ITEM 1A - RISK FACTORS
In the normal course of our business activities, we are exposed to a variety of risks. The following discussion sets forth the risk factors that we have identified as being most significant to Northern Trust. Although we discuss these risk factors primarily in the context of their potential effects on our business, financial condition or results of operations, you should understand that these effects can have further negative implications such as: reducing the price of our common stock and other securities; reducing our capital, which can have regulatory and other consequences; affecting the confidence that clients, counterparties and/or applicable regulators have in us, with a resulting negative effect on our ability to conduct and grow our businesses; and reducing the attractiveness of our securities to rating agencies and potential purchasers, which may affect adversely our ability to raise capital and secure other funding or the cost at which we are able to do so. Further, additional risks beyond those discussed below, elsewhere in this Annual Report on Form 10-K or in other of our reports filed with, or furnished to, the SEC also could affect us adversely. We cannot assure you that the risk factors herein or elsewhere in our other reports address all potential risks that we may face.
These risk factors also serve to describe factors which may cause our results to differ materially from those described in forward-looking statements included herein or in other documents or statements that make reference to this Annual Report on Form 10-K. Forward-looking statements and other factors that may affect future results are discussed under “Forward-Looking Statements” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
COVID-19 Pandemic-Related Risks
Our business, results of operations, and financial condition generally have been, and will continue to be, adversely affected by the ongoing COVID-19 pandemic.
The ongoing COVID-19 pandemic, and governmental and societal responses thereto, have had a severe impact on global economic and market conditions, including heightened volatility in financial markets; global supply chain disruptions; and the institution of social distancing and shelter-in-place requirements that have resulted in temporary closures of many businesses, lost revenues, and increased unemployment.
These conditions have impacted—and/or may in the future impact—our business, results of operations, and financial condition negatively, including through lower net interest income resulting from lower interest rates; increased provisions for credit losses; lower revenue from certain of our fee-based businesses; impairments on the securities we hold; and decreased demand for certain of our products and services. Additionally, our liquidity and regulatory capital could be adversely impacted by volatility and disruptions in the capital and credit markets; volatility in foreign exchange rates; deposit flows; and client draws on lines of credit. Our business operations may also be disrupted if significant portions of our workforce are unable to work effectively, including because of illness, quarantines, government actions, or other restrictions in connection with the pandemic. Further, work-from-home and other modified business practices may introduce additional operational risks, including resiliency, cybersecurity, and execution risks, which may result in inefficiencies or delays, and may affect our ability to, or the manner in which we, conduct our business activities.
While governmental authorities have taken unprecedented measures to provide economic assistance to individual households and businesses, stabilize the markets, and support economic growth, the ultimate success of these measures is unknown and they may not be sufficient to mitigate fully the negative impact of the ongoing pandemic. Further, some measures may have a negative impact on our business, while our participation in other measures could result in reputational harm, litigation, or regulatory and government actions, proceedings, or penalties.
The extent to which the COVID-19 pandemic continues to impact our business, results of operations and financial condition will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, the duration and spread of the outbreak, its severity, the actions to contain the virus or treat its impact, the distribution, acceptance and efficacy of a vaccine, and how quickly and to what extent normal economic and operating conditions can resume. The ongoing pandemic may also have the effect of heightening many of the other risks described in this section entitled “Risk Factors” and any subsequent filings with the SEC.
Market Risks
We are dependent on fee-based business for a majority of our revenues, which may be affected adversely by market volatility, a downturn in economic conditions, underperformance and/or negative trends in investment preferences.
Our principal operational focus is on fee-based business, which is distinct from commercial banking institutions that earn most of their revenues from loans and other traditional interest-generating products and services. Fees for many of our products and services are based on the market value of assets under management, custody or administration; the volume of transactions processed; securities lending volume and spreads; and fees for other services rendered, all of which may be impacted negatively by market volatility, a downturn in economic conditions, underperformance and/or negative trends in investment preferences. For example, downturns in equity markets and decreases in the value of debt-related investments
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resulting from market disruption, illiquidity or other factors historically have reduced the valuations of the assets we manage or service for others, which generally impacted our earnings negatively. Market volatility and/or weak economic conditions also may affect wealth creation, investment preferences, trading activities, and savings patterns, which impact demand for certain products and services that we provide.
Our earnings also may be affected by poor investment returns or changes in investment preferences driven by factors beyond market volatility or weak economic conditions. For example, poor absolute or relative investment performance in funds or client accounts that we manage or in investment products that we design or provide could result in declines in the market values of portfolios that we manage and/or administer and may affect our ability to retain existing assets and to attract new clients or additional assets from existing clients. Further, broader changes in investment preferences that lead to less investment in mutual funds or other collective funds, such as the shift in investor preference to lower fee products, could impact our earnings negatively.
Changes in interest rates can affect our earnings negatively.
The direction and level of interest rates are important factors in our earnings. In response to the COVID-19 pandemic, the Federal Reserve Board further reduced interest rates, which generally had already been low relative to historical levels. This has had, and may continue to have, a negative impact on our net interest margin, which is the difference between what we earn on our assets and the interest rates we pay for deposits and other sources of funding. Low-interest-rate environments also have a negative impact on our fees earned on certain of our products. For example, we have waived certain fees associated with money market mutual funds due to the low level of short-term interest rates. Low net interest margins and fee waivers each negatively impact our earnings.
Conversely, in some circumstances, a rise in interest rates also may affect us negatively. For example, we may be impacted negatively if such an increase were to cause: market volatility and downturns in equity markets, resulting in a decrease in the valuations of the assets we manage or service for others, which generally impact our earnings negatively; our clients to transfer funds into investments with higher rates of return, resulting in decreased deposit levels and higher fund or account redemptions; our borrowers to experience difficulties in making higher interest payments, resulting in increased credit costs, provisions for loan and lease losses and charge-offs; reduced bond and fixed income fund liquidity, resulting in lower performance, yields and fees; a decline in the value of securities held in our portfolio of investment securities, resulting in decreased levels of capital and liquidity; or higher funding costs.
Further, although we have policies and procedures in place to assess and mitigate potential impacts of interest rate risks, if our assumptions about any number of variables are incorrect, these policies and procedures to mitigate risk may be ineffective, which could impact earnings negatively.
Please see “Market Risk” in the “Risk Management” section included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a more detailed discussion of interest rate and market risks we face.
Changes in the monetary, trade and other policies of various regulatory authorities, central banks, governments and international agencies may reduce our earnings and affect our growth prospects negatively.
The monetary, trade and other policies of U.S. and international governments, agencies and regulatory bodies have a significant impact on economic conditions and overall financial market performance. For example, the Federal Reserve Board regulates the supply of money and credit in the United States, and its policies determine in large part the level of interest rates and our cost of funds for lending and investing, which are important factors in our earnings. The actions of the Federal Reserve Board or other regulatory authorities also may reduce the value of financial instruments we hold. Further, their policies can affect our borrowers by increasing interest rates or making sources of funding less available, which may increase the risk that borrowers fail to repay their loans from us. Changes in monetary, trade and other governmental policies are beyond our control and can be difficult to predict, and we cannot determine the ultimate effect that any such changes would have upon our business, financial condition or results of operations.
The ultimate impact on us of the United Kingdom’s withdrawal from the European Union remains uncertain.
The UK ceased to be a member state of the EU on January 31, 2020, and the transition period provided for in the withdrawal agreement entered by the UK and the EU ended on December 31, 2020. In December 2020, the UK and the EU agreed on a trade and cooperation agreement that will apply provisionally after the end of the transition period until it is ratified by the parties to the agreement. On December 30, 2020, the UK passed legislation giving effect to the trade and cooperation agreement, with the EU expected to formally adopt the agreement in early 2021. While the trade and cooperation agreement covers the general objectives and framework of the relationship between the UK and the EU, it generallydoes not address the regulation of financial services. Instead, the parties adopted a declaration of their intention to agree by March 2021 upon a Memorandum of Understanding establishing a framework for regulatory cooperation on financial services.
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Consequently, the ultimate impact of Brexit on the Corporation and the Bank remains uncertain and will depend on the terms of the post-Brexit relationships that remain to be negotiated between the UK and other EU nations, particularly in the area of financial services. Brexit has contributed, and may continue to contribute, to market volatility, particularly the valuation of the Euro and British pound, and could have significant adverse effects on our businesses, financial condition and results of operations. In conjunction with our Brexit-related preparations, we have implemented certain changes to our organizational structure, including the establishment of an EU-domiciled credit institution in Luxembourg. We have incurred, and may in the future continue to incur, additional costs associated with such measures while unforeseen political, regulatory, or other developments related to Brexit, or operational issues associated with the organizational restructuring related thereto, also may result in additional costs and disruption to our UK and EU businesses.
Uncertainty about the financial stability of various regions or countries across the globe, including the risk of defaults on sovereign debt and related stresses on financial markets, could have a significant adverse effect on our earnings.
Risks and concerns about the financial stability of various regions or countries across the globe could have a detrimental impact on economic and market conditions in these or other markets across the world. Foreign market and economic disruptions have affected, and may in the future affect, consumer confidence levels and spending, personal bankruptcy rates, levels of incurrence of and default on consumer debt, and home prices. Economic challenges faced in various foreign markets, including negative interest rates in some jurisdictions, or lack of confidence in the financial markets may adversely affect certain portions of our business, financial condition, and results of operations.
Declines in the value of securities held in our investment portfolio can affect us negatively.
Our investment securities portfolio represents a greater proportion, and our loan and lease portfolios represent a smaller proportion, of our total consolidated assets in comparison to many other financial institutions. The value of securities available for sale and held to maturity within our investment portfolio, which is generally determined based upon market values available from third-party sources, may fluctuate as a result of market volatility and economic or financial market conditions. Declines in the value of securities held in our investment portfolio negatively impact our levels of capital and liquidity. Although we have policies and procedures in place to assess and mitigate potential impacts of market risks, including hedging-related strategies, those policies and procedures are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Accordingly, we could suffer adverse effects as a result of our failure to anticipate and manage these risks properly.
Volatility levels and fluctuations in foreign currency exchange rates may affect our earnings.
We provide foreign exchange services to our clients, primarily in connection with our global custody business. Foreign currency volatility influences our foreign exchange trading income as does the level of client activity. Foreign currency volatility and changes in client activity may result in reduced foreign exchange trading income. Fluctuations in exchange rates may raise the potential for losses resulting from foreign currency trading positions, where aggregate obligations to purchase and sell a currency other than the U.S. dollar do not offset each other or offset each other in different time periods. We also are exposed to non-trading foreign currency risk as a result of our holdings of non-U.S. dollar denominated assets and liabilities, investments in non-U.S. subsidiaries, and future non-U.S. dollar denominated revenue and expense.
We have policies and procedures in place to assess and mitigate potential impacts of foreign exchange risks, including hedging-related strategies. Any failure or circumvention of our procedures to mitigate risk may impact earnings negatively. Please see “Market Risk” in the “Risk Management” section included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” for a more detailed discussion of market risks we face.
Changes in a number of particular market conditions can affect our earnings negatively.
In past periods, reductions in the volatility of currency-trading markets, the level of cross-border investing activity, and the demand for borrowing securities or willingness to lend such securities have affected our earnings from activities such as foreign exchange trading and securities lending negatively. If these conditions occur in the future, our earnings from these activities may be affected negatively. In a few of our businesses, such as securities lending, our fee is calculated as a percentage of our clients’ earnings, such that market and other factors that reduce our clients’ earnings from investments or trading activities also reduce our revenues.
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Operational Risks
Many types of operational risks can affect our earnings negatively.
We regularly assess and monitor operational risk in our businesses. Despite our efforts to assess and monitor operational risk, our risk management program may not be effective in all cases. Factors that can impact operations and expose us to risks varying in size, scale and scope include:
•failures of technological systems or breaches of security measures, including, but not limited to, those resulting from computer viruses or cyber-attacks;
•human errors or omissions, including failures to comply with applicable laws or corporate policies and procedures;
•theft, fraud or misappropriation of assets, whether arising from the intentional actions of internal personnel or external third parties;
•defects or interruptions in computer or communications systems;
•breakdowns in processes, over-reliance on manual processes, which are inherently more prone to error than automated processes, breakdowns in internal controls or failures of the systems and facilities that support our operations;
•unsuccessful or difficult implementation of computer systems upgrades;
•defects in product design or delivery;
•difficulty in accurately pricing assets, which can be aggravated by market volatility and illiquidity and lack of reliable pricing from third-party vendors;
•negative developments in relationships with key counterparties, third-party vendors, employees or associates in our day-to-day operations; and
•external events that are wholly or partially beyond our control, such as pandemics, geopolitical events, political unrest, natural disasters or acts of terrorism.
While we have in place many controls and business continuity plans designed to address many of these factors, these plans may not operate successfully to mitigate these risks effectively. We also may fail to identify or fully understand the implications and risks associated with changes in the financial markets or our businesses—particularly as our geographic footprint, product pipeline and client types evolve—and consequently fail to enhance our controls and business continuity plans to address those changes in an adequate or timely fashion. If our controls and business continuity plans do not address the factors noted above and operate to mitigate the associated risks successfully, such factors may have a negative impact on our business, financial condition or results of operations. In addition, an important aspect of managing our operational risk is creating a risk culture in which all employees fully understand that there is risk in every aspect of our business and the importance of managing risk as it relates to their job functions. We continue to enhance our risk management program to support our risk culture, ensuring that it is sustainable and appropriate for our role as a major financial institution. Nonetheless, if we fail to provide the appropriate environment that sensitizes all of our employees to managing risk, our business could be impacted adversely.
Failures of our technological systems or breaches of our security measures, including, but not limited to, those resulting from cyber-attacks, may result in losses.
