Northern Trust Corp (NTRS) 2008 Q1 法說會逐字稿

Good day everyone and welcome to the Northern Trust Corporation's first quarter 2008 earnings conference call. Today's call is being recorded.

At this time, I would like to turn the call over to the Director of Investor Relations, Ms. Bev Fleming for opening remarks and introductions. Please go ahead, Ms. Fleming.

Thank you. Welcome to Northern Trust Corporation's first quarter 2008 earnings conference call. Whether you are participating in today's conference live, or via replay, we appreciate the time you are taking to listen to Northern Trust's first quarter 2008 financial results. Joining me on our call this morning are Steve Fradkin, Northern Trust's Chief Financial Officer, Aileen Blake, Controller, and Preeti Sullivan from our Investor Relations team.

For those of you who did not receive our first quarter earnings press release or financial trends report via e-mail this morning, they are both available on our website at NorthernTrust.com. In addition, this April 15th call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through April 22nd. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now for our Safe Harbor statement. What we say during today's conference call may include forward-looking statements, which are Northern Trust's current estimates or expectations of future events or future results. Actual results of course could differ materially from those indicated by these statements because the realization of those results is subject to many risks and uncertainties. I urge you to read our 2007 financial Annual Report, and our periodic reports to the SEC, for detailed information about factors that could affect actual results. Again thank you for your time today.

Let me now turn the call over to Steve Fradkin.

Well thank you Bev, and good morning everyone. Let me extend my welcome to all of you listening to Northern Trust Corporation's first quarter 2008 earnings conference call. Earlier this morning Northern Trust announced first quarter reported net income of $385 million, and reported earnings per share of $1.71. Our first quarter reported results include two items related to our membership in Visa USA. The first item is a $168 million pretax gain related to Visa's March Initial Public Offering.

This gain which is accounted for on the Other Operating income line of our income statement represents the mandatory redemption under Visa's Certificate of Incorporation, of a portion approximately 4 million shares of our ownership in Visa. On an after-tax basis the gain equaled approximately $105 million. Our remaining Visa ownership of 6.2 million Class B shares is at the present time equivalent to approximately 4.4 million Class A shares. We anticipate further dilution of the Class B shares, as matters progress related to Visa's indemnified litigation.

The second item related to our Visa ownership is a $76 million pretax reduction in expense. This expense reduction reflected in the Other Operating expense line of our income statement, equaled approximately $48 million on an after-tax basis. In connection with the IPO, Visa set aside $3 billion of the IPO proceeds in a litigation escrow account. Our proportionate share of the escrow account equals $76 million, and is reflected in this quarter's income statement as a reduction in expense.

Recall that in our results last quarter we took a $150 million charge associated with our ownership in Visa. This charge represented our estimated portion of potential losses arising from certain litigation in which Visa is involved, and for which we and other Visa members have provided indemnification. This quarter's $76 million pretax reduction in expense, represents a reversal of approximately half of the $150 million charge we took in the fourth quarter of 2007.

As we indicated at that time, we did expect that our proceeds from Visa's IPO would more than offset any liabilities related to the Visa litigation. We continue to maintain a $74 million Visa indemnification reserve on our balance sheet. The aggregate impact of these two Visa related items benefited pretax income by $244 million. The net after tax benefit of these two Visa related items equaled $154 million, or $0.68 per share in the first quarter.

Excluding the benefit of the IPO, Northern Trust reported record operating per share equal to $1.03 in the first quarter, representing a very strong increase of 23% compared to the $0.84that we reported in the first quarter of 2007. Operating net income also equaled a quarterly record of $232 million, representing an increase of 24% year-over-year. This was our 13th consecutive quarter of double-digit year-over-year growth in operating earnings per share, and our 12th consecutive quarter of double-digit year-over-year growth in operating net income.

Our operating performance in the first quarter of 2008, met all four of our long term across cycle strategic financial targets. For the quarter we achieved strong revenue growth of 19%, almost 250 basis points of positive operating leverage, 23% growth in operating earnings per share, and an operating return on equity of 19.85%.

We have organized our conference call today into four sections. First I will briefly offer a few market-related perspectives on the environment we encountered during the quarter, and how it impacted our results. Second, for the benefit of those of you who maintain detailed models on Northern Trust, I will outline four items that you should consider as you evaluate our operating results this quarter. Third, I will review the quarters financial performance focusing on those items that most impacted our results, and finally, I will offer a few strategic perspectives on developments during the first quarter for each of our businesses. As always, Bev and I will then be pleased to answer your questions.

Let me begin with the perspective on the financial markets. Once again the markets in the first quarter of 2008 experienced a variety of dislocations, as the crisis in the credit markets deepened in the first quarter. Following similar market turmoil in the second half of 2007, uncertainty led to volatility and equity market declines.

At Northern Trust, we have a strong business model with diversified sources of revenue. Some of our revenue line items, notably foreign exchange trading and net interest income, benefited from the market conditions and from actions that the Federal Reserve Bank undertook in the first quarter. Currency, volatility, and related client volumes provided attractive opportunities in foreign exchange. While spread income benefited from the Fed's 200 basis point reduction in the Fed funds rate during the quarter.

