outages to run the data center. Northern Trust is also updating its existing business continuity plans for Year 2000. This process is well underway and will continue through the third quarter of 1999, as plans are reviewed, refined and validated. As part of its credit analysis process, Northern Trust has developed a project plan for assessing the Year 2000 readiness of its significant credit customers. An initial assessment of Year 2000 readiness has been completed for virtually all of these customers. The assessment has identified only $12.0 million in exposure to clients identified as having more than moderate Year 2000 risk. Northern Trust will continue to monitor the progress of these and other credit customers, taking action (which may include additional credit loss provisions) where appropriate. In addition, as part of its fiduciary activities, Northern Trust has developed and is implementing a plan for taking the Year 2000 issue into consideration in evaluating investment portfolios, and a plan to evaluate and deal with the Year 2000 issues presented by other types of property held in trust. Northern Trust is also contacting clients and customers to explain its Year 2000 Program. The estimated total expense for Northern Trust's Year 2000 renovation project is $35 million. This estimate includes the cost of purchasing licenses for software programming tools, the cost of the time of internal staff in Worldwide Technology and the cost of consultants. The estimate does not include the time that internal staff in user departments are devoting to testing programming changes, although this testing is not expected to add significant incremental costs. All Year 2000 costs are expensed as incurred. As of December 31, 1998, $21.6 million of the estimated $35 million of project costs have been incurred. $11.5 million of these costs were incurred in 1998. The remaining costs are expected to be incurred fairly evenly through the first quarter of 2000. Of the total Worldwide Technology Group expenses (excluding depreciation and amortization) for 1997, 1998 and 1999, it is estimated that 12% to 14% will be for Year 2000 remediation costs, or less than 1.5% of Northern Trust's anticipated aggregate noninterest expenses for those years. Although the priority given to Year 2000 work may result in extending the time for completing some other technology projects, these delays are not expected to have a material effect on Northern Trust's business. EURO CONVERSION. On January 1, 1999, the "legacy" currencies of eleven of the fifteen members of the European Union became convertible at fixed rates into the euro, which became the common legal currency of the participating members. The legacy currencies are scheduled to remain legal tender for public and private transactions, as denominations of the euro, until June 30, 2002. During the three year transition period, transactions may be settled in either the legacy currency or the euro. At the end of the year Northern Trust successfully added euro capability to its global custody, foreign exchange, securities lending and related businesses. Extensive preparations and planning allowed Northern Trust to complete this significant conversion in a manner that was transparent to clients and involved no interruption of services. The effects of the euro on various aspects of Northern Trust's business are difficult to predict. In the foreign exchange market, volatility in pricing for transactions between legacy currencies had already decreased considerably by year-end 1998, as had volumes; after January 1, 1999 these transactions are no longer being conducted. Northern Trust currently estimates that foreign ex- change profits have been or will be reduced by approximately 10% in the aggregate as a result of these developments. Although a new market has developed for transactions involving the euro and the U.S. dollar, it is impossible to predict the extent to which foreign exchange profits arising from this new market will replace profits from transactions involving legacy currencies and the U.S. dollar or the extent to which reductions in foreign exchange profits will be offset by other foreign exchange initiatives. It is generally expected that the advent of the euro will increase liquidity in European equity and debt markets, 34 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- but its impact on trading strategies, which have an effect on Northern Trust's global securities lending business, remains unclear. Northern Trust will lend for clients securities denominated in euro, and has also created vehicles that allow delivery and investment of collateral denominated in euro. Northern Trust has also developed euro-denominated deposit and money market fund products for introduction early in 1999 and is reviewing other investment management strategies in light of the euro. RISK MANAGEMENT - ------------------------------------------------------------------------------- Asset Quality and Credit Risk Management SECURITIES. A high quality securities portfolio is maintained with 86% of the total portfolio comprised of U.S. Treasury or federal agency securities. The remainder of the portfolio is comprised of obligations of states and political subdivisions, preferred stock and other securities. At December 31, 1998, 74% of these securities were rated triple-A or double-A, 13% were rated single-A and 13% were below A or not rated by Standard and Poor's and/or Moody's Investors Service. Other securities consist primarily of Federal Home Loan Bank stock. Northern Trust is an active participant in the repurchase agreement market. This market provides a relatively low cost alternative for short-term funding. Se-curities sold under agreements to repurchase are held by the counterparty until the repurchase transaction matures. Increases in the fair value of these securities in excess of the repurchase liability could subject Northern Trust to credit risk in the event of default by the counterparty. To minimize this risk, collateral values are continuously monitored and Northern Trust sets limits on exposure with counterparties and regularly assesses their financial condition. LOANS AND OTHER EXTENSIONS OF CREDIT. A certain degree of credit risk is inherent in Northern Trust's various lending activities. Credit risk is managed through the Credit Policy function, which is designed to ensure adherence to a high level of credit standards. The Credit Policy function reports to the Corporation's Chief Financial Officer. Credit Policy provides a system of checks and balances for Northern Trust's diverse credit-related activities by establishing and monitoring all credit-related policies and practices throughout Northern Trust and ensuring their uniform application. These activities are designed to ensure that credit exposure is diversified on an industry and client basis, thus lessening overall credit risk. These credit management activities also apply to Northern Trust's use of derivative financial instruments, including foreign exchange contracts and interest risk management instruments. Individual credit authority for commercial loans and within Personal Financial Services is limited to specified amounts and maturities. Credit decisions involving commitment exposure in excess of the specified individual limits are submitted to the appropriate Credit Approval Committee (Committee). Each Committee is chaired by the executive in charge of the area and has a Credit Policy officer as a voting participant. Each Committee's credit approval authority is specified, based on commitment levels, credit ratings and maturities. Credits involving commitment exposure in excess of these group credit limits require the approval of the Senior Credit Committee. Credit Policy established the Counterparty Risk Management Committee in order to manage counterparty risk more effectively. This committee has sole credit authority for exposure to all foreign banks, certain domestic banks which Credit Policy deems to be counterparties and which do not have commercial credit relationships within the Corporation, and certain other exposures. Under the auspices of Credit Policy, country exposure limits are reviewed and approved on a country-by-country basis. As part of Northern Trust's ongoing credit granting process, internal credit ratings are assigned to each client and credit before credit is extended, based on creditworthiness. Credit Policy performs at least annually a review of selected significant credit exposures to identify at the earliest possible stages clients who might be facing financial difficulties. Internal credit ratings are also reviewed during this process. Above average risk loans, which will vary from time to time, receive special attention by both lending officers and Credit Policy. This approach allows management to take remedial action in an effort to deal with potential problems. An integral part of the Credit Policy function is a formal review of all past due and potential problem loans to determine which credits, if any, need to be placed on nonaccrual status or charged off. As more fully described on pages 38 through 40, the provision for credit losses is reviewed quarterly to determine the amount necessary to maintain an adequate reserve for credit losses. Management of credit risk is reviewed by various bank regulatory agencies. Independent auditors also perform a review of credit-related procedures, the loan portfolio and other extensions of credit, and the reserve for credit losses as part of their examination of the consolidated financial statements. A further way in which credit risk is managed is by requiring collateral. Management's assessment of the borrower's creditworthiness determines whether collateral is obtained. The amount and type of collateral held varies but may include deposits held in financial institutions, U.S. Treasury securities, other marketable securities, income-producing commercial properties, accounts receivable, property, plant and equipment, and 35 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ================================================================================ inventory. Collateral values are monitored on a regular basis to ensure that they are maintained at an appropriate level. The largest component of credit risk relates to the loan portfolio. Although credit exposure is well-diversified, there are certain groups that meet the accounting definition under SFAS No. 105 of credit risk concentrations. According to this statement, group concentrations of credit risk exist if a number of borrowers or other counterparties are engaged in similar activities and have similar economic characteristics that would cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. The fact that an extension of credit falls into one of these groups does not indicate that the credit has a higher than normal degree of credit risk. These groups are: residential real estate, middle market companies and small businesses, banks and bank holding companies and commercial real estate. RESIDENTIAL REAL ESTATE. The residential real estate loan portfolio totaled $5.9 billion or 45% of total domestic loans at December 31, 1998, compared with $5.2 billion or 43% at December 31, 1997. Residential real estate loans consist of conventional home mortgages and equity credit lines, which generally require a loan to collateral value of no more than 75% to 80% at inception. Of the total $5.9 billion in residential real estate loans, $3.0 billion were in the greater Chicago area with the remainder distributed throughout the other geographic regions served by Northern Trust. Legally binding commitments to extend credit, which are primarily equity credit lines, totaled $657.1 million and $455.9 million as of December 31, 1998 and 1997, respectively. MIDDLE MARKET COMPANIES AND SMALL BUSINESSES. Credit exposure to middle market companies and small businesses is primarily in the form of commercial loans, which totaled $1.8 billion at December 31, 1998 and $1.6 billion as of December 31, 1997. These loans are to a diversified group of borrowers that are predominantly in the manufacturing, wholesaling, distribution and services industries, most of which have total annual sales of less than $500 million. The largest component of this group of borrowers is located in the midwestern areas served by the Bank. Middle market and small businesses have been an important focus of business development, and it is part of the strategic plan to continue to selectively grow the portfolio with such entities. The credit risk associated with middle market and small business lending is principally influenced by general economic conditions and the resulting impact on the borrower's operations. Off-balance sheet credit exposure to middle market companies and small businesses in the form of legally binding commitments to extend credit, standby letters of credit, and commercial letters of credit totaled $1.9 billion, $981.0 million, and $12.6 million, respectively, as of December 31, 1998, and $1.9 billion, $830.1 million, and $22.7 million, respectively, as of December 31, 1997. BANKS AND BANK HOLDING COMPANIES. On-balance sheet credit risk to banks and bank holding companies, both domestic and international, totaled $5.8 billion and $5.5 billion at December 31, 1998 and 1997, respectively. The majority of this exposure consisted of short-term money market assets, which totaled $4.0 billion at both December 31, 1998 and 1997, and noninterest-bearing demand balances maintained at correspondent banks which totaled $1.4 billion as of December 31, 1998, compared to $1.1 billion at year-end 1997. Commercial loans to banks totaled $320 million and $232 million, respectively, as of December 31, 1998 and 1997. The majority of these loans were to U.S. bank holding companies, primarily in the seventh Federal Reserve District, for their acquisition purposes. Such lending activity is limited to entities which have a substantial business relationship with Northern Trust. Legally binding commitments to extend credit to banks and bank holding companies totaled $158 million and $222 million as of December 31, 1998 and 1997, respectively. COMMERCIAL REAL ESTATE. In managing its credit exposure, management has defined a commercial real estate loan as one where: (1) the borrower's principal business activity is the acquisition or the development of real estate for commercial purposes; (2) the principal collateral is real estate held for commercial purposes and loan repayment is expected to flow from the operation of the property; or (3) the loan repayment is expected to flow from the sale or refinance of real estate as a normal and ongoing part of the business. Unsecured lines of credit to firms or individuals engaged in commercial real estate endeavors are included without regard to the use of loan proceeds. The commercial real estate portfolio consists of interim loans and commercial mortgages. The interim loans, which totaled $318.8 million and $235.0 million as of December 31, 1998 and 1997, respectively, are composed primarily of loans to developers that are highly experienced and well-known to Northern Trust. Short- term interim loans provide financing for the initial phases of the acquisition or development of commercial real estate, with the intent that the borrower will refinance the loan through another financial institution or sell the project upon its completion. The interim loans are primarily in the Chicago market in which Northern Trust has a strong presence and a thorough knowledge of the local economy. 36 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- NONPERFORMING ASSETS AND 90 DAY PAST DUE LOANS - -------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- December 31 - --------------------------------------------------------------------------- (In Millions) 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------- Nonaccrual Loans Domestic Residential Real Estate $ 5.2 $ 5.3 $ 3.2 $ 2.4 $ 1.3 Commercial 21.8 26.3 2.2 17.5 15.7 Commercial Real Estate 2.9 7.1 11.3 9.0 9.1 Personal .6 .2 .2 .1 .3 Other -- -- -- -- -- Lease Financing -- -- -- -- .1 - --------------------------------------------------------------------------- Total Domestic 30.5 38.9 16.9 29.0 26.5 International -- -- -- .2 1.3 - --------------------------------------------------------------------------- Total Nonaccrual Loans 30.5 38.9 16.9 29.2 27.8 - --------------------------------------------------------------------------- Restructured Loans 2.4 2.5 2.6 2.7 -- Other Real Estate Owned 2.3 1.9 1.9 1.8 2.2 - --------------------------------------------------------------------------- Total Nonperforming Assets $35.2 $43.3 $21.4 $33.7 $30.0 - --------------------------------------------------------------------------- Total 90 Day Past Due Loans (Still accruing) $30.0 $13.9 $15.2 $22.0 $17.3
Commercial mortgage financing, which totaled $358.3 million and $347.1 mil- lion as of December 31, 1998 and 1997, respectively, is provided for the ac- quisition of income producing properties. Cash flows from the properties gen- erally are sufficient to amortize the loan. These loans average less than $500,000 each and are primarily located in the suburban Chicago and Florida markets. At December 31, 1998, off-balance sheet credit exposure to commercial real estate developers in the form of legally binding commitments to extend credit and standby letters of credit totaled $77.1 million and $28.4 million, respectively. At December 31, 1997, legally binding commitments were $73.7 million and standby letters of credit were $36.0 million. FOREIGN OUTSTANDINGS. Short-term interbank time deposits with foreign banks represent the largest category of foreign outstandings. The Chicago head office and the London Branch actively participate in the interbank market with U.S. and foreign banks. In recent years, international commercial lending activities have been focused on import and export financing for U.S.-based clients. As used in this discussion, foreign outstandings are cross-border outstandings as defined by the Securities and Exchange Commission. They consist of loans, acceptances, interest-bearing deposits with financial institutions, accrued interest and other monetary assets. Not included are letters of credit, loan commitments, and foreign office local currency claims on residents funded by local currency liabilities. Foreign outstandings related to a specific country are net of guarantees given by third parties resident outside the country and the value of tangible, liquid collateral held outside the country. However, transactions with branches of foreign banks are included in these outstandings and are classified according to the country location of the foreign banks' head office. Risk related to foreign outstandings is continually monitored and internal limits are imposed on foreign exposure. The following table provides information on foreign outstandings by country that exceed 1.00% of Northern Trust's assets. FOREIGN OUTSTANDINGS - --------------------------------------------------------------------------------
Commercial (In Millions) Banks and Other Total - -------------------------------------------------------------------------------- At December 31, 1998 Germany $1,007 $ -- $1,007 Italy 396 -- 396 United Kingdom 316 61 377 France 312 -- 312 Belgium 289 -- 289 - -------------------------------------------------------------------------------- At December 31, 1997 Germany $ 502 $ -- $ 502 Japan 394 -- 394 United Kingdom 251 71 322 - -------------------------------------------------------------------------------- At December 31, 1996 Japan $ 993 $ -- $ 993
Aggregate foreign outstandings by country falling between 0.75% and 1.00% of total assets at December 31, 1998 totaled $266 million to the Netherlands. This compares with $192 million to France at December 31, 1997 and none at December 31, 1996. NONPERFORMING ASSETS AND 90 DAY PAST DUE LOANS. Nonperforming assets consist of nonaccrual loans, restructured loans and Other Real Estate Owned (OREO). OREO is comprised of commercial and residential properties acquired in partial or total satisfaction of problem loans. Past due loans are loans that are delinquent 90 days or more and still accruing interest. The balance in this category at any reporting period can 37 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANALYSIS OF RESERVE FOR CREDIT LOSSES - --------------------------------------------------------------------------------
($ In Millions) 1998 1997 1996 1995 1994 - --------------------------------------------------------------------------------------------------------------------- Balance at Beginning of Year $ 147.6 $ 148.3 $ 147.1 $ 144.8 $ 145.5 - --------------------------------------------------------------------------------------------------------------------- Charge-Offs Residential Real Estate .8 .8 .2 .6 .1 Commercial 9.6 11.4 6.2 5.5 5.3 Commercial Real Estate .3 .7 7.4 3.6 4.1 Personal .8 1.3 1.5 1.2 1.2 Other .3 .2 .3 .8 -- - --------------------------------------------------------------------------------------------------------------------- Total Charge-Offs 11.8 14.4 15.6 11.7 10.7 - --------------------------------------------------------------------------------------------------------------------- Total Recoveries 1.8 4.7 3.8 5.8 4.0 - --------------------------------------------------------------------------------------------------------------------- Net Charge-Offs 10.0 9.7 11.8 5.9 6.7 Provision for Credit Losses 9.0 9.0 12.0 6.0 6.0 Reserve Related to Acquisitions .2 -- 1.0 2.2 -- - --------------------------------------------------------------------------------------------------------------------- Balance at End of Year $ 146.8 $ 147.6 $ 148.3 $ 147.1 $ 144.8 - --------------------------------------------------------------------------------------------------------------------- Loans and Leases at Year-End $13,646.9 $12,588.2 $10,937.4 $9,906.0 $8,590.6 - --------------------------------------------------------------------------------------------------------------------- Average Total Loans and Leases $13,315.0 $11,812.9 $10,332.1 $9,136.0 $8,316.1 - --------------------------------------------------------------------------------------------------------------------- As a Percent of Year-End Loans and Leases Net Loan Charge-Offs .07% .08% .11% .06% .08% Provision for Credit Losses .07 .07 .11 .06 .07 Reserve Balance at Year-End 1.08 1.17 1.36 1.49 1.69 - --------------------------------------------------------------------------------------------------------------------- As a Percent of Average Loans and Leases Net Loan Charge-Offs .07% .08% .11% .06% .08% Reserve Balance at Year-End 1.10 1.25 1.44 1.61 1.74
fluctuate widely based on the timing of cash collections, renegotiations and renewals. Maintaining a low level of nonperforming assets is important to the ongoing success of a financial institution. Northern Trust's comprehensive credit re- view and approval process is critical to the ability to minimize nonperforming assets on a long-term basis. In addition to the negative impact on both net in- terest income and credit losses, nonperforming assets also increase operating costs due to the expense associated with collection efforts. The table on the preceding page presents the nonperforming assets and past due loans for the current year and the prior years. Of the total loan portfolio of $13.6 billion at December 31, 1998, $32.9 million or 0.24% was nonperforming, a decrease of $8.5 million from year-end 1997 . Included in the portfolio of nonaccrual loans are those which meet the criteria as being "impaired" under the definition in SFAS No. 114. A loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due according to the contractual terms of the loan agreement. As of December 31, 1998, impaired loans, which also have been classified as nonperforming, totaled $32.0 million, with $5.9 million of the reserve for credit losses allocated to these loans. PROVISION AND RESERVE FOR CREDIT LOSSES. The provision for credit losses is the charge against current earnings that is determined by management, through a disciplined credit review process, as the amount needed to maintain a reserve that is sufficient to absorb credit losses inherent in Northern Trust's loan and lease portfolios and other credit undertakings. The reserve provides for probable losses that have been identified with specific borrower relationships (specific loss component) and for probable losses that are believed to be inherent in the loan and lease portfolios and other credit undertakings but that have not yet been specifically identified (inherent loss component). Specific Component of the Reserve. The specific component of the reserve is determined on a loan-by-loan basis as part of the regular review of classified and nonperforming loans and potential charge-offs. The specific reserve is based on a loan's current book value compared to the present value of its projected future cash flows, collateral value or market value, as is relevant for the particular loan. At December 31, 1998, the specific reserve component amounted to $5.9 million compared to $10.7 million at the end of 1997. During 1998, and as part of the regular review of classified and nonperforming loans and potential charge-offs, management determined that certain loans with specific reserves allo- 38 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- cated to them in 1997 had deteriorated and needed to be charged-off. Although most of the $11.8 million in charge-offs during the year were taken against and reduced the specific loss component of the reserve, that reduction was partially offset by higher allocations needed on some of the credits with specific reserves and other newly-identified commercial credits, resulting in a net $4.8 million decrease in the specific loss component of the reserve in 1998. The increase in the specific loss component of the reserve in 1997 was principally due to one larger nonperforming loan. Management did not view the developments in either year as evidence of any changing trend in credit quality. Allocated Inherent Component of the Reserve. The allocated portion of the inherent reserve is based on management's review of historical charge-off experience as well as management's judgment for loans in each credit rating category over a period of time which management determines is adequate to reflect longer term economic trends. One building block in reaching the appropriate allocated inherent reserve is an analysis of loans by credit rating categories. Credit ratings are determined by members of the Credit Policy Group at the time each loan is approved. These credit ratings are subject to periodic reviews of the loan portfolio in which the Credit Policy Group, which is independent of line management, makes the final determination of ratings for each loan in the portfolio. Credit ratings range from "1" for the strongest credits to "9" for the weakest credit rating; a "9" rated loan would normally represent a complete loss. At December 31, 1998, for loans with credit ratings "1" through "4," the loss ratio for each past year was calculated by expressing the loan charge-offs in each rating category as a percentage of previous year-end outstanding loans in that rating category. These yearly loss ratios for each credit rating category were then averaged over the prior five years to develop the historical loss ratio. Prior to 1998, this historical loss ratio methodology was also followed for higher risk loans rated "5" through "8." In 1998, the loss factors on these higher-risk loans were refined by considering both historical loss ratios and regulatory guidelines to provide a more consistent and reliable method for taking account of credit trends in measuring loss exposure. In addition, management broadened the analysis of credit risk by using a range of estimated loss when facts and circumstances so dictate. In 1997, management changed the measurement period for calculating the historical loss ratio to use only the most recent five years, in order to more closely align the ratios to the economic factors currently affecting the portfolio. Previously, the cumulative average historical charge-off ratios represented experience beginning in 1987, with subsequent years added to the base. Management also decided in 1997 to use for the commercial and commercial real estate segments of the portfolio an "industry base" reserve of 1% in order to measure the loss estimated to be inherent in these riskier segments. Because commercial and commercial real estate loans had in Northern Trust's experience produced significant losses in brief periods at particular points in economic cycles, management believed it appropriate to use a reserve higher than recent charge-off experience would suggest. This decision was supported by what management perceived to be industry practice for minimum reserve levels, and is intended to prevent an understatement of reserves based upon over-reliance on recent, favorable economic conditions. At December 31, 1998, after evaluating the current level of uncertainty in international markets and its effect on borrowers, management concluded it was appropriate to set this base ALLOCATION OF THE RESERVE FOR CREDIT LOSSES - -------------------------------------------------------------------------------
December 31 - ---------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ---------------------------------------------------------------------------------------------------------------------------- Percent of Percent of Percent of Percent of Percent of Loans to Loans to Loans to Loans to Loans to Reserve Total Reserve Total Reserve Total Reserve Total Reserve Total ($ in Millions) Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans - ---------------------------------------------------------------------------------------------------------------------------- Specific Reserve $ 5.9 --% $ 10.7 --% $ .8 --% $ 1.3 --% $ .3 --% - ---------------------------------------------------------------------------------------------------------------------------- Inherent Reserve Residential Real Estate 11.0 43 3.7 41 7.1 42 5.4 39 5.2 38 Commercial 77.4 29 87.1 30 71.2 29 84.4 32 85.9 31 Commercial Real Estate 11.8 5 6.4 5 5.1 5 6.8 5 12.3 6 Personal 3.2 11 .6 10 6.2 9 8.4 8 5.5 8 Other -- 5 -- 7 -- 9 -- 10 -- 11 Lease Financing 2.9 4 2.9 3 2.9 2 2.9 2 2.9 2 International 3.6 3 -- 4 2.3 4 2.6 4 2.9 4 Unallocated 31.0 -- 36.2 -- 52.7 -- 35.3 -- 29.8 -- - ---------------------------------------------------------------------------------------------------------------------------- Total Inherent Reserve $140.9 100% $136.9 100% $147.5 100% $145.8 100% $144.5 100% - ---------------------------------------------------------------------------------------------------------------------------- Total Reserve $146.8 100% $147.6 100% $148.3 100% $147.1 100% $144.8 100%
This allocation method should not be interpreted as an indication of expected losses within the next year or any specified time period. 39 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- reserve at 1%. During 1998 management also decided to extend the base reserve methodology to international exposure. In the current year, management also increased the portion of the inherent reserve allocated to residential loans, in light of the increasing size of the mortgage portfolio as a percentage of all lending. Management in 1997 reduced the amounts of credit exposure assigned to undrawn loan commitments and standby letters of credit, to reflect this exposure by using the factors applied in risk-based capital calculations. In 1996 the full notional amount of the off-balance sheet exposures had been used for purposes of this calculation. In 1998 management further refined its methodology by reducing the loss factor assigned to undrawn loan commitments and standby letters of credit from the 1% used in 1997 to .25% in order to reflect the nature and extent of the credit exposure on these instruments as currently perceived. The $9.2 million increase in the allocated portion of the inherent reserve during 1998 to $109.9 million at December 31, 1998, was principally a function of the increase in the amount of loans and other credit exposure and the decision to apply the base reserve methodology to international exposure. Other changes in methodology essentially offset each other. Unallocated Inherent Component of the Reserve. The unallocated portion of the inherent loss reserve is based on management's review of other factors affecting the determination of probable losses inherent in the portfolio, which are not necessarily captured by the application of historical loss ratios. This portion of the reserve analysis involves the exercise of judgment and reflects all appropriate considerations, including management's view that the reserve should have a margin that recognizes the imprecision inherent in the process of estimating expected credit losses. An important consideration in establishing the level of the unallocated portion of the reserve was the fact that the loan portfolio, and in particular commercial loans, continued to grow in 1998 at a significant rate, as they had done throughout the period 1994-97. The overall decrease in this portion of the reserve from $36.2 million to $31.0 million primarily reflects the reassignment of part of this reserve to the allocated inherent reserve through application of the "industry base" reserve to international exposure, as described above. Management viewed this as a more clear identification of some of the risk previously dealt with by the unallocated inherent reserve. The decrease in the unallocated inherent portion of the reserve also reflects management's judgment that credit quality in other respects continues to be strong. Other Factors. During 1998, there were no significant changes in concentration of credits that impacted asset quality. The total amount of highest risk loans, those rated "6" to "8", that was used in the determination of the reserve level at the end of 1998 was estimated to be approximately $99 million. The decline from the actual December 31, 1997 balance for these loans of $118 million primarily reflects charge-offs on one commercial loan and repayments received on other of these lower-rated credits. These changes were not deemed significant in determining loan loss reserves, although changes in the amounts in each category would have affected the allocated inherent loss reserve analysis. There were no "9" rated loans reported at any time during these periods because loans are charged-off when they are so rated. Nonperforming loans fell from $41.4 million at December 31, 1997 to $32.9 million at December 31, 1998, reflecting principally charge-offs on one commercial loan. This change was deemed relatively minor in a loan portfolio that exceeded $13.3 billion on average throughout the period. Overall Reserve. Management's evaluation of the factors above resulted in a reserve for credit losses of $146.8 million at December 31, 1998 compared to $147.6 million at the end of 1997, reflecting the conclusion that losses inherent in the portfolio were larger than would otherwise be suggested by the favorable charge-off experience in recent years and the view that the absolute level of the reserve should not decline appreciably given the continuing growth in the portfolio. However, the reserve as a percentage of total loans declined to 1.08% at December 31, 1998 from 1.17% at year-end 1997. This decline is consistent with the trend Northern Trust has experienced during the recent economic expansion whereby conservative underwriting standards, improved credit quality and favorable charge-off experience have offset the steady growth in the portfolio. Provision. The resulting provision for credit losses was $9.0 million for the year, while net charge-offs totaled $10.0 million. Market Risk Management OVERVIEW. The Board of Directors has overall responsibility for Northern Trust's interest rate and foreign exchange risk management policies. To ensure adherence to these policies, the Corporate Asset and Liability Policy Committee (ALCO) establishes and monitors guidelines to control the sensitivity of earnings to changes in interest rates. The guidelines apply to both on- and off-balance sheet positions. ALCO also establishes and monitors limits for foreign exchange risk. The goal of the ALCO process is to maximize earnings while maintaining a high quality balance sheet and carefully controlling interest rate and foreign exchange risk. ASSET/LIABILITY MANAGEMENT. Asset/liability management activities include lending, accepting and 40 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- INTEREST RATE SENSITIVITY ANALYSIS - -------------------------------------------------------------------------------