Any failure, interruption or breach in the security of our systems could severely disrupt our operations. Our systems involve the use of clients’ and our proprietary and confidential information, and security breaches, including cyber-attacks, could expose us to a risk of theft, loss or other misappropriation of this information. Our security measures may be breached due to the actions of outside parties, employee error, failure of our controls with respect to granting access to our systems, malfeasance or otherwise, and, as a result, an unauthorized party may obtain access to our or our clients’ proprietary and confidential information, resulting in the theft, loss, destruction, gathering, monitoring, or other misappropriation of this information. Regulators globally are also introducing the potential for greater monetary fines on institutions that suffer from breaches leading to the misappropriation of such information. Most states, the EU and other non-U.S. jurisdictions also have adopted their own statutes and/or regulations concerning data privacy and security and requiring notification of data breaches. These and other changes in laws or regulations associated with the enhanced protection of personal and other types of information could greatly increase the size of potential fines related to the protection of such information.
Information security risks for large financial institutions like us are significant in part because of the evolving proliferation of new technologies, the use of the internet, mobile devices, and cloud technologies to conduct financial transactions and the increased sophistication and activities of hackers, terrorists, organized crime and other external parties, including foreign state actors. If we fail to continue to upgrade our technology infrastructure to ensure effective information security relative to the type, size and complexity of our operations, we could become more vulnerable to cyber-attack and, consequently, subject to significant regulatory penalties. Additionally, our computer, communications, data processing, networks, backup, business continuity or other operating, information or technology systems, including those that we outsource to other providers, may fail to operate properly or become disabled, overloaded or damaged as a result of a
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number of factors, including events that are wholly or partially beyond our control, which could have a negative effect on our ability to conduct our business activities.
The third parties with which we do business also are susceptible to the foregoing risks (including regarding the third parties with which they are similarly interconnected or on which they otherwise rely), and our or their business operations and activities may therefore be affected adversely, perhaps materially, by failures, terminations, errors or malfeasance by, or attacks or constraints on, one or more financial, technology, infrastructure or government institutions or intermediaries with whom we or they are interconnected or conduct business. In addition, our clients often use their own devices, such as computers, smart phones and tablets, to manage their accounts, which may heighten the risk of system failures, interruptions or security breaches.
In recent years, several financial services firms suffered successful cyber-attacks launched both domestically and from abroad, resulting in the disruption of services to clients, loss or misappropriation of sensitive or private information, and reputational harm. We and our clients have been, and expect to continue to be, subject to a wide variety of cyber-attacks and threats, including computer viruses, ransomware and other malicious code, distributed denial of service attacks, and phishing attacks, and it is possible that we could suffer material losses resulting from a breach. Because the techniques used to obtain unauthorized access, disable or degrade service or sabotage systems change frequently and often are not recognized until launched against a target, we may be unable to anticipate these techniques, to implement adequate preventative measures, or to address them until they are discovered. In addition, successful cyber-attacks may persist for an extended period of time before being detected. Because any investigation of an information security incident would be inherently unpredictable, the extent of a particular information security incident and the path of investigating the incident may not be immediately clear. It may take a significant amount of time before such an investigation can be completed and full and reliable information about the incident is known. While such an investigation is ongoing, we may not necessarily know the extent of the harm or how best to remediate it, certain errors or actions could be repeated or compounded before they are discovered and remediated, and communication to the public, regulators, clients and other stakeholders may be inaccurate, any or all of which could further increase the costs and consequences of an information security incident.
We could be the subject of legal claims or proceedings related to security incidents, including regulatory investigations and actions. Further, the market perception of the effectiveness of our security measures could be harmed, our reputation could suffer and we could lose clients in conjunction with security incidents, each of which could have a negative effect on our business, financial condition and results of operations. A breach of our security also may affect adversely our ability to effect transactions, service our clients, manage our exposure to risk or expand our business. An event that results in the loss of information also may require us to reconstruct lost data or reimburse clients for data and credit monitoring services, which could be costly and have a negative impact on our business and reputation.
Further, even if not directed at us, attacks on financial or other institutions important to the overall functioning of the financial system or on our counterparties could affect, directly or indirectly, aspects of our business.
Errors, breakdowns in controls or other mistakes in the provision of services to clients or in carrying out transactions for our own account can subject us to liability, result in losses or have a negative effect on our earnings in other ways.
In our asset servicing, investment management, fiduciary administration and other business activities, we effect or process transactions for clients and for ourselves that involve very large amounts of money. Failure to manage or mitigate operational risks properly can have adverse consequences, and increased volatility in the financial markets may increase the magnitude of resulting losses. For example, in the third quarter of 2020 we incurred a $43.4 million charge related to a corporate action processing error. Given the high volume of transactions we process, errors that affect earnings may be repeated or compounded before they are discovered and corrected.
Our dependence on technology, and the need to update frequently our technology infrastructure, exposes us to risks that also can result in losses.
Our businesses depend on information technology infrastructure, both internal and external, to record and process, among other things, a large volume of increasingly complex transactions and other data, in many currencies, on a daily basis, across numerous and diverse markets and jurisdictions. Due to our dependence on technology and the important role it plays in our business operations, we must constantly improve and update our information technology infrastructure. Upgrading, replacing, and modernizing these systems can require significant resources and often involves implementation, integration and security risks that could cause financial, reputational and operational harm. Failure to ensure adequate review and consideration of critical business and regulatory issues prior to and during the introduction and deployment of key technological systems or failure to align operational capabilities adequately with evolving client commitments and expectations may have a negative impact on our results of operations. The failure to respond properly to, and invest in, changes and advancements in technology could limit our ability to attract and retain clients, prevent us from offering products and services comparable to those offered by our competitors, inhibit our ability to meet regulatory requirements or otherwise have a material adverse effect on our operations.
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The systems and models we employ to analyze, monitor and mitigate risks, as well as for other business purposes, are inherently limited, may not be effective in all cases and, in any case, cannot eliminate all risks that we face.
We use various systems and models in analyzing and monitoring several risk categories, as well as for other business purposes. However, these systems and models are inherently limited because they involve techniques and judgments that cannot anticipate every economic and financial outcome in the markets in which we operate, nor can they anticipate the specifics and timing of such outcomes. Further, these systems and models may fail to quantify accurately the magnitude of the risks we face. Our measurement methodologies rely on many assumptions and historical analyses and correlations. These assumptions may be incorrect, and the historical correlations on which we rely may not continue to be relevant. Consequently, the measurements that we make may not adequately capture or express the true risk profiles of our businesses or provide accurate data for other business purposes, each of which ultimately could have a negative impact on our business, financial condition and results of operations. Errors in the underlying model or model assumptions, or inadequate model assumptions, could result in unanticipated and adverse consequences, including material loss or noncompliance with regulatory requirements or expectations.
A failure or circumvention of our controls and procedures could have a material adverse effect on our business, financial condition and results of operations.
We regularly review and update our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system will be met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, financial condition and results of operations. If we identify material weaknesses in our internal control over financial reporting or are otherwise required to restate our financial statements, we could be required to implement expensive and time-consuming remedial measures and could lose investor confidence in the accuracy and completeness of our financial reports. In addition, there are risks that individuals, either employees or contractors, consciously circumvent established control mechanisms by, for example, exceeding trading or investment management limitations, or committing fraud.
Failure of any of our third-party vendors to perform can result in losses.
Third-party vendors provide key components of our business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, and network access. Our use of third-party vendors exposes us to the risk that such vendors may not comply with their servicing and other contractual obligations to us, including with respect to indemnification and information security, and to the risk that we may not satisfy applicable regulatory responsibilities regarding the management and oversight of third parties and outsourcing providers. While we have established risk management processes and continuity plans, any disruptions in service from a key vendor for any reason or poor performance of services could have a negative effect on our ability to deliver products and services to our clients and conduct our business. Replacing these third-party vendors or performing the tasks they perform for ourselves could create significant delay and expense.
We are subject to certain risks inherent in operating globally which may affect our business adversely.
In conducting our U.S. and non-U.S. business, we are subject to risks of loss from various unfavorable political, economic, legal or other developments, including social or political instability, changes in governmental policies or policies of central banks, expropriation, nationalization, confiscation of assets, price controls, capital controls, exchange controls, unfavorable tax rates and tax court rulings and changes in laws and regulations. Less mature and often less regulated business and investment environments heighten these risks in various emerging markets. Our non-U.S. operations accounted for 28% of our revenue in 2020. Our non-U.S. businesses are subject to extensive regulation by various non-U.S. regulators, including governments, securities exchanges, central banks and other regulatory bodies in the jurisdictions in which those businesses operate. In many countries, the laws and regulations applicable to the financial services industry are uncertain and evolving and may be applied with extra scrutiny to foreign companies. Moreover, the regulatory and supervisory standards and expectations in one jurisdiction may not conform with standards or expectations in other jurisdictions. Even within a particular jurisdiction, the standards and expectations of multiple supervisory agencies exercising authority over our affairs may not be harmonized fully. Accordingly, it may be difficult for us to determine the exact requirements of local laws in every market or manage our relationships with multiple regulators in various jurisdictions. Our inability to remain in compliance with local laws in a particular market and manage our relationships with regulators could have an adverse effect not only on our businesses in that market but also on our reputation generally. The failure to mitigate properly such risks or the failure of our operating infrastructure to support such international activities could result in operational failures and regulatory fines or sanctions, which could affect our business and results of operations adversely.
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We actively strive to optimize our geographic footprint. This optimization may occur by establishing operations in lower-cost locations or by outsourcing to third-party vendors in various jurisdictions. These efforts expose us to the risk that we may not maintain service quality, control or effective management within these operations. In addition, we are exposed to the relevant macroeconomic, political and similar risks generally involved in doing business in those jurisdictions. The increased elements of risk that arise from conducting certain operating processes in some jurisdictions could lead to an increase in reputational risk. During periods of transition, greater operational risk and client concern exist with respect to maintaining a high level of service delivery.
In addition, we are subject in our global operations to rules and regulations relating to corrupt and illegal payments, money laundering, and laws relating to doing business with certain individuals, groups and countries, such as the U.S. Foreign Corrupt Practices Act, the USA PATRIOT Act, the UK Bribery Act, and economic sanctions and embargo programs administered by the U.S. Office of Foreign Assets Control and similar agencies worldwide. While we have invested and continue to invest significant resources in training and in compliance monitoring, the geographic diversity of our operations, employees, clients and customers, as well as the vendors and other third parties with whom we deal, presents the risk that we may be found in violation of such rules, regulations, laws or programs and any such violation could subject us to significant penalties or affect our reputation adversely.
Failure to control our costs and expenses adequately could affect our earnings negatively.
Our success in controlling the costs and expenses of our business operations also impacts operating results. Through various parts of our business strategy, we aim to produce efficiencies in operations that help reduce and control costs and expenses, including the costs of losses associated with operating risks attributable to servicing and managing financial assets. Failure to control these and other costs could affect our earnings negatively and reduce our competitive position.
Pandemics, natural disasters, global climate change, acts of terrorism and global conflicts may have a negative impact on our business and operations.
Pandemics, natural disasters, global climate change, acts of terrorism, global conflicts or other similar events have in the past, and may in the future have, a negative impact on our business and operations. While we have in place business continuity plans, such events may still damage our facilities, disrupt or delay the normal operations of our business (including communications and technology), result in harm to or cause travel limitations on our employees, and have a similar impact on our clients, suppliers, third-party vendors and counterparties. These events also could impact us negatively to the extent that they result in reduced capital markets activity, lower asset price levels, or disruptions in general economic activity in the United States or abroad, or in financial market settlement functions. In addition, these or similar events may impact economic growth negatively, which could have an adverse effect on our business and operations, and may have other adverse effects on us in ways that we are unable to predict. Please see “COVID-19 Pandemic-Related Risks” in this “Risk Factors” section for a description of risks associated with the ongoing COVID-19 pandemic.
Credit Risks
Failure to evaluate accurately the prospects for repayment when we extend credit or maintain an adequate allowance for credit losses can result in losses or the need to make additional provisions for credit losses, both of which reduce our earnings.
We evaluate extensions of credit before we make them and then provide for credit risks based on our assessment of the credit losses inherent in our loan portfolio, including undrawn credit commitments. This process requires us to make difficult and complex judgments. Challenges associated with our credit risk assessments include identifying the proper factors to be used in assessments and accurately estimating the impacts of those factors. Allowances that prove to be inadequate may require us to realize increased provisions for credit losses or write down the value of certain assets on our balance sheet, which in turn would affect earnings negatively.
Market volatility and/or weak economic conditions can result in losses or the need for additional provisions for credit losses, both of which reduce our earnings.
Credit risk levels and our earnings also can be affected by market volatility and/or weakness in the economy in general and in the particular locales in which we extend credit, a deterioration in credit quality or a reduced demand for credit. Adverse changes in the financial performance or condition of our borrowers resulting from market volatility and/or weakened economic conditions could impact the borrowers’ abilities to repay outstanding loans, which could in turn impact our financial condition and results of operations negatively.
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The failure or perceived weakness of any of our significant counterparties could expose us to loss.
The financial markets are characterized by extensive interconnections among financial institutions, including banks, broker/dealers, collective investment funds and insurance companies. As a result of these interconnections, we and many of our clients have counterparty exposure to other financial institutions. This counterparty exposure presents risks to us and to our clients because the failure or perceived weakness of any of our counterparties has the potential to expose us to risk of loss. Instability in the financial markets has resulted historically in some financial institutions becoming less creditworthy. During such periods of instability, we are exposed to increased counterparty risks, both as principal and in our capacity as agent for our clients. Changes in market perception of the financial strength of particular financial institutions can occur rapidly, are often based upon a variety of factors and can be difficult to predict. In addition, the criteria for and manner of governmental support of financial institutions and other economically important sectors remain uncertain. Further, the consolidation of financial services firms and the failures of other financial institutions has in the past increased, and may in the future increase, the concentration of our counterparty risk. These risks are heightened by the fact that our operating model relies on the use of unaffiliated sub-custodians to a greater degree than certain of our competitors that have banking operations in more jurisdictions than we do. We are not able to mitigate all of our and our clients’ counterparty credit risk. If a significant individual counterparty defaults on an obligation to us, we could incur financial losses that have a material and adverse effect on our business, financial condition and results of operations.
