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, 2021. 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 23 U.S. states and Washington, D.C., and across 23 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
During the COVID-19 pandemic, Northern Trust has remained focused on the health and well-being of its workforce, meeting its clients’ needs and supporting its communities. The majority of Northern Trust’s workforce continues to work remotely and the Corporation continues to adjust its response to the pandemic as needed. The timing of any return to office for our workforce will be driven by the operational, business, and client needs of each location, and will be guided by health and safety guidelines and relevant government mandates. In addition, as the prolonged public health crisis has unfolded, Northern Trust has responded by providing additional health and well-being resources to its employees, including expanded virtual access to health care and well-being programs and diversity, equity, and inclusion resources; a well-being learning center with tools for working effectively in a virtual environment; and virtual focus groups allowing employees to provide feedback and build connections with colleagues. Northern Trust also provided additional paid-time-off for a COVID-19 diagnosis and supported all employees electing to receive the COVID-19 vaccine with additional paid-time-off to obtain and recover from the primary series vaccine or booster shot. To facilitate COVID-19 vaccinations in India and the Philippines, Northern Trust hosted on-site vaccine drives (in India) and participated in a program which provided access to vaccines for our employees (in the Philippines). Northern Trust also reimbursed vaccine costs for employees and their immediate family members in India.
During the pandemic, Northern Trust offered credit assistance to impacted clients under a government lending program and provided payment deferrals. In addition, there have been two forms of relief provided to lenders exempting certain loan modifications which would otherwise be classified as troubled debt restructuring from such classification. Northern Trust 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. Both of these assistance measures have declined since the start of the pandemic. For further information, please refer to Note 6, “Loans and Leases,” provided in Item 8. “Financial Statements and Supplementary Data.”
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FINANCIAL OVERVIEW
TABLE 4: FINANCIAL HIGHLIGHTS
FOR THE YEAR ENDED DECEMBER 31,
PER COMMON SHARE
Cash Dividends Declared Per Common Share 2.80 2.80 2.60
SELECTED RATIOS AND METRICS
Return on Average Common Equity 13.9 % 11.2 % 14.9 %
Average Stockholders’ Equity to Average Assets 7.5 8.2 9.1
Net Income increased $336.0 million, or 28%, to $1.55 billion in 2021 from $1.21 billion in 2020. Earnings per diluted common share was $7.14 in 2021 compared to $5.46 in 2020. Return on average common equity increased to 13.9% in 2021 from 11.2% in 2020.
Revenue increased $363.7 million to $6.46 billion in 2021 from $6.10 billion in the prior year, primarily driven by increases in Trust, Investment and Other Servicing Fees of 9% and Other Operating Income of 26%, partially offset by a decrease in Net Interest Income of 4%.
Client assets under custody/administration (AUC/A) increased 12% from $14.53 trillion as of December 31, 2020 to $16.25 trillion as of December 31, 2021, primarily reflecting favorable markets and net inflows, partially offset by unfavorable currency translation. Client assets under custody, a component of AUC/A, increased 12% from $11.26 trillion as of December 31, 2020 to $12.61 trillion as of December 31, 2021. Client assets under custody included $8.24 trillion of global custody assets as of December 31, 2021, which increased 11% from $7.42 trillion as of December 31, 2020. Client assets under management increased 14% to $1.61 trillion as of December 31, 2021 from $1.41 trillion at December 31, 2020 due to favorable markets and net inflows.
The Provision for Credit Losses in 2021 was a release of credit reserves of $81.5 million as compared to a provision of $125.0 million in 2020. The release of credit reserves during 2021 was primarily due to a decrease in the reserve evaluated on a collective basis, which relates to pooled financial assets sharing similar risk characteristics, and was driven by improvements in projected economic conditions and portfolio credit quality, partially offset by portfolio growth. The decrease in the collective basis reserve was primarily reflected in the commercial and institutional portfolio. The prior-year provision 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 at the time and downgrades in the portfolio, both resulting from the COVID-19 pandemic and related market and economic impacts. Increases in the collective basis reserve were primarily in the commercial and institutional and commercial real estate portfolios. In addition, 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, was recorded on January 1, 2020 upon adoption of the Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments — Credit Losses: Measurement of Credit Losses on Financial Instruments.”
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Noninterest Expense of $4.54 billion in 2021 increased $187.7 million, or 4%, from $4.35 billion in 2020, primarily reflecting increased Outside Services, Compensation, Equipment and Software and Employee Benefits, partially offset by lower Other Operating Expense and Occupancy. Employee Benefits expense in 2021 included pension settlement charges of $27.9 million.
The Provision for Income Taxes in 2021 totaled $464.8 million, representing an effective tax rate of 23.1%. The Provision for Income Taxes in 2020 totaled $418.3 million, representing an effective tax rate of 25.7%. The decrease in the effective tax rate was primarily driven by the lower net tax impact from international operations and $26.8 million of prior-year tax expense related to the reversal of tax benefits previously recognized through earnings.
Northern Trust continued to maintain a strong capital position during 2021, with all capital ratios exceeding those required for classification as “well-capitalized” under federal bank regulatory capital requirements. For additional information, please refer to the “Capital Management” section.
CONSOLIDATED RESULTS OF OPERATIONS
The following information summarizes our consolidated results of operations for 2021 compared to 2020. For a discussion related to the consolidated results of operations for 2020 compared to 2019, 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 ended December 31, 2020 (2020 Form 10-K), which was filed with the United States Securities and Exchange Commission on February 23, 2021.
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 2021 of $6.46 billion increased $363.7 million, or 6%, from $6.10 billion in 2020. Noninterest Income represented 79% and 76% of total revenue in 2021 and 2020, respectively, and totaled $5.08 billion in 2021, which increased $424.2 million, or 9%, from $4.66 billion in 2020.
Noninterest Income in 2021 increased primarily reflecting higher Trust, Investment and Other Servicing Fees and Other Operating Income. Trust, Investment and Other Servicing Fees of $4.36 billion in 2021 increased $366.1 million, or 9%, from $4.00 billion in 2020, primarily due to favorable markets and new business, partially offset by higher money market mutual fund fee waivers. Other Operating Income of $243.9 million in 2021 increased $49.9 million, or 26%, from $194.0 million in the prior year, primarily due to higher banking and credit-related service charges, distributions from investments in community development projects and gains from property sales.
Net Interest Income on a fully taxable equivalent (FTE) basis in 2021 of $1.42 billion decreased $59.3 million, or 4%, from $1.48 billion in 2020, 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 0.99% in 2021 from 1.19% in 2020, primarily due to lower average interest rates, partially offset by favorable balance sheet volume and mix shift.Average earning assets increased $19.7 billion, or 16%, from $124.1 billion in 2020 to $143.9 billion in 2021, primarily reflecting higher levels of short-term interest bearing deposits, Securities, and Loans and Leases.
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Additional information regarding Northern Trust’s revenue by type is provided in the following table.
TABLE 5: REVENUE
FOR THE YEAR ENDED DECEMBER 31,
Noninterest Income
Investment Security Losses, net (0.3) (0.4) (1.4)
(1) Net Interest Income stated on a GAAP basis. Net Interest Income on an FTE basis includes FTE adjustments of $35.6 million, $34.4 million, and $32.8 million for 2021, 2020, and 2019, 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 in “Supplemental Information—Reconciliation to Fully Taxable Equivalent” within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section.
Trust, Investment and Other Servicing Fees
Trust, Investment and Other Servicing Fees were $4.36 billion in 2021 compared with $4.00 billion in 2020, 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 low-interest-rate environment. Northern Trust voluntarily waived $287.8 million and $29.3 million of money market mutual fund fees for the years ended December 31, 2021 and 2020, respectively. These fee waivers are impacted by the level of yields earned and account balances in certain funds, as the yields in these funds remain insufficient to pay the stated fees associated with such funds. If the level of short-term interest rates were to increase as currently expected, fee waivers would likely decline.
The components of Trust, Investment and Other Servicing Fees are provided in the following table.
TABLE 6: 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 the number of accounts. The asset values used to calculate these fees vary depending on the individual fee
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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 2020 to 2021 primarily due to favorable markets, new business and favorable currency translation. Investment Management fees decreased from 2020 to 2021 primarily due to higher money market mutual fund fee waivers, partially offset by favorable markets and new business.
The following tables provide a breakdown of the C&IS assets under custody and under management.
TABLE 7: C&IS ASSETS UNDER CUSTODY
DECEMBER 31, CHANGE
TABLE 8: 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 $195.6 billion and $186.9 billion at December 31, 2021 and 2020, 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. Fee income in the regions (Central, East and West) increased from 2020 to 2021, primarily due to favorable markets and new business, partially offset by higher money market mutual fund fee waivers. Global Family Office fee income decreased slightly primarily due to higher money market mutual fund fee waivers, partially offset by favorable markets and new business. The following tables provide a summary of Wealth Management assets under custody and under management.
TABLE 9: WEALTH MANAGEMENT ASSETS UNDER CUSTODY
DECEMBER 31, CHANGE
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TABLE 10: 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 customized services, including but not limited to investment consulting, global custody, fiduciary, and private banking, to meet the complex financial needs of ultra-high-net-worth individuals and family offices across the globe.
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 11: EQUITY MARKET INDICES
DAILY AVERAGES YEAR-END
TABLE 12: FIXED INCOME MARKET INDICES
AS OF DECEMBER 31,
Barclays Capital U.S. Aggregate Bond Index 2,355 2,392 (2) %
Barclays Capital Global Aggregate Bond Index 532 559 (5)
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 in this amount.
At December 31, 2021, AUC/A increased from December 31, 2020, primarily reflecting favorable markets and net inflows, partially offset by unfavorable currency translation. Assets under custody, a component of AUC/A, at December 31, 2021, increased from December 31, 2020, and included $8.24 trillion of global custody assets, compared to $7.42 trillion at December 31, 2020.
The following table presents AUC/A by reporting segment.
TABLE 13: ASSETS UNDER CUSTODY/ADMINISTRATION BY REPORTING SEGMENT
DECEMBER 31, CHANGE
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The following table presents assets under custody, a component of AUC/A, by reporting segment.