Other revenue line items on the other hand were adversely impacted by market conditions. Trust investment and other servicing fees in particular were hurt by both lower equity markets and the impact of negative marks in one mark to market investment fund. As our call progresses this morning, I will provide you with detail and perspective on each of these revenue line items. But I think it is important to note at the outset of today's call, that market conditions in the first quarter both helped and hindered revenue growth, as I am sure you would expect in this tumultuous environment.

As you analyze our first quarter financial performance, I want to draw your attention to four items that impacted our reported results. These are in addition to the Visa matter that I already discussed. First, in the quarter we recorded a gain of $4.9 million on certain credit default swap contracts, that is we use to mitigate risks, credit risks, associated with specific commercial loans. We have made use of credit default swaps as a regular part of our risk management discipline, and the value of the swaps has been mark to market each quarter. However, the gain which is reflected on our income statement in the other operating income line item was larger than normal, and so I want to draw it to your attention.

Second, in the first quarter Northern Trust recorded a gain of $4.9 million on the sale of our remaining shares of CME Group, which is the parent company of the Chicago Mercantile Exchange. The gain on the sale of these shares is shown on our income statement in the Investment Security transactions line.

Third, the other operating expense line item includes $8.7 million worth of expense, which represents the fair value of our liability related to the capital support agreements that we entered into on February 21st, to support certain cash funds that invest in the Whistlejacket structured investment vehicle.

I should add that no capital contributions were made to any of the funds as of March 31st. The $8.7 million of expense represents a mark to market of the fair value of our liability under the capital support agreements, in accordance with Financial Accounting Standards Board Statement Number 133. In line with this Accounting Standard, we will continue to mark to market the fair value of our capital support agreements each quarter, until those agreements expire.

And fourth, we recorded a tax benefit of $5 million related to our decision to indefinitely reinvest outside the United States, the prior earnings of two subsidiaries not previously included in our past APB Opinion Number 23 elections. While we have had an on-going quarterly benefit associated with APB 23 since the fourth quarter of 2006, the first quarter 2008 benefit was incrementally higher by $5 million, as a result of the inclusion of these additional subsidiaries.

With that background, let me review the first quarter's key performance drivers. My comments that follow will be on an operating basis, exclusive of the two Visa related items that impacted both revenue and expense. I will start with revenues focusing on the major items that impacted our results. We are very pleased with our top line performance in the first quarter of 2008, particularly given the backdrop of an on-going turbulent macro economic environment.

Operating revenues in the first quarter equaled $978 million, up an exceptionally strong 19%, or $154 million, compared to last year's first quarter. Operating revenues grew 1%, or $5 million, on a sequential quarter basis. The key line items that contributed to our revenue growth this quarter were trust investment and other servicing fees, foreign exchange trading income, and net interest income. Trust investment and other servicing fees increased 8% year-over-year, or $38 million to $527 million.

Within this line item, PFS Trust investment and other servicing fees equaled $228 million in the first quarter, representing an increase of 6%, or $14 million year-over-year. PFS fee growth is driven in part by our ability to retain and grow our business with existing personal clients, while at the same time winning new clients to PFS. First quarter net new business in PFS was very strong, representing our best quarter since the fourth quarter of 2006.

We are very gratified to have started the new year in PFS with strong levels of gross new business in the quarter. Combined with our lowest level of distributed business since the second quarter of 2003. Offsetting our strong new business however, was a weaker equity market environment. Our PFS states which represented 85% of our total PFS fees in 2007, earned fees primarily via a methodology that lags current markets by one month. Based upon this methodology, the S&P 500 declined 2% for the purposes of our first quarter fees, which resulted in a headwind to PFS fee growth.

On a sequential quarter basis, PFS fees declined 2%, or $4 million. The positive impact of strong net new business in the first quarter was more than offset by weak equity markets. The S&P 500 was down 8.3% using our PFS month lag fee methodology, constituting a considerable headwind for PFS fees on a sequential quarter basis. Fees in PFS are derived from the assets that we manage, or custody for personal clients.

PFS asset aggregation in the first quarter was strong as evidenced by our healthy new business results. PFS assets under management equaled $146 billion at quarter end, up 5%, or $7 billion from a year ago. Assets under custody in PFS equaled $322 billion on March 31, up 8%, or $25 billion year-over-year.

In considering the single digit year-over-year growth rates, it is important to note the backdrop of a tough market environment, which saw a 6.9% decline in the S&P 500 year-over-year. On sequential quarter basis, PFS assets were down 2%, or $2 billion, and PFS assets under custody were down 3%, or $10 billion since year end. Again, when compared with the decline of 9.9% in the S&P 500 during the first quarter, our performance on a relative basis reflects the strong net new business results that I mentioned earlier.

Switching to our Institutional business, C&IS Trust Investment and other servicing fees equaled $298 million in the first quarter, an increase of 9%, or $24 million year-over-year. C&IS fees include three primary revenue areas, custody and funded administration, institutional asset management, and security lending. Let me discuss the performance of each in the first quarter. C&IS custody and fund administration fees equaled a record $175 million in the first quarter, up 24%, or $34 million year-over-year.

This strong double-digit custody and fund administration fee growth was driven by excellent new business, particularly in global custody, and by higher transaction volumes during the quarter. As with our fees and PFS, the market environment influences our C&IS fee growth. Recall that C&IS custody fees are built primarily on a one quarter lag basis. Thus our 24% year-over-year growth in custody fees was supported albeit modestly, by equity market growth as evidenced by the 3.5% quarter lag growth in the S&P 500, and the 1.2% growth in the EFA index.