Changes in the method pursuant to which LIBOR or other interest rate benchmarks are determined could adversely impact our business and results of operations.
Many financial markets currently rely on interbank offered rates (each, an “IBOR”) as mutually agreed upon reference rates serving as the basis for the pricing and valuation of assets, trading positions, loans and other financial transactions. Global regulators have signaled interest in replacing existing IBOR rates with alternative reference rates. While there are multiple IBORs, LIBOR is the most widely used interest rate benchmark in the world and serves as the reference rate for our floating-rate funding, certain of the products that we own or offer, various lending and securities transactions in which we are involved, and many derivatives that we use to manage our or our clients’ risk. On November 30, 2020, ICE Benchmark Administration (“IBA”), the administrator of U.S. Dollar LIBOR (“USD LIBOR”) and other IBORs, announced that, following required consultations, (i) it intends to cease publication of 1-week and 2-month USD LIBOR at the end of 2021 and (ii) subject to compliance with applicable regulations, including as to representativeness, it does not intend to cease publication of the remaining USD LIBOR tenors until June 30, 2023. Globally, financial market participants have begun to transition away from LIBOR and other IBORs to alternative reference rates, and following the IBA’s announcement, U.S. regulators, including the Federal Reserve Board, issued statements encouraging banks to stop entering into new USD LIBOR contracts “as soon as practicable,” and by no later than December 31, 2021. Any change in the availability or calculation of LIBOR or other interest rate benchmarks may affect adversely the cost or availability of floating-rate funding; the yield on loans or securities held by us; the amounts received and paid on derivative instruments we have entered into; the value of loans, securities, or derivative instruments held by us or our clients, which, in the case of assets held by our clients, could also negatively impact the amount of fees we earn in relation to such assets; the trading market for securities based on LIBOR or other benchmarks; the terms of new loans being made using different or modified reference rates; or our ability to use derivative instruments to manage risk effectively. While we are working to facilitate an orderly transition from LIBOR to alternative interest rate benchmarks for us and our clients, there continues to be uncertainty regarding the effect that these developments, any discontinuance, modification or other reforms to LIBOR or any other interest rate benchmarks, or the establishment of alternative reference rates may have on LIBOR or other interest rate benchmarks. Further, the potential transition away from the use of LIBOR or other interest rate benchmarks, or uncertainty related to any such potential transition, may cause us to recognize additional costs, experience operational disruptions or result in client disputes or litigation, which may negatively impact our business, financial condition or results of operations.
Liquidity Risks
If we do not manage our liquidity effectively, our business could suffer.
Liquidity is essential for the operation of our business. Market conditions, unforeseen outflows of funds or other events could have a negative effect on our level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations, and fund new business transactions at a reasonable cost and in a timely manner. If our access to stable and low-cost sources of funding, such as customer deposits, is reduced, we may need to use alternative funding, which could be more expensive or of limited availability. Further evolution in the regulatory requirements relating to liquidity and risk management also may impact us negatively. Additional regulations may impose more stringent liquidity requirements for large financial institutions, including the Corporation and the Bank. Given the overlap and complex interactions of these regulations with other regulatory changes, the full impact of the adopted and proposed regulations remains uncertain until their full implementation. For more information on these
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regulations and other regulatory changes, see “Supervision and Regulation—Liquidity Standards” in Item 1, “Business.” Any substantial, unexpected or prolonged changes in the level or cost of liquidity could affect our business adversely.
If the Bank is unable to supply the Corporation with funds over time, the Corporation could be unable to meet its various obligations.
The Corporation is a legal entity separate and distinct from the Bank and the Corporation’s other subsidiaries. The Corporation relies on dividends paid to it by the Bank to meet its obligations and to pay dividends to stockholders of the Corporation. There are various legal limitations on the extent to which the Bank and the Corporation’s other subsidiaries can supply funds to the Corporation by dividend or otherwise. Dividend payments by the Bank to the Corporation in the future will require continued generation of earnings by the Bank and could require regulatory approval under certain circumstances. For more information on dividend restrictions, see “Supervision and Regulation—Payment of Dividends” in Item 1, “Business.”
We may need to raise additional capital in the future, which may not be available to us or may only be available on unfavorable terms.
We may need to raise additional capital to provide sufficient resources to meet our business needs and commitments, to accommodate the transaction and cash management needs of our clients, to maintain our credit ratings in response to regulatory changes, including capital rules, or for other purposes. However, our ability to access the capital markets, if needed, will depend on a number of factors, including the state of the financial markets. Rising interest rates, disruptions in financial markets, negative perceptions of our business or our financial strength, or other factors may impact our ability to raise additional capital, if needed, on terms acceptable to us. Any diminished ability to raise additional capital, if needed, could subject us to liability, restrict our ability to grow, require us to take actions that would affect our earnings negatively or otherwise affect our business and our ability to implement our business plan, capital plan and strategic goals adversely.
Any downgrades in our credit ratings, or an actual or perceived reduction in our financial strength, could affect our borrowing costs, capital costs and liquidity adversely.
Rating agencies publish credit ratings and outlooks on our creditworthiness and that of our obligations or securities, including long-term debt, short-term borrowings, preferred stock and other securities. Our credit ratings are subject to ongoing review by the rating agencies and thus may change from time to time based on a number of factors, including our own financial strength, performance, prospects and operations as well as factors not under our control, such as rating-agency-specific criteria or frameworks for our industry or certain security types, which are subject to revision from time to time, and conditions affecting the financial services industry generally.
Downgrades in our credit ratings may affect our borrowing costs, our capital costs and our ability to raise capital and, in turn, our liquidity adversely. A failure to maintain an acceptable credit rating also may preclude us from being competitive in certain products. Additionally, our counterparties, as well as our clients, rely on our financial strength and stability and evaluate the risks of doing business with us. If we experience diminished financial strength or stability, actual or perceived, a decline in our stock price or a reduced credit rating, our counterparties may be less willing to enter into transactions, secured or unsecured, with us, our clients may reduce or place limits on the level of services we provide them or seek other service providers, or our prospective clients may select other service providers, all of which may have other adverse effects on our business.
The risk that we may be perceived as less creditworthy relative to other market participants is higher in a market environment in which the consolidation, and in some instances failure, of financial institutions, including major global financial institutions, could result in a smaller number of larger counterparties and competitors. If our counterparties perceive us to be a less viable counterparty, our ability to enter into financial transactions on terms acceptable to us or our clients, on our or our clients’ behalf, will be compromised materially. If our clients reduce their deposits with us or select other service providers for all or a portion of the services we provide to them, our revenues will decrease accordingly.
Our success with large, complex clients requires substantial liquidity.
A significant portion of our business involves providing certain services to large, complex clients, which, by their nature, require substantial liquidity. Our failure to manage successfully the liquidity and balance sheet issues attendant to this portion of our business may have a negative impact on our ability to meet client needs and grow.
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Regulatory and Legal Risks
Failure to comply with regulations can result in penalties and regulatory constraints that restrict our ability to grow or even conduct our business, or that reduce earnings.
Virtually every aspect of our business around the world is regulated, generally by governmental agencies that have broad supervisory powers and the ability to impose sanctions. These regulations cover a variety of matters, including required capital levels, prohibited activities, and privacy and data protection. Some of these requirements are directed specifically at protecting depositors of the Bank, the federal deposit insurance fund and the banking system as a whole, not our stockholders or other security holders. Regulatory violations or the failure to meet formal or informal commitments made to regulators could generate penalties, require corrective actions that increase costs of conducting business, result in limitations on our ability to conduct business, restrict our ability to expand or impact our reputation adversely. Failure to obtain necessary approvals from regulatory agencies on a timely basis could affect proposed business opportunities and results of operations adversely. Similarly, changes in laws or failure to comply with new requirements or with future changes in laws or regulations may impact our results of operations and financial condition negatively.
Changes by the U.S. and other governments to laws, regulations and policies applicable to the financial services industry may heighten the challenges we face and make regulatory compliance more difficult and costly.
Various regulatory bodies have demonstrated heightened enforcement scrutiny of financial institutions through many regulatory initiatives. These initiatives have increased compliance costs and regulatory risks and may lead to financial and reputational damage in the event of a compliance violation. While we have programs in place, including policies, training and various forms of monitoring, designed to ensure compliance with legislative and regulatory requirements, these programs and policies may not always protect us from conduct by individual employees. Governments may take further actions to change significantly the way financial institutions are regulated, either through new legislation, new regulations, new applications of existing regulations or a combination of all of these methods. We cannot currently predict the impact, if any, of these changes to our business. Additionally, governments and regulators may take actions that increase intervention in the normal operation of our businesses and the businesses of our competitors in the financial services industry, and likely would involve additional legislative and regulatory requirements imposed on banks and other financial services companies. Any such actions could increase compliance costs and regulatory risks, lead to financial and reputational damage in the event of a violation, affect our ability to compete successfully, and also may impact the nature and level of competition in the industry in unpredictable ways. The full scope and impact of possible legislative or regulatory changes and the extent of regulatory activity is uncertain and difficult to predict.
For example, we are unable to predict what, if any, changes to the laws and regulations applicable to the financial services industry may be enacted by the new U.S. Congress in conjunction with the new U.S. presidential administration under unified party control, and what the impact of any such changes will be upon our business, financial condition, and results of operations. Moreover, the turnover of the U.S. presidential administration is expected to result in certain changes in the leadership and senior staffs of the federal banking agencies which are likely to impact the rulemaking, supervision, examination and enforcement priorities and policies of such agencies, the potential impacts of which, if any, we cannot predict at this time.
We may be impacted adversely by claims or litigation, including claims or litigation relating to our fiduciary responsibilities.
Our businesses involve the risk that clients or others may sue us, claiming that we have failed to perform under a contract or otherwise failed to carry out a duty perceived to be owed to them. Our trust, custody and investment management businesses are particularly subject to this risk. This risk is heightened when we act as a fiduciary for our clients and may be further heightened during periods when credit, equity or other financial markets are deteriorating in value or are particularly volatile, or when clients or investors are experiencing losses. In addition, regulators, tax authorities and courts have increasingly sought to hold financial institutions liable for the misconduct of their clients where such regulators and courts have determined that the financial institution should have detected that the client was engaged in wrongdoing, even though the financial institution had no direct knowledge of the wrongdoing.
Claims made or actions brought against us, whether founded or unfounded, may result in injunctions, settlements, damages, fines or penalties, which could have a material adverse effect on our financial condition or results of operations or require changes to our business. Even if we defend ourselves successfully, the cost of litigation is often substantial, and public reports regarding claims made against us may cause damage to our reputation among existing and prospective clients or negatively impact the confidence of counterparties, rating agencies and stockholders, consequently affecting our earnings negatively.
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We may be impacted adversely by regulatory enforcement matters.
In the ordinary course of our business, we are subject to various supervisory, governmental and enforcement inquiries, examinations, investigations and subpoenas. These may be directed generally to participants in the businesses in which we are involved or may be directed specifically at us. In conjunction with both supervisory and enforcement matters, we may face limits on our ability to conduct or expand our business, be required to implement corrective actions that increase the costs of conducting business, or become subject to civil or criminal penalties or other remedial sanctions, any of which could result in reputational damage or otherwise have an adverse impact on us.
We may fail to set aside adequate reserves for, or otherwise underestimate our liability relating to, pending and threatened claims, with a negative effect on our earnings.
We estimate our potential liability for pending and threatened claims and record reserves when appropriate pursuant to generally accepted accounting principles (GAAP). The process is inherently subject to risk, including the risks that a judge or jury could decide a case contrary to our evaluation of the law or the facts or that a court could change or modify existing law on a particular issue important to the case. Our earnings will be adversely affected if our reserves are not adequate.
If we fail to comply with legal standards, we could incur liability to our clients or lose clients, which could affect our earnings negatively.
Managing or servicing assets with reasonable prudence in accordance with the terms of governing documents and applicable laws is an important part of our business. Failure to comply with the terms of governing documents and applicable laws, manage adequately the risks or manage appropriately the differing interests often involved in the exercise of fiduciary responsibilities may subject us to liability or cause client dissatisfaction, which may impact negatively our earnings and growth.
Strategic Risks
If we do not execute strategic plans successfully, we will not grow as we have planned and our earnings growth will be impacted negatively.
Our growth depends upon successful, consistent execution of our business strategies. A failure to execute these strategies will impact growth negatively. A failure to grow organically or to integrate successfully an acquisition could have an adverse effect on our business. The challenges arising from generating organic growth or the integration of an acquired business may include preserving valuable relationships with employees, clients, suppliers and other business partners, delivering enhanced products and services, as well as combining accounting, data processing and internal control systems. To the extent we enter into transactions to acquire complementary businesses and/or technologies, we may not achieve the expected benefits of such transactions, which could result in increased costs, lowered revenues, ineffective deployment of capital, regulatory concerns, exit costs or diminished competitive position or reputation. These risks may be increased if the acquired company operates internationally or in a geographic location where we do not already have significant business operations.
Execution of our business strategies also may require certain regulatory approvals or consents, which may include approvals of the Federal Reserve Board and other domestic and non-U.S. regulatory authorities. These regulatory authorities may impose conditions on the activities or transactions contemplated by our business strategies which may impact negatively our ability to realize fully the expected benefits of certain opportunities. Further, acquisitions we announce may not be completed if we do not receive the required regulatory approvals, if regulatory approvals are significantly delayed or if other closing conditions are not satisfied.