December 31, 1998 - ------------------------------------------------------------------------------------------------ 1-3 4-12 1-2 3-5 Over 5 (In Millions) Months Months Years Years Years Total - ------------------------------------------------------------------------------------------------ Earning Assets Money Market Assets $ 4,290.5 $ 139.8 $ -- $ -- $ 20.6 $ 4,450.9 Securities-Available for Sale 4,942.9 247.0 38.7 5.1 141.5 5,375.2 -Held to Maturity 115.3 81.6 33.7 61.2 180.7 472.5 -Trading Account 9.1 -- -- -- -- 9.1 Loans and Leases 4,288.7 1,501.9 1,105.3 2,873.0 3,878.0 13,646.9 - ------------------------------------------------------------------------------------------------ Total Earning Assets $13,646.5 $1,970.3 $1,177.7 $2,939.3 $ 4,220.8 $23,954.6 - ------------------------------------------------------------------------------------------------ Source of Funds Savings and NOW Accounts $ 3,408.1 $ -- $ -- $ -- $ 597.6 $ 4,005.7 Money Market Deposit Accounts and Savings Certificates 3,407.2 1,090.5 326.7 112.7 391.0 5,328.1 Other Time 4,146.5 228.4 69.7 82.5 .9 4,528.0 Senior Notes and Long-Term Debt .1 700.4 22.5 128.4 306.8 1,158.2 Debt-Floating Rate Capital Securities 267.4 -- -- -- -- 267.4 Other Borrowings 5,157.5 1.4 -- 175.0 53.4 5,387.3 Noninterest-Related Funds, net (898.7) 90.0 -- -- 4,088.6 3,279.9 - ------------------------------------------------------------------------------------------------ Total Source of Funds $15,488.1 $2,110.7 $ 418.9 $ 498.6 $ 5,438.3 $23,954.6 - ------------------------------------------------------------------------------------------------ Interest Sensitive Gap $(1,841.6) $ (140.4) $ 758.8 $2,440.7 $(1,217.5) $ -- Off-Balance Sheet Hedges 1,092.7 284.0 (215.0) (661.1) (500.6) -- - ------------------------------------------------------------------------------------------------ Adjusted Interest Sensitive Gap $ (748.9) $ 143.6 $ 543.8 $1,779.6 $(1,718.1) $ -- - ------------------------------------------------------------------------------------------------ Cumulative Interest Sensitive Gap $ (748.9) $ (605.3) $ (61.5) $1,718.1 $ -- $ --
- --Assets and liabilities whose rates are variable are reported based on their repricing dates. Those with fixed rates are reported based on their scheduled contractual repayment dates, except for certain investment securities and loans secured by 1-4 family residential properties that are based on anticipated prepayments. - --The interest rate sensitivity assumptions presented for demand deposits, noninterest-bearing time deposits, savings accounts and NOW accounts are based on historical and current experiences regarding product portfolio retention and interest rate repricing behavior. The portion of these deposits which are considered long-term and stable have been classified in the Over 5 Years category. placing deposits, investing in securities, issuing debt, and hedging interest rate risk with off-balance sheet instruments. The primary market risk associated with asset/liability management activities is interest rate risk. Sensitivity of earnings to interest rate changes arises when yields on assets change in a different time period or in a different amount from that of interest costs on liabilities. To mitigate interest rate risk, the structure of the balance sheet is managed so that movements of interest rates on assets and liabilities (adjusted for off-balance sheet hedges) are highly correlated and contribute to earnings even in periods of volatile interest rates. Northern Trust utilizes the following measurement techniques in the management of interest rate risk: simulation of earnings; simulation of the economic value of equity; and gap analysis. These three techniques are complementary and are used in concert to provide a comprehensive picture of interest rate risk management capability. Simulation of earnings is the primary tool used to measure the sensitivity of earnings to interest rate changes. Using computer modeling techniques, Northern Trust is able to measure the potential impact of different interest rate assumptions on pre-tax earnings. All on-balance sheet positions, as well as derivative financial instruments (principally interest rate swaps) that are used to manage interest rate risk, are included in the model simulation. Northern Trust used model simulations to measure its earnings sensitivity relative to management's most likely interest rate scenario as of December 31, 1998. This interest rate scenario assumed a steady interest rate environment during 1999. The interest sensitivity was tested by running alternative scenarios above and below the most likely interest rate outcome. The table on the following page shows the effect on 1999 pre-tax earnings of 100 and 200 basis point upward and downward movements in interest rates relative to management's interest rate assumptions. Each of the movements in interest rates was assumed to have occurred gradually over a one year period. The 100 basis point increase, for example, consisted of twelve consecutive monthly increases of 8.3 basis points. The following assumptions were also incorporated into the model simulations: . the balance sheet size was assumed to remain constant over the one year simulation horizon. 41 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- . maturing assets and liabilities were invested or deposited into identical items with the same maturity. . prepayments on mortgage loans were projected under each rate scenario using a mortgage analytics system that incorporated market prepayment assumptions. . changes in the spreads between retail deposit rates and asset yields were estimated based on historical patterns and current competitive trends. INTEREST RATE RISK SIMULATION OF PRE-TAX INCOME AS OF DECEMBER 31, 1998 - -------------------------------------------------------------------------------
Estimated Impact on 1999 Pre-tax Income (In Millions) Increase/(Decrease) - --------------------------------------------------------- Increase in Interest Rates Above Management's Interest Rate Forecast 100 Basis Points $ (9.0) 200 Basis Points (16.8) Decrease in Interest Rates Below Management's Interest Rate Forecast 100 Basis Points 6.9 200 Basis Points 11.7
The simulations of earnings do not incorporate any management actions which might moderate the negative consequences of interest rate deviations. For that reason and others, they do not reflect likely actual results but serve as conservative estimates of interest rate risk. A second technique used to measure interest rate risk is simulation of the economic value of equity, which provides estimates of the potential future impact on equity of various changes in interest rates. The potential effect of interest rate changes on equity is derived from the impact of such changes on the market values of assets, liabilities and off-balance sheet instruments. Northern Trust limits aggregate market risk, as measured in this fashion, to an acceptable level within the context of risk-return trade-offs. The third technique that is used to measure interest rate risk is gap analysis. The calculation of the interest sensitivity gap which is shown in the table on the preceding page, measures the timing mismatches between assets and liabilities. This interest sensitivity gap is determined by subtracting the amount of liabilities from the volume of assets that reprice in a particular time interval. A liability sensitive position results when more liabilities than assets reprice or mature within a given period. Under this scenario, as interest rates decline, increased net interest revenue will be generated. Conversely, an asset sensitive position results when more assets than liabilities reprice within a given period; in this instance, net interest revenue would benefit from an increasing interest rate environment. The economic impact of creating a liability or asset sensitive position depends on the magnitude of actual changes in interest rates relative to the current expectations of market participants. A variety of actions are used to implement interest risk management strategies, including: . purchases of securities; . sales of securities that are classified as available for sale; . sales of held for sale residential real estate loans; . issuance of senior notes; . placing and taking Eurodollar time deposits; and . hedging with various types of derivative financial instruments. Northern Trust strives to use the most effective instruments for implementing its interest risk management strategies, considering the costs, liquidity and capital requirements of the various alternatives. For more detail regarding how derivative financial instruments are used to implement interest risk management strategies, refer to Note 21 on page 64. FOREIGN EXCHANGE TRADING. Foreign exchange trading activities consist principally of providing foreign exchange services to clients. Most of these services are provided in connection with Northern Trust's growing global custody business. However, in the normal course of business Northern Trust also engages in proprietary trading of foreign currencies. The primary market risk associated with these activities is foreign exchange risk. Foreign currency positions exist when aggregate obligations to purchase and sell a currency other than the U.S. dollar do not offset each other, or offset each other in different time periods. Northern Trust mitigates the risk related to its foreign currency positions by establishing limits on the amounts of and durations of its positions. The limits on overnight inventory positions are generally lower than the limits established for intra-day trading activity. All overnight positions are monitored by a risk management function, which is separate from the trading function, to ensure that the limits are not exceeded. Although position limits are important in controlling foreign exchange risk, they are not a substitute for the experience or judgment of Northern Trust's senior management and its foreign currency traders, who have extensive knowledge of the foreign currency markets. Foreign currency positions and strategies are adjusted as needed in response to changing market conditions. As part of its risk management activities, Northern Trust regularly measures the risk of loss associated with foreign currency positions using a value at risk model. This statistical model provides an estimate, based on a 95% confidence interval, of the potential loss in earn- 42 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ings that may be incurred if an adverse one-day shift in foreign currency exchange rates were to occur. The model, which is based on a variance/co- variance methodology, incorporates historical currency price data and historical correlations in price movement among the currencies. All foreign currency positions, including foreign denominated assets and liabilities that were not converted to U.S. dollars through the use of hedge contracts, are included in the model. Northern Trust's value at risk, based on foreign currency positions totaled $98 thousand and $91 thousand as of December 31, 1998 and 1997, respectively. Value at risk totals representing the average, high and low for 1998 were $285 thousand, $472 thousand and $98 thousand, respectively. These totals indicate the degree of risk inherent in foreign currency positions as of year-end and during the year. However, it is not a prediction of an expected loss. Actual future gains and losses will vary depending on market conditions and the size and duration of future foreign currency positions. OTHER TRADING ACTIVITIES. Market risk associated with other trading activities is negligible. Northern Trust is a party to various interest risk management instruments, most of which consist of interest rate swaps entered into to meet clients' interest risk management needs. When Northern Trust enters into such swaps, its policy is to mitigate the resulting interest rate risk with an offsetting swap or with futures contracts. Northern Trust carries in its trading portfolio a small inventory of securities that are held for sale to its clients. The interest rate risk associated with these securities is insignificant. Liquidity Risk Management The objective of liquidity risk management is to ensure that Northern Trust can meet its cash flow requirements and to capitalize on business opportunities on a timely and cost effective basis. Management monitors the liquidity position on a daily basis to ensure that funds are available at a minimum cost to meet loan and deposit cash flows. The liquidity profile is also structured to ensure that the capital needs of the Corporation and its banking subsidiaries are met. Management maintains a detailed liquidity contingency plan designed to adequately respond to dramatic changes in market conditions. Liquidity is secured by managing the mix of items on the balance sheet and expanding potential sources of liquidity. The balance sheet sources of liquidity include the short-term money market portfolio, unpledged available for sale securities, maturing loans, and the ability to securitize a portion of the loan portfolio. Further, liquidity arises from the diverse funding base and the fact that a significant portion of funding comes from clients that have other relationships with Northern Trust. A significant source of liquidity is the ability to draw funding from both domestic and international markets. The Bank's senior long-term debt is rated AA- by Standard & Poor's, Aa3 by Moody's Investors Service, AA+ by Thomson BankWatch, and AA by Fitch IBCA. These ratings put The Northern Trust Company in the top tier of United States banks. Northern Trust maintains a liquid balance sheet with loans representing only 49% of total assets. Further, at December 31, 1998, it had a significant liquidity reserve on its balance sheet in the form of cash and due from banks, securities available for sale, and money market assets, which in aggregate totaled $12.2 billion or 44% of total assets. The Corporation's uses of cash consist mainly of dividend payments to the Corporation's common and preferred stockholders, the payment of principal and interest to note holders, purchases of its common stock and acquisitions. These requirements are met largely by dividend payments from its subsidiaries, and by interest and dividends earned on investment securities and money market assets. Bank subsidiaries have the ability to pay dividends during 1999 equal to their 1999 eligible net profits plus $432.8 million. Bank subsidiary dividends are subject to certain restrictions that are explained in Note 15 on page 60. The Corporation's liquidity, defined as the amount of marketable assets in excess of commercial paper, was strong at $130.3 million at year-end 1998. The cash flows of the Corporation are shown in Note 30 on page 73. The Corporation also has a $50 million back-up line of credit for its commercial paper issuance. The Corporation's strong credit ratings allow it to access credit markets on favorable terms. Capital Management One of management's primary objectives is to maintain a strong capital position to merit the confidence of clients, the investing public, bank regulators and stockholders. A strong capital position helps Northern Trust take advantage of profitable investment opportunities when they arise and would help withstand unforeseen adverse developments. In 1998, average common equity increased 13% or $195 million reaching a record $1.8 billion at year-end, while total risk-weighted assets rose 9%. Total equity as of December 31, 1998 was $1.9 billion including $120 million of auction rate preferred stock. The average dividend rate declared on the $120 million of auction rate preferred stock was 4.12% during 1998. During 1998 the Corporation purchased 1,626,213 of its own shares as part of the buyback program authorized in 1996. The Corporation may purchase, after December 31, 1998, up to 1.6 million additional shares under the current buyback program. 43 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CAPITAL ADEQUACY - --------------------------------------------------------------------------------
December 31 - -------------------------------------------------------------------- ($ In Millions) 1998 1997 - -------------------------------------------------------------------- Tier 1 Capital Common Stockholders' Equity $ 1,820 $ 1,619 Debt-Floating Rate Capital Securities 267 267 Goodwill and Other Intangible Assets (124) (122) Net Unrealized (Gain) Loss on Securities 1 (2) - -------------------------------------------------------------------- Total Tier 1 Capital 1,964 1,762 - -------------------------------------------------------------------- Tier 2 Capital Auction Rate Preferred Stock 120 120 Reserve for Credit Losses 147 148 Long-Term Debt * 390 315 - -------------------------------------------------------------------- Total Tier 2 Capital 657 583 - -------------------------------------------------------------------- Total Risk-Based Capital 2,621 2,345 - -------------------------------------------------------------------- Risk-Weighted Assets** $20,074 $18,342 - -------------------------------------------------------------------- Total Assets End of Period (EOP) $27,870 $25,315 Average Fourth Quarter Assets** 28,467 25,646 Total Loans--EOP 13,647 12,588 Ratios Risk-Based Capital to Risk-Weighted Assets Tier 1 9.8% 9.6% Total (Tier 1 and Tier 2) 13.1 12.8 Leverage 6.9 6.9 - -------------------------------------------------------------------- Common Stockholders' Equity to Total Loans EOP 13.3% 12.9% Total Assets EOP 6.5 6.4 Stockholders' Equity to Total Loans EOP 14.2 13.8 Total Assets EOP 7.0 6.9
Notes: *Long-Term Debt that qualifies for risk-based capital amortizes for the purpose of inclusion in tier 2 capital during the five years before maturity. **Assets have been adjusted for goodwill and other intangible assets, net unrealized gain (loss) on securities and excess reserve for credit losses that have been excluded from tier 1 and tier 2 capital, if any. The Board of Directors increased the quarterly dividend by 14% to $.24 per common share in November 1998. Over the last five years the common dividend has increased 118%. The higher capital levels and resulting increase in risk-based capital ratios in 1998 was the result of Northern Trust's ongoing policy of retaining a sufficient percentage of earnings in the Corporation to allow for strategic expansion while maintaining a strong balance sheet. Northern Trust Corporation's risk-based capital ratios were strengthened in 1997 by the issuance in January 1997 of $150 million Floating Rate Capital Securities, Series A and by the issuance in April 1997 of $120 million Floating Rate Capital Securities, Series B, both of which qualify as tier 1 capital. Both series of the Floating Rate Capital Securities have a 30 year fixed maturity. All of Northern Trust's capital ratios were well above the ratios that are a requirement for regulatory treatment as "well capitalized." At December 31, 1998, tier 1 capital was 9.8% and total capital was 13.1% of risk-weighted assets. These risk-based capital ratios are well above the minimum requirements of 4.0% for tier 1 and 8.0% for total risk-based capital ratios. Northern Trust's leverage ratio (tier 1 capital to fourth quarter average assets) of 6.9% is also well above the regulatory requirement of 3.0%. In addition, each of the subsidiary banks had a ratio of at least 8.6% for tier 1 capital, 10.9% for total risk-based capital, and 6.0% for the leverage ratio. Operational and Fiduciary Risk Management In providing banking and trust services, Northern Trust, in addition to safekeeping and managing trust and corporate assets, processes cash and securities transactions exceeding $150 billion on average each business day. These activities expose Northern Trust to operational and fiduciary risk. Controls over such processing activities are closely monitored to safeguard the assets of Northern Trust and its clients. However, from time to time Northern Trust has incurred losses related to these risks and there can be no assurance that such losses will not occur in the future. Operational risk is the risk of unexpected losses attributable to human error, systems failures, fraud, or inadequate internal controls and procedures. This risk is mitigated through a system of internal controls that are designed to keep operating risk at appropriate levels in view of Northern Trust's corporate standards and the risks inherent in the markets in which Northern Trust operates. The system of internal controls includes policies and procedures that require the proper authorization, approval, documentation and monitoring of transactions. Each business unit is responsible for complying with corporate policies and external regulations applicable to the unit, and is responsible for establishing specific procedures to do so. Northern Trust's internal auditors monitor the overall effectiveness of the system of internal controls on an ongoing basis. Fiduciary risk is the risk of loss that may occur as a result of breaching a fiduciary duty to a client. To limit this risk, the Trust Investment Committee establishes corporate policies and procedures to ensure that obligations to clients are discharged faithfully and in compliance with applicable legal and regulatory requirements. These policies and procedures provide guidance and establish standards related to the creation, sale, and management of investment products, trade execution, and counterparty selection. Business units have the primary responsibility for adhering to the policies and procedures applicable to their businesses 44 NORTHERN TRUST CORPORATION MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- FORWARD-LOOKING INFORMATION - -------------------------------------------------------------------------------- This annual report contains statements that may be considered forward-looking, such as the discussion of Northern Trust's financial goals, expansion and business development plans, business prospects and positioning with respect to market, demographic and pricing trends, new business results, credit quality, outlook and reserves, planned capital expenditures and technology spending, planned schedules or expected completion dates for Year 2000 work, and the effect of various matters (including Year 2000 issues and the introduction of the euro) on Northern Trust's business. These statements speak of Northern Trust's plans, goals, beliefs or expectations, refer to estimates or use similar terms. Those relating to Year 2000 matters also constitute Year 2000 readiness disclosures. Actual results could differ materially from the results indicated by these statements because the realization of those results is subject to many uncertainties including: . The future health of the U.S. and international economies and other economic factors that affect wealth creation, investment and savings patterns, and Northern Trust's interest rate risk exposure and credit risk. . Changes in U.S. and worldwide securities markets, with respect to the market values of financial assets and the level of volatility in certain markets such as foreign exchange. . Regulatory developments and changes in accounting requirements or interpretations in the U.S. and other countries where Northern Trust has significant business. . Changes in the nature of Northern Trust's competition resulting from industry consolidation, regulatory change and other factors, as well as actions taken by particular competitors. . Northern Trust's success in continuing to generate significant levels of new business in its existing markets, as well as its success in identifying and penetrating targeted markets, through acquisition or otherwise, and generating a profit in those markets in a reasonable time. . Northern Trust's ability to continue to fund and accomplish technological innovation, improve processes and controls and attract and retain capable staff in order to deal with increasing volume and complexity in many of its businesses and technology challenges, such as Year 2000 systems renovation. . The ability of various vendors, clients, counterparties and governmental or private entities on which Northern Trust's business depends, or in which Northern Trust invests for itself or its clients to complete Year 2000 systems renovation efforts on a timely basis and in a manner that allows them to continue normal business operations or furnish products, services or data to Northern Trust without disruption, as well as Northern Trust's ability to accurately evaluate their readiness in this regard and, where necessary, develop and implement effective contingency plans. . The accuracy and effectiveness of Northern Trust's assessment of and work on issues such as those described under the caption "Year 2000 Project." . The impact of the euro on Northern Trust's global custody business and foreign exchange trading results. . The ability of each of Northern Trust's principal businesses to maintain a product mix that achieves satisfactory margins. . Changes in tax laws or other legislation that could affect Northern Trust's personal and institutional asset administration businesses. Some of these uncertainties that may affect future results are discussed in more detail in the sections of "Item 1-- Business" of the 1998 Annual Report on Form 10-K captioned "Government Policies," "Competition" and "Regulation and Supervision." All forward-looking statements included in this document are based upon information presently available, and Northern Trust assumes no obligation to update any forward-looking statement. 45 NORTHERN TRUST CORPORATION CONSOLIDATED BALANCE SHEET - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
December 31 - -------------------------------------------------------------------------------- ($ In Millions) 1998 1997 - -------------------------------------------------------------------------------- Assets Cash and Due from Banks $ 2,366.0 $ 1,738.9 Federal Funds Sold and Securities Purchased under Agreements to Resell (Note 4) 1,164.4 2,991.7 Time Deposits with Banks 3,264.7 2,283.2 Other Interest-Bearing 21.8 34.5 Securities (Note 3) Available for Sale 5,375.2 3,733.3 Held to Maturity (Fair value-$485.7 in 1998 and $473.4 in 1997) 472.5 456.1 Trading Account 9.1 8.8 - -------------------------------------------------------------------------------- Total Securities 5,856.8 4,198.2 - -------------------------------------------------------------------------------- Loans and Leases (Note 5) Commercial and Other 7,761.7 7,401.5 Residential Mortgages 5,885.2 5,186.7 - -------------------------------------------------------------------------------- Total Loans and Leases (Net of unearned income-$224.3 in 1998 and $151.9 in 1997) 13,646.9 12,588.2 - -------------------------------------------------------------------------------- Reserve for Credit Losses (Note 6) (146.8) (147.6) Buildings and Equipment (Notes 8 and 9) 340.2 316.4 Customers' Acceptance Liability 33.3 31.4 Trust Security Settlement Receivables 336.7 291.4 Other Assets (Note 18) 986.0 989.1 - -------------------------------------------------------------------------------- Total Assets $27,870.0 $25,315.4 - -------------------------------------------------------------------------------- Liabilities Deposits Demand and Other Noninterest-Bearing $ 3,927.5 $ 3,510.1 Savings and Money Market 4,614.7 4,278.9 Savings Certificates 2,175.0 2,092.6 Other Time 540.2 572.0 Foreign Offices-Demand 413.4 451.0 -Time 6,531.9 5,455.4 - -------------------------------------------------------------------------------- Total Deposits 18,202.7 16,360.0 Federal Funds Purchased 2,025.1 821.2 Securities Sold under Agreements to Repurchase (Note 4) 2,114.9 1,139.7 Commercial Paper 148.1 146.8 Other Borrowings 1,099.2 2,876.6 Senior Notes (Note 10) 700.0 785.0 Long-Term Debt (Note 10) 458.2 439.5 Debt-Floating Rate Capital Securities (Note 11) 267.4 267.4 Liability on Acceptances 33.3 31.4 Other Liabilities 880.8 708.8 - -------------------------------------------------------------------------------- Total Liabilities 25,929.7 23,576.4 - -------------------------------------------------------------------------------- Stockholders' Equity Preferred Stock (Note 12) 120.0 120.0 Common Stock, $1.66 2/3 Par Value; Authorized 280,000,000 shares in 1998 and 1997; Outstanding 111,214,740 shares and 111,367,436 shares in 1998 and 1997, respectively (Notes 12 and 14) 189.9 189.9 Capital Surplus 212.9 225.5 Retained Earnings 1,582.9 1,330.8 Net Unrealized Gain (Loss) on Securities Available for Sale (Note 3) (.6) 2.1 Common Stock Issuable-Performance Plan (Note 25) 30.4 11.7 Deferred Compensation-ESOP and Other (44.3) (37.5) Treasury Stock (at cost-2,746,022 shares in 1998 and 2,593,326 shares in 1997) (150.9) (103.5) - -------------------------------------------------------------------------------- Total Stockholders' Equity 1,940.3 1,739.0 - -------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $27,870.0 $25,315.4 - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements on pages 50-73. 46 NORTHERN TRUST CORPORATION CONSOLIDATED STATEMENT OF INCOME - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
For the Year Ended December 31 - -------------------------------------------------------------------------------- ($ In Millions Except Per Share Information) 1998 1997 1996 - -------------------------------------------------------------------------------- Noninterest Income Trust Fees $ 816.3 $ 689.2 $ 594.4 Foreign Exchange Trading Profits 103.5 104.8 58.8 Treasury Management Fees 69.9 60.2 55.3 Security Commissions and Trading Income 28.0 26.1 23.9 Other Operating Income (Note 16) 52.6 53.5 47.2 Investment Security Gains (Note 3) 1.3 .7 .4 - -------------------------------------------------------------------------------- Total Noninterest Income 1,071.6 934.5 780.0 - -------------------------------------------------------------------------------- Net Interest Income (Note 17) Interest Income 1,503.1 1,332.8 1,151.5 Interest Expense 1,025.9 894.6 763.2 - -------------------------------------------------------------------------------- Net Interest Income 477.2 438.2 388.3 Provision for Credit Losses (Note 6) 9.0 9.0 12.0 - -------------------------------------------------------------------------------- Net Interest Income after Provision for Credit Losses 468.2 429.2 376.3 - -------------------------------------------------------------------------------- Noninterest Expenses Compensation (Notes 25 and 26) 518.1 448.3 368.8 Employee Benefits (Note 19) 91.3 79.0 72.5 Occupancy Expense (Notes 8 and 9) 67.9 66.7 60.7 Equipment Expense (Note 8) 62.2 62.2 56.0 Other Operating Expenses (Note 18) 257.6 235.6 210.9 - -------------------------------------------------------------------------------- Total Noninterest Expenses 997.1 891.8 768.9 - -------------------------------------------------------------------------------- Income before Income Taxes 542.7 471.9 387.4 Provision for Income Taxes (Note 13) 188.8 162.5 128.6 - -------------------------------------------------------------------------------- Net Income $ 353.9 $ 309.4 $ 258.8 - -------------------------------------------------------------------------------- Net Income Applicable to Common Stock $ 349.0 $ 304.4 $ 253.9 - -------------------------------------------------------------------------------- Net Income Per Common Share (Note 14) -Basic $ 3.15 $ 2.74 $ 2.27 -Diluted 3.04 2.66 2.21 - -------------------------------------------------------------------------------- Average Number of Common Shares Outstanding -Basic 110,683,488 110,977,645 111,933,829 -Diluted 114,867,058 114,661,156 114,839,118 - -------------------------------------------------------------------------------- See accompanying notes to consolidated financial statements on pages 50-73. CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME For the Year Ended December 31 - -------------------------------------------------------------------------------- (In Millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Net Income $ 353.9 $ 309.4 $ 258.8 Other Comprehensive Income (before tax) Unrealized Gains (Losses) on Securities Available for Sale Unrealized Holding Gains (Losses) Arising during the Period (3.2) 1.3 (1.6) Less: Reclassification Adjustments for Gains Included in Net Income (1.0) (.5) (.1) Minimum Pension Liability Adjustment (5.7) (3.8) (1.4) Income Tax Benefit Related to Items of Other Comprehensive Income 3.7 1.1 1.2 - -------------------------------------------------------------------------------- Other Comprehensive Income (6.2) (1.9) (1.9) - -------------------------------------------------------------------------------- Comprehensive Income $ 347.7 $ 307.5 $ 256.9 - --------------------------------------------------------------------------------
