EX-13 6 dex13.htm ANNUAL REPORT Annual Report
Table of Contents

FINANCIAL REVIEW

 

22

Consolidated Financial Highlights of Financial Condition and Results of Operations

 

23

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

66

Management’s Report on Internal Control Over Financial Reporting

 

67

Report of Independent Registered Public Accounting Firm with Respect to Internal Control over Financial Reporting

 

68

Consolidated Financial Statements

 

72

Notes to Consolidated Financial Statements

 

126

Report of Independent Registered Public Accounting Firm

 

127

Consolidated Financial Statistics

 

130

Senior Officers

 

131

Board of Directors

 

132

Corporate Information


Table of Contents

CONSOLIDATED FINANCIAL HIGHLIGHTS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

SUMMARY OF SELECTED CONSOLIDATED FINANCIAL DATA

 

($ In Millions Except Per Share Information)    2010        2009        2008        2007        2006  

FOR THE YEAR ENDED DECEMBER 31

                                                    

Noninterest Income

                                                    

Trust, Investment and Other Servicing Fees

   $ 2,081.9         $ 2,083.8         $ 2,134.9         $ 2,077.6         $ 1,791.6   

Foreign Exchange Trading Income

     382.2           445.7           616.2           351.3           247.3   

Security Commissions and Trading Income

     60.9           62.4           77.0           67.6           62.7   

Treasury Management Fees

     78.1           81.8           72.8           65.3           65.4   

Gain on Visa Share Redemption

                         167.9                       

Other Operating Income

     146.3           136.8           186.9           95.3           83.0   

Investment Security Gains (Losses), net

     (20.4        (23.4        (56.3        6.5           1.4   

Total Noninterest Income

     2,729.0           2,787.1           3,199.4           2,663.6           2,251.4   

Net Interest Income

     918.7           999.8           1,079.1           845.4           744.7   

Provision for Credit Losses

     160.0           215.0           115.0           18.0           15.0   

Income before Noninterest Expenses

     3,487.7           3,571.9           4,163.5           3,491.0           2,981.1   

Noninterest Expenses

                                                    

Compensation

     1,108.0           1,099.7           1,133.1           1,038.2           876.6   

Employee Benefits

     237.6           242.1           223.4           234.9           217.6   

Outside Services

     460.4           424.5           413.8           386.2           316.2   

Equipment and Software Expense

     287.1           261.1           241.2           219.3           205.3   

Occupancy Expense

     167.8           170.8           166.1           156.5           145.4   

Visa Indemnification (Benefits) Charges

     (33.0        (17.8        (76.1        150.0             

Other Operating Expenses

     270.0           136.3           786.3           245.1           195.8   

Total Noninterest Expenses

     2,497.9           2,316.7           2,887.8           2,430.2           1,956.9   

Income before Income Taxes

     989.8           1,255.2           1,275.7           1,060.8           1,024.2   

Provision for Income Taxes

     320.3           391.0           480.9           333.9           358.8   

Net Income

   $ 669.5         $ 864.2         $ 794.8         $ 726.9         $ 665.4   

Net Income Applicable to Common Stock

   $ 669.5         $ 753.1         $ 782.8         $ 726.9         $ 665.4   

Average Total Assets

   $ 76,008         $ 74,314         $ 73,029         $ 60,588         $ 53,106   

PER COMMON SHARE

                                                    

Net Income – Basic

   $ 2.74         $ 3.18         $ 3.51         $ 3.28         $ 3.03   

– Diluted

     2.74           3.16           3.47           3.23           2.99   

Cash Dividends Declared

     1.12           1.12           1.12           1.03           .94   

Book Value – End of Period (EOP)

     28.19           26.12           21.89           20.44           18.03   

Market Price – EOP

     55.41           52.40           52.14           76.58           60.69   

AT YEAR END

                                                    

Senior Notes

   $ 1,896         $ 1,552         $ 1,053         $ 654         $ 445   

Long-Term Debt

     2,729           2,838           3,293           2,682           2,308   

Floating Rate Capital Debt

     277           277           277           277           276   

RATIOS

                                                    

Dividend Payout Ratio

     40.8        35.2        32.0        31.4        30.8

Return on Average Assets

     .88           1.16           1.09           1.20           1.25   

Return on Average Common Equity

     10.09           12.73           15.98           17.46           17.57   

Tier 1 Capital to Risk-Weighted Assets – EOP

     13.6           13.4           13.1           9.7           9.8   

Total Capital to Risk-Weighted Assets – EOP

     15.6           15.8           15.4           11.9           11.9   

Risk-Adjusted Leverage Ratio

     8.8           8.8           8.5           6.8           6.7   

Average Stockholders’ Equity to Average Assets

     8.7           8.9           7.0           6.9           7.1   

 

OPERATING RESULTS – A NON-GAAP FINANCIAL MEASURE WHICH EXCLUDES VISA RELATED ADJUSTMENTS

 

  

($ In Millions Except Per Share Information)    2010        2009        2008        2007        2006  

Operating Earnings

   $ 648.6         $ 853.0         $ 641.3         $ 821.1         $ 665.4   

Operating Earnings per Common Share – Basic

   $ 2.66         $ 3.13         $ 2.82         $ 3.71         $ 3.03   

– Diluted

     2.65           3.11           2.79           3.65           2.99   

Operating Return on Average Common Equity

     9.89        12.68        12.89        19.72        17.57

 

Operating results for 2010, 2009, 2008 and 2007 exclude adjustments relating to Visa Inc. (Visa). Excluded for 2010, 2009 and 2008 are Visa indemnification related benefits totaling $33.0 million, $17.8 million and $244.0 million, respectively. Excluded for 2007 are Visa indemnification related charges totaling $150.0 million. The 2008 benefits included a gain on the mandatory partial redemption of Northern Trust’s Visa shares totaling $167.9 million and a $76.1 million offset of the Visa indemnification related charges recorded in 2007. Visa related adjustments are discussed in further detail in Note 19 to the consolidated financial statements.

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

OVERVIEW OF CORPORATION

 

Focused Business Strategy

Northern Trust Corporation (Northern Trust or the Corporation) is a leading provider of asset servicing, fund administration, asset management, fiduciary and banking solutions for corporations, institutions, families, and individuals worldwide. Northern Trust focuses on servicing and managing client assets in two target market segments: individuals, families, and privately held businesses through its Personal Financial Services (PFS) business unit; and institutional investors worldwide through its Corporate and Institutional Services (C&IS) business unit. An important element of this strategy is to provide an array of asset management and related services to PFS and C&IS clients, which are provided primarily by a third business unit, Northern Trust Global Investments (NTGI). In executing this strategy, Northern Trust emphasizes quality through a high level of service complemented by the effective use of technology, delivered by a fourth business unit, Operations & Technology (O&T).

 

Business Structure

A financial holding company, Northern Trust conducts business through various U.S. and non-U.S. subsidiaries, including The Northern Trust Company (Bank). The Corporation has 78 offices in 18 U.S. states and 16 international locations in North America, Europe, the Asia Pacific region and the Middle East.

Except where the context otherwise requires, the term “Northern Trust” refers to Northern Trust Corporation and its subsidiaries on a consolidated basis.

 

FINANCIAL OVERVIEW

 

Amidst the prolonged uncertain macroeconomic environment, Northern Trust has been focused on growing its business in our targeted markets throughout 2010. Client assets under custody and management, important components of Northern Trust’s business, both grew during 2010. Client assets under custody experienced double-digit growth, equaling $4.1 trillion at year end, up 12% from $3.7 trillion in 2009, and included $2.3 trillion of global custody assets, 17% higher than a year ago. Client assets under management rose 3% to $643.6 billion from $627.2 billion in the prior year. Increases in client assets under custody and management reflect both higher market valuations and new business won from both existing and new clients. Northern Trust continues to maintain its strong capital position, exceeding “well capitalized” levels under federal bank regulatory capital requirements. At year end, total stockholders’ equity equaled $6.83 billion, up 8%, from $6.31 billion a year earlier.

Despite the constraints of the persistent low interest rate environment and continued difficult business conditions experienced in 2010, which have negatively impacted net interest income and trust fee levels, Northern Trust achieved net income of $669.5 million and earnings per common share totaled $2.74. These compare with $864.2 million of net income and earnings per common share of $3.16 in the year ended December 31, 2009. Per share earnings in 2009 were reduced by $111.1 million, equal to $.47 per share, from preferred stock dividends and discount accretion in connection with Northern Trust’s participation in the U.S. Department of the Treasury’s (U.S. Treasury) Capital Purchase Program (CPP), but benefitted from a net expense reduction of $109.3 million, equal to $.29 per share, associated with the final support payments and expiration of support provided to cash investment funds under the Corporation’s Capital Support Agreement (CSA) obligations.

Reported results in both 2010 and 2009 were impacted by various adjustments related to Visa, as further described in Note 19 to the consolidated financial statements. A reconciliation of operating earnings, a non-GAAP financial measure which excludes Visa related adjustments, to reported earnings prepared in accordance with U.S. generally accepted accounting principles (GAAP) is provided on page 63.

Revenues in 2010 equaled $3.69 billion on a fully taxable equivalent (FTE) basis, a decrease of 4% from 2009. Revenues were impacted by an $82.2 million, or 8%, decrease in net interest income (FTE) due to the effect on the net interest margin of the persistently low interest rate environment. The net interest margin for the current year declined to 1.41% from 1.56% in 2009. Revenues also were affected by a $63.5 million, or 14%, drop in foreign exchange trading income as a result of reduced currency volatility, partially offset by increased client volumes from 2009 levels. Trust, investment and other servicing fees – the largest component of consolidated revenues – totaled $2.08 billion, consistent with 2009. The benefits of higher market valuations during the year and new business were offset by a decrease in securities lending revenue as a result of lower recoveries of previously recorded unrealized asset valuation losses in a mark-to-market investment fund. Trust, investment and other servicing fees were also impacted by money market mutual fund fee waivers, which totaled $62.5 million in 2010 compared to $26.2 million in 2009, due to the persistent low level of short-term interest rates.

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Operating noninterest expenses, which exclude Visa indemnification related adjustments of $33.0 million and $17.8 million in 2010 and 2009, respectively, equaled $2.53 billion, an increase of 8% from 2009, primarily reflecting increased expenses associated with outside services, equipment and software as well as other operating expense items.

Credit loss provisions were $160.0 million in 2010 and $215.0 million in 2009. While the provision declined in 2010, the current year provision level reflects continued weakness in residential and commercial real estate loans in certain markets. Loans and leases equaled $28.1 billion at year end, an increase of 1% from $27.8 billion at the end of 2009.

In 2010, Northern Trust did not achieve its four long-term, across cycle, strategic financial targets, measured exclusive of Visa related items. Revenue and earnings per share growth were negative 4% and negative 13%, respectively, compared to the target revenue growth of 8-10% and earnings per share goal of 10-12% growth. In addition, we did not achieve positive operating leverage and the return on common equity achieved was 10% compared to the target of 16-18%. We recognize these targets as difficult to achieve in the current economic environment, but continue to believe they currently reflect our long-term, across cycle, strategic objectives.

 

CONSOLIDATED RESULTS OF OPERATIONS

 

REVENUE

Northern Trust generates the majority of its revenue from noninterest income that primarily consists of trust, investment and other servicing fees. Net interest income comprises the remainder of revenues and consists of interest income generated by earning assets, net of interest expense on deposits and borrowed funds.

Revenue for 2010 was $3.69 billion on an FTE basis. Revenue declined 4% from $3.83 billion in 2009, which in turn was down 12% from 2008 revenues of $4.33 billion. When adjusted to an FTE basis, yields on taxable, nontaxable, and partially taxable assets are comparable; the adjustment to an FTE basis has no impact on net income. Noninterest income represented 74% of total taxable equivalent revenue in 2010 and totaled $2.73 billion, down 2% from $2.79 billion in 2009. Noninterest income represented 73% of total taxable equivalent revenue in 2009 and was lower by 13% from $3.20 billion in 2008. Net interest income on an FTE basis for 2010 was $957.8 million, down 8% from $1.04 billion in 2009, which was down 8% from $1.13 billion in 2008.

The decrease in current year revenues primarily reflects reduced net interest income attributable to a decrease in the net interest margin as a result of the low interest rate environment. The net interest margin declined to 1.41% in 2010 from 1.56% in 2009. The prolonged low interest rate environment has resulted in reduced yields on the securities portfolio as maturing investments have been replaced by lower yielding assets. In addition, due to continuing weakness in loan demand, balance sheet growth has been concentrated in lower yielding assets, while a larger percentage of funding has come from interest-bearing sources. Partly offsetting this reduction was a $1.19 billion, or 2%, increase in average earning assets. 2010 revenues were also impacted by lower foreign exchange trading income, which totaled $382.2 million, down 14% compared with $445.7 million in 2009, as a result of reduced currency volatility, partially offset by increased client volumes from 2009.

Trust, investment and other servicing fees – the largest component of noninterest income – totaled $2.08 billion in both 2010 and 2009. Higher market valuations during the year and new business were offset by a decrease in securities lending revenue. Securities lending revenue in 2010 totaled $195.2 million as compared with $336.7 million in 2009. The current year decrease was primarily due to a reduction in the level of recoveries of previously recorded unrealized asset valuation losses in a mark-to-market investment fund used in our securities lending activities. Recoveries of previously recorded unrealized asset valuation losses totaled approximately $114 million in 2010 compared with approximately $204 million recorded in 2009. As of September 30, 2010, securities in the mark-to-market fund had been sold with the proceeds reinvested into a short duration fund, eliminating the mark-to-market impact on securities lending revenue in future periods. Excluding the impact of the asset valuation recoveries, securities lending fees decreased approximately $52 million, reflecting narrower spreads on the investment of cash collateral, partially offset by increased average volumes. Additional information regarding Northern Trust’s revenue by type is provided below.

 

2010 TOTAL REVENUE OF $3.69 BILLION (FTE)

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Noninterest Income

The components of noninterest income, and a discussion of significant changes during 2010 and 2009, are provided below.

 

NONINTEREST INCOME

 

                                  CHANGE  
(In Millions)      2010        2009        2008       

2010 / 2009

    

2009 / 2008

 

Trust, Investment and Other Servicing Fees

     $ 2,081.9         $ 2,083.8         $ 2,134.9           N/M         (2 )% 

Foreign Exchange Trading Income

       382.2           445.7           616.2           (14 )%       (28

Security Commissions and Trading Income

       60.9           62.4           77.0           (2      (19

Treasury Management Fees

       78.1           81.8           72.8           (5      12   

Gain on Visa Share Redemption

                           167.9                   N/M   

Other Operating Income

       146.3           136.8           186.9           7         (27

Investment Security Gains (Losses), net

       (20.4        (23.4        (56.3        (13      (58

Total Noninterest Income

     $ 2,729.0         $ 2,787.1         $ 3,199.4           (2 )%       (13 )% 

 

2010 NONINTEREST INCOME

 

LOGO

 

Trust, Investment and Other Servicing Fees

Trust, investment and other servicing fees accounted for 56% of total taxable equivalent revenue in 2010. These fees were $2.08 billion in both 2010 and 2009. For a more detailed discussion of 2010 trust, investment and other servicing fees, refer to the “Business Unit Reporting” section.

Trust, investment and other servicing fees are based generally on the market value of assets held in custody, managed and serviced; the volume of transactions; securities lending volume and spreads; and fees for other services rendered. Certain market value calculations on which fees are based are performed on a monthly or quarterly basis in arrears. Certain investment management fee arrangements also may provide for performance fees, based on client portfolio returns that exceed predetermined levels. Securities lending revenues have been impacted by Northern Trust’s share of unrealized investment gains and losses in one investment fund that is used in our securities lending activities and is accounted for at fair value. As of September 30, 2010, securities in the mark-to-market fund had been sold with the proceeds reinvested into a short duration fund, eliminating the mark-to-market impact on securities lending revenue in future periods. Based on an analysis of historical trends and current asset and product mix, management estimates that a 10% rise or fall in overall equity markets would cause a corresponding increase or decrease in Northern Trust’s trust, investment and other servicing fees of approximately 4% and in total revenues of approximately 2%.

 

The following table presents selected average month-end, average quarter-end, and year-end equity market indices and the percentage changes year over year.

 

MARKET INDICES    AVERAGE OF MONTH-END               AVERAGE OF QUARTER-END               YEAR-END         
     2010      2009      CHANGE        2010      2009      CHANGE        2010      2009      CHANGE  

S&P 500 ®

     1,131         949         19        1,150         972         18        1,258         1,115         13

MSCI EAFE ® (in U.S. dollars)

     1,511         1,342         13           1,538         1,369         12           1,658         1,581         5   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

 

C&IS client relationships are priced generally to reflect earnings from such activities as foreign exchange trading and custody related deposits not included in trust, investment and other servicing fees. Custody related deposits maintained with bank subsidiaries and foreign branches are primarily interest-bearing and averaged $30.0 billion in 2010, $30.4 billion in 2009, and $33.2 billion in 2008. Assets under custody and assets under management form the primary basis of our trust, investment and other servicing fees. At December 31, 2010, assets under custody were $4.08 trillion, up 12% from $3.66 trillion a year ago. Assets under custody included $2.26 trillion of global custody assets. Managed assets totaled $643.6 billion, up 3% from $627.2 billion at the end of 2009.

