Northern Trust Corp (NTRSO) 2004 Q1 法說會逐字稿

Good day everyone and welcome to the Northern Trust Corporation's first quarter 2004 earnings conference call. Today's call is being recorded. Conducting the teleconference today, is the Director of Investor Relations, Ms. Bev Fleming. Please go ahead madam.

Thank you Steve, good morning everyone and thank you for joining us to review Northern Trust first quarter financial results. Joining us are Steve Fradkin, our Chief Financial Officer, Harry Short, Controller, and Mark Bette my colleague in Investor Relations.

If you did not receive our earning release our financial trend report, by e-mail this morning they are both available on our Web site at www.northerntrust.com. I also need to mention that this April 20 call is being Webcast live and can be found on our Web site.

The only authorized rebroadcast of this call is the replay that will be available through April 27. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now for our Safe Harbor statements, what we say during today's conference call may include forward-looking statements such statement's that relate to our financial goals, dividend policy, expansion and business development plans, anticipated expense levels and projected profit improvement, business prospects, and positioning with respect to market and pricing trends, strategic initiatives, reengineering and outsourcing activities, new business results and outlook, changes in securities market prices, credit quality including reserve levels, planned capital expenditure and technology spending, and the effect of any extraordinary events in various other matters, including developments in litigation and regulation involving Northern Trust and changes in accounting policies, standards, and interpretations on our business results.

Actual results, of course; could differ materially from those included in these-- indicated by these statements. I urge you to read the 2003 annual report and our periodic reports to the SEC for additional information about factors that could affect actual results.

Now, let me hand the call over to Steve Fradkin.

Thank, Bev, and good morning, everyone. Let me extend my welcome to all of you listening to Northern Trust's first quarter earnings conference call. Before I get started, I want to point out that our annual shareholders' meeting begins at 10:30 central time this morning.

As is customary for the first quarter call, I will need to conclude today's remarks, allowing sufficient time for all of us to get to the annual meeting.

Accordingly, please accept my apologies in advance in the event that we have to end the question and answer period earlier than we would otherwise normally do.

Earlier this morning, Northern Trust reported first quarter, 2004 earnings per share of 57 cents, up 36% as compared to the 42 cents reported in the first quarter of 2003.

We are very pleased with this earnings performance. Solid revenue growth trends were exhibited across our businesses, and we achieved strong, positive operating leverage of 6% in the quarter.

Let me highlight a number of factors that influenced our first quarter performance, before I detail some of the key financial highlights.

On the positive side of the equation, the external environment shows marked improvement versus last year. The S&P's 500, NASDAQ, and EFA indices were up 33%, 49%, and 54% respectively as compared to March 31, 2003. Market performance in the first quarter of 2004 was more subdued versus full year 2003, but remained on a slightly positive trend as compared from the difficult markets experienced from 2000 through 2002.

A dramatic rebound has occurred in the markets since the lows seen in October of 2002. Nevertheless, let me remind you for the purposes of perspective, that even after the recent increases, the major market indices are still well below their all-time highs.

Keeping this perspective in mind, we are pleased to report that both of trust assets under the administration and managed assets were at record levels of $2.3 trillion and $521 billion respectively. Also at record levels were trust fees in both of our business units, Personal Financial Services and Corporate & Institutional Services. Consolidated net new business results equaled $27 million or 8% of first quarter trust fees. Excluding last quarter's results, where we achieved a record new business quarter in C&IS, you have to go back to the second quarter of 2002 to find comparable consolidated net new business wins.

Credit quality remains very strong with non-performing assets equal to $72 million down from $80 million at year-end 2003 and $94 million one year ago.

We reduced our credit loss reserve by $5.7 million, similar to the action we took last quarter. We recorded a $5 million negative provision for credit losses during the first quarter, and experienced only $700,000 in net charge offs.

Our seven and eight-rated loan the highest-risk-rated loans based on the internal rating scale, declined $29 million or 14% from $213 million at year-end to approximately $184 million at March 31. The decline in both seven and eight-rated loans and in non performing loans stemmed directly from cash receipts during the first quarter to pay down existing loan balances on our highest-risk loans.

Offsetting these very positive revenue and credit trends were two additional items that I would like to highlight for you. Low interest rates continued to put pressure on net interest income and securities lending. Although, both of these revenue contributors improved on a sequential basis.