This statement was adopted in 1998 in accordance with SFAS No. 130 "Reporting Comprehensive Income." 47 NORTHERN TRUST CORPORATION CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
For the Year Ended December 31 - ------------------------------------------------------------------------------- (In Millions) 1998 1997 1996 - ------------------------------------------------------------------------------- Preferred Stock Balance at January 1 $ 120.0 $ 120.0 $ 170.0 Conversion of Preferred Stock, Series E -- -- (50.0) - ------------------------------------------------------------------------------- Balance at December 31 120.0 120.0 120.0 - ------------------------------------------------------------------------------- Common Stock Balance at January 1 189.9 189.9 93.6 Conversion of Preferred Stock, Series E -- -- 1.3 Transfer from Capital Surplus-Two-for-One Stock Split -- -- 95.0 - ------------------------------------------------------------------------------- Balance at December 31 189.9 189.9 189.9 - ------------------------------------------------------------------------------- Capital Surplus Balance at January 1 225.5 231.7 306.1 Stock Issued-Incentive Plan and Awards (12.6) (6.2) (8.6) Conversion of Preferred Stock, Series E -- -- 29.2 Transfer to Common Stock-Two-for-One Stock Split -- -- (95.0) - ------------------------------------------------------------------------------- Balance at December 31 212.9 225.5 231.7 - ------------------------------------------------------------------------------- Retained Earnings Balance at January 1 1,330.8 1,110.2 928.8 Net Income 353.9 309.4 258.8 Dividends Declared-Common Stock (96.9) (83.8) (72.5) Dividends Declared-Preferred Stock (4.9) (5.0) (4.9) - ------------------------------------------------------------------------------- Balance at December 31 1,582.9 1,330.8 1,110.2 - ------------------------------------------------------------------------------- Net Unrealized Gain (Loss) on Securities Available for Sale Balance at January 1 2.1 1.6 2.6 Unrealized Gain (Loss), net (2.7) .5 (1.0) - ------------------------------------------------------------------------------- Balance at December 31 (.6) 2.1 1.6 - ------------------------------------------------------------------------------- Common Stock Issuable-Performance Plan Balance at January 1 11.7 10.4 14.7 Stock Issuable, net of Stock Issued 18.7 1.3 (4.3) - ------------------------------------------------------------------------------- Balance at December 31 30.4 11.7 10.4 - ------------------------------------------------------------------------------- Deferred Compensation-ESOP and Other Balance at January 1 (37.5) (35.5) (39.4) Compensation Deferred (18.3) (8.9) (2.7) Compensation Amortized 15.0 9.3 7.5 Unfunded Pension Liability, net (3.5) (2.4) (.9) - ------------------------------------------------------------------------------- Balance at December 31 (44.3) (37.5) (35.5) - ------------------------------------------------------------------------------- Treasury Stock Balance at January 1 (103.5) (84.2) (23.8) Stock Options and Awards 69.9 51.0 42.9 Stock Purchased (117.3) (70.3) (122.5) Conversion of Preferred Stock, Series E -- -- 19.2 - ------------------------------------------------------------------------------- Balance at December 31 (150.9) (103.5) (84.2) - ------------------------------------------------------------------------------- Total Stockholders' Equity at December 31 $1,940.3 $1,739.0 $1,544.1 - -------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements on pages 50-73. 48 NORTHERN TRUST CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
For the Year Ended December 31 - -------------------------------------------------------------------------------- (In Millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Cash Flows From Operating Activities: Net Income $ 353.9 $ 309.4 $ 258.8 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Credit Losses 9.0 9.0 12.0 Depreciation on Buildings and Equipment 52.4 49.3 46.8 (Increase) Decrease in Interest Receivable (23.0) (4.7) 17.7 Increase (Decrease) in Interest Payable (10.7) 20.6 9.4 Amortization and Accretion of Securities and Unearned Income (214.9) (190.0) (120.2) Amortization of Software, Goodwill and Other Intangibles 54.1 51.0 42.3 Deferred Income Tax 57.0 38.0 29.5 Net (Increase) Decrease in Trading Account Securities (.3) (4.0) 84.1 Other, net 153.4 (77.5) (32.4) - -------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 430.9 201.1 348.0 - -------------------------------------------------------------------------------- Cash Flows From Investing Activities: Net (Increase) Decrease in Federal Funds Sold and Securities Purchased under Agreements to Resell 1,827.3 (1,969.1) (860.5) Net Increase in Time Deposits with Banks (981.5) (223.2) (492.4) Net (Increase) Decrease in Other Interest- Bearing Assets 12.7 79.8 (59.8) Purchases of Securities--Held to Maturity (233.4) (162.6) (2,068.7) Proceeds from Maturity and Redemption of Securities--Held to Maturity 218.9 207.2 2,112.9 Purchases of Securities--Available for Sale (110,806.2) (75,308.5) (31,666.5) Proceeds from Sale, Maturity and Redemption of Securities--Available for Sale 109,456.3 76,121.5 32,611.3 Net Increase in Loans and Leases (1,147.7) (1,708.0) (1,066.5) Purchases of Buildings and Equipment (84.5) (57.5) (56.8) Proceeds from Sale of Buildings and Equipment 8.3 3.3 -- Net (Increase) Decrease in Trust Security Settlement Receivables (45.3) 70.9 (35.2) Decrease in Cash Due to Acquisitions (15.0) (53.0) (14.6) Other, net (1.7) (1.2) (10.6) - -------------------------------------------------------------------------------- Net Cash Used in Investing Activities (1,791.8) (3,000.4) (1,607.4) - -------------------------------------------------------------------------------- Cash Flows From Financing Activities: Net Increase in Deposits 1,842.7 2,563.8 1,308.0 Net Increase (Decrease) in Federal Funds Purchased 1,203.9 168.2 (1,647.1) Net Increase (Decrease) in Securities Sold under Agreements to Repurchase 975.2 173.6 (892.6) Net Increase (Decrease) in Commercial Paper 1.3 (2.2) 2.3 Net Increase (Decrease) in Short-Term Other Borrowings (1,770.8) (157.0) 2,273.2 Proceeds from Term Federal Funds Purchased 1,730.8 1,612.4 2,630.2 Repayments of Term Federal Funds Purchased (1,737.4) (1,720.9) (2,637.2) Proceeds from Senior Notes & Long-Term Debt 801.4 803.4 901.5 Repayments on Senior Notes & Long-Term Debt (867.7) (331.7) (520.3) Proceeds from Debt-Floating Rate Capital Securities -- 267.4 -- Treasury Stock Purchased (116.5) (66.2) (118.2) Net Proceeds from Stock Options 19.5 13.0 12.1 Cash Dividends Paid on Common and Preferred Stock (98.5) (85.3) (74.7) Other, net 4.1 7.2 5.8 - -------------------------------------------------------------------------------- Net Cash Provided by Financing Activities 1,988.0 3,245.7 1,243.0 - -------------------------------------------------------------------------------- Increase (Decrease) in Cash and Due from Banks 627.1 446.4 (16.4) Cash and Due from Banks at Beginning of Year 1,738.9 1,292.5 1,308.9 - -------------------------------------------------------------------------------- Cash and Due From Banks at End of Year $ 2,366.0 $ 1,738.9 $ 1,292.5 - -------------------------------------------------------------------------------- Schedule of Noncash Investing and Financing Activities: Building Purchase Obligation $ -- $ 20.0 $ -- Conversion of Preferred Stock, Series E to Common Stock -- -- 49.7 Supplemental Disclosures of Cash Flow Information: Interest Paid $ 1,036.6 $ 874.1 $ 753.8 Income Taxes Paid 128.0 102.5 82.7 - --------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements on pages 50-73. 49 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 1. ACCOUNTING POLICIES--The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and reporting practices prescribed for the banking industry. A description of the significant accounting policies follows: A. BASIS OF PRESENTATION. The consolidated financial statements include the accounts of Northern Trust Corporation (Corporation) and its wholly-owned subsidiary The Northern Trust Company (Bank) and their wholly-owned subsidiaries. Throughout the notes, the term "Northern Trust" refers to Northern Trust Corporation and subsidiaries. Significant intercompany balances and transactions have been eliminated in consolidation. The consolidated statement of income includes results of acquired and pooled subsidiaries from the dates of acquisition. B. NATURE OF OPERATIONS. The Corporation is a bank holding company whose principal subsidiary is the Chicago-based Bank. The Corporation also owns banks in Florida, Arizona, California, Texas and Colorado, a federal savings bank in Michigan, and various other nonbank subsidiaries, including a securities brokerage firm, registered investment advisers NTGA and NTQA and a retirement services company. Northern Trust generates the majority of its revenues from its two primary business units, Corporate and Institutional Services (C&IS) and Personal Financial Services (PFS). Investment products and services are provided to clients in C&IS and PFS through a third business unit, Northern Trust Global Investments (NTGI). The C&IS unit provides trust and custody-related services in the United States and foreign markets to corporations and institutions; investment management services; a full range of commercial banking services to large domestic corporations and financial institutions; treasury management services to meet the needs of major corporations and financial institutions; and foreign exchange services for global custody clients and Northern Trust's own account. The PFS unit provides personal trust, investment management, estate administration, personal banking and mortgage lending services, and also provides commercial banking services to middle market companies. These services are delivered through the Bank and the network of subsidiaries in Florida, Arizona, California, Texas, Colorado and Michigan. C. USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. D. FOREIGN CURRENCY TRANSLATION. Foreign currency asset and liability accounts of overseas branches and subsidiaries are translated at current rates of exchange, except for buildings and equipment which are translated at rates in effect at the date of acquisition. Income and expense accounts are translated at month-end rates of exchange. Foreign exchange trading positions are valued daily at prevailing market rates. Gains and losses on trading positions and on positions entered into to hedge foreign denominated investments are recognized currently in other operating income. Unrealized gains on trading positions are reported as other assets and unrealized losses are reported as other liabilities in the consolidated balance sheet. Gains and losses on foreign currency positions that were entered into to hedge specific, firm foreign currency obligations are deferred and recognized in income over the life of the underlying asset or liability or as the underlying expense or commitment is incurred. E. SECURITIES. Securities Available for Sale consist of debt and equity securities that are not intended to be held to maturity and are not held for trading. Securities available for sale are reported at fair value, with unrealized gains and losses credited or charged, net of the tax effect, directly to stockholders' equity. Realized gains and losses on securities available for sale are determined on a specific identification basis and are reported in the consolidated statement of income as investment security gains and losses. Securities Held to Maturity consist of debt securities that management intends to, and Northern Trust has the ability to, hold until maturity. Such securities are reported at cost, adjusted for amortization of premium and accretion of discount. Securities Held for Trading are stated at fair value. Realized and unrealized gains and losses on securities held for trading are reported in the consolidated statement of income under security commissions and trading income. F. INTEREST RISK MANAGEMENT INSTRUMENTS. Interest risk management instruments include interest rate swap contracts, futures contracts, options and similar contracts. Northern Trust is a party to various interest risk management instruments as part of its asset/liability management activities, to meet the interest risk management needs of its clients and as part of its trading activity for its own account. Unrealized gains and receivables on interest risk management instruments are reported as other assets and unrealized losses and payables are reported as other liabilities in the consolidated balance sheet. Asset/Liability Management Instruments. Interest rate swaps are the primary interest risk management instrument used for asset/liability management purposes 50 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Futures contracts, options, and similar contracts are also used for asset/liability management, but these contracts do not have a material impact on Northern Trust's financial condition or net income. Accrued interest income or expense on asset/liability management swaps is recognized as a component of the interest income or expense of the hedged items. Unrealized gains and losses on such swaps are recognized consistent with the method of accounting for the hedged items. For example, there is no recognition of unrealized gains and losses on swaps used to hedge items that are carried at their amortized cost. Unrealized gains and losses on interest rate swaps used to hedge available for sale securities are reported in stockholders' equity, net of applicable taxes. A swap that is classified in the asset/liability management category must be assigned to hedge a specific asset or liability and must reduce Northern Trust's interest rate risk. It must also achieve its intended objective of converting the yield on the hedged asset or liability to the desired rate. This criteria is assumed to have been met if the interest rate on the hedged asset or liability is identical to the offsetting interest rate on the swap. If the two rates are not identical, the correlation between the levels of the two rates since the inception of the swap must be measured to ensure that the swap is meeting its intended objective. In addition, the notional amount of the swap must be less than or equal to the par amount of the item being hedged. If a forward swap is entered into to hedge an anticipated transaction, the significant terms (e.g., the expected date, type of instrument, quantity, and maturity date) of the anticipated transaction must be identified, and it must be probable that the anticipated transaction will occur. If an asset/liability management swap is terminated or ceases to meet the criteria described above, any realized or unrealized gain or loss at the time is deferred and amortized over the remainder of the original hedge period. Any subsequent realized or unrealized gains or losses are reported as security commissions and trading income in the consolidated statement of income. If the item being hedged is sold, any deferred or unrealized gain or loss on the swap at the time of the transaction is considered in the calculation of the gain or loss on the sale. If the swap is not terminated, it must be marked to market on a prospective basis, with realized and unrealized gains and losses included in security commissions and trading income in the consolidated statement of income. Client-Related and Trading Instruments. Interest risk management instruments entered into to meet clients' interest risk management needs or for trading purposes are carried at fair value, with realized and unrealized gains and losses included in security commissions and trading income. G. LOANS AND LEASES. Loans that are held to maturity are reported at the principal amount outstanding, net of unearned income. Residential real estate loans classified as held for sale are reported at the lower of aggregate cost or market value. Interest income on loans is recorded on an accrual basis until, in the opinion of management, there is a question as to the ability of the debtor to meet the terms of the contract, or when interest or principal is more than 90 days past due and the loan is not well-secured and in the process of collection. At the time a loan is placed on nonaccrual status, interest accrued but not collected is reversed against interest income of the current period. Loans are returned to accrual status when factors indicating doubtful collectibility no longer exist. Interest collected on non-accrual loans is applied to principal unless, in the opinion of management, collectibility of principal is not in doubt. Premiums and discounts on loans are recognized as an adjustment of yield by the interest method based on the contractual terms of the loan. Commitment fees that are considered to be an adjustment to the loan yield, loan origination fees and certain direct costs are deferred and accounted for as an adjustment to the yield. Unearned lease income from direct financing and leveraged leases is recognized using the interest method. This method provides a constant rate of return on the unrecovered investment over the life of the lease. H. RESERVE FOR CREDIT LOSSES. The reserve for credit losses represents manage- ment's estimate of probable inherent losses which have occurred as of the date of the financial statements. The loan and lease portfolio and other credit ex- posures are regularly reviewed to evaluate the adequacy of the reserve for credit losses. In determining the level of the reserve, Northern Trust evalu- ates the reserve necessary for specific nonperforming loans and also estimates losses inherent in other credit exposures. The result is a reserve with these components: Specific Reserve. The amount of specific reserves is determined through a loan-by-loan analysis of nonperforming loans that considers expected future cash flows, the value of collateral and other factors that may impact the borrower's ability to pay. Allocated Inherent Reserve. The amount of the allocated portion of the inherent loss reserve is based on loss factors assigned to Northern Trust's credit exposures based on internal credit ratings. These loss factors are primarily based on management's judgment concerning the effect of the business cycle on the creditworthiness of Northern Trust's borrowers, as well as historical charge-off experience. Unallocated Inherent Reserve. Management determines the unallocated portion of the inherent loss reserve based on factors that cannot be associated with 51 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- a specific credit or loan categories. These factors include management's subjective evaluation of local and national economic and business conditions, portfolio concentration and changes in the character and size of the loan portfolio. The unallocated portion of the inherent loss reserve reflects management's attempt to ensure that the overall reserve appropriately reflects a margin for the imprecision necessarily inherent in estimates of expected credit losses. The continuous control process maintained by the Credit Policy Group and the lending staff and the quarterly analysis of specific and inherent loss components is the principal method relied upon by management to ensure that changes in estimated credit loss levels are adjusted on a timely basis. Management also considers the experience of peer institutions and regulatory guidance in addition to Northern Trust's own experience. Loans, leases and other extensions of credit deemed uncollectable are charged to the reserve. Subsequent recoveries, if any, are credited to the reserve. Actual losses may vary from current estimates and the amount of the provison may be either greater than or less than actual net charge-offs. The related provison for credit losses, which is charged to income, is the amount necessary to adjust the reserve to the level determined through the above process. I. MORTGAGE SERVICING RIGHTS. Mortgage servicing rights are capitalized as a separate asset when purchased or when acquired through the origination of mortgage loans that are subsequently sold with the servicing rights retained. The servicing rights are included in other assets and are amortized as an offset to other operating income over their estimated life. Servicing rights are evaluated for impairment based on their fair value. For purposes of measuring impairment, Northern Trust stratifies its servicing rights by loan type and interest rate. Fair value is determined considering market prices for similar assets. J. FEES ON STANDBY LETTERS OF CREDIT AND PARTICIPATIONS IN BANKERS ACCEPTANCES. Fees on standby letters of credit are recognized in other operating income on the straight-line method over the lives of the underlying agreements. Commissions on bankers acceptances are recognized in other operating income when received. K. BUILDINGS AND EQUIPMENT. Buildings and equipment owned are carried at original cost less accumulated depreciation. The charge for depreciation is computed on the straight-line method based on the following range of lives: buildings--10 to 30 years; equipment--4 to 10 years; and leasehold improve- ments--lease term to 15 years. Leased properties meeting certain criteria are capitalized and amortized using the straight-line method over the lease period. L. OTHER REAL ESTATE OWNED (OREO). OREO is comprised of commercial and residential real estate properties acquired in partial or total satisfaction of problem loans. OREO assets are carried at the lower of cost or fair value. Losses identified at the time of acquisition of such properties are charged against the reserve for credit losses. Subsequent write-downs that may be required to the carrying value of these assets and losses realized from asset sales are charged to other operating expenses. M. INTANGIBLE ASSETS. Goodwill, arising from the excess of purchase price over the fair value of net assets of acquired businesses, is being amortized using the straight-line method primarily over fifteen years. Other purchased intangible assets arising from acquisitions are amortized using various methods over the estimated lives of the assets. Software is being amortized using the straight-line method over the estimated useful life of the asset, ranging from 5 to 7 years. N. TRUST ASSETS AND FEES. Assets held in fiduciary or agency capacities are not included in the consolidated balance sheet, since such items are not assets of Northern Trust. Income from trust activities is recorded on the accrual basis. O. TRUST SECURITY SETTLEMENT RECEIVABLES. These receivables represent other items in the process of collection presented on behalf of trust clients. P. INCOME TAXES. In accordance with SFAS No. 109, "Accounting for Income Taxes," an asset and liability approach to accounting for income taxes is followed. The objective is to recognize the amount of taxes payable or refundable for the current year, and to recognize deferred tax assets and liabilities resulting from temporary differences between the amounts reported in the financial statements and the tax bases of assets and liabilities. The measurement of tax assets and liabilities is based on enacted tax laws and applicable tax rates. Q. CASH FLOW STATEMENTS. Cash and cash equivalents have been defined as "Cash and Due from Banks." 2. RECLASSIFICATIONS--Certain reclassifications have been made to prior periods' consolidated financial statements to place them on a basis comparable with the current period's consolidated financial statements. 3. SECURITIES--SECURITIES AVAILABLE FOR SALE. The following tables summarize the amortized cost, fair values and remaining maturities of securities available for sale. 52 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- RECONCILIATION OF AMORTIZED COST TO FAIR VALUES OF SECURITIES AVAILABLE FOR SALE - --------------------------------------------------------------------------------
December 31, 1998 - ----------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair (In Millions) Cost Gains Losses Value - ----------------------------------------------------------------------------- U.S. Government $ 259.0 $ 1.0 $ -- $ 260.0 Obligations of States and Political Subdivisions 256.2 9.9 -- 266.1 Federal Agency 4,697.5 1.0 3.1 4,695.4 Preferred Stock 135.0 .4 -- 135.4 Other 19.3 -- 1.0 18.3 - ----------------------------------------------------------------------------- Total $5,367.0 $12.3 $4.1 $5,375.2
Unrealized gains and losses on off-balance sheet financial instruments used to hedge available for sale securities totaled $2.3 million and $11.5 million, respectively, as of December 31, 1998. Unrealized gains on these hedges are reported as other assets in the consolidated balance sheet; unrealized losses are reported as other liabilities. As of December 31, 1998, stockholders' equity included a charge of $.6 million, net of the related tax benefit, to recognize the depreciation on securities available for sale, net of the related hedges.
December 31, 1997 - ----------------------------------------------------------------------------- Gross Gross Amortized Unrealized Unrealized Fair (In Millions) Cost Gains Losses Value - ----------------------------------------------------------------------------- U.S. Government $ 469.3 $ .9 $ .2 $ 470.0 Obligations of States and Political Subdivisions 123.5 6.7 -- 130.2 Federal Agency 2,969.0 1.7 .9 2,969.8 Preferred Stock 128.5 .4 .1 128.8 Other 35.2 -- .7 34.5 - ----------------------------------------------------------------------------- Total $3,725.5 $ 9.7 $1.9 $3,733.3
Unrealized gains and losses on off-balance sheet financial instruments used to hedge available for sale securities totaled $.1 million and $4.6 million, respectively, as of December 31, 1997. Unrealized gains on these hedges are reported as other assets in the consolidated balance sheet; unrealized losses are reported as other liabilities. As of December 31, 1997, stockholders' equity included a credit of $2.1 million, net of tax, to recognize the appreciation on securities available for sale, net of the related hedges. REMAINING MATURITY OF SECURITIES AVAILABLE FOR SALE - --------------------------------------------------------------------------------
December 31, 1998 - -------------------------------------------------------------------------------- Amortized Fair (In Millions) Cost Value - -------------------------------------------------------------------------------- Due in One Year or Less $4,647.2 $4,647.7 Due After One Year Through Five Years 324.3 323.6 Due After Five Years Through Ten Years 30.2 32.7 Due After Ten Years 365.3 371.2 - -------------------------------------------------------------------------------- Total $5,367.0 $5,375.2
Asset-backed and mortgage-backed securities were included in the above table taking into account anticipated future prepayments. SECURITIES HELD TO MATURITY. The following tables summarize the book values, fair values and remaining maturities of securities held to maturity. RECONCILIATION OF BOOK VALUES TO FAIR VALUES OF SECURITIES HELD TO MATURITY - --------------------------------------------------------------------------------
December 31, 1998 - ------------------------------------------------------------------------ Gross Gross Book Unrealized Unrealized Fair (In Millions) Value Gains Losses Value - ------------------------------------------------------------------------ U.S. Government $ 55.3 $ .1 $ -- $ 55.4 Obligations of States and Political Subdivisions 261.8 15.5 .1 277.2 Federal Agency 3.0 -- -- 3.0 Other 152.4 -- 2.3 150.1 - ------------------------------------------------------------------------ Total $472.5 $15.6 $2.4 $485.7 December 31, 1997 - ------------------------------------------------------------------------ Gross Gross Book Unrealized Unrealized Fair (In Millions) Value Gains Losses Value - ------------------------------------------------------------------------ U.S. Government $ 72.0 $ -- $ -- $ 72.0 Obligations of States and Political Subdivisions 276.7 18.4 -- 295.1 Federal Agency 14.3 -- -- 14.3 Other 93.1 -- 1.1 92.0 - ------------------------------------------------------------------------ Total $456.1 $18.4 $1.1 $473.4
REMAINING MATURITY OF SECURITIES HELD TO MATURITY - --------------------------------------------------------------------------------
December 31, 1998 - ------------------------------------------------------------------------------- Book Fair (In Millions) Value Value - ------------------------------------------------------------------------------- Due in One Year or Less $115.9 $117.4 Due After One Year Through Five Years 108.0 113.8 Due After Five Years Through Ten Years 100.1 104.4 Due After Ten Years 148.5 150.1 - ------------------------------------------------------------------------------- Total $472.5 $485.7
Mortgage-backed securities were included in the above table taking into account anticipated future prepayments. 53 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Refer to Note 21 for additional detail related to in terest risk management instruments used to hedge securities. INVESTMENT SECURITY GAINS AND LOSSES. Realized gross security gains, which were included in the consolidated statement of income, totaled $1.3 million in 1998. Of the $1.3 million of gains in 1998, $.3 million resulted when held to maturity and available for sale securities were called at a premium while $1.0 million resulted from the sale of securities classified as avail-able for sale. Realized gross security gains and losses totaled $1.2 million and $.5 million, respectively, in 1997. The $1.2 million in gains in 1997 resulted when held to maturity and available for sale securities were called at a premium. Realized gross security losses in 1997 resulted entirely from the sale of securities classified as available for sale. Realized gross security gains and losses in 1996 totaled $1.5 million and $1.1 million, respectively. 4. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL AND SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE--Securities purchased under agreements to resell and securities sold under agreements to repurchase are recorded at the amounts at which the securities were acquired or sold plus accrued interest. To minimize any potential credit risk associated with these transactions, the fair value of the securities purchased or sold is continuously monitored, limits are set on exposure with counterparties, and the financial condition of counterparties is regularly assessed. It is Northern Trust's policy to take possession of securities purchased under agreements to resell. The following tables summarize information related to securities purchased under agreements to resell and securities sold under agreements to repurchase. SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL - --------------------------------------------------------------------------------
December 31 - -------------------------------------------------------------------------------- ($ In Millions) 1998 1997 - -------------------------------------------------------------------------------- Average Balance During the Year $ 681.5 $ 356.3 Average Interest Rate Earned During the Year 5.43% 5.56% Maximum Month-End Balance During the Year 2,278.9 2,435.5
SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - --------------------------------------------------------------------------------
December 31 - -------------------------------------------------------------------------------- ($ In Millions) 1998 1997 - -------------------------------------------------------------------------------- Average Balance During the Year $1,506.0 $1,519.9 Average Interest Rate Paid During the Year 5.33% 5.38% Maximum Month-End Balance During the Year 4,136.0 3,708.9
5. LOANS AND LEASES--Amounts outstanding in selected loan categories are shown below.
December 31 - ------------------------------------------------------------------------------- (In Millions) 1998 1997 - ------------------------------------------------------------------------------- Domestic Residential Real Estate $ 5,885.2 $ 5,186.7 Commercial 3,937.9 3,734.8 Broker 147.6 170.1 Commercial Real Estate 677.1 582.1 Personal 1,463.4 1,207.2 Other 509.6 890.1 Lease Financing 528.3 347.0 - ------------------------------------------------------------------------------- Total Domestic 13,149.1 12,118.0 International 497.8 470.2 - ------------------------------------------------------------------------------- Total Loans and Leases $13,646.9 $12,588.2
Other domestic and international loans include $592.6 million at December 31, 1998, and $924.5 million at December 31, 1997 of overnight trust-related advances in connection with next day security settlements. Lease financing includes leveraged leases of $308.4 million at December 31, 1998, and $179.6 million at December 31, 1997. Residential real estate loans held for sale totaled $51.4 million and $39.7 million at December 31, 1998 and 1997, respectively. Refer to Note 21 for detail related to interest risk management instruments used to hedge loans. NONPERFORMING ASSETS. Presented below are outstanding amounts of nonaccrual loans, restructured loans and OREO.