 

ASSETS UNDER CUSTODY            DECEMBER 31        CHANGE       

FIVE-YEAR
COMPOUND
GROWTH

RATE

 
($ In Billions)    2010        2009        2008        2007        2006        2010 / 2009       

Corporate & Institutional

   $ 3,711.1         $ 3,325.9         $ 2,719.2         $ 3,802.9         $ 3,263.5           12        7

Personal

     370.2           331.1           288.3           332.3           281.9           12           10   

Total Assets Under Custody

   $ 4,081.3         $ 3,657.0         $ 3,007.5         $ 4,135.2         $ 3,545.4           12        7

 

C&IS ASSETS UNDER CUSTODY

($ in Billions)

 

  

PFS ASSETS UNDER CUSTODY

($ in Billions)

 

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ASSETS UNDER MANAGEMENT            DECEMBER 31        CHANGE       

FIVE-YEAR
COMPOUND
GROWTH

RATE

 
($ In Billions)    2010        2009        2008        2007        2006        2010 /2009       

Corporate & Institutional

   $ 489.2         $ 482.0         $ 426.4         $ 608.9         $ 562.5           1        (1 )% 

Personal

     154.4           145.2           132.4           148.3           134.7           6           6   

Total Managed Assets

     643.6         $ 627.2         $ 558.8         $ 757.2         $ 697.2           3        1

 

C&IS ASSETS UNDER MANAGEMENT

($ in Billions)

 

  

PFS ASSETS UNDER MANAGEMENT

($ in Billions)

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Custodied and managed assets were invested as follows:

 

ASSETS UNDER CUSTODY    DECEMBER 31  
($ In Billions)    2010        2009  
       C&IS         PFS        Consolidated           C&IS         PFS        Consolidated   

Equities

     48      46     48        48      42     47

Fixed Income Securities

     35         26        34           34         28        34   

Cash and Other Assets

     17         28        18           18         30        19   
ASSETS UNDER MANAGEMENT    DECEMBER 31  
($ In Billions)    2010        2009  
       C&IS         PFS        Consolidated           C&IS         PFS        Consolidated   

Equities

     48      36     45        45      35     42

Fixed Income Securities

     15         33        19           14         33        19   

Cash and Other Assets

     37         31        36           41         32        39   

 

Foreign Exchange Trading Income

Northern Trust provides foreign exchange services in the normal course of business as an integral part of its global custody services. Active management of currency positions, within conservative limits, also contributes to trading income. Foreign exchange trading income decreased 14%, or $63.5 million, and totaled $382.2 million in 2010 compared with $445.7 million last year. The decrease from the prior year primarily reflects reduced currency volatility, partially offset by increased client volumes.

 

Security Commissions and Trading Income

Security commissions and trading income is generated primarily from securities brokerage services provided by Northern Trust Securities, Inc. The current year decline to $60.9 million from $62.4 million in 2009 principally reflects decreased revenue from core brokerage services.

 

Treasury Management Fees

The fee portion of treasury management revenues decreased to $78.1 million from $81.8 million in 2009. The 2009 fees reflect the pass through of a higher level of Federal Deposit Insurance Corporation (FDIC) premium charges. Treasury management revenues in 2010 were impacted by lower transaction volumes.

 

Other Operating Income

The components of other operating income include:

 

                                  CHANGE  
(In Millions)      2010        2009        2008       

2010 / 2009

      

2009 / 2008

 

Banking Service Fees

     $ 57.3         $ 53.1         $ 39.4           8        35

Loan Service Fees

       60.3           52.1           30.0           16           74   

Non-Trading Foreign Exchange Gains (Losses)

       (2.8        (1.4        36.1           100           N/M   

Credit Default Swap Gains (Losses)

       (1.7        (4.6        35.4           (63        N/M   

Other Income

       33.2           37.6           46.0           (12        (18
                                                        

Total Other Operating Income

     $ 146.3         $ 136.8         $ 186.9           7        (26 )% 

 

The increase in banking service fees primarily reflects higher letter of credit revenue. Growth in commercial loan- related commitment fees explains the rise in loan service fees. Non-trading foreign exchange gains (losses) reflect the impact of foreign exchange rate movements during the period on the translation to functional currencies of assets and liabilities denominated in nonfunctional currencies, net of currency-related hedging activity. Credit default swap gains and losses reflect the mark-to-market adjustments of credit default swap contracts used to mitigate credit risk associated with specific commercial credits. The other income decrease is primarily a result of a prior year gain on the sale of leases, partially offset by a current year gain on the sale of a building.

 

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Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Investment Security Gains (Losses)

Net investment security losses were $20.4 million in 2010 compared to $23.4 million in 2009. The current and prior year included $21.2 million and $26.7 million, respectively, of pre-tax charges for the credit-related other-than-temporary impairment of residential mortgage backed securities held within Northern Trust’s balance sheet investment securities portfolio.

 

NONINTEREST INCOME — 2009 COMPARED WITH 2008

Trust, investment and other servicing fees for 2009 accounted for 75% of total noninterest income and 54% of total taxable equivalent revenue. These fees decreased 2% in 2009 to $2.08 billion from $2.13 billion in 2008, attributable primarily to lower market valuations during the majority of 2009.

Foreign exchange trading income decreased 28% in 2009 to $445.7 million from a record $616.2 million in 2008. The decrease reflected significantly reduced currency volatility and client volumes from the record levels in 2008.

Revenues from security commissions and trading income totaled $62.4 million in 2009, compared with $77.0 million in 2008. The decrease primarily reflected decreased revenue from core brokerage services.

Treasury management fees were $81.8 million in 2009, up 12% from the $72.8 million reported in 2008. More clients elected to pay for services in fees rather than with compensating deposit balances and there was a higher level of pass through of FDIC premium charges.

Other operating income totaled $136.8 million in 2009, a decrease of 27% from $186.9 million in 2008. The decrease primarily reflected credit default swap and non-trading foreign exchange losses incurred in 2009 as compared to credit default swap and non-trading foreign exchange gains in 2008, partially offset by higher loan and banking service fee revenues attributable to higher commercial loan-related commitment fee revenue and letter of credit revenue, respectively.

Net investment security losses of $23.4 million in 2009 and $56.3 million in 2008 included $26.7 million and $61.3 million, respectively, of other-than-temporary impairment charges. A gain of $4.9 million was recorded in 2008 from the sale of CME Group Inc. stock.

 

Net Interest Income

An analysis of net interest income on an FTE basis, major balance sheet components impacting net interest income, and related ratios are provided below.

 

ANALYSIS OF NET INTEREST INCOME (FTE)

 

                                CHANGE  
($ In Millions)    2010        2009        2008        2010 / 2009        2009 / 2008  

Interest Income

   $ 1,296.7         $ 1,406.0         $ 2,478.5           (7.8 )%         (43.3 )% 

FTE Adjustment

     39.1           40.2           49.8           (2.7        (19.3
                                                      

Interest Income – FTE

     1,335.8           1,446.2           2,528.3           (7.6        (42.8

Interest Expense

     378.0           406.2           1,399.4           (6.9        (71.0
                                                      

Net Interest Income – FTE Adjusted

     957.8           1,040.0         $ 1,128.9           (7.9 )%         (7.9 )% 
                                                      

Net Interest Income – Unadjusted

   $ 918.7         $ 999.8         $ 1,079.1           (8.1 )%         (7.3 )% 
                                                      

AVERAGE BALANCE

                                                    

Earning Assets

   $ 67,865.4         $ 66,670.8         $ 64,249.9           1.8        3.8

Interest-Related Funds

     57,179.4           53,671.6           55,173.9           8.0           (2.7

Net Noninterest-Related Funds

     10,686.0           12,999.2           9,076.0           (23.8        43.2   
                                                      
                               

CHANGE IN PERCENTAGE

 

AVERAGE RATE

                                                    

Earning Assets

     1.97        2.17        3.94        (.20        (1.77

Interest-Related Funds

     .66           .76           2.54           (.10        (1.78

Interest Rate Spread

     1.31           1.41           1.40           (.10        .01   

Total Source of Funds

     .56           .61           2.18           (.05        (1.57

Net Interest Margin

     1.41        1.56        1.76        (.15        (.20

Refer to pages 128 and 129 for additional analysis of net interest income.

 

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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 interest-related hedging activity. Earning assets – securities, loans and money market assets – are financed by a large base of interest-bearing funds that include personal and institutional deposits, wholesale deposits, short-term borrowings, senior notes and long-term debt. Earning assets also are funded by net noninterest-related funds, which include demand deposits, the reserve for credit losses and stockholders’ equity, reduced by nonearning assets such as cash and due from banks; items in process of collection; and buildings and equipment. The dominant factors that affect net interest income are variations in the level and mix of earning assets; interest-bearing funds; net noninterest-related funds; and their relative sensitivity to interest rate movements. In addition, the levels of nonperforming assets and client compensating deposit balances used to pay for services impact net interest income.

Net interest income in 2010 was $918.7 million, down 8% from $999.8 million in 2009. When adjusted to an FTE basis, yields on taxable, nontaxable and partially taxable assets are comparable, although the adjustment to an FTE basis has no impact on net income. Net interest income on an FTE basis for 2010 was $957.8 million, a decline of 8% from $1.04 billion in 2009. The net interest margin was 1.41% for 2010, down from the previous year’s 1.56%. The net interest margin was negatively impacted by several factors. The prolonged low interest rate environment resulted in reduced yields on the securities portfolio as maturing investments were replaced by lower yielding assets. In addition, due to continuing weakness in loan demand, balance sheet growth has been concentrated in lower yielding assets, while a larger percentage of funding has come from interest-bearing sources.

Earning assets averaged $67.9 billion in 2010, up 2% from the $66.7 billion reported in the prior year. This growth reflects a $2.5 billion increase in securities, partially offset by a $1.2 billion decrease in loans and leases, and a $.1 billion decrease in money market assets.

Loans and leases averaged $27.5 billion, 4% lower than the $28.7 billion in 2009. The year-to-year comparison reflects a 19% decrease in average commercial and institutional loans to $6.2 billion from $7.6 billion in 2009. Residential real estate loans averaged $10.8 billion in 2010, an increase of 2% from $10.7 billion in 2009. Average private client loans totaled $5.0 billion, up 7% from $4.7 billion in the prior year, while commercial real estate loans averaged $3.3 billion, up 2% from $3.2 billion in 2009.

Securities averaged $19.9 billion, up 14% from 2009, with the growth primarily in negotiable certificates of deposits, U.S. government, and other asset-backed securities.

The increase in average earning assets of $1.2 billion was funded primarily by higher levels of interest-related funds. The growth in interest-related funds was attributable to higher average client balances in non-U.S. office interest-bearing deposits, partially offset by lower average short-term borrowings. Average noninterest-related funding sources in 2010 declined $2.3 billion from 2009, primarily due to a decrease in average demand and other noninterest-bearing deposits. In November 2010, Northern Trust issued $500 million of 3.450% fixed-rate senior notes of the Corporation due on November 4, 2020. The senior notes are non-callable and unsecured, and were issued at a discount to yield 3.464%.

Stockholders’ equity averaged $6.6 billion in 2010 and 2009. In April 2009, 17,250,000 common shares were issued in connection with a public offering for which $834.1 million of cash proceeds were received.

For additional analysis of average balances and interest rate changes affecting net interest income, refer to the Average Statement of Condition with Analysis of Net Interest Income on pages 128 and 129.

 

NET INTEREST INCOME – 2009 COMPARED WITH 2008

Net interest income decreased in 2009 as compared to 2008 primarily as a result of a significant reduction in the net interest margin attributable to depressed interest rates, partially offset by an increase in average earning assets. The net interest margin decreased to 1.56% from 1.76% in 2008, reflecting significant decline in yields on short-term assets and the diminished value of noninterest-related funding sources because of the significant decline in interest rates in 2009.

Earning assets averaged $66.7 billion in 2009, up 4% from $64.2 billion in 2008. The growth reflected a $5.1 billion increase in average securities balances and a $1.3 billion increase in average loans and leases, partially offset by a $3.9 billion decrease in money market assets. The increase in average earning assets of $2.5 billion was funded primarily by higher levels of noninterest-bearing deposits and an increase in stockholders’ equity. Interest-related funding sources in 2009 declined $1.5 billion from 2008, primarily due to lower levels of non-U.S. office time deposits, partially offset by increases in domestic deposits, short-term borrowings and senior notes.

 

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Stockholders’ equity for 2009 averaged $6.6 billion, up $1.5 billion, or 29% from 2008. The increase primarily reflected cash proceeds of $834.1 million received from the April 2009 issuance of 17,250,000 common shares in connection with a public offering, the $1.576 billion of preferred stock issued to the U.S. Treasury in November 2008 in connection with the Corporation’s participation in the U.S. Treasury’s CPP, and the retention of earnings. The preferred stock issued under the CPP was repurchased in full in June 2009.

 

Provision for Credit Losses

The provision for credit losses was $160.0 million in 2010 compared with $215.0 million in 2009 and a $115.0 million provision in 2008. The current year provision, though reduced from the prior year level, reflects the continued weakness in residential real estate and commercial real estate loans in certain markets. For a fuller discussion of the reserve and provision for credit losses for 2010, 2009, and 2008, refer to pages 58 through 60.

 

Noninterest Expenses

Noninterest expenses for 2010 totaled $2.50 billion, up 8% from $2.32 billion in 2009. The components of noninterest expenses and a discussion of significant changes during 2010 and 2009 are provided below.

 

NONINTEREST EXPENSES

 

                                  CHANGE  
(In Millions)      2010        2009        2008       

2010 / 2009

      

2009 / 2008

 

Compensation

     $ 1,108.0         $ 1,099.7         $ 1,133.1           1        (3 )% 

Employee Benefits

       237.6           242.1           223.4           (2        8   

Outside Services

       460.4           424.5           413.8           8           3   

Equipment and Software Expense

       287.1           261.1           241.2           10           8   

Occupancy Expense

       167.8           170.8           166.1           (2        3   

Visa Indemnification Benefits

       (33.0        (17.8        (76.1        85           77   

Other Operating Expense

       270.0           136.3           786.3           98           (83
                                                        

Total Noninterest Expenses

     $ 2,497.9         $ 2,316.7         $ 2,887.8           8        (20 )% 

 

Compensation and Benefits

Compensation costs, the largest component of noninterest expenses, increased $8.3 million from 2009. The increase reflects the reversal in 2009 of accruals totaling $22.2 million related to performance stock units granted in 2008 and 2007 which were no longer expected to vest, partially offset by a decrease in salary expense in the current year. Staff on a full- time equivalent basis totaled approximately 12,800 at December 31, 2010 compared with approximately 12,400 at December 31, 2009, and averaged 12,600 in 2010, up 2% compared with 12,300 in 2009. The 2010 increases primarily reflect additional staff to support international growth. The decrease in employee benefit costs for 2010 primarily reflects lower federal and employee insurance benefits.

 

Outside Services

Outside services expense of $460.4 million in 2010 increased $35.9 million from the prior year due to higher expenses associated with investment manager sub-advisor fees, and technical services. Investment manager sub-advisor fees are those paid to external investment managers for services provided to certain funds Northern Trust manages and those relating to custom client programs. Technical services include expenses for systems and application support; the provision of market and research data; and outsourced check processing and lockbox services, among other services.

 

Equipment and Software Expense

Equipment and software expense, comprised of depreciation and amortization; rental; and maintenance costs, increased $26.0 million in 2010 compared to 2009. The increase primarily reflects higher levels of computer software depreciation and amortization from additional investments in capital assets and an increase in equipment expense from higher computer maintenance and equipment rental.

 

Occupancy Expense

Net occupancy expense totaled $167.8 million in 2010 compared to $170.8 million in 2009, reflecting decreased building depreciation, rent expense, and real estate taxes, partially offset by expenses associated with building operations.

 

Visa Indemnification Charges

In 2010, 2009 and 2008, reductions to Northern Trust’s Visa indemnification liability and related charges totaled $33.0

 

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million, $17.8 million and $76.1 million, respectively. Northern Trust, as a member bank of Visa U.S.A., and in conjunction with other member banks, is obligated to share in losses resulting from certain indemnified litigation involving Visa. The reductions reflect Northern Trust’s proportionate share of funds that Visa deposited into its litigation escrow account in those years. Visa indemnification charges are further discussed in Note 19 to the consolidated financial statements.