On a sequential quarter basis, C&IS custody fees increased 4%, or $7 million, as the impact of new business and currency rates, more than offset the challenging equity market environment. Recall that on a quarter lag sequential quarter basis the S&P 500 was down 3.8%, and the EFA index was down 3.2%. An important contributor to C&IS custody fees is our ability to successfully aggregate client assets.

Institutional assets under custody equaled $3.7 trillion at quarter end, up 6%, or $203 billion from a year ago, yet down 4%, or $143 billion versus last quarter. The sequential quarter decline reflects the quarter's lower equity market values, as the S&P 500 fell 9.9% in the quarter, and the EFA Index fell 15.5%. International growth continued to be the key factor driving overall C&IS custody asset growth in the first quarter.

Global custody assets equaled $2 trillion on March 31st, up 12%, or $222 billion year-over-year, as compared with the 16.9% decrease in the EFA Index in the same period. On a sequential quarter basis, global custody assets declined 4%, or $78 billion, reflecting lower equity markets, as evidenced by a sequential quarter decline of 15% in the EFA Index.

Investment management fees in C&IS equaled $75 million in the first quarter, an increase of 4%, or $3 million year-over-year. Growth was driven entirely by new business, which more than offset the downdraft of the broader market environment. New business results were strong in our Manager of Managers, Quantitative Management, and Short Duration Assignments.

On a sequential quarter basis, C&IS investment management fees were essentially flat at $75 million, reflecting good new business trends, offset by lower equity markets. Managed assets for institutional clients equaled a record $633 billion at quarter end, up 3%, or $16 billion, compared with one year ago, and up 4%, or $24 billion sequentially. Managed assets held up very well in this difficult market environment, as new business transitions more than offset the headwind from the lower equity markets.

C&IS securities lending fees equaled $32 million in the first quarter, representing a decrease of 30%, or $14 million compared with last year's first quarter, and a decrease of 42%, or $23 million, compared with the fourth quarter of 2007. Securities lending collateral equaled $267 billion at quarter end, down 10%, or $30 billion versus one year ago, and down 1%, or $2 billion compared with December 31. The year-over-year decline reflects the deleveraging phenomenon that occurred during the second half of 2007, as well as lower equity market values.

As we did in the third and fourth quarters of last year, let me pause for a minute and provide some prospecting around our Securities Lending results in the first quarter. Similar to our experience in the second half of last year, our Securities Lending results in the first quarter were adversely impacted by the on-going disruption in the credit environment, particularly during the month of March.

It is important to note however that there were very positive offsets in our Securities Lending business during the first quarter, including strong demand for Treasury Securities, and the Federal Reserve's continued easing of the Federal Funds rate by 300 basis points since September of 2007. This noted, the unusually high level of credit market dislocation, once again negatively impacted the returns achieved in the one mark to market cash collateral investment fund used for Securities Lending.

As of March 31, approximately 5% of our $267 billion in Securities Lending cash collateral, was invested in our client selection and direction in this total return short duration Fixed Income Fund. As I mentioned last quarter, this is our only meaningful fund that is structured as a mark to market fund, and understanding this designation is essential to understanding the impact during the first quarter, just as occurred in the third and fourth quarters of 2007.

The consequences of being a mark to market fund during the first quarter of 2008 were again severe. Even more severe than what was experienced in the second half of 2007. Pricing pressure on Fixed Income securities continue. Asset value changes, in this case asset value markdowns, flowed directly through to the total return of this fund, thus impacting the earnings of a small number of securities lending clients and Northern Trust Securities Lending fees as well.

While the environment was a challenging one for this fund in particular, and therefore for our overall Securities Lending revenues, I want to remind you of a few key points that we discussed with you last quarter in our last quarter's conference call. First, this mark to market fund has followed it's investment guidelines consistently and appropriately. No atypical portfolio management decisions were made in the fund, prior to, during, or after quarter end.

Second the fund does not use leverage. Third, the fund has a very high quality profile, 65% of the securities held in it, are either rated AAA or AA. Fourth, the fund is conservatively managed with an interest rate sensitivity of 49 days, and a credit based weighted average maturity of 1.63 years as of March 31. Fifth, the first quarter total return of the fund reflected negative returns on a broad base of holdings.

There does not exist at this time any permanent impairment of any holdings. All of the asset markdowns recorded in the fund during the first quarter are unrealized. We expect given what we know at this time, that all of the funds holdings will mature at par. Because we expect all of the funds holding to mature at par, no actions have been taken to sell all, or a portion of any holdings, that have mark to market losses.

Any future positive marks will be reflected in the yield on the fund, and in the result in Securities Lending revenues reported by Northern Trust. And lastly, the fund is used as Securities Lending cash collateral option by only a small number, approximately 10, of our clients. None of these clients uses this mark to market fund exclusively for their collateral investments. All have other less aggressive funds, to round out their total collateral investments.

As I did in the last two quarters, let me end this discussion of our Securities Lending performance by providing you with a perspective on what our results would have been, had this collateral been invested in our most commonly used Securities Lending collateral fund. This comparison illustrates the magnitude of the impact that mark to market accounting can have in the current environment.