On the expense front, other operating expenses increase on both a on a year-over-year and sequential basis. The largest contributor to the increase was an $11.6 million securities processing loss. I will provide additional detail on both the impact of interest rates, and the expense item later in my remarks.Now let me take a few minutes to review the key revenue and expense driver's in details. Revenues in the first quarter were $578 million up 14% as compared to the year earlier quarter.

The two biggest contributors to this strong year-over-year growth in revenues were trust fees up 17 %, and foreign exchange trading profits, which were double the level achieved in last year's first quarter. On asequential basis, revenues were up 6% versus the fourth quarter. Our personal financial services business unit reported first-quarter trust fees of $162 million, an increase of 12%, or $17 million as compared to the year-ago quarter. PFS trust fees were up 4% or $6 million sequentially. All states and the Wealth Management Group reported increased trust fees compared to last year. The Illinois offices were up $6 million or 12% year over year and up $2 million or 4% sequentially.

Florida fees were up $2 million or 11% from last years first quarter and flat sequentially. Trust fees in our remaining states increased $6 million or 15% versus last year, and $2 million or 6% sequentially.Recall that during our fourth quarter, 2003 conference call, we detailed for you a change in fee collection methodology for some of our PFS states. In the first quarter of 2004, we began collecting fees on a monthly basis in Illinois, Texas, Arizona, and several other newer states. This change in fee methodology did not have a material impact on PFS trust fees during the first quarter.

Florida continues to calculate fees using an average daily valuation during the quarter. Trust fees in our Wealth Management Group, which services families typically with assets of $75 million or more equaled $19 million, up $1 million or 6% versus a year ago, and up $1.4 million, or 8% sequentially. For those of you with detailed fee models, Wealth Management Group fees remain on a one-quarter-lag basis. Assets under administration and Wealth Management were $93 billion, up $29 billion or 45% from up with year ago, and $8 billion or 10% from year-end. Managed assets in Wealth Management Group totaled $18 billion at March 31, up from $14 billion one year ago and $17 billion at year-end.

Our PFS new business results in the first quarter were a positive $9 million in net new analyzed trust fees sold, compared to $8 million one year ago, and $7 million last quarter. Total assets under administration in PFS at March 31 were a record, $205 billion, up 31% from a year ago, and up 5% from year-end.

Managed assets in PFS also reached a record $106.5 billion, up 22% from a year ago, and 2% from the $104 billion we recorded at year-end. Corporate & Institutional Services trust fees of $166 million increased 22%, or $30 million from last year's first quarter, and were up 7% or $11 million on asequential basis. All major product categories contributed to this strong growth. Custody fees increased $12 million or 23% year-over-year, and $3 million or 5% sequentially. Continued custody fee growth emanated from the strength in our global custody asset accumulation. Global custody assets at March 31 equaled $824 billion, an increase of 73% or $348 billion versus one year ago.

Investment management fees in C&IS up $58 million also showed double-digit growth, up $9 million or 19% versus one year ago. Investment management fees were up 5% or $3 million sequentially. Securities lending fees equaled $29 million, up $6 million versus one year ago, and $5 million as compared to last quarter. Securities lending volumes were very strong with quarter-end collateral values equal to a record $157 billion, up 60% versus one year ago, and 18% sequentially.

The increase in volumes is split evenly among three factors. Higher market evaluation, new business, and the additional assets brought on with the passive asset management acquisition. The impact of higher volumes was partially offset by the low-interest rate environment, which continues to put pressure on spreads earned of the investment of collateral.

Net new recurring business in C&IS in the first quarter equaled $18 million on an analyzed basis. This compares with $16 million last year and a record $25 million booked in the fourth quarter. The $18 million level represents 11% of total C&IS trust fees, an indicator of the strong, organic growth we are achieving. Our international business continues to be the strongest contributor to new business in C&IS.

In addition, we continue to see excellent new business flows from existing clients. During the first quarter, 60% of the new trust fees came from existing clients, adding to their suite of services with Northern Trust. We continue to be very pleased with the business results in C&IS. Assets under administration in C&IS were up 46% from a year ago to $2.1 trillion. Managed assets of $414 billion were up $136 billion from last year, or 49%. Both represent record levels.