 

Other Operating Expenses

The components of other operating expenses were as follows:

 

                                  CHANGE  
(In Millions)      2010        2009        2008       

2010 /2009

      

2009 /2008

 

Business Promotion

     $ 81.0         $ 66.6         $ 87.8           22        (24 )% 

FDIC Insurance Premiums

       33.9           54.1           5.6           (37        N/M   

Staff Related

       37.4           31.3           38.1           19           (18

Other Intangibles Amortization

       14.4           16.2           17.8           (11        (9

Capital Support Agreements

                 (109.3        314.1           N/M           N/M   

Securities Lending Client Support

                           167.6                     N/M   

Auction Rate Securities Purchase Program

                           54.6                     N/M   

Other Expenses

       103.3           77.4           100.7           33           (23
                                                        

Total Other Operating Expenses

     $ 270.0         $ 136.3         $ 786.3           98        (83 )% 

 

Business promotion for the current year increased primarily due to higher advertising and travel related expenses. The decrease in FDIC insurance premiums reflects the 2009 special assessment of $20.2 million. Staff related expenses, which include costs associated with the hiring and training of staff, employee relocation assistance, and other similar employee related expenses, also increased in the current year. The 2009 capital support agreements balance is attributable to a net expense reduction of $109.3 million associated with the final support payments and expiration of the CSA obligations. The other expenses component of other operating expenses reflects higher charges related to account servicing activities and increases in other miscellaneous expense categories.

 

NONINTEREST EXPENSE — 2009 COMPARED WITH 2008

Noninterest expenses for 2009 totaled $2.32 billion, down 20% from $2.89 billion in 2008. On an operating basis, which excludes the Visa related pre-tax benefits in 2009 and 2008, noninterest expenses decreased $629.4 million, or 21%. 2008 results were impacted by $536.3 million of client support related charges, including $314.1 million of support provided to cash investment funds under CSAs. Noninterest expenses for 2009 included a net expense reduction of $109.3 million associated with the final support payments and expiration of the CSA obligations.

Compensation costs decreased $33.4 million, or 3%, from 2008 and reflected the impact of lower salary expense and performance-based equity compensation, offset partially by higher cash-based incentives. 2008 included a $17.0 million charge in connection with initiatives to reduce staff expense levels. Staff on a full time equivalent basis averaged 12,300 in 2009, up 5% from 11,700 in 2008. The 2009 increase was attributable to additional staff to support international growth. Staff on a full time equivalent basis totaled 12,400 at December 31, 2009, compared with 12,200 at year-end 2008.

Employee benefit costs for 2009 were $242.1 million, up $18.7 million, or 8%, from $223.4 million in 2008, reflecting higher defined benefit and defined contribution plan expenses and staff levels.

Outside services expense totaled $424.5 million in 2009, up 3% from $413.8 million in 2008 due to higher technical services and investment manager sub-advisor expenses.

Equipment and software expense increased 8% to $261.1 million in 2009 from $241.2 million in 2008. The increase reflected higher levels of computer software depreciation and amortization from continued investments in information technology infrastructure.

Net occupancy expense for 2009 was $170.8 million, up 3% from $166.1 million in 2008 due to increased rent expense.

Reductions to Northern Trust’s Visa indemnification liability and related charges totaled $17.8 million and $76.1 million in 2009 and 2008, respectively.

Other operating expenses totaled $136.3 million in 2009, down from $786.3 million in 2008 and included a net expense reduction of $109.3 million associated with the final support payments and expiration of the CSA obligations. Other operating expenses for 2008 included $536.3 million of client support related charges comprised of $314.1 million in connection with support provided to investment vehicles under the CSAs, $167.6 million of support provided to Northern

 

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Trust’s securities lending clients and $54.6 million related to the establishment of a program to purchase certain illiquid auction rate securities that were purchased by a limited number of Northern Trust clients. Other operating expenses also declined in 2009 due to lower business promotion, staff related expenses and other miscellaneous expenses, partially offset by a special assessment of FDIC insurance premiums of $20.2 million and higher assessment rates and an increase in insured domestic balances. The 2008 other expenses component included a $20.1 million currency translation related benefit associated with Lehman Brothers bankruptcy matters.

 

Provision for Income Taxes

The provision for income tax and effective tax rates are impacted by levels of pre-tax income, effective state tax rates, and the impact of certain subsidiaries whose earnings are indefinitely reinvested, as well as non-recurring items such as the resolution of tax matters. The 2010 income tax provision was $320.3 million, representing an effective rate of 32.4%. This compares with $391.0 million of income tax expense and an effective rate of 31.2% in 2009. The increase in the effective rate for 2010 is attributable to a lower level of state income tax benefits in the current year as compared to 2009 and income tax benefits recorded in 2009 relating to the resolution of certain structured leasing tax positions taken in periods prior to 2009.

The tax provisions for 2010 and 2009 reflect reductions totaling $20.1 million and $20.9 million, respectively, related to certain non-U.S. subsidiaries whose earnings are being indefinitely reinvested. The decrease in the current year amount reflects an increase in the average effective tax rate of non-U.S. subsidiaries, partially offset by the Corporation’s election to indefinitely reinvest the earnings of an additional non-U.S. subsidiary.

The 2008 income tax provision of $480.9 million represented an effective rate of 37.7%. The effective tax rate in 2008 reflected a $61.3 million charge related to revised estimates regarding the outcome of the Corporation’s tax position with respect to certain structured leasing transactions and a $47.8 million reduction in the tax provision related to non-U.S. subsidiaries whose earnings are being indefinitely reinvested.

 

BUSINESS UNIT REPORTING

 

Northern Trust, under the leadership of Chairman, President, and Chief Executive Officer Frederick H. Waddell, is organized around its two principal client-focused business units, C&IS and PFS. Investment management services and products are provided to the clients of these business units and to other U.S. and non-U.S. clients by NTGI. Operations support is provided to each of the business units by O&T. Mr. Waddell has been identified as the chief operating decision maker, having final authority over resource allocation decisions and performance assessment.

C&IS and PFS results are presented to promote a greater understanding of their financial performance. The information, presented on an internal management-reporting basis, derives from internal accounting systems that support Northern Trust’s strategic objectives and management structure. Management has developed accounting systems to allocate revenue and expenses related to each segment. They incorporate processes for allocating assets, liabilities and equity, and the applicable interest income and expense. Equity is allocated based on the proportion of economic capital associated with the business units.

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 consistent with those described in Note 1 to the consolidated financial statements. Transfers of income and expense items are recorded at cost; there is no consolidated profit or loss on sales or transfers between business units. Northern Trust’s presentations are not necessarily consistent with similar information for other financial institutions.

 

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CONSOLIDATED FINANCIAL INFORMATION

 

                                CHANGE  
(In Millions)    2010        2009        2008       

2010 / 2009

    

2009 / 2008

 

Noninterest Income

                                                  

Trust, Investment and Other Servicing Fees

   $ 2,081.9         $ 2,083.8         $ 2,134.9           N/M      (2 )% 

Gain on Visa Share Redemption

                         167.9                   N/M   

Other

     647.1           703.3           896.6           (8      (22

Net Interest Income (FTE)*

     957.8           1,040.0           1,128.9           (8      (8
                                                    

Revenues (FTE)*

     3,686.8           3,827.1           4,328.3           (4      (12

Provision for Credit Losses

     160.0           215.0           115.0           (26      87   

Visa Indemnification Benefits

     (33.0        (17.8        (76.1        85         (77

Noninterest Expenses

     2,530.9           2,334.5           2,963.9           8         (21
                                                    

Income before Income Taxes*

     1,028.9           1,295.4           1,325.5           (21      (2

Provision for Income Taxes*

     359.4           431.2           530.7           (17      (19
                                                    

Net Income

   $ 669.5         $ 864.2         $ 794.8           (23 )%       9
                                                    

Average Assets

   $ 76,008.2         $ 74,314.2         $ 73,028.5           2      2

* Stated on an FTE basis. The consolidated figures include $39.1 million, $40.2 million, and $49.8 million of FTE adjustment for 2010, 2009, and 2008, respectively.

 

Corporate and Institutional Services

The C&IS business unit is a leading global provider of asset servicing, asset management, securities lending, brokerage, banking and related services to corporate and public retirement funds, foundations, endowments, fund managers, insurance companies, sovereign wealth and government funds. Asset servicing, asset management, and related services encompass a full range of industry leading capabilities including but not limited to: global master trust and custody, trade settlement, and reporting; fund administration; cash management; investment risk and performance analytical services; and investment operations outsourcing. Client relationships are managed through the Bank and the Bank’s and the Corporation’s other subsidiaries, including support from international locations in North America, Europe, the Middle East, and the Asia Pacific region. Asset servicing relationships managed by C&IS often include investment management, transition management, and commission recapture services provided through NTGI. C&IS also provides related foreign exchange services from offices located in the U.S., U.K. and Singapore.

 

The following table summarizes the results of operations of C&IS for the years ended December 31, 2010, 2009, and 2008 on a management-reporting basis.

 

CORPORATE AND INSTITUTIONAL SERVICES

RESULTS OF OPERATIONS

 

                                CHANGE  
(In Millions)    2010        2009        2008       

2010 / 2009

    

2009 / 2008

 

Noninterest Income

                                                  

Trust, Investment and Other Servicing Fees

   $ 1,175.1         $ 1,236.8         $ 1,225.9           (5 )%       1

Other

     522.7           571.3           804.6           (9      (29

Net Interest Income (FTE)*

     271.8           416.0           571.1           (35      (27
                                                    

Revenues (FTE)*

     1,969.6           2,224.1           2,601.6           (11      (15

Provision for Credit Losses

     (16.1        30.7           25.2           N/M         22   

Noninterest Expenses

     1,328.9           1,200.6           1,779.5           11         (33
                                                    

Income before Income Taxes*

     656.8           992.8           796.9           (34      25   

Provision for Income Taxes*

     222.4           350.8           308.2           (37      14   
                                                    

Net Income

   $ 434.4         $ 642.0         $ 488.7           (32 )%       31
                                                    

Percentage of Consolidated Net Income

     65        74        61                    
                                                    

Average Assets

   $ 38,749.3         $ 38,117.1         $ 49,490.4           2      (23 )% 

* Stated on an FTE basis.

 

 

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The decrease in C&IS net income in 2010 resulted from reductions in securities lending revenue, a component of trust, investment and other servicing fees; net interest income; and foreign exchange trading income; and higher noninterest expenses; partially offset by a negative provision for credit losses. Other components of trust, investment and other servicing fees increased in 2010 primarily attributable to new business and improved market valuations. The net income increase in 2009 as compared to 2008 primarily reflects reduced noninterest expenses, increased securities lending revenue, and new business, partially offset by reduced foreign exchange trading income and net interest income.

 

C&IS Trust, Investment and Other Servicing Fees

C&IS trust, investment and other servicing fees are attributable to four general product types: Custody and Fund Administration, Investment Management, Securities Lending, and Other Services. Custody and fund administration fees are driven primarily by asset values, transaction volumes and number of accounts. Custody fees related to asset values are often priced based on values at the beginning of each quarter; however, there are custody fees that are based on quarter-end or month-end values or average values for a month or quarter. The fund administration fees that are asset value related are generally priced using average daily balances. Investment management fees are based primarily on market values throughout a period.

Securities lending revenue is affected by market values; the demand for securities to be lent, which drives volumes; and the interest rate spread earned on the investment of cash deposited by investment firms as collateral for securities they have borrowed. Securities lending revenue has also included Northern Trust’s share of unrealized gains and losses on one mark-to-market investment fund used in securities lending activities. As of September 30, 2010, securities in the mark-to-market fund had been sold with the proceeds reinvested into a short duration fund, eliminating the mark-to-market impact on securities lending revenue in future periods. The other services fee category in C&IS includes such products as benefit payment, performance analysis, electronic delivery, and other services. Revenues from these products are based generally on the volume of services provided or a fixed fee.

 

Provided below are the components of C&IS trust, investment and other servicing fees and a breakdown of its assets under custody and under management.

 

 

CORPORATE AND INSTITUTIONAL SERVICES

TRUST, INVESTMENT AND OTHER SERVICING FEES

 

(In Millions)    2010        2009        2008  

Custody and Fund Administration

   $ 646.1         $ 583.0         $ 661.6   

Investment Management

     261.2           247.1           277.4   

Securities Lending

     195.2           336.7           221.4   

Other Services

     72.6           70.0           65.5   
                                

Total Trust, Investment and Other Servicing Fees

   $ 1,175.1         $ 1,236.8         $ 1,225.9   

 

2010 C&IS FEES

 

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CORPORATE AND INSTITUTIONAL SERVICES

ASSETS UNDER CUSTODY

 

              DECEMBER 31  
(In Billions)    2010        2009        2008  

North America

   $ 1,999.6         $ 1,861.9         $ 1,661.1   

Europe, Middle East, and Africa

     1,280.7           1,085.9           801.7   

Asia Pacific Region

     331.7           263.6           146.2   

Securities Lending

     99.1           114.5           110.2   
                                

Total Assets Under Custody

   $ 3,711.1         $ 3,325.9         $ 2,719.2   

 

2010 C&IS ASSETS UNDER CUSTODY

 

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CORPORATE AND INSTITUTIONAL SERVICES

ASSETS UNDER MANAGEMENT

 

     DECEMBER 31  
(In Billions)    2010        2009        2008  

North America

   $ 284.7         $ 257.6         $ 232.3   

Europe, Middle East, and Africa

     69.0           63.5           52.8   

Asia Pacific Region

     36.4           46.4           31.1   

Securities Lending

     99.1           114.5           110.2   

Total Assets Under Management

   $ 489.2         $ 482.0         $ 426.4   

 

2010 C&IS ASSETS UNDER MANAGEMENT

 

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Custody and fund administration fees, the largest component of trust, investment and other servicing fees, increased $63.1 million, or 11%, to $646.1 million from $583.0 million in 2009, primarily reflecting higher fund administration and global custody fee revenues. Fees from investment management totaled $261.2 million, up from $247.1 million in the year-ago period. The 6% increase primarily reflects higher market valuations during the majority of the year, partially offset by $12.9 million of money market mutual fund fee waivers due to the persistent low level of short-term interest rates. Money market mutual fund fee waivers for 2009 totaled $2.3 million. Securities lending revenue decreased $141.5 million, or 42%, to $195.2 million compared with $336.7 million in 2009. The current year includes the recovery of previously recorded unrealized asset valuation losses of approximately $114 million related to a mark-to-market investment fund used in our securities lending activities, compared to recoveries of approximately $204 million in 2009. Excluding the impact of asset valuation recoveries, securities lending fees decreased by approximately $52 million, reflecting lower spreads on the investment of cash collateral, partially offset by higher average volumes.

 

C&IS assets under custody were $3.7 trillion at December 31, 2010, 12% higher than $3.3 trillion at December 31, 2009. Managed assets totaled $489.2 billion and $482.0 billion, at December 31, 2010 and 2009, respectively. Cash and other assets deposited by investment firms as collateral for securities borrowed from custody clients are managed by Northern Trust and are included in assets under custody and under management. This collateral totaled $99.1 billion and $114.5 billion at December 31, 2010 and 2009, respectively.

 

C&IS Other Noninterest Income

Other noninterest income for 2010 decreased $48.6 million, or 9%, to $522.7 million from $571.3 million in 2009. The decrease primarily reflects a $65.3 million, or 15%, decrease in foreign exchange trading income due to reduced currency volatility in the current year, partially offset by increased client volumes as compared to 2009. Other noninterest income for 2009 of $571.3 million decreased $233.3 million, or 29%, from $804.6 million in 2008. This decrease resulted from lower foreign exchange trading income compared to 2008’s record levels, due to significantly reduced currency volatility and client volumes in 2009. The decrease also reflected the impact of mark-to-market adjustments on credit default swap contracts, which totaled a loss of $4.6 million in 2009 as compared to a gain of $35.4 million in 2008, and the impact of non-trading foreign exchange net of hedging activity, which totaled a loss of $1.4 million in 2009 compared to a gain of $36.1 million recorded in 2008.

 

C&IS Net Interest Income

Net interest income decreased $144.2 million, or 35%, in 2010 to $271.8 million from $416.0 million in 2009. The decrease is attributable to the impact on the net interest margin of the persistently low interest rate environment. The C&IS net interest margin in 2010 was .77% compared to 1.25% in 2009 and 1.27% in 2008. The decrease in net interest margin in 2010 is attributable to narrower spreads on money market assets funded by non-U.S. interest-bearing deposits, a lower average loan balance, and a larger percentage of funding from interest-bearing sources. The decline in interest rates also impacted net interest income in 2009, which was down $155.1 million, or 27%, from $571.1 million in 2008, as did an $11.7 billion, or 26%, decrease in average earning assets in 2009, primarily short-term money market assets.