Again for the purposes of illustration, our Securities Lending results in the first quarter, would have been $93 million higher, than the $32 million fee amount that we reported, had the clients in the mark to market fund, been invested in our most commonly used pool. Therefore, we would have reported year-over-year fee growth in Securities Lending of 174%, as opposed to our actual reported decline of 30%.

Let me now shift the discussion to our other key revenue line items, starting with net interest income, which accounted for 27% of revenues in the first quarter. As you analyze our net interest income performance, please note that effective this quarter custody related deposit and overdraft amounts previously included within other operating income, are now included within net interest income. The prior periods have been restated in our earnings press release and financial trends report. This reclassification was made to better align interest income from custody client overdraft and interest expense from sub custodian charges, with their related balance sheet classification.

Net interest income equaled a record $266 million, an increase of 24%, or $52 million compared with last year. The year-over-year increase in net interest income was attributable to a higher level of earning assets, and an 8 basis point increase in the net interest margin.

On a sequential quarter basis, net interest income increased a strong 5%, or $14 million, primarily driven by earning asset growth. Average earning assets equaled $60 billion in the first quarter, an increase of 17%, or $9 billion year-over-year, and 6%, or $3 billion sequentially.

Our balance sheet growth remains liability driven which in turn drives this strong growth in earning assets. Non-U.S. office time deposits continue to be the fastest growing liability on our balance sheet, averaging $34 billion in the first quarter, up 24%, or $7 billion versus last year, and up 8%, or $3 billion sequentially. This strong growth in non-U.S. office time deposits, is directly related to our international success in the institutional custody business, which I described earlier.

Our net interest margin in the first quarter equaled 1.79%, up 8 basis points from the prior year, and flat sequentially. The year-over-year increase in the net interest margin was driven by wider spreads between overnight rates, and one to three month rates, primarily driven by the 300 basis points of Fed rate cuts since September. The final significant contributor to revenue growth in the first quarter was foreign exchange trading income, which equaled a record $113 million, up 68%, or $46 million compared with the first quarter of 2007.

On a sequential quarter basis, foreign exchange trading income increased 2%, or $2 million. The key drivers of our quarterly results in foreign exchange were volume and volatility. Both remain very high in the first quarter, due in part to the continued disruption in the financial markets. Credit quality remained exceptionally strong at quarter end, with nonperforming assets equal to only $36 million, down $1 million, or 3% from a year ago.

Nonperforming assets increased on a sequential quarter basis by $6 million, reflecting the addition of three small loans to nonperforming status, offset by the payoff of one nonperforming loan. Nonperforming assets equaled only 13 basis points of total loans at quarter end. During the first quarter we recorded a loan loss provision of $20 million, compared with no provision in the first quarter of last year, and an $8 million provision in the fourth quarter of 2007.

Approximately 40% of the $20 million provision reflects strong commercial loan growth this quarter. Another 30% of the provision reflects our decision to increase the credit loss reserve, to reflect the weakening economic environment. The remainder reflects current quarter net charge-offs of $2.4 million, and a credit rating downgrade on two additional exposures.

Now let me shift my comments to a review of the key expense categories that impacted our first quarter performance. Expenses during the first quarter of 2008 equaled $535 million, which includes the Visa-related expense reduction that I mentioned earlier. Excluding that item expenses equaled $611 million, representing an increase of 16%, or $86 million from the year ago quarter.

On a sequential quarter basis excluding expenses were down 3%, or $21 million. Compensation expense equaled $286 million, and increased 17%, or $41 million from the year ago period. Approximately 40% of the year-over-year increase in compensation expense reflects higher staffing levels, to accommodation growth and expansion.

Staffing levels equaled approximately 11,300 full time equivalent positions at quarter end, up 14% year-over-year. Our office in Bangalore India now employs approximately 850 staff members, up from approximately 350 one year ago. The second largest contributor to the increased level of compensation expense year-over-year, was higher incentive compensation, due to better corporate performance.

On a sequential quarter basis, circumstances compensation expense increased 1%, or $4 million, primarily reflecting higher staff levels and equity-based incentives, offset partially by lower current year cash-based incentives, as compared with the fourth quarter's true-up, to reflect that year's corporate performance.

Employee benefit expenses equaled $57 million in the first quarter, up 1%, or $1 million versus last year, and down 8%, or $5 million sequentially. The modest year-over-year increase and the sequential decline primarily reflect lower pension expense. Outside services equaled $94 million, an increase of 12%, or $10 million compared with last year, and a decrease of 14%, or $15 million sequentially. The year-over-year increase primarily reflects higher consultant, legal and technical expenses, as well as an increase in volume-related global sub custodian fees.

The sequential quarter decline reflects lower consultant, depository, and sub custodian fees. Equipment and software related expense equalled $54 million in the first quarter, up 6%, or $3 million year-over-year, and down 8%, or $5 million sequentially. The year-over-year increase is primarily attributable to higher software amortization, resulting from continued investment in technology. The sequential decline represents the typical annual pattern, where the expense associated with the depreciation and amortization of equipment and capitalized software is typically lower in the first half of the year, compared to the second half.