December 31 - ------------------------------------------------------------------------------- (In Millions) 1998 1997 - ------------------------------------------------------------------------------- Nonaccrual Loans Domestic-Commercial Real Estate $ 2.9 $ 7.1 -Other 27.6 31.8 International -- -- - ------------------------------------------------------------------------------- Total Nonaccrual Loans 30.5 38.9 Restructured Loans 2.4 2.5 Other Real Estate Owned 2.3 1.9 - ------------------------------------------------------------------------------- Total Nonperforming Assets $35.2 $43.3
Included in nonperforming assets were loans with a recorded investment at December 31, 1998 and December 31, 1997 of $32.0 million and $38.3 million, respectively, which were also classified as impaired. At December 31, 1998 and December 31, 1997 impaired loans totaling $8.5 million and $7.9 million, respectively, had no portion of the reserve for credit losses specifically allocated to them, while $23.5 million at 54 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- December 31, 1998 had a specific allocated reserve of $5.9 million and $30.4 million at December 31, 1997 had a specific allocated reserve of $4.7 million. Total recorded investment in impaired loans averaged $29.9 million in 1998 and $34.4 million in 1997. Total interest income recognized on impaired loans was $120 thousand and $191 thousand in 1998 and 1997, respectively. There were $4.4 million of unfunded loan commitments and standby letters of credit issued to borrowers whose loans were classified as nonaccrual at December 31, 1998, while there were none at December 31, 1997. Interest income that would have been recorded on domestic nonaccrual loans in accordance with their original terms amounted to $3.2 million in 1998, $3.6 million in 1997 and $3.1 million in 1996, compared with amounts that were actually recorded of $.3 million, $.8 million and $.9 million, respectively. Write-downs and realized losses on OREO of $52 thousand in 1998 and $.4 million in each of the prior two years presented were charged to other operating expenses. 6. RESERVE FOR CREDIT LOSSES--Changes in the reserve for credit losses were as follows:
(In Millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Balance at Beginning of Year $147.6 $148.3 $147.1 - -------------------------------------------------------------------------------- Charge-Offs Domestic Commercial Real Estate (.3) (.7) (7.4) Other (11.5) (13.7) (8.0) International -- -- (.2) - -------------------------------------------------------------------------------- Total Charge-Offs (11.8) (14.4) (15.6) Recoveries 1.8 4.7 3.8 - -------------------------------------------------------------------------------- Net Charge-Offs (10.0) (9.7) (11.8) Provision for Credit Losses 9.0 9.0 12.0 Reserve Related to Acquisitions .2 -- 1.0 - -------------------------------------------------------------------------------- Balance at End of Year $146.8 $147.6 $148.3
7. MORTGAGE SERVICING RIGHTS--Servicing rights capitalized as a result of originating mortgage loans and selling the loans with the servicing rights retained totaled $2.2 million and $.7 million during 1998 and 1997, respectively. Amortization of the servicing rights totaled $1.0 million during 1998 and $94 thousand during 1997, resulting in carrying values of $2.1 million and $914 thousand as of December 31, 1998 and 1997, respectively. There were no valuation allowances established to record impairment of mortgage servicing rights during 1998 or 1997. 8. BUILDINGS AND EQUIPMENT--Summary of buildings and equipment is presented below.
December 31, 1998 - ------------------------------------------------------------------------------- Net Original Accumulated Book (In Millions) Cost Depreciation Value - -------------------------------------------------------------------------------- Land $ 37.9 $ -- $ 37.9 Buildings 100.3 37.2 63.1 Equipment 257.7 119.2 138.5 Leasehold Improvements 55.7 25.5 30.2 Buildings Leased under Capital Leases (Note 9) 86.6 16.1 70.5 - -------------------------------------------------------------------------------- Total Buildings and Equipment $538.2 $198.0 $340.2
December 31, 1997 - -------------------------------------------------------------------------------- Net Original Accumulated Book (In Millions) Cost Depreciation Value - -------------------------------------------------------------------------------- Land $ 39.1 $ -- $ 39.1 Buildings 102.2 35.8 66.4 Equipment 231.1 113.0 118.1 Leasehold Improvements 65.4 32.9 32.5 Buildings Leased under Capital Leases (Note 9) 74.1 13.8 60.3 - -------------------------------------------------------------------------------- Total Buildings and Equipment $511.9 $195.5 $316.4
The charge for depreciation amounted to $52.4 million in 1998, $49.3 million in 1997 and $46.8 million in 1996. 9. LEASE COMMITMENTS--At December 31, 1998, Northern Trust was obligated under a number of noncancellable operating leases for premises and equipment. Certain leases contain rent escalation clauses, based on market indices or increases in real estate taxes and other operating expenses and renewal option clauses calling for increased rentals. There are no restrictions imposed by any lease agreement regarding the payment of dividends, debt financing or Northern Trust entering into further lease agreements. Minimum annual lease commitments as of December 31, 1998, for all noncancellable operating leases are as follows:
Future Minimum (In Millions) Lease Payments - -------------------------------------------------------------------------------- 1999 $ 31.9 2000 31.2 2001 27.4 2002 24.4 2003 20.4 Later Years 108.8 - -------------------------------------------------------------------------------- Total Minimum Lease Payments $244.1
55 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Net rental expense for all operating leases is included in occupancy expense and amounted to $27.8 million in 1998, $27.4 million in 1997 and $24.0 million in 1996. The building and land utilized at the Chicago operations center has been leased under an agreement which qualifies as a capital lease. The long-term financing for the property was provided by the Corporation and the Bank. In the event of sale or refinancing, the Bank will receive all proceeds except for 58% of any proceeds in excess of the original project costs which will be paid to the lessor. In June 1997, the Bank entered into an agreement to purchase a building and adjacent land located across the street from the Chicago operations center for $23.5 million in January 2000. The building contains approximately 340,000 square feet of rentable office space. Prior to the purchase date, the Bank is leasing, in phases which began in 1997, approximately two floors of this six- story building. The present value of the land and building is reported in buildings and equipment, and the related purchase obligation appears in long- term debt in the consolidated balance sheet. The table below reflects the future minimum lease payments required under capital leases, net of any payments received on the long-term financing, and the present value of net capital lease obligations at December 31, 1998.
Future Minimum (In Millions) Lease Payments, Net - -------------------------------------------------------------------------------- 1999 $ 1.3 2000 1.4 2001 1.6 2002 1.6 2003 1.7 Later Years 11.4 - -------------------------------------------------------------------------------- Total Minimum Lease Payments, net 19.0 Less: Amount Representing Interest 7.8 - -------------------------------------------------------------------------------- Net Present Value under Capital Lease Obligations $11.2
10. SENIOR NOTES, LONG-TERM DEBT AND LINES OF CREDIT--SENIOR NOTES. Summary of Bank senior notes outstanding at December 31 is presented below.
($ In Millions) Rate 1998 1997 - -------------------------------------------------------------------------------- Due 1998 (a) (b) Fixed 5.75-6.29% $ -- $405.0 Floating 5.60-5.85 -- 380.0 Due 1999 (a) (b) Fixed 5.81 100.0 -- Floating 5.20-5.45 600.0 -- - -------------------------------------------------------------------------------- Total Bank Senior Notes $700.0 $785.0
Refer to bottom of next table for applicable notes. LONG-TERM DEBT. Summary of long-term debt outstanding at December 31 is presented below.
($ In Millions) 1998 1997 - -------------------------------------------------------------------------------- Corporation-Subordinated Debt 9.15% Notes due March 1998 (a) $ -- $ 10.0 9.20% Notes due March 1998 (a) -- 13.0 9.00% Notes due May 1998 (a) -- 50.0 9.20% Notes due May 2001 (a) 25.0 25.0 Bank-Subordinated Debt 6.50% Notes due May 2003 (a) 100.0 100.0 6.70% Notes due Sept. 2005 (a) (b) 100.0 100.0 7.30% Notes due Sept. 2006 (a) (b) 100.0 100.0 6.25% Notes due June 2008 (a) (b) 100.0 -- - -------------------------------------------------------------------------------- Subordinated Long-Term Debt $425.0 $398.0 - -------------------------------------------------------------------------------- Corporation-Other Long-Term Debt 8.23% ESOP Installment Notes with Final Payment due December 1998 (c) $ -- $ 9.5 Capital Lease Obligations (d) 11.2 11.4 Building Purchase Obligation (d) 22.0 20.6 - -------------------------------------------------------------------------------- Other Long-Term Debt $ 33.2 $ 41.5 - -------------------------------------------------------------------------------- Total Long-Term Debt $458.2 $439.5 - -------------------------------------------------------------------------------- Long-Term Debt Qualifying as Risk-Based Capital $390.0 $315.0
(a) Not redeemable prior to maturity. (b) Under the terms of its current Offering Circular, the Bank has the ability to offer from time to time its senior bank notes in an aggregate principal amount of up to $1.7 billion at any one time outstanding and up to an additional $300 million of subordinated notes. Each senior note will mature from 30 days to fifteen years and each subordinated note will mature from five years to fifteen years, following its date of original issuance. Each note will mature on such date as selected by the initial purchaser and agreed to by the Bank. (c) Notes were issued directly by the ESOP trust to finance the purchase of 8,640,000 common shares. The Corporation unconditionally guarantees the payment of principal, premium, if any, and interest. The interest rate is subject to adjustment in the event of certain tax law changes affecting ESOP plans. Refer to Note 19. (d) Refer to Note 9. Refer to Note 21 for detail related to interest risk management instruments used to hedge notes. LINES OF CREDIT. The Corporation currently maintains commercial paper back-up facility lines of credit with three banks totaling $50 million. The termination date is November 2001. The commitment fee is determined by a pricing matrix that is based on the long-term senior debt ratings of the Corporation. Currently, the annual fee is one-tenth of 1% of the commitment. There were no borrowings under commercial paper back-up facilities during 1998 or 1997. 56 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 11. DEBT--FLOATING RATE CAPITAL SECURITIES. The following table summarizes the book value of Floating Rate Capital Securities outstanding:
December 31 - ---------------------------------------------------------- (In Millions) 1998 1997 - ---------------------------------------------------------- $150 Million Series A due January 15, 2027 $148.6 $148.6 $120 Million Series B due April 15, 2027 118.8 118.8 - ---------------------------------------------------------- Total Debt-Floating Rate Capital Securities $267.4 $267.4
On January 16, 1997, the Corporation issued $150 million of Floating Rate Cap- ital Securities, Series A, through a statutory business trust wholly-owned by the Corporation ("NTC Capital I"). On April 25, 1997, the Corporation also is- sued, through a separate wholly-owned statutory business trust ("NTC Capital II"), $120 million of Floating Rate Capital Securities, Series B. The sole as- sets of the trusts are Subordinated Debentures of Northern Trust Corporation which have the same interest rates and maturity dates as the corresponding dis- tribution rates and redemption dates of the Floating Rate Capital Securities. The outstanding principal amounts of the Subordinated Debentures held by NTC Capital I and NTC Capital II are $154.6 million and $123.7 million, respective- ly. The Series A Securities were issued at a discount to yield 60.5 basis points above the three-month London Interbank Offered Rate (LIBOR), while the Series B Securities were issued at a discount to yield 67.9 basis points above the three-month LIBOR. Both Series A and B Securities qualify as tier 1 capital for regulatory purposes. The Corporation has fully, irrevocably and unconditionally guaranteed all payments due on such Capital Securities. The holders of the Capital Securities are entitled to receive preferential cumulative cash distributions quarterly in arrears (based on the liquidation amount of $1,000 per Capital Security) at an interest rate equal to the rate on the corresponding Subordinated Debentures. The interest rate on the Series A and Series B securities is equal to three- month LIBOR plus 0.52% and 0.59%, respectively. Subject to certain exceptions, the Corporation has the right to defer payment of interest on the Subordinated Debentures at any time or from time to time for a period not exceeding 20 consecutive quarterly periods provided that no extension period may extend beyond the stated maturity date. If interest is deferred on the Subordinated Debentures, distributions on the Capital Securities will also be deferred and the Corporation will not be permitted, subject to certain exceptions, to pay or declare any cash distributions with respect to the Corporation's capital stock or debt securities that rank the same as or junior to the Subordinated Debentures, until all past due distributions are paid. The Subordinated Debentures are unsecured and subordinated to substantially all of the Corporation's existing indebtedness. The Corporation has the right to redeem the Series A Subordinated Debentures on or after January 15, 2007 and the Series B Subordinated Debentures on or after April 15, 2007, in each case in whole or in part. In addition, the Corporation has the right to redeem the Subordinated Debentures held by either trust in whole but not in part at any time within 90 days following certain defined tax or regulatory capital treatment changes, at a price equal to the principal amount plus accrued and unpaid interest. 12. STOCKHOLDERS' EQUITY--PREFERRED STOCK. The Corporation is authorized to issue 10,000,000 shares of preferred stock without par value. The Board of Directors of the Corporation is authorized to fix the particular preferences, rights, qualifications and restrictions for each series of preferred stock issued. Summary of preferred stock outstanding is presented below.
December 31 - ---------------------------------------------------- (In Millions) 1998 1997 - ---------------------------------------------------- Auction Rate Preferred Stock Series C 600 shares @ $100,000 per share $ 60.0 $ 60.0 Flexible Auction Rate Cumulative Preferred Stock Series D 600 shares @ $100,000 per share 60.0 60.0 - ---------------------------------------------------- Total Preferred Stock $120.0 $120.0
SERIES C--In 1987, 600 shares of Auction Rate Preferred Stock Series C (APS) were issued, with a $100,000 per share stated value. Dividends on the shares of APS are cumulative. Rates are determined every 49 days by Dutch auction unless the Corporation fails to pay a dividend or redeem any shares for which it has given notice of redemption, in which case the dividend rate will be set at 175% of the 60-day "AA" Composite Commercial Paper Rate. The dividend rate in any auction will not exceed a percentage determined by the prevailing credit rating of the APS. The current maximum dividend rate is 120% of the 60-day "AA" Composite Commercial Paper Rate. No dividends other than dividends payable in junior stock, such as common stock, may be paid on common stock until full cumulative dividends on the APS have been paid. The average rate for this issue as declared during 1998 was 4.11%. The shares of APS are redeemable at the option of the Corporation, in whole or in part, on any Dividend Payment Date at $100,000 per share, plus accrued and unpaid dividends. SERIES D--In 1990, 600 shares of Flexible Auction Rate Cumulative Preferred Stock Series D (FAPS) were issued with a $100,000 per share stated value. Each dividend period contains 49 days (the "Short-Term Dividend Period") or a number of days greater than 49 days (as selected by the Term Selection Agent) which is divisible 57 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- by seven (the "Long-Term Dividend Period"). Rates for each dividend period are determined by Dutch auction unless the Corporation fails to pay the full amount of any dividend or redemption. The dividend rate in any auction will not exceed a percentage (currently 125%), determined by the prevailing credit rating of the FAPS, of the 60-day "AA" Composite Commercial Paper Rate or the Reference Rate, which rate is the Composite Commercial Paper Rate or the Treasury Rate, as appropriate for the length of each Short-Term or Long-Term Dividend Period, respectively. If the Corporation fails to pay the full amount of any dividend or redemption, each dividend period thereafter (until auctions are resumed) will be a Short-Term Dividend Period and the dividend rate will be 250% of the 60-day "AA" Composite Commercial Paper Rate; additional dividends will accrue for the balance of any Long-Term Dividend Period in which such a failure to pay occurs. No dividends other than dividends payable in junior stock, such as com- mon stock, may be paid on common stock until full cumulative dividends on the FAPS have been paid. The average rate for this issue as declared during 1998 was 4.13%. The shares of FAPS are redeemable at the option of the Corporation, in whole or in part, at $100,000 per share plus accrued and unpaid dividends. PREFERRED STOCK PURCHASE RIGHTS. In 1989, the Board of Directors of the Corporation declared a dividend distribution of one Preferred Stock Purchase Right on each outstanding share of the Corporation's common stock to the stockholders of record on October 31, 1989. The Rights are subject to anti- dilution provisions, and each Right is now exercisable for one-sixth of one- hundredth of a share of Series A Junior Participating Preferred Stock at an exercise price of $41.67 for each such fractional share. The Rights are evidenced by the common stock certificates and are not exercisable or transferable apart from the common stock until twenty days after a person or group acquires 15 percent or more of the Corporation's voting power or announces a tender or exchange offer which could result in ownership of 25 percent or more of the voting power. Shares of the Participating Preferred Stock purchasable upon exercise of the Rights will not be redeemable. In the event that a person or group acquires 25 percent or more of the Corporation voting power or if the Corporation merges or engages in certain self-dealing transactions with a 15 percent or more stockholder, each Right will entitle the holder, other than such person or group in certain circumstances, to purchase that number of shares of common stock of the Corporation or then shares of surviving company which at the time of the transaction would have a market value of twice the exercise price of the Right. The Rights do not have voting rights and are redeemable at the option of the Corporation at a price of one-sixth of one cent per Right either at the option of the Corporation at any time prior to the close of business on the 20th day following publication of the acquisition of 15 percent or more of the voting power by a person or group or automatically upon the occurence of any of certain events. Unless earlier redeemed, the Rights will expire on October 31, 1999. On July 21, 1998 the Board of Directors of the Corporation declared a dividend distribution of one new Preferred Stock Purchase Right for each outstanding share of the Corporation's common stock issuable to stockholders of record at the close of business on the earlier of October 31, 1999 or the date on which the rights issued under the 1989 Rights Agreement are exchanged or redeemed in accordance with the provisions of the 1989 Rights Agreement. Each new Right will be exercisable for one one-hundredth of a share of Series A Junior Participating Preferred Stock at an exercise price of $330.00, subject to adjustment. When issued, the new Rights will be evidenced by the common stock certificates and will not be exercisable or transferable apart from the common stock until twenty days after a person or group acquires 15 percent or more of the shares of common stock then outstanding or announces a tender or exchange offer which if consummated would result in ownership of 15 percent or more of the outstanding common stock. In the event that any person or group acquires 15 percent or more of the outstanding shares of common stock, each new Right will entitle the holder, other than such person or group, to purchase that number of shares of common stock of the Corporation having a market value of twice the exercise price of the new Right. At any time thereafter if the Corporation consummates a business combination transaction or sells substantially all of its assets, each new Right will entitle the holder, other than the person or group acquiring 15 percent or more of the outstanding shares of common stock, to purchase that number of shares of surviving company stock which at the time of the transaction would have a market value of twice the exercise price of the new Right. The new Rights will not have voting rights and will be redeemable at the option of the Corporation at a price of one cent per Right at any time prior to the close of business on the twentieth day following announcement by the Corporation of the acquisition of 15 percent or more of the outstanding common stock by a person or group. Unless earlier redeemed, the new Rights will expire on October 31, 2009. COMMON STOCK. Under the Corporation's current common stock buyback program, an additional 1.6 million shares may be purchased after December 31, 1998. 58 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- These shares may be repurchased from time to time in open market purchases, and the shares would be used primarily for management incentive plans and other corporate purposes. An analysis of changes in the number of shares of common stock outstanding follows:
1998 1997 1996 - ----------------------------------------------------------------- Balance at January 1 111,367,436 111,247,732 55,664,412 Distribution of Two-for- One Stock Split -- -- 55,664,412 Conversion of Preferred Stock, Series E -- -- 2,396,744 Employee Benefit Plans: Incentive Plan and Awards 302,677 315,147 377,086 Stock Options Exercised 1,170,840 1,214,310 1,242,034 Treasury Stock Purchases (1,626,213) (1,409,753) (4,096,956) - ----------------------------------------------------------------- Balance at December 31 111,214,740 111,367,436 111,247,732
Note: 1996 share activity reflects the December 1996 two-for-one stock split. 13. INCOME TAXES--The table below reconciles the total provision for income taxes recorded in the consolidated statement of income with the amounts computed at the statutory federal tax rate of 35%.
(In Millions) 1998 1997 1996 - --------------------------------------------------- Tax at Statutory Rate $189.9 $165.2 $135.6 Tax-Exempt Income (10.6) (10.7) (11.6) State Taxes, net 8.9 8.5 4.8 Other .6 (.5) (.2) - --------------------------------------------------- Provision for Income Taxes $188.8 $162.5 $128.6
The components of the consolidated provision for income taxes for each of the three years ended December 31, are as follows:
(In Millions) 1998 1997 1996 - ------------------------------------------------- Current Tax Provision: Federal $113.1 $102.4 $ 91.4 State 7.6 6.8 3.8 Foreign 11.1 15.3 3.9 - ------------------------------------------------- Total 131.8 124.5 99.1 - ------------------------------------------------- Deferred Tax Provision: Federal 51.0 31.7 26.0 State 6.0 6.3 3.5 - ------------------------------------------------- Total 57.0 38.0 29.5 - ------------------------------------------------- Provision for Income Taxes $188.8 $162.5 $128.6
In addition to the amounts shown in the above tables, tax liabilities or (benefits) have been recorded directly to stockholders' equity for the following items:
(In Millions) 1998 1997 - -------------------------------------------------------------------- Current Tax Benefit for Employee Stock Options and Other Employee Benefit Plans $(22.8) $(15.6) Deferred Tax Effect of Unrealized Security Gains (Losses) (1.6) .3 Deferred Tax Effect of Minimum Pension Liabilities (2.1) (1.4)
Deferred taxes result from temporary differences between the amounts reported in the consolidated financial statements and the tax bases of assets and liabilities. Deferred tax liabilities and assets have been computed as follows:
December 31 - ------------------------------------------------------------ (In Millions) 1998 1997 - ------------------------------------------------------------ Deferred Tax Liabilities: Lease Financing $173.9 $122.4 Software Development 48.4 39.3 Accumulated Depreciation 8.2 9.2 State Taxes, net 14.1 9.2 Other Liabilities 12.2 12.8 - ------------------------------------------------------------ Gross Deferred Tax Liabilities 256.8 192.9 - ------------------------------------------------------------ Deferred Tax Assets: Reserve for Credit Losses 51.1 51.2 Other Assets 26.9 16.3 - ------------------------------------------------------------ Gross Deferred Tax Assets 78.0 67.5 Valuation Reserve -- -- - ------------------------------------------------------------ Deferred Tax Assets, net of Valuation Reserve 78.0 67.5 - ------------------------------------------------------------ Net Deferred Tax Liabilities $178.8 $125.4
At December 31, 1998, Northern Trust had a federal net operating loss carryforward of $4.3 million resulting from business acquisitions, which is available to reduce future tax return liabilities. In addition, Northern Trust had state net operating loss and tax credit carryforwards of $19.8 million and $1.5 million, respectively. The carryforwards are subject to various limitations imposed by tax law. 59 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 14. NET INCOME PER COMMON SHARE COMPUTATIONS--The computation of net income per common share is presented below.