If we are not able to attract, retain and motivate key personnel, our business could be negatively affected.
Our success depends, in large part, on our ability to attract new employees, retain and motivate our existing employees, and continue to compensate our employees competitively. Competition for the best employees in most activities in which we engage can be intense, and there can be no assurance that we will be successful in our efforts to recruit and retain key personnel. Factors that affect our ability to attract and retain talented and diverse employees include our compensation and benefits programs, our profitability and our reputation for rewarding and promoting qualified employees. Our ability to attract and retain key executives and other employees may be hindered as a result of existing and potential regulations applicable to incentive compensation and other aspects of our compensation programs. These regulations may not apply to some of our competitors and to other institutions with which we compete for talent. The unexpected loss of services of key personnel, both in businesses and corporate functions, could have a material adverse impact on our business because of their skills, knowledge of our markets, operations and clients, years of industry experience and, in some cases, the difficulty of promptly finding qualified replacement personnel. Similarly, the loss of key employees, either individually or as a group, could affect our clients’ perception of our abilities adversely.
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We are subject to intense competition in all aspects of our businesses, which could have a negative effect on our ability to maintain satisfactory prices and grow our earnings.
We provide a broad range of financial products and services in highly competitive markets. We compete against large, well-capitalized, and geographically diverse companies that are capable of offering a wide array of financial products and services at competitive prices. In certain businesses, such as foreign exchange trading, electronic networks present a competitive challenge. Additionally, technological advances and the growth of internet-based commerce have made it possible for other types of institutions to offer a variety of products and services competitive with certain areas of our business. Many of these nontraditional service providers have fewer regulatory constraints and some have lower cost structures. The same may be said for competitors based in non-U.S. jurisdictions, where legal and regulatory environments may be more favorable than those applicable to the Corporation and the Bank as U.S.-domiciled financial institutions. These competitive pressures may have a negative effect on our earnings and ability to grow. Pricing pressures, as a result of the willingness of competitors to offer comparable or improved products or services at a lower price, also may result in a reduction in the price we can charge for our products and services, which could have, and in some cases has had, a negative effect on our ability to maintain or increase our profitability.
Damage to our reputation could have a direct and negative effect on our ability to compete, grow and generate revenue.
The failure to meet client expectations or fiduciary or other obligations, operational failures, litigation, regulatory actions or fines, the actual or alleged actions of our affiliates, vendors or other third parties with which we do business, the actual or alleged actions or statements of our employees or adverse publicity could materially and adversely affect our reputation as well as our ability to attract and retain clients or key employees. Damage to our reputation for delivery of a high level of service could undermine the confidence of clients and prospects in our ability to serve them and accordingly affect our earnings negatively. Damage to our reputation also could affect the confidence of rating agencies, regulators, stockholders and other parties in a wide range of transactions that are important to our business and the performance of our common stock. Failure to maintain our reputation ultimately would have an adverse effect on our ability to manage our balance sheet or grow our business. Actions by the financial services industry generally or by other members of or individuals in the financial services industry also could impact our reputation negatively. Further, whereas negative public opinion once was driven primarily by adverse news coverage in traditional media, the proliferation of social media channels utilized by us and third parties, as well as the personal use of social media by our employees and others, may increase the risk of negative publicity, including through the rapid dissemination of inaccurate, misleading or false information, which could harm our reputation or have other negative consequences.
We need to invest in innovation constantly, and the inability or failure to do so may affect our businesses and earnings negatively.
Our success in the competitive environment in which we operate requires consistent investment of capital and human resources in innovation, particularly in light of the current “FinTech” environment, in which financial institutions are investing significantly in evaluating new technologies, such as artificial intelligence, machine learning, blockchain and other distributed ledger technologies, and developing potentially industry-changing new products, services and industry standards. Our investment is directed at generating new products and services, and adapting existing products and services to the evolving standards and demands of the marketplace. Among other things, investing in innovation helps us maintain a mix of products and services that keeps pace with our competitors and achieve acceptable margins. Our investment also focuses on enhancing the delivery of our products and services in order to compete successfully for new clients or gain additional business from existing clients, and includes investment in technological innovation as well. Effectively identifying gaps or weaknesses in our product offerings also is important to our success. Falling behind our competition in any of these areas could affect our business opportunities, growth and earnings adversely. There are substantial risks and uncertainties associated with innovation efforts, including an increased risk that new and emerging technologies may expose us to increased cybersecurity and other information technology threats. We must invest significant time and resources in developing and marketing new products and services, and expected timetables for the introduction and development of new products or services may not be achieved and price and profitability targets may not be met. Further, our revenues and costs may fluctuate because new products and services generally require start-up costs while corresponding revenues take time to develop or may not develop at all.
Failure to understand or appreciate fully the risks associated with development or delivery of new product and service offerings will affect our businesses and earnings negatively.
The success of our innovation efforts depends, in part, on the successful implementation of new product and service initiatives. Not only must we keep pace with competitors in the development of these new offerings, but we must accurately price them (as well as existing products) on a risk-adjusted basis and deliver them to clients effectively. Our identification of risks arising from new products and services, both in their design and implementation, and effective
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responses to those identified risks, including pricing, is key to the success of our efforts at innovation and investment in new product and service offerings.
Our success with large, complex clients requires an understanding of the market and legal, regulatory and accounting standards in various jurisdictions.
A significant portion of our business involves providing certain services to large, complex clients which require an understanding of the market and legal, regulatory and accounting standards in various jurisdictions. Any failure to understand, address or comply with those standards appropriately could affect our growth prospects or affect our reputation negatively. We identify and manage risk through our business strategies and plans and our risk management practices and controls. If we fail to identify and manage significant risks successfully, we could incur financial loss, suffer damage to our reputation that could restrict our ability to grow or conduct business profitably, or become subject to regulatory penalties or constraints that could limit some of our activities or make them significantly more expensive. In addition, our businesses and the markets in which we operate are continuously evolving. We may fail to understand fully the implications of changes in legal or regulatory requirements, our businesses or the financial markets or fail to enhance our risk framework to address those changes in a timely fashion. If our risk framework is ineffective, either because it fails to keep pace with changes in the financial markets, legal and regulatory requirements, our businesses, our counterparties, clients or service providers or for other reasons, we could incur losses, suffer reputational damage or find ourselves out of compliance with applicable regulatory or contractual mandates or expectations. These risks are magnified as client requirements become more complex and as our increasingly global business requires end-to-end management of operational and other processes across multiple time zones and many inter-related products and services.
We may take actions to maintain client satisfaction that result in losses or reduced earnings.
We may take action or incur expenses in order to maintain client satisfaction or preserve the usefulness of investments or investment vehicles we manage in light of changes in security ratings, liquidity or valuation issues or other developments, even though we are not required to do so by law or the terms of governing instruments. The risk that we will decide to take actions to maintain client satisfaction that result in losses or reduced earnings is greater in periods when credit or equity markets are deteriorating in value or are particularly volatile and liquidity in markets is disrupted.
Other Risks
Changes in tax laws and interpretations and tax challenges may affect our earnings negatively.
Both U.S. and non-U.S. governments and tax authorities, including states and municipalities, from time to time issue new, or modify existing, tax laws and regulations. These authorities may also issue new, or modify existing, interpretations of those laws and regulations. These new laws, regulations or interpretations, and our actions taken in response to, or reliance upon, such changes in the tax laws may impact our tax position in a manner that affects our earnings negatively.
In the course of our business, we are sometimes subject to challenges from U.S. and non-U.S. tax authorities, including states and municipalities, regarding the amount of taxes due. These challenges may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions, all of which may require a greater provision for taxes or otherwise affect earnings negatively.
Changes in accounting standards may be difficult to predict and could have a material impact on our consolidated financial statements.
New accounting standards, changes to existing accounting standards, or changes in the interpretation of existing accounting standards by the Financial Accounting Standards Board, the International Accounting Standards Board, the SEC or bank regulatory agencies, or otherwise reflected in GAAP, potentially could have a material impact on our financial condition and results of operations. These changes are difficult to predict and in some cases we could be required to apply a new or revised standard retroactively, resulting in the revised treatment of certain transactions or activities, or even the restatement of consolidated financial statements for prior periods.
Our ability to return capital to stockholders is subject to the discretion of our Board of Directors and may be limited by U.S. banking laws and regulations, applicable provisions of Delaware law, or our failure to pay full and timely dividends on our preferred stock and the terms of our outstanding debt.
Holders of our common stock are entitled to receive only such dividends and other distributions of capital as our Board of Directors may declare out of funds legally available for such payments under Delaware law. Although we have declared cash dividends on shares of our common stock historically, we are not required to do so. In addition to the approval of our Board of Directors, our ability to take certain actions, including our ability to pay dividends, repurchase stock, and make other capital distributions, is dependent upon, among other things, their payment being made in accordance with the capital plan rules and capital adequacy standards of the Federal Reserve Board. On June 25, 2020, the Federal Reserve Board
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imposed restrictions that were designed to cause large bank holding companies to preserve capital, including suspending share repurchases, capping dividend payments, and only allowing common stock dividends according to a formula based on recent income. On December 18, 2020, the Federal Reserve Board extended a portion of these restrictions to limit share repurchases and dividend payments based on recent income. These restrictions will apply for the first quarter of 2021 and may be extended further.
A significant source of funds for the Corporation is dividends from the Bank. As a result, our ability to pay dividends on the Corporation’s common stock will depend on the ability of the Bank to pay dividends to the Corporation. There are various legal limitations on the extent to which the Bank and the Corporation’s other subsidiaries can supply funds to the Corporation by dividend or otherwise. Dividend payments by the Bank to the Corporation in the future will require continued generation of earnings by the Bank and could require regulatory approval under certain circumstances. If the Bank is unable to pay dividends to the Corporation in the future, our ability to pay dividends on the Corporation’s common stock would be affected adversely.
Our ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of our common stock or any of our shares that rank junior to our preferred stock as to the payment of dividends and/or the distribution of any assets on any liquidation, dissolution or winding-up of the Corporation also generally will be prohibited in the event that we do not declare and pay in full dividends on our Series D Non-Cumulative Perpetual Preferred Stock (Series D preferred stock) and Series E Non-Cumulative Perpetual Preferred Stock (Series E preferred stock). Further, in the future if we default on certain of our outstanding debt or elect to defer interest payments on our Floating Rate Capital Debt we will be prohibited from making dividend payments on our common stock until such payments have been brought current.
Any reduction or elimination of our common stock dividend, or even our failure to increase our common stock dividend along with our competitors, likely would have a negative effect on the market price of our common stock. For more information on dividend restrictions, see “Supervision and Regulation—Payment of Dividends” and “Supervision and Regulation—Capital Planning and Stress Testing” in Item 1, “Business.”
ITEM 1B – UNRESOLVED STAFF COMMENTS
None.
ITEM 2 – PROPERTIES
The executive offices of the Corporation and the Bank are located at 50 South La Salle Street in Chicago. This Bank-owned building is occupied by various divisions of Northern Trust’s businesses. Adjacent to this building is one office building in which the Bank leases space principally for corporate support functions. Financial services are provided by the Bank and other subsidiaries of the Corporation through a network of offices in 22 U.S. states and Washington, D.C., and across 22 locations in Canada, Europe, the Middle East and the Asia-Pacific region. The majority of those offices are leased. The Bank’s other primary U.S. operations are located in five facilities: a leased facility at 333 South Wabash Avenue in Chicago; a leased facility in Tempe, Arizona; and one leased and two Bank-owned supplementary operations/data center buildings located in the western suburbs of Chicago. A majority of the Bank’s London-based staff is located at a leased facility at Canary Wharf in London. Additional support and operations activity originates from four facilities in India, two facilities in Ireland, and one facility in the Philippines, all of which are leased. The Bank and the Corporation’s other subsidiaries operate from various other facilities in North America, Europe, the Asia-Pacific region, and the Middle East, most of which are leased.
The Corporation believes that its owned and leased facilities are suitable and adequate for its business needs. The Corporation continues to evaluate its owned and leased facilities and may determine from time to time that certain of its facilities are no longer necessary for its operations. There is no assurance that the Corporation will be able to dispose of any excess facilities or that it will not incur costs in connection with such dispositions, which could be material to its operating results in a given period.
For additional information relating to properties and lease commitments, refer to Note 9, “Buildings and Equipment” and Note 10, “Lease Commitments,” included under Item 8, “Financial Statements and Supplementary Data,” and which information is incorporated herein by reference.
ITEM 3 – LEGAL PROCEEDINGS
The information presented under the caption “Legal Proceedings” in Note 26, “Commitments and Contingent Liabilities,” included under Item 8, “Financial Statements and Supplementary Data,” is incorporated herein by reference.
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ITEM 4 – MINE SAFETY DISCLOSURES
Not applicable.
SUPPLEMENTAL ITEM – INFORMATION ABOUT OUR EXECUTIVE OFFICERS
The following sets forth certain information with regard to each executive officer of the Corporation.
Michael G. O’Grady - Mr. O’Grady, age 55, joined Northern Trust in 2011 and has served as Chairman of the Board since January 2019, as Chief Executive Officer since 2018 and as President since 2017. Prior to that, Mr. O’Grady served as Executive Vice President and President of Corporate & Institutional Services from 2014 to 2016 and as Chief Financial Officer from 2011 to 2014. Before joining Northern Trust, Mr. O’Grady served as a Managing Director in Bank of America Merrill Lynch’s Investment Banking Group.
Lauren E. Allnutt - Ms. Allnutt, age 44, joined Northern Trust in 2008 and has served as an Executive Vice President since November 2020 and as Controller since May 2019. Prior to that, Ms. Allnutt served as manager of Global Financial Control from 2014 to April 2019 and led International Accounting Policy and Control from 2013 to 2014.