 

C&IS Provision for Credit Losses

The provision for credit losses was negative $16.1 million for 2010 primarily reflecting reduced loan balances and, to a lesser extent, improvement in underlying asset quality metrics within the commercial loan segment. The provision for credit

 

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losses was $30.7 million for 2009 compared with $25.2 million in 2008 and reflected the weakness in the broader economic environment.

 

C&IS Noninterest Expenses

C&IS noninterest expenses were up $128.3 million, or 11%, in 2010 and totaled $1.33 billion compared to $1.20 billion in 2009. The 2009 noninterest expenses included a net expense reduction of $100.6 million associated with the final support payments and expiration of the CSA obligations. Excluding the 2009 expense reduction, noninterest expenses in 2010 increased by $27.7 million as a result of higher indirect expense allocations for product and operating support and higher compensation and employee benefit expenses. The increase in compensation expense reflects the reversal in 2009 of accruals related to performance stock units granted in 2008 and 2007 which were no longer expected to vest. Noninterest expenses in 2008 included $454.9 million of client support related charges. Excluding client support related charges in both 2009 and 2008, the $23.2 million decrease in noninterest expenses for 2009 reflected lower staff related, outside services, business promotion, and other operating expenses, partially offset by increased indirect expense allocations for product and operating support.

 

Personal Financial Services

The PFS business unit provides personal trust, investment management, custody, and philanthropic services; financial consulting; guardianship and estate administration; brokerage services; and private and business banking. PFS focuses on high net worth individuals and families, business owners, executives, professionals, retirees, and established privately-held businesses in its target markets. PFS also includes the Wealth Management Group, which provides customized products and services to meet the complex financial needs of individuals and family offices in the United States and throughout the world with assets typically exceeding $200 million. PFS services are delivered through 78 offices in 18 U.S. states as well as offices in London and Guernsey.

 

The following table summarizes the results of operations of PFS for the years ended December 31, 2010, 2009, and 2008 on a management-reporting basis.

 

PERSONAL FINANCIAL SERVICES

RESULTS OF OPERATIONS

 

                                CHANGE  
(In Millions)    2010        2009        2008       

2010 / 2009

    

2009 / 2008

 

Noninterest Income

                                                  

Trust, Investment and Other Servicing Fees

   $ 906.8         $ 847.0         $ 909.0           7      (7 )% 

Other

     133.3           138.7           132.6           (4      5   

Net Interest Income (FTE)*

     591.8           538.1           542.7           10         (1
                                                    

Revenues (FTE)*

     1,631.9           1,523.8           1,584.3           7         (4

Provision for Credit Losses

     176.1           184.3           89.8           (4      N/M   

Noninterest Expenses

     1,103.0           1,044.6           1,087.9           6         (4
                                                    

Income before Income Taxes*

     352.8           294.9           406.6           20         (28

Provision for Income Taxes*

     132.8           112.4           156.1           18         (27
                                                    

Net Income

   $ 220.0         $ 182.5         $ 250.5           21      (27 )% 
                                                    

Percentage of Consolidated Net Income

     33        21        32                    
                                                    

Average Assets

   $ 23,564.5         $ 24,534.8         $ 22,868.7           (4 )%       7

* Stated on an FTE basis.

 

PFS net income increased $37.5 million, or 21%, from 2009 as a result of higher revenues and a lower provision for credit losses, partially offset by increases in noninterest expenses and the provision for income taxes. PFS revenue totaled $1.63 billion in 2010, an increase of $108.1 million, or 7%, from $1.52 billion in 2009 primarily attributable to a 7% increase in trust, investment and other servicing fees and an 10% increase in net interest income. These increases were partially offset by higher money market mutual fund fee waivers and decreases in security commission and trading income and in treasury management fees. PFS net income in 2009 decreased $68.0 million, or 27%, from 2008 primarily reflecting a $94.5 million increase in the provision for credit losses and a decline in trust, investment and other servicing fees, partially offset by a reduction in noninterest expenses. Net income in 2008 of $250.5 million included $81.4 million of

 

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client support related charges. PFS revenues in 2009 decreased 4% to $1.52 billion from 2008 results of $1.58 billion, primarily reflecting a $62.0 million, or 7%, reduction in trust, investment and other servicing fees, and a 1% decrease in net interest income.

 

 

PFS Trust, Investment and Other Servicing Fees

Provided below is a summary of PFS trust, investment and other servicing fees and assets under custody and under management.

 

PERSONAL FINANCIAL SERVICES

TRUST, INVESTMENT AND OTHER SERVICING FEES

 

     YEAR ENDED DECEMBER 31  
(In Millions)    2010      2009      2008  

Midwest

   $ 373.0       $ 327.6       $ 341.5   

Southeast

     200.3         188.6         212.4   

Wealth Management

     123.2         135.8         142.4   

West

     97.8         91.2         104.1   

Southwest

     88.0         82.5         93.6   

Northeast

     24.5         21.3         15.0   
                            

Total Trust, Investment and Other Servicing Fees

   $ 906.8       $ 847.0       $ 909.0   

 

2010 PFS FEES

 

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PERSONAL FINANCIAL SERVICES

ASSETS UNDER CUSTODY

 

     DECEMBER 31  
(In Billions)    2010      2009      2008  

Wealth Management

   $ 221.9       $ 196.0       $ 168.4   

Midwest

     64.1         58.2         53.3   

Southeast

     36.7         34.0         29.7   

West

     18.8         17.0         15.8   

Southwest

     16.0         14.1         12.7   

Northeast

     12.7         11.8         8.4   
                            

Total Assets Under Custody

   $ 370.2       $ 331.1       $ 288.3   

 

2010 PFS ASSETS UNDER CUSTODY

 

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PERSONAL FINANCIAL SERVICES

ASSETS UNDER MANAGEMENT

 

     DECEMBER 31  
(In Billions)    2010      2009      2008  

Midwest

   $ 60.4       $ 57.0       $ 53.0   

Wealth Management

     31.5         31.4         29.0   

Southeast

     29.1         27.3         24.3   

West

     14.2         12.9         11.6   

Southwest

     12.4         10.8         9.9   

Northeast

     6.8         5.8         4.6   
                            

Total Assets Under Management

   $ 154.4       $ 145.2       $ 132.4   

 

2010 PFS ASSETS UNDER MANAGEMENT

 

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The PFS regions shown above are comprised of the following: Midwest includes Illinois, Michigan, Wisconsin, Missouri, Ohio and Minnesota; Southeast includes Florida and Georgia; West includes California, Washington, and Nevada; Southwest includes Texas, Arizona, and Colorado; Northeast includes New York, Connecticut, Massachusetts, and Delaware; Wealth Management includes the results from the focus on the family office segment, complex fiduciary assignments and ultra-wealthy individuals through the provision of specialized asset management, investment consulting, global custody, fiduciary and private

 

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banking services for domestic and international clients.

Fees in the majority of locations in which PFS operates and all mutual fund-related revenue are calculated based on market values. PFS trust, investment and other servicing fees were $906.8 million in 2010, up 7% from $847.0 million in 2009, which in turn was down 7% from $909.0 million in 2008. The current year performance benefitted from higher market valuations and new business compared to lower market valuations during the majority of 2009. Impacting the results in both years were waived fees in money market funds totaling $49.6 million and $23.9 million in 2010 and 2009, respectively, due to the low level of short-term interest rates. Trust, investment and other servicing fees for 2009 was lower than 2008, reflecting lower market valuations and the $23.9 million of waived fees in money market mutual funds.

At December 31, 2010, assets under custody in PFS were $370.2 billion, compared with $331.1 billion at December 31, 2009. Managed assets were $154.4 billion at December 31, 2010 compared to $145.2 billion at the previous year end.

 

PFS Other Noninterest Income

Other noninterest income for the year totaled $133.3 million compared to $138.7 million in 2009, a decrease of 4% primarily driven by a decrease in core brokerage fee revenue and treasury management fees. The other noninterest income increase of 5% in 2009 compared to 2008 resulted from growth in treasury management fees and commercial loan-related commitment fee revenue.

 

PFS Net Interest Income

Net interest income was $591.8 million for the year, up 10% from $538.1 million in 2009, which was 1% lower than 2008. Average loan volume increased $62.4 million in 2010, and the net interest margin increased to 2.55% from 2.23% in 2009. The increase in the net interest margin reflects increased yields on loans and lower cost of funds from interest-bearing sources. The net interest margin for 2009 was down from the 2008 margin of 2.43% as 2009 was impacted by a significant decrease in yields on short-term assets and the diminished value of noninterest-related funding sources resulting from the extended period of low interest rates.

 

PFS Provision for Credit Losses

The provision for credit losses was $176.1 million for 2010, compared with $184.3 million in 2009, and $89.8 million in 2008. The current year provision, though reduced from the prior year level, reflects continued weakness in residential and commercial real estate loans in certain markets. The increase from 2008 to 2009 reflected the weakness in the broader economic environment. For a fuller discussion of the reserve and provision for credit losses refer to pages 58 through 60.

 

PFS Noninterest Expenses

Noninterest expenses of PFS increased $58.4 million, or 6%, to $1.10 billion in 2010 compared to $1.04 billion in 2009, primarily attributable to higher indirect expense allocations for product and operating support, higher compensation, and increased charges associated with account servicing activities. Noninterest expenses for 2009 were 4% lower than 2008 and included a net expense reduction totaling $8.7 million associated with the final support payments and expiration of the CSA obligations, while 2008 noninterest expenses included client support related charges totaling $81.4 million, including the support provided under the CSAs.

 

Northern Trust Global Investments

NTGI, through various subsidiaries of the Corporation, provides a broad range of investment management and related services and other products to U.S. and non-U.S. clients, including clients of C&IS and PFS. Clients include institutional and individual separately managed accounts, bank common and collective funds, registered investment companies, non-U.S. collective investment funds and unregistered private investment funds. NTGI offers both active and passive equity and fixed income portfolio management, as well as alternative asset classes (such as private equity and hedge funds of funds) and multi-manager products and advisory services. NTGI’s activities also include transition management, overlay services, and other risk management services. NTGI’s business operates internationally through subsidiaries, joint ventures, alliances, and distribution arrangements and its revenue and expenses are fully allocated to C&IS and PFS.

At year-end 2010, Northern Trust managed $643.6 billion in assets for personal and institutional clients compared with $627.2 billion at year-end 2009. The increase in assets reflects higher equity markets in 2010 and new business.

 

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NORTHERN TRUST GLOBAL INVESTMENTS

2010 ASSETS UNDER MANAGEMENT OF $643.6 BILLION

 

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ASSET CLASSES

 

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CLIENT SEGMENTS

 

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MANAGEMENT STYLES

 

Operations and Technology

The O&T business unit supports all Northern Trust business activities, including the processing and product management activities of C&IS, PFS and NTGI. These activities are conducted principally in the operations and technology centers in Chicago, London, and Bangalore.

 

Corporate Financial Management Group

The Corporate Financial Management Group includes the Chief Financial Officer, Controller, Treasurer, and Investor Relations functions. The Group is responsible for Northern Trust’s accounting and financial infrastructure and for managing the Corporation’s financial position.

 

Corporate Risk Management Group

The Corporate Risk Management Group includes the Credit Policy and other Corporate Risk Management functions. The Credit Policy function is described in the “Risk Management – Loans and Other Extensions of Credit” section. The Corporate Risk Management Group monitors, measures, and facilitates the management of risks across the businesses of the Corporation and its subsidiaries.

 

Treasury and Other

Treasury and Other includes income and expense associated with the wholesale funding activities and the investment portfolios of the Corporation and the Bank. Treasury and Other also includes certain corporate-based expenses, executive level compensation and nonrecurring items not allocated to the business units.

 

The following table summarizes the results of operations of Treasury and Other for the years ended December 31, 2010, 2009, and 2008 on a management-reporting basis.

 

TREASURY AND OTHER

RESULTS OF OPERATIONS

 

                                  CHANGE  
(In Millions)      2010        2009        2008       

2010 / 2009

      

2009 / 2008

 

Gain on Visa Share Redemption

     $         $         $ 167.9           N/M           N/M   

Other Noninterest Income

       (8.9        (6.7        (40.6        33        (84 )% 

Net Interest Income (FTE)*

       94.2           85.9           15.1           10           N/M   
                                                        

Revenues (FTE)*

       85.3           79.2           142.4           8           (44

Visa Indemnification Benefits

       (33.0        (17.8        (76.1        85           77   

Noninterest Expenses

       99.0           89.3           96.5           11           (8
                                                        

Income before Income Taxes*

       19.3           7.7           122.0           N/M           (94

Provision (Benefit) for Income Taxes*

       4.2           (32.0        66.4           N/M           N/M   
                                                        

Net Income

     $ 15.1         $ 39.7         $ 55.6           (62 )%         (29 )% 

Percentage of Consolidated Net Income

       2        5        7                      

Average Assets

     $ 13,694.4         $ 11,662.3         $ 669.4           17        N/M   

* Stated on an FTE basis.

 

 

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The Treasury and Other negative other noninterest income for the years ended 2010, 2009, and 2008 include losses of $21.2 million, $26.7 million and $61.3 million, respectively, from the write-down of residential mortgage-backed securities determined to be other-than-temporarily impaired. The 2010 increase in net interest income reflects the benefit of higher average assets and an increase in levels of capital allocated to Treasury and Other, partially offset by reduced yields on the securities portfolio, as maturing investments have been replaced by lower yielding assets. The increase in average assets reflects higher levels of average securities balances in 2010 compared to 2009. Noninterest expenses in 2010 equaled $99.0 million, up 11% from 2009. Within noninterest expenses, compensation expense increased compared to 2009, reflecting increased salary expense in 2010 and the reversal in 2009 of accruals related to performance stock units granted in 2008 and 2007 which were no longer expected to vest. Noninterest expenses were $89.3 million for 2009, a decrease of 8%, compared to $96.5 million in 2008 and reflected lower performance-based compensation and salaries. The tax benefit in 2009 primarily reflects the favorable resolution of certain state tax positions taken in prior years and other federal and state tax matters not allocated to the business units for management reporting purposes.

 

CRITICAL ACCOUNTING ESTIMATES

 

The use of estimates and assumptions is required in the preparation of financial statements in conformity with GAAP and actual results could differ from those estimates. The Securities and Exchange Commission has issued guidance relating to the disclosure of critical accounting estimates. Critical accounting estimates are those that require management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on Northern Trust’s future financial condition and results of operations.

For Northern Trust, accounting estimates that are viewed as critical are those relating to reserving for credit losses, pension plan accounting, other-than-temporary impairment

(OTTI) of investment securities, and accounting for structured leasing transactions. Management has discussed the development and selection of each critical accounting estimate with the Audit Committee of the Corporation’s Board of Directors (Board).

 

Reserve for Credit Losses

The reserve for credit losses represents management’s estimate of probable losses that have occurred as of the date of the financial statements. The loan and lease portfolio and other credit exposures are regularly reviewed to evaluate the adequacy of the reserve for credit losses. In determining the level of the reserve, Northern Trust evaluates the adequacy of the reserve related to performing loans and lending-related commitments as well as loans and lending-related commitments that are deemed impaired.

The quarterly analysis of specific and inherent loss components and the control process maintained by Credit Policy and the lending staff, as described in the “Risk Management – Loans and Other Extensions of Credit” section, are the principal methods relied upon by management for the timely identification of, and adjustment for, changes in estimated credit loss levels. In addition to Northern Trust’s own experience, management also considers the experience of peer institutions and regulatory guidance. Control processes and analyses employed to evaluate the adequacy of the reserve for credit losses are reviewed on at least an annual basis and modified as considered appropriate.

Loans, leases and other extensions of credit deemed uncollectible are charged to the reserve. Subsequent recoveries, if any, are credited to the reserve. The provision for credit losses, which is charged to income, is the amount necessary to adjust the reserve to the level determined through the above process. Actual losses may vary from current estimates and the amount of the provision may be either greater than or less than actual net charge-offs.

Management’s estimates utilized in establishing an adequate reserve for credit losses are not dependent on any single assumption. Management evaluates numerous variables, many of which are interrelated or dependent on other assumptions and estimates, in determining reserve adequacy. Due to the inherent imprecision in accounting estimates, other estimates or assumptions could reasonably have been used in the current period and changes in estimates are reasonably likely to occur from period to period. Additionally, as an integral part of their examination process, various federal and state regulatory agencies also review the reserve for credit losses. These agencies may require that certain loan balances be classified differently or charged off when their credit evaluations differ from those of management, based on their judgments about information available to them at the time of their examination. However,

 

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management believes that the established reserve for credit losses appropriately addresses these uncertainties and is adequate to cover probable losses which have occurred as of the date of the financial statements.

The reserve for credit losses consists of the following components:

 

Specific Reserve: The amount of specific reserves is determined through an individual evaluation of loans and lending-related commitments considered impaired that is based on expected future cash flows, the value of collateral, and other factors that may impact the borrower’s ability to pay.