($ In Millions Except Per Share Information) 1998 1997 1996 - ------------------------------------------------------------------------------ Basic Net Income Per Common Share Net Income $353.9 $309.4 $258.8 Less: Dividends on Preferred Stock (4.9) (5.0) (4.9) - ------------------------------------------------------------------------------ Net Income Applicable to Common Stock $349.0 $304.4 $253.9 Average Number of Common Shares Outstanding 110,683,488 110,977,645 111,933,829 Basic Net Income Per Common Share $ 3.15 $ 2.74 $ 2.27 Diluted Net Income Per Common Share Net Income Applicable to Common Stock $349.0 $304.4 $253.9 - ------------------------------------------------------------------------------ Average Number of Common Shares Outstanding 110,683,488 110,977,645 111,933,829 Plus: Dilutive Potential Common Shares Stock Options 3,232,277 2,846,992 1,968,038 Performance Shares 614,984 579,737 611,072 Series E Convertible Preferred Stock -- -- 190,928 Other 336,309 256,782 135,251 - ------------------------------------------------------------------------------ Average Common and Potential Common Shares 114,867,058 114,661,156 114,839,118 - ------------------------------------------------------------------------------ Diluted Net Income Per Common Share $ 3.04 $ 2.66 $ 2.21
15. RESTRICTIONS ON SUBSIDIARY DIVIDENDS AND LOANS OR ADVANCES--Provisions of state and federal banking laws restrict the amount of dividends that can be paid to the Corporation by its banking subsidiaries. Under applicable state and federal laws, no dividends may be paid in an amount greater than the net profits then on hand, subject to other applicable provisions of law. In addition, prior approval from the relevant federal banking regulator is required if dividends declared by any of the Corporation's banking subsidiaries in any calendar year will exceed its net profits (as defined) for that year, combined with its retained net profits for the preceding two years. Based on these regulations, the Corporation's banking subsidiaries, without regulatory approval, could declare dividends during 1999 equal to their 1999 eligible net profits (as defined) plus $432.8 million. The ability of each banking subsidiary to pay dividends to the Corporation may be further restricted as a result of regulatory policies and guidelines relating to dividend payments and capital adequacy. State and federal laws limit the transfer of funds by a banking subsidiary to the Corporation and certain of its affiliates in the form of loans or extensions of credit, investments or purchases of assets. Transfers of this kind to the Corporation or a nonbanking subsidiary by a banking subsidiary are each limited to 10% of the banking subsidiary's capital and surplus with respect to each affiliate and to 20% in the aggregate, and are also subject to certain collateral requirements. These transactions, as well as other transactions between a banking subsidiary and the Corporation or its affiliates, must also be on terms substantially the same as, or at least as favorable as, those prevailing at the time for comparable transactions with non-affiliated companies or, in the absence of comparable transactions, on terms, or under circumstances, including credit standards, that would be offered to, or would apply to, non- affiliated companies. 16. OTHER OPERATING INCOME--Included in the 1997 results is $11.1 million resulting from settlements reached with Illinois banking regulators concerning the disposition of certain unclaimed balances accumulated over a number of years. In 1998, nonrecurring gains totaled $3.8 million. 60 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 17. NET INTEREST INCOME--The components of net interest income were as follows:
(In Millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Interest Income Loans and Leases $ 884.4 $ 793.1 $ 693.4 Securities--Taxable 383.1 332.0 325.1 --Non-Taxable 24.9 25.3 26.8 Time Deposits with Banks 155.0 133.5 84.9 Federal Funds Sold and Securities Purchased under Agreements to Resell and Other 55.7 48.9 21.3 - -------------------------------------------------------------------------------- Total Interest Income 1,503.1 1,332.8 1,151.5 - -------------------------------------------------------------------------------- Interest Expense Deposits 580.4 522.2 447.8 Federal Funds Purchased 139.8 92.4 97.9 Securities Sold under Agreements to Repurchase 80.2 81.7 103.4 Commercial Paper 8.0 7.9 7.8 Other Borrowings 132.3 112.4 64.5 Senior Notes 36.5 30.9 14.4 Long-Term Debt 31.8 32.6 27.4 Debt-Floating Rate Capital Securities 16.9 14.5 -- - -------------------------------------------------------------------------------- Total Interest Expense 1,025.9 894.6 763.2 - -------------------------------------------------------------------------------- Net Interest Income $ 477.2 $ 438.2 $ 388.3
18. OTHER OPERATING EXPENSES--The components of other operating expenses were as follows:
(In Millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Business Promotion $ 36.4 $ 32.0 $ 26.9 Outside Services Purchased 86.1 81.0 76.7 Telecommunications 15.4 13.2 11.4 Postage and Supplies 23.3 22.0 21.9 Software Amortization 40.0 41.1 32.6 Goodwill and Other Intangibles Amortization 14.1 9.9 9.7 Other Expense 42.3 36.4 31.7 - -------------------------------------------------------------------------------- Total Other Operating Expenses $257.6 $235.6 $210.9
Software, goodwill and other intangible assets are included in other assets in the consolidated balance sheet. Software totaled $172.8 million at December 31, 1998 and $145.1 million at December 31, 1997. Goodwill totaled $98.1 million at December 31, 1998 and $96.0 million at December 31, 1997. Other intangibles totaled $44.7 million at December 31, 1998 and $48.3 million at December 31, 1997. 19. EMPLOYEE BENEFITS--PENSION. A noncontributory qualified pension plan covers substantially all employees. Assets held by the plan consist primarily of listed stocks and corporate bonds. Northern Trust also maintains a noncontributory nonqualified pension plan for participants whose retirement benefit payments under the qualified plan are expected to exceed the limits imposed by federal tax law. Northern Trust has a nonqualified trust, referred to as a "Rabbi" Trust, to fund benefits in excess of those permitted in certain of its qualified plans. The primary purpose of the trust is to fund nonqualified retirement benefits. This arrangement offers certain officers a degree of assurance for payment of benefits in excess of those permitted in the related qualified plans. The assets remain subject to the claims of creditors and are not the property of the employees. Therefore, they are accounted for as corporate assets and are included in other assets in the consolidated balance sheet. 61 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The following tables set forth the status and the net periodic pension cost of the domestic qualified and nonqualified pension benefit plans for 1998 and 1997. Prior service costs and unrecognized net assets established at January 1, 1986 are being amortized on the straight-line basis over 13.2 years. PLAN STATUS
- -------------------------------------------------------------------------------- Nonqualified Qualified Plan Plan - ------------------------------------------------------------------------------- September 30 - ------------------------------------------------------------------------------- ($ In Millions) 1998 1997 1998 1997 - ------------------------------------------------------------------------------- Accumulated Benefit Obligation $189.5 $167.5 $ 23.8 $ 17.4 - ------------------------------------------------------------------------------- Projected Benefit 231.2 219.2 30.4 23.8 Plan Assets at Fair Value 284.0 288.2 -- -- - ------------------------------------------------------------------------------- Plan Assets In Excess of (Less Than) Projected Benefit Obligation 52.8 69.0 (30.4) (23.8) Unrecognized Net Asset (.9) (2.2) -- (.1) Unrecognized Net Loss 25.0 17.6 18.7 12.7 Unrecognized Prior Service Cost (Benefit) (6.7) (7.3) 1.6 2.0 Valuation Adjustment (.2) (.3) -- -- - ------------------------------------------------------------------------------- Prepaid (Accrued) Pension Cost at September 30 70.0 76.8 (10.1) (9.2) Net Expense October to December (1.7) (1.9) (1.0) (.2) Additional Minimum Liability at December 31 -- -- (12.6) (7.3) - ------------------------------------------------------------------------------- Prepaid (Accrued) Pension Cost at December 31 $ 68.3 $ 74.9 $(23.7) $(16.7) - ------------------------------------------------------------------------------- Assumptions: Discount Rates 7.00% 7.25% 6.00% 6.75% Rate of Increase in Compensation Level 5.40 5.90 5.40 5.90 Expected Long-Term Rate of Return on Assets 9.00 9.00 N/A N/A
NET PERIODIC PENSION COST - -------------------------------------------------------------------------------
Nonqualified Qualified Plan Plan - ------------------------------------------------------------------------------- (In Millions) 1998 1997 1998 1997 - ------------------------------------------------------------------------------- Service Cost $ 12.7 $ 10.6 $ 1.3 $ 1.1 Interest Cost 16.2 15.9 1.6 1.4 Expected Return on Plan Assets (22.8) (20.1) -- -- Amortization: Net Loss 2.6 3.0 1.0 .6 Transition Asset (1.4) (1.4) -- -- Prior Service Cost (Benefit) (.6) (.6) .4 .3 - ------------------------------------------------------------------------------- Net Periodic Pension Cost $ 6.7 $ 7.4 $ 4.3 $ 3.4
CHANGE IN BENEFIT OBLIGATION
- -------------------------------------------------------------------------------- Nonqualified Qualified Plan Plan - -------------------------------------------------------------------------------- (In Millions) 1998 1997 1998 1997 - -------------------------------------------------------------------------------- Beginning Balance $ 219.2 $ 206.1 $ 23.8 $ 19.4 Service Cost 12.7 10.6 1.3 1.1 Interest Cost 16.2 15.9 1.6 1.4 Actuarial Loss 2.6 3.8 6.9 4.7 Benefits Paid (19.5) (17.2) (3.2) (2.8) - -------------------------------------------------------------------------------- Ending Balance $ 231.2 $ 219.2 $ 30.4 $ 23.8
CHANGE IN QUALIFIED PLAN ASSETS
- -------------------------------------------------------------------------------- (In Millions) 1998 1997 - -------------------------------------------------------------------------------- Fair Value of Assets at Beginning of Plan Year $288.2 $229.0 Actual Return on Assets 15.2 56.9 Employer Contribution .1 19.5 Benefits Paid (19.5) (17.2) - -------------------------------------------------------------------------------- Fair Value of Assets at End of Plan Year $284.0 $288.2
Pension expense for 1996 was $7.4 million and $3.5 million for the qualified and nonqualified plans, respectively. Total assets in the "Rabbi" Trust related to the nonqualified pension plan at December 31, 1998 and 1997 amounted to $16.2 million and $14.3 million, respectively. A pension plan is also maintained for the London Branch employees. At December 31, 1998, the fair value of assets and the projected benefit obligation totaled approximately $13.7 million and $15.2 million, respectively. At December 31, 1997, the fair value of assets and the projected benefit obligation were $13.0 million and $11.0 million, respectively. Pension expense for 1998 and 1997 was $1.9 million and $1.4 million, respectively. THRIFT INCENTIVE PLAN. The Corporation and its subsidiaries have a defined contribution Thrift Incentive Plan covering substantially all employees. The corporate contribution is contingent upon the level of employee contribution and meeting a predefined earnings target for the year. The maximum corporate contribution was equal to 4% of an employee's salary. The estimated contribution to this plan is charged to employee benefits and totaled $10.4 million in 1998, $9.1 million in 1997 and $8.0 million in 1996. EMPLOYEE STOCK OWNERSHIP PLAN (ESOP). A leveraged ESOP in which substantially all employees of Northern Trust are eligible to participate was established in 1989. Of the original 9 million shares in the ESOP Trust, 7.6 million shares have been allocated as of December 31, 1998. The remaining ESOP shares are 62 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- being allocated over the three-year period ending December 31, 2001. The Corporation will make an additional contribution of $5.4 million in cash or shares of common stock in each of the years 2002 and 2003. Dividends paid on unallocated shares held in the ESOP Trust are used for debt service on the ESOP notes. Although the original debt used to purchase the ESOP shares has been repaid, a loan provided by the Corporation in 1996 to refinance a portion of the original debt will continue to be repaid through 2001. Compensation expense is accounted for based primarily on the amount of cash paid by Northern Trust to the ESOP for principal payments on the ESOP notes. The ESOP shares not yet allocated to individual accounts are treated as deferred compensation and accounted for as a reduction of stockholders' equity. The following table presents information related to the ESOP.
(In Millions) 1998 1997 - -------------------------------------------------------------------------------- Total ESOP Compensation Expense $3.4 $2.6 Interest Incurred on ESOP-Related Debt .6 1.3 Amount Contributed to ESOP-Related Debt 3.1 3.4 Dividends and Interest on Unallocated ESOP Shares Used for Debt Service 1.7 1.8
OTHER POSTRETIREMENT BENEFITS. Northern Trust maintains an unfunded postretirement health care plan. Employees retiring under the provisions of The Northern Trust Pension Plan who have attained 15 years of service are eligible for postretirement health care coverage. These benefits are provided either through an indemnity plan, subject to deductibles, co-payment provisions and other limitations or through health maintenance organizations. The provisions may be changed at the discretion of Northern Trust, which also reserves the right to terminate these benefits at any time. The following tables set forth the plan status at December 31 and the net periodic postretirement benefit cost of the domestic postretirement health care plan for 1998 and 1997. The transition obligation at January 1, 1993 is being amortized to expense over a twenty year period. PLAN STATUS
- -------------------------------------------------------------------------------- (In Millions) 1998 1997 - -------------------------------------------------------------------------------- Accumulated Postretirement Benefit Obligation (APBO) Measured at September 30: Retirees and Dependents $15.7 $15.0 Actives Eligible for Benefits 5.6 4.7 Actives Not Yet Eligible 10.2 8.7 - -------------------------------------------------------------------------------- Total APBO 31.5 28.4 Unamortized Transition Obligation (8.1) (8.7) Unrecognized Net Loss (4.4) (3.2) - -------------------------------------------------------------------------------- Net Postretirement Benefit Liability $19.0 $16.5
NET PERIODIC POSTRETIREMENT BENEFIT COST
- -------------------------------------------------------------------------------- (In Millions) 1998 1997 - -------------------------------------------------------------------------------- Service Cost $ .9 $ .9 Interest Cost 2.1 2.0 Amortization--Transition Obligation .6 .5 --Actuarial Loss -- .1 - -------------------------------------------------------------------------------- Net Periodic Postretirement Benefit Cost $ 3.6 $ 3.5
CHANGE IN POSTRETIREMENT BENEFIT OBLIGATION
- -------------------------------------------------------------------------------- (In Millions) 1998 1997 - -------------------------------------------------------------------------------- Beginning Balance $28.4 $33.3 Service Cost .9 .9 Interest Cost 2.1 2.0 Actuarial (Gain) Loss 1.2 (4.8) Benefits Paid (1.1) (.9) Plan Change -- (2.1) - -------------------------------------------------------------------------------- Ending Balance $31.5 $28.4
Postretirement health care expense for 1996 was $5.1 million. The weighted average discount rate used in determining the accumulated postretirement benefit obligation was 7.00% at December 31, 1998 and 7.25% at December 31, 1997. For measurement purposes, an 8.3% annual increase in the cost of covered health care benefits was assumed for 1999. This rate is assumed to decrease gradually to 5.5% in 2002 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing or decreasing the assumed health care trend rate by one percentage point in each year would have the following effect.
1--Percentage 1--Percentage Point Increase Point Decrease - -------------------------------------------------------------------------------- Effect on Total Service and Interest Cost Components $ .1 $ (.1) Effect on Postretirement Benefit Obligation 1.7 (1.5)
20. CONTINGENT LIABILITIES--Because of the nature of its activities, Northern Trust is subject to pending and threatened legal actions that arise in the normal course of business. In the judgment of management, after consultation with legal counsel, none of the litigation to which the Corporation or any of its subsidiaries is a party will have a material effect, either individually or in the aggregate, on the consolidated financial position or results of operations. 63 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 21. OFF-BALANCE SHEET FINANCIAL INSTRUMENTS--COMMITMENTS AND LETTERS OF CREDIT. Northern Trust, in the normal course of business, enters into various types of commitments and issues letters of credit to meet the liquidity and credit enhancement needs of its clients. Credit risk is the principal risk associated with these instruments. The contractual amounts of these instruments represent the credit risk should the instrument be fully drawn upon and the client default. To control the credit risk associated with entering into commitments and issuing letters of credit, Northern Trust subjects such activities to the same credit quality and monitoring controls as its lending activities. Commitments and letters of credit consist of the following: Legally Binding Commitments to Extend Credit generally have fixed expiration dates or other termination clauses. Since a significant portion of the commitments are expected to expire without being drawn upon, the total commitment amount does not necessarily represent future loans or liquidity requirements. Participations in Bankers Acceptances obligate Northern Trust, in the event of default by the counterparty, to reimburse the holder of the acceptance an amount equal to its participation in the acceptance. Commercial Letters of Credit are instruments issued by Northern Trust on behalf of its clients that authorize a third party (the beneficiary) to draw drafts up to a stipulated amount under the specified terms and conditions of the agreement. Commercial letters of credit are issued primarily to facilitate international trade. Standby Letters of Credit obligate Northern Trust to meet certain financial obligations of its clients, if, under the contractual terms of the agreement, the clients are unable to do so. These instruments are primarily issued to support public and private financial commitments, including commercial paper, bond financing, initial margin requirements on futures exchanges and similar transactions. The following table shows the contractual amounts of commitments and letters of credit. COMMITMENTS AND LETTERS OF CREDIT - -------------------------------------------------------------------------------- December 31 - -------------------------------------------------------------------------------- (In Millions) 1998 1997 - -------------------------------------------------------------------------------- Legally Binding Commitments to Extend Credit $13,409.1 $11,946.6 Participations in Bankers Acceptances -- 7.8 Commercial Letters of Credit 94.2 98.6 Standby Letters of Credit: Corporate 359.8 401.9 Industrial Revenue 893.4 843.0 Other 380.3 298.3 - -------------------------------------------------------------------------------- Total Standby Letters of Credit* $ 1,633.5 $ 1,543.2 *These amounts include $156.6 million and $199.1 million of standby letters of credit secured by cash deposits or participated to others as of December 31, 1998 and 1997, respectively. The weighted average maturity of standby letters of credit was 21 months at December 31, 1998 and 24 months at December 31, 1997. RISK MANAGEMENT INSTRUMENTS. These instruments include foreign exchange contracts, foreign currency futures contracts, and various interest risk management instruments. Northern Trust is a party to various risk management instruments that are used in the normal course of business to meet the risk management needs of its clients; as part of its trading activity for its own account; and as part of its asset/liability management activities. The major risk associated with these instruments is that interest or foreign exchange rates could change in an unanticipated manner, resulting in higher interest costs or a loss in the underlying value of the instrument. These risks are mitigated by establishing limits for risk management positions, monitoring the level of actual positions taken against such established limits, monitoring the level of any interest rate sensitivity gaps created by such positions, and by using hedging techniques. When establishing position limits, market liquidity and volatility, as well as experience in each market, are all taken into account. The estimated credit risk associated with these instruments relates to the failure of the counterparty to pay based on the contractual terms of the agreement, and is generally limited to the gross unrealized market value gains on these instruments. The amount of credit risk will increase or decrease during the lives of the instruments as interest and foreign exchange rates fluctuate. This risk is controlled by limiting such activity to an approved list of counterparties and by subjecting such activity to the same credit and quality controls as are followed in lending and investment activities. 64 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Risk management instruments include: Foreign Exchange Contracts are agreements to exchange specific amounts of currencies at a future date, at a specified rate of exchange. Foreign exchange contracts are entered into primarily to meet the foreign exchange risk management needs of clients. Foreign exchange contracts are also used for trading purposes and asset/liability management. Foreign Currency and Interest Rate Futures Contracts are agreements for delayed delivery of foreign currency, securities or money market instruments in which the buyer agrees to take delivery at a specified future date of a specified currency, security, or instrument, at a specified price or yield. All of Northern Trust's futures contracts are traded on organized exchanges that require the daily settlement of changes in the value of the contracts. Futures contracts are utilized in trading activities and asset/liability management to limit Northern Trust's exposure to unfavorable fluctuations in foreign exchange rates or interest rates. Interest Rate Protection Contracts are agreements which enable clients to transfer, modify or reduce their interest rate risk. As a seller of interest rate protection, Northern Trust receives a fee at the outset of the agreement and then assumes the risk of an unfavorable change in interest rates. Northern Trust also purchases interest rate protection contracts for asset/liability management. Interest Rate Swap Contracts involve the exchange of fixed and floating rate interest payment obligations without the exchange of the underlying principal amounts; these types of transactions constitute the majority of the interest rate swap portfolio. Forward Sale Contracts represent commitments to sell a specified amount of securities at an agreed upon date and price. Northern Trust utilizes forward sale contracts principally in connection with its sale of mortgage loans. Exchange-Traded Option Contracts grant the buyer the right, but not the obligation, to purchase or sell at a specified price, a stated number of units of an underlying financial instrument, at a future date. The following table shows the contractual/notional amounts of risk management instruments. The notional amounts of risk management instruments do not represent credit risk, and are not recorded in the consolidated balance sheet. They are used merely to express the volume of this activity. RISK MANAGEMENT INSTRUMENTS - --------------------------------------------------------------------------------
Contractual/Notional Amounts December 31 - --------------------------------------------------------------------- (In Millions) 1998 1997 - --------------------------------------------------------------------- Asset/Liability Management: Foreign Exchange Contracts $ 139.7 $ 155.8 Foreign Currency Futures Contracts -- 4.0 Interest Rate Futures Contracts Sold 1.0 -- Interest Rate Protection Contracts Purchased 130.0 85.0 Interest Rate Swap Contracts 2,274.1 2,812.7 Forward Sale Contracts 96.7 50.9 Client-Related and Trading: Foreign Exchange Contracts 13,958.9 16,193.1 Interest Rate Futures Contracts Purchased 100.0 -- Interest Rate Futures Contracts Sold 100.0 10.0 Interest Rate Protection Contracts-Purchased 36.0 13.8 -Sold 42.6 24.9 Interest Rate Swap Contracts 40.1 63.5
RISK MANAGEMENT INSTRUMENTS USED FOR ASSET/LIABILITY MANAGEMENT. Northern Trust utilizes various types of risk management instruments, primarily interest rate swaps, as tools for managing interest rate and option risk related to its own balance sheet. The following table summarizes the expected maturities and weighted average interest rates to be paid and received on the asset/liability management swap portfolio at December 31, 1998. A key assumption in the preparation of the table is that floating rates remain constant at December 31, 1998 levels. REMAINING MATURITY OF ASSET/LIABILITY MANAGEMENT INTEREST RATE SWAPS - --------------------------------------------------------------------------------
($ In Millions) 1999 2000 2001 2002 2003 2004-2008 Total - ----------------------------------------------------------------------------- Pay Fixed Notional Amount $186.5 439.1 206.7 259.2 349.4 518.2 $1,959.1 Average Pay Rate 6.56% 5.46 6.89 5.67 6.83 6.35 6.22% Average Receive Rate 5.42 5.34 5.38 4.50 5.40 5.31 5.24 - ----------------------------------------------------------------------------- Receive Fixed Notional Amount $100.0 15.0 -- -- 100.0 -- $ 215.0 Average Pay Rate 5.07% 5.34 -- -- 5.27 -- 5.18% Average Receive Rate 5.81 5.99 -- -- 6.31 -- 6.06 - ----------------------------------------------------------------------------- Pay and Receive Variable (Basis Swaps) Notional Amount $100.0 -- -- -- -- -- $ 100.0 Average Pay Rate 5.22% -- -- -- -- -- 5.22% Average Receive Rate 4.96 -- -- -- -- -- 4.96
65 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Some of the principal uses of risk management instruments, together with the notional amounts outstanding, are described as follows: Convert Yields on Securities to an Effective LIBOR Rate. At December 31, 1998, interest rate swaps with a notional amount of $459 million were used to convert fixed and floating rate interest payments on securities (classified as available for sale) to floating rate payments indexed to LIBOR. Reduce Interest Rate Risk From Fixed Rate Loans Funded with Variable Rate Liabilities. Northern Trust paid a fixed rate and received a floating rate on interest rate swaps with a notional amount of $1.4 billion at December 31, 1998 to hedge the interest rate risk from fixed rate loans. For accounting purposes these swaps were designated to either convert the fixed rate on the loan to an effective floating rate or to convert floating rate funding to a fixed rate. Interest rate floors with a notional amount of $130 million at December 31, 1998 were used to hedge mortgage loan prepayment risk. Swaps Combined with Liabilities to Obtain Favorable Funding Costs. Interest rate swaps with a notional amount of $400 million at December 31, 1998 were used in conjunction with the issuance of senior notes and subordinated notes to obtain desired funding characteristics. Of these swaps, $200 million converted fixed rate notes to floating rate funding indexed to LIBOR, $100 million converted floating rate notes to a different floating rate index, and $100 million converted a floating rate note to a fixed rate. The use of swaps in combination with notes permitted Northern Trust to issue notes with rate and maturity features that were most desired by investors while converting the rate characteristics to meet its needs. Hedging Foreign Currency Risk. Forward foreign exchange contracts and foreign currency futures contracts were used to reduce exposure to fluctuations in the dollar value of capital investments in foreign subsidiaries and from foreign currency assets and obligations. The notional amounts of these contracts at year-end 1998 were $139.7 million of forward foreign exchange contracts. Hedging Mortgages Held for Sale. Northern Trust hedges the market risk of its portfolio of fixed rate commitments and mortgages held for sale with a combination of derivative financial instruments. At December 31, 1998 the portfolio was hedged with $96.7 million of forward sales of mortgage-backed securities. Deferred gains related to interest risk management instruments used for asset/liability management and included in the consolidated balance sheet at year-end 1998 totaled $.6 million. There were no deferred gains or losses at year-end 1997. CLIENT AND TRADING-RELATED INTEREST RISK MANAGEMENT INSTRUMENTS. Net revenue associated with client and trading-related interest risk management activities totaled $.2 million, $.3 million, and $.3 million during 1998, 1997, and 1996, respectively. The majority of these revenues are related to interest rate swaps, futures contracts, and interest rate protection agreements, and are reported as trading income in the consolidated statement of income. OTHER OFF-BALANCE SHEET FINANCIAL INSTRUMENTS. As part of securities custody activities and at the direction of trust clients, Northern Trust lends securities owned by clients to borrowers who are reviewed by the Credit Policy Credit Approval Committee. In connection with these activities, Northern Trust has issued certain indemnifications against loss resulting from the bankruptcy of the borrower of securities. The borrowing party is required to fully collateralize securities received with cash, marketable securities, or irrevocable standby letters of credit. As securities are loaned, collateral is maintained at a minimum of 100 percent of the fair value of the securities plus accrued interest, with revaluation of the collateral on a daily basis. The amount of securities loaned as of December 31, 1998 and 1997 subject to indemnification was $28.5 billion and $29.5 billion, respectively. Because of the requirement to fully collateralize securities borrowed, management believes that the exposure to credit loss from this activity is remote. The Bank is a participating member of various cash and securities clearing organizations such as The Depository Trust Company in New York. It participates in these organizations on behalf of its clients and on behalf of itself as a result of its own investment and trading activities. A wide variety of securities transactions are settled through these organizations, including those involving obligations of states and political subdivisions, asset-backed securities, commercial paper, Eurodollars and securities issued by the Government National Mortgage Association. As a result of its participation in cash and securities clearing organizations, the Bank could be responsible for a pro rata share of certain credit-related losses arising out of the clearing activities. The method in which such losses would be shared by the clearing members is stipulated in each clearing organization's membership agreement. Credit exposure related to these agreements varies from day to day, primarily as a result of fluctuations in the volume of transactions cleared through the organizations. The estimated credit exposure at December 31, 1998 and 1997 was $72 million and $73 million, respectively, based on the clearing volume for those days. Controls related to these clearing transactions are closely monitored to protect the assets of Northern Trust. 66 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 22. FAIR VALUE OF FINANCIAL INSTRUMENTS--SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," requires disclosure of the estimated fair value of certain financial instruments. Considerable judgment is required to interpret market data when computing estimates of fair value. Accordingly, the estimates presented are not necessarily indicative of the amounts Northern Trust could have realized in a market exchange. The information provided below should not be interpreted as an estimate of the fair value of Northern Trust since the disclosures, in accordance with SFAS No. 107, exclude the values of nonfinancial assets and liabilities, as well as a wide range of franchise, relationship, and intangible values, which are integral to a full assessment of the consolidated financial position. The use of different assumptions and/or estimation methods may have a material effect on the computation of estimated fair values. Therefore, comparisons between Northern Trust's disclosures and those of other financial institutions may not be meaningful. The following methods and assumptions were used in estimating the fair values of the financial instruments: Securities. Fair values of securities were based on quoted market values, when available. If quoted market values were not available, fair values were based on quoted market values for comparable instruments. Loans (not including lease financing receivables). The fair values of one- to-four family residential mortgages were based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. The fair values of the remainder of the loan portfolio were estimated using a discounted cash flow method in which the discount rate used was the rate at which Northern Trust would have originated the loan had it been originated as of the financial statement date, giving effect to current economic conditions on loan collectibility. Savings Certificates, Other Time and Foreign Offices Time Deposits. The fair values of these instruments were estimated using a discounted cash flow method that incorporated market interest rates. Senior Notes, Long-Term Debt, and Floating Rate Capital Securities. Fair values were based on quoted market prices, when available. If quoted market prices were not available, fair values were based on quoted market prices for comparable instruments. Off-Balance Sheet Financial Instruments. The fair values of commitments and letters of credit represent the amount of unamortized fees on these instruments. The fair values of all other off-balance sheet financial instruments were estimated using market prices, pricing models, or quoted market prices of financial instruments with similar characteristics. Financial Instruments Valued at Carrying Value. Due to their short maturity, the respective carrying values of certain on-balance sheet financial instru- ments approximated their fair values. These financial instruments include cash and due from banks; money market assets; customers' acceptance liability; trust security settlement receivables; federal funds purchased; securities sold under agreements to repurchase; commercial paper; other borrowings; and liability on acceptances. The fair values required to be disclosed for demand, savings, and money market deposits pursuant to SFAS No. 107 must equal the amounts disclosed in the consolidated balance sheet. Fair Values of On-Balance Sheet Financial Instruments. The following table summarizes the fair values of on-balance sheet financial instruments.
December 31 - ------------------------------------------------------------------------------ 1998 1997 - ------------------------------------------------------------------------------ Book Fair Book Fair (In Millions) Value Value Value Value - ------------------------------------------------------------------------------ Assets Cash and Due From Banks $2,366.0 $2,366.0 $ 1,738.9 $ 1,738.9 Money Market Assets 4,450.9 4,450.9 5,309.4 5,309.4 Securities: Available for Sale 5,375.2 5,375.2 3,733.3 3,733.3 Held to Maturity 472.5 485.7 456.1 473.4 Trading Account 9.1 9.1 8.8 8.8 Loans (excluding leases), net of credit loss reserve: Held to Maturity 12,920.4 13,072.5 12,053.9 12,114.9 Held for Sale 51.4 51.6 39.7 40.0 Acceptance Liability 33.3 33.3 31.4 31.4 Trust Security Settlement Receivables 336.7 336.7 291.4 291.4 Liabilities Deposits: Demand, Savings and Money Market 8,955.6 8,955.6 8,240.0 8,240.0 Savings Certificates, Other Time and Foreign Offices Time 9,247.1 9,267.7 8,120.0 8,138.1 Federal Funds Purchased 2,025.1 2,025.1 821.2 821.2 Repurchase Agreements 2,114.9 2,114.9 1,139.7 1,139.7 Commercial Paper 148.1 148.1 146.8 146.8 Other Borrowings 1,099.2 1,099.2 2,876.6 2,876.6 Senior Notes 700.0 699.8 785.0 784.9 Long-Term Debt 458.2 482.3 439.5 450.4 Debt-Floating Rate Capital Securities 267.4 295.2 267.4 267.7 Liability on Acceptances 33.3 33.3 31.4 31.4
67 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Fair Values of Off-Balance Sheet Financial Instruments. The following tables summarize the fair values of off-balance sheet financial instruments.
