Northern Trust Has a Strong Wealth-Management Business but Expense Control Is Key 

Equity Analyst

Rajiv Bhatia

Northern Trust consists of two moaty segments: wealth management and a custody business known asset servicing (previously corporate and institutional services, or C&IS). Both segments are supported by the firm’s asset-management capabilities.

The asset servicing segment provides custody and ancillary services to assets owners and asset managers. With approximately $14 trillion in firmwide assets under custody or administration, Northern Trust is smaller than BNY Mellon and State Street, which each boast over $35 trillion in AUC/A. While the firm is smaller than some of its competitors, this segment still earns solid returns, and its segment operating margin is similar to that of its larger competitors. 

Northern Trust’s wealth-management business is focused on serving the needs of ultrawealthy clients. In particular, the global family office unit caters to clients with $200 million-plus in assets. Within the United States, Northern Trust’s wealth-management operations are well diversified across different regions. We believe that Northern Trust’s sterling reputation, entrenched position, and client inertia help insulate it from competition. Another advantage Northern Trust has is that its ultrawealthy clients tend to be conservative in asset allocation. Less than half of the segment’s AUM is invested in equities, with the remainder roughly split evenly between fixed-income securities and cash/other assets. 

Higher inflation has taken a toll on its expense initiatives. Noninterest expense as a percentage of noninterest income rose sharply after the financial crisis, reaching 102% in 2011. Through expense management, this dipped to 93% in 2020 and 89% in 2021. However, the equity and fixed income downturn coupled with inflation and hiring resulted in an elevated ratio (102%) in 2022.

Business Strategy & Outlook

We believe custody tends to be a wide-moat business, built on cost advantages and switching costs. Northern Trust currently services about $14 trillion in assets. Given the low basis points paid for custody services, we believe this is a business where scale matters. Technology is important to the custody banks. Both State Street and BNY Mellon spent over $2 billion on technology in 2019, and we estimate Northern Trust spent approximately $800 million in technology investments and capital expenditures. We believe these numbers are difficult to match for smaller firms. 

In addition to scale, we believe the clients of the custody banks face meaningful switching costs from process disruption, the interconnectedness of a clients’ workflows, and the custodian’s infrastructure as well as onboarding costs. As a result, Northern Trust’s clients tend to be sticky.

In the custody segment, we believe the hedge fund administration business is a lucrative business for Northern Trust. Given that hedge funds have high fees, they are less sensitive to the basis points paid for fund administration. In addition, in some cases, these fees are passed through to investors. Finally, during investor due diligence, switching fund administrators can invite additional scrutiny similar to that of switching an auditor. 

We believe Northern Trust’s wealth-management segment is also a wide-moat business. Northern Trust specifically caters to high-net-worth and ultra-high-net-worth customers, which can include family offices, business owners, executives, and other wealthy clients. Its global family office unit, for example, caters to clients with $200 million in assets or more. Although the switching costs might not be explicitly large, the benefits of switching from one private wealth manager to another are uncertain to clients. In contrast to a pure asset manager, clients are typically more focused on financial planning, estate planning, tax planning, and wealth preservation rather than beating the market. We believe private wealth operators with long histories of advising and managing money have developed strong intangible assets in their brands.

Wide

Economic Moat

Northern Trust

Northern Trust Corp. is a financial holding company, which engages in the provision of asset servicing, fund administration, asset management, fiduciary, and banking solutions for corporations, institutions, families, and individuals. It operates through the following segments: Corporate & Institutional Services and Wealth Management. The Corporate & Institutional Services Segment offers asset servicing, brokerage, banking and related services to corporate and public retirement funds, foundations, endowments, fund managers, insurance companies and sovereign wealth funds. The Wealth Management Segment includes 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. The company was founded in 1971 and is headquartered in Chicago, IL.

Earnings data Q2 2023

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Northern Trust Corporation (NTRS) Q1 2023 Earnings Call Transcript

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