Northern Trust Corp (NTRSO) 2003 Q1 法說會逐字稿

Good day, everyone. And welcome to this Northern Trust corporation first quarter 2003 earnings conference call. Today's call is being recorded. Conducting the teleconference is the Chief Financial Officer, Mr. Perry Pero, please begin, sir.

Good morning and thank you for joining us to review our first quarter financial results. Here with me today in Chicago are Bev Fleming our director of investor relationship Harry Short or controller Steve Fradkin our Executive Vice President of finance. For any of you who did not receive our earnings release or financial trend report via E-mail or fax this morning, they are both available on our website and Northerntrust.com. I would also like to mention that this April 15th call is being web cast live and is accessible through our website. The only authorized rebroadcast of this call is the replay that will be available on our website through April 22nd. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. In keeping with our practice, I need to make this Safe Harbor Statement. What I say during today's conference call may include forward-looking statements, such as statements that relate to our financial goals, dividend policy expansion and business development plans, business prospects and positioning with respect to market and pricing trends, strategic initiatives, reengineering in outsourcing activities, new business results and outlook, changes in security market price, credit quality including reserve levels, capital and expenditure and technology spending and in the effect of extraordinary events and various other matters including changes in accounting standards and interpretations on our business, actual results of course could differ materially from those indicated by these statements. I urge all of you to read our 2002 annual report, and our periodic reports to the SEC for additional information about factors that could affect actual results. As many of you are aware, Northern Trust will hold its annual shareholders' meeting later this morning at 1030 A.M. central time. We will be web casting our annual meeting live, and I welcome to you listen to it on Northern Trust.com. Given the timing of today's conference call, relative to our annual meeting, unlike our previous conference calls, I will need to cut off your questions at 10 minutes after 1000 central time so we can attend the meeting. Now, let me review our first quarter results. This morning, Northern Trust reported first quarter 2003 earnings per share of 42 cents, down 25% from a year ago. Obviously, we are disappointed with these results, which are comparable to the low earnings levels we reported in last year's third and fourth quarters. These earnings results reflect the challenges of a very difficult external environment. As evidence by geopolitical issues, a stock market that is into its fourth year of declines historically low interest rates that are pressuring our margins, and in an economy that is demonstrating minimal growth. However, we remain positive about the outlook for Northern Trust. We are winning new business in the marketplace, and the underlying demographic trends in our target markets continue to be favorable ones. Consequently, we remain focused on investing in our core businesses. For example, our press release this morning highlighted a number of important, strategic initiatives for our company -- both ongoing and new. First, we continue to invest for the future success of our core businesses. Two strategic acquisitions are in the final closing process. Our acquisition of the pass of asset management of Deutsche Banc had its first closing of January 31st of this year. At that time, we added $44 billion in passive assets for a purchase price of $100 million. We have had subsequent closings as of that time and as of march 31st, we've had $51 billion of new passive assets in our total reported managed assets base. We expect of total of approximately $65 billion in new passive assets and a final purchase price of approximately $140 million, when all closings on the Deutsche Banc acquisition are completed. Our second acquisition under way is legacy south. An asset management firm in Atlanta. In transaction gives us entry into the attractive Atlanta market where we will be able to leverage our industry leading personal strategy That acquisition, pending regulatory approval should close by the end of this month. We continue to focus our resources on businesses where we have a clear leadership position. And where growth and profitability dynamics are favorable. To that end, we are closely evaluating all of our businesses and where appropriate outsourcing or exiting some so that resources can be allocated to those with the best future potential. For example, this morning, we announced an agreement to sell certain banking assets of our Higgins Road retail branch on the northwest side of Chicago to first Midwest Bank corp. The first price is based primarily on the level of deposits transferred and expected to result in a net gain that could range from $14 million to $17 million. We expect this sale to close in the second quarter. We also recently announced the outsourcing of our mortgage processing operations to cendant mortgage corporation. Similar to our outsourcing of check processing and lock box operations to five serve, this deal with cendant places our mortgage back office in the hands a clear industry leader. Allowing us to continue to offer our clients a leading residential mortgage product, while focusing our back office resources on our core businesses. In essence, residential mortgages will continue to be a principle part of our PFS banking activities and we will continue to book the mortgages on our balance sheet. Now, let's review our first quarter's major revenue and expense items. Revenues in the first quarter were $527 million. Down 6% compared to last year's first quarter, and flat sequentially. The four most significant drivers of year-over-year decline in revenues are the following -- First, equity markets, march 31st, 2003, once again down substantially from the year earlier period. The S&P 500 was down 26% versus last year and the NASDAQ was down 27%. Equity market declines have the greatest and most direct impact on our personal trust fees, which were down almost $15 million year over year. Second, securities lending fees. One component of our institutional trust fees were down almost $7 million year over year. Lower spreads and volumes were the key contributors to this 24% decline in securities lending fees versus last year. Third, net interest income declined $7 million year over year, reflecting the low interest rate environment and the related market reduction in mortgage yields. For example, a good proxy for the decline in mortgage rates is the report of Freddie Mac, that the 15-year mortgage rate averaged 5.21% in the first quarter of 2003, as compared to 6.46% a year ago. Our clients have taken advantage of the lower rates by refinancing or modifying their mortgages with us. Finally, foreign exchange trading profits of $20.7 million in the first quarter were almost $4 million or 15% lower than a year ago representing lower client volumes. The combined impact of these four items essentially accounted for the very disappointing year over year decline of $33.5 million in our first quarter revenues. Now I would like to review each of our revenue line items in some detail. Our personal financial services business unit reported a 9% or $15 million decrease in first quarter trust fees as compared to the year ago quarter. PFS trust fees were down -- also down 1% or $1.5 million sequentially. Fee generation in this business unit continues to be hampered by the ongoing