TABLE 14: ASSETS UNDER CUSTODY BY REPORTING SEGMENT
DECEMBER 31, CHANGE
Consolidated assets under custody increased from the prior year, primarily reflecting favorable markets and net inflows, partially offset by unfavorable currency translation.
The following table presents the investment allocation of Northern Trust’s custodied assets by reporting segment.
TABLE 15: 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
The following table presents Northern Trust’s assets under custody by investment type.
TABLE 16: ASSETS UNDER CUSTODY BY INVESTMENT TYPE
DECEMBER 31, CHANGE
The following table presents Northern Trust’s assets under management by reporting segment.
TABLE 17: ASSETS UNDER MANAGEMENT BY REPORTING SEGMENT
DECEMBER 31, CHANGE
Assets under management at the end of 2021 increased from 2020. The increase primarily reflected favorable markets and net inflows.
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The following tables present the investment allocation and management style of Northern Trust’s assets under management by reporting segment.
TABLE 18: ASSETS UNDER MANAGEMENT BY INVESTMENT TYPE
DECEMBER 31,
C&IS WM TOTAL C&IS WM TOTAL C&IS WM TOTAL
TABLE 19: ASSETS UNDER MANAGEMENT BY MANAGEMENT STYLE
DECEMBER 31,
C&IS WM TOTAL C&IS WM TOTAL C&IS WM TOTAL
Other Noninterest Income
The components of other noninterest income, and a discussion of significant changes during 2021 and 2020, are provided below.
TABLE 20: OTHER NONINTEREST INCOME
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Investment Security Losses, net (0.3) (0.4) (1.4) 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 2021 increased from 2020, primarily driven by higher client volumes, 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 2021 decreased from 2020.
Security Commissions and Trading Income
Security Commissions and Trading Income, generated primarily from securities brokerage services provided by Northern Trust Securities, Inc., in 2021 increased from 2020, primarily driven by higher revenue from core brokerage, partially offset by lower revenue from interest rate swaps.
Other Operating Income
Other Operating Income in 2021 increased from 2020 primarily due to higher banking and credit-related service charges, distributions from investments in community development projects and gains from property sales.
Please refer to Note 20, “Other Operating Income” included under Item 8, “Financial Statements and Supplementary Data,” for additional details related to other operating income.
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Investment Security Losses, Net
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 Held to Maturity Debt Securities Portfolio” in Note 7, “Allowance for Credit Losses” included under Item 8, “Financial Statements and Supplementary Data.”
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 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 in “Supplemental Information—Reconciliation to Fully Taxable Equivalent” within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section.
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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
AVERAGE SOURCE OF FUNDS
Deposits
Interest Rate Spread — — 0.98 — — 1.14 — — 1.40
(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 19%, 20% and 23% as of December 31, 2021, 2020 and 2019, respectively. On the basis of averages, the percentage of total liabilities attributable to foreign activities was 58%, 56% and 53% as of December 31, 2021, 2020 and 2019, 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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TABLE 22: ANALYSIS OF NET INTEREST INCOME CHANGES DUE TO VOLUME AND RATE(1)
Increase (Decrease) in Net Interest Income (FTE)
Federal Funds Sold — — — (0.2) (0.2) (0.4)
Securities
Interest-Bearing Deposits
Savings Certificates and Other Time (4.0) (7.7) (11.7) (9.3) 9.6 0.3
Securities Sold under Agreements to Repurchase 0.1 (0.9) (0.8) (1.7) (3.7) (5.4)
Floating Rate Capital Debt (0.8) (1.7) (2.5) — (4.0) (4.0)
(1) Changes not due solely to average balance changes or rate changes are allocated proportionately to average balanceandrate based on their relative absolute magnitudes.
Notes: 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 $35.6 million in 2021, $34.4 million in 2020 and $32.8 million in 2019. 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 in “Supplemental Information—Reconciliation to Fully Taxable Equivalent” within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section. 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 within Interest-Bearing Due from and Deposits with Banks and within Loans and Leases. Interest expense on cash collateral positions is reported above within 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.
Net Interest Income in 2021 decreased from 2020. Net Interest Income, stated on an FTE basis, decreased from 2020, due to a lower net interest margin, partially offset by higher levels of average earning assets. Average earning assets increased in 2021 from 2020, 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 net interest margin in 2021 decreased from 2020. The net interest margin on an FTE basis in 2021 decreased from 2020, primarily due to lower average interest rates, partially offset by favorable balance sheet volume and mix shift.
Federal Reserve and Other Central Bank Deposits and Other averaged $39.0 billion in 2021, which increased $11.1 billion, or 40%, from $27.9 billion in 2020, 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 and the loan portfolio. Average Securities were $60.8 billion and increased $4.7 billion, or 8%, from $56.1 billion in the prior-year period and include certain community development investments, Federal Home Loan Bank stock, and Federal Reserve stock of $925.5 million, $158.0 million and $70.0 million, respectively, which are recorded in Other Assets on the consolidated balance sheets. Average taxable Securities were $57.8 billion in 2021 and $50.9 billion in 2020. Average
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nontaxable Securities, which represent securities that are primarily exempt from U.S. federal and state income taxes, were $3.0 billion in 2021 and $5.2 billion in 2020. Interest-Bearing Due From and Deposits with Banks averaged $5.8 billion in 2021 and $5.4 billion in 2020.
Loans and Leases averaged $37.2 billion, which increased $3.7 billion, or 11%, from $33.5 billion in 2020, primarily reflecting higher levels of private client, commercial real estate, non-U.S. loans, commercial and institutional, and residential real estate loans. Private client loans averaged $13.7 billion and increased $2.2 billion, or 20%, from $11.5 billion for the prior-year period. Commercial real estate loans averaged $4.0 billion and increased $723.3 million, or 22%, from $3.3 billion for the prior-year period. Non-U.S. loans averaged $2.5 billion and increased $557.6 million, or 28%, from $2.0 billion for the prior-year period. Commercial and institutional loans averaged $10.4 billion and increased $81.5 million, or 1%, from $10.3 billion for the prior-year period. Residential real estate loans averaged $6.2 billion and increased $74.3 million, or 1%, from $6.1 billion for the prior-year period.
Northern Trust utilizes a diverse mix of funding sources. Average Interest-Bearing Deposits increased $13.8 billion, or 16%, to $98.9 billion in 2021 from $85.1 billion in 2020. Average Interest-Related Funds increased $11.2 billion, or 11%, to $108.7 billion in 2021 from $97.5 billion in 2020. 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 $8.5 billion, or 32%, to $35.2 billion in 2021 from $26.7 billion in 2020, primarily resulting from higher levels of Demand and Other Noninterest-Bearing Deposits. Average Demand and Other Noninterest-Bearing Deposits increased $7.7 billion , or 33%, to $31.1 billion in 2021 from $23.4 billion in 2020. The average rate on total source of funds was 0.02% in 2021 and 0.16% in 2020.
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 70% of total average Interest-Bearing Deposits for the year ended December 31, 2021.
Stockholders’ Equity
Stockholders’ Equity averaged $11.7 billion in 2021, compared with $11.2 billion in 2020. The increase in average Stockholders’ Equity of $504.4 million, or 5%, was primarily attributable to Retained Earnings, partially offset by lower Accumulated Other Comprehensive Income since the prior year, repurchases of common stock pursuant to the Corporation’s share repurchase program and decreased Additional Paid-in Capital. During the year ended December 31, 2021, the Corporation maintained its quarterly common stock dividend at $0.70 per share and repurchased 2,527,544 shares of common stock, returning $861.5 million in capital to common stockholders, compared to $891.8 million in 2020.
The share repurchases were predominantly made pursuant to the repurchase program authorized by the Board of Directors in July 2018. In October 2021, this program was terminated and replaced with a new repurchase program, under which the Board of Directors authorized the Corporation 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 equity incentive plans. 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.”
Provision for Credit Losses
There was an $81.5 million release of credit reserves in 2021, as compared to a provision of $125.0 million in 2020. The release of credit reserves during 2021 was primarily due to a decrease in the reserve evaluated on a collective basis, which relates to pooled financial assets sharing similar risk characteristics, and was driven by improvements in projected economic conditions and portfolio credit quality, partially offset by portfolio growth. The decrease in the collective basis reserve was primarily reflected in the commercial and institutional portfolio. The prior-year provision 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 at the time and downgrades in the portfolio, both resulting from the COVID-19 pandemic and related market and economic impacts. Increases in the collective basis reserve were primarily in the commercial and institutional and commercial real estate portfolios. In addition, 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, was recorded on January 1, 2020 upon adoption of the Accounting Standards Update (ASU) No. 2016-13, “Financial Instruments — Credit Losses: Measurement of Credit Losses on Financial Instruments.”
2021 Annual Report | Northern Trust Corporation 41
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Net recoveries in 2021 totaled $6.3 million resulting from $0.7 million of charge-offs and $7.0 million of recoveries, compared to net charge-offs of $3.2 million in the prior-year resulting from $9.7 million of charge-offs and $6.5 million of recoveries.
Nonaccrual assets at December 31, 2021 decreased 5% from the prior year-end. Commercial real estate, residential real estate, and commercial and institutional accounted for 54%, 30%, and 16%, respectively, of total nonaccrual loans and leases at December 31, 2021. Residential real estate, commercial real estate, commercial and institutional, and private client loans accounted for 47%, 31%, 20%, and 2%, respectively, of total nonaccrual loans and leases at December 31, 2020. For additional discussion of the Allowance for Credit Losses, refer to the “Asset Quality” section.
Noninterest Expense
Noninterest Expense for 2021 increased from 2020, primarily reflecting increased Outside Services, Compensation, Equipment and Software and Employee Benefits, partially offset by lower Other Operating Expense and Occupancy. Employee Benefits expense in 2021 included pension settlement charges of $27.9 million.
The components of Noninterest Expense and a discussion of significant changes during 2021 and 2020 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 2021 from 2020, primarily reflecting higher incentives and salary expense. The prior year reflects $52.5 million of severance-related charges. Staff on a full-time equivalent basis totaled approximately 21,100 at December 31, 2021, up 1% from approximately 20,900 at December 31, 2020.
Employee Benefits
Employee Benefits expense in 2021 increased from 2020, primarily reflecting higher retirement plan expenses, medical costs and payroll taxes. There were $27.9 million of pension settlement charges in 2021.