December 31 - ------------------------------------------------------------- 1998 1997 - ------------------------------------------------------------- Book Fair Book Fair (In Millions) Value Value Value Value - ------------------------------------------------------------- Commitments and Letters of Credit: Loan Commitments $ .5 $ .5 $ 2.1 $ 2.1 Letters of Credit 1.3 1.3 1.0 1.0 Asset/Liability Management: Foreign Exchange Contracts Assets 1.2 1.2 1.9 1.9 Liabilities .5 .5 1.7 1.7 Interest Rate Swap Contracts Assets 6.5 10.2 13.1 15.1 Liabilities 14.5 72.7 8.2 39.9 Other Financial Instruments Assets .4 1.3 .3 .4 Liabilities -- -- .4 .4
Fair Value - ------------------------------------------------------------- (In Millions) 1998 1997 - ------------------------------------------------------------- Client-Related and Trading:* Foreign Exchange Contracts Assets $179.2 $215.9 Liabilities 175.0 214.7 Interest Rate Swap Contracts Assets .9 .7 Liabilities .8 .6
*Assets and liabilities associated with foreign exchange contracts averaged $191.0 million and $157.0 million, respectively, during 1998. Assets and liabilities associated with other client-related and trading account instruments averaged $1.5 million and $.6 million, respectively, during 1998. 23. CONCENTRATIONS OF CREDIT RISK--The information in the section titled Loans and Other Extensions of Credit found on pages 35 through 37 is incorporated by reference. 24. PLEDGED AND RESTRICTED ASSETS--Certain of Northern Trust's subsidiaries, as required or permitted by law, pledge assets to secure public and trust depos- its, repurchase agreements and for other purposes. On December 31, 1998, secu- rities and loans totaling $5.6 billion ($4.6 billion of U.S. Government and agency securities, $484 million of obligations of states and political subdivi- sions and $479 million of loans and other securities), were pledged. Collateral required for these purposes totaled $4.2 billion. Deposits maintained at the Federal Reserve Bank to meet reserve requirements averaged $276.3 million in 1998 and $258.9 million in 1997. 25. STOCK-BASED COMPENSATION PLANS--Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation," establishes financial accounting and reporting standards for stock-based compensation plans. SFAS No. 123 allows two alternative accounting methods: (1) a fair-value- based method, or (2) an intrinsic-value-based method which is prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations. Northern Trust has elected to account for its stock-based incentive plans and awards under APB 25, and has adopted the disclosure requirements of SFAS No. 123. A description of Northern Trust's stock-based compensation is presented below. AMENDED INCENTIVE STOCK PLAN--AMENDED 1992 INCENTIVE STOCK PLAN (PLANS). The Amended Incentive Stock Plan was superseded by the Amended 1992 Incentive Stock Plan and terminated on December 31, 1994. Outstanding grants and awards under the Amended Incentive Stock Plan will remain in effect in accordance with their terms, but no further grants or awards will be made. The Amended 1992 Incentive Stock Plan (Plan) was adopted in 1992 and has been amended on several occasions. The Plan is administered by the Compensation and Benefits Committee (Committee) of the Board of Directors. Directors and key officers of the Corporation or its subsidiaries are eligible to receive awards under the Plan. Awards under the Plan may be granted in any one or a combination of (a) incentive stock options and non-qualified stock options, (b) stock appreciation rights, (c) stock awards, (d) performance shares, and (e) stock equivalents. The total number of shares of the Corporation's common stock authorized for distribution under the Plan is 16,000,000. As of December 31, 1998, shares available for future grants under the Plan totaled 5,666,033. Stock Options. Stock options consist of options to purchase common stock at purchase prices not less than 100% of the fair market value thereof on the date the option is granted. Options have a maximum ten year life and will vest and become exercisable in six months to two years after the date of grant. In addition, the Plan provides that all options may become exercisable upon a change of control as defined in the Plan. All options terminate at such time as determined by the Committee and as provided in the terms and conditions of the respective option grants. 68 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- A summary of the status of stock options under the Plans at December 31, 1998, 1997 and 1996 and changes during the years then ended is presented in the table below.
1998 1997 1996 - ------------------------------------------------------------------------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price - ------------------------------------------------------------------------------------ Options Outstanding, January 1 7,444,402 $26.72 7,494,612 $19.96 7,468,946 $16.52 Granted ($64.50 to $80.19 per share in 1998) 1,336,150 69.44 1,178,500 56.63 1,315,700 33.16 Exercised ($6.96 to $56.63 per share in 1998) (1,170,840) 17.18 (1,214,310) 14.00 (1,242,034) 13.18 Cancelled (35,500) 43.51 (14,400) 27.67 (48,000) 21.77 - ------------------------------------------------------------------------------------ Options Outstanding December 31 ($8.42 to $80.19 per share) 7,574,212 $35.66 7,444,402 $26.72 7,494,612 $19.96 - ------------------------------------------------------------------------------------ Options Exercisable, December 31 5,102,562 $22.23 4,958,202 $17.92 4,961,312 $15.62
The following is a summary of outstanding and exercisable options under the Plans at December 31, 1998.
Options Outstanding - --------------------------------------------------------------------------- Weighted Average Weighted Remaining Average Number Contractual Exercise Outstanding Exercisable Life Price - --------------------------------------------------------------------------- $8.42 to $15.50 per share 1,021,100 1,021,100 1.8 Years $12.00 $18.63 to $33.50 per share 4,056,462 4,056,462 6.0 Years 24.49 $56.63 to $80.19 per share 2,496,650 25,000 9.2 Years 63.49
Stock Awards. Under the Plans, stock awards or equivalents can be awarded by the Committee to participants which entitle them to receive a payment in cash or Northern Trust Corporation common stock based on such terms and conditions as the Committee deems appropriate. Total expense applicable to stock awards was $2.1 million in 1998, $.9 million in 1997 and $.5 million in 1996. In 1998, 1997 and 1996, 65,000 shares, 49,750 shares and 12,000 shares, respectively, of restricted stock were awarded with a weighted average grant-date fair value of $73.21, $56.63 and $26.78, respectively. As of December 31, 1998, restricted stock awards outstanding totaled 208,250 shares. These shares vest, subject to continuing employment, over a period of five to nine years. Performance Shares. Under the performance share provisions of the Plans, participants will be entitled to have each award credited to an account maintained for them if established performance goals are achieved with distribution after vesting. The value of shares earned but not yet distributed under the Plan is credited to performance share accounts and is shown in stockholders' equity as Common Stock Issuable-Performance Plan. Total salary expense for performance shares was $23.6 million in 1998, $20.5 million in 1997 and $9.7 million in 1996. In 1998, 1997 and 1996, 319,500 shares, 312,000 shares and 331,000 shares, respectively, were granted with a weighted average grant-date fair value of $72.00, $44.25 and $26.88, respectively. As of December 31, 1998, 574,143 shares of stock had been credited to performance share accounts subject to meeting vesting conditions and 953,866 shares had been granted, subject to meeting established performance goals and vesting conditions, for three-year performance periods ending in 1998 through 2000. DIRECTOR STOCK PLAN. Each non-employee director of the Corporation received or will receive a grant of 500 shares of common stock on the date of each annual meeting of stockholders in the years 1997, 1998 and 1999 under the Northern Trust Corporation 1997 Stock Plan for Non-Employee Directors adopted in February 1997. Under the terms of the plan, directors may elect to defer the payment of their annual stock grant or cash-based compensation until termination of services as director. Amounts deferred are converted into stock units representing shares of common stock of the Corporation. Distributions of stock grants will be distributed in stock. Distributions of the stock unit account that relates to cash-based compensation will be made in cash based on the fair value of the stock units. OTHER STOCK-BASED COMPENSATION ARRANGEMENTS. The Corporation, in conjunction with an acquisition, awarded 432,280 restricted shares of the Corporation's common stock with a grant-date fair value of $23.75 to certain subsidiary employee participants contingent upon continued employment, non-competition agreements and, in some cases, meeting predetermined performance goals. 69 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Total salary expense related to this arrangement totaled $3.2 million in 1998, $2.9 million in 1997 and $1.8 million in 1996. PRO FORMA INFORMATION. Pro forma information regarding net income and earnings per share is required by SFAS No. 123, and has been determined as if the Corporation had accounted for its stock-based compensation under SFAS No. 123. For purposes of estimating the fair value of the Corporation's employee stock options at the grant-date, a Black-Scholes option pricing model was used with the following weighted average assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of 5.68%, 6.10% and 6.64%; dividend yields of 1.21%, 1.30% and 1.92%; volatility factors of the expected market price of the Corporation's common stock of 24.4%, 20.9% and 22.4%; and a weighted average expected life of the option of 7.6 years, 6.0 years and 5.8 years. The weighted average fair value of options granted in 1998, 1997 and 1996 was $25.16, $17.20 and $9.11, respectively. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' six months to two year vesting period. Under SFAS No. 123, options and awards granted prior to 1995 are not required to be included in the pro forma information. Because the SFAS No. 123 method of accounting has not been applied to options and other stock-based compensation granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years. The Corporation's pro forma information follows:
(In Millions Except Per Share Information) 1998 1997 1996 - -------------------------------------------------------------------- Net Income as Reported $353.9 $309.4 $258.8 Pro Forma Adjustments Increase (Decrease) Due To: Stock Options (14.7) (9.2) (4.8) Performance Shares and Other Arrangements 8.2 8.1 1.4 - -------------------------------------------------------------------- Pro Forma Net Income $347.4 $308.3 $255.4 - -------------------------------------------------------------------- Earnings Per Share as Reported: Basic $ 3.15 $ 2.74 $ 2.27 Diluted 3.04 2.66 2.21 Pro Forma Earnings Per Share: Basic $ 3.09 $ 2.73 $ 2.24 Diluted 2.98 2.64 2.18
26. CASH-BASED COMPENSATION PLANS--Various incentive plans provide for cash incentives and bonuses to selected employees based upon accomplishment of corporate net income objectives, business unit goals and individual performance. The plans provide for acceleration of benefits in certain circumstances including a change in control. The estimated contributions to these plans are charged to salary expense and totaled $86.0 million in 1998, $68.0 million in 1997 and $45.3 million in 1996. 27. BUSINESS SEGMENTS AND RELATED INFORMATION--Information describing the Corporation's major business segments is contained in the section titled Business Segments, found on pages 28 through 31, and is incorporated by reference. The operations of the Northern Trust are managed on a business unit basis and include components of both domestic and foreign source income and assets. Foreign source income and assets are not separately identified in its internal management reporting system. However, in order to comply with the financial reporting requirements of the Securities and Exchange Commission, Northern Trust is required to disclose foreign activities based on the domicile of the customer. Due to the complex and integrated nature of its foreign and domestic activities it is impossible to segregate with precision revenues, expenses and assets between its U.S. and foreign domiciled customers. Therefore, certain subjective estimates and assumptions have been made to allocate revenues, expenses and assets between domestic and international operations as described below. Northern Trust's international activities are centered in the commercial banking, treasury activities, foreign exchange and global custody businesses of the Bank, three overseas branches, one Edge Act subsidiary, the Hong Kong subsidiaries, NTGA, and Northern Trust of Florida. Net income from international operations includes the direct net income contributions of foreign branches, foreign subsidiaries and the Edge Act subsidiary. The Bank and Northern Trust of Florida international profit contributions reflect direct salary and other expenses of the business units, plus expense allocations for interest, occupancy, overhead and the provision for credit losses. For purposes of this disclosure, all foreign exchange profits have been allocated to international operations. The interest expense is allocated to international operations based on specifically matched or pooled funding. Alloca- 70 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- DISTRIBUTION OF TOTAL ASSETS AND OPERATING PERFORMANCE
- ----------------------------------------------------------------------------------------------------------------------------------- 1998 1997 1996 - ----------------------------------------------------------------------------------------------------------------------------------- Income Income Income Total Operating before Net Total Operating before Net Total Operating before Net (In Millions) Assets Income (a) Taxes Income Assets Income (a) Taxes Income Assets Income (a) Taxes Income - ----------------------------------------------------------------------------------------------------------------------------------- International $ 4,371.8 $ 220.5 $119.5 $ 74.5 $ 3,260.2 $ 203.2 $112.5 $ 70.1 $ 2,805.0 $ 128.6 $ 65.3 $ 40.6 Domestic 23,498.2 1,328.3 423.2 279.4 22,055.2 1,169.5 359.4 239.3 18,803.3 1,039.7 322.1 218.2 - ----------------------------------------------------------------------------------------------------------------------------------- Total $27,870.0 $1,548.8 $542.7 $353.9 $25,315.4 $1,372.7 $471.9 $309.4 $21,608.3 $1,168.3 $387.4 $258.8
The table summarizes international performance based on the domicile of the primary obligor without regard to guarantors or the location of collateral. (a) Operating Income is comprised of net interest income and noninterest income. tions of indirect noninterest expenses related to international activities are not significant but, when made, are based on various methods such as time, space and number of employees. Prior year information has been restated to place it on a basis consistent with the current period's presentation and allocation methodology. 28. ACQUISITIONS--On November 15, 1996, the Corporation completed the acquisition of Metroplex Bancshares, Inc., parent company of Bent Tree National Bank (Bent Tree) in Dallas, Texas for $14.6 million in cash. The transaction was recorded under the purchase method of accounting. Included in the acquisition cost were $6.0 million of goodwill and $2.1 million of other intangibles, which are being amortized over fifteen and ten years, respectively. Bent Tree was merged into Northern Trust Bank of Texas N.A. during the first quarter of 1997. On December 31, 1997, the Corporation completed the acquisition of ANB Investment Management and Trust Company (ANB IMC) from First Chicago NBD Corporation for $53 million in cash. The transaction was recorded under the purchase method of accounting. Included in the acquisition cost were $36.0 million of goodwill and $10.0 million of other intangibles which will be amortized over fifteen and ten years, respectively. Subsequent to the acquisition, ANB IMC's name was changed to Northern Trust Quantitative Advisors, Inc. On May 15, 1998, the Corporation completed the acquisition of Trustbank Financial Corp., parent of Trust Bank of Colorado, for $15 million in cash. The transaction was recorded under the purchase method of accounting. Included in the acquisition cost was $10.4 million of goodwill which is being amortized over fifteen years. 29. REGULATORY CAPITAL REQUIREMENTS--Northern Trust and its subsidiary banks are subject to various regulatory capital requirements administered by the federal bank regulatory authorities. Under these requirements, banks must maintain specific ratios of total and tier 1 capital to risk-weighted assets and of tier 1 capital to average assets in order to be classified as "well capitalized." The regulatory capital requirements impose certain restrictions upon banks that meet minimum capital requirements but are not "well capitalized" and obligate the federal bank regulatory authorities to take "prompt corrective action" with respect to banks that do not maintain such minimum ratios. Such prompt corrective action could have a direct material effect on a bank's financial statements. As of December 31, 1998, each of Northern's subsidiary banks had capital ratios above the level required for classification as a "well capitalized" institution and had not received any regulatory notification of a lower classification. There are no conditions or events since that date that management believes have adversely affected the capital categorization of any subsidiary bank for these purposes. The table on the following page summarizes the risk-based capital amounts and ratios for Northern Trust and for each of its subsidiary banks whose net income for 1998 exceeded 10% of the consolidated total. 71 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
Minimum to Qualify Actual as Well Capitalized - --------------------------------------------------------------------------------------------------------- ($ In Millions) Amount Ratio Amount Ratio - --------------------------------------------------------------------------------------------------------- As of December 31, 1998: Total Capital to Risk-Weighted Assets Consolidated $2,621 13.1% $2,007 10.0% The Northern Trust Company 1,934 11.5 1,676 10.0 Northern Trust Bank of Florida N.A. 224 10.9 206 10.0 Tier 1 Capital to Risk-Weighted Assets Consolidated 1,964 9.8 1,204 6.0 The Northern Trust Company 1,443 8.6 1,006 6.0 Northern Trust Bank of Florida N.A. 204 9.9 123 6.0 Tier 1 Capital (to Fourth Quarter Average Assets) Consolidated 1,964 6.9 1,423 5.0 The Northern Trust Company 1,443 6.0 1,209 5.0 Northern Trust Bank of Florida N.A. 204 7.4 138 5.0 As of December 31, 1997: Total Capital to Risk-Weighted Assets Consolidated $2,345 12.8% $1,834 10.0% The Northern Trust Company 1,687 10.9 1,549 10.0 Northern Trust Bank of Florida N.A. 191 11.1 173 10.0 Tier 1 Capital to Risk-Weighted Assets Consolidated 1,762 9.6 1,101 6.0 The Northern Trust Company 1,269 8.2 929 6.0 Northern Trust Bank of Florida N.A. 174 10.1 104 6.0 Tier 1 Capital (to Fourth Quarter Average Assets) Consolidated 1,762 6.9 1,282 5.0 The Northern Trust Company 1,269 5.7 1,104 5.0 Northern Trust Bank of Florida N.A. 174 7.3 119 5.0
30. NORTHERN TRUST CORPORATION (Corporation only)--Condensed financial information is presented below. Investments in wholly-owned subsidiaries are carried on the equity method of accounting. CONDENSED BALANCE SHEET - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- December 31 - -------------------------------------------------------------------------------- (In Millions) 1998 1997 - -------------------------------------------------------------------------------- Assets Cash on Deposit with Subsidiary Bank $ .4 $ .6 Time Deposits with Banks 123.5 279.4 Securities 154.9 139.8 Investments in Wholly-Owned Subsidiaries--Bank Subsidiaries 1,874.5 1,633.1 --Nonbank Subsidiaries 102.6 92.4 Loans--Nonbank Subsidiaries 7.6 8.3 --Other 1.3 1.4 Buildings and Equipment 7.2 7.6 Other Assets 191.0 180.1 - -------------------------------------------------------------------------------- Total Assets $2,463.0 $2,342.7 - -------------------------------------------------------------------------------- Liabilities Commercial Paper $ 148.1 $ 146.8 Long-Term Debt 301.0 383.5 Other Liabilities 73.6 73.4 - -------------------------------------------------------------------------------- Total Liabilities 522.7 603.7 Stockholders' Equity 1,940.3 1,739.0 - -------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $2,463.0 $2,342.7
CONDENSED STATEMENT OF INCOME - -------------------------------------------------------------------------------- For the Year Ended December 31 - -------------------------------------------------------------------------------- (In Millions) 1998 1997 1996 - -------------------------------------------------------------------------------- Operating Income Dividends--Bank Subsidiaries $113.5 $ 85.5 $113.9 --Nonbank Subsidiaries 21.9 5.6 1.6 Intercompany Interest and Other Charges 11.2 20.0 10.2 Interest and Other Income 5.2 7.2 8.0 - -------------------------------------------------------------------------------- Total Operating Income 151.8 118.3 133.7 - -------------------------------------------------------------------------------- Operating Expenses Interest Expense 30.5 33.3 18.9 Other Operating Expenses 13.6 13.1 6.9 - -------------------------------------------------------------------------------- Total Operating Expenses 44.1 46.4 25.8 - -------------------------------------------------------------------------------- Income before Income Taxes and Equity in Undistributed Net Income of Subsidiaries 107.7 71.9 107.9 Benefit for Income Taxes (13.8) (10.3) (5.1) - -------------------------------------------------------------------------------- Income before Equity in Undistributed Net Income of Subsidiaries 121.5 82.2 113.0 Equity in Undistributed Net Income of Subsidiaries--Bank Subsidiaries 232.8 219.9 137.9 --Nonbank Subsidiaries (.4) 7.3 7.9 - -------------------------------------------------------------------------------- Net Income $353.9 $309.4 $258.8 - -------------------------------------------------------------------------------- Net Income Applicable to Common Stock $349.0 $304.4 $253.9 72 NORTHERN TRUST CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
- ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- CONDENSED STATEMENT OF CASH FLOWS - ------------------------------------------------------------------------------- For the Year Ended December 31 - ------------------------------------------------------------------------------- (In Millions) 1998 1997 1996 - ------------------------------------------------------------------------------- Operating Activities: Net Income $ 353.9 $ 309.4 $ 258.8 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Equity in Undistributed Net Income of Subsidiaries (232.4) (227.2) (145.8) (Increase) Decrease in Accrued Income 2.1 (1.2) .9 Increase in Prepaid Expenses (.3) (3.0) (.3) Other, net 27.6 8.7 11.0 - ------------------------------------------------------------------------------- Net Cash Provided by Operating Activities 150.9 86.7 124.6 - ------------------------------------------------------------------------------- Investing Activities: Net (Increase) Decrease in Time Deposits with Banks 155.9 (178.4) (5.4) Purchases of Securities (303.7) (392.1) (354.4) Sales of Securities 290.9 369.6 361.3 Proceeds from Maturity and Redemption of Securities 2.0 32.8 19.2 Capital Investments in Subsidiaries (26.3) (61.2) (14.6) Net Decrease in Loans to Subsidiaries .7 7.9 47.2 Net Decrease in Other Loans .1 .2 .2 Other, net (1.9) (.2) (.5) - ------------------------------------------------------------------------------- Net Cash Provided by (Used in) Investing Activities 117.7 (221.4) 53.0 - ------------------------------------------------------------------------------- Financing Activities: Net Increase (Decrease) in Commercial Paper 1.3 (2.2) 2.3 Repayment of Long-Term Debt (82.5) (8.8) (10.2) Proceeds from Long-Term Debt Issued to Subsidiaries -- 275.6 -- Repayment of Long-Term Debt Issued to Subsidiaries (.1) -- -- Treasury Stock Purchased (116.5) (66.2) (118.2) Cash Dividends Paid on Common and Preferred Stock (98.5) (85.3) (74.7) Net Proceeds from Stock Options 19.5 13.0 12.1 Other, net 8.0 9.2 10.9 - ------------------------------------------------------------------------------- Net Cash Provided by (Used in) Financing Activities (268.8) 135.3 (177.8) - ------------------------------------------------------------------------------- Net Change in Cash on Deposit with Subsidiary Bank (.2) .6 (.2) Cash on Deposit with Subsidiary Bank at Beginning of Year .6 -- .2 - ------------------------------------------------------------------------------- Cash on Deposit with Subsidiary Bank at End of Year $ .4 $ .6 $ --
73 NORTHERN TRUST CORPORATION REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- TO THE STOCKHOLDERS AND BOARD OF DIRECTORS OF NORTHERN TRUST CORPORATION: - -------------------------------------------------------------------------------- We have audited the accompanying consolidated balance sheet of Northern Trust Corporation (a Delaware Corporation) and subsidiaries as of December 31, 1998 and 1997, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1998. These financial statements are the responsibility of the Corporation's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Northern Trust Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998 in conformity with generally accepted accounting principles. Arthur Andersen LLP Chicago, Illinois, January 19, 1999 74 NORTHERN TRUST CORPORATION CONSOLIDATED FINANCIAL STATISTICS
- ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ AVERAGE BALANCE SHEET - ------------------------------------------------------------------------------ ($ In Millions) 1998 1997 1996 1995 1994 - ------------------------------------------------------------------------------ Assets Cash and Due from Banks $ 1,205.7 $ 1,095.4 $ 1,072.9 $ 1,178.7 $ 1,206.6 Federal Funds Sold and Securities Purchased under Agreements to Resell 967.5 815.3 333.3 204.2 237.0 Time Deposits with Banks 2,827.1 2,574.7 1,699.5 1,643.9 2,063.3 Other Interest-Bearing 44.1 52.6 50.7 16.6 119.9 Securities U.S. Government and Other 7,025.0 5,956.4 5,940.9 5,703.9 4,482.0 Obligations of States and Political Subdivisions 434.0 408.8 414.1 434.7 465.1 Trading Account 11.8 9.0 8.8 54.4 53.8 - ------------------------------------------------------------------------------ Total Securities 7,470.8 6,374.2 6,363.8 6,193.0 5,000.9 - ------------------------------------------------------------------------------ Loans and Leases Commercial and Other 7,798.2 6,967.7 6,084.0 5,556.3 5,183.1 Residential Mortgages 5,516.8 4,845.2 4,248.1 3,579.7 3,133.0 - ------------------------------------------------------------------------------ Total Loans and Leases 13,315.0 11,812.9 10,332.1 9,136.0 8,316.1 - ------------------------------------------------------------------------------ Reserve for Credit Losses (147.1) (148.1) (147.5) (146.2) (145.2) Other Assets 1,507.6 1,474.7 1,259.5 1,183.3 1,087.2 - ------------------------------------------------------------------------------ Total Assets $27,190.7 $24,051.7 $20,964.3 $19,409.5 $17,885.8 - ------------------------------------------------------------------------------ Liabilities Deposits Demand and Other Noninterest-Bearing $ 3,228.0 $ 2,963.9 $ 2,732.9 $ 2,747.3 $ 2,592.5 Savings and Money Market 4,263.3 3,895.4 3,620.7 3,312.4 3,385.7 Savings Certificates 2,144.5 2,035.8 2,062.4 2,000.3 1,229.6 Other Time 571.8 717.3 549.2 542.7 412.8 Foreign Offices-Demand 503.8 486.4 347.8 299.1 361.7 -Time 5,781.7 4,971.2 3,826.2 3,493.4 3,284.8 - ------------------------------------------------------------------------------ Total Deposits 16,493.1 15,070.0 13,139.2 12,395.2 11,267.1 - ------------------------------------------------------------------------------ Federal Funds Purchased 2,620.6 1,690.2 1,842.2 1,564.0 1,350.7 Securities Sold under Agreements to Repurchase 1,506.0 1,519.9 1,973.3 1,769.7 1,444.3 Commercial Paper 145.9 142.7 143.7 146.0 138.1 Other Borrowings 2,540.4 2,120.9 1,274.1 1,034.5 1,007.5 Senior Notes 653.3 539.3 267.5 394.0 781.8 Long-Term Debt 445.8 435.8 360.7 271.3 293.6 Debt-Floating Rate Capital Securities 267.4 224.1 -- -- -- Other Liabilities 693.6 679.3 477.9 462.1 377.2 - ------------------------------------------------------------------------------ Total Liabilities 25,366.1 22,422.2 19,478.6 18,036.8 16,660.3 - ------------------------------------------------------------------------------ Stockholders' Equity 1,824.6 1,629.5 1,485.7 1,372.7 1,225.5 - ------------------------------------------------------------------------------ Total Liabilities and Stockholders' Equity $27,190.7 $24,051.7 $20,964.3 $19,409.5 $17,885.8 - ------------------------------------------------------------------------------ Ratios Dividend Payout Ratio 27.7% 27.5% 28.5% 28.6% 28.4% Return on Average Assets 1.30 1.29 1.23 1.13 1.02 Return on Average Common Equity 20.47 20.17 18.64 17.58 16.57 Tier 1 Capital to Risk- Weighted Assets-End of Period 9.78 9.61 8.19 8.82 8.95 Total Capital to Risk- Weighted Assets-End of Period 13.06 12.78 11.87 12.49 12.36 Leverage Ratio 6.90 6.87 6.42 6.19 6.22 Average Stockholders' Equity to Average Assets 6.71 6.78 7.09 7.07 6.85 Average Loans and Leases Times Average Stockholders' Equity 7.3x 7.2x 7.0x 6.7x 6.8x - ------------------------------------------------------------------------------ Stockholders-End of Period 3,373 3,380 3,335 3,331 2,962 Staff-End of Period (Full-time equivalent) 8,156 7,553 6,933 6,531 6,608 - ------------------------------------------------------------------------------