weak equity markets, as 39% of the managed assets in PFS are invested in equities. Fees reported by our Illinois offices were down $5 million year over year and up $300,000 sequentially. Florida fees were down $6 million from last year's first quarter and also down $2 million sequentially. Our remaining ten states had a sequential increase of $1 million or 2% in their trust fees. Trust fees and our wealth management group, which serves families typically with assets of $100 million or more, were down 6% versus a year ago, and 3% sequentially. Again, the principle reason for the decline in is the market. Trust assets and wealth management were $64 billion, down 8% from one year ago, and down less than $1 billion or 1% from December 31st. Managed assets and wealth management totaled $14 billion at the end of the first quarter, down 5% year over year and 1% sequentially. Our PFS new business results in the first quarter were a positive $8 million in that new annualized trust fees sold. The first quarter's sharp decline in the equity markets, which commenced in mid-January, negative geopolitical headlines and the weak economy all combined to make this a challenging quarter to book new business. A situation similar to what we saw in last year's third quarter. Trust assets, under administration in PFS at march 31st, were $156 billion, down 10% from year ago and essentially unchanged from December 31st. Assets under investment management of $87.3 billion were down 9% from a year ago and down less than 1% from the $87.7 billion we had at December 31st. This small decline reflects again that we are not exclusively an equity manager. Corporate and institutional service trust fees of $153.8 million declined 6% from last year's first quarter, and were up 4.5% or $6.6 million on a sequential basis. Securities lending fees essentially accounted for the year-over-year decline. During the first quarter, securities lending fees were $22 million, down $7 million from last year, but up $1 million from the fourth quarter. The lower securities lending fees compared to last year stem from narrower spreads earned on the cash collateral and a lower lend able base because of the market decline. During the first quarter, C&IS custody fees of $53 million were down 4.5% from last year. Sequentially, custody fees were up $1 million. Investment management fees of $48.8 million were up $600,000 versus year ago and up $4 million or 9% sequentially. This year's first quarter, C&IS investment management fees included approximately $2.7 million in fees from the acquired passive asset management business. Retirement consulting fees of $17.5 million were down 10% compared to last year's first quarter and up 2% sequentially. Net new recurring trust business sold in C&IS for the quarter was $15 million in annualized fees. This performance is indicative of the terrific wins C&IS has achieved in the U.S. and global markets. If you have been following us closely in 2003, you would have noted an increase pace of press releases announcing specific wins, where clients have given us their permission to highlight their selection of Northern Trust. I encourage you to review our press releases on Northerntrust.com to see a specific list of corporate and institutional clients who have selected Northern Trust as their provider. Trust assets and C&IS were down 7% from a year ago to $1.43 trillion, while managed assets were up $49 billion to $278 billion. On a sequential basis, our managed assets increased $63 billion from $215 billion at December 31st. Included in our C&IS managed assets at end of the first quarter were $51 billion in passive assets acquired from Deutsche Banc. Signaling that apart from that acquisition, we had a net increase of $12 billion in our C&IS managed asset base. This strategic acquisition now places us as the third largest institutional index manager, a position which gives us the prominence to get into passive manager searches and the scale to compete successfully. As you review our first quarter announced wins on our website, you will see index mandate wins from new and existing clients totally $1.9 billion. Affirmation that our strategy to become a top-tier player in the global passive market has been an early success. So, our index management business is growing. Not only from the purchase of the Deutch passive assets but also from winning new mandates in the market. Global custody assets totaled $476 billion at quarter end, up 1% a year ago and 1% from the end of 2002. The international segment of C&IS continues to exhibit strong sales success, particularly in the Nordic region of Europe and the United Kingdom. We recently announced several significant global custody wins in the UK and in the Nordic region. For example in April, we are transitioning in $8 billion in global custody assets from Electa, the largest manager of pension assets in Sweden. This was a high-profile win in the Nordic region and it's indicative of the momentum that we have achieved in this area. Our free foreign exchange trading desk reported trading profits of $21 million compared to $24 million in last year's first quarter and $19 million in the fourth quarter of last year. These lower results stem from lower FX client volumes. Other operating income in the first quarter equaled $17.5 million, as compared to $18.2 million in the same period last year. Sequentially, other operating income was up $6.7 million. You will recall that two items negatively impacted fourth quarter 2002 other operating income. First, we wrote off our entire $4.8 million equity investment in the global strait through processing association, and secondly, during the fourth quarter, we completely charged off $4.6 million in the residual value of a leveraged lease on a united airlines aircraft. Both of these charges were written off against other income and will put in perspective for you the large sequential quarter increase in our other operating income. Net interest income equaled $153.5 million. Down 5% or $7 million from a year ago. And down 7% or $11 million sequentially. The unprecedented low interest rate environment is clearly placing a drag on our net interest income, as long-term assets, primarily mortgages and short-term assets primarily money market assets are re-pricing at very low rates by historical standards. Total loans average $17.6 billion, which is down 1% from compared to a year ago. Residential mortgages grew 4% to average $7.8 billion and now represent 44% of our total loan portfolio. Commercial loans averaged $4 billion, down 14% from a year ago, reflecting the lackluster economic conditions, resulting in tighter management of working capital, and lower capital expenditures by our commercial clients. Personal loans were up 14% to $2.4 billion. The net interest margin was 1.87%, down from 1.92% last year and up from the 1.85% then-interest margin in last year's fourth quarter. Our provision for loan losses was $5 million in the first quarter. During the quarter, net charge-offs equaled $3.4 million only eight basis points on average loans. Credit quality continues as a bright spot in our first quarter performance non-performing assets equaled $93.6 million at march 31st, down $25 million from a year ago and down $1 million from the $94.6 million level at the end of 2002. Expenses during the first quarter of 2003 equaled $370 million, up $20 million or 6% from the year-ago quarter and up $9 million or 2.5% from the fourth quarter of 2002. If you adjust for $4.7 million in expenses resulting from our acquisition of the passive asset management business, total non-interest expenses would have been up 4% from last year, and only 1% sequentially. Compared to a year ago, our compensation expense was up 6 million.