 

Inherent Reserve: The amount of inherent loss reserves is based primarily on reserve factors which incorporate management’s evaluation of historical charge-off experience and various qualitative factors such as management’s evaluation of economic and business conditions and changes in the character and size of the loan portfolio. Reserve factors are applied to loan and lease credit exposures aggregated by shared risk characteristics and are reviewed quarterly by Northern Trust’s Loan Loss Reserve Committee which includes representatives from Credit Policy, business unit management, and Corporate Financial Management.

 

Pension Plan Accounting

As summarized in Note 21 to the consolidated financial statements, Northern Trust maintains a noncontributory defined benefit pension plan covering substantially all U.S. employees (the Qualified Plan) and a noncontributory supplemental pension plan (the Nonqualified Plan). Certain European-based employees also participate in local defined benefit pension plans that have been closed to new employees in prior years and have been closed to future benefit accruals, effective in 2010. Measuring cost and reporting liabilities resulting from defined benefit pension plans requires the use of several assumptions regarding future interest rates, asset returns, compensation increases and other actuarial-based projections relating to the plans. Due to the long-term nature of this obligation and the estimates that are required to be made, the assumptions used in determining the periodic pension expense and the projected pension obligation are closely monitored and annually reviewed for adjustments that may be required. The Financial Accounting Standards Board’s (FASB) pension accounting guidance requires that differences between the estimates and actual experience be recognized as other comprehensive income in the period in which they occur. The differences are amortized into net periodic pension expense from accumulated other comprehensive income over the future working lifetime of eligible participants. As a result, differences between the estimates made in the calculation of periodic pension expense and the projected pension obligation and actual experience affect stockholders’ equity in the period in which they occur but continue to be recognized as expense systematically and gradually over subsequent periods.

Northern Trust recognizes the significant impact that these pension-related assumptions have on the determination of the pension obligations and related expense and has established procedures for monitoring and setting these assumptions each year. These procedures include an annual review of actual demographic and investment experience with the pension plan’s actuaries. In addition to actual experience, adjustments to these assumptions consider observable yields on fixed income securities, known compensation trends and policies, as well as economic conditions and investment strategies that may impact the estimated long-term rate of return on plan assets.

In determining the pension expense for the U.S. plans in 2010, Northern Trust utilized a discount rate of 6.00% for both the Qualified Plan and the Nonqualified Plan. The rate of increase in the compensation level is based on a sliding scale that averaged 4.02%. The expected long-term rate of return on Qualified Plan assets was 8.00%.

In evaluating possible revisions to pension-related assumptions for the U.S. plans as of Northern Trust’s December 31, 2010 measurement date, the following were considered:

 

Discount Rate: Northern Trust estimates the discount rate for its U.S. pension plans by applying the projected cash flows for future benefit payments to several published discount rate yield curves as of the measurement date. These yield curves are composed of individual, zero-coupon interest rates for 60 different time periods over a 30-year time horizon. Zero-coupon rates utilized by the yield curves are mathematically derived from observable market yields for AA-rated corporate bonds. The yield curve models referenced by Northern Trust in establishing the discount rate supported a rate between 5.31% and 5.73%, with an average decrease of 48 basis points over the prior year. As such, Northern Trust decreased the discount rate for the Qualified and Nonqualified plans from 6.00% for December 31, 2009 to 5.50% for December 31, 2010.

 

Compensation Level: As long-term compensation policies remained consistent with prior years, no changes were made to the compensation scale assumption since its 2007 revision based on a review of actual salary experience of eligible employees.

 

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Rate of Return on Plan Assets: The expected return on plan assets is based on an estimate of the long-term (30 years) rate of return on plan assets, which is determined using a building block approach that considers the current asset mix and estimates of return by asset class based on historical experience, giving proper consideration to diversification and rebalancing. Current market factors such as inflation and interest rates are also evaluated before long-term capital market assumptions are determined. Peer data and historical returns are reviewed to check for reasonability and appropriateness. As a result of these analyses, Northern Trust’s rate of return assumption was maintained at 8.00% for 2010.

 

Mortality Table: Northern Trust uses the mortality table proposed by the U.S. Treasury for use in accordance with the provisions of the Pension Protection Act of 2006 (PPA) for both pre- and post-retirement mortality assumptions. This table is based on the RP2000 mortality table with projections of expected future mortality.

In order to illustrate the sensitivity of these assumptions on the expected periodic pension expense in 2011 and the projected benefit obligation, the following table is presented to show the effect of increasing or decreasing each of these assumptions by 25 basis points.

 

(In Millions)    25 BASIS
POINT
INCREASE
     25 BASIS
POINT
DECREASE
 

Increase (Decrease) in 2011 Pension Expense

                 

Discount Rate Change

     (4.8      5.0   

Compensation Level Change

     2.7         (2.5

Rate of Return on Asset Change

     (2.5      2.5   

Increase (Decrease) in Projected Benefit Obligation

                 

Discount Rate Change

     (33.0      34.9   

Compensation Level Change

     11.8         (11.2

 

Pension Contributions: The deduction limits specified by the Internal Revenue Code for contributions made by sponsors of defined benefit pension plans are based on a “Target Liability” under the provisions of the PPA. Northern Trust contributed $68.0 million to the Qualified Plan in 2010 and $175.0 million in 2009. The investment return on these contributions decreases the U.S. pension expense. This benefit will be partially offset by the related forgone interest earnings on the funds contributed. The minimum required contribution is expected to be zero in 2011 and for several years thereafter. The maximum deductible contribution is estimated at $160.0 million for 2011.

As a result of the pension-related assumptions currently utilized, the contributions to the Qualified Plan, and other actuarial experiences of the qualified and nonqualified plans, the estimated U.S. pension expense is expected to increase by approximately $9.0 million in 2011 from the 2010 expense of $23.2 million.

 

Other-Than-Temporary Impairment of Investment Securities

Under GAAP, companies are required to perform periodic reviews of securities with unrealized losses to determine whether the declines in value are considered other-than-temporary. For available-for-sale and held-to-maturity securities that management has no intent to sell, and believes it more-likely-than-not that it will not be required to sell, prior to recovery, the consolidated statement of income reflects only the credit loss component of an impairment, while the remainder of the fair value loss is recognized in accumulated other comprehensive income. The credit loss component recognized in earnings is identified as the amount of principal cash flows not expected to be received over the remaining term of the security as projected using the Corporation’s cash flow projections. For debt securities that Northern Trust intends to sell, or would more-likely-than-not be required to sell, before the expected recovery of the amortized cost basis, the full impairment (that is, the difference between the security’s amortized cost basis and fair value) is recognized in earnings. The application of significant judgment is required in determining the assumptions used in assessing whether an OTTI exists and, if so, in the calculation of the credit loss component of the OTTI. Assumptions used in this process are inherently subject to change in future periods. Different judgments or subsequent changes in estimates could result in materially different impairment loss recognition. The economic and financial market conditions experienced since the onset of the economic downturn in 2008 have negatively affected the liquidity and pricing of investment securities generally and residential mortgage-backed securities in particular, and have resulted in an increase in the likelihood and severity of OTTI charges.

Northern Trust conducts security impairment reviews quarterly to evaluate those securities within its investment portfolio that have indications of possible OTTI. A determination as to whether a security’s decline in market value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Factors considered in determining whether impairment is other-than-temporary include, but are not limited to, the length of time which the security has been impaired; the severity of the impairment; the cause of the impairment; the financial condition and near-term prospects

 

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of the issuer; activity in the market of the issuer which may indicate adverse credit conditions; and Northern Trust’s ability and intent not to sell, and the likelihood that it will not be required to sell, the security for a period of time sufficient to allow for any expected recovery in its value. The Corporate Asset and Liability Policy Committee reviews the results of impairment analyses and concludes on whether OTTI exists.

Impairment reviews conducted in 2010 and 2009 identified nine and fourteen residential mortgage-backed securities, respectively, determined to be other-than-temporarily impaired and credit-related losses totaling $21.2 million and $26.7 million, respectively, were recognized in connection with the write-down of the securities. The remaining securities with unrealized losses within Northern Trust’s portfolio as of December 31, 2010 and 2009 were not considered to be other-than-temporarily impaired. However, due to market and economic conditions, additional OTTI may occur in future periods.

 

Accounting for Structured Leasing Transactions

Through its leasing subsidiary, Norlease, Inc., Northern Trust acts as a lessor in leveraged lease transactions primarily for transportation equipment, including commercial aircraft and railroad equipment. Northern Trust’s net investment in leveraged leases is reported at the aggregate of lease payments receivable and estimated residual values, net of non-recourse debt and unearned income. Unearned income is required to be recognized in interest income in a manner that yields a level rate of return on the net investment. Determining the net investment in a leveraged lease and the interest income to be recognized requires management to make assumptions regarding the amount and timing of cash flows, estimates of residual values, and the impact of income tax regulations and rates. Changes in these assumptions in future periods could affect asset balances and related interest income.

Northern Trust has several leveraged leasing transactions commonly referred to as Lease-In/Lease-Out (LILO) and Sale-In/Sale-Out (SILO) transactions. As part of the Internal Revenue Service’s (IRS) audit of the Corporation’s 1997-2004 federal income tax returns, the IRS challenged the Corporation’s tax position for certain structured leasing transactions and proposed to disallow certain tax deductions and assess related interest and penalties. In the third quarter of 2009, Northern Trust reached a settlement agreement with the IRS with respect to certain of these transactions. The Corporation is in settlement discussions with the IRS Appeals Office regarding the remaining disputed structured leasing transactions. The Corporation anticipates that the IRS will continue to disallow deductions relating to the remaining challenged leases and possibly include other lease transactions with similar characteristics as part of its audit of tax returns filed after 2004. The Corporation believes that these transactions are valid leases for U.S. tax purposes and that its tax treatment of these transactions is appropriate based on its interpretation of the tax regulations and legal precedents; a court or other judicial authority, however, could disagree. Accordingly, management’s estimates of future cash flows related to leveraged leasing transactions include assumptions about the eventual resolution of this matter, including the timing and amount of any potential payments. Due to the nature of this tax matter, it is difficult to estimate future cash flows with precision.

For the year ended December 31, 2010, revised cash flow estimates regarding the timing and amount of leveraged lease income tax deductions reduced interest income by $.9 million and reduced the provision for income taxes, inclusive of interest and penalties, by $.8 million. Revisions of cash flow estimates regarding the timing and amount of leveraged lease income tax deductions increased 2009 interest income by $1.1 million and increased the 2009 provision for income taxes, inclusive of interest and penalties, by $1.5 million. For the year ended December 31, 2008, revised cash flow estimates regarding the timing of leveraged lease income tax deductions reduced interest income by $38.9 million and increased the provision for income taxes, inclusive of interest and penalties, by $61.3 million. Management does not believe that subsequent changes that may be required in these assumptions would have a material effect on the consolidated financial position or liquidity of Northern Trust, although they could have a material effect on operating results for a particular period.

 

FAIR VALUE MEASUREMENTS

 

The preparation of financial statements in conformity with GAAP requires certain assets and liabilities to be reported at fair value. As of December 31, 2010, approximately 26% of Northern Trust’s total assets and approximately 3% of its total liabilities were carried on the balance sheet at fair value. As discussed more fully in Note 30 to the consolidated financial statements, GAAP requires entities to categorize financial assets and liabilities carried at fair value according to a three-level valuation hierarchy. The hierarchy gives the highest priority to quoted, active market prices for identical assets and liabilities (Level 1) and the lowest priority to valuation techniques that require significant management judgment because one or more of the significant inputs are unobservable in the market place (Level 3). Approximately 3% of Northern Trust’s assets carried

 

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at fair value are classified as Level 1; Northern Trust typically does not hold equity securities or other instruments that would be actively traded on an exchange.

Approximately 95% of Northern Trust’s assets and 97% of its liabilities carried at fair value are categorized as Level 2, as they are valued using models in which all significant inputs are observable in active markets. Investment securities classified as available for sale make up 93% of Level 2 assets with the remaining 7% primarily consisting of derivative financial instruments. Level 2 liabilities consist of derivative financial instruments.

Investment securities are principally valued by third party pricing vendors. Northern Trust has a well established process to validate all prices received from pricing vendors. Prices are compared to separate independent sources such as non-binding broker quotes and other vendor price feeds to ensure the fair value determination is consistent with GAAP and to ensure the proper classification of assets and liabilities in the fair value hierarchy.

As of December 31, 2010, all derivative assets and liabilities were classified in Level 2 and approximately 98%, measured on a notional value basis, related to client-related and trading activities, predominantly consisting of foreign exchange contracts. Derivative instruments are valued internally using widely accepted models that incorporate inputs readily observable in actively quoted markets and do not require significant management judgment. Northern Trust evaluated the impact of counterparty credit risk and its own credit risk on the valuation of derivative instruments. Factors considered included the likelihood of default by us and our counterparties, the remaining maturities of the instruments, our net exposures after giving effect to master netting agreements, available collateral, and other credit enhancements in determining the appropriate fair value of our derivative instruments. The resulting valuation adjustments are not considered material.

As of December 31, 2010, the fair value of Northern Trust’s Level 3 assets and liabilities were $367.8 million and $58.6 million, respectively, and represented approximately 2% of assets and 3% of liabilities carried at fair value, respectively. Level 3 assets consist of auction rate securities purchased from Northern Trust clients. The lack of activity in the auction rate security market has resulted in a lack of observable market inputs to use in determining fair value. Therefore, Northern Trust incorporated its own assumptions about future cash flows and the appropriate discount rate adjusted for credit and liquidity factors. In developing these assumptions, Northern Trust incorporated the contractual terms of the securities, the type of collateral, any credit enhancements available, and relevant market data, where available. As of December 31, 2010, Level 3 liabilities included financial guarantees relating to standby letters of credit and a net estimated liability for Visa related indemnifications. Northern Trust’s recorded liability for standby letters of credit, reflecting the obligation it has undertaken, is measured as the amount of unamortized fees on these instruments. The fair value of the net estimated liability for Visa related indemnifications is based on available market data and significant management judgment.

While Northern Trust believes its valuation methods for its assets and liabilities carried at fair value are appropriate and consistent with other market participants, the use of different methodologies or assumptions, particularly as applied to Level 3 assets and liabilities, could have a material effect on the computation of their estimated fair values.

 

IMPLEMENTATION OF ACCOUNTING STANDARDS

 

Information related to recent accounting pronouncements is contained in Note 2 to the consolidated financial statements.

 

CAPITAL EXPENDITURES

 

Proposed significant capital expenditures are reviewed and approved by Northern Trust’s senior management and, where appropriate, by the Board. This process is designed to assure that the major projects to which Northern Trust commits its resources produce benefits compatible with its strategic goals.

Capital expenditures in 2010 included ongoing enhancements to Northern Trust’s hardware and software capabilities as well as the build out of new data and resiliency centers and the expansion or renovation of several existing and new offices. Capital expenditures for 2010 totaled $311.1 million, of which $220.6 million was for software, $56.0 million was for computer hardware and machinery, $19.4 million was for building and leasehold improvements, and $15.1 million was for furnishings. These capital expenditures are designed principally to support and enhance Northern Trust’s transaction processing, investment management, and asset servicing capabilities, as well as relationship management and client interaction. Additional capital expenditures planned for systems technology will result in future expenses for the depreciation of hardware and amortization of software. Depreciation on computer hardware and machinery and software amortization are charged to equipment and software expense. Depreciation on building and leasehold improvements and on furnishings is charged to occupancy expense and equipment expense, respectively. Capital expenditures for 2009 totaled $299.8 million, of which $181.6

 

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million was for software, $40.2 million was for computer hardware and machinery, $68.3 million was for building and leasehold improvements, and $9.7 million was for furnishings.

 

OFF-BALANCE SHEET ARRANGEMENTS

 

Assets Under Custody and Assets Under Management

Northern Trust, in the normal course of business, holds assets under custody, management and servicing in a fiduciary or agency capacity for its clients. In accordance with GAAP, these assets are not assets of Northern Trust and are not included in its consolidated balance sheet.

 

Financial Guarantees and Indemnifications

Northern Trust issues financial guarantees in the form of standby letters of credit to meet the liquidity and credit enhancement needs of its clients. 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.

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 issuing letters of credit, Northern Trust subjects such activities to the same credit quality and monitoring controls as its lending activities. Certain standby letters of credit have been secured with cash deposits or participated to others. Northern Trust is obligated to meet the entire financial obligation of these agreements and in certain cases is able to recover the amounts paid through recourse against cash deposits or other participants.

Standby letters of credit totaled $4.3 billion and $4.8 billion at December 31, 2010 and 2009, respectively. These amounts include $602.3 million and $618.7 million of standby letters of credit secured by cash deposits or participated to others as of December 31, 2010 and 2009, respectively. The weighted average maturity of standby letters of credit was 20 months at December 31, 2010 and 21 months at December 31, 2009.