Outside Services
Outside Services expense in 2021 increased from 2020, primarily due to higher technical services costs, third-party advisory fees and sub-custodian expenses.
Equipment and Software
Equipment and Software expense in 2021 increased from 2020, primarily reflecting higher software support and rental costs and higher amortization.
Occupancy
Occupancy expense in 2021 decreased from 2020, primarily due to early lease exits arising from workplace real estate strategies in the prior year, which included $11.9 million of expense related to an early lease exit.
Other Operating Expense
Other Operating Expense in 2021 decreased from 2020 primarily due to lower charges associated with account servicing activities and a decline in other miscellaneous expenses. The account servicing activities in the prior year included a $43.4 million charge related to a corporate action processing error. Please refer to Note 21, “Other Operating Expense” included under Item 8, “Financial Statements and Supplementary Data,” for additional details related to other operating expenses.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Provision for Income Taxes
The 2021 Provision for Income Taxes was $464.8 million, representing an effective rate of 23.1%. This compares with a Provision for Income Taxes of $418.3 million and an effective rate of 25.7% in 2020. The decrease in the effective tax rate was primarily driven by the lower net tax impact from international operations and $26.8 million of prior-year tax expense related to the reversal of tax benefits previously recognized through earnings.
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 2021 compared to 2020. For a discussion related to the consolidated results of operations by reporting segment for 2020 compared to 2019, refer to Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Form 10-K, which was filed with the SEC on February 23, 2021.
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. Additionally, segment information is presented on an FTE basis as management believes an FTE presentation provides a clearer indication of net interest income. The adjustment to an FTE basis has no impact on Net Income.
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.” Transfers of income and expense items are recorded at cost; there is no consolidated profit or loss on sales or transfers between reporting segments. Northern Trust’s presentations are not necessarily consistent with similar information for other financial institutions.
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, which are reported within the Other segment.
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.
Effective January 1, 2021, Northern Trust implemented enhancements to its FTP methodology, including enhancements impacting the allocation of net interest income between C&IS and Wealth Management. These methodology enhancements affect the results of each of these reporting segments. Due to the lack of historical information, segment results for periods ended prior to January 1, 2021 have not been revised to reflect the methodology enhancements.
2021 Annual Report | Northern Trust Corporation 43
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table presents the earnings and average assets for the Corporation.
TABLE 24: CONSOLIDATED FINANCIAL INFORMATION
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income
Provision for Credit Losses (81.5) 125.0 (14.5) N/M N/M
(1) Non-GAAP financial measures stated on an FTE basis. The consolidated figures include $35.6 million, $34.4 million, and $32.8 million of FTE adjustments for 2021, 2020, and 2019, 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 in “Supplemental Information—Reconciliation to Fully Taxable Equivalent” within this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section.
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, 2021, 2020, and 2019 on a management-reporting basis.
TABLE 25: C&IS RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income
Provision for Credit Losses (33.8) 38.1 1.9 N/M N/M
Percentage of Consolidated Net Income 41 % 43 % 48 %
(1) Non-GAAP financial measures stated on an FTE basis.
C&IS Net Income
Net Income increased in 2021 compared to 2020, primarily reflecting higher Trust, Investment and Other Servicing Fees, a release of credit reserves in the current year as compared to a provision in the prior year and higher Other Noninterest
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Income, partially offset by higher Noninterest Expense, lower Net Interest Income and an increase in the Provision for Income Taxes.
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 2021 increased from 2020, primarily driven by higher client volumes, partially offset by lower foreign exchange swap activity in Treasury.
C&IS Other Noninterest Income
Other Noninterest Income for 2021 increased from 2020, primarily due to Other Operating Income and Security Commissions and Trading Income.
C&IS Net Interest Income
Net Interest Income on an FTE basis decreased in 2021 from 2020, 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 0.60% from 0.75%. Average earning assets of $111.0 billion, increased $16.4 billion, or 17%, from $94.6 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 $69.7 billion in 2021 as compared to $60.5 billion in 2020.
C&IS Provision for Credit Losses
There was a release of credit reserves of $33.8 million for 2021 compared to a provision of $38.1 million for 2020. The release of credit reserves during 2021 was primarily due to a decrease in the reserve evaluated on a collective basis, which relates to pooled financial assets sharing similar risk characteristics. The decrease in the collective basis reserve was driven by improvements in projected economic conditions and portfolio credit quality. The 2020 provision reflected an increase in the reserve evaluated on a collective basis driven by current and projected economic conditions at the time 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.
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 2021 from 2020. The increase primarily reflects higher expense allocations, Outside Services expense and Compensation expense including incentives.
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. 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 also includes Global Family Office, which provides customized services, including but not limited to: investment consulting; global custody; fiduciary; and private banking to meet the complex financial needs of ultra-high-net-worth individuals and family offices across the globe. 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 $1.07 trillion, $1.06 trillion, and $416.1 billion, respectively, at December 31, 2021. 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.
2021 Annual Report | Northern Trust Corporation 45
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table summarizes the results of operations of Wealth Management for the years ended December 31, 2021, 2020, and 2019 on a management-reporting basis.
TABLE 26: WEALTH MANAGEMENT RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income
Provision for Credit Losses (47.7) 86.9 (16.4) N/M N/M
Percentage of Consolidated Net Income 61 % 60 % 53 %
(1) Non-GAAP financial measures stated on an FTE basis.
Wealth Management Net Income
Wealth Management Net Income increased in 2021, primarily reflecting higher Trust, Investment and Other Servicing Fees, a release of credit reserves in the current year as compared to a provision in the prior year and higher Other Noninterest Income, partially offset by higher Noninterest Expense, lower Net Interest Income and an increase in the Provision for Income Taxes.
Wealth Management Trust, Investment and Other Servicing Fees
For an explanation of Wealth Management 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.
Wealth Management Other Noninterest Income
Other Noninterest Income for 2021 increased from 2020, primarily due to higher Other Operating Income driven by gains on property sales.
Wealth Management Net Interest Income
Net Interest Income on an FTE basis for 2021 decreased from 2020, primarily attributable to a decrease in the net interest margin, partially offset by an increase in earning assets. Net interest margin on an FTE basis decreased to 2.47% from 2.94%. Average earning assets of $32.8 billion in 2021, increased $3.3 billion, or 11%, from $29.5 billion in 2020. Earning assets and funding sources for the year ended December 31, 2021 were primarily comprised of loans and domestic interest-bearing deposits, respectively.
Wealth Management Provision for Credit Losses
There was a release of credit reserves of $47.7 million for 2021 compared to a provision of $86.9 million in 2020. The release of credit reserves during 2021 was primarily due to a decrease in the reserve evaluated on a collective basis, which relates to pooled financial assets sharing similar risk characteristics. The decrease in the collective basis reserve was driven by improvements in projected economic conditions and portfolio credit quality, partially offset by portfolio growth. The decrease in the collective basis reserve was primarily reflected in the commercial and institutional and private client portfolios. The 2020 provision reflected an increase in the reserve evaluated on a collective basis driven by current and projected economic conditions at the time and downgrades in the portfolio, both resulting from the ongoing COVID-19 pandemic and related market and economic impacts, primarily impacting the commercial real estate and commercial and institutional portfolios.
Wealth Management Noninterest Expense
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 2021 from 2020.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The increase primarily reflects higher expense allocations, Compensation expense including incentives and Employee Benefits.
Other
Income and expenses associated with non-recurring activities such as certain costs associated with acquisitions, divestitures, litigation, restructuring, and tax adjustments are included within Other. The following table summarizes the results of operations of the Other segment for the years ended December 31, 2021, 2020, and 2019 on a management-reporting basis.
TABLE 27: OTHER RESULTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, CHANGE
Noninterest Income $ (21.3) $ (18.3) $ (17.1) N/M N/M
Net Interest Income(1) — — — N/M N/M
Income (Loss) before Income Taxes(1) (43.1) (54.1) (23.5) N/M N/M
Provision (Benefit) for Income Taxes(1) (10.7) (13.5) (5.8) N/M N/M
Percentage of Consolidated Net Income (2) % (3) % (1) %
Average Assets $ — $ — $ — N/M N/M
(1) Non-GAAP financial measures stated on an FTE basis.
Other—Noninterest Income
Noninterest Income in 2021 decreased from 2020 due to higher expenses for existing swap agreements related to Visa Inc. Class B common shares.
Other—Noninterest Expense
Noninterest Expense in 2021 decreased from 2020, primarily due to lower costs arising from prior-year workplace real estate strategies and a one-time supplemental payment to employees in response to COVID-19 pandemic in the prior year, offset by pension settlement charges in 2021.
Asset Management
Asset Management, through the Corporation’s various subsidiaries, supports the C&IS and Wealth Management reporting segments by providing a broad range of asset management and related services and other products to clients around the world. Investment solutions are delivered through separately managed accounts, bank common and collective funds, registered investment companies, exchange traded funds, non-U.S. collective investment funds, and unregistered private investment funds. Asset Management’s capabilities include active and passive equity; active and passive fixed income; cash management; multi-asset and alternative asset classes (such as private equity and hedge funds of funds); and multi-manager advisory services and products. Asset Management’s activities also include overlay services and other risk management services. Asset Management operates internationally through subsidiaries and distribution arrangements and its revenue and expense are allocated fully to C&IS and Wealth Management.
2021 Annual Report | Northern Trust Corporation 47
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
At December 31, 2021, Northern Trust managed $1.61 trillion in assets for personal and institutional clients, including $1.19 trillion for C&IS clients and $416.1 billion for Wealth Management clients. The following table presents consolidated assets under management as of December 31, 2021, 2020 and 2019 by investment type.
TABLE 28: CONSOLIDATED ASSETS UNDER MANAGEMENT BY INVESTMENT TYPE
DECEMBER 31, CHANGE
Assets under management increased at year-end 2021 from year-end 2020. The increase primarily reflected favorable markets and net inflows. The following table presents activity in consolidated assets under management by product during the years ended December 31, 2021, 2020 and 2019.
TABLE 29: ACTIVITY IN CONSOLIDATED ASSETS UNDER MANAGEMENT BY PRODUCT
Inflows by Product
Outflows by Product
Market Performance, Currency & Other
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CONSOLIDATED BALANCE SHEET REVIEW
The following tables summarize selected consolidated balance sheet information.
