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Northern Trust Corporation: A New Preferred Stock IPO In The New Normal ‘Below-5%’ Environment

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Introduction

Our goal is to present to you our IPO analysis for every new fixed-income security that enters the market and to find out if there is any trading potential. In this article, we want to shed light on the newest preferred stock issued by Northern Trust Corporation (NTRS). Even though the product may not be of interest to us and our financial objectives, it definitely is worth taking a look at.

The New Issue

Before we submerge into our brief analysis, here is a link to the 424B2 Filing by Northern Trust Corporation – the prospectus.

Source: SEC.gov

For a total of 16M shares issued, the total gross proceeds to the company are $400M. You can find some relevant information about the new preferred stock in the table below:

Source: Author’s spreadsheet

Northern Trust Corporation4.70%Series E Non-Cumulative Perpetual Preferred Stock (NASDAQ: NTRSO) pays a qualified fixed dividend at a rate of 4.70%. The new preferred stock has a ‘BBB-+ Standard & Poor’s rating and is callable as of 01/01/2025. Currently, the new issue is trading a little above its par value at a price of $25.26. This translates into a 4.65% Current Yield and Yield-to-Call.

Here is the product’s Yield-to-Call curve:

Source: Author’s spreadsheet

The Company

Northern Trust Corporation is a financial holding company. The Company provides asset servicing, fund administration, asset management, fiduciary and banking solutions for corporations, institutions, families and individuals across the world. Its segments include Corporate & Institutional Services (C&IS), Wealth Management, and Treasury and Other. The C&IS segment is a 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. The Wealth Management segment 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. It conducts its business through various subsidiaries.

Source: Reuters.com | Northern Trust Corporation

Below, you can see a price chart of the common stock, NTRS.

Source: Tradingview.com

The dividend of the common stock is constantly increasing, from $0.56 in 2000 to $1.94 in 2018 (even after the Great Recession in 2008, the company had managed to keep its current annual distribution unchanged for 4 years, until 2012). Also for 2019, NTRS is expected to have paid $2.60 yearly dividend. With a market price of $100.34, the current yield of NTRS is at 2.59%. As an absolute value, this means it pays $558.71M in dividends yearly. For comparison, the yearly dividend expenses for all outstanding preferred stocks (with the newly issued series E Preferred Stock) of the company are around $65.2M.

In addition, with a market capitalization of around $22B, NTRS is one of the largest ‘Asset Management’ companies in the US (according to FINVIZ).

Capital Structure

Below, you can see a snapshot of Northern Trust Corp’s capital structure as of its Quarterly Report in September 2019. You can also see how the capital structure evolved historically.

Source: Marketwatch.com | Company’s Balance Sheet

As of Q3 2019, NTRS had a total debt of $12.3B ranking senior to the newly issued preferred stock. The new Series E preferred shares rank junior to all outstanding debt and equal to the other outstanding preferred stocks of the company totaling $882M.

The Ratios Which We Should Care About

Our purpose today is not to make an investment decision regarding the common stock of NTRS but to find out if its new preferred stock has the need quality to be part of our portfolio. Here is the moment where I want to remind you of two important aspects of the preferred stocks compared to the common stocks.

  • Preferred shareholders have priority over a company’s income, meaning they are paid dividends before common shareholders.
  • Common stockholders are last in line when it comes to company assets, which means they will be paid out after creditors, bondholders, and preferred shareholders.

Based on our research and experience, these are the most important metrics we use when comparing preferred stocks:

  • Market Cap/(Long-term debt + Preferreds) – This is our main criteria when determining credit risk. The bigger the ratio, the safer the preferred. Based on the latest annual report and taking into consideration the latest preferred issue, we have a ratio of 22,000/(12,300 + 1,282) = 1.62, which is a excellent number for all creditors of the company, indicating the company is very well leveraged.
  • Earnings/(Debt and Preferred Payments) – This is also quite easy to understand approach. One can use EBITDA instead of earnings, but we prefer to have our buffer in what is left to the common stockholder. The higher this ratio, the better. The ratio with the TTM results is 1,466/(314 + 65) = 3.87 which indicates that there is a solid buffer for the bondholders and preferred stockholders, and they no need to worry about the payments.

The Northern Trust Corp Family

NTRS has four more outstanding preferred stocks:

  • Northern Trust Corp Series A Junior Participating Preferred Stock,
  • Northern Trust Corp Fixed Rate Cumulative Perpetual Preferred Stock, Series B,
  • Northern Trust Corp 5.85% Series C Non-Cumulative Perpetual Preferred Stock (NTRSP), and
  • Northern Trust Corp Series D Non-Cumulative Perpetual Preferred Stock,

only one of which is listed on the National Exchange, the Series C Preferred Stock.