Compensation expense includes both salaries which were up due to annual meriting increases and incentives which were up year over year due to true up investments made over last year's quarter. Sequentially, compensation expense was up $2 million. Primarily reflecting January 1st staff meriting increases and the increase in our staff attributable to the passive management asset acquisition. We continue to closely manage staff growth here at the Northern. Total staff at march 31st was 9,336 people, down 72 positions from a year ago, yet up 19 from year end 2002. The increase from last quarter is due to the addition of approximately 30 positions associated with our passive asset management acquisition. Employee benefit expenses were up only 200,000 from last year, yet were up $8.6 million sequentially. The sequential increase can be readily explained by the following four items. One, the normal first quarter increase in FICA expense. Two, an increase in our pension expense as detailed in our 2002 annual report. Third, the fourth quarter 2002 year-end true-up of our 401(K) plans corporate match, and finally, the impact of our additional passive asset management staff due to the Deutcha acquisition. Occupancy expenses were up $300 million both year over year and sequentially primarily due to the relocation of our London office to Canary Wharf. Other operating expenses were $9 Million higher from last year's quarter yet down $7 million sequentially. The sequential decrease follows our typical fourth quarter to first quarter pattern. You'll recall from our last conference call that the fourth quarter typically sees an elevated level of other operating expenses. The year-over-year increase is attributable to a number of items including, First, higher software amortization costs related to our continued investment in technology. Secondly, an increase in professional services. Third, our stepped up pace of business promotion including events and advertising. Fourth, higher payments to our lockbox provider, and finally, an increase in tangibles and amortization related it our acquisition of the passive asset management business. During the first quarter, we repurchased one million shares of Northern Trust common stock at a cost of $33 million. Diluted shares were down $770,000 shares from December 31st to 223.4 million shares, primarily due to our stock buyback program and the decline in the stock price resulting in fewer option shares in the money. We can purchase an additional 546,000 shares under our buyback authorization. Finally in keeping with our practice, we increase average common equity by 8% to a record $2.87 billion in the first quarter. To wrap up these comments, the first quarter results we reported this morning are truly disappointing ones for us. We are in the process of making targeted strategic decisions, such as I highlighted at the beginning of my remarks. These are certainly very different economic times than those of several years ago. And we are working hard to position Northern Trust to continue to succeed going forward. Now, in view of the time constraints we have this morning for this earnings conference call due for our annual meeting and to allow for as many of you as possible to ask questions, I will close my overview comments on the first quarter, and begin the q and a session. Cynthia, will you kindly open up the call for our questions or comments from our participants.