Robert P. Browne - Mr. Browne, age 55, joined Northern Trust in 2009 as Executive Vice President and Chief Investment Officer. Before joining Northern Trust, Mr. Browne served in various senior investment-related roles at ING Investment Management Holdings N.V.
Peter B. Cherecwich - Mr. Cherecwich, age 56, joined Northern Trust in 2007 and has served as Executive Vice President and President of Corporate & Institutional Services since 2017. Prior to that, Mr. Cherecwich served as Executive Vice President and President of Global Fund Services from 2010 to 2017 and as Chief Operating Officer of Corporate & Institutional Services from 2008 to 2014. From 2007 to 2008, he served as Head of Institutional Strategy & Product Development. Before joining Northern Trust, Mr. Cherecwich served in several executive and operational roles at State Street Corporation.
Steven L. Fradkin - Mr. Fradkin, age 59, joined Northern Trust in 1985 and has served as Executive Vice President and President of Wealth Management since 2014. Prior to that, Mr. Fradkin served as President of Corporate & Institutional Services from 2009 to 2014. From 2004 to 2009, he served as Chief Financial Officer.
Mark C. Gossett - Mr. Gossett, age 59, joined Northern Trust in 1983 and has served as Executive Vice President and Chief Risk Officer since February 2020. Prior to that, Mr. Gossett served as Chief Credit Officer and Head of Market and Liquidity Risk from 2014 to January 2020 and as Co-Head of Global Foreign Exchange from 2012 to 2014. Mr. Gossett also previously served as the Chief Risk Officer of Asset Management from 2009 to 2012 and as the Chief Operating Officer of Asset Management from 2005 to 2009.
Susan C. Levy - Ms. Levy, age 63, joined Northern Trust in 2014 and has served as Executive Vice President and General Counsel since that time and as Corporate Secretary since 2018. Before joining Northern Trust, Ms. Levy served as Managing Partner of the law firm Jenner & Block from 2008 to 2014, where she was a partner since 1990.
Teresa A. Parker - Ms. Parker, age 60, joined Northern Trust in 1982 and has served as Executive Vice President and President of Corporate & Institutional Services for Europe, Middle East and Africa since 2017. Prior to that, Ms. Parker served as Chief Operating Officer of Corporate & Institutional Services from 2014 to 2017. From 2009 to 2014, she served as Executive Vice President, Corporate & Institutional Services for the Asia-Pacific region.
Thomas A. South - Mr. South, age 51, joined Northern Trust in 1999 and has served as Executive Vice President and Chief Information Officer since 2018. Prior to that, Mr. South served as Chief Business Architect from 2014 to 2018 and as Chief Operating Officer of Operations & Technology from 2013 to 2014.
Joyce M. St. Clair - Ms. St. Clair, age 61, joined Northern Trust in 1992 and has served as Executive Vice President and Chief Human Resources Officer since 2018. Prior to that, Ms. St. Clair served as Executive Vice President and Chief Capital Management Officer from 2015 to 2018, as President of Enterprise Operations from 2014 to 2015, as President of Operations & Technology from 2011 to 2014, and as Chief Risk Officer from 2007 to 2011.
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Shundrawn A. Thomas - Mr. Thomas, age 47, joined Northern Trust in 2004 and has served as Executive Vice President and President of Asset Management since 2017. Prior to that, Mr. Thomas served as Executive Vice President and Head of the Funds and Managed Accounts Group from 2014 to 2017 and as Head of the Exchange-Traded Funds Group from 2010 to 2014. Mr. Thomas also previously served as President and Chief Executive Officer of Northern Trust Securities, Inc. from 2009 to 2010 and as Head of Corporate Strategy from 2006 to 2009.
Jason J. Tyler - Mr. Tyler, age 49, joined Northern Trust in 2011 and has served as Executive Vice President and Chief Financial Officer since January 2020. Prior to that, Mr. Tyler served as Chief Financial Officer of Wealth Management from 2018 to December 2019, as Global Head of Asset Management’s Institutional Group from 2014 to 2018, and as Global Head of Strategy from 2011 to 2014. Before joining Northern Trust, Mr. Tyler served in certain executive and operational roles at Ariel Investments and Bank One/American National Bank.
All officers are appointed annually by the Board of Directors. Officers continue to hold office until their successors are duly elected or until their death, resignation or removal by the Board.
2020 Annual Report | Northern Trust Corporation 27
PART II
ITEM 5 – MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on The NASDAQ Stock Market LLC under the symbol “NTRS.” There were 1,643 shareholders of record as of January 31, 2021.
The following table shows certain information relating to the Corporation’s purchases of common stock for the three months ended December 31, 2020.
TABLE 3: REPURCHASES OF COMMON STOCK IN THE FOURTH QUARTER OF2020
Total (Fourth Quarter) — $ — — 6,487,647
On March 16, 2020, the Corporation suspended its share repurchase program, previously announced by the Corporation on July 17, 2018, under which the Corporation’s Board of Directors authorized the Corporation to repurchase up to 25.0 million shares of the Corporation’s common stock. The repurchase authorization approved by the Board of Directors has no expiration date. Beginning in the second quarter of 2020, the Federal Reserve announced certain measures to ensure that large financial institutions, including Northern Trust, remain resilient despite the economic uncertainty resulting from the ongoing COVID-19 pandemic. Specifically, for the third and fourth quarters of 2020, no share repurchases were permitted by these institutions. On December 18, 2020, the Federal Reserve again extended its capital distribution limits into the first quarter of 2021 with certain modifications, which include continuing to limit dividend payments based on recent income and limiting share repurchases based on recent income. During the first quarter of 2021, the Corporation restarted its share repurchase program in accordance with such limitations. For more information, please refer to Note 15, “Stockholders’ Equity,” provided in Item 8, “Financial Statements and Supplementary Data.”
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COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
The following graph compares the cumulative total stockholder return on the Corporation’s common stock to the cumulative total return of the S&P 500 Index and the KBW Bank Index for the five fiscal years ended December 31, 2020. The cumulative total stockholder return assumes the investment of $100 in the Corporation’s common stock and in each index on December 31, 2015 and assumes reinvestment of dividends. The KBW Bank Index is a modified-capitalization-weighted index made up of 24 of the largest banking companies in the United States. The Corporation is included in the S&P 500 Index and the KBW Bank Index.
Total Return Assumes $100 Invested on
December 31, 2015 with Reinvestment of Dividends
DECEMBER 31,
2020 Annual Report | Northern Trust Corporation 29
ITEM 6 – SELECTED FINANCIAL DATA
CONDENSED STATEMENTS OF INCOME ($ In Millions)
PER COMMON SHARE
SELECTED BALANCE SHEET DATA ($ In Millions)
At Year End:
Average Balances:
CLIENT ASSETS ($ In Billions)
SELECTED RATIOS AND METRICS
Financial Ratios and Metrics:
Average Stockholders’ Equity to Average Assets 8.2 9.1 8.3 8.3 7.9
Supplementary Leverage(2) N/A 8.6 N/A 7.6 N/A 7.0
Supplementary Leverage(2) N/A 6.8 N/A 6.8 N/A 3.0
(1)For the purposes of disclosing Assets Under Custody/Administration, to the extent that both custody and administration services are provided, the value of the assets is included only once.
(2) Effective January 1, 2018, the Corporation and Bank are subject to a minimum supplementary leverage ratio of 3 percent. Refer to the “Supervision and Regulation—Capital Adequacy Requirements” section of Item 1, “Business” for further information on the supplementary leverage ratio.
30 2020 Annual Report | Northern Trust Corporation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following is management’s discussion and analysis of the financial condition and results of operations (MD&A) of Northern Trust Corporation (Corporation) for the year ended December 31, 2020. The following should be read in conjunction with the consolidated financial statements and related footnotes included in this report. Investors also should read the section entitled “Forward-Looking Statements.”
BUSINESS OVERVIEW
The Corporation is a leading provider of wealth management, asset servicing, asset management and banking solutions to corporations, institutions, families and individuals. The Corporation focuses on managing and servicing client assets through its two client-focused reporting segments: Corporate & Institutional Services (C&IS) and Wealth Management. Asset management and related services are provided to C&IS and Wealth Management clients primarily by the Asset Management business.
The Corporation conducts business through various U.S. and non-U.S. subsidiaries, including The Northern Trust Company (the Bank). The Corporation was formed as a holding company for the Bank in 1971. The Corporation has a global presence with offices in 22 U.S. states and Washington, D.C., and across 22 locations in Canada, Europe, the Middle East and the Asia-Pacific region. Except where the context requires otherwise, the terms “Northern Trust,” “we,” “us,” “our,” “its,” or similar terms refers to the Corporation and its subsidiaries on a consolidated basis.
COVID-19 PANDEMIC AND RECENT EVENTS
The COVID-19 pandemic presented health and economic challenges on an unprecedented scale during the year ended December 31, 2020. During this time, Northern Trust focused on the health and well-being of its workforce, meeting its clients’ needs and supporting its communities. Although planning is underway to return to the office when conditions permit, the vast majority of staff is expected to continue to work remotely for some time to come.
Workforce
As governments implement plans to reopen their respective jurisdictions, Northern Trust has begun its return-to-office (RTO) planning under the oversight of its COVID Executive Committee composed of senior leadership across various functions. Plans for RTO were developed on a location-by-location basis based on business unit needs. Northern Trust considers site readiness, transportation options, technology capabilities, and workforce alignment, and has plans for the return of a small portion of each office’s population in the initial RTO phase to allow for optimal social distancing. To ensure the health and well-being of Northern Trust’s workforce, clients and visitors, several social distancing elements and other protective measures were implemented, such as temperature screenings, where allowable by law, distribution of personal protective equipment, and workforce health self-certifications. Several offices returned portions of their workforce in the second half of 2020.
Client Service
Northern Trust offered assistance to its clients affected by the COVID-19 pandemic by lending under a government lending program and providing payment deferrals. The Corporation continues to assess developments in government actions meant to support the economy, as further discussed below.
U.S. Small Business Administration’s Paycheck Protection Program
During the second quarter of 2020, Northern Trust became a lender under the Paycheck Protection Program, as amended (PPP), which is administered by the U.S. Small Business Administration (SBA), an agency of the U.S. Department of the Treasury, which works with financial institutions in providing loans to small businesses. The PPP, which is meant to aid small businesses during the COVID-19 pandemic, was created under the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which was signed into law on March 27, 2020.
As of December 31, 2020, Northern Trust had 1,087 outstanding loans totaling $207.1 million under the PPP. 41 loans totaling $6.7 million underwent the loan forgiveness process, with 36 loans totaling $6.7 million being fully forgiven as of December 31, 2020.
The original timeframe for PPP lending expired on June 30, 2020, when Congress acted to extend PPP lending for a 5-week period to allow small businesses additional time to apply for the remaining PPP funds allocated by Congress in connection with the CARES Act. Northern Trust continued to lend under the PPP through the new August 8, 2020 deadline. The Economic Aid to Hard-Hit Small Businesses, Nonprofits and Venues Act (the Economic Aid Act) amended the PPP by extending the authority of the SBA to guarantee loans and the ability of PPP lenders to disburse PPP loans until
2020 Annual Report | Northern Trust Corporation 31
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
March 31. 2021. For further information on the PPP, please refer to Note 6, “Loans and Leases,” provided in Item 8, “Financial Statements and Supplementary Data.”
Troubled Debt Restructuring (TDR) Relief
Due to the economic environment arising from the COVID-19 pandemic, there have been two forms of relief provided to lenders exempting certain loan modifications which would otherwise be classified as TDRs from such classification. The first of these forms of relief is provided by certain interagency guidance from various banking regulators, including the Federal Reserve Board, the FDIC, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Consumer Financial Protection Bureau (Interagency Guidance). The other is provided under section 4013 of the CARES Act. Northern Trust has elected to apply each of these forms of relief, when applicable, in providing borrowers with qualifying loan modifications, including payment deferrals, in response to the COVID-19 pandemic. For further information on TDRs, please refer to Note 6, “Loans and Leases,” provided in Item 8, “Financial Statements and Supplementary Data.”
Community Support
COVID-19 Relief Support
Through December 31, 2020, Northern Trust provided $2.5 million in COVID-19 relief support to numerous organizations serving those most affected by the pandemic. Grantees include Americares, Doctors Without Borders, Feeding America, the Global FoodBanking Network, the Irish Red Cross, Meals on Wheels, NHS Charities Together, the Solidarity Response Fund for the World Health Organization, United Way Worldwide, World Food Program, and other COVID-19 relief funds in Chicago and Illinois to benefit those in need.
Small Business Support
Through December 31, 2020, Northern Trust provided $110.5 million in low-cost funding to assist Community Development Financial Institutions (CDFIs), which are instrumental in providing loans to small businesses and non-profit organizations under the PPP. The funding helps meet urgent demand among small businesses and non-profit groups by providing flexible terms and low rates. CDFIs provide loans, investments, financial services and technical assistance to underserved populations and communities. This funding, which is reported in Debt Securities Held to Maturity on the consolidated balance sheets, is separate and distinct from the $207.1 million of outstanding principal of loans made under the PPP.
Additional COVID-19 economic and market-related impacts to the Corporation’s financial condition and results of operations are discussed throughout this Annual Report on Form 10-K.
FINANCIAL OVERVIEW
Net Income decreased $282.9 million, or 19%, to $1.21 billion in 2020 from $1.49 billion in 2019. Earnings per diluted common share was $5.46 in 2020 compared to $6.63 in 2019. Return on average common equity decreased to 11.2% in 2020 from 14.9% in 2019.
Revenue increased $27.7 million to $6.10 billion in 2020 from $6.07 billion in the prior year, primarily driven by increases in Trust, Investment and Other Servicing Fees of 4%, Other Operating Income of 33%, Foreign Exchange Trading Income of 16%, and Security Commissions and Trading Income of 29%, partially offset by a decrease in Net Interest Income of 14%.