TABLE 30: SELECT CONSOLIDATED BALANCE SHEET INFORMATION
Assets
Interest-Bearing Due from and Deposits with Banks(2) 3.9 6.6 (2.7) (42)
Securities Purchased under Agreements to Resell 0.7 1.6 (0.9) (57)
Liabilities and Stockholders' Equity
Demand and Other Noninterest-Bearing Deposits 48.3 43.1 5.2 12
Federal Funds Purchased — 0.3 (0.3) N/M
Securities Sold under Agreements to Repurchase 0.5 — 0.5 N/M
(1) Federal Reserve and Other Central Bank Deposits and Other includes collateral deposits with certain securities depositories and clearing houses for the purpose of presenting earning assets; such deposits are presented in Other Assets on the consolidated balance sheets.
(2) 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.
(3) Total Securities includes certain community development investments and Federal Home Loan Bank and Federal Reserve stock, which are classified in Other Assets on the consolidated balance sheets.
TABLE 31: SELECT AVERAGE CONSOLIDATED BALANCE SHEET INFORMATION
TWELVE MONTHS ENDED DECEMBER 31,
Assets
Interest-Bearing Due from and Deposits with Banks(2) 5.8 5.4 0.4 7
Securities Purchased under Agreements to Resell 1.1 1.2 (0.1) (15)
Liabilities and Stockholders' Equity
Demand and Other Noninterest-Bearing Deposits 31.1 23.4 7.7 33
Federal Funds Purchased 0.2 1.0 (0.8) (81)
Securities Sold under Agreements to Repurchase 0.2 0.2 — 6
(1) Federal Reserve and Other Central Bank Deposits and Other includes collateral deposits with certain securities depositories and clearing houses for the purpose of presenting earning assets; such deposits are presented in Other Assets on the consolidated balance sheets.
(2) 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.
(3) Total Securities includes certain community development investments and Federal Home Loan Bank and Federal Reserve stock, which are classified in Other Assets on the consolidated balance sheets.
Average balances are considered to be a better measure of balance sheet trends, as period-end balances can be impacted by the timing of deposit and withdrawal activity involving large client balances. The current growth in both the period-end and average consolidated balance sheets was primarily driven by higher customer deposit balances.
2021 Annual Report | Northern Trust Corporation 49
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Short-Term Borrowings. Short-term borrowings includes Federal Funds Purchased, Securities Sold under Agreements to Repurchase, and Other Borrowings. Securities Sold under Agreements to Repurchase are accounted for as collateralized financings and recorded at the amounts at which the securities were sold plus accrued interest. To minimize any potential credit risk associated with these transactions, the fair value of the securities sold is monitored, limits are set on exposure with counterparties, and the financial condition of counterparties is regularly assessed. Securities Sold under Agreements to Repurchase are held by the counterparty until the repurchase.
During the third quarter of 2021, Northern Trust became a Government Securities Division (GSD) netting and sponsoring member in the Fixed Income Clearing Corporation (FICC) sponsored member program. FICC, a wholly-owned subsidiary of The Depository Trust & Clearing Corporation, is a central counterparty and provides netting and settlement for the U.S. Government securities marketplace. Northern Trust nets securities sold under repurchase agreements against those purchased under resale agreements when FICC is the counterparty. See Note 5, “Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase,” Note 26, “Commitments and Contingent Liabilities” and Note 28, “Offsetting of Assets and Liabilities” to the consolidated financial statements provided in Item 8, “Financial Statements and Supplementary Data” for additional information on Northern Trust’s repurchase and reverse repurchase agreements.
Stockholders’ Equity. The increase in average Stockholders’ Equity was primarily attributable to Retained Earnings, partially offset by lower Accumulated Other Comprehensive Income since the prior year, repurchases of common stock pursuant to the Corporation’s share repurchase program and decreased Additional Paid-in Capital.
During the year ended December 31, 2021, the Corporation declared cash dividends totaling $593.9 million to common stockholders and repurchased 2,527,544 shares of common stock, including 394,326 shares withheld related to share-based compensation, at a total cost of $267.6 million ($105.90 average price per share).
During the year ended December 31, 2021, the Corporation declared cash dividends totaling $41.8 million to preferred stockholders.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Asset Quality
Securities Portfolio
The following table presents the remaining maturity and average yield of Northern Trust's held to maturity (HTM) debt securities and available for sale (AFS) debt securities by security type as of December 31, 2021.
TABLE 32: REMAINING MATURITY AND AVERAGE YIELD OF HELD TO MATURITY AND AVAILABLE FOR SALE DEBT SECURITIES
($ in Millions) BOOK YIELD BOOK YIELD BOOK YIELD BOOK YIELD BOOK YIELD
Held to Maturity Debt Securities
U.S. Government $ 47.0 0.03% $ 47.0 0.03% $ — —% $ — — % $ — —% 2 mo.
Available for Sale Debt Securities
Note: Yield is calculated on amortized cost and presented on a taxable equivalent basis giving effect to the applicable federal and state tax rates.
2021 Annual Report | Northern Trust Corporation 51
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Northern Trust maintains a high quality debt securities portfolio. Debt securities not explicitly rated were grouped where possible under the credit rating of the issuer of the security. The following tables provide the fair value of AFS debt securities and amortized cost of HTM debt securities by credit rating.
TABLE 33: FAIR VALUE OF AVAILABLE FOR SALE DEBT SECURITIES BY CREDIT RATING
($ In Millions) AAA AA A BBB NOT RATED TOTAL
U.S. Government $ 2,426.1 $ — $ — $ — $ — $ 2,426.1
Obligations of States and Political Subdivisions 1,133.2 2,742.9 — — — 3,876.1
($ In Millions) AAA AA A BBB NOT RATED TOTAL
U.S. Government $ 2,799.9 $ — $ — $ — $ — $ 2,799.9
Obligations of States and Political Subdivisions 918.1 2,165.5 — — — 3,083.6
Percent of Total 88 % 8 % 3 % — % 1 % 100 %
As of December 31, 2021, the 1% of AFS debt securities not rated by Moody’s Investors Service, Inc. (Moody’s), S&P Global Ratings (S&P Global) or Fitch Ratings, Inc. (Fitch Ratings) consisted of corporate debt securities and covered bonds.
As of December 31, 2020, the 1% of AFS debt securities not rated by Moody’s, S&P Global or Fitch Ratings consisted of corporate debt, covered bonds, and other asset-backed securities.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 34: AMORTIZED COST OF HELD TO MATURITY DEBT SECURITIES BY CREDIT RATING
($ In Millions) AAA AA A BBB NOT RATED TOTAL
U.S. Government $ 47.0 $ — $ — $ — $ — $ 47.0
Obligations of States and Political Subdivisions — 0.8 — — — 0.8
Government Sponsored Agency 5,927.6 — — — — 5,927.6
Certificates of Deposit — — — — 674.7 674.7
(In Millions) AAA AA A BBB NOT RATED TOTAL
U.S. Government $ 90.0 $ — $ — $ — $ — $ 90.0
Obligations of States and Political Subdivisions — 1.0 — 1.1 — 2.1
Government Sponsored Agency 3.0 — — — — 3.0
Certificates of Deposit — — — — 807.2 807.2
As of December 31, 2021 and December 31, 2020, the 5% and 7%, respectively, of HTM debt securities not rated by Moody’s, S&P Global or Fitch Ratings consisted of certificates of deposit with a remaining life of less than six months, as well as investments purchased by Northern Trust to fulfill its obligations under the Community Reinvestment Act (CRA). Northern Trust fulfills its obligations under the CRA by making qualified investments for purposes of supporting institutions and programs that benefit low-to-moderate income communities within Northern Trust’s market area.
Net unrealized losses within the investment securities portfolio totaled $187.1 million at December 31, 2021, compared to net unrealized gains of $872.6 million as of December 31, 2020. Net unrealized losses as of December 31, 2021 were comprised of $345.1 million and $532.2 million of gross unrealized gains and losses, respectively. Net unrealized gains as of December 31, 2020 were comprised of $981.9 million and $109.3 million of gross unrealized gains and losses, respectively.
As of December 31, 2021, the $38.0 billion AFS debt securities portfolio had unrealized losses of $110.2 million related to government-sponsored agency, which are primarily attributable to changes in market interest rates and credit spreads since their purchase. As of December 31, 2020, the $42.0 billion AFS debt securities portfolio had unrealized losses of $26.9 million related to government-sponsored agency, which are primarily attributable to changes in market interest rates and credit spreads since their purchase. As of December 31, 2021 and December 31, 2020, 14% and 16%, respectively, of the AFS corporate debt securities portfolio was backed by guarantees provided by U.S. and non-U.S. government entities.
As of December 31, 2021, the $23.6 billion HTM debt securities portfolio had an unrealized loss of $106.1 million, $80.0 million and $71.6 million related to government sponsored agency, sub-sovereign, supranational and non-U.S. agency bonds, and other residential mortgage-backed securities, respectively, which are primarily attributable to changes in overall market interest rates and credit spreads since their purchase. As of December 31, 2020, the $17.8 billion HTM debt securities portfolio had an unrealized loss of $76.5 million related to other residential mortgage-backed securities, which is primarily attributable to changes in overall market interest rates and credit spreads since their purchase.
2021 Annual Report | Northern Trust Corporation 53
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
HTM debt securities consist of securities that management intends to, and Northern Trust has the ability to, hold until maturity. During the year ended December 31, 2021, $6.9 billion of government sponsored agency securities were transferred from AFS to HTM for capital management purposes, all of which were transferred in the second quarter of 2021. Upon transfer of a debt security from the AFS to HTM classification, the amortized cost is reset to fair value. Any net unrealized gain or loss at the date of transfer will remain in AOCI and be amortized into net interest income over the remaining life of the securities using the effective interest method. The amortization of amounts retained in AOCI will offset the effect on interest income of the amortization of the premium or discount resulting from transferring the securities at fair value. During the year ended December 31, 2020, $301.5 million of securities reflected in U.S. government were transferred from AFS to HTM, all of which were transferred in the second quarter of 2020.
For additional information relating to the securities portfolio, refer to Note 4, “Securities,” provided in Item 8, “Financial Statements and Supplementary Data.”
