These stated results equated to a 9.18% return on average equity (ROE) in 2Q'14, compared to 9.28% in the sequential quarter and 10.2% in the year-ago quarter. Fitch continues to note that these results remain satisfactory from a credit perspective, but below the company's long-term averages and Fitch's estimate of Northern's long-term cost of equity.
Northern's total revenue was up 4% versus to the sequential quarter and 6% relative to the year-ago quarter as growth in fee income from higher equity markets globally and some new business wins were offset by continued weakness in market-based revenue such as foreign exchange (FX) trading and securities lending income. Fitch had expected this given still strong equity markets and very low volatility in foreign exchange markets.
The company's expenses for 2Q'14 climbed 6% sequentially and 11% from the year-ago quarter, indicating some negative operating leverage in both periods. The higher level of expenses has been primarily driven by higher compensation expense and increased technology expense. As a result, Fitch is not overly surprised by the pre-tax charge noted above, since as long as the interest rate environment remains low Northern may have to become more aggressive in managing its expense base.
Northern's net interest income (NII) remains a key component of the company's earnings profile at 23% of overall revenue in 2Q'14. Given the company's conservative posture and short balance sheet duration, the company's net interest margin (NIM) declined to 1.04% in 2Q'14. This is largely due to incremental deposit balances being placed at the Federal Reserve, which earn a mere 25 basis points.
Fitch believes that in a rising short-term interest rate environment, whenever that may occur, Northern's NII has the potential to expand significantly and therefore drive earnings growth. In this type of scenario NII should become a much bigger piece of the overall revenue profile as well.
Fitch continues to view Northern's credit quality as sound, but does note that credit metrics are likely at a cyclical trough. Over time, Fitch would expect some reversion in these metrics but given Northern's conservative underwriting, would expect its credit metrics to remain well below industry averages.
Fitch continues to view Northern's funding profile and capitalization as sound. Deposits now constitute 67% of Northern's total liabilities and the company's Basel III Tier 1 common equity ratio under both the standardized and advanced approach was 12.7% at 2Q'14. Fitch views this strong capital position, combined with the company's relative low risk balance sheet, as key differentiators that support Northern's high ratings.
Additional information is available at www.fitchratings.com
Source: Fitch Ratings
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