As part of the Corporation’s securities custody activities and at the direction of clients, Northern Trust lends securities owned by clients to borrowers who are reviewed and approved by Northern Trust’s Senior Credit Committee. The borrower is required to fully collateralize securities received with cash or marketable securities. As securities are loaned, collateral is maintained at a minimum of 100 percent of the fair value of the securities plus accrued interest, with the collateral revalued on a daily basis. In connection with these activities, Northern Trust has issued certain indemnifications to clients against loss that is a direct result of a borrower’s failure to return securities when due, should the value of such securities exceed the value of the collateral posted. The amount of securities loaned as of December 31, 2010 and 2009 subject to indemnification was $74.9 billion and $82.3 billion, respectively. Because of the credit quality of the borrowers and the requirement to fully collateralize securities borrowed, management believes that the exposure to credit loss from this activity is not significant.

Northern Trust, as a member bank of Visa U.S.A., Inc., is obligated to share in losses resulting from certain indemnified litigation involving Visa. In the fourth quarter of 2007, Northern Trust recorded liabilities totaling $150.0 million in connection with the indemnifications. As anticipated, Visa placed a portion of the proceeds from its initial public offering into an escrow account to fund the settlements of, or judgments in, the indemnified litigation. Northern Trust recorded $76.1 million, its proportionate share of the escrow account balance, in the first quarter of 2008 as an offset to the indemnification liabilities and related charges recorded in the fourth quarter of 2007. In 2009 and 2010, Northern recorded additional offsets to the indemnification liability totaling $17.8 million and $33.0 million, respectively, as Visa deposited additional funds into its litigation escrow account. Northern Trust’s net Visa related indemnification liability at December 31, 2010 and 2009 totaled $23.1 million and $56.1 million, respectively. The value of Northern Trust’s remaining Visa shares is expected to be more than adequate to offset any remaining indemnification liabilities related to Visa litigation. Visa indemnifications are further discussed in Note 19 to the consolidated financial statements.

 

Variable Interests

Variable Interest Entities (VIEs) are defined within GAAP as entities which either have a total equity investment that is insufficient to permit the entity to finance its activities without additional subordinated financial support or whose equity investors lack the characteristics of a controlling financial interest. Investors that finance a VIE through debt or equity interests, or other counterparties that provide other forms of

 

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support, such as guarantees, subordinated fee arrangements, or certain types of derivative contracts, are variable interest holders in the entity and the variable interest holder, if any, that has both the power to direct the activities that most significantly impact the entity and a variable interest that could potentially be significant to the entity is deemed to be the VIE’s primary beneficiary and is required to consolidate the VIE.

Northern Trust acts as asset manager for various funds in which clients of Northern Trust are investors. As an asset manager of funds, the Corporation earns a competitively priced fee that is based on assets managed and varies with each fund’s investment objective. Based on its analysis, Northern Trust’s interests in funds considered VIEs are not considered significant variable interests under GAAP.

As discussed in further detail in Note 27 to the consolidated financial statements, although not obligated to do so, in 2008, Northern Trust entered into CSAs with certain of these entities (Funds) which held notes, asset backed securities, and other instruments whose values had been adversely impacted by widening risk premiums and liquidity spreads and significant rating agency downgrades. As of December 31, 2009, all CSAs had expired in connection with the final settlements of covered securities. However, under prior accounting standards the Funds were considered VIEs and the CSAs reflected Northern Trust’s implicit variable interest in the credit risk of the affected Funds. The Funds were designed to create and pass to investors interest rate and credit risk. In determining whether Northern Trust was the primary beneficiary of the Funds during the period in which the CSAs were in place, expected loss calculations based on the characteristics of the underlying investments in the Funds were used to estimate the expected losses related to interest rate and credit risk, while also considering the relative rights and obligations of each of the variable interest holders. These analyses concluded that interest rate risk was the primary driver of expected losses within the Funds. As such, Northern Trust determined that it was not the primary beneficiary of the Funds and was not required to consolidate them within its consolidated balance sheet.

As discussed in further detail in Note 12 to the consolidated financial statements, in 1997, Northern Trust issued Floating Rate Capital Securities, Series A and Series B, through statutory business trusts wholly-owned by the Corporation (“NTC Capital I” and “NTC Capital II”, respectively). The sole assets of the trusts are Subordinated Debentures of Northern Trust Corporation that have the same interest rates and maturity dates as the corresponding distribution rates and redemption dates of the Floating Rate Capital Securities. NTC Capital I and NTC Capital II are considered VIEs; however, as the sole asset of each trust is a receivable from the Corporation and the proceeds to the Corporation from the receivable exceed the Corporation’s investment in the VIEs’ equity shares, the Corporation is not permitted to consolidate the trusts, even though the Corporation owns all of the voting equity shares of the trusts, has fully guaranteed the trusts’ obligations, and has the right to redeem the preferred securities in certain circumstances.

In leveraged leasing transactions, Northern Trust acts as lessor of the underlying asset subject to the lease, and typically funds 20% of the asset’s cost via an equity ownership in a trust with the remaining 80% provided by third party non-recourse debt holders. In such transactions, the trusts, which are VIEs, are created to provide the lessee use of the property with substantially all of the rights and obligations of ownership. The lessee’s maintenance and operation of the leased property has a direct effect on the fair value of the underlying property, and the lessee also has the ability to increase the benefits it can receive and limit the losses it can suffer by the manner in which it uses the property. As a result, Northern Trust has determined that it is not the primary beneficiary of these VIEs given it lacks the power to direct the activities that most significantly impact the economic performance of the VIEs.

Northern Trust invests in affordable housing projects that are designed to generate a return primarily through the realization of tax credits. The affordable housing projects are formed as limited partnerships and LLCs, and Northern Trust typically invests as a limited partner/investor member in the form of equity contributions. The economic performance of the affordable housing projects, which are deemed to be VIEs, is driven by the performance of their underlying investment projects as well as the VIEs’ ability to operate in compliance with the rules and regulations necessary for the qualification of tax credits generated by equity investments. Northern Trust has determined that it is not the primary beneficiary of these VIEs as it lacks the power to direct the activities that most significantly impact the economic performance of the underlying project or to affect the VIEs’ ability to operate in compliance with the rules and regulations necessary for the qualification of tax credits generated by equity investments. This power is held by the general partners and managing members who exercise full and exclusive control of the operations of the VIEs.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

Liquidity Risk Management

The objectives of liquidity risk management are to ensure that Northern Trust can meet its cash flow obligations under both normal and adverse economic conditions while maintaining its ability to capitalize on business opportunities in a timely and cost effective manner.

 

Governance and Risk Management Framework

Northern Trust manages its liquidity on a global basis, utilizing regional management when appropriate. Corporate liquidity policies, risk appetite and limits are reviewed annually by the Business Risk Committee of the Board and approved by the Board. Management’s Corporate Asset and Liability Policy Committee (ALCO) is responsible for recommending liquidity policies to the Board, establishing internal guidelines, approving contingency plans, assessing Northern Trust’s overall liquidity status, and reviewing reports and analyses on a regular basis. The Corporate Treasury department has the day-to-day responsibility for measuring, analyzing and managing liquidity risk within the guidelines and limits established by ALCO and the Board.

Northern Trust’s Global Liquidity Management framework focuses on five key areas: Position Management; Modeling and Analysis; Contingency Planning; Peer Group Comparisons and Management Reporting; and provides for the review and management of the liquidity of the Corporation separate from that of its banking subsidiaries. It is through this framework that management monitors its sources and uses of liquidity, evaluates their level of stability under various circumstances, plans for adverse situations, benchmarks itself against other banks, provides information to senior management, and complies with various U.S. and international regulations.

Position management incorporates daily monitoring of cash positions and anticipating future funding requirements given both internal and external events. Liquidity is provided by a variety of sources, including client deposits (institutional and personal) from our C&IS and PFS businesses, wholesale funding from the capital markets, maturities of short-term investments, and unencumbered liquid assets that can be sold or pledged to secure additional funds. While management does not view the Federal Reserve’s discount window as a primary source of liquidity, the Bank can borrow substantial amounts from the discount window on a collateralized basis. Liquidity is used by a variety of activities, including client withdrawals, purchases of securities, net loan growth, and draws on unfunded commitments to extend credit. Northern Trust maintains a very liquid balance sheet with loans representing only 34% of total assets as of December 31, 2010. Further, at December 31, 2010 there were significant sources of liquidity within Northern Trust’s consolidated balance sheet in the form of securities available for sale and short-term money market assets, which in aggregate totaled $46.5 billion or 55% of total assets. At December 31, 2010, Northern Trust had over $14 billion of securities and loans readily available as collateral to support Federal Reserve discount window borrowings.

Liquidity modeling and analysis evaluates a bank’s ability to meet its cash flow obligations given a variety of possible internal and external events and under different economic conditions. Northern Trust uses liquidity modeling to support its contingent liquidity plans, gain insight into its liquidity position and strengthen its liquidity policies and practices. Liquidity modeling is performed using multiple independent scenarios, across major currencies, at a consolidated Corporate level and for various U.S. and international banking subsidiaries. These scenarios, which include both company specific and systemic events, analyze their potential impacts on our domestic and foreign deposits, wholesale funds, financial market access, external borrowing capacity and off-balance sheet obligations.

Another important area of Northern Trust’s liquidity risk management is the development and maintenance of its contingent liquidity plans. A Global Contingent Liquidity Action Plan covering the Corporation, Bank and major subsidiaries is approved by ALCO and regularly updated and tested. This plan, which can be activated in the event of an actual liquidity crisis, details organizational responsibilities and defines specific actions designed to ensure the proper maintenance of liquidity during periods of stress. In addition, international banking subsidiaries have individual contingency plans, which incorporate the global plan.

Northern Trust also analyzes its liquidity profile against a peer group of large U.S. bank holding companies, including other major custody banks. This analysis provides management with benchmarking information, highlights industry trends and supports the establishment of new policies and strategies.

Management regularly reviews various reports, analyses and other information depicting changes in Northern Trust’s liquidity mix and funding concentrations, overall financial market conditions and other internal and external liquidity metrics. Management uses this information to evaluate the overall status of Northern Trust’s liquidity position and anticipate potential events that could stress that position in the future. An overall Liquidity Status Level for Northern Trust, established and regularly reviewed by ALCO, is monitored on an ongoing basis by the Corporate Treasury department. Downgrades in liquidity status resulting from internal,

 

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external or industry-wide events, trigger specific pre-determined actions and limits designed to position Northern Trust to better respond to potential liquidity stresses.

 

Regulatory Environment

In recent years, U.S. regulatory agencies took various actions in order to improve liquidity in the financial markets. One of those actions was the establishment by the FDIC in October of 2008 of the Temporary Liquidity Guarantee Program. Among other provisions, this program guaranteed funds over $250,000 in noninterest-bearing, and certain interest-bearing, transaction deposit accounts held at FDIC insured banks. This additional FDIC protection above $250,000 was extended to January 1, 2013 by the Dodd-Frank Act.

During 2009 and 2010, many U.S. and international regulatory agencies proposed certain new rules and finalized others that address the management of liquidity risk for financial institutions. In December 2010, the International Basel Committee on Banking Supervision issued an International Framework for Liquidity Risk Measurement, Standards and Monitoring. This framework document outlines a standardized approach to international liquidity management and introduced two new liquidity measures, a Liquidity Coverage Ratio (LCR) and a Net Stable Funding Ratio (NSFR). Individual country regulators, including the Federal Reserve, are now expected to develop specific regulations for financial institutions under their jurisdiction. After an observation period beginning in 2011, which could include revisions to either ratio, the LCR is expected to be introduced in January 2015 and the NSFR in January 2018. Also, in March 2010, U.S. regulatory agencies issued a joint Interagency Policy Statement on Funding and Liquidity Risk Management. Northern Trust actively follows these regulatory developments and regularly evaluates its liquidity risk management framework against these proposals and industry best practices in order to comply with applicable regulations and further enhance its liquidity policies.

 

Corporation Liquidity

The liquidity of the Corporation is managed separately from that of its banking subsidiaries. The primary sources of cash for the Corporation are dividend payments from its subsidiaries, issuance of debt, issuance of equity (common and preferred), and interest and dividends earned on investment securities and money market assets. The Corporation’s uses of cash consist mainly of dividend payments to the Corporation’s stockholders, the payment of principal and interest to note holders, investments in its subsidiaries, purchases of its common stock, and acquisitions. The most significant uses of cash by the Corporation during 2010 were $271.2 million of common dividends paid to stockholders and $213.3 million of investments in its subsidiaries. On June 17, 2009, the Corporation repurchased in full the preferred stock issued under the U.S. Treasury’s CPP for $1,576.0 million. In addition, on August 26, 2009, the Corporation repurchased from the U.S. Treasury the associated warrant for the purchase of the Corporation’s common stock for $87.0 million. Also during 2009, the Corporation paid preferred stock dividends to the U.S. Treasury of $46.6 million. For additional detail, see Note 13 to the consolidated financial statements.

On November 4, 2010, the Corporation issued $500 million of 3.450% fixed-rate senior notes due November 4, 2020. These notes are non-callable, unsecured and were issued at a discount to yield 3.464%.

On May 1, 2009, the Corporation issued 17,250,000 shares of common stock with a par value of $1.66 2/3 per share. Cash proceeds from the common stock totaled $834.1 million. Also on May 1, 2009, the Corporation issued $500 million of 4.625% fixed-rate senior notes due May 1, 2014. These notes are non-callable and unsecured and were issued at par.

During 2010, the Corporation received $67.2 million of dividends, all received from nonbank subsidiaries. Bank subsidiary dividends are subject to certain restrictions, as discussed in further detail in Note 29 to the consolidated financial statements. Bank subsidiaries have the ability to pay dividends during 2011 equal to their 2011 eligible net profits plus $1.01 billion.

The Corporation’s liquidity, defined as the amount of highly marketable assets, was strong at $1.57 billion at year-end 2010 and $1.49 billion at year-end 2009. The cash flows of the Corporation are shown in Note 33 to the consolidated financial statements.

A significant source of liquidity for both the Corporation and the Bank is the ability to draw funding from capital markets globally. The availability and cost of these funds are influenced by our credit rating; as a result, a downgrade could have an adverse impact on our liquidity. The credit ratings of the Corporation and the Bank as of December 31, 2010, provided below, allow Northern Trust to access capital markets on favorable terms.

 

    

Standard &

Poor’s

     Moody’s      FitchRatings  

Northern Trust Corporation:

                          

Commercial Paper

     A-1+         P-1         F1+   

Senior Debt

     AA-         A1         AA-   

The Northern Trust Company:

                          

Short-Term Deposit / Debt

     AA/A-1+         P-1         F1+   

Long-Term Deposit / Debt

     AA/A-1+         Aa3         AA-   

Outlook

     Stable         Stable         Stable   

 

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The following table shows Northern Trust’s contractual obligations at December 31, 2010.

 

CONTRACTUAL OBLIGATIONS

 

     PAYMENT DUE BY PERIOD  
(In Millions)    TOTAL        ONE YEAR
AND LESS
       1-3 YEARS        4-5 YEARS        OVER 5
YEARS
 

Senior Notes*

   $ 1,896.1         $ 249.9         $ 646.8         $ 500.0         $ 499.4   

Subordinated Debt*

     1,148.7           150.0           200.0           231.6           567.1   

Federal Home Loan Bank Borrowings*

     1,532.5           426.4           870.0           135.0           101.1   

Floating Rate Capital Debt*

     276.9                                         276.9   

Capital Lease Obligations**

     71.4           7.7           16.0           16.7           31.0   

Operating Leases**

     723.6           73.7           142.5           117.9           389.5   

Purchase Obligations***

     326.7           139.8           144.0           36.9           6.0   
                                                      

Total Contractual Obligations

   $ 5,975.9         $ 1,047.5         $ 2,019.3         $ 1,038.1         $ 1,871.0   

Note: Obligations as shown do not include deposit liabilities or interest requirements on funding sources.

* Refer to Notes 11 and 12 to the consolidated financial statements for further details.

** Refer to Note 9 to the consolidated financial statements for further details.

*** Purchase obligations consist primarily of ongoing operating costs related to outsourcing arrangements for certain cash management services and the support and maintenance of the Corporation’s technological requirements. Certain obligations are in the form of variable rate contracts and, in some instances, 2010 activity was used as a base to project future obligations.

 

Capital Management

One of Northern Trust’s primary objectives is to maintain a strong capital position to merit and maintain the confidence of clients, the investing public, bank regulators and stockholders. A strong capital position helps Northern Trust take advantage of profitable investment opportunities and withstand unforeseen adverse developments.