Client assets under custody/administration (AUC/A) increased 21% from $12.05 trillion as of December 31, 2019 to $14.53 trillion as of December 31, 2020, primarily reflecting net inflows, favorable markets, and favorable currency translation. Client assets under custody, a component of AUC/A, increased 22% from $9.23 trillion as of December 31, 2019 to $11.26 trillion as of December 31, 2020. Client assets under custody included $7.42 trillion of global custody assets as of December 31, 2020, which increased 26% from $5.89 trillion as of December 31, 2019. Client assets under management increased 14% to $1.41 trillion as of December 31, 2020 from $1.23 trillion at December 31, 2019 due to favorable markets and net inflows.
Trust, Investment and Other Servicing Fees, which represent the largest component of total revenue, increased 4% to $4.00 billion in 2020, from $3.85 billion in 2019, primarily due to new business and favorable markets, partially offset by money market mutual fund fee waivers.
Foreign Exchange Trading Income of $290.4 million in 2020 increased 16% from $250.9 million in 2019, primarily driven by higher client volumes and increased market volatility, partially offset by lower foreign exchange swap activity in Treasury.
Security Commissions and Trading Income of $133.2 million in 2020 increased 29% from $103.6 million in 2019, primarily driven by higher core brokerage revenue and revenue from interest rate swaps.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Other Operating Income of $194.0 million in 2020 increased 33% from $145.5 million in 2019, primarily due to higher income related to a bank-owned life insurance program implemented during 2019, a charge in the prior year related to the decision made to sell substantially all of the lease portfolio, and higher miscellaneous income.
Net Interest Income on a fully taxable equivalent (FTE) basis of $1.48 billion in 2020, decreased $233.1 million, or 14%, from $1.71 billion in 2019, due to a decreased net interest margin, partially offset by higher levels of average earning assets. The net interest margin on an FTE basis decreased to 1.19% in 2020 from 1.60% in 2019, primarily due to lower interest rates.
The Corporation adopted Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments” (ASU 2016-13) on January 1, 2020, which significantly changed the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of financial instruments. Upon adoption of ASU 2016-13, the Corporation recorded a $13.7 million increase in the Allowance for Credit Losses with a corresponding cumulative effect adjustment to decrease Retained Earnings by $10.1 million, net of income taxes. For more information on the adoption of ASU 2016-13, please refer to Note 2, “Recent Accounting Pronouncements,” provided in Item 8, “Financial Statements and Supplementary Data.”
The Provision for Credit Losses in 2020 was $125.0 million as compared to a credit provision of $14.5 million in 2019. The provision for 2020 reflected an increase in the reserve evaluated on a collective basis. The increase in the collective basis reserve was primarily driven by current and projected economic conditions and downgrades in the portfolio, both resulting from the ongoing COVID-19 pandemic and related market and economic impacts, with increases primarily in the commercial and institutional and commercial real estate portfolios. The prior-year credit provision primarily reflected a decrease in the inherent reserve related to the residential real estate portfolio due to a reduction in outstanding loans and improved credit quality and reductions to the specific reserve related to the commercial and institutional and residential real estate portfolios, partially offset by an increase in the inherent reserve related to the private client portfolio due to an increase in outstanding loans and lower credit quality. Loans and Leases of $33.8 billion as of December 31, 2020 increased from $31.4 billion as of December 31, 2019. Net charge-offs for the year ended December 31, 2020 were $3.2 million, compared to net recoveries of $0.7 million for the year ended December 31, 2019. Nonaccrual assets increased to $132.4 million as of December 31, 2020 from $86.8 million as of December 31, 2019.
Noninterest Expense of $4.35 billion in 2020 increased $204.7 million, or 5%, from $4.14 billion in 2019, primarily reflecting increased Compensation, Equipment and Software, Employee Benefits, Occupancy, and Other Operating Expense, partially offset by lower Outside Services. Noninterest Expense in 2020 included severance-related charges of $55.0 million in connection with a reduction in force, a $43.4 million charge related to a corporate action processing error, and Occupancy expense related to an early lease exit arising from a workplace real estate strategy of $11.9 million.
The Provision for Income Taxes in 2020 totaled $418.3 million, representing an effective tax rate of 25.7%. The Provision for Income Taxes in 2019 totaled $451.9 million, representing an effective tax rate of 23.2%. The increase in the effective tax rate was primarily driven by $26.8 million of tax expense related to the reversal of tax benefits previously recognized through earnings and higher taxes payable on the income of the Corporation’s non-U.S. branches.
Northern Trust continued to maintain a strong capital position during 2020, with all capital ratios exceeding those required for classification as “well-capitalized” under federal bank regulatory capital requirements. Total Stockholders’ Equity increased 5% from $11.1 billion in 2019 to $11.7 billion at year-end 2020. During the fourth quarter of 2019, the Corporation issued and sold 16 million depositary shares, each representing 1/1,000th ownership interest in a share of Series E Non-Cumulative Perpetual Preferred Stock for proceeds of $391.4 million, net of underwriting discounts, commissions, and other issuance costs. These proceeds were subsequently used to fund the redemption of all outstanding shares of the Corporation’s Series C Non-Cumulative Perpetual Preferred Stock on January 2, 2020.
The Corporation suspended its open-market share repurchase program on March 16, 2020. Prior to the suspension, 2,743,876 shares of common stock were repurchased on the open market at a total cost of $246.4 million. Subsequent to the suspension, the only shares repurchased were shares of common stock withheld upon the vesting of share-based compensation to satisfy tax withholding obligations. During the year ended December 31, 2020, the Corporation repurchased 3,276,589 shares of common stock, including 532,713 shares withheld related to share-based compensation, at a total cost of $299.8 million. During the year ended December 31, 2020, the Northern Trust quarterly common stock dividend remained unchanged from the end of the prior year at $0.70 per share. During the first quarter of 2021, the Corporation restarted its share repurchase program in accordance with limitations established by the Federal Reserve.
CONSOLIDATED RESULTS OF OPERATIONS
The following information summarizes our consolidated results of operations for 2020 compared to 2019. For a discussion related to the consolidated results of operations for 2019 compared to 2018, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year
2020 Annual Report | Northern Trust Corporation 33
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ended December 31, 2019 (2019 Form 10-K), which was filed with the United States Securities and Exchange Commission on February 25, 2020.
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 revenue and consists of Interest Income generated by earning assets, net of Interest Expense on deposits and borrowed funds.
Revenue in 2020 of $6.10 billion increased from $6.07 billion in 2019. Noninterest Income represented 76% and 72% of total revenue in 2020 and 2019, respectively, and totaled $4.66 billion in 2020, which increased 6% from $4.40 billion in 2019.
Noninterest Income in 2020 increased primarily reflecting higher Trust, Investment and Other Servicing Fees, Other Operating Income, Foreign Exchange Trading Income, and Security Commissions and Trading Income. Trust, Investment and Other Servicing Fees of $4.00 billion in 2020 increased $142.9 million, or 4%, from $3.85 billion in 2019, primarily due to new business and favorable markets, partially offset by money market mutual fund fee waivers. Foreign Exchange Trading Income in 2020 of $290.4 million increased $39.5 million, or 16%, compared with $250.9 million in 2019, primarily driven by higher client volumes and increased market volatility, partially offset by lower foreign exchange swap activity in Treasury. Security Commissions and Trading Income of $133.2 million in 2020 increased 29% from $103.6 million in 2019, primarily driven by higher core brokerage revenue and revenue from interest rate swaps. Other Operating Income of $194.0 million in 2020 increased 33% from $145.5 million in the prior year, primarily due to higher income related to a bank-owned life insurance program implemented during 2019, a charge in the prior year related to the decision made to sell substantially all of the lease portfolio, and higher miscellaneous income.
Net Interest Income on an FTE basis in 2020 of $1.48 billion decreased $233.1 million, or 14%, from $1.71 billion in 2019, due to a decreased net interest margin, partially offset by higher levels of average earning assets. The net interest margin on an FTE basis decreased to 1.19% in 2020 from 1.60% in 2019, primarily due to lower interest rates.Average earning assets increased $17.0 billion, or 16%, from $107.1 billion in 2019 to $124.1 billion in 2020, primarily reflecting higher levels of short-term interest bearing deposits, Securities, and Loans and Leases.
Additional information regarding Northern Trust’s revenue by type is provided in the following table.
TABLE 4: REVENUE
FOR THE YEAR ENDED DECEMBER 31,
Noninterest Income
Security Commissions and Trading Income 133.2 103.6 98.3
Investment Security Gains (Losses), net (0.4) (1.4) (1.0)
Trust, Investment and Other Servicing Fees
Trust, Investment and Other Servicing Fees were $4.00 billion in 2020 compared with $3.85 billion in 2019, and are based primarily on the market value of assets held in custody, managed or 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. Low-interest-rate environments have historically had a negative impact on fees earned on certain products.
Beginning in the second quarter of 2020, the Corporation began to waive a portion of certain fees associated with money market mutual funds due to the current low-interest-rate environment. Northern Trust voluntarily waived $29.3 million of money market mutual fund fees for the year ended December 31, 2020, of which $23.6 million was waived in the fourth quarter of 2020, related to the low-interest-rate environment. These fee waivers, which are expected to continue in the low-interest-rate environment in which the yields in certain funds remain insufficient to pay the stated fees associated with such funds, will adversely impact Trust, Investment and Other Servicing Fees within the C&IS and Wealth Management reporting segments. Northern Trust did not waive any money market mutual fund fees due to interest rates in the year ended December 31, 2019.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The components of Trust, Investment and Other Servicing Fees are provided in the following table.
TABLE 5: TRUST, INVESTMENT AND OTHER SERVICING FEES
FOR THE YEAR ENDED DECEMBER 31, CHANGE
C&IS Trust, Investment and Other Servicing Fees
Wealth Management Trust, Investment and Other Servicing Fees
Corporate & Institutional Services
C&IS Trust, Investment and Other Servicing Fees are primarily attributable to services related to custody, fund administration, investment management, and securities lending. Custody and fund administration fees, the largest component of C&IS fees, are driven primarily by values of client assets under custody/administration, transaction volumes and number of accounts. The asset values used to calculate these fees vary depending on the individual fee arrangements negotiated with each client. Custody fees related to asset values are client specific and are priced based on month-end market values, quarter-end market values, or the average of month-end market values for the quarter. The fund administration fees that are asset-value-related are priced using month-end, quarter-end, or average daily balances. Investment management fees are based generally on market values of client assets under management throughout the period. Typically, the asset values used to calculate fee revenue are based on a one-month or one-quarter lag.
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. The other services fee category in C&IS includes such products as investment risk and analytical services, benefit payments, and other services. Revenue from these products is based generally on the volume of services provided or a fixed fee.
Custody and fund administration fees increased from 2019 to 2020 primarily due to new business and favorable currency translation, partially offset by unfavorable non-U.S. markets. Investment management fees increased from 2019 to 2020 primarily due to new business and favorable markets, partially offset by money market mutual fund fee waivers.
The following tables provide a breakdown of the C&IS assets under custody and under management.
TABLE 6: C&IS ASSETS UNDER CUSTODY
DECEMBER 31, CHANGE
2020 Annual Report | Northern Trust Corporation 35
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 7: C&IS ASSETS UNDER MANAGEMENT
DECEMBER 31, CHANGE
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 securities lending collateral totaled $186.9 billion and $163.0 billion at December 31, 2020 and 2019, respectively.
Wealth Management
Wealth Management fee income is calculated primarily based on market values and is impacted by both one-month and one-quarter lagged asset values. Wealth Management fees increased from 2019 to 2020, primarily due to favorable markets and new business, partially offset by money market mutual fund fee waivers. The following tables provide a summary of Wealth Management assets under custody and under management.
TABLE 8: WEALTH MANAGEMENT ASSETS UNDER CUSTODY
DECEMBER 31, CHANGE
TABLE 9: WEALTH MANAGEMENT ASSETS UNDER MANAGEMENT
DECEMBER 31, CHANGE
The Wealth Management regions shown are comprised of the following: Central includes Illinois, Michigan, Minnesota, Missouri, Ohio and Wisconsin; East includes Connecticut, Delaware, Florida, Georgia, Massachusetts, New York, Pennsylvania, and Washington, D.C.; West includes Arizona, California, Colorado, Nevada, Texas and Washington. Global Family Office provides specialized asset management, investment consulting, global custody, fiduciary, and private banking services to ultra-wealthy domestic and international clients.
Market Indices
The following tables present selected market indices and the percentage changes year over year to provide context regarding equity and fixed income market impacts on the Corporation’s results.
TABLE 10: EQUITY MARKET INDICES
DAILY AVERAGES YEAR-END
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 11: FIXED INCOME MARKET INDICES
AS OF DECEMBER 31,
Barclays Capital U.S. Aggregate Bond Index 2,392 2,225 8 %
Barclays Capital Global Aggregate Bond Index 559 512 9
Client Assets
Northern Trust, in the normal course of business, holds assets under custody/administration and management 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 sheets. AUC/A and assets under management are a driver of our Trust, Investment and Other Servicing Fees. For the purposes of disclosing AUC/A, to the extent that both custody and administration services are provided, the value of the assets is included only once.
At December 31, 2020, AUC/A increased from December 31, 2019, primarily reflecting net inflows, favorable markets, and favorable currency translation. Assets under custody, a component of AUC/A, at December 31, 2020, increased from December 31, 2019, and included $7.42 trillion of global custody assets, compared to $5.89 trillion at December 31, 2019.
The following table presents AUC/A by reporting segment.
TABLE 12: ASSETS UNDER CUSTODY/ADMINISTRATION BY REPORTING SEGMENT
DECEMBER 31, CHANGE
The following table presents assets under custody, a component of AUC/A, by reporting segment.