76 NORTHERN TRUST CORPORATION CONSOLIDATED FINANCIAL STATISTICS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ANALYSIS OF NET INTEREST INCOME
- ------------------------------------------------------------------------------------------------------------ (Interest and Rate on a Taxable Equivalent Basis) 1998 1997 - ------------------------------------------------------------------------------------------------------------ ($ In Millions) Interest Volume Rate Interest Volume Rate - ------------------------------------------------------------------------------------------------------------ Average Earning Assets Money Market Assets Federal Funds Sold and Resell Agreements $ 53.0 $ 967.5 5.48% $ 45.9 $ 815.3 5.63% Time Deposits with Banks 155.0 2,827.1 5.48 133.5 2,574.7 5.18 Other 2.7 44.1 6.14 3.0 52.6 5.68 - ------------------------------------------------------------------------------------------------------------ Total Money Market Assets 210.7 3,838.7 5.49 182.4 3,442.6 5.30 - ------------------------------------------------------------------------------------------------------------ Securities U.S. Government 22.4 374.2 5.99 48.8 822.9 5.94 Obligations of States and Political Subdivisions 38.2 434.0 8.81 38.1 408.8 9.32 Federal Agency 362.1 6,385.0 5.67 281.9 4,890.1 5.77 Other 18.3 265.8 6.87 14.9 243.4 6.11 Trading Account .8 11.8 6.53 .7 9.0 7.33 - ------------------------------------------------------------------------------------------------------------ Total Securities 441.8 7,470.8 5.91 384.4 6,374.2 6.03 - ------------------------------------------------------------------------------------------------------------ Loans and Leases 886.5 13,315.0 6.66 798.7 11,812.9 6.76 - ------------------------------------------------------------------------------------------------------------ Total Earning Assets $1,539.0 $24,624.5 6.25% $1,365.5 $21,629.7 6.32% - ------------------------------------------------------------------------------------------------------------ Average Source of Funds Deposits Savings and Money Market $ 141.3 $ 4,263.3 3.31% $ 125.8 $ 3,895.4 3.23% Savings Certificates 122.1 2,144.5 5.69 117.2 2,035.8 5.76 Other Time 30.6 571.8 5.35 39.4 717.3 5.50 Foreign Offices Time 286.4 5,781.7 4.95 239.8 4,971.2 4.82 - ------------------------------------------------------------------------------------------------------------ Total Deposits 580.4 12,761.3 4.55 522.2 11,619.7 4.49 Federal Funds Purchased 139.8 2,620.6 5.34 92.4 1,690.2 5.47 Securities Sold under Agreements to Repurchase 80.2 1,506.0 5.33 81.7 1,519.9 5.38 Commercial Paper 8.0 145.9 5.51 7.9 142.7 5.54 Other Borrowings 132.3 2,540.4 5.21 112.4 2,120.9 5.30 Senior Notes 36.5 653.3 5.58 30.9 539.3 5.75 Long-Term Debt 31.8 445.8 7.14 32.6 435.8 7.48 Debt-Floating Rate Capital Securities 16.9 267.4 6.32 14.5 224.1 6.49 - ------------------------------------------------------------------------------------------------------------ Total Interest-Related Funds 1,025.9 20,940.7 4.90 894.6 18,292.6 4.89 - ------------------------------------------------------------------------------------------------------------ Interest Rate Spread -- -- 1.35% -- -- 1.43% - ------------------------------------------------------------------------------------------------------------ Noninterest-Related Funds -- 3,683.8 -- -- 3,337.1 -- - ------------------------------------------------------------------------------------------------------------ Total Source of Funds $1,025.9 $24,624.5 4.17% $ 894.6 $21,629.7 4.14% - ------------------------------------------------------------------------------------------------------------ Net Interest Income/Margin $ 513.1 -- 2.08% $ 470.9 -- 2.18% - ------------------------------------------------------------------------------------------------------------ Net Interest Income/Margin Components Domestic $ 502.7 $21,118.7 2.38% $ 466.0 $18,492.2 2.52% International 10.4 3,505.8 .30 4.9 3,137.5 .16 - ------------------------------------------------------------------------------------------------------------ Consolidated $ 513.1 $24,624.5 2.08% $ 470.9 $21,629.7 2.18% - ------------------------------------------------------------------------------------------------------------
Notes--Average volume includes nonaccrual loans. --Interest on loans and money market assets includes fees of $4.3 million in 1998, $3.9 million in 1997, $4.3 million in 1996, $5.1 million in 1995 and $6.8 million in 1994. --Total interest income includes adjustments on loans and securities (primarily obligations of states and political subdivisions) to a taxable equivalent basis. Such adjustments are based on the U.S. federal income tax rate (35%) and State of Illinois income tax rate (7.18%) before giving effect to the deductibility of state taxes for federal income tax purposes. Lease financing receivable balances are reduced by deferred income. Total taxable equivalent interest adjustments amounted to $35.9 million in 1998, $32.7 million in 1997, $33.6 million in 1996, $37.6 million in 1995 and $33.4 million in 1994. --Yields on the portion of the securities portfolio classified as available for sale are based on amortized cost. 78 NORTHERN TRUST CORPORATION - -------------------------------------------------------------------------------- - --------------------------------------------------------------------------------
1996 1995 1994 - -------------------------------------------------------------------------------------------- Interest Volume Rate Interest Volume Rate Interest Volume Rate - -------------------------------------------------------------------------------------------- $ 18.3 $ 333.3 5.49% $ 12.3 $ 204.2 6.02% $ 10.9 $ 237.0 4.59% 84.9 1,699.5 5.00 92.1 1,643.9 5.60 97.8 2,063.3 4.74 3.0 50.7 5.91 1.1 16.6 6.88 5.2 119.9 4.31 - -------------------------------------------------------------------------------------------- 106.2 2,083.5 5.10 105.5 1,864.7 5.66 113.9 2,420.2 4.71 - -------------------------------------------------------------------------------------------- 97.6 1,702.0 5.73 70.4 1,225.7 5.74 73.8 1,779.6 4.15 40.8 414.1 9.86 46.8 434.7 10.75 52.8 465.1 11.35 228.4 4,010.7 5.69 258.8 4,124.8 6.28 114.2 2,333.6 4.90 13.7 228.2 6.00 22.0 353.4 6.21 19.6 368.8 5.31 .6 8.8 7.09 3.8 54.4 7.04 4.3 53.8 7.91 - -------------------------------------------------------------------------------------------- 381.1 6,363.8 5.99 401.8 6,193.0 6.49 264.7 5,000.9 5.29 - -------------------------------------------------------------------------------------------- 697.8 10,332.1 6.75 634.3 9,136.0 6.94 503.5 8,316.1 6.05 - -------------------------------------------------------------------------------------------- $1,185.1 $18,779.4 6.31% $1,141.6 $17,193.7 6.64% $882.1 $15,737.2 5.61% - -------------------------------------------------------------------------------------------- $ 114.3 $ 3,620.7 3.16% $ 109.1 $ 3,312.4 3.29% $ 85.3 $ 3,385.7 2.52% 119.1 2,062.4 5.78 120.6 2,000.3 6.03 56.9 1,229.6 4.63 29.9 549.2 5.44 31.5 542.7 5.81 18.6 412.8 4.50 184.5 3,826.2 4.82 182.1 3,493.4 5.21 137.2 3,284.8 4.18 - -------------------------------------------------------------------------------------------- 447.8 10,058.5 4.45 443.3 9,348.8 4.74 298.0 8,312.9 3.58 97.9 1,842.2 5.31 91.2 1,564.0 5.83 55.5 1,350.7 4.11 103.4 1,973.3 5.24 102.6 1,769.7 5.80 61.9 1,444.3 4.28 7.8 143.7 5.40 8.6 146.0 5.87 5.9 138.1 4.31 64.5 1,274.1 5.07 55.6 1,034.5 5.38 36.0 1,007.5 3.57 14.4 267.5 5.37 23.7 394.0 6.00 33.8 781.8 4.32 27.4 360.7 7.59 21.4 271.3 7.88 23.0 293.6 7.84 -- -- -- -- -- -- -- -- -- - -------------------------------------------------------------------------------------------- 763.2 15,920.0 4.79 746.4 14,528.3 5.14 514.1 13,328.9 3.86 - -------------------------------------------------------------------------------------------- -- -- 1.52% -- -- 1.50% -- -- 1.75% - -------------------------------------------------------------------------------------------- -- 2,859.4 -- -- 2,665.4 -- -- 2,408.3 -- - -------------------------------------------------------------------------------------------- $ 763.2 $18,779.4 4.06% $ 746.4 $17,193.7 4.34% $514.1 $15,737.2 3.27% - -------------------------------------------------------------------------------------------- $ 421.9 -- 2.25% $ 395.2 -- 2.30% $368.0 -- 2.34% - -------------------------------------------------------------------------------------------- $ 420.6 $16,678.5 2.52% $ 392.6 $15,193.7 2.58% $357.3 $12,890.4 2.77% 1.3 2,100.9 .06 2.6 2,000.0 .13 10.7 2,846.8 .38 - -------------------------------------------------------------------------------------------- $ 421.9 $18,779.4 2.25% $ 395.2 $17,193.7 2.30% $368.0 $15,737.2 2.34% - --------------------------------------------------------------------------------------------
79 NORTHERN TRUST CORPORATION CONSOLIDATED FINANCIAL STATISTICS - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- QUARTERLY FINANCIAL DATA - --------------------------------------------------------------------------------
STATEMENT OF INCOME 1998 - -------------------------------------------------------------------------------------------------------------- Entire Fourth Third Second First ($ In Millions Except Per Share Information) Year Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------------------------------------- Trust Fees $ 816.3 216.7 203.6 202.3 193.7 Other Noninterest Income 255.3 67.9 61.1 63.4 62.9 Net Interest Income Interest Income 1,503.1 382.6 392.9 370.3 357.3 Interest Expense 1,025.9 256.2 274.9 251.1 243.7 - -------------------------------------------------------------------------------------------------------------- Net Interest Income 477.2 126.4 118.0 119.2 113.6 Provision for Credit Losses 9.0 1.0 1.0 3.0 4.0 Noninterest Expenses 997.1 269.4 243.8 247.7 236.2 Provision for Income Taxes 188.8 49.0 47.7 47.0 45.1 - -------------------------------------------------------------------------------------------------------------- Net Income $ 353.9 91.6 90.2 87.2 84.9 - -------------------------------------------------------------------------------------------------------------- Net Income Applicable to Common Stock $ 349.0 90.4 89.0 86.0 83.6 - -------------------------------------------------------------------------------------------------------------- Per Common Share Net Income-Basic $ 3.15 .82 .81 .78 .75 -Diluted 3.04 .79 .78 .75 .73 - -------------------------------------------------------------------------------------------------------------- AVERAGE BALANCE SHEET Assets Cash and Due from Banks $ 1,205.7 1,319.2 1,116.3 1,163.0 1,224.5 Money Market Assets 3,838.7 5,067.2 3,388.0 3,381.0 3,506.4 Securities 7,470.8 6,736.5 8,393.3 7,570.5 7,177.5 Loans and Leases 13,315.0 13,981.0 13,428.4 13,100.7 12,735.0 Reserve for Credit Losses (147.1) (146.7) (146.6) (147.2) (147.7) Other Assets 1,507.6 1,634.0 1,381.8 1,504.1 1,510.2 - -------------------------------------------------------------------------------------------------------------- Total Assets $27,190.7 28,591.2 27,561.2 26,572.1 26,005.9 - -------------------------------------------------------------------------------------------------------------- Liabilities and Stockholders' Equity Deposits Demand and Other Noninterest-Bearing $ 3,228.0 3,394.4 3,131.2 3,223.0 3,161.6 Savings and Other Interest-Bearing 6,407.8 6,537.1 6,381.9 6,429.5 6,280.1 Other Time 571.8 564.6 678.1 517.4 525.6 Foreign Offices 6,285.5 6,907.4 6,381.5 5,711.5 6,132.2 - -------------------------------------------------------------------------------------------------------------- Total Deposits 16,493.1 17,403.5 16,572.7 15,881.4 16,099.5 Purchased Funds 6,812.9 7,017.4 7,434.8 6,739.4 6,042.4 Senior Notes 653.3 700.0 366.0 800.9 750.0 Long-Term Debt 445.8 462.8 462.5 422.9 434.5 Debt-Floating Rate Capital Securities 267.4 267.4 267.4 267.4 267.4 Other Liabilities 693.6 842.9 619.6 654.7 656.1 Stockholders' Equity 1,824.6 1,897.2 1,838.2 1,805.4 1,756.0 - -------------------------------------------------------------------------------------------------------------- Total Liabilities and Stockholders' Equity $27,190.7 28,591.2 27,561.2 26,572.1 26,005.9 - -------------------------------------------------------------------------------------------------------------- ANALYSIS OF NET INTEREST INCOME Earning Assets $24,624.5 25,784.7 25,209.7 24,052.2 23,418.9 Interest-Related Funds 20,940.7 21,999.8 21,518.6 20,361.2 19,853.1 Noninterest-Related Funds 3,683.8 3,784.9 3,691.1 3,691.0 3,565.8 Net Interest Income (Taxable equivalent) 513.1 135.2 127.7 128.2 122.0 Net Interest Margin (Taxable equivalent) 2.08% 2.08 2.01 2.14 2.11 - -------------------------------------------------------------------------------------------------------------- COMMON STOCK DIVIDEND AND MARKET PRICE Dividends $ .87 .24 .21 .21 .21 Market Price Range-High 89.88 89.88 83.25 79.38 78.13 -Low 55.75 58.81 55.75 67.44 60.38 - --------------------------------------------------------------------------------------------------------------
Note: The common stock of Northern Trust Corporation is traded on the Nasdaq National Market under the symbol NTRS. 80
NORTHERN TRUST CORPORATION - -------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------- - -------------------------------------------------------------------------------------------- 1997 - -------------------------------------------------------------------------------------------- Entire Fourth Third Second First Year Quarter Quarter Quarter Quarter - -------------------------------------------------------------------------------------------- $ 689.2 185.2 177.4 168.3 158.3 245.3 62.1 77.3 54.9 51.0 1,332.8 361.8 339.2 331.8 300.0 894.6 248.5 229.6 222.6 193.9 - -------------------------------------------------------------------------------------------- 438.2 113.3 109.6 109.2 106.1 9.0 3.0 5.0 .5 .5 891.8 233.6 234.7 217.0 206.5 162.5 42.7 43.6 39.5 36.7 - -------------------------------------------------------------------------------------------- $ 309.4 81.3 81.0 75.4 71.7 - -------------------------------------------------------------------------------------------- $ 304.4 80.0 79.7 74.2 70.5 - -------------------------------------------------------------------------------------------- $ 2.74 .72 .72 .67 .64 2.66 .70 .70 .65 .62 - -------------------------------------------------------------------------------------------- $ 1,095.4 1,094.5 1,056.2 1,073.9 1,158.0 3,442.6 3,938.4 3,553.1 3,371.1 2,895.1 6,374.2 6,879.2 6,232.1 6,514.5 5,861.1 11,812.9 12,502.5 12,001.2 11,610.4 11,120.5 (148.1) (147.8) (148.2) (148.4) (148.3) 1,474.7 1,501.7 1,469.0 1,438.2 1,490.5 - -------------------------------------------------------------------------------------------- $24,051.7 25,768.5 24,163.4 23,859.7 22,376.9 - -------------------------------------------------------------------------------------------- $ 2,963.9 3,003.7 2,934.0 2,880.7 3,037.8 5,931.2 5,993.2 5,840.6 5,918.7 5,973.2 717.3 709.4 771.0 772.6 614.6 5,457.6 6,526.4 5,749.8 4,993.4 4,535.5 - -------------------------------------------------------------------------------------------- 15,070.0 16,232.7 15,295.4 14,565.4 14,161.1 5,473.7 5,648.5 4,961.0 6,132.0 5,153.3 539.3 793.7 844.0 245.1 265.0 435.8 443.7 443.6 427.9 427.8 224.1 267.4 267.3 236.0 123.8 679.3 679.1 702.1 647.6 688.6 1,629.5 1,703.4 1,650.0 1,605.7 1,557.3 - -------------------------------------------------------------------------------------------- $24,051.7 25,768.5 24,163.4 23,859.7 22,376.9 - -------------------------------------------------------------------------------------------- $21,629.7 23,320.1 21,786.4 21,496.0 19,876.7 18,292.6 19,870.2 18,388.5 18,235.5 16,639.6 3,337.1 3,449.9 3,397.9 3,260.5 3,237.1 470.9 121.5 117.6 117.7 114.1 2.18% 2.07 2.14 2.20 2.33 - -------------------------------------------------------------------------------------------- $ .75 .21 .18 .18 .18 71.50 71.50 59.50 51.88 45.25 34.00 54.63 47.25 35.88 34.00 - --------------------------------------------------------------------------------------------
81 NORTHERN TRUST CORPORATION CORPORATE STRUCTURE - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- NORTHERN TRUST CORPORATION 50 South LaSalle Street, Chicago, Illinois 60675 (312) 630-6000 PRINCIPAL SUBSIDIARY The Northern Trust Company 50 South LaSalle Street, Chicago, Illinois 60675 120 East Oak Street, Chicago, Illinois 60611 125 South Wacker Drive, Chicago, Illinois 60675 2814 North Fullerton, Chicago, Illinois 60647 7801 South State Street, Chicago, Illinois 60619 8501 West Higgins Road, Chicago, Illinois 60631 6401 North Harlem Avenue, Chicago, Illinois 60631 826 S. Northwest Highway, Barrington, Illinois 60010 2550 Waukegan Road, Glenview, Illinois 60025 579 Central Avenue, Highland Park, Illinois 60035 4 North Washington, Hinsdale, Illinois 60521 120 East Scranton Avenue, Lake Bluff, Illinois 60044 265 Deerpath Road, Lake Forest, Illinois 60045 959 South Waukegan Road, Lake Forest, Illinois 60045 701 South McKinley Road, Lake Forest, Illinois 60045 400 East Diehl Road, Naperville, Illinois 60563 One Oakbrook Terrace, Oakbrook Terrace, Illinois 60181 1501 Woodfield Road, Schaumburg, Illinois 60173 62 Green Bay Road, Winnetka, Illinois 60093 London Branch 155 Bishopsgate, London EC2M 3XS, United Kingdom Cayman Islands Branch P.O. Box 501, Georgetown, Cayman Islands, British West Indies Singapore Branch 80 Raffles Place #46-02, UOB Plaza 1, Singapore 048624 SUBSIDIARIES OF THE NORTHERN TRUST COMPANY The Northern Trust International Banking Corporation One World Trade Center, Suite 3941, New York, New York 10048 The Northern Trust Company of Hong Kong Limited Suite 703-4 One Pacific Place 88 Queensway, Hong Kong Northern Trust Trade Services Limited Asia Pacific Tower, 17th Floor, 3 Garden Road, Central, Hong Kong Northern Trust Fund Managers (Ireland) Limited Connaught House 30 Herbert Street Dublin 2, Ireland NorLease, Inc. 50 South LaSalle Street, Chicago, Illinois 60675 The Northern Trust Company, Canada 161 Bay Street, Suite 4540, B.C.E. Place Toronto, Ontario, Canada M5J 2S1 NTG Services LLC 155 Bishopsgate, London EC2M 3XS, United Kingdom NT Mortgage Holdings LLC 50 South LaSalle Street Chicago, Illinois 60675 INTERNATIONAL AFFILIATE Transatlantic Trust Corporation 75 Rochford Street, P.O. Box 429 Charlottetown, Prince Edward Island, Canada C1A 7K7 OTHER SUBSIDIARIES OF THE CORPORATION Northern Trust Bank of Florida N.A. 700 Brickell Avenue, Miami, Florida 33131 595 Biltmore Way, Coral Gables, florida 33134 328 Crandon Boulevard, Suite 101, Key Biscayne, Florida 33149 3001 Aventura Boulevard, Aventura, Florida 33180 8600 NW 17th Street, Suite 120, Miami, Florida 33126 1100 East Las Olas Boulevard, Fort Lauderdale, Florida 33301 2601 East Oakland Park Boulevard, Fort Lauderdale, Florida 33306 301 Yamato Road, Boca Raton, Florida 33431 770 East Atlantic Avenue, Delray Beach, Florida 33483 440 Royal Palm Way, Palm Beach, Florida 33480 11780 U.S. Highway 1, Suite 100, North Palm Beach, Florida 33408 2201 S.E. Kingswood Terrace, Monterey Commons, Stuart, Florida 34996 755 Beachland Boulevard, Vero Beach, Florida 32963 1440 South A1A, Vero Beach, Florida 32963 84 NORTHERN TRUST CORPORATION CORPORATE STRUCTURE - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- OTHER SUBSIDIARIES OF THE CORPORATION continued 4001 Tamiami Trail North, Naples, Florida 34103 375 Fifth Avenue South, Naples, Florida 34102 26790 South Tamiami Trail, Bonita Springs, Florida 34134 8060 College Parkway S.W., Fort Myers, Florida 33919 1515 Ringling Boulevard, Sarasota, Florida 34236 901 Venetia Bay Boulevard, Suite 100, Venice, Florida 34292 540 Bay Isles Road, Longboat Key, Florida 34228 233 15th Street West, Bradenton, Florida 34205 6320 Venture Drive, Suite 100, Bradenton, Florida 34202 100 Second Avenue South, St. Petersburg, Florida 33701 425 North Florida Avenue, Tampa, Florida 33602 Northern Trust Bank of Arizona N.A. 2398 East Camelback Road, Phoenix, Arizona 85016 6373 East Tanque Verde Road, Tucson, Arizona 85715 10220 West Bell Road, Sun City, Arizona 85351 10015 West Royal Oak Road, Sun City, Arizona 85351 7600 E. Doubletree Ranch Road, Scottsdale, Arizona 85258 19432 R. H. Johnson Boulevard, Sun City West, Arizona 85375 1525 South Greenfield Road, Mesa, Arizona 85206 3450 East Sunrise Drive, Tucson, Arizona 85718 Northern Trust Bank of California N.A. 355 South Grand Avenue, Suite 2600, Los Angeles, California 90071 620 Newport Center Drive, Suite 200, Newport Beach, California 92660 4370 LaJolla Village Drive, Suite 1000, San Diego, California 92122 1125 Wall Street, La Jolla, California 92037 206 East Anapamu Street, Santa Barbara, California 93101 1485 East Valley Road, (Montecito), Santa Barbara, California 93108 580 California Street, Suite 1800, San Francisco, California 94104 575 Redwood Highway, Mill Valley, California 94941 (opening spring 1999) 10877 Wilshire Boulevard (Westwood), Suite 100, Los Angeles, California 90024 74-900 Highway 111, Suite 121, Indian Wells, California 92210 421 North Rodeo Drive, Penthouse, Beverly Hills, California 90210 Northern Trust Bank of Texas N.A. 2020 Ross Avenue, Dallas, Texas 75201 5540 Preston Road, Dallas, Texas 75205 16475 Dallas Parkway, Addison, Texas 75001 2701 Kirby Drive, Houston, Texas 77098 600 Bering Drive, Houston, Texas 77057 10000 Memorial Drive, Houston, Texas 77024 700 Rusk Street, Houston, Texas 77002 Northern Trust Bank, FSB 1701 North Woodward Avenue, Suite 110, Bloomfield Hills, Michigan 48304 Northern Trust Bank of Colorado 1200 17th Street, 24th Floor, Denver, Colorado 80202 Northern Trust Global Advisors, Inc. 300 Atlantic Street, Suite 400, Stamford, Connecticut 06901 The Northern Trust Company of Connecticut 300 Atlantic Street, Suite 400, Stamford, Connecticut 06901 NT Global Advisors, Inc. 161 Bay Street, Suite 4540, B.C.E. Place, Toronto, Ontario, Canada M5J 2S1 NT Fund Advisors of Quebec, Inc. 770 Sherbrooke Street West, Suite 1420, Montreal, Quebec, Canada H3A 1G1 Northern Trust Global Advisors, Limited 155 Bishopsgate, London EC2M 3XS, United Kingdom Northern Trust Quantitative Advisors, Inc. 50 South LaSalle Street, Chicago, Illinois 60675 The Northern Trust Company of New York 40 Broad Street, New York, New York 10004 Northern Trust Cayman International, Ltd. P.O. Box 1586, Grand Cayman, Cayman Islands, British West Indies Northern Trust Securities, Inc. 50 South LaSalle Street, Chicago, Illinois 60675 Northern Trust Retirement Consulting, L.L.C. 400 Perimeter Center Terrace, Suite 850, Atlanta, Georgia 30346 19119 North Creek Parkway, Suite 200, Bothell, Washington 98011 85 EX-21 7 SUBSIDIARIES OF THE REGISTRANT EXHIBIT NUMBER (21) TO 1998 FORM 10-K NORTHERN TRUST CORPORATION SUBSIDIARIES AS OF MARCH 1, 1999
Percent Jurisdiction of Owned Incorporation ------- -------------- The Northern Trust Company 100% Illinois NorLease, Inc. 100% Delaware MFC Company, Inc. 100% Delaware The Northern Trust Company, Canada 100% Ontario, Canada Nortrust Nominees Ltd. 100% London The Northern Trust Company U.K. Pension Plan Limited 100% London The Northern Trust International Banking Corporation 100% Edge Act The Northern Trust Company of Hong Kong Limited 100% Hong Kong Northern Trust Trade Services Limited 100% Hong Kong Northern Trust Fund Managers (Ireland) Limited 100% Ireland NTG Services, LLC 100% Delaware LLC NT Mortgage Holdings, LLC 99.6% Delaware LLC Northern Trust of Florida Corporation 100% Florida Northern Trust Cayman International, Ltd. 100% Cayman Islands, BWI Northern Trust Bank of Florida N.A. 100% National Bank Realnor Properties, Inc. 100% Florida Realnor Special Properties, Inc. 100% Florida Realnor 1177, Inc. 100% Florida Realnor Hallandale, Inc. 100% Florida Nortrust of Arizona Holding Corporation 100% Arizona Northern Trust Bank of Arizona N.A. 100% National Bank Northern Trust of California Corporation 100% Delaware Northern Trust Bank of California N.A. 100% National Bank Berry, Hartell, Evers & Osborne, Inc. 100% Delaware, (INACTIVE) Metroplex Bancshares, Inc. 100% Texas Metroplex Delaware Financial Corporation 100% Delaware Northern Trust Bank of Texas N.A. 75.5% National Bank Fiduciary Services Inc. 100% Texas Tanglewood Bancshares, Inc. 100% Texas Northern Trust Bank of Texas N.A. 24.5% National Bank
NORTHERN TRUST CORPORATION SUBSIDIARIES AS OF MARCH 1, 1999 (continued)
Percent State of Owned Incorporation ------- --------------- Northern Futures Corporation 100% Delaware, (INACTIVE) Northern Trust of Colorado Corporation 100% Delaware Northern Trust Bank of Colorado 100% Colorado Northern Trust Bank, FSB - Michigan 100% Federal Thrift Northern Trust Holdings L.L.C. 100% Delaware Northern Investment Corporation 100% Delaware Northern Investment Management Company 100% Delaware Northern Trust Securities, Inc. 100% Delaware Northern Trust Services, Inc. 100% Illinois Nortrust Realty Management, Inc. 100% Illinois The Northern Trust Company of New York 100% New York Northern Trust Retirement Consulting, L.L.C. 100% Delaware Northern Trust Global Advisors, Inc. 100% Delaware NT Global Advisors, Inc. 100% Ontario, Canada Northern Trust Global Advisors Limited 100% England The Northern Trust Company of Connecticut 100% Connecticut NT Fund Advisors of Quebec, Inc. 100% Quebec, Canada Northern Trust Quantitative Advisors, Inc. 100% Illinois NTC Capital I 100% Delaware NTC Capital II 100% Delaware
EX-23 8 CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS EXHIBIT NUMBER (23) TO 1998 FORM 10-K CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS As independent public accountants, we hereby consent to the incorporation of our report dated January 19, 1999, incorporated by reference in the Northern Trust Corporation's Annual Report on Form 10-K for the year end December 31, 1998, into the Corporation's previously filed Form S-8 Registration Statements File Nos. 33-22546, 33-47597, 33-63843, 333-00809, 333-25135, 333-25283, 333- 35685, 333-52623, 333-53259; and the Corporation's previously filed Form S-3 Nos. 333-18951, 333-25649 and 333-45203. ARTHUR ANDERSEN LLP Chicago, Illinois March 12, 1999 EX-24 9 POWERS OF ATTORNEY EXHIBIT NUMBER (24) TO 1998 FORM 10-K POWER OF ATTORNEY - ----------------- KNOW ALL MEN BY THESE PRESENTS: That the undersigned officers and directors of Northern Trust Corporation hereby severally constitute and appoint William A. Osborn, Perry R. Pero and Peter L. Rossiter, and each of them singly, our true and lawful attorneys and agents with full power to them and each of them singly, to sign for us in our names, in the capacities indicated below, Form 10-K, annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, for the fiscal year ended December 31, 1998, and to file such Form, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, hereby granting to such attorneys and agents, and each of them, full power of substitution and revocation in the premises, and generally to do all such things in our name and behalf in our capacities as officers and directors to enable Northern Trust Corporation to comply with the provisions of the Securities Exchange Act of 1934, as amended, and all regulations of the Securities and Exchange Commission thereunder, hereby ratifying and confirming our signatures as they may be signed by our attorneys, or any one of them, to such Form, and all that our attorneys and agents, or any of them, may do or cause to be done by virtue of these presents. IN WITNESS WHEREOF, the undersigned have hereunto executed this Power of Attorney this 16th day of February, 1999. ------ William A. Osborn Barry G. Hastings - -------------------------------- -------------------------------- William A. Osborn Barry G. Hastings Chairman of the Board, Chief President, Chief Operating Executive Officer and Director Officer and Director Perry R. Pero Harry W. Short - -------------------------------- -------------------------------- Perry R. Pero Harry W. Short Senior Executive Vice President Senior Vice President and Controller and Chief Financial Officer (Chief Accounting Officer) Duane L. Burnham Delores E. Cross - -------------------------------- -------------------------------- Duane L. Burnham Delores E. Cross Director Director Robert S. Hamada -------------------------------- Robert S. Hamada Director Robert A. Helman Arthur L. Kelly - -------------------------------- -------------------------------- Robert A. Helman Arthur L. Kelly Director Director Frederick A. Krehbiel William G. Mitchell - -------------------------------- -------------------------------- Frederick A. Krehbiel William G. Mitchell Director Director Edward J. Mooney Harold B. Smith - -------------------------------- -------------------------------- Edward J. Mooney Harold B. Smith Director Director William D. Smithburg Bide L. Thomas - -------------------------------- -------------------------------- William D. Smithburg Bide L. Thomas Director Director STATE OF ILLINOIS ) ) SS COUNTY OF COOK ) I, Victoria Antoni , a Notary Public, DO HEREBY CERTIFY that the --------------------- above named directors and officers of Northern Trust Corporation, personally known to me to be the same persons whose names are subscribed to the foregoing instrument, appeared before me this day in person, and severally acknowledged that they signed and delivered the instrument as their free and voluntary act, for the uses and purposes therein set forth. GIVEN under my hand and notarial seal this 16th day of February, 1999. ------ Victoria Antoni ------------------------- Notary Public My Commission Expires: 7/25/99 - ---------------------- EX-27 10 FINANCIAL DATA SCHEDULE