Securities purchased under agreements to resell and securities sold under agreements to repurchase are accounted for as collateralized financings and recorded at the amounts at which the securities were acquired or sold plus accrued interest. To minimize any potential credit risk associated with these transactions, the fair value of the securities purchased or sold is monitored, limits are set on exposure with counterparties, and the financial condition of counterparties is regularly assessed. It is Northern Trust’s policy to take possession, either directly or via third-party custodians, of securities purchased under agreements to resell. Securities sold under agreements to repurchase are either directly held by, or pledged to the counterparty until the repurchase.
For additional information relating to the securities sold under agreements to repurchase, refer to Note 5, “Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase,” provided in Item 8, “Financial Statements and Supplementary Data.”
Loans and Leases
For additional information relating to the loan and leases portfolio, refer to Note 6, “Loans and Leases,” and Note 8, “Concentrations of Credit Risk” provided in Item 8, “Financial Statements and Supplementary Data.”
The following table presents the remaining maturity of loans and leases by segment and class as of December 31, 2021.
TABLE 35: REMAINING MATURITY OF LOANS AND LEASES
U.S.:
Commercial
Lease Financing, net 11.0 — — 11.0 —
Personal
Non-U.S.:
Note: Non-U.S. loans primarily include short duration exposures related to custodied client investments.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
TABLE 36: INTEREST RATE SENSITIVITY OF LOANS AND LEASES
Fixed Rate:
Commercial
Personal
Variable Rate:
Commercial
Lease Financing, net 11.0 — — 11.0 —
Personal
Nonaccrual Assets and 90 Days Past Due Loans
Nonaccrual assets consist of nonaccrual loans and leases and other real estate owned (OREO). OREO is comprised of commercial and residential properties acquired in partial or total satisfaction of loans. Loans that are delinquent 90 days or more and still accruing interest can fluctuate widely at any reporting period based on the timing of cash collections, renegotiation and renewals. For additional information relating to nonaccrual loans, refer to Note 6, “Loans and Leases,” 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
The following table presents nonaccrual assets and loans that were delinquent 90 days or more and still accruing interest at December 31, 2021 and 2020.
TABLE 37: NONACCRUAL ASSETS
DECEMBER 31,
Nonaccrual Loans and Leases
Commercial
Commercial and Institutional $ 19.5 $ 26.4
Commercial Real Estate 66.6 40.2
Personal
Residential Real Estate $ 36.2 $ 62.2
Private Client — 2.9
Total Nonaccrual Loans and Leases 122.3 131.7
Other Real Estate Owned 3.0 0.7
90 Day Past Due Loans Still Accruing $ 28.3 $ 8.9
Nonaccrual Loans and Leases to Total Loans and Leases 0.30 % 0.39 %
Nonaccrual assets as of December 31, 2021 decreased from December 31, 2020, primarily due to net payoffs in the residential real estate and commercial and institutional portfolios, partially offset by a net increase in the commercial real estate portfolio. In addition to the negative impact on net interest income and the risk of credit losses, nonaccrual assets also increase operating costs due to the expense associated with collection efforts. Changes in the level of nonaccrual assets may be indicative of changes in the credit quality of one or more loan classes. Changes in credit quality impact the allowance for credit losses through the resultant adjustment of the allowance evaluated on an individual basis and the quantitative and qualitative factors used in the determination of the allowance evaluated on a collective basis within the allowance for credit losses.
Allowance for Credit Losses
The allowance for credit losses—which represents management’s best estimate of lifetime expected credit losses related to various portfolios subject to credit risk, off-balance sheet credit exposure, and specific borrower relationships—is determined by management through a disciplined credit review process. Northern Trust measures expected credit losses of financial assets with similar risk characteristics on a collective basis. A financial asset is measured individually if it does not share similar risk characteristics with other financial assets and the related allowance is determined through an individual evaluation.
Management’s estimates utilized in establishing an appropriate level of allowance for credit losses are not dependent on any single assumption. In determining an appropriate allowance level, management evaluates numerous variables, many of which are interrelated or dependent on other assumptions and estimates, and takes into consideration past events, current conditions and reasonable and supportable forecasts.
The results of the credit reserve estimation methodology are reviewed quarterly by Northern Trust’s Credit Loss Reserve Committee, which receives input from Credit Risk Management, Treasury, Corporate Finance, the Economic Research group, and each of Northern Trust’s business units.
As of December 31, 2021, the allowance for credit losses related to loans and leases, undrawn loan commitments and standby letters of credit, HTM debt securities, and other financial assets, was $138.4 million, $34.1 million, $11.2 million, and $1.0 million, respectively. As of December 31, 2020, the allowance for credit losses related to loans and leases, undrawn loan commitments and standby letters of credit, HTM debt securities, and other financial assets, was $190.7 million, $61.1 million, $7.3 million, and $0.8 million, respectively. For additional information relating to the allowance for credit losses and the changes in the allowance for credit losses during the years ended December 31, 2021 and 2020 due to charge-offs, recoveries and provisions for credit losses, refer to Note 7, “Allowance for Credit Losses,” 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
The following table shows the net recoveries (charge-offs) to average loans and leases by segment and class at December 31, 2021, 2020, and 2019.
TABLE 38: NET RECOVERIES (CHARGE-OFFS) TO AVERAGE LOANS AND LEASES
Net Recoveries (Charge-Offs) to Average Loans and Leases
Commercial
Commercial and Institutional 0.01 % 0.02 % (0.03) %
Total Commercial — (0.03) (0.02)
Personal
Private Client 0.01 — —
Net Recoveries (Charge-Offs)
Commercial
Commercial and Institutional $ 0.9 $ 1.8 $ (2.6)
Commercial Real Estate (0.3) (5.7) 0.5
Total Commercial 0.6 (3.9) (2.1)
Personal
Residential Real Estate 4.4 1.2 2.5
Total Net Recoveries (Charge-Offs) $ 6.3 $ (3.2) $ 0.7
Average Loans and Leases
Commercial
Personal
Net recoveries (charge-offs) for the following segments were zero and therefore excluded from the above table as the ratio of net recoveries (charge-offs) to average loans and leases is also zero: Lease Financing, net, Other, and Non-U.S. The average loans and leases balances were also not provided in the table for Lease Financing, net, Other, and Non-U.S.
Total average loans and leases for all loan portfolio categories were $37.2 billion, $33.5 billion, and $31.1 billion for the years ended December 31, 2021, 2020, and 2019, respectively.
The SEC requires the disclosure of the Allowance for Credit Losses that is applicable to international operations. The disclosure has been prepared in compliance with this disclosure requirement and is used in determining non-U.S. operating performance. The amounts disclosed should not be construed as being the only amounts that are available for non-U.S. loan charge-offs, since the entire Allowance for Credit Losses assigned to Loans and Leases is available to absorb losses on both U.S. and non-U.S. loans. In addition, these amounts are not intended to be indicative of future charge-off trends. Please refer to the following table for the non-U.S. allowance balances.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following table shows the allowance evaluated on an individual and collective basis for the loans and leases portfolio by segment and class at December 31, 2021 and 2020.
TABLE 39: ALLOCATION OF THE ALLOWANCE FOR CREDIT LOSSES
DECEMBER 31,
Evaluated on an Individual Basis $ 10.1 — % $ 10.7 — %
Evaluated on a Collective Basis
Commercial
Lease Financing, net 0.4 — 0.4 —
Other — 2 — 1
Personal
Other — — — —
Total Allowance Evaluated on a Collective Basis $ 162.4 $ 241.1
Total Allowance for Credit Losses $ 172.5 $ 251.8
Allowance Assigned to:
Undrawn Commitments and Standby Letters of Credit 34.1 61.1
Total Allowance for Credit Losses $ 172.5 $ 251.8
Allowance Assigned to Loans and Leases to Total Loans and Leases 0.34 % 0.56 %
Allowance Related to Credit Exposure Evaluated on an Individual Basis: The allowance is determined through an individual evaluation of loans, leases, and lending-related commitments that have defaulted, generally those with Borrower Ratings of 8 and 9, that is based on expected future cash flows, the value of collateral, and other factors that may impact the borrower’s ability to pay.
The allowance evaluated on an individual basis for Loans and Leases decreased $0.6 million from $10.7 million at December 31, 2020 to $10.1 million at December 31, 2021, primarily attributable to a decrease in outstanding loans in the commercial real estate and residential real estate portfolios, partially offset by an increase in outstanding loans in the commercial and institutional portfolio.
Allowance Related to Credit Exposure Evaluated on a Collective Basis: Expected credit losses are measured on a collective basis as long as the financial assets included in the respective pool share similar risk characteristics. If financial assets are deemed to not share similar risk characteristics, an individual assessment is warranted.
The allowance evaluated on a collective basis for Loans and Leases decreased $78.7 million to $162.4 million at December 31, 2021, compared with $241.1 million at December 31, 2020, primarily due to a decrease in the reserve evaluated on a collective basis, which relates to pooled financial assets sharing similar risk characteristics, and was driven by improvements in projected economic conditions and portfolio credit quality, partially offset by portfolio growth. The decrease in the collective basis reserve was primarily reflected in the commercial and institutional portfolio.
Overall Allowance: The evaluation of the reserve evaluated on an individual and collective basis resulted in a total allowance for credit losses of $184.7 million at December 31, 2021, compared with $259.9 million at the end of 2020. The allowance of $138.4 million assigned to Loans and Leases, as a percentage of total Loans and Leases, was 0.34% at December 31, 2021, which decreased from a $190.7 million allowance assigned to Loans and Leases, representing 0.56% of total Loans and Leases at December 31, 2020. Allowances assigned to undrawn loan commitments and standby letters of credit totaled $34.1 million and $61.1 million at December 31, 2021 and 2020, respectively, and are included in Other Liabilities on the consolidated balance sheets.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Capital Expenditures
Capital expenditures in 2021 included continued investments to enhance Northern Trust’s software and hardware capabilities, the opening of new offices, and the renovation of several existing offices. Capital expenditures for 2021 totaled $515.1 million, of which $419.6 million was for software, $40.2 million was for building and leasehold improvements, $52.6 million was for computer hardware, and $2.7 million was for furnishings. These capital expenditures principally support, enhance, and protect Northern Trust’s investment management, asset servicing and wealth management systems and capabilities, with focus on delivering innovative solutions to better serve our clients. Additional capital expenditures committed for technology platforms will result in future expense for the depreciation of hardware and amortization of software. Software amortization and depreciation on computer hardware are charged to Equipment and Software expense. Depreciation on building and leasehold improvements and on furnishings is charged to Occupancy expense and equipment expense, respectively. Capital expenditures for 2020 totaled $560.4 million, of which $424.6 million was for software, $66.6 million was for building and leasehold improvements, $65.4 million was for computer hardware, and $3.8 million was for furnishings.