Other Operating expense excluding the Visa-related benefit equaled $78 million, an increase of 52%, or $27 million compared with last year. On a sequential quarter basis, Other Operating expense decreased 4%, or $3 million. The year-over-year increase of $27 million was driven primarily by three factors, business promotion and advertising expenses associated with the Northern Trust Open Golf Tournament, the previously discussed $8.7 million charge associated with the capital support agreements, and higher year-over-year charges associated with securities processing activities. The sequential quarter decline reflects lower charges associated with securities processing activities, offset by the charge related to the capital support agreements, and higher business promotion and advertising.

Our reported provision for income taxes in the first quarter equaled $193 million, resulting in a reported effective tax rate equal to 33.4%. On an operating basis, excluding the two previously discussed Visa benefits, our provision for taxes equaled $102 million, resulting in an operating effective tax rate of 30.6%. This compares to a tax rate of 33.9% in the first quarter of last year. The lower tax rate on a year-over-year basis reflects the on-going benefit of earnings generated in tax jurisdictions outside the United States, with more favorable tax rates.

Recall too from my earlier comments that the first quarter included a nonrecurring tax benefit of $5 million, related to our decision to indefinitely reinvest outside the United States the prior year earnings of two non-U.S. subsidiaries.

Northern Trust repurchased 911,000 shares of common stock in the first quarter at a cost of $64 million. Diluted shares averaged 224.8 million. We can purchase an additional 7.8 million shares under a buyback authorization approved by our Board of Directors in October of 2006. In keeping with our practice, we increased average common equity by 17% versus one year ago, to a record $4.6 billion at quarter end. This performance represented our 80th consecutive quarter of increasing common equity, which equates to 20 consecutive years.

Let me close with a few perspectives on some of our overarching developments in the first quarter related to each of our major lines of business. In Personal Financial Services, we were very pleased to report strong net new business in the first quarter, especially given the backdrop of the challenging economic environment. We saw clear indications in the first quarter across the breath of our private client franchise of a flight to quality, as both clients and prospects sought out the expertise and hallmark financial stability, that Northern Trust has demonstrated for more than a century.

Consistent with that expertise, in January we published our Third Annual 'Wealth in America' report, which focused on issues facing U.S. high net worth households, as drawn from a national survey conducted by Northern Trust. Our Annual 'Wealth in America' report, is but one example of the leadership position that Northern Trust has established in the affluent marketplace, and further underscores our understanding of the trends that will impact this business in the future.

In C&IS, we were also gratified to report a strong quarter of new business results. In fact, just yesterday, we announced that Northern Trust was named as global custodian for $11 billion in assets for the Employees Retirement System of the state of Hawaii. Earlier in April we announced we had been chosen by Handelsbanken, as global custodian for their clients in Norway, Denmark, and Finland, which brought us an addition $15 billion in new client assets under custody from the Nordic region.

And in March we were pleased to report that Lincoln Financial Group selected Northern Trust as custodian for it's defined benefit retirement plan totaling $1.1 billion in plan assets. We also announced several new leadership moves in C&IS reflecting both the outstanding talent that we cultivate within Northern Trust, and our focus on attracting top talent from outside our organization.

Bif Bowman, a 23-year veteran of Northern Trust was named Region Executive for our important and growing business in Europe, the Middle East, and Africa. Paul Cutts, a 15-year employee, relocated from Amsterdam, to our new office in Melbourne Australia, where he lead our efforts in that growth region of the world. And Jon Dunham joined us from one of our competitors, as Head of North American Sales. These leadership changes in C&IS serve to further strengthen our positioning globally in the Institutional Custody business.

In Northern Trust Global Investments, our asset management business, Steve Potter was named President in late March. Steve who was already a member of the corporation's Management Committee, had previously led our highly successful International business in C&IS. Prior to moving to London in 2001, Steve led the Institutional group within Northern Trust Global Investments.

He takes over leadership of NTGI at an exciting time, given our strong new business results and exciting new product initiatives, such as our recent launch of a unique series of International Exchange Traded Funds, and introduction of the Northern Global Sustainability Index Fund. A fund that responds to the growing demand for socially responsible investment products.

In closing, it was a record quarter with strong double-digit growth in EPS and net income, accomplished against a challenging environment backdrop. Our accumulation of client assets which represent one indicator of our success in maintaining and building the client franchise, again was strong relative to the environment. Revenue growth, particularly M&A and from foreign exchange and net interest income was outstanding, as was new business across approximate PFS and C&IS.

And while our results in the quarter benefited on the margin from the CME share gain, positive marks on certain credit default swaps, and a one-time benefit in our tax provision, we also had to navigate through significant negative marks in one Securities Lending collateral fund, the fair value expense impact of the capital support agreements, with the length of the Whistlejacket SIV, first-year expense of the Northern Trust Open, and a higher provision for credit losses.

All said, we are very pleased with our results in the quarter. Before I conclude I want to point out that our Annual Shareholders Meeting begins at 10:30 Central Time this morning, and os customary with our first quarter calls, I will need to end today's call, allowing sufficient time for all of us to get to the Annual Meeting. Accordingly, please accept my apologies in advance, in the event we have to close off the question-and-answer session, earlier than we would otherwise normally do.

Now Bev and I would be pleased to answer your questions. Abe, please open the call for questions.

