Banks earn profits by obtaining funds at short-term interest rates and lending at higher long-term rates. That traditional business model is currently challenged by the relatively small spread between prevailing short- and long-term rates, a situation represented by a flat yield curve. Indeed, the difficult interest rate environment was identified as one reason that North Fork Bank
Net interest income -- the difference between a bank's interest income and interest expense -- accounts for a relatively modest 25% of revenue at Northern Trust
Northern Trust was founded in Chicago in 1889 to help invest and manage the wealth of some of the city's new business leaders. The company has extended its private banking services nationwide and boasts that more than 20% of the Forbes' list's 400 richest families are clients of the firm. Of course, the firm's client base also includes many of the merely well-off -- those with investable assets of at least $1 million. Northern Trust eagerly reminds investors that this affluent segment is projected to grow eight times faster than the overall U.S. population over the next five years.
Most of Northern Trust's income comes from trust fees related to investment management, administration, and custody of client assets. The personal financial services segment accounts for about half of the trust fees earned, and a corporate and institutional business segment generates the other half. Unlike interest income, fee income tends to be stable over time and does not contain the credit risk associated with a large lending franchise. Northern Trust currently has more than $600 billion in assets under management and nearly $3 trillion in lower-margin assets under custody, ranking it with State Street
Northern Trust has been expanding abroad through acquisitions of institutional investment managers, and the strategy has contributed to a strong revenue growth trend. Only a market correction is likely to interrupt Northern Trust's growth, and management estimates that a 10% market decline would likely have only a corresponding 2% effect on trust fees. With EPS growth in the mid-teens and a 20 times P/E multiple, shares of Northern Trust seem fairly valued for a company with such a low-risk profile.
Since Northern Trust does not offer the types of services normally associated with banks, such as credit cards and other retail banking products, it resembles a traditional bank largely in name only. But given the uncertainty surrounding both the direction of the yield curve and the banking industry's credit risk, Northern Trust's private banking and custody focus might make the shares an excellent way to diversify a portfolio's other financial services holdings.
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