Deposits
The following table provides the scheduled maturity of total time deposits in denominations of $250,000 or greater at December 31, 2021. For additional information, refer to Note 12, “Deposits,” provided in Item 8, “Financial Statements and Supplementary Data.”
TABLE 40: REMAINING MATURITY OF TIME DEPOSITS $250,000 OR MORE
U.S. OFFICE NON-U.S. OFFICES
(In Millions) CERTIFICATES OF DEPOSIT OTHER TIME TOTAL
Deposits not insured by the FDIC as of December 31, 2021 and 2020 totaled $150.3 billion and $135.5 billion, respectively. These deposit amounts are derived by adding estimated domestic office uninsured deposits as allowed by Federal Financial Institutions Examination Council instructions to all foreign office deposits. Estimated uninsured domestic office deposits are determined by calculating and totaling the deposits in excess of the deposit insurance limit on an individual account basis.
Short-Term Borrowings
During the third quarter of 2021, Northern Trust became a Government Securities Division (GSD) netting and sponsoring member in the Fixed Income Clearing Corporation (FICC) sponsored member program. FICC, a wholly-owned subsidiary of The Depository Trust & Clearing Corporation, is a central counterparty and provides netting and settlement for the U.S. Government securities marketplace. Northern Trust nets securities sold under repurchase agreements against those purchased under resale agreements when FICC is the counterparty.
Securities purchased under agreements to resell and securities sold under agreements to repurchase are accounted for as collateralized financings and recorded at the amounts at which the securities were acquired or sold plus accrued interest. To minimize any potential credit risk associated with these transactions, the fair value of the securities purchased or sold is monitored, limits are set on exposure with counterparties, and the financial condition of counterparties is regularly assessed. It is Northern Trust’s policy to take possession, either directly or via third-party custodians, of securities purchased under agreements to resell. Securities sold under agreements to repurchase are either directly held by, or pledged to the counterparty until the repurchase. See Note 5, “Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase,” Note 26, “Commitments and Contingent Liabilities” and Note 28, “Offsetting of Assets and Liabilities” provided in Item 8, “Financial Statements and Supplementary Data” for additional information on our repurchase and reverse repurchase agreements.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Geographic Area Information
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 assets. Non-U.S. source 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 assets between U.S. and non-U.S.-domiciled customers. Therefore, certain subjective estimates and assumptions have been made to allocate assets between U.S. and non-U.S. operations.
The following tables present selected average assets and liabilities attributable to non-U.S. operations (based on the obligor’s domicile) and the percent of those balances to total consolidated average assets. For additional information refer to Note 32, “Reporting Segments and Related Information,” provided in Item 8, “Financial Statements and Supplementary Data.”
TABLE 41: SELECTED AVERAGE ASSETS AND LIABILITIES ATTRIBUTABLE TO NON-U.S. OPERATIONS
Non-U.S. Outstandings
As used in this discussion, non-U.S. outstandings are cross-border outstandings as defined by the SEC. They consist of loans, securities, interest-bearing deposits with financial institutions, accrued interest and other monetary assets. Not included are letters of credit, loan commitments, and non-U.S. office local currency claims on residents. Non-U.S. outstandings related to a country are net of guarantees given by third parties resident outside the country and the value of tangible, liquid collateral realizable outside the country. However, transactions with branches of non-U.S. banks are included in these outstandings and are classified according to the country location of the non-U.S. bank’s head office.
Short-term interbank time deposits with non-U.S. banks represent the largest category of non-U.S. outstandings. Northern Trust actively participates in the interbank market with U.S. and non-U.S. banks.
Northern Trust places deposits with non-U.S. counterparties that have strong internal (Northern Trust) risk ratings and external credit ratings. These non-U.S. banks are approved and monitored by Northern Trust’s Capital Markets Credit Committee, which has credit authority for exposure to all non-U.S. banks and approves credit limits. This process includes financial analysis of the non-U.S. banks, use of an internal risk rating system and consideration of external market indicators. Each counterparty is reviewed at least annually and potentially more frequently based on credit fundamentals or general market conditions. Separate from the entity-specific review process, the average life to maturity of deposits with non-U.S. banks is deliberately maintained on a short-term basis in order to respond quickly to changing credit conditions. Northern Trust also utilizes certain risk mitigation tools and agreements that may reduce exposures through use of collateral and/or balance sheet netting. Additionally, the Capital Markets Credit Committee oversees country-risk analyses and imposes limits on country exposure. For additional information refer to Note 32, “Reporting Segments and Related Information,” 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
STATEMENTS OF CASH FLOWS
The following discusses the statement of cash flow activities for the years ended December 31, 2021, 2020, and 2019.
TABLE 42: CASH FLOW ACTIVITY SUMMARY
FOR THE YEAR ENDED DECEMBER 31,
Net cash provided by (used in):
Effect of Foreign Currency Exchange Rates on Cash (159.6) 84.6 74.7
Change in Cash and Due from Banks $ (1,332.7) $ (69.7) $ (122.4)
Operating Activities
Net cash provided by operating activities of $1.4 billion for the year ended December 31, 2021 was primarily attributable to period earnings and the impact of higher non-cash charges such as depreciation and amortization, partially offset by higher net collateral deposited with derivative counterparties and in receivables.
For the year ended December 31, 2020, net cash provided by operating activities of $1.9 billion primarily reflected period earnings and the impact of higher non-cash charges such as depreciation and amortization and provision for credit losses.
Investing Activities
Net cash used in investing activities of $18.6 billion for the year ended December 31, 2021 was primarily attributable to increased levels of deposits with the Federal Reserve and other central banks, higher levels of loans and leases and net purchases of AFS debt securities, partially offset by lower levels of interest-bearing deposits with banks.
For the year ended December 31, 2020, net cash used in investing activities of $29.9 billion primarily reflected higher levels of deposits with the Federal Reserve and other central banks, net purchases of HTM debt securities, higher levels of loans and leases, and net purchases of AFS debt securities.
Financing Activities
Net cash provided by financing activities of $16.1 billion for the year ended December 31, 2021 was primarily attributable to higher levels of total deposits and securities sold under agreements to repurchase, partially offset by dividends paid on common stock, repayment of the 3.375% senior notes previously issued by the Corporation that matured in August 2021, lower short-term other borrowings, and the repayment of floating rate capital debt. The increase in total deposits was primarily attributable to higher levels of savings, money market and other interest-bearing deposits, non-U.S. interest-bearing deposits, and demand and other noninterest-bearing deposits.
For the year ended December 31, 2020, net cash provided by financing activities of $27.9 billion primarily reflected higher levels of total deposits and proceeds from the issuance by the Corporation of 1.95% senior notes, partially offset by lower short-term other borrowings, dividends paid on common stock, repayment of the 3.45% senior notes previously issued by the Corporation that matured in November 2020, lower securities sold under agreements to repurchase, and the redemption of the Series C Non-Cumulative Perpetual Preferred Stock. The increase in total deposits was primarily attributable to higher levels of non-U.S. office noninterest-bearing deposits, non-U.S. interest-bearing deposits, savings, money market and other interest-bearing deposits, and demand and other noninterest-bearing deposits.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
CAPITAL MANAGEMENT
One of Northern Trust’s primary objectives is to maintain a strong capital position to merit the confidence of clients, counterparties, creditors, regulators and stockholders. A strong capital position helps Northern Trust execute its strategies and withstand unforeseen adverse developments.
Senior management, with oversight from the Capital Governance Committee and the full Board of Directors, is responsible for capital management and planning. Northern Trust manages its capital on both a total Corporation basis and a legal entity basis. The Capital Committee is responsible for measuring and managing capital metrics against levels set forth within the Capital Policy approved by the Capital Governance Committee of the Board of Directors. In establishing the metrics related to capital, a variety of factors are taken into consideration, including the unique risk profiles of Northern Trust’s businesses, regulatory requirements, capital levels relative to peers, and the impact on credit ratings.
Capital levels strengthened in 2021 as average stockholders’ equity increased $504.4 million, or 5%, reaching $11.7 billion. Total stockholders’ equity was $12.0 billion at December 31, 2021, as compared to $11.7 billion at December 31, 2020. Preferred dividends totaling $41.8 million were declared in 2021. During 2021, the Corporation maintained its quarterly common stock dividend of $0.70 per common share. Common dividends totaling $593.9 million were declared in 2021. During the year ended December 31, 2021, the Corporation repurchased 2,527,544 shares of common stock, including 394,326 shares withheld related to share-based compensation, at an average price per share of $105.90.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In accordance with Basel III requirements, capital ratios are calculated using both the standardized and advanced approaches. For each ratio, the lower of the result calculated under the standardized approach and the advanced approach serves as the effective ratio for purposes of determining capital adequacy. The following table provides a reconciliation of the Corporation’s common stockholders’ equity to total risk-based capital and its risk-based capital ratios, under the applicable U.S. regulatory rules as of December 31, 2021 and 2020.
TABLE 43: CAPITAL ADEQUACY
STANDARDIZED APPROACH ADVANCED APPROACH STANDARDIZED APPROACH ADVANCED APPROACH
Common Equity Tier 1 Capital
Additional Tier 1 Capital
Tier 2 Capital
Qualifying Allowance for Credit Losses 184.8 — 259.9 —
Floating Rate Capital — — 53.9 53.9
Common Stockholders’ Equity to:
Risk-Based Capital Ratios
Supplementary Leverage(3) N/A 8.2 N/A 8.6
(1) Risk-weighted assets exclude, as applicable under each regulatory approach, amounts primarily related to goodwill, certain other intangible assets, and net unrealized gains or losses on securities and reflect adjustments for excess allowances for credit losses that have been excluded from Tier 1 and Tier 2 capital, if any.