Thank you, Mr. Fradkin. (OPERATOR INSTRUCTIONS). We will go first to Mark Fitzgibbon at Sandler O'Neill. Please go ahead.

Good morning, thanks for taking my question Steve. The balance sheet grew by about $10 billion from the linked quarter, which I believe you pointed out was driven by foreign office time deposits, I wonder if you could talk to us about how you are pricing these deposits. I know it is part of a whole relationship What sort of hurdle rates of return you are looking for, and give us a sense for maybe how large a component of liabilities you would be willing to let foreign office time deposits become?

I think, Mark, I don't know that I can answer all of your questions directly. But I think a couple of key things are important to remember. One, that really is an outgrowth of the growth in our Global Custody business. So it is closely linked, and obviously at any given point our clients have more or less cash, but that is an important component of the driver.

Two, those are market competitive rates in the sense that the market is dynamic, it moves around. But these are large sophisticated institutional investors. If we can't be competitive, we will not be able to attract those deposits.

So I would say that the spreads on those will move around in tandem with market conditions. But we do have to price those competitively. They are not viewed as compensating balances might be in some other businesses. And we haven't put any limits on the growth. As I say, it is an important part of what we do for our clients and we monitor it carefully, but we don't have any limits on it at the present time.

I guess what I am wondering though, Steve is the more you do of this kind of business over time, is that going to drag down returns, because this is arguably more price sensitive line of business than some of the other products and services that you sell?

We have seen the mix in our net interest margin evolve over time, as the proportion of loans on a relative basis has shrunk. So taking out where the Fed goes up and down, that has been a factor we have had to contend with, but we still think this is an important part of our business mix, and something we want to continue to attract.

The last question I had was in PFS, it looks like there was a little bit more softness from the Illinois business in the quarter than what we have seen in the past, were there any specific issues or changes that caused that drop in the Illinois business?

No, I don't think there was anything specific, and again you have to be very careful of the market conditions. You know, we feel very good about the franchise overall, and in Illinois. I can't think of anything specific that would have showed up in Illinois this quarter.

Thank you.

You are welcome.

Next to Mike Mayo, Deutsche Bank, please go ahead.

Hi, Steve.

Hi Mike.

Can you give more color on the Securities Lending revenues? Should we expect this lower level to persist, and just so I am hearing you correctly, I thought you said it would have been up 174%, instead of a decline of 30%. So I think that means you would have had $100 million or so more in revenue, or $0.25 per share this quarter, had you had that higher level. So please correct my math, or my understanding.

First, to make sure you have the correct number. The number that Steve stated was $93 million in additional Securities Lending revenues, that we would have, had this particular collateral been invested in our most commonly used pool. It was $93 million, and the math we did was that Securities Lending would have increased by 174%, and the other thing I would point out is that as you saw, this would also have obviously had an effect on our total revenue growth. Revenue growth for the quarter on an operating basis was up 19%, had we had that additional $93 million, it would have been up 30%.

So how should we think about that? Is that a one-time effect, or should we assume a lower run rate of Securities Lending revenues going forward?

Well, I think, Mike, there are a lot of ifs and buts around this. As you know, we don't provide earnings guidance. The key takeaway is that this is happening as a consequence of the mark to market phenomenon that we are experiencing.

In theory, and that is all I can give you, on the assumption that there is no degradation in these securities, those marks will reverse at maturity, and we and our clients will benefit from that in the future. But I don't think in the current climate, I or anyone else wants to make any projections about specifically when that will be or the magnitude of the effect.

And Mike, just to refresh everybody's memory on the call. This is the third quarter that we have had this phenomenon occur. In the third quarter, the first time we explained this to you, the impact was a $36 million impact. In the fourth quarter it was a $46 million impact, and here in the first quarter, particularly with the difficulties experienced in the credit markets in the month of March, it was $93 million.

From that perspective, we certainly couldn't call it a one-time occurrence as you have said. But we have been very clear I think, that as Steve mentioned, that we don't believe it is a particular securities in this fund that currently hold negative marks. We don't believe that they become permanently impaired, and we do believe that this will turn around as either the credit market conditions improve, or as those securities mature at par.

The other piece to remember, Mike, it is a broad number of securities. This isn't anchored to one or two individual securities. But again we can't give you the guidance. We can explain what the phenomenon is, and the magnitude of that phenomenon, but the timing of the recoupment, we will just have to let the markets do their thing.

Then the 8.7 million Other Operating expenses, their value of the capital support agreement, could you just give us a little more color on that?

Sure, we use a standard option pricing methodology. Think about the capital support agreement, as a commitment that has to be valued each quarter. We are using an option pricing methodology to calculate the value of that agreement, which we put at 8.7 million in the quarter. We will again have to look at that until the expiration of those contracts, that was the phenomenon we experienced in the first quarter. Let me remind you however, that there was no contribution made to any of the funds. So no Whistlejacket securities were sold, we sold at a loss resulting in a degradation of the NAV of the funds, this is merely the valuation of the CSA, and it's value, if you will.

Do you think of your risk management as being extra sensitive to the capital markets, you already benefit or get hurt, depending on the direction of the stock market, to the extent that the credit markets go in that same direction. Are you just that much more sensitive to it, how do you think about that in terms of a risk management?