TABLE 13: ASSETS UNDER CUSTODY BY REPORTING SEGMENT
DECEMBER 31, CHANGE
Consolidated assets under custody increased from the prior year, primarily reflecting net inflows, favorable markets, and favorable currency translation.
The following table presents the investment allocation of Northern Trust’s custodied assets by reporting segment.
TABLE 14: ALLOCATION OF ASSETS UNDER CUSTODY
DECEMBER 31,
C&IS WM TOTAL C&IS WM TOTAL C&IS WM TOTAL
Securities Lending Collateral 2 — 2 2 — 2 2 — 2
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table presents Northern Trust’s assets under custody by investment type.
TABLE 15: ASSETS UNDER CUSTODY BY INVESTMENT TYPE
DECEMBER 31, CHANGE
The following table presents Northern Trust’s assets under management by reporting segment.
TABLE 16: ASSETS UNDER MANAGEMENT BY REPORTING SEGMENT
DECEMBER 31, CHANGE
Assets under management at the end of 2020 increased from 2019. The increase primarily reflected favorable markets and net inflows.
The following tables present the investment allocation and management style of Northern Trust’s assets under management by reporting segment.
TABLE 17: ASSETS UNDER MANAGEMENT BY INVESTMENT TYPE
DECEMBER 31,
C&IS WM TOTAL C&IS WM TOTAL C&IS WM TOTAL
TABLE 18: ASSETS UNDER MANAGEMENT BY MANAGEMENT STYLE
DECEMBER 31,
C&IS WM TOTAL C&IS WM TOTAL C&IS WM TOTAL
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Other Noninterest Income
The components of other noninterest income, and a discussion of significant changes during 2020 and 2019, are provided below.
TABLE 19: OTHER NONINTEREST INCOME
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Investment Security Gains (Losses), net (0.4) (1.4) (1.0) N/M N/M
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 foreign exchange trading income. Foreign Exchange Trading Income in 2020 increased from 2019, primarily driven by higher client volumes and increased market volatility, partially offset by lower foreign exchange swap activity in Treasury.
Treasury Management Fees
Treasury Management Fees, generated from cash and treasury management products and services provided to clients, in 2020 increased from 2019.
Security Commissions and Trading Income
Security Commissions and Trading Income, generated primarily from securities brokerage services provided by Northern Trust Securities, Inc., in 2020 increased from 2019, primarily driven by higher core brokerage revenue and revenue from interest rate swaps.
Other Operating Income
The components of Other Operating Income are provided in the following table.
TABLE 20: OTHER OPERATING INCOME
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Other income in 2020 increased from 2019, primarily due to higher income related to a bank-owned life insurance program implemented during 2019, a charge in the prior year related to the decision made to sell substantially all of the lease portfolio, and higher miscellaneous income.
Investment Security Gains (Losses), Net
Losses in 2019 included $0.3 million of charges related to the other-than-temporary impairment (OTTI) of certain Community Reinvestment Act (CRA) eligible held-to-maturity debt securities. ASU 2016-13, adopted on January 1, 2020, replaced the legacy OTTI model with an estimated credit loss model. Refer to the caption "Investment Security Gains and Losses” in Note 4, “Securities,” and the caption “Allowance for Debt Securities Held to Maturity Securities Portfolio” in Note 7, “Allowance for Credit Losses” included under Item 8, “Financial Statements and Supplementary Data.”
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net Interest Income
Net Interest Income is defined as the total of Interest Income and amortized fees on earning assets, less Interest Expense on deposits and borrowed funds, adjusted for the impact of interest-related hedging activity. Earning assets — including Federal Funds Sold, Securities Purchased under Agreements to Resell, Interest-Bearing Due From and Deposits with Banks, Federal Reserve and Other Central Bank Deposits and Other, Securities, and Loans and Leases — are financed by a large base of interest-bearing funds that include client deposits, short-term borrowings, Senior Notes and Long-Term Debt. Short-term borrowings include Federal Funds Purchased, Securities Sold Under Agreements to Repurchase, and Other Borrowings. Earning assets also are funded by noninterest-related funds, which include demand deposits and Stockholders’ Equity. Net Interest Income is subject to variations in the level and mix of earning assets and interest-bearing funds and their relative sensitivity to interest rates. In addition, the levels of nonaccruing assets and client compensating deposit balances used to pay for services impact Net Interest Income.
Net interest margin is the difference between what we earn on our assets and what we pay for deposits and other sources of funding. The direction and level of interest rates are important factors in our earnings. Net interest margin is calculated by dividing annualized Net Interest Income by average interest-earning assets.
Net Interest Income stated on an FTE basis is a non-GAAP financial measure that facilitates the analysis of asset yields. Management believes an FTE presentation provides a clearer indication of net interest margins for comparative purposes. When adjusted to an FTE basis, yields on taxable, nontaxable, and partially taxable assets are comparable; however, the adjustment to an FTE basis has no impact on Net Income. A reconciliation of Net Interest Income on a GAAP basis to Net Interest Income on an FTE basis is provided on page 85.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following tables present an analysis of average daily balances and interest rates affecting Net Interest Income and an analysis of Net Interest Income changes.
TABLE 21: AVERAGE CONSOLIDATED BALANCE SHEETS WITH ANALYSIS OF NET INTEREST INCOME (INTEREST AND RATE ON A FULLY TAXABLE EQUIVALENT BASIS)(1)
INTEREST-EARNING ASSETS
Securities
Allowance for Credit Losses — (178.0) — — (111.4) — — (126.3) —
AVERAGE SOURCE OF FUNDS
Deposits
Interest Rate Spread — — 1.14 — — 1.40 — — 1.29
Note: Net Interest Income (FTE Adjusted), a non-GAAP financial measure, includes adjustments to a fully taxable equivalent basis for loans and securities. The adjustments are based on a federal income tax rate of 21.0%, where the rate is adjusted for applicable state income taxes, net of related federal tax benefit. Total taxable equivalent interest adjustments amounted to $34.4 million in 2020, $32.8 million in 2019 and $41.2 million in 2018. A reconciliation of Net Interest Income and net interest margin on a GAAP basis to Net Interest Income and net interest margin on an FTE basis (each of which is a non-GAAP financial measure) is provided on page 85. Net interest margin is calculated by dividing annualized Net Interest Income by average interest-earning assets. Interest revenue on cash collateral positions is reported above in Interest-Bearing Due From and Deposits with Banks and in Loans and Leases. Interest Expense on cash collateral positions is reported above in Non-U.S. Offices Interest-Bearing Deposits. Related cash collateral received from and deposited with derivative counterparties is recorded net of the associated derivative contract in Other Assets and Other Liabilities, respectively.
(1) Northern Trust’s non-U.S. activities are primarily related to its asset servicing, asset management, foreign exchange, cash management, and commercial banking businesses. The operations of Northern Trust are managed on a reporting segment basis and include components of both U.S and non-U.S. source income and assets. Non-U.S. source income and assets are not separately identified in Northern Trust’s internal management reporting system. However, Northern Trust is required to disclose non-U.S. activities based on the domicile of the customer. Due to the complex and integrated nature of Northern Trust’s activities, it is difficult to segregate with precision revenues, expenses and assets between U.S. and non-U.S.-domiciled customers. On the basis of averages, the percentage of total assets attributable to foreign activities was 20%, 23% and 25% as of December 31, 2020, 2019 and 2018, respectively. On the basis of averages, the percentage of total liabilities attributable to foreign activities was 56%, 53% and 54% as of December 31, 2020, 2019 and 2018, respectively. For additional information, refer to the Geographic Area Information section of Note 32, “Reporting Segments and Related Information,” provided in Item 8, “Financial Statements and Supplementary Data.”
(2) Federal Reserve and Other Central Bank Deposits and Other includes collateral deposits with certain securities depositories and clearing houses, which are classified in Other Assets on the consolidated balance sheets.
(3) Interest-Bearing Due from and Deposits with Banks includes the interest-bearing component of Cash and Due from Banks and Interest-Bearing Deposits with Banks as presented on the consolidated balance sheets.
(4) Other securities include certain community development investments and Federal Home Loan Bank and Federal Reserve stock, which are classified in Other Assets on the consolidated balance sheets.
(5) Average balances include nonaccrual loans. Lease financing receivable balances are reduced by deferred income.
(6) Cash and Due from Banks and Other Central Bank Deposits includes the noninterest-bearing component of Federal Reserve and Other Central Bank Deposits on the consolidated balance sheets.
(7) Rate calculations are based on actual balances rather than the rounded amounts presented in the Average Consolidated Balance Sheets with Analysis of Net Interest Income.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 22: ANALYSIS OF NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE
Increase (Decrease) in Net Interest Income (FTE)
Federal Funds Sold (0.2) (0.2) (0.4) — — —
Securities
Obligations of States and Political Subdivisions 26.9 (3.1) 23.8 5.7 4.8 10.5
Interest-Bearing Deposits
Savings Certificates and Other Time (9.3) 9.6 0.3 — 8.4 8.4
Securities Sold under Agreements to Repurchase (1.7) (3.7) (5.4) (6.5) 5.1 (1.4)
Floating Rate Capital Debt — (4.0) (4.0) — 0.7 0.7
Note: Changes not due solely to average balance changes or rate changes are allocated proportionately to average balanceandrate based on their relative absolute magnitudes.
Net Interest Income in 2020 decreased from 2019. Net Interest Income, stated on an FTE basis decreased from 2019, due to a lower net interest margin, partially offset by higher levels of average earning assets. Average earning assets increased in 2020 from 2019, primarily reflecting higher levels of short-term interest bearing deposits, Securities, and Loans and Leases. Funding of the balance sheet reflected higher levels of client deposits. The increase in average client deposits resulted from the large inflows experienced at the end of the first quarter of 2020, and these balances were largely maintained throughout the year.
The net interest margin in 2020 decreased from 2019. The net interest margin on an FTE basis in 2020 decreased from 2019, primarily due to lower interest rates. Low levels of market interest rates are expected to continue to impact our net interest income.
Federal Reserve and Other Central Bank Deposits and Other averaged $27.9 billion in 2020, which increased $9.4 billion, or 51%, from $18.5 billion in 2019, which resulted from significant deposit inflows. The higher level of client deposits were primarily placed with the Federal Reserve and other central banks and in the securities portfolio. Average Securities were $56.1 billion and increased $5.4 billion, or 11%, from $50.7 billion in the prior-year period and include certain community development investments, Federal Home Loan Bank stock, and Federal Reserve stock of $769.6 million, $202.9 million and $63.5 million, respectively, which are recorded in Other Assets on the consolidated balance sheets. Average taxable Securities were $50.9 billion in 2020 and $43.9 billion in 2019. Average nontaxable Securities, which represent securities that are primarily exempt from U.S. federal and state income taxes, were $5.2 billion in 2020 and $6.8 billion in 2019. Interest-Bearing Due From and Deposits with Banks averaged $5.4 billion in 2020 and $6.0 billion in 2019.
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Loans and Leases averaged $33.5 billion, which increased $2.4 billion, or 8%, from $31.1 billion in 2019, primarily reflecting higher levels of commercial and institutional, private client, commercial real estate, and non-U.S. loans, partially offset by a decrease in residential real estate loans. Commercial and institutional loans averaged $10.3 billion and increased $1.3 billion, or 15%, from $9.0 billion for the prior-year period. Private client loans averaged $11.5 billion and increased $706.9 million, or 7%, from $10.7 billion for the prior-year period. Commercial real estate loans averaged $3.3 billion and increased $335.6 million, or 12%, from $2.9 billion for the prior-year period. Non-U.S. loans averaged $2.0 billion and increased $262.7 million, or 15.3%, from $1.7 billion for the prior-year period. Residential real estate loans averaged $6.1 billion and decreased $180.9 million, or 3%, from $6.3 billion for the prior-year period.
Northern Trust utilizes a diverse mix of funding sources. Average Interest-Bearing Deposits increased $12.8 billion, or 18%, to $85.1 billion in 2020 from $72.3 billion in 2019. Average Interest-Related Funds increased $12.0 billion, or 14%, to $97.5 billion in 2020 from $85.5 billion in 2019. The balances within short-term borrowing classifications vary based on funding requirements and strategies, interest rate levels, changes in the volume of lower-cost deposit sources, and the availability of collateral to secure these borrowings. Average net noninterest-related funds increased $5.1 billion, or 23%, to $26.7 billion in 2020 from $21.6 billion in 2019, primarily resulting from higher levels of Demand and Other Noninterest-Bearing Deposits and Other Liabilities, partially offset by Other Assets. Average Demand and Other Noninterest-Bearing Deposits increased $5.9 billion, or 34%, to $23.4 billion in 2020 from $17.5 billion in 2019. The average rate on total source of funds was 0.16% in 2020 and 0.77% in 2019.
Interest expense for Interest-Bearing Deposits in the current year was driven by low and negative interest rates for Non-U.S. Offices Interest-Bearing Deposits and low interest rates on domestic Interest-Bearing Deposits. Average Non-U.S. Offices Interest-Bearing Deposits comprised 71% of total average Interest-Bearing Deposits for the year ended December 31, 2020.
Stockholders’ Equity averaged $11.2 billion in 2020, compared with $10.6 billion in 2019. The increased Stockholders’ Equity of $544.2 million, or 5%, was primarily attributable to earnings and accumulated other comprehensive income since the prior-year period, partially offset by the repurchase of common stock pursuant to the Corporation’s share repurchase program, the redemption of preferred stock during the first quarter of 2020, and dividend declarations. During the year ended December 31, 2020, the Corporation maintained its quarterly common stock dividend at $0.70 per share and repurchased 3,276,589 shares of common stock, returning $891.8 million in capital to common stockholders, compared to $1.7 billion in 2019.