(2) Adjusted average fourth quarter assets exclude amounts primarily related to goodwill, other intangible assets, and net unrealized gains or losses on securities.
(3) In November 2019, the Federal Reserve Board and other U.S. federal banking agencies adopted a final rule that established a deduction for central bank deposits from the total leverage exposures of custodial banking organizations, including the Corporation and the Bank, equal to the lesser of (i) the total amount of funds the custodial banking organization and its consolidated subsidiaries have on deposit at qualifying central banks and (ii) the total amount of client funds on deposit at the custodial banking organization that are linked to fiduciary or custodial and safekeeping accounts. The rule became effective on April 1, 2020.
Further, on April 1, 2020, the Federal Reserve Board issued an interim final rule that requires bank holding companies, including the Corporation, to deduct, on a temporary basis, deposits with the Federal Reserve Board and investments in U.S. Treasury securities from their total leverage exposure. The U.S. Treasury securities deduction is applied in addition to the central bank deposits relief referred to above. This rule became effective on April 1, 2020 and expired on April 1, 2021.
On May 15, 2020, the U.S. federal banking agencies released an interim final rule that permits insured depository institutions of bank holding companies also to temporarily exclude deposits with the Federal Reserve Board and investments in U.S. Treasury securities from their total leverage exposure. The Bank did not elect to take this deduction.
The supplementary leverage ratios at December 31, 2021 and December 31, 2020 for the Corporation and the Bank reflect the impact of these final rules.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As of December 31, 2021 and 2020, the Corporation’s capital ratios exceeded the requirements for classification as “well-capitalized” under applicable U.S. regulatory requirements. As a result of the stress test results published by the Federal Reserve on June 25, 2020, Northern Trust’s stress capital buffer requirement for the 2020 Capital Plan cycle was set at 2.5%. The 2020 stress capital buffer became effective October 1, 2020, and resulted in an effective Common Equity Tier 1 capital ratio minimum requirement of 7.0% inclusive of this buffer. The results of the 2021 stress test, published by the Federal Reserve Board on June 24, 2021, resulted in Northern Trust’s stress capital buffer and effective Common Equity Tier 1 capital ratio minimum requirement remaining in effect for the 2021 Capital Plan cycle, which began on October 1, 2021.
Further information regarding the Corporation’s and the Bank’s capital ratios and the minimum requirements for classification as “well-capitalized” is provided in the “Supervision and Regulation—Capital Adequacy Requirements” section of Item 1, “Business,” and Note 33, “Regulatory Capital Requirements,” provided in Item 8, “Financial Statements and Supplementary Data.”
CRITICAL ACCOUNTING ESTIMATES
Our significant accounting policies are described in Note 1, “Summary of Significant Accounting Policies,” provided in Item 8, “Financial Statements and Supplementary Data.” The use of estimates and assumptions is required in the preparation of financial statements in conformity with GAAP and actual results could differ from those estimates. The SEC has issued guidance relating to the disclosure of critical accounting estimates. Critical accounting estimates are those that require management to make subjective or complex judgments about the effect of matters that are inherently uncertain and may change in subsequent periods. Changes that may be required in the underlying assumptions or estimates in these areas could have a material impact on Northern Trust’s future financial condition and results of operations.
For Northern Trust, accounting estimates that are viewed as critical are those relating to the allowance for credit losses and pension plan accounting. Management has discussed the development and selection of each critical accounting estimate with the Audit Committee of the Board of Directors (Audit Committee).
Allowance for Credit Losses
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 changes 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 $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 allowance for credit losses — which represents management’s estimate of lifetime expected credit losses related to various portfolios subject to credit risk, off-balance sheet credit exposure, and specific borrower relationships — is determined by management through a disciplined credit review process. Northern Trust measures expected credit losses of financial assets with similar risk characteristics on a collective basis. A financial asset is measured individually if it does not share similar risk characteristics with other financial assets and the related allowance is determined through an individual evaluation.
Management’s estimates utilized in establishing an appropriate level of allowance for credit losses are not dependent on any single assumption. In determining an appropriate allowance level, management evaluates numerous variables, many of which are interrelated or dependent on other assumptions and estimates, and takes into consideration past events, current conditions and reasonable and supportable forecasts. Due to the inherent imprecision in accounting estimates, other estimates or assumptions could reasonably have been used in 2021 and changes in estimates are reasonably likely to occur from period to period.
The allowance for credit losses consists of the following components:
Evaluated on a Collective Basis. Expected credit losses are measured on a collective basis as long as the financial assets included in the respective pool share similar risk characteristics. If financial assets are deemed to not share similar risk characteristics, an individual assessment is warranted.
The allowance estimation methodology for the collective assessment is based on data representative of the Corporation’s financial asset portfolio from a historical observation period that includes both expansionary and recessionary periods. The estimation methodology and the related qualitative adjustment framework segregate the loan and lease portfolio into segments based on loan and obligor-specific factors, including loan type, borrower type, collateral type, loan size, and borrower credit quality. For each segment, the probability of default and loss given default are derived for each quarter of the remaining life of each instrument. For the first two years (the reasonable and supportable period), these
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
factors are derived by applying quarterly macroeconomic projections using models developed from historical data on macroeconomic factors and loans with similar factors. For periods beyond the reasonable and supportable period, Northern Trust reverts to its long-run historical loss experiences on a straight-line basis over four quarters. The projected exposure at default for every quarter is based on contractual balance projections as of each quarter-end, with adjustments made for potential draws on off-balance sheet commitments.
For each of the different parameters, specific credit models for the individual loan segments were developed. For each segment, the probability of defaultand the loss given default are applied to the exposure at default for each projected quarter to determine the quantitative component of the allowance. The quantitative allowance is then reviewed within the qualitative adjustment framework, through which management applies judgment by assessing internal risk factors, potential limitations in the quantitative methodology, and environmental factors that are not fully contemplated in the forecast to compute adjustments to the quantitative allowance that may impact individual or multiple segments of the loan portfolio.
ASU 2016-13 requires the use of projected macroeconomic factors. The Corporation uses multiple forecasts approved by Northern Trust’s Macroeconomic Scenario Development Committee (MSDC). The baseline forecast aligns with the Corporation’s latest thinking on macroeconomic projections for the next eight quarters. The forecasts are weighted at each evaluation period and are management’s best estimate of future economic projections at that time.
The allowance estimate is sensitive to changes in portfolio composition, portfolio quality, and macroeconomic forecasts. Increases in the amount of borrowing and material downgrades to the quality of the lending portfolio will increase the reserve, all else equal. Similarly, deteriorating projections for macroeconomic conditions will increase the reserve. Macroeconomic factors that are particularly correlated to Northern Trust’s loan and lease portfolio are equity market values, market volatility, corporate profits, residential and commercial real estate price indices, unemployment, and disposable income. To demonstrate the sensitivity to changes in macroeconomic conditions, Northern Trust applied a 100% probability weighting to downturn conditions, resulting in an increase to the collective component of the allowance for the loan and lease portfolio of approximately $128.3 million. The investment security and other financial assets portfolios are less sensitive to macroeconomic factors in terms of overall reserve impact due to factors such as high credit quality, short duration, and low historical losses.
The commercial and institutional (C&I) portfolio utilizes Northern Trust’s internal borrower rating assessments to determine initial credit quality. A sensitivity analysis was performed to determine the impact of upgrades or downgrades by shifting the rating up or down by one rating class, assuming no changes to other factors, such as macroeconomic projections or qualitative adjustments. The analysis excludes defaulted loans and does not assume a default event; hence, borrowers at the lowest non-default rating were not downgraded. Similarly, those at the highest rating could not be upgraded. Assuming the final forecast probability weighting, the collective component of the allowance assigned to the C&I portfolio would increase by approximately $78.1 million if all C&I borrowers were downgraded by one performing rating class. The C&I collective allowance would decrease by approximately $21.3 million if borrower ratings were upgraded by one rating class (if possible).
The results of the credit reserve estimation methodology are reviewed quarterly by Northern Trust’s Credit Loss Reserve Committee, which receives input from Credit Risk Management, Treasury, Corporate Finance, the Economic Research group, and each of Northern Trust’s business units. The Credit Loss Reserve Committee determines the probability weights applied to each forecast approved by MSDC, and also reviews and approves qualitative adjustments to the collective allowance in line with Northern Trust’s qualitative adjustment framework.
Evaluated on an Individual Basis. The allowance is determined through an individual evaluation of financial assets that have defaulted that is based on expected future cash flows, the value of collateral, and other factors that may impact the borrower’s ability to pay. For defaulted loans for which the amount of allowance, if any, is determined based on the value of the underlying real estate collateral, third-party appraisals are typically obtained and utilized by management. These appraisals are generally less than twelve months old and are subject to adjustments to reflect management’s judgment as to the realizable value of the collateral.
Analysis and Controls. The quarterly analysis of the individual and collective allowance components and the control process maintained by Credit Risk Management and the lending staff are the principal methods relied upon by management for the timely identification and estimation of individual expected credit losses. In addition to Northern Trust’s own experience, management also considers regulatory guidance. Control processes and analyses employed to determine an appropriate level of allowance for credit losses are reviewed at least annually and modified as considered appropriate.
Management believes that the allowance for credit losses adequately considers these uncertainties and has been established at an appropriate level. Actual losses may vary from current estimates and the amount of the provision for credit losses may be greater or less than actual net charge-offs in any particular period.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Pension Plan Accounting
Northern Trust maintains a noncontributory defined benefit pension plan covering substantially all U.S. employees (U.S. Qualified Plan) and a U.S. noncontributory supplemental pension plan (U.S. Non-Qualified Plan). Certain European-based employees also retain benefits in local defined benefit pension plans, of which the majority are closed to new employees and to future benefit accruals. Measuring cost and reporting liabilities resulting from defined benefit pension plans requires the use of several assumptions regarding future interest rates, asset returns, compensation increases, mortality rates, and other actuarial-based projections relating to the plans. Due to the long-term nature of this obligation and the estimates that are required to be made, the assumptions used in determining the periodic pension expense and the projected benefit obligation are closely monitored and reviewed annually for adjustments that may be required. Pension accounting guidance requires that differences between estimates and actual experience be recognized as other comprehensive income in the period in which they occur. The differences are amortized into net periodic pension expense from accumulated other comprehensive income over the average remaining service period of eligible participants. As a result, differences between the estimates made in the calculation of periodic pension expense and the projected benefit obligation and actual experience affect stockholders’ equity in the period in which they occur but continue to be recognized as expense systematically and gradually over subsequent periods.