Northern Trust manages its capital on a total Corporation basis and on a legal entity basis. The Corporate Treasury department has the day-to-day responsibility for measuring and managing capital levels within guidelines established by the Capital Management Policy and the Capital Committee. The management of capital also involves regional management when appropriate. In establishing the guidelines for capital, a variety of factors are taken into consideration, including the overall risk of Northern Trust’s businesses, regulatory requirements, capital levels relative to our peers, and the impact on our credit ratings.

 

Capital levels were strengthened as average common equity in 2010 increased 12% or $.72 billion reaching $6.63 billion. Total stockholders’ equity was $6.83 billion at December 31, 2010, as compared to $6.31 billion at December 31, 2009. The Corporation declared common dividends totaling $273.4 million in 2010 and the Board maintained the quarterly dividend at $.28 per common share. The common dividend has increased 22% from its level five years ago. The Corporation’s share buyback program is used for general corporate purposes, including management of the Corporation’s capital level. During 2010, the Corporation purchased 131,261 of its own common shares at an average price per share of $52.33 in connection with equity based compensation plans. Under the share buyback program, the Corporation may purchase up to 7.2 million additional shares after December 31, 2010.

 

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CAPITAL ADEQUACY

     DECEMBER 31  
($ In Millions)    2010        2009  

TIER 1 CAPITAL

                   

Common Stockholders’ Equity

   $ 6,830         $ 6,312   

Floating Rate Capital Securities

     269           268   

Goodwill and Other Intangible Assets

     (454        (462

Pension and Other Postretirement Benefit Adjustments

     296           305   

Other

     36           99   

Total Tier 1 Capital

     6,977           6,522   

TIER 2 CAPITAL

                   

Reserve for Credit Losses Assigned to Loans and Leases

     320           309   

Off-Balance Sheet Credit Loss Reserve

     38           31   

Reserves Against Identified Losses

     (64        (44

Long-Term Debt*

     766           893   

Total Tier 2 Capital

     1,060           1,189   

Total Risk-Based Capital

   $ 8,037         $ 7,711   

Risk-Weighted Assets**

   $ 51,472         $ 48,784   

Total Assets – End of Period (EOP)

   $ 83,844         $ 82,142   

Average Fourth Quarter Assets**

     79,655           74,537   

Total Loans – EOP

     28,132           27,806   

RATIOS

                   

Risk-Based Capital Ratios

                   

Tier 1

     13.6        13.4

Total (Tier 1 and Tier 2)

     15.6           15.8   

Leverage

     8.8           8.8   

Tier 1 Common Equity***

     13.0           12.8   

COMMON STOCKHOLDERS’ EQUITY TO

                   

Total Loans EOP

     24.28        22.70

Total Assets EOP

     8.15           7.68   

* 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.

*** A reconciliation of tier 1 common equity to tier 1 capital calculated under GAAP is provided below.

 

The following table provides a reconciliation of tier 1 common equity, a non-GAAP financial measure which excludes floating rate capital securities, to tier 1 capital calculated in accordance with applicable regulatory requirements and GAAP.

 

     DECEMBER 31  
($ In Millions)    2010        2009  

Tier 1 Capital

   $ 6,977         $ 6,522   

Less: Floating Rate Capital Securities

     269           268   

Tier 1 Common Equity

     6,708           6,254   

Tier 1 Capital Ratio

     13.6        13.4

Tier 1 Common Equity Ratio

     13.0        12.8

 

Northern Trust is providing the ratio of tier 1 common equity to risk-weighted assets in addition to its capital ratios prepared in accordance with regulatory requirements and GAAP as it is an additional measure that the Corporation and investors use to assess capital adequacy.

The 2010 capital levels reflect Northern Trust’s ongoing retention of earnings to allow for strategic expansion while maintaining a strong balance sheet and a capital level commensurate with its risk profile. At December 31, 2010, the Corporation’s tier 1 capital ratio was 13.6% and its total capital ratio was 15.6% of risk-weighted assets, both well above the ratios that are a requirement for regulatory classification as “well-capitalized”. The “well-capitalized” minimum ratios are 6.0% and 10.0%, respectively. The Corporation’s leverage ratio (tier 1 capital to fourth quarter average assets) of 8.8% is also well above the “well-capitalized” minimum requirement of 5.0%. In addition, each of the Corporation’s U.S. subsidiary banks had a ratio of at least 10.5% for tier 1 capital, 12.6% for total risk-based capital, and 8.0% for the leverage ratio, and each of Corporation’s non-U.S. banking subsidiaries had capital ratios above their specified minimum requirements.

 

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The current risk-based capital guidelines that apply to the Corporation and its U.S. subsidiary banks, commonly referred to as Basel I, are based upon the 1988 capital accord of the International Basel Committee on Banking Supervision (Basel Committee), a committee of central banks and bank supervisors, as implemented by the Federal Reserve Board.

The Corporation also is subject to the Basel II framework for risk-based capital adequacy. The U.S. bank regulatory agencies have issued final rules with respect to implementation of the Basel II framework. Under the final Basel II rules, the Corporation is one of a small number of “core” banking organizations. As a result, the Corporation and its U.S. subsidiary banks will be required to use the advanced approaches under Basel II for calculating risk-based capital related to credit risk and operational risk, instead of the methodology reflected in the regulations effective prior to adoption of Basel II. The rules also require core banking organizations to have rigorous processes for assessing overall capital adequacy in relation to their total risk profiles, and to publicly disclose certain information about their risk profiles and capital adequacy.

The Corporation has for several years been preparing to comply with the advanced approaches of the Basel II framework. The Corporation is also addressing issues related to implementation timing differences between the U.S. and other jurisdictions, to ensure that the Corporation and the bank subsidiaries comply with regulatory requirements and expectations in all jurisdictions where they operate. Current results from a required parallel run of the Basel II risk-based capital framework have demonstrated that the use of the advanced approaches of the Basel II framework have not resulted in the Corporation’s or its U.S. subsidiary banks’ tier 1 Capital or total risk-based capital ratios falling below the levels required for categorization as “well capitalized.”

On September 12, 2010, the Group of Governors and Heads of Supervision, the oversight body of the Basel Committee, announced agreement on the calibration and phase-in arrangements for a strengthened set of capital requirements, known as Basel III. Under these standards, when fully phased-in on January 1, 2019, banking institutions will be required to satisfy three risk based capital ratios:

Ÿ  

A tier 1 common equity ratio of at least 7.0%, inclusive of 4.5% minimum tier 1 common equity ratio, net of regulatory deductions, and inclusive of the new 2.5% “capital conservation buffer” of common equity to risk-weighted assets;

Ÿ  

A tier 1 capital ratio of at least 8.5%, inclusive of the 2.5% capital conservation buffer; and

Ÿ  

A total capital ratio of at least 10.5%, inclusive of the 2.5% capital conservation buffer.

 

The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a tier 1 common equity ratio above the minimum but below the conservation buffer may face constraints on dividends, equity repurchases and compensation based on the amount of such shortfall. The Basel Committee also announced that a “countercyclical buffer” of 0% to 2.5% of common equity or other loss-absorbing capital “will be implemented according to national circumstances” as an “extension” of the conservation buffer during periods of excess credit growth.

Basel III also introduces a non-risk adjusted tier 1 leverage ratio of 3%, based on a measure of total exposure rather than total assets, and new liquidity standards. The phase-in of the new rules is to commence on January 1, 2013, with the phase-in of the capital conservation buffer commencing January 1, 2015 and the rules to be fully phased-in by January 1, 2019.

In November 2010, Basel III was endorsed by the Seoul G20 Leaders Summit and will be subject to individual adoption by member nations, including the United States. The federal banking agencies will likely implement changes to the current capital adequacy standards applicable to the Corporation and its U.S. subsidiary banks in light of Basel III. If adopted by federal banking agencies, Basel III could lead to significantly higher capital requirements and more restrictive leverage and liquidity ratios. The ultimate impact of the new capital and liquidity standards on the Corporation and its U.S. subsidiary banks is currently being reviewed at this time and will depend on a number of factors, including the rulemaking and implementation by the U.S. banking regulators. The Corporation cannot determine the ultimate effect that potential legislation, or subsequent regulations, if enacted, would have upon the Corporation’s earnings or financial position. However, as the Corporation currently understands Basel III, it believes its capital strength, balance sheet and business model leave it well positioned for Basel III.

 

RISK MANAGEMENT

 

Overview

The Board provides risk oversight of management through its Audit, Business Strategy, Compensation and Benefits, and Business Risk Committees. The Audit Committee provides oversight with respect to risks relating to financial reporting and the legal component of compliance risk. The Business Strategy Committee provides oversight with respect to strategic risk for Northern Trust and its subsidiaries.

 

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The Compensation and Benefits Committee reviews incentive compensation arrangements and practices to assess the extent to which such arrangements and practices discourage inappropriate risk-taking behavior by participants. The Business Risk Committee provides oversight with respect to the following risks inherent in Northern Trust’s businesses: credit risk, market and liquidity risk, fiduciary risk, operational risk and the regulatory component of compliance risk.

The Business Risk Committee has approved a Corporate Risk Appetite Statement articulating Northern Trust’s expectation that risk is consciously considered as part of strategic decisions and in day-to-day activities. Northern Trust’s business units are expected to manage business activities consistent with the Corporate Risk Appetite Statement. Risk tolerances are further detailed in separate strategic, credit, operational, market, fiduciary and compliance risk policies and appetite statements. Various corporate committees and oversight entities have been established to review and approve risk management strategies, standards, management practices and tolerance levels. These committees and entities monitor and provide periodic reporting to the respective committees of the Board on risk performance and effectiveness of risk management processes.

Northern Trust’s assessment of risks is built upon its risk universe, a foundational component of Northern Trust’s integrated Enterprise Wide Risk Management Framework. The risk universe represents the major risk categories and sub-categories to which Northern Trust may be exposed through its business activities.

 

RISK CATEGORY   RISK MEASUREMENT      RISK TO EARNINGS AND/OR CAPITAL RESULTING FROM:
Credit   Credit Risk      Failure of a borrower or counterparty to perform on an obligation.
Operational; Fiduciary; Compliance   Operational Risk      Inadequate or failed internal process, people and systems; or from external events.
Market and Liquidity   Market Risk – Trading Book      Changes in the value of trading positions.
  Interest Rate Risk – Banking Book      Changes in interest rates.
    Liquidity Risk      Funding needs during difficult markets.
Strategic   Reputation Risk      Damage to the entity’s reputation from negative public opinion.
  Strategy Risk      Adverse effects of business decisions, improper implementation of business decisions, unexpected external events.
  Business Risk      Developments in the markets in which the entity operates.

 

Asset Quality and Credit Risk Management

 

Securities Portfolio

Northern Trust maintains a high quality securities portfolio, with 85% of the total portfolio at December 31, 2010 composed of U.S. Treasury and government sponsored agency securities, Federal Home Loan Bank and Federal Reserve Bank stock, and triple-A rated corporate notes, asset-backed securities, supranational and sovereign bonds, auction rate securities and obligations of states and political subdivisions. The remaining portfolio was composed of corporate notes, asset-backed securities, negotiable certificates of deposits, obligations of states and political subdivisions, auction rate securities and other securities, of which as a percentage of the total securities portfolio, 4% were rated double-A, 2% were rated below double-A, and 9% were not rated by Standard and Poor’s or Moody’s Investors Service (primarily negotiable certificates of deposits of banks whose long term ratings are at least A).

Corporate notes are primarily government guaranteed, such as bonds issued under the FDIC Temporary Liquidity Guarantee Program, with 88% of corporate notes rated triple-A, 12% rated double-A, and none rated below double-A. Residential mortgage-backed securities rated below double-A, which represented 76% of total residential mortgage-backed securities, had a total amortized cost and fair value of $244.9 million and $194.0 million, respectively, and were comprised primarily of subprime and Alt-A securities. Securities classified as “other asset-backed” at December 31, 2010 were predominantly floating rate, with average lives less than 5 years, and 100% were rated triple-A.

Total unrealized losses within the investment securities portfolio at December 31, 2010 were $99.5 million as compared to $159.7 million at December 31, 2009. The $60.2 million decrease in unrealized losses from the prior year end primarily reflects the improved valuations of residential mortgage-backed and other asset-backed securities due to improving credit markets and the tightening of credit spreads during 2010. As discussed above in the “Critical Accounting Estimates – Other-Than-Temporary Impairment of Investment Securities” section, processes are in place to

 

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provide for the timely identification of OTTI. Losses totaling $21.2 million were recognized in 2010 in connection with the write-down of securities determined to be other-than-temporarily impaired, as compared with $26.7 million in 2009 and $61.3 million in 2008. The remaining securities with unrealized losses within Northern Trust’s portfolio as of December 31, 2010 are not considered to be other-than-temporarily impaired. However, due to market and economic conditions, additional OTTI may occur in future periods.

Northern Trust is a participant in the repurchase agreement market. This market provides a relatively low cost alternative for short-term funding. Securities purchased under agreements to resell and securities sold under agreements to repurchase are accounted for as collateralized financings and 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 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. Securities sold under agreements to repurchase are held by the counterparty until the repurchase.

 

Loans and Other Extensions of Credit

Credit risk is inherent in many of Northern Trust’s activities. A significant component of credit risk relates to the loan portfolio. In addition, credit risk is inherent in certain contractual obligations such as legally binding unfunded commitments to extend credit, commercial letters of credit, and standby letters of credit. These contractual obligations and arrangements are discussed in Note 26 to the consolidated financial statements and are presented in tables that follow. Northern Trust focuses its lending efforts on clients who are looking to utilize a full range of financial services with Northern Trust.

Credit risk is managed through the Credit Policy function, which is designed to assure adherence to a high level of credit standards. Credit Policy reports to the Corporation’s Head of Corporate Risk Management. 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 assuring their uniform application. These activities are designed to diversify credit exposure on an industry and client basis and reduce 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 and personal loans 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 or their designee and has a Credit Policy officer as a voting participant. Each Committee’s credit approval authority is specified, based on commitment levels, risk ratings and maturities. Credits involving commitment exposure in excess of these limits require the approval of the Senior Credit Committee. All exposures approved by the Committees and the Senior Credit Committee require unanimous approval of all voting members.

The Counterparty Risk Management Committee established by Credit Policy manages counterparty risk. This committee has sole credit authority for exposure to all non-U.S. banks, certain U.S. 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 direction of Credit Policy, country exposure limits are reviewed and approved by the Counterparty Risk Management Committee on a country-by-country basis.

As part of its credit process, Northern Trust utilizes an internal borrower risk rating system to support identification, approval, and monitoring of credit risk. Borrower risk ratings are used in credit underwriting, management reporting, setting of loss allowances, and economic capital calculations. Borrower risk ratings are discussed further in Note 5 to the consolidated financial statements.

Credit Policy oversees a range of portfolio reviews that focus on significant and/or weaker-rated credits. This approach allows management to take remedial action in an effort to deal with potential problems. In addition, independent from Credit Policy, the Loan Review Unit undertakes both on-site and off-site file reviews that evaluate effectiveness of management’s implementation of Credit Policy’s requirements.

Northern Trust maintains a loan watch list. Borrowers designated as watch list represent exposures with elevated credit risk profiles that are monitored through internal watch lists, and consist of credits with borrower ratings of “6 – 9”. These credits, which include all nonperforming credits, are expected to exhibit minimally acceptable probabilities of default, elevated risk of default or are currently in default. Loans outstanding to watch list borrowers associated with these risk profiles that are not currently in default but have limited financial flexibility totaled $769.4 million at

 

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December 31, 2010. Cash flows and capital levels range from acceptable to potentially insufficient to meet current requirements and borrowers typically have minimal cushion in adverse down cycle scenarios. An integral part of the Credit Policy function is a formal review of past due and potential problem loans to determine which credits, if any, need to be placed on nonperforming status or charged off.

As more fully described in the “Provision and Reserve For Credit Losses” section below, the provision for credit losses is determined through a disciplined credit review process, to be the amount needed to maintain a reserve that is sufficient to absorb probable credit 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, unfunded commitments, and standby letters of credit (inherent loss component).

 

COMPOSITION OF LOAN PORTFOLIO    DECEMBER 31  
(In Millions)    2010        2009        2008        2007        2006  

Commercial

                                                    

Commercial and Institutional

   $ 5,914.5         $ 6,312.1         $ 8,293.4         $ 5,556.4         $ 4,679.1   

Commercial Real Estate

     3,242.4           3,213.2           3,014.0           2,350.3           1,836.3   

Lease Financing, net

     1,063.7           1,004.4           1,143.8           1,168.4           1,291.6   

Non-U.S.