Thank you, Mr. Pero. Today's question and answer session will be conducted electronically. If you would like to answer a question, please press the star key followed by the digit one on your touch tone telephone. We will proceed in the order that you signal. If you are using a speakerphone, please make sure that your mute function is turned off to allow your signal to reach our equipment. Once again, if you would like to ask a question, please press star one. We will take our first question from Jed Gore with Synova capital. Please go ahead

Thanks for taking my question.

Good morning.

Good morning sir. Calling from New York city. I was wondering if you had a target in mind in terms of an operating margin or return on equity that you'd like to defend in terms of expenses going forward assuming the market doesn't improve all that much?

We've had a targeted return on equity in the range of 18 to 20% and obviously we didn't make it. That's about all that I can tell you there. I mean, we are below that. We were at -- in terms of the earnings report that we came out today we were at a level of 13.32%. We didn't make our target. And our target is public he announced and has been for many years in the range of 18 to 20%. That's why this is a disappointing quarter and we have got work to get it up.

Okay. Good luck, thank you.

Thank you, I appreciate the good luck.

We will take our next question from Mark Fitzgibbon with Sandler O'Neil, please go ahead.

Good morning, Perry.

Mark, thank you for joining us.

Thank you for having me. I had a couple of questions. The first, I was wondering if you could give us a sense of the approximate run rate of revenues on that passive business to be in the second quarter?