Northern Trust recognizes the significant impact that these pension-related assumptions have on the determination of the pension obligations and related expense and has established procedures for monitoring and setting these assumptions each year. These procedures include an annual review of actual demographic and investment experience with the pension plans’ actuaries. In addition to actual experience, adjustments to these assumptions consider observable yields on fixed income securities, known compensation trends and policies, as well as economic conditions and investment strategies that may impact the estimated long-term rate of return on plan assets.
In determining the pension expense for the U.S. Qualified Plan in 2021, Northern Trust utilized a discount rate of 2.75% as of December 31, 2020, 3.05% as of June 30, 2021, and 3.06% as of September 30, 2021, and 3.03% as of December 31, 2021. The application of settlement accounting in 2021 required interim re-measurements of the U.S. Qualified Plan throughout 2021. The discount rate utilized for the U.S. Non-Qualified Plan as of December 31, 2020 was 2.45% . For both plans, the rate of increase in the compensation level is based on a graded schedule from 9.00% to 2.50% that averaged 4.97%. The expected long-term rate of return on U.S. Qualified Plan assets was 5.25% as of both December 31, 2020 and June 30, 2021, and 5.00% as of September 30, 2021.
In evaluating possible revisions to pension-related assumptions for the U.S. pension plans as of Northern Trust’s December 31, 2021 measurement date, the following were considered:
•Discount Rate: Northern Trust estimates the discount rate for its U.S. pension plans by applying the plan specific projected cash flows for future benefit payments for each plan to the Aon AA Above Median yield curve as of the measurement date. This yield curve is composed of individual zero-coupon interest rates for 198 different time periods over a 99-year time horizon. Zero-coupon rates utilized by the yield curve are mathematically derived from observable market yields for AA-rated corporate bonds. This yield curve model referenced by Northern Trust in establishing the discount rate resulted in a rate of 3.03% and 2.80% at December 31, 2021 for the U.S. Qualified and U.S. Non-Qualified Plans, respectively.
•Compensation Level: Based on a review of actual and anticipated salary experience, the compensation scale assumption is based on a graded schedule from 9.00% to 2.50% that averages 4.97%.
•Rate of Return on Plan Assets: The expected return on plan assets is based on an estimate of the long-term (30 years) rate of return on plan assets, which is determined using a building block approach that considers the current asset mix and estimates of return by asset class based on historical experience, giving proper consideration to diversification and rebalancing. Current market factors such as inflation and interest rates are also evaluated before long-term capital market assumptions are determined. Peer data and historical returns are reviewed to check for reasonability and appropriateness. As a result of these analyses, Northern Trust’s rate of return assumption for the U.S. Qualified Plan is 5.25% for 2022.
•Mortality Table: As of December 31, 2021, Northern Trust has adopted the aggregate Pri-2012 mortality table with a 2012 base year, which was released by the Society of Actuaries in October 2019. Northern Trust’s pension obligations reflect proposed future improvement under scale MP-2021, which was released by the Society of Actuaries in October 2021. This assumption was updated at December 31, 2021 from improvement scale MP-2020. The updated improvement scale applies to annuity payments only and results in slightly higher projected mortality improvement rates than estimated by the MP-2020 improvement scale. Mortality assumptions on lump sum payments remain static and continue to be in line with the IRS prescribed table for minimum lump sums in 2022.
Excluding pension settlement charges, net pension expense in 2022 is expected to decrease by approximately $10.1 million, primarily driven by lower loss amortization due to strong asset returns in previous years and the 2021 settlement recognition.
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MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In order to illustrate the sensitivity of these assumptions on the expected U.S pension plans’ periodic pension expense in 2022 and the projected benefit obligation as of December 31, 2021, the following table is presented to show the effect of increasing or decreasing each of these assumptions by 25 basis points.
TABLE 44: SENSITIVITY OF U.S. PENSION PLANS ASSUMPTIONS
($ In Millions) 25 BASISPOINT INCREASE 25 BASISPOINT DECREASE
Increase (Decrease) in 2022 Pension Expense
Discount Rate Change $ (3.8) $ 4.0
Compensation Level Change 2.6 (2.5)
Rate of Return on Plan Assets Change (3.8) 3.8
Increase (Decrease) in 2021 Projected Benefit Obligation
Discount Rate Change (50.3) 53.2
Compensation Level Change 11.1 (10.7)
Pension Contributions. The deduction limits specified by the Internal Revenue Code for contributions made by sponsors of defined benefit pension plans are based on a “Target Liability” under the provisions of the Pension Protection Act of 2006. There were no contributions to the U.S. Qualified Plan for the 2021 plan year. The minimum required contribution to the U.S. Qualified Plan is expected to be zero in 2022. The maximum deductible contribution is estimated at $413.0 million for 2022.
FAIR VALUE MEASUREMENTS
The preparation of financial statements in conformity with GAAP requires certain assets and liabilities to be reported at fair value. As of December 31, 2021, approximately 21% of Northern Trust’s total assets and less than 1% of total liabilities were carried on the consolidated balance sheets at fair value. As of December 31, 2020, approximately 25% of Northern Trust’s total assets and approximately 1% of its total liabilities were carried on the consolidated balance sheets at fair value. As discussed more fully in Note 3, “Fair Value Measurements,” provided in Item 8, “Financial Statements and Supplementary Data,” GAAP requires entities to categorize financial assets and liabilities carried at fair value according to a three-level valuation hierarchy. The hierarchy gives the highest priority to quoted, active market prices for identical assets and liabilities (Level 1) and the lowest priority to valuation techniques that require significant management judgment because one or more of the significant inputs are unobservable in the market place (Level 3). Approximately 6% and 7% of Northern Trust’s assets carried at fair value are classified as Level 1 as of December 31, 2021 and 2020, respectively. Northern Trust typically does not hold equity securities or other instruments that are actively traded on an exchange.
As of December 31, 2021, approximately 94% of Northern Trust’s assets and 96% of its liabilities carried at fair value are categorized as Level 2, as they are valued using models in which all significant inputs are observable in active markets. Investment debt securities classified as AFS make up 98% of Level 2 assets with the remaining 2% primarily consisting of derivative financial instruments. Level 2 liabilities are comprised solely of derivative financial instruments.
As of December 31, 2020, approximately 93% of Northern Trust’s assets and 98% of its liabilities carried at fair value are categorized as Level 2, as they are valued using models in which all significant inputs are observable in active markets. Investment debt securities classified as AFS make up 97% of Level 2 assets with the remaining 3% primarily consisting of derivative financial instruments. Level 2 liabilities are comprised solely of derivative financial instruments.
Northern Trust’s Level 2 assets include AFS and trading account securities, the fair values of which are determined predominantly by external pricing vendors. Northern Trust has a well-established process to validate prices received from pricing vendors as discussed more fully in Note 3, “Fair Value Measurements,” provided in Item 8, “Financial Statements and Supplementary Data.”
As of December 31, 2021 and 2020, all derivative assets and liabilities, excluding the swap related to the sale of certain Visa Class B common shares described below, were classified as Level 2 and approximately 96% and 95%, respectively, were measured on a notional value basis, related to client-related and trading activities, predominantly consisting of foreign exchange contracts. Derivative instruments are valued internally using widely accepted income-based models that incorporate inputs readily observable in actively quoted markets and reflect contractual terms of contracts. Northern Trust evaluated the impact of counterparty credit risk and its own credit risk on the valuation of derivative instruments. Factors considered included the likelihood of default by Northern Trust and its counterparties, the remaining maturities of the instruments, net exposures after giving effect to master netting agreements, available collateral, and other credit enhancements in determining the appropriate fair value of derivative instruments. The resulting valuation adjustments are not considered material.
2021 Annual Report | Northern Trust Corporation 67
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
As of December 31, 2021 and 2020, Northern Trust’s Level 3 liabilities consisted of swaps that Northern Trust entered into with the purchaser of 1.1 million and 1.0 million shares of Visa Inc. Class B common stock (Visa Class B common shares) previously held by Northern Trust and sold in June 2016 and 2015, respectively. Pursuant to the swaps, Northern Trust retains the risks associated with the ultimate conversion of the Visa Class B common shares into shares of Visa Inc. Class A common stock (Visa Class A common shares), such that the counterparty will be compensated for any dilutive adjustments to the conversion ratio and Northern Trust will be compensated for any anti-dilutive adjustments to the ratio. The swaps also require periodic payments from Northern Trust to the counterparty calculated by reference to the market price of Visa Class A common shares and a fixed rate of interest. The fair value of the swaps are determined using a discounted cash flow methodology. The significant unobservable inputs used in the fair value measurement are Northern Trust’s own assumptions about estimated changes in the conversion rate of the Visa Class B common shares into Visa Class A common shares, the date on which such conversion is expected to occur and the estimated growth rate of the Visa Class A common share price. See “Visa Class B Common Shares” under Note 26, “Commitments and Contingent Liabilities,” provided in Item 8, “Financial Statements and Supplementary Data,” for further information.
While Northern Trust believes its valuation methods for its assets and liabilities carried at fair value are appropriate and consistent with other market participants, the use of different methodologies or assumptions, particularly as applied to Level 3 assets, could have a material effect on the computation of their estimated fair values.
RECENT ACCOUNTING PRONOUNCEMENTS AND DEVELOPMENTS
In November 2021, the Financial Accounting Standards Board (FASB) issued ASU No. 2021-10, “Government Assistance (Topic 832): Disclosures by Business Entities about Government Assistance” (ASU 2021-10). The amendments in ASU 2021-10 require annual disclosures about transactions with a government that are accounted for by applying a grant or contribution accounting model by analogy to other accounting guidance within Topic 958, Not-for-Profit Entities, or International Accounting Standards 20, Accounting for Government Grants and Disclosure of Government Assistance. ASU 2021-10 is effective for interim and annual periods beginning after December 15, 2021, although early adoption is permitted. ASU 2020-10 is not expected to have a significant impact on Northern Trust’s consolidated financial condition or results of operations.
RISK MANAGEMENT