     1,046.2           728.5           1,791.7           2,274.1           1,733.3   

Other

     346.6           457.5           909.6           438.8           363.7   

Total Commercial

   $ 11,613.4         $ 11,715.7         $ 15,152.5         $ 11,788.0         $ 9,904.0   

Personal

                                                    

Residential Real Estate

   $ 10,854.9         $ 10,807.7         $ 10,381.4         $ 9,171.0         $ 8,674.4   

Private Client

     5,423.7           5,004.4           4,832.2           4,016.6           3,558.5   

Other

     240.0           277.9           389.3           364.5           472.8   

Total Personal

   $ 16,518.6         $ 16,090.0         $ 15,602.9         $ 13,552.1         $ 12,705.7   

Total Loans and Leases

   $ 28,132.0         $ 27,805.7         $ 30,755.4         $ 25,340.1         $ 22,609.7   

 

SUMMARY OF OFF-BALANCE SHEET FINANCIAL INSTRUMENTS WITH CONTRACT

AMOUNTS THAT REPRESENT CREDIT RISK

 

   DECEMBER 31  
(In Millions)    2010        2009  

Unfunded Commitments to Extend Credit

                   

One Year and Less

   $ 10,985.6         $ 11,564.7   

Over One Year

     16,243.9           14,087.1   

Total

   $ 27,229.5         $ 25,651.8   

Standby Letters of Credit

   $ 4,344.7         $ 4,798.8   

Commercial Letters of Credit

     32.8           31.2   

Custody Securities Lent with Indemnification

     74,884.1           82,306.3   

 

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UNFUNDED COMMITMENTS TO EXTEND CREDIT AT DECEMBER 31, 2010

BY INDUSTRY SECTOR

 

(In Millions)    COMMITMENT EXPIRATION  
   TOTAL
COMMITMENTS
       ONE YEAR
AND LESS
       OVER ONE YEAR        OUTSTANDING
LOANS
 

Commercial and Institutional
Industry Sector

                                         

Finance and Insurance

   $ 2,935.1         $ 1,550.0         $ 1,385.1         $ 847.5   

Holding Companies

     54.1           47.9           6.2           77.1   

Manufacturing

     6,389.6           1,424.7           4,964.9           1,149.2   

Mining

     233.7           15.0           218.7           86.4   

Public Administration

     76.8           9.0           67.8           261.6   

Retail Trade

     842.2           206.1           636.1           132.1   

Services

     4,812.5           2,159.8           2,652.7           2,731.2   

Transportation and Warehousing

     341.3           50.5           290.8           108.5   

Utilities

     974.1           198.2           775.9           80.8   

Wholesale Trade

     854.9           156.2           698.7           325.4   

Other Commercial

     97.4           55.0           42.4           114.7   
                                           

Commercial and Institutional*

   $ 17,611.7         $ 5,872.4         $ 11,739.3         $ 5,914.5   

Commercial Real Estate

     249.0           152.6           96.4           3,242.4   

Lease Financing, net

                                   1,063.7   

Non-U.S.

     1,263.4           1,040.9           222.5           1,046.2   

Other

     297.0           261.0           36.0           346.6   
                                           

Total Commercial

   $ 19,421.1         $ 7,326.9         $ 12,094.2         $ 11,613.4   
                                           

Personal

                                         

Residential Real Estate

     2,514.7           463.5           2,051.2           10,854.9   

Private Client

     5,232.9           3,141.8           2,091.1           5,423.7   

Other

     60.8           53.4           7.4           240.0   
                                           

Total Personal

   $ 7,808.4         $ 3,658.7         $ 4,149.7         $ 16,518.6   
                                           

Total

   $ 27,229.5         $ 10,985.6         $ 16,243.9         $ 28,132.0   

* Commercial and institutional industry sector information is presented on the basis of the North American Industry Classification System (NAICS).

 

NON-U.S. OUTSTANDINGS

As used in this discussion, non-U.S. 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 non-U.S. office local currency claims on residents funded by local currency liabilities. Non-U.S. outstandings related to a 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 non-U.S. banks are included in these outstandings and are classified according to the country location of the non-U.S. bank’s head office.

Short-term interbank time deposits with non-U.S. banks represent the largest category of non-U.S. outstandings. Northern Trust actively participates in the interbank market with U.S. and non-U.S. banks. International commercial lending activities also include import and export financing for U.S.-based clients.

Northern Trust places deposits with non-U.S. counterparties that have strong internal (Northern Trust) risk ratings and external credit ratings. These non-U.S. banks are approved and monitored by Northern Trust’s Counterparty Risk Management Committee, which has credit authority for exposure to all non-U.S. banks and employs a review process that results in credit limits. This process includes financial analysis of the non-U.S. banks, use of an internal risk rating system and consideration of external ratings from rating agencies. Each counterparty is reviewed at least annually and potentially more frequently based on deteriorating credit fundamentals or general market conditions. Separate from the entity-specific review process, the average life to maturity of deposits with non-U.S. banks is deliberately maintained on a short-term basis in order to respond quickly to changing credit conditions. Northern Trust also utilizes certain risk mitigation tools and agreements that may reduce exposures through use of cash collateral and/or balance sheet netting.

Additionally, the Counterparty Risk Management Committee performs a country-risk analysis and imposes limits to country exposure. The following table provides information on non-U.S. outstandings by country that exceed 1.00% of Northern Trust’s assets.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

NON-U.S. OUTSTANDINGS

 

(In Millions)    BANKS       

COMMERCIAL

AND OTHER

       TOTAL  

At December 31, 2010

                              

Australia

   $ 2,114         $ 3,159         $ 5,273   

United Kingdom

     3,440           30           3,470   

France

     3,291                     3,291   

Singapore

     1,313           14           1,327   

Switzerland

     1,284           17           1,301   

Spain

     894                     894   
                                

At December 31, 2009

                              

United Kingdom

   $ 2,348         $ 27         $ 2,375   

France

     2,078           1           2,079   

Australia

     1,310           364           1,674   
                                

At December 31, 2008

                              

United Kingdom

   $ 2,640         $ 63         $ 2,703   

France

     2,455           1           2,456   

Belgium

     1,382                     1,382   

Canada

     1,252           3           1,255   

Netherlands

     1,025           95           1,120   

Channel Islands & Isle of Man

     823           11           834   
                                

Countries whose aggregate outstandings totaled between .75% and 1.00% of total assets were as follows: Sweden with aggregate outstandings of $816 million and Canada with aggregate outstandings of $810 million at December 31,2010; Spain with aggregate outstandings of $807 million, Netherlands with aggregate outstandings of $787 million and Singapore with aggregate outstandings of $654 million at December 31, 2009; and Ireland with aggregate outstandings of $773 million and Spain with aggregate outstandings of $752 million at December 31, 2008.

 

NONPERFORMING ASSETS AND 90 DAY PAST DUE LOANS

Nonperforming assets consist of nonperforming loans and Other Real Estate Owned (OREO). OREO is comprised of commercial and residential properties acquired in partial or total satisfaction of loans. Loans that are delinquent 90 days or more and still accruing interest can fluctuate widely at any reporting period based on the timing of cash collections, renegotiations and renewals. The following table presents nonperforming assets and loans that were delinquent 90 days or more and still accruing for the current and prior four years.

 

NONPERFORMING ASSETS    DECEMBER 31  
(In Millions)    2010        2009        2008        2007        2006  

Nonperforming Loans

                                                    

Commercial

                                                    

Commercial and Institutional

   $ 58.0         $ 48.5         $ 21.3         $ 10.4         $ 18.8   

Commercial Real Estate

     116.4           109.3           35.8                       

Non-U.S.

                                             1.2   
                                                      

Total Commercial

     174.4           157.8           57.1           10.4           20.0   
                                                      

Personal

                                                    

Residential Real Estate

   $ 153.3         $ 116.9         $ 32.7         $ 5.8         $ 8.1   

Private Client

     5.3           3.8           6.9           7.0           7.6   
                                                      

Total Personal

     158.6           120.7           39.6           12.8           15.7   
                                                      

Total Nonperforming Loans and Leases

     333.0           278.5           96.7           23.2           35.7   

Other Real Estate Owned

     45.5           29.6           3.5           6.1           1.4   
                                                      

Total Nonperforming Assets

   $ 378.5         $ 308.1         $ 100.2         $ 29.3         $ 37.1   
                                                      

90 Day Past Due Loans Still Accruing

   $ 13.0         $ 15.1         $ 27.8         $ 8.6         $ 24.6   
                                                      

Nonperforming Loans to Total Loans and Leases

     1.18        1.00        .31        .09        .16
                                                      

Reserve for Credit Losses Assigned to Loans and Leases to Nonperforming Loans

     1.0        1.1        2.37        6.38        3.93

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Of the total loan portfolio of $28.1 billion at December 31, 2010, $333.0 million or 1.18% was nonperforming, compared with $278.5 million, or 1.00%, at December 31, 2009, and 96.7 million, or .31%, at December 31, 2008. The increases in nonperforming loans of $54.5 million and $181.8 million in 2010 and 2009, respectively, primarily reflect the deterioration in overall economic conditions experienced since the onset of the economic downturn in 2008. The duration and severity of the economic downturn, together with its impact on equity and real estate values, had a negative effect on Northern Trust’s loan portfolio, primarily the residential real estate and commercial real estate classes, as well as the commercial and institutional class, resulting in an increase in the number of loans that were downgraded to nonperforming and of OREO properties. The deterioration in credit quality, as evidenced by increased nonperforming loan balances, impacts the level of the reserve for credit losses through the resultant adjustment of the specific reserves and of the qualitative factors used in the determination of the inherent reserve levels within the reserve for credit losses. The residential real estate and commercial real estate nonperforming loan balances as of December 31, 2010 reflect the continued weakness in those loan classes within certain markets. Additional information regarding residential real estate and commercial real estate loans is provided below.

 

RESIDENTIAL REAL ESTATE

The residential real estate loan portfolio is primarily composed of mortgages to clients with whom Northern Trust is seeking to establish a comprehensive financial services relationship. At December 31, 2010, residential real estate loans totaled $10.9 billion or 40% of total U.S. loans at December 31, 2010, compared with $10.8 billion or 40% at December 31, 2009. All mortgages were underwritten utilizing Northern Trust’s credit standards which do not allow for the origination of loan types generally considered to be of high risk in nature, such as option ARM loans, subprime loans, loans with initial “teaser” rates, and loans with excessively high loan-to-value ratios. 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 65% to 80% at inception. Revaluations of supporting collateral are obtained upon refinancing or default or when otherwise considered warranted. Collateral revaluations for mortgages are performed by independent third parties.

Of the total $10.9 billion in residential real estate loans, $4.0 billion were in the greater Chicago area, $2.9 billion were in Florida, and $1.4 billion were in California, with the remainder distributed throughout the other geographic regions within the U.S. served by Northern Trust. Legally binding commitments to extend residential real estate credit, which are primarily equity credit lines, totaled $2.5 billion at December 31, 2010 and 2009.

 

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 commercial mortgages and construction, acquisition and development loans extended primarily to highly experienced developers and/or investors well known to Northern Trust. Underwriting standards generally reflect conservative loan-to-value ratios and debt service coverage requirements. Recourse to borrowers through guarantees is also commonly required.

Commercial mortgage financing is provided for the acquisition or refinancing of income producing properties. Cash flows from the properties generally are sufficient to amortize the loan. These loans average approximately $1.4 million each and are primarily located in the Illinois, Florida, California, and Arizona markets. Construction, acquisition and development loans provide financing for commercial real estate prior to rental income stabilization. The intent is generally that the borrower will sell the project or refinance the loan through a commercial mortgage with Northern Trust or another financial institution upon completion.

The table below provides additional detail regarding commercial real estate loan types:

 

(In Millions)    2010        2009  

Commercial Mortgages:

                   

Office

   $ 605.3         $ 592.7   

Apartment/ Multi-family

     572.4           521.6   

Retail

     517.8           453.1   

Industrial/ Warehouse

     383.7           378.1   

Other

     193.7           119.7   
                     

Total Commercial Mortgages

     2,272.9           2,065.2   

Construction, Acquisition and Development Loans

     591.8           678.2   

Single Family Investment

     246.8           272.5   

Other Commercial Real Estate Related

     130.9           197.3   
                     

Total Commercial Real Estate Loans

   $ 3,242.4         $ 3,213.2   

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

At December 31, 2010, legally binding commitments to extend credit and standby letters of credit to commercial real estate borrowers totaled $249.0 million and $116.1 million, respectively. At December 31, 2009 legally binding commitments and standby letters of credit totaled $475.8 million and $43.2 million, respectively.

 

IMPAIRED LOANS

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 or when its terms have been modified as a concession resulting from the debtor’s financial difficulties, referred to as a troubled debt restructuring. All troubled debt restructurings are considered impaired loans in the calendar year of their restructuring. In subsequent years, a troubled debt restructuring may cease being classified as impaired if the loan was modified at a market rate and has performed according to the modified terms for at least six months. A loan that has been modified at a below market rate will return to performing status if it satisfies the six month performance requirement; however, it will remain classified as impaired. As of December 31, 2010, impaired loans totaled $301.2 million and included $56.3 million of loans deemed troubled debt restructurings. Impaired loans had $51.7 million of the reserve for credit losses allocated to them. Impaired loans are measured based upon the loan’s market price, the present value of expected future cash flows, discounted at the loan’s effective interest rate, or at the fair value of the collateral if the loan is collateral dependent. If the loan valuation is less than the recorded value of the loan, dependent upon the level of certainty of loss, either a specific reserve is established or a charge-off is recorded for the difference. Smaller balance (individually less than $250,000) homogeneous loans are collectively evaluated for impairment and excluded from impaired loan disclosures in accordance with applicable accounting standards.

 

Provision and Reserve for Credit Losses

Changes in the reserve for credit losses were as follows:

 

(In Millions)    2010      2009      2008  

Balance at Beginning of Year

   $ 340.6       $ 251.1       $ 160.2   

Charge-Offs

     (150.1      (132.3      (25.7

Recoveries

     6.9         6.5         2.5   

Net Charge-Offs

     (143.2      (125.8      (23.2

Provision for Credit Losses

     160.0         215.0         115.0   

Effect of Foreign Exchange Rates

     (.1      .3         ( .9

Balance at End of Year

   $ 357.3       $ 340.6       $ 251.1   

 

The provision for credit losses is the charge to current earnings that is determined by management, through a disciplined credit review process, to be the amount needed to maintain a reserve that is sufficient to absorb probable credit 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, unfunded commitments, and standby letters of credit (inherent loss component). The following table shows the specific portion of the reserve and the allocated portion of the inherent reserve and its components by loan category at December 31, 2010 and at each of the prior four year-ends, and the unallocated portion of the inherent reserve at December 31, 2007 and 2006.

 

58   |   2010 ANNUAL REPORT TO SHAREHOLDERS   |   NORTHERN TRUST CORPORATION


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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

ALLOCATION OF THE RESERVE FOR CREDIT LOSSES

 

     DECEMBER 31  
     2010     2009     2008     2007     2006  
($ In Millions)    RESERVE
AMOUNT
    PERCENT OF
LOANS TO
TOTAL LOANS
    RESERVE
AMOUNT
    PERCENT OF
LOANS TO
TOTAL LOANS
    RESERVE
AMOUNT
    PERCENT OF
LOANS TO
TOTAL LOANS
    RESERVE
AMOUNT
    PERCENT OF
LOANS TO
TOTAL LOANS
    RESERVE
AMOUNT
    PERCENT OF
LOANS TO
TOTAL LOANS
 

Specific Reserve

   $ 63.7          $ 43.8          $ 23.5          $ 10.8          $ 19.6       

Allocated Inherent Reserve

                                                                                

Commercial

                                                                                

Commercial and Institutional

     113.6        21        137.6        23        114.7        27        64.1        22        55.0        21   

Commercial Real Estate

     76.7        11        65.6        11        43.8        10        28.4        9        21.5        8   

Lease Financing, net

     1.3        4        1.4        4        3.3        3        3.6        5        3.7        6   

Non-U.S.

     3.8        4        4.9        3        7.4        6        7.4        9        6.6        8   

Other

            1               1               3               2               1   

Total Commercial

     195.4        41        209.5        42        169.2        49        103.5        47        86.8        44   

Personal

                                                                                

Residential Real Estate

     81.6        39        66.8        39        37.0        34        13.6        36        13.4        38   

Private Client

     16.6        19        20.5        18        21.4        16        6.2        16        5.9        16   

Other

            1               1               1               1               2   

Total Personal

     98.2        59        87.3        58        58.4        51        19.8        53        19.3        56   

Total Allocated Inherent Reserve

   $ 293.6        100   $ 296.8        100   $ 227.6        100   $ 123.3        100   $ 106.1        100

Unallocated Inherent Reserve

                                               26.1               25.3          

Total Reserve for Credit Losses

   $ 357.3        100   $ 340.6        100   $ 251.1        100   $ 160.2        100   $ 151.0        100

Reserve Assigned to:

                                                                                

Loans and Leases

   $ 319.6              $ 309.2              $ 229.1              $ 148.1              $ 140.4           

Unfunded Commitments and Standby Letters of Credit

     37.7                31.4                22.0                12.1                10.6