Well, first of all, when you look at that $2.7 million revenue item that I told you, that just reflects two months in the quarter. So you need to step it up by another month if you're going it do a run rate. And then as we signaled when we announced the acquisition, we -- our expectation is that over time, we're going to get a higher level of securities lending business from that activity, and we're going to get transition management business. So our expectation is the tempo going forward will be ever increasing and the other thing we have is I signaled is that we've only gotten approximately a portion of the assets at this point in time. We have got $51 billion in assets and we expect to get approximately $65 billion in assets here. And we will have subsequent closing. So the first two months are -- put it lightly -- just an initial peek what these revenues will be. So you can't just take those two months of 2.7 and traject forward. We're going to be getting more assets transitioned in, because the transaction isn't completed and we expect to do more with them.

And, Perry, on the expense side I think that you had 4.7 million in expense and that's a two-month run rate as well?

That's a two-month run rate but within that obviously we are paying Deutsche Banc to do some of this processing for us and they are going to be doing it for a short time period as we establish our processes here in place to switch over the business, which we hope to do some time in the second quarter.

Okay.

So there's a higher level of expenses there, because we're paying them to process and of course in those expenses, which you'll see going forward is the expense that we'll have for the people that came on board, plus we have some in tangible amortization. But there is a portion of going forward that will relate to getting rid of the expenses that we're paying Deutsche Banc to do the business for us. But I'm not giving you any forecast here of what we expect these to do, I am just giving a sense that we only had two months of the business, so then on the revenue's side you need to make an adjustment for that, and then on the expense side, I am sharing with you that we are paying Deutsche Banc to do some of this process for us and that's a very short-term interim staff. So you can't really extrapolate that much from the first quarter and say these what are the ongoing long-term results of the acquisition are. Honestly, give that you forward look, because it's only a portion of the quarter that's reflected with this revenue and expense activity.

Okay, and then the second question relates it to the balance sheet's rate sensitivity position. Are you making any adjustments to that in the wake of the pressure you are feeling at the margin? And would you be willing to position the balance sheet to be a little bit asset sensitive, and you know, given your outlook for rates?

Well, given, given the final rates, that's the question there. We've basically have always had the balance sheet very conservatively positioned due to rate change, and what we're being impacted here is the unprecedented level of refinancing and modifications that are going on in the mortgage portfolio as a result of what I tried to put into perspective what is happening across America with mortgage rate, and that's where we're getting the pressure at this point in time. And we're sensitive to our sensitivity to rates and the level of managed interest income and the margin. But we are challenged. I mean, at 1.25%, our non-interest related funds which are over 5 billion, the range of 5 to 6 billion are not getting much a return compared to as recently as two years ago, you were in the range of 6% with that kind of a non-interest related fund source in which you could earn on it. We are constantly reviewing the balance sheet. We essentially keep it on a conservative position and we are essentially being inordinately impacted because of what happened to mortgages, mark is really the key point in this time, and hasn't been much that we could do in the short term to realign the balance sheet.

Thank you, Perry.

We will take our next question from Christopher Marinac from SunTrust Robinson Humphrey Capital Markets Go ahead.

Good morning.

Are you calling from Atlanta or on the road?

From Atlanta.

Thank you for joining us, Chris.

You bet. Have you seen any sign in the last couple of weeks of the bottoming of the FX or the securities lending business?

I have no idea. I mean the uncertainty level has been sky high. I mean, I don't know if we've seen the robbing yet to tells that you we're there. You know that old saying the first robbing is the sign it's I have no idea, Chris.

Perry, if we take an optimistic look and if things were to clear there, how much leverage do you think that business has, again, again the level of rate, can it be significant or modest?

The leverage in what FX and securities lending?

correct.

That's dependent on a lot of factors. It's very hard -- your FX is the mood of the money managers in terms of their cross investing. And the mood of the capital cross borders have decidedly declined here in the recent past, past few quarters going over a year, really had not much activity there. That's where we get the bulk of our activity, it's client flow which is the money managers as they buy and sell in various markets. One would always want to be hopeful but I can't forecast what that mood will be by the money managers relative to global investments and securities lending has the spread that you earned on the collateral -- cash collateral and the low interest rates put a lot of pressure on that business.

Sure.

So I really can't give you a sense there, Chris, you know, the level of uncertainty quite frankly I don't think has changed that remarkable in the last two weeks. Obviously, the war headlines are decidedly more positive, but there are a lot of other issues that are impacting the outlook. Above and beyond the war in Iraq.