9 This schedule contains summary financial information extracted from the Consolidated Balance Sheet and the Consolidated Statement of Income and is qualified in its entirety by reference to such financial statements. 1,000 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 2,365,973 3,264,686 1,164,363 9,067 5,375,194 472,536 485,706 13,646,905 146,839 27,870,026 18,202,700 5,883,394 914,095 929,503 189,935 0 120,000 1,630,399 27,870,026 884,429 407,273 211,435 1,503,137 580,390 1,025,917 477,220 9,000 1,346 997,126 542,679 353,915 0 0 353,915 3.15 3.04 2.08 30,529 29,962 2,386 0 147,638 11,800 1,862 146,849 112,225 3,561 31,063
EX-99 11 DESCRIPTION OF COMMON STOCK EXHIBIT NUMBER (99) TO 1998 FORM 10-K DESCRIPTION OF COMMON STOCK (Filed for the Purpose of Updating the Description of Common Stock of Northern Trust Corporation Previously Registered under the Securities Exchange Act of 1934) GENERAL Northern Trust Corporation (the "Corporation") is authorized to issue 280,000,000 shares of Common Stock with a par value of $1.66-2/3 per share ("Common Stock"). As of March 1, 1999, there were 111,403,286 shares of Common Stock outstanding. Holders of Common Stock have no preemptive rights to subscribe for additional shares . The rights of the holders of the Corporation's Common Stock are qualified by the rights of the holders of the Corporation's preferred stock (the "Preferred Stock"). The Corporation is authorized to issue 10,000,000 shares of Preferred Stock without par value. The Board of Directors of the Corporation is authorized to fix the particular preferences, rights, qualifications and restrictions for each series of Preferred Stock issued. As of March 1, 1999, 600 shares of Auction Rate Preferred Stock Series C, with a $100,000 per share stated value, and 600 shares of Flexible Auction Rate Cumulative Preferred Stock Series D, with a $100,000 per share stated value, were outstanding. Subject to the preferential rights of the holders of the Corporation's Preferred Stock outstanding at any time, holders of Common Stock are entitled to receive, out of the funds legally available therefor, such dividends as may be declared from time to time by the Board of Directors. In the event of the liquidation, dissolution, distribution of assets or winding up of the Corporation, after distribution in full of the preferential amounts, if any, to be distributed to the holders of shares of Preferred Stock, holders of Common Stock are entitled to receive all the remaining assets of the Corporation, divided ratably in proportion to the number of shares held by each. The holders of Common Stock have one vote for each share held by them and are entitled to cumulative voting in the election of directors. The voting rights of the holders of Common Stock are qualified, however, by the voting rights of the holders of the Corporation's Preferred Stock in the following circumstances: (i) the holders of 66 2/3% of the Preferred Stock must approve as a class any amendment to the Corporation's Certificate of Incorporation that would adversely affect the powers, preferences, rights or privileges of the Preferred Stock (provided that, if such an amendment would adversely affect only one or more, but not all, series of Preferred Stock, then only the series so affected would be entitled to the above-described vote); (ii) the holders of 66 2/3% of the Preferred Stock must approve as a class the creation, authorization, or issuance of any shares of stock of the Corporation (or obligation or security convertible into or evidencing the right to purchase such shares) ranking prior to the Preferred Stock as to dividends or upon liquidation, or any reclassification of authorized stock into such prior shares; (iii) in the event at the time of any annual meeting of stockholders for the election of directors there shall exist a default in payment of a specified number of dividends (generally six quarterly dividends or dividends payable over at least 540 days), the number of directors on the Corporation's Board of Directors shall be increased by two (2), and the holders of Preferred Stock, voting as a class and to the exclusion of the holders of Common Stock, shall have the right to elect two directors to fill such vacancies to serve full terms, and such voting rights shall continue until there are no dividends in arrears upon the Preferred Stock. Shares of Common Stock are not subject to redemption. The outstanding shares of Common Stock are fully paid and nonassessable. Norwest Bank Minnesota, N.A. is the transfer agent, registrar and dividend disbursing agent for the Common Stock. 1989 PREFERRED STOCK PURCHASE RIGHTS On October 17, 1989 the Board of Directors of the Corporation declared a dividend distribution of one right (each a "Right") for each outstanding share of Common Stock of the Corporation. The distribution was payable on October 31, 1989 to stockholders of record on that date. Each Right initially entitled the holder, following a distribution of the Rights as described below, to buy one one-hundredth of a share of a new series of Preferred Stock of the Corporation, denominated "Series A Junior Participating Preferred Stock" (the "Junior Participating Preferred Stock") at a price of $250 per one one-hundredth of a share, subject to adjustment (as a result of anti-dilution adjustments to date, each Right, if distributed, would be exercisable for one-sixth of one one-hundredth of a share of Junior Participating Preferred Stock at an exercise price of $41.67 for each such fractional share). The Rights are represented by and 2 traded with the Common Stock certificates and will not be exercisable or transferable apart from the Common Stock until the earlier of (i) twenty days after a public announcement that a person or group has acquired beneficial ownership of 15% or more of the Voting Power (such person or group being called an "Acquiring Person" and such date of first public announcement being called the "Stock Acquisition Date") or (ii) twenty days after a person or group commences, or announces it intends to commence, a tender or exchange offer, the consummation of which would give such person or group 25% or more of the Voting Power (the earlier of such days being called the "Distribution Date"). Descendants of company-founder Byron L. Smith and certain related trusts and other entities (or a group comprised solely of such persons) will not be deemed to be an Acquiring Person as long as all such persons beneficially own Common Stock or other securities of the Corporation representing less than 23% of the Voting Power. Voting Power means the voting power of all securities of the Corporation then outstanding generally entitled to vote for the election of directors of the Corporation. Separate certificates for the Rights will be mailed to holders of Common Stock as of the Distribution Date, and thereafter the separate Right certificates alone will evidence the Rights. If, after October 17, 1989, any person becomes the beneficial owner of 25% or more of the Voting Power, the Rights will adjust so that, assuming the Rights are then exercisable, each Right (other than Rights held by an Acquiring Person which will become void) will entitle its holder to purchase, at the then current exercise price of the Right, that number of shares of Common Stock of the Corporation having, at the time of such transaction, a market value of two times the exercise price of the Right. If the Corporation is the surviving corporation in a merger involving an Acquiring Person and the Common Stock is not changed or exchanged, or if an Acquiring Person engages in certain types of self-dealing transactions, each Right (other than Rights owned by the Acquiring Person which will become void), assuming it is then exercisable, will entitle its holder to purchase at the then current exercise price of the Right, that number of shares of Common Stock of the Corporation having, at the time of such transaction, a market value of two times the exercise price of the Right. If, on or after the Stock Acquisition Date, the Corporation is acquired in a merger or other business combination or 50% or more of its assets or earning power is sold, each Right, assuming it is then exercisable, will entitle its holder to purchase, at the then current exercise price of the Right, that number of shares of Common Stock of the surviving company having, at the time of such transaction, a market value of two times the exercise price of the Right. At any time after the Rights become exercisable for Common Stock, the Board of Directors of the Corporation may exchange the unexercised Rights 3 (other than Rights owned by any Acquiring Person which have become void), in whole or in part, at an exchange ratio (as adjusted, the "Exchange Ratio") of one share of Common Stock, or one one-hundredth of a share of Junior Participating Preferred Stock (or of a share of a class or series of the Corporation's Preferred Stock having equivalent rights, preferences and privileges), per Right, subject to adjustment (as a result of anti-dilution adjustments to date, the Exchange Ratio currently is one-sixth of one share of Common Stock per Right). Notwithstanding the foregoing, no such exchange of the Rights may be authorized by the Board of Directors during the Special Period (as defined below) or at any time when the Rights are not redeemable. At any time prior to the earlier of (i) the date on which an Automatic Redemption Event (as defined below) occurs, (ii) the close of business on the twentieth day following the Stock Acquisition Date, or (iii) the Final Expiration Date, the Corporation may redeem the Rights at a price of $.01 per Right (as adjusted, the "Redemption Price"; as a result of anti-dilution adjustments to date, the Redemption Price is currently $.00167). Immediately upon the occurrence of an Automatic Redemption Event or upon the authorization of the redemption of the Rights by the Board of Directors of the Corporation, the Rights will terminate and the only right of the holders of Rights will be to receive the Redemption Price. "Automatic Redemption Event" means (i) any person becomes the beneficial owner of securities of the Corporation which in the aggregate represent 14% or more of the Voting Power, (ii) any person commences, or publicly announces its intent to commence, a tender or exchange offer if upon consummation thereof such person, together with all affiliates and associates of such person, would be the beneficial owner of securities of the Corporation which in the aggregate represent 15% or more of the Voting Power, (iii) any person makes by public announcement or by written communication that is or becomes the subject of a public announcement, or publicly announces its intent to make, a proposal to the Corporation or its stockholders for (1) a merger, consolidation or similar transaction involving the Corporation or any of its subsidiaries, (2) a purchase or other acquisition of all or a substantial portion of the assets or deposits of the Corporation and its subsidiaries or (3) a purchase or other acquisition of securities representing 15% or more of the Voting Power (any transaction of the type described in clauses (1), (2) and (3) above, an "Acquisition Transaction"), or (iv) any person files an application or notice with the Board of Governors of the Federal Reserve System, or any other federal or state banking regulatory authority, which application or notice seeks approval to engage in any transaction constituting an Acquisition Transaction. Notwithstanding the foregoing, in the event that within 270 days of a public announcement by a third party of an intent or proposal to engage (without the current and continuing concurrence of the Board of Directors) in a transaction involving an acquisition of or business combination with the Corporation or otherwise to become an Acquiring Person, there is an election of directors (whether at one 4 or more stockholder meetings and/or pursuant to written stockholder consents) resulting in a majority of the Board of Directors being comprised of persons who were not nominated by the Board of Directors in office immediately prior to such election, then following such election and for a period of 180 days (the "Special Period"), the Rights, if otherwise then redeemable, will only be redeemable by the Board of Directors either (1) if they have followed certain prescribed procedures or (2) in any other case, provided that, if in any such other case their decision regarding redemption and any acquisition or business combination is challenged as a breach of fiduciary duty of care or loyalty, the directors can establish the entire fairness of such decision without the benefit of any business judgement rule or other presumption. The procedures required under clause (1) include: (a) the retention of an independent financial advisor, and the receipt by the Board of Directors of (i) the views of such advisor regarding whether redemption of the Rights will serve the best interests of the Corporation and its stockholders, or (ii) such advisor's statement that it is unable to express such a view, setting forth the reasons therefor; and (b) with respect to any pending acquisition or business combination proposal (i) the implementation by the Board of Directors, with the advice of its independent financial advisor, of a process and procedures which the Board of Directors and such advisor conclude would be most likely to result in the best value reasonably available to stockholders, (ii) receipt of a fairness opinion from such advisor, and the Board of Directors determining, and such advisor confirming, that it has no reason to believe that a superior transaction is reasonably available, and (iii) execution of a definitive transaction agreement. The Rights will expire on October 31, 1999 (the "Final Expiration Date"), unless earlier exchanged or redeemed by the Corporation as described above. Until a Right is exercised, the holder thereof will have no rights as a stockholder of the Corporation, including without limitation, the right to vote or receive dividends. The original Rights Agent was Harris Trust and Savings Bank ("Harris Trust"). Effective as of November 10, 1997, Harris Trust was removed as Rights Agent under the Rights Agreement and Norwest Bank Minnesota, N.A. was appointed to serve as successor Rights Agent thereunder. So long as the Rights are attached to the Common Stock, the Corporation will issue one Right with each new share of Common Stock issued so that all such shares will have attached Rights. No fractional shares will be issued, other than fractional shares of Junior Participating Preferred Stock of the Corporation that are integral multiples of one one-hundredth of a share, and a cash payment will be made in lieu thereof based on the market price of the Junior Participating Preferred or Common Stock on the last trading day prior to the date of exercise. Prior to the Distribution Date, the Rights Agreement may be amended without the approval of any holders of the Rights at the direction of the Corporation for any purpose, except as described below. After the Distribution Date, however, the 5 Board of Directors of the Corporation may amend the Rights Agreement only to cure any ambiguity, to cure any defective or inconsistent provisions, to make changes which do not adversely affect the interest of the holders of the Rights (other than an Acquiring Person or an affiliate or associate of an Acquiring Person) or to shorten or lengthen any time period under the Rights Agreement; provided that no amendment to adjust the time period governing redemption may be made at any time when the Rights are not redeemable. Notwithstanding the foregoing, (1) no supplement or amendment may be made to the Rights Agreement which changes the Redemption Price, the Final Expiration Date, the purchase price or the number of one one-hundredths of a share of Junior Participating Preferred Stock for which a Right is exercisable, unless such supplement or amendment does not adversely affect the interests of the holders of Rights certificates (other than an Acquiring Person or an affiliate or associate of an Acquiring Person) and (2) no supplement or amendment may be made to the Rights Agreement during the Special Period or at a time when the Rights are not redeemable, other than to cure any ambiguity or to cure any defective or inconsistent provisions. The Rights may have certain anti-takeover effects. The Rights will cause substantial dilution to a person or group that attempts to acquire the Corporation unless the acquisition is conditioned on a substantial number of Rights being acquired. The Rights should not interfere with any merger or other business combination properly approved by the Board of Directors. 1998 PREFERRED STOCK PURCHASE RIGHTS On July 21, 1998, the Board of Directors of the Corporation declared a dividend distribution of one right (each a "New Right") for each outstanding share of the Common Stock of the Corporation to stockholders of record at the close of business on the earlier of October 31, 1999, the date on which the Rights Agreement expires, or the date on which the Rights issued under the Rights Agreement are exchanged or redeemed in accordance with the provisions of the Rights Agreement (such date being referred to as the "Record Date"). Each New Right will entitle the registered holder to purchase from the Corporation one one-hundredth of a share of Junior Participating Preferred Stock, no par value, of the Corporation at an exercise price of $330.00, subject to adjustment (as adjusted from time to time, the "Purchase Price"). The description and terms of the New Rights are set forth in a Rights Agreement, dated as of July 21, 1998, between the Corporation and the Rights Agent, as amended by Amendment No. 1 thereto, dated as of November 18, 1998 and Amendment No. 2 thereto, dated as of February 16, 1999 (as so amended, the "New Rights Agreement"). The New Rights Agreement was adopted by the Board of Directors to replace the Rights Agreement upon the expiration or redemption of the Rights, which 6 will occur no later than October 31, 1999. In no event will both the Rights and the New Rights be exercisable. Initially following the Record Date, the New Rights will be attached to all certificates representing shares of Common Stock then outstanding, and no separate Rights Certificates will be distributed. Unless earlier redeemed by the Board of Directors in accordance with the New Rights Agreement, the New Rights will separate from the Common Stock and a "New Distribution Date" will occur upon the earlier of (i) 20 days following the New Stock Acquisition Date (as defined below) or (ii) 20 days (or such later date as the Board of Directors shall determine, provided that no deferral of such date may be made by the Board of Directors at any time during the New Special Period (as defined below)) after the date a tender or exchange offer that would result in a person or group beneficially owning 15% or more of the outstanding shares of Common Stock is first published, sent or given to the Corporation's stockholders. The "New Special Period" is defined as the 180-day period following the effectiveness of any election of directors, occurring within 270 days of a public announcement by a third party of an intent or proposal to engage (without the current and continuing concurrence of the Board of Directors) in a transaction involving an acquisition of or business combination with the Corporation or otherwise to become a New Acquiring Person (as defined below), which election results in a majority of the Board of Directors being comprised of persons who were not nominated by the Board of Directors in office immediately prior to such election. The "New Stock Acquisition Date" is defined as the earlier of (x) the first date of public announcement by the Corporation that any person or group (other than certain exempt persons or groups) has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the shares of Common Stock then outstanding or (y) the date that any person enters into an agreement or arrangement with the Corporation or any of its subsidiaries providing for an Acquisition Transaction (as defined below) (any person described in clause (x) or clause (y) above is referred to as a "New Acquiring Person"). Descendants of Corporation founder Byron L. Smith and certain related trusts and other entities (or a group comprised solely of such persons) will not be deemed to be a New Acquiring Person for purposes of clause (x) above as long as all such persons beneficially own less than 23% of the outstanding shares of Common Stock. A "New Acquisition Transaction" is defined as (a) a merger, consolidation or similar transaction as a result of which stockholders of the Corporation will own less than 60% of the outstanding shares of Common Stock or the common stock of a publicly-traded entity which controls the Corporation or into which the Corporation has been merged or otherwise combined (based solely on the shares of Common Stock received by such stockholders, in their capacity as stockholders of the Corporation, pursuant to such transactions), (b) a purchase of all or a substantial portion of assets of the Corporation and its subsidiaries, or (c) a purchase 7 or other acquisition of securities representing 15% or more of the shares of Common Stock then outstanding. Following the Record Date and until the New Distribution Date, (i) the New Rights will be evidenced by the Common Stock certificates and will be transferred with and only with such Common Stock certificates, (ii) new Common Stock certificates issued after the Record Date will contain a notation incorporating the New Rights Agreement by reference and (iii) the surrender for transfer of any certificate for Common Stock outstanding will also constitute the transfer of the New Rights associated with the Common Stock represented by such certificate. The New Rights will not be exercisable until the New Distribution Date and will expire at the close of business on October 31, 2009 (subject to extension), unless earlier redeemed by the Corporation as described below. As soon as practicable after the New Distribution Date, Rights Certificates will be mailed to holders of record of the Common Stock as of the close of business on the New Distribution Date and, thereafter, the separate Rights Certificates alone will represent the New Rights. Except as otherwise determined by the Board of Directors, only shares of Common Stock issued prior to the New Distribution Date will be issued with New Rights. In the event (a "Flip-in Event") that any person, at any time after the date of the New Rights Agreement, becomes a New Acquiring Person, each holder of a New Right thereafter will have the right to receive, upon exercise thereof, Common Stock (or, in certain circumstances, cash, property or other securities of the Corporation) having a value equal to two times the Purchase Price. Notwithstanding any of the foregoing, following the occurrence of a Flip-in Event, all New Rights that are, or (under certain circumstances specified in the New Rights Agreement) were, beneficially owned by a New Acquiring Person, any of its associates or affiliates, and certain of its transferees, will be null and void. Moreover, the New Rights will not be exercisable following the first occurrence of a Flip-in Event until such time as the New Rights are no longer redeemable by the Corporation as described below. In the event that, at any time following the New Stock Acquisition Date, (i) the Corporation is acquired in a merger or other business combination transaction or (ii) 50% or more of the Corporation's assets or earning power is sold or transferred (each, a "Flip-over Event"), each holder of a New Right (except New Rights which previously have been voided as described above) shall thereafter have the right to receive, upon exercise thereof, common stock or other securities of the acquiring company having a value equal to two times the Purchase Price. 8 The Purchase Price payable, and the number of shares of Junior Participating Preferred Stock or other securities or property issuable, upon exercise of the New Rights are subject to adjustment from time to time in accordance with customary antidilution provisions. Following the occurrence of a Flip-in Event or a Flip-over Event, the antidilution provisions will apply to the Common Stock or other securities for which the New Rights are then exercisable. With certain exceptions, no adjustment to the Purchase Price will be required until cumulative adjustments amount to at least 1% of the Purchase Price. No fractional shares will be issued, other than fractional shares of Junior Participating Preferred Stock that are integral multiples of one one- hundredth of a share, and a cash payment will be made in lieu thereof based on the market price of the Junior Participating Preferred or Common Stock on the last trading day prior to the date of exercise. At any time after the New Rights become exercisable for Common Stock, the Board of Directors may exchange the unexercised New Rights (other than New Rights owned by any New Acquiring Person which have become void), in whole or in part, at an exchange ratio of one share of Common Stock, or one one-hundredth of a share of Junior Participating Preferred Stock (or of a share of a class or series of the Corporation's Preferred Stock having equivalent rights, preferences and privileges), per New Right (subject to adjustment). Notwithstanding the foregoing, no such exchange of the New Rights may be authorized by the Board of Directors during the New Special Period or at any time when the New Rights are not redeemable. The Board of Directors is empowered to redeem the New Rights in whole, but not in part, at the Redemption Price at any time before the earlier of (i) the close of business on the 20th day following the New Stock Acquisition Date or (ii) the final expiration date of the New Rights. Immediately upon the action of the Board of Directors ordering redemption of the New Rights, the New Rights will terminate and the only right of the holders of New Rights will be to receive the Redemption Price. Notwithstanding the foregoing, in the event that within 270 days of a public announcement by a third party of an intent or proposal to engage (without the current and continuing concurrence of the Board of Directors) in a transaction involving an acquisition of or business combination with the Corporation or otherwise to become a New Acquiring Person, there is an election of directors (whether at one or more stockholder meetings and/or pursuant to written stockholder consents) resulting in a majority of the Board of Directors being comprised of persons who were not nominated by the Board of Directors in office immediately prior to such election, then following such election and for a period of 180 days (the "New Special Period"), the New Rights, if otherwise then redeemable, will only be redeemable by the Board of Directors either (1) if they have followed certain prescribed procedures 9 or (2) in any other case, provided that, if in any such other case their decision regarding redemption and any acquisition or business combination is challenged as a breach of fiduciary duty of care or loyalty, the directors can establish the entire fairness of such decision without the benefit of any business judgement rule or other presumption. The procedures required under clause (1) include: (a) the retention of an independent financial advisor, and the receipt by the Board of Directors of (i) the views of such advisor regarding whether redemption of the New Rights will serve the best interests of the Corporation and its stockholders, or (ii) such advisor's statement that it is unable to express such a view, setting forth the reasons therefor; and (b) with respect to any pending acquisition or business combination proposal (i) the implementation by the Board of Directors, with the advice of its independent financial advisor, of a process and procedures which the Board of Directors and such advisor conclude would be most likely to result in the best value reasonably available to stockholders, (ii) receipt of a fairness opinion from such advisor, and the Board of Directors determining, and such advisor confirming, that it has no reason to believe that a superior transaction is reasonably available, and (iii) execution of a definitive transaction agreement. Until a New Right is exercised, the holder thereof, as such, will have no rights as a stockholder of the Corporation, including, without limitation, the right to vote or to receive dividends. While the distribution of the New Rights will not be taxable to stockholders or to the Corporation, stockholders may, depending upon the circumstances, recognize taxable income in the event that the New Rights become exercisable for Common Stock (or other consideration) or for common stock of an acquiring company as set forth above. The New Rights Agreement may be amended by the Board of Directors without the approval of any holders of the New Rights (a) prior to the New Distribution Date, in any manner and (b) after the New Distribution Date, in order to (i) cure any ambiguity, (ii) correct or supplement provisions which may be defective or inconsistent, (iii) make changes which do not adversely affect the interests of holders of New Rights (other than those held by a New Acquiring Person or certain related persons) or (iv) shorten or lengthen any time period under the New Rights Agreement (including the time period governing redemption), provided that no supplement or amendment to the New Rights Agreement may be made during the New Special Period or at any time when the New Rights are nonredeemable other than supplements or amendments of the type contemplated by clause (i) or (ii) above. The New Rights may have certain anti-takeover effects. The New Rights will cause substantial dilution to a person or group that attempts to acquire the Corporation unless the acquisition is conditioned on a substantial number of New 10 Rights being acquired. The New Rights should not interfere with any merger or other business combination properly approved by the Board of Directors. 11 -----END PRIVACY-ENHANCED MESSAGE-----