Well I think from a risk management standpoint, Mike, we think and worry about everything, we worry about disaster recoveries, we worry about credit cycles, we worry about interest rates, we worry about operating errors. It runs the gamut. So certainly in a job like mine, we are very concerned about every facet of our business.

I think the thing that we were trying to state at the beginning of this call, and I suspect you will hear from others is, the market environment has been particularly challenging. I don't think I am telling you anything you don't know. It has been very wild, very gyrating, the equity markets, the fixed income markets, interest rates, and so forth. So that is one dimension of our business that we have to think about from a risk management discipline perspective, but there are certainly others that we will have to contend with.

Thank you.

Next to Nancy Bush, NAB Research.

Good morning, Steve.

Hi, Nancy.

This is an incredibly broad and hypothetical question, but I think it is becoming increasingly important. As we look at the Trust and processing companies, and see how they are benefiting this quarter from the rapid declines in interest rates, sooner or later this will turn around, although none of us knows when. Can you just give me your general thoughts, about what will happen when rates start to go up, particularly if they go up as quickly as they have gone down?

Again, I don't want to provide guidance, but I think we have tried to be very clear, Nancy, that we absolutely did benefit on the net interest income line from this phenomenon. I think the important thing that I would drive you to, and we have seen rates up and down the last 20 years, you saw the phenomenon in the post-September 11th era. What we have found is that rates on the way down provide us with a very short term benefit as they did this quarter. But rates remaining very low for sustained periods of time, provide us with more headwind.

I think the key takeaway I would point you to however, Nancy, this quarter is the balance. While it is true that we did benefit on a net interest income line, and the FX line, we also had to struggle through a number of things, related to trust investment and other servicing fees, and the mark to market in Securities Lending, and so forth. So it is not always going to stay at the same level, but I think we have got good balance to the business model that helps us manage through that cycle, when we see softer net interest income.

Also if I could just ask in PFS, what are you seeing on the lower end of the business? We have talked often about that. The entry level PFS client, are you seeing any change in trends there?

I think PFS is a very good story. If you think about where our fee growth in PFS has gone in recent years. Back in 2003 our year-over-year fee growth in PFS was down 1.5%. In 2004, it was up 8%. In 2005, it was 9% year-over-year growth, 2006, 10%, 2007, 15%. And remember that 85% of PFS plus or minus relates to that broad based franchise.

We feel good about the traction that we have got, the positioning that we are in. As I alluded to in my prepared remarks, I think the first quarter was really telling. I can't break out the data for you, but I can give you gobs of anecdotal stories about the flight to quality, and the safe haven status that we had during some of the challenges of the first quarter. So we like the momentum there. Obviously the downdraft in the markets hurts us a little bit on the fee line, and on the asset accumulation line, but I think it is an outstanding story for PFS generally, and as you characterized it, the lower level of our PFS franchise in particular.

Thank you.

You are welcome.

We will go next to James Mitchell at Buckingham Research.

Hey, good morning.

Hi Jim.

Just want to clarify on the losses, the mark to market loss for Securities Lending, is the right way to think about it, you had about 175 million in cumulative losses over the last three quarters. Again, if that all, if you are able to hold on to the assets until they recover or mature, that 175 million should creep back into earnings over time. Obviously you don't know when. Is that the right way to think about it?

You are correct.

Okay. Is there any pressure, I guess the only way that doesn't work is if you are forced to sell these assets at these levels, because investors pull out. How should we think about the risk of the investors in that fund, whether it is controlled by you, or your 10 clients that are in it. How do we think about the commitment of seeing it through to the end?

That is right. Notwithstanding the quality of the investments, if you will, if the investors pulled out of the fund, we would be forced to sell, and would not recoup those unrealized losses. A couple of thoughts, one, remember that this is a small group of sophisticated investors, you are only talking about 10 clients here. And they don't use this fund exclusively. So I can't provide any assurance about what they are going to do.

They have independent views and judgments to make. But I think they definitely understand the nature of the issue here, the accounting that has taken place thus far, and the benefit that they at least theoretically will [incur], to the extent that they stay in the fund, but we will have to see what they decide over time.

Right. The maturity is about 18 months it sounds like, right? And is that, much of it is backloaded, and we have to wait and see over time, or is it more spread out, and you start to see some maturing in a shorter term?

Well, the weighted average maturity as you said is about 1.63 years. But the maturities are spread out starting here in 2008, and proceeding down the road for several years. So you need to focus on the 1.63 as being a weighted average.

Right. Okay. One last question if I may, on the Securities Lending business, ex the sort of mark to market issues, volumes were flat as you mentioned down 1% sequentially, but clearly the revenues were probably up 15 to 20%. Now that is obviously from continued benefits on the spread side. Is that primarily from the Fed cut, and if we see less Fed cuts maybe the spreads start to narrow again, or is there something more complicated going on?

That, we did benefit from the Fed cut, and there is significant demand for Treasury securities right now. So, yes, there is an environmental effect that benefited the non-mark to market funds phenomenon.

I am just trying to get a sense of if Securities Lending spreads moved that quickly, if there is less cuts this quarter, it can step down the spread, it can step down quickly, or is it slower kind of a move?

No, it is a pretty short-term phenomenon. So we absolutely did benefit. If you didn't see that kind of movement in future quarters, you would not see this dramatic a change.