Very well, Perry. Good, thanks very much.

Okay.

Once again, ladies and gentlemen, if you would like to ask a question at this time, please press star one now on your touch tone telephone.

Is there anyone else out there? I know we have a lot of competition this morning. I know the other trust processors are talking at the same time, so we have far fewer on, we have a good representation here, but this is one the lighter ones we've had on the conference call because everybody was releasing this morning. Anyone else on the line, Cynthia?

We do have another question. We will go next to Ben Ram with Legg Mason, please go ahead.

Good morning, Perry.

Are you calling from Baltimore.

We are in Baltimore..

Welcome, thank you for joining us.

Thanks for having me, could you shed some light, please -- I guess it's the last three quarters in the recovery line? I know charge-offs have been higher --

Talking about loans.

The recoveries and the net charge-offs to give us the net charge-off number, the last two and three quarters really have been quite higher know, significantly higher than the last couple of years. But can you shed any light that for me?

What do you specifically want?

I guess the total recovery number, if you just look back at '99, 2000, 2001, about million 2 to million 5 and this quarter it was 2.6 million, last quarter it was 3.8 million. Prior quarter was 1.6. Just wanted to get some color on that, that was due to anything specific or --

At a very high level, what you should sense is, non-performers -- look at the level of non-performers and how they increased rather markedly. You know, they peaked here in this current cycle at $118 million in the first quarter of last year, and obviously we've been working through when we charged off the loans, there didn't appear to be any values, but they're sometimes collateral values and so forth and able to realize recoveries. What has happened here on some loans charged off in prior periods is pursued of a variety of recovery processes. We've had a step up, and essentially reflected the fact that our non-performers began to peak as the recession started, recession started some time in 2000. And we began to peak in 2002, and you've had that phenomenon going on. And if you historically go back to the prior recession of a decade ago, you would have seen the same pattern occur.

Fair enough, thank you.

We will take a follow-up question from mark from Sandler O'Neil, please go ahead.

Hi, Perry.

Going to have a three Pete, Mark.

Yeah, to take advantage of the light volume of calls.

Okay.

I was wondering if had a goal in mind of expense growth say in the next four to six quarters given the challenging revenue environment and excluding any acquisitions related increases in expenses?

Well, I always have it start off that we don't forecast but we've been managing the expense base very, very tightly and your best proxy is to look at how the staff head count has been managed such that we have had net declines in the staff here for some time since our revenues began to plateau and our objective going forward is the same very intense management on that line of the -- of the business. You know, we're far off from right now from what our productivity goal is, 160%. We are mindful of that. And the biggest component of expenses that we have are compensation and employee benefits. That ranges anywhere and given any period from 56 to 59% are of our total expenses, and we've had a lot of attention on that category, and I can share with you, because we highlight the staff headcount, it just hasn't been going, it's been going down and that's our principle focus plus other parts of the business.

And then secondly, and unrelated, I wondered if you could sort of aggregate the total amount of custody of new business wins have you gotten and kind of when you would anticipate those rolling in?

I don't -- I don't have a -- I don't have a role in transition schedule that I can share with you. But we obviously did very well in C&IS given all of the external environments with the net new annualized trust fees of $15 million. You can look at the level and comparable prior quarters, that is a good run rate and when you reflect the environment that we're working in, there's obviously more business to come in and as I try to put some perspective on it, one of our major wins in the Nordic region Electa, which is Swedish-based, we won that in the prior quarter but it is transitioning now. So that gives you a sense of the momentum. And obviously none of the fees associated with that asset base are in the numbers. And are there others like that.

Thank you.

At this time, it appears we have no further questions. Mr. Pero I turn the call back over to you for closing comments.

Cynthia, thank you very much. And for all of those who joined Us today we thank you very much and look forward to being with you in mid-July to report on our second quarter. Again, many thanks for joining us.

This does conclude the Northern Trust corporation first quarter 2003 conference earning call. We do thank you for your participation and you may disconnect at this time.--- 0--- 0