In July 2018, the Board of Directors approved a stock repurchase authorization to repurchase up to 25.0 million shares of the Corporation’s common stock. Shares are repurchased by the Corporation to, among other things, manage the Corporation’s capital levels. Repurchased shares are used for general purposes, including the issuance of shares under stock option and other incentive plans. The Corporation suspended this program on March 16, 2020. Subsequent to the Corporation suspending its open-market share repurchase program, the only shares repurchased were shares of common stock withheld upon the vesting of share-based compensation to satisfy tax withholding obligations.
Beginning in the second quarter of 2020, the Federal Reserve announced certain measures to ensure that large financial institutions, including Northern Trust, remain resilient despite the economic uncertainty resulting from the ongoing COVID-19 pandemic. Specifically, for the third and fourth quarters of 2020, no share repurchases were permitted by these institutions and dividend payments were limited to the amount paid in the second quarter and could not exceed the payor’s average net income for the four preceding quarters. On December 18, 2020, the Federal Reserve again extended its capital distribution limits into the first quarter of 2021 with certain modifications, which include continuing to limit dividend payments based on recent income and limiting share repurchases based on recent income. During the first quarter of 2021, the Corporation restarted its share repurchase program in accordance with such limitations. The repurchase authorization approved by the Board of Directors has no expiration date, thus the Corporation retains the ability to resume repurchases thereunder when circumstances warrant and applicable regulations permit. Please refer to Note 15, “Stockholders’ Equity,” provided in Item 8, “Financial Statements and Supplementary Data.”
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Provision for Credit Losses
The Corporation adopted ASU No. 2016-13 on January 1, 2020, which significantly changed the way impairment of financial instruments is recognized by requiring immediate recognition of estimated credit losses expected to occur over the remaining life of financial instruments. For more information on the adoption of ASU 2016-13, please refer to Note 2, “Recent Accounting Pronouncements,” provided in Item 8, “Financial Statements and Supplementary Data.”
The Provision for Credit Losses was a provision of $125.0 million in 2020, as compared to a credit provision of $14.5 million in 2019. The provision for 2020 primarily reflected an increase in the reserve evaluated on a collective basis. The increase in the collective basis reserve was primarily driven by current and projected economic conditions and downgrades in the portfolio, both resulting from the ongoing COVID-19 pandemic and related market and economic impacts, with increases primarily in the commercial and institutional and commercial real estate portfolios. The prior-year credit provision primarily reflected a decrease in the inherent reserve related to the residential real estate portfolio due to a reduction in outstanding loans and improved credit quality and reductions to the specific reserve related to the commercial and institutional and residential real estate portfolios, partially offset by an increase in the inherent reserve related to the private client portfolio due to an increase in outstanding loans and lower credit quality.
Net charge-offs in 2020 totaled $3.2 million resulting from $9.7 million of charge-offs and $6.5 million of recoveries, compared to net recoveries of $0.7 million in the prior-year resulting from $6.5 million of charge-offs and $7.2 million of recoveries.
Nonaccrual assets at December 31, 2020 increased 53% from the prior year-end. Residential real estate, commercial real estate, commercial and institutional, and private client loans accounted for 47%, 31%, 20%, and 2%, respectively, of nonaccrual loans and leases at December 31, 2020. Residential real estate, commercial and institutional, commercial real estate, private client, and non-U.S. loans accounted for 85%, 9%, 4%, 1%, and 1%, respectively, of total nonaccrual loans and leases at December 31, 2019. For additional discussion of the Allowance for Credit Losses, refer to the “Asset Quality” section.
Noninterest Expense
Noninterest Expense for 2020 increased from 2019, primarily reflecting increased Compensation, Equipment and Software, Employee Benefits, Occupancy, and Other Operating Expense, partially offset by lower Outside Services. Noninterest Expense for 2020 included severance-related charges of $55.0 million in connection with a reduction in force, a $43.4 million charge related to a corporate action processing error, and Occupancy expense related to an early lease exit arising from a workplace real estate strategy of $11.9 million.
The components of Noninterest Expense and a discussion of significant changes during 2020 and 2019 are provided below.
TABLE 23: NONINTEREST EXPENSE
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Compensation
Compensation expense, the largest component of Noninterest Expense, increased in 2020 from 2019, primarily reflecting higher salary expense driven by staff growth and base pay adjustments, $52.5 million of severance-related charges in connection with a reduction in force, and a one-time supplemental payment to certain employees in response to the COVID-19 pandemic, partially offset by lower cash-based incentives and long-term performance-based incentive expense. Staff on a full-time equivalent basis totaled approximately 20,900 at December 31, 2020, up 6% from approximately 19,800 at December 31, 2019.
Employee Benefits
Employee Benefits expense in 2020 increased from 2019, primarily reflecting higher retirement plan expenses.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Outside Services
Outside Services expense in 2020 decreased from 2019, primarily due to lower data processing and consulting services, partially offset by higher sub-custodian expenses. Included in Outside Services is $2.5 million of outplacement costs associated with the reduction in force.
Equipment and Software
Equipment and Software expense in 2020 increased from 2019, primarily reflecting higher depreciation and amortization and software support costs.
Occupancy
Occupancy expense in 2020 increased from 2019, primarily reflecting higher rent arising from workplace real estate strategies, including $11.9 million of expense related to an early lease exit, partially offset by an asset retirement obligation reduction resulting from a lease renegotiation.
Other Operating Expense
The components of Other Operating Expense are provided in the following table.
TABLE 24: OTHER OPERATING EXPENSE
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Other Operating Expense in the current year increased compared to the prior year primarily due to a $43.4 million charge related to a corporate action processing error as well as increases in mutual fund co-administration fees, partially offset by lower business promotion expense due to reduced business travel and lower staff-related expense.
Provision for Income Taxes
The 2020 Provision for Income Taxes was $418.3 million, representing an effective rate of 25.7%. This compares with a Provision for Income Taxes of $451.9 million and an effective rate of 23.2% in 2019. The increase in the effective tax rate was primarily driven by $26.8 million of tax expense related to the reversal of tax benefits previously recognized through earnings and higher taxes payable on the income of the Corporation’s non-U.S. branches.
See Note 22, “Income Taxes,” provided in Item 8, “Financial Statements and Supplementary Data,” for more information on income taxes.
REPORTING SEGMENTS AND RELATED INFORMATION
The following information summarizes our consolidated results of operations by reporting segment for 2020 compared to 2019. For a discussion related to the consolidated results of operations by reporting segment for 2019 compared to 2018, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2019 Form 10-K, which was filed with the SEC on February 25, 2020.
Northern Trust is organized around its two client-focused reporting segments: C&IS and Wealth Management. Asset management and related services are provided to C&IS and Wealth Management clients primarily by the Asset Management business. The revenue and expenses of Asset Management and certain other support functions are allocated fully to C&IS and Wealth Management.
Reporting segment financial information, presented on an internal management-reporting basis, is determined by accounting systems used to allocate revenue and expense to each segment, and incorporates processes for allocating assets, liabilities, equity and the applicable interest income and expense utilizing a funds transfer pricing (FTP) methodology. Under the methodology, assets and liabilities receive a funding charge or credit that considers interest rate risk, liquidity risk, and other product characteristics on an instrument level. Equity is allocated to the reporting segments based on a variety of factors including, but not limited to, risk, regulatory considerations, and internal metrics. Allocations of capital and certain corporate expense 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, “Summary of Significant Accounting Policies,” provided in Item 8, “Financial Statements and Supplementary Data.” Transfers of income and expense items are recorded at cost; there is no consolidated profit or loss on sales or transfers between
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
reporting segments. Northern Trust's presentations are not necessarily consistent with similar information for other financial institutions.
Effective January 1, 2019, Northern Trust implemented several enhancements to its FTP methodology, including the allocation of contingent liquidity charges to C&IS and Wealth Management client instruments and products. These methodology enhancements affect the results of each reporting segment. Due to the lack of historical information, segment results for periods ended prior to January 1, 2019 have not been revised to reflect the methodology enhancements.
Also effective January 1, 2019, revenues, expenses and average assets are allocated to C&IS and Wealth Management, with the exception of non-recurring activities such as certain costs associated with acquisitions, divestitures, litigation, restructuring, and tax adjustments not directly attributable to a specific reporting segment.
For reporting periods ended prior to January 1, 2019, income and expense associated with the wholesale funding activities and investment portfolios of the Corporation and the Bank, as well as certain corporate-based expense, executive-level compensation and nonrecurring items, were not allocated to C&IS and Wealth Management, and were reported in Treasury and Other.
Reporting segment results are subject to reclassification when organizational changes are made. The results are also subject to refinements in revenue and expense allocation methodologies, which are typically reflected on a prospective basis. The following table presents the earnings and average assets for the Corporation.
TABLE 25: CONSOLIDATED FINANCIAL INFORMATION
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income
Provision for Credit Losses 125.0 (14.5) (14.5) N/M —
(1) Non-GAAP financial measures stated on an FTE basis. The consolidated figures include $34.4 million, $32.8 million, and $41.2 million of FTE adjustments for 2020, 2019, and 2018, respectively. A reconciliation of total consolidated revenue, Net Interest Income and net interest margin on a GAAP basis to revenue, Net Interest Income and net interest margin on an FTE basis, respectively, (each of which is a non-GAAP financial measure) is provided on page 85.
Corporate & Institutional Services
C&IS is a leading global provider of asset servicing and related services to corporate and public retirement funds, foundations, endowments, fund managers, insurance companies, sovereign wealth funds, and other institutional investors around the globe. Asset servicing and related services encompass a full range of capabilities including but not limited to: custody; fund administration; investment operations outsourcing; investment management; investment risk and analytical services; employee benefit services; securities lending; foreign exchange; treasury management; brokerage services; transition management services; banking and cash management. Client relationships are managed through the Bank and the Bank’s and the Corporation’s other subsidiaries, including support from locations in North America, Europe, the Middle East, and the Asia-Pacific region. The following table summarizes the results of operations of C&IS for the years ended December 31, 2020, 2019, and 2018 on a management-reporting basis.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 26: C&IS RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income
Provision for Credit Losses 38.1 1.9 1.9 N/M —
Percentage of Consolidated Net Income 43 % 48 % 58 %
(1) Non-GAAP financial measures stated on an FTE basis.
C&IS Net Income
Net Income decreased in 2020 compared to 2019, primarily due to lower Net Interest Income and higher Noninterest Expense, partially offset by higher Noninterest Income.
C&IS Trust, Investment and Other Servicing Fees
For an explanation of C&IS Trust, Investment, and Other Servicing Fees, please see the “Trust, Investment, and Other Servicing Fees” section within the Consolidated Results of Operations section of the MD&A.
C&IS Foreign Exchange Trading Income
Foreign Exchange Trading Income in 2020 increased from 2019, primarily driven by higher client volumes and increased market volatility.
C&IS Other Noninterest Income
Other Noninterest Income for 2020 increased from 2019, primarily due to Security Commissions and Trading Income and Other Operating Income.
C&IS Net Interest Income
Net Interest Income on an FTE basis decreased in 2020 from 2019, due to a lower net interest margin, partially offset by an increase in average earning assets. Net interest margin on an FTE basis decreased to 0.75% from 1.26%. Average earning assets of $94.6 billion, increased $15.5 billion, or 20%, from $79.1 billion in the prior year. The earning assets in C&IS consisted primarily of intercompanyassets and Loans and Leases. Funding sources were primarily comprised of non-U.S. custody-related interest-bearing deposits, which averaged $60.5 billion in 2020, increased from $54.9 billion in 2019.
C&IS Provision for Credit Losses
On January 1, 2020, the Corporation adopted ASU 2016-13. For more information on the adoption, please refer to Note 2, “Recent Accounting Pronouncements,” provided in Item 8, “Financial Statements and Supplementary Data.” The C&IS Provision for Credit Losses was a provision of $38.1 million for 2020 and $1.9 million for 2019. The 2020 provision reflected an increase in the reserve evaluated on a collective basis driven by current and projected economic conditions and downgrades in the portfolio, both resulting from the ongoing COVID-19 pandemic and related market and economic impacts on the commercial and institutional portfolio. The 2019 provision reflected an increase to the inherent reserve for outstanding loans due to lower credit quality, partially offset by a decrease to the specific reserve related to standby letters of credit and outstanding loans.
C&IS Noninterest Expense
Total C&IS Noninterest Expense, which includes the direct expense of the reporting segment, indirect expense allocations for product and operating support, and indirect expense allocations for certain corporate support services, increased in 2020 from 2019. The increase primarily reflects higher expense allocations, including a $43.4 million charge related to a corporate action processing error, higher Compensation expense, Employee Benefits, Outside Services, and Equipment and Software expense, partially offset by lower business promotion expense due to reduced business travel and lower staff-related expenses.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Wealth Management
Wealth Management focuses on high-net-worth individuals and families, business owners, executives, professionals, retirees, and established privately-held businesses in its target markets. The business also includes the Global Family Office, which provides customized 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. In supporting these targeted segments, Wealth Management provides trust, investment management, custody, and philanthropic services; financial consulting; guardianship and estate administration; family business consulting; family financial education; brokerage services; and private and business banking. Wealth Management is one of the largest providers of advisory services in the United States with assets under custody/administration, assets under custody, and assets under management of $879.4 billion, $875.1 billion, and $347.8 billion, respectively, at December 31, 2020. Wealth Management services are delivered by multidisciplinary teams through a network of offices in 19 U.S. states and Washington, D.C., as well as offices in London, Guernsey, and Abu Dhabi.
The following table summarizes the results of operations of Wealth Management for the years ended December 31, 2020, 2019, and 2018 on a management-reporting basis.
TABLE 27: WEALTH MANAGEMENT RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income
Foreign Exchange Trading Income 14.1 18.7 4.2 (25) N/M
Provision for Credit Losses 86.9 (16.4) (16.4) N/M —