Great. Thank you very much.

You are welcome.

We will go to Tom McCrohan, Janney Montgomery Scott. Please go ahead.

Hi. A quick follow up on that Sec Lending question. Just to clarify, it is this unexpected rate cuts that really benefit you guys, is that right?

That is correct.

Okay. So with an anticipated Fed cut, do you still get a benefit but just not as much?

Yes, it is the unexpected this is more dramatic, if you will.

Got it. The $20 million credit division this quarter, and maybe you said this in your prepared remarks and I missed it, how much of the $20 million provision was allocated to the capital support agreement, if any?

It is separate. None of it.

None of it.

None.

So the provision of $20 million, about 40% of it relates to loan growth. We saw terrific demand for credit, total loans were up 24% year-over-year, and about 30% of it was a result of the overarching weakening in the environment, or our judgment of that. And then, the balance related to some downgrades.

Okay. And I might be comparing apples-to-oranges, but back in February when you disclosed on the conference call, regarding the SIV expose through kind of your internally managed funds, was any of that related to the Sec Lending, or is that completely separate?

No, that is --

The 4.5 billion of securities, SIV securities that are currently held in 10-year funds. Is any of that exposure related to the Securities Lending collateral pool, or that is completely separate?

I don't know if I can give you that by fund. What I can say is our overall exposure to SIVs is modest. I think, Tom, you should think about it less as Securities Lending related, and more just an asset in a short duration fund.

Okay. Fair enough. The capital support agreements, it is not really supporting the collateral pool for Securities Lending, right?

It is supporting any funds that has exposure to Whistlejacket.

Okay, I hear you. And separate topic on the wealth management side, that revenue trend has just been great, at least in the last five quarters. I was wondering if you could just talk a little bit about what is driving the strength of wealth management, and relatedly, has there been in the past any migrations from clients that were not classified as wealth management, which is kind of a PFS client, and the magnitude of that where, maybe it is not material where you have so much classified as within your Illinois PFS segment, and then over time they get so large that you reclassify them as wealth management.

A couple of things, one just to level set for everyone, wealth management for us is those large families, typically a couple hundred million dollars and above in assets under custody. As you know, and as we have stated before, we serve today a little over 20% of the Forbes 400 most affluent families, and Tom you are right, the growth there has been steady and consistent and attractive. None of that growth is attributable to any, if you will, internal reclassification.

Right.

That is real growth, if you will.

Keep in mind, Tom, that we wouldn't arbitrarily do an internal reclassification of a client, from one segment to wealth management. It is really the clients decision as to whether or not the service delivery and the technology they are getting, they want the wealth management product. So it is not something we would do arbitrarily when they reached 75 or $100 million.

The other thing I would point out is that our number of family relationships at the end of the quarter reached 400, which was up pretty nicely from where it had been the previous quarter. We have had nice new business in wealth management as well.

Great. Congratulations. A month from now, Bev and Steve, when you host your Annual Investor Day, can you give us any preview on the agenda and what topics you might be discussing?

Thank you for bringing that up. We were going to say that at the close, but we are going to be holding our Investor Day here in Chicago on March 28th. The invitations were just mailed at the end of last week. We will start with lunch. For those of you wanting to travel in the morning, you can do that.

We will start from lunch, proceed through the afternoon, and then have a reception at the end of the day. Each of our business units will be making a presentation on their growth strategies. Steve of course will be giving an update on financial topics of interest, and of course our CEO, Rick Waddell will be giving his perspective as well. So May 28th beginning at 12 Noon through a reception at early evening.

Expect that similar to prior Investor Day format?

Yes, sir.

Great. Thank you.

We do have another question in the queue, this is Robert Lee from KBW.

Thanks, good morning.

Hi, Rob.

How are you doing? I know you have got to get to your Board meeting, but quick question on the loan growth. Is it possible to get some color on what has been driving that strong growth, has it been just growth in the Asset Servicing business, and maybe overdrafts, or how much of that is maybe being driven by, I know you have hired a lot of, a fair number of people from LaSalle, and what not. How much of that is being driven by the kind of opportunities you are seeing in more traditional loan growth?

This is Bev. I think the strongest growth area that you will see, we will put the table in our 10-Q as we always do, is in Commercial lending. I think what we are seeing there is increased demand from clients for bank credit, as other sources of liquidity have been drying up for them.

We have seen as we look at the commercial loan growth, it is almost equally split between our large corporate client base, our middle market client base, and our health care not-for-profit client base. It is the same type of lending that we do for clients, high quality, which is we have had a higher demand, because bank credit has been a little bit more in demand, as liquidity sources elsewhere have dried up.

To put it another way, Rob, it has not been as a consequences, here in Chicago, where there has been a lot of the LaSalle bankers going to other firms, it has not been a consequence of that. It is just demand.

Great. Thank you.

You are welcome.

And Mr. Fradkin, we have no other questions in the queue. So I would like to turn the call back to you for any closing comments.

Let me again thank everyone for joining us for the first quarter conference call. We look forward to seeing you at our Investor Day on May 28th in Chicago, and to updating you on our second quarter financial results on July 16th. Thank you very much.

Thank you. That does conclude the call. We do appreciate your participation. At this time, you may disconnect. Thank you.