Source: Author’s spreadsheet

However, the company uses the proceeds of the newly issued Series E Preferred Stock to redeem the Series C one (NASDAQ:NTRSP). Although, in the following chart, you can see a comparison between NTRSP and the fixed-income securities benchmark, the iShares Preferred and Income Securities ETF (PFF). What we see is a more sustainable behavior during the last year’s mini-crisis that continues as a less volatile performance thereafter, mainly due to the upcoming call date of the preferred stock and the high probability of redemption.

Source: Tradingview.com

Furthermore, there are 10 Corporate Bonds issued by the company:

Source: FINRA

For my comparison, I choose the bond that matures closest to the call date of NTRSO, the 2025 Corporate Bond.

Source: FINRA | NTRS4065678

NTRS4065678, as it is the FINRA ticker, is rated an ‘A’ and has a yield-to-maturity of 2.379%. This should be compared to the 4.65% yield-to-call of NTRSO, but when making that comparison, remember that NTRSO’s YTC is the maximum you could realize if you hold the preferred stock until 2025. The result is a yield spread of 2.3% between the two securities. This yield margin can be justified by the higher rank in the capital structure and the higher credit rating of the bond.

Sector Comparison

The charts below contain all preferred stocks and units in the ‘Asset Management’ sector (according to Finviz.com) that pay a fixed rate distribution:

  • By Yield-to-Call and Current Yield

Source: Author’s database

The upper right stock is the one the highest YTC and the highest CY at the same time. In this case, it is RILYP, but it is very far from the quality of the rest of the group securities. It is the only that is not rated from any of the big three rating agencies, while the rest of the group carries an investment-grade rating. ECF-A that is not rated by Standart&Poor’s, is still rated by Moody’s an “A1” that is an analog for “A+” by S&P.

  • By Years-to-Call and Yield-to-Call

To see the real Yield curve of these securities, we’ll have to exclude the negative YTC securities:

Source: Author’s database

  • Here is the full list:

Source: Author’s database

All ‘BBB+’ Preferred Stocks

This section contains all preferred stocks that pay a fixed dividend rate, have a par value of $25, a ‘BBB+’ Standard & Poor’s rating, and positive Yield-to-Call. The first chart is presented by Yield-to-Call and Current Yield of the securities.

Source: Author’s database

To see how the real Yield curve of these securities looks, we’ll have to include two more conditions: the preferred stocks don’t have to be callable and have to trade above par value. The next chart will present the BBB+ preferred stocks by their Years-to-Call and Yield-to-Call:

Source: Author’s database

Special Optional Redemption

The Series E Preferred Stock may be redeemed at our option in whole, but not in part, including prior to January 1, 2025, upon the occurrence of a “regulatory capital treatment event,” as described under “Description of Series E Preferred Stock — Redemption,” at a redemption price equal to $25,000 per share (equivalent to $25 per depositary share), plus any declared and unpaid dividends, without accumulation of any undeclared dividends. If we redeem the Series E Preferred Stock, the depositary will redeem a proportionate number of depositary shares.

Source: 424B5 Filing by Northern Trust Corporation

Addition to the iShares Preferred and Income Securities ETF

With the current market capitalization of the new issue of around $400M, NTRSO is a possible addition to the S&P US Preferred Stock iShares Index during some of the next rebalancings. If so, it will also be included in the holdings of the main benchmark, PFF, which is the ETF that seeks to track the investment results of this index, and which is important to us due to its influence on the behavior of all fixed-income securities. I’ll just remind you about the last year rally in the fixed-income borne from the redemption of the two “giants” HSEA and HSEB and the released cash of over $600M used from PFF to buy more of the rest of its holdings.

Conclusion

As fixed-income traders, we follow every one preferred stock or baby bond, which is listed on the stock exchange. As such, NTRSO is no exception, and the homework we always do we share it with the public. It is not necessary for the IPO to be an arbitrage and a bargain, but in many cases, the new security happens to be better than the ones already trading on the market.

The company has good financials in terms of fixed income investors, having 1.6x times more equity than liabilities and is paying 8.5x times more dividends on its common stock than all of its outstanding preferred stocks that are standing above in the capital structure. So, here the credit risk is absolutely out of the table. Despite its lower nominal yield, NTRSO has one of the highest YTW when compared to the other investment-grade preferred stocks and units in the sector. The same is also observed in comparison with all other BBB+ preferred stocks. However, its current yield is the lowest both in the sector and also with those that have the same rating of “BBB+” as the new IPO. The newly issued preferred stock is one of nine issues that brake the 5% nominal yield mark for the past 3 months, something that had only happened once for the last 3 years (GDL-C in March 2018). Moreover, refinancing at a rate of 4.70% hasn’t happened since 2013 (if we don’t count SPE-B that is slightly different from the regular preferred stocks), when ELU and GEK were issued, both baby bonds. Despite, it has the highest YTW from its peers, I don’t find the new issue attractive at all as despite we are entering a lowe rate environment, it is still the most interest-sensitive. Overall, I don’t see any potential here.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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