Foreign exchange trading profits doubled versus last year to $41 million and increased 52% sequentially. The year-over-year increase reflects a number of factors. First, the improved global economic climate versus the year earlier period contributed to increased client activity.

Second, recall that uncertainty leading up to the March 2003 invasion of Iraq had a negative impact on investor manager activity last year dampening the year earlier results. Finally, the first quarter saw increased volatility throughout the quarter in the major currencies, including the Euro and pound sterling and toward quarter end, the yen. Securities commission and trading income equaled $14.5 million, up 13% year over year, and 9% sequentially. Higher equity commission, transition management, and commission recapture revenues all contributed to a year-over-year increase.

Other operating income in the first quarter equaled $19.7 million, as compared to $17.5 million in the same period last year, and $19.8 million last quarter. Net interest income equaled $152 million, down 1% or $2 million from a year ago, and up 1% or $2 million sequentially.

The low interest rate environment continued to put pressure on our net interest margin, which stood at 1.73%, down from 1.87% last year, but up from 1.63% in the fourth quarter. Total loans averaged $17.3 billion, down 2% compared to a year ago. Loans to individuals continue to be a growth area. With residential mortgages up 2% from last year, Residential mortgages averaged $7.9 billion and represented 46% of our total loan portfolio at March 31.

Personal loans were up 4% to $2.5 billion. Commercial loans declined 15% from a year ago to average $3.4 billion in the quarter, reflecting loan pay-downs and lackluster demand. As I mentioned at the outset of this call, credit quality continues to be excellent. During the quarter, we reported a negative provision for loan losses of $5 million compared to a regular $5 million provision last year.

You may recall that cash receipts on our seven and eight-rated loans also led to a provision credit totaling $15 million in the fourth quarter of 2003. This quarter's credit is a continuation of the trend begun in the fourth quarter and is indicative of our excellent credit quality. During the first quarter, net charge offs equaled only $700,000. Non-performing assets decreased to $72 million at March 31, down from $92 million last year, and $80 million at year-end.

Expenses during the first quarter of 2004 equaled $377 million, up 8%, or $28 million from the year-ago quarter, and 9% or $30 million sequentially. Compensation expense equaled $165 million, up $7 million or 4% sequentially. The increase reflects annual salary merit increases for staff, and higher incentive compensation accruals due to better corporate performance.

Headcount continues to be aggressively managed and equaled 7,994 full time equivalent positions at March 31, down 62 people from the year-end and down 689 positions from March 31, 2003. We have essentially completed the structural dimensions of our expense reduction program with a few minor actions to be finalized between now and June.

Benefit expenses equaled $38 million, up 21%, or $7 million sequentially, reflecting higher FICA Expense in every year's per yearly quarters and higher pension expense. You recall that in our recent 10-K filing, we estimated that pension expense would increase by approximately $8 million in 2004, reflecting lower interest rates, the aging of plan participants, and salary increases.Occupancy expenses were up 2% sequentially to $30.7 million. Included in this quarter's occupancy expenses was an additional $1.2 million charge associated with the reduction in leased office space. Equipment expenses were down 7% sequentially to $20 million.

Other operating expenses of $123 million were up $17 million, or 17% versus the $105 million we reported last quarter. This sequential increase relates to the expense item that I discussed at the beginning of this call. We experienced an $11.6 million loss in our securities processing activities, involving an offer to convert a foreign company's ordinary shares into its American depository receipts or ADR's. We did not process the request on a timely basis, and in the course of making clients hold, incurred the loss noted.

We repurchased 939,000 shares of Northern Trust common stock in the first quarter at a cost of $45.5 million. Diluted shares were essentially flat versus year-end at 224.4 million shares. We can purchase an additional 9.3 million shares under our buyback authorization. Finally, in keeping with our practice, we increased common equity by 7% versus one year ago, to a record $3.1 billion at March 31. This represents the 64th consecutive quarter that we have increased common equity.

Let me now take a moment to provide some broader thoughts on the quarter, and some chief themes we are seeing for perspective to supplement our financial results. First, a perspective on interest rates and our positioning. We have commented in recent quarters about the negative impact of the low interest rate environment on our business.

The low-rate environment has been particularly challenging for our net interest income and securities lending activities. For the full year 2003, net interest income was $50 million, or 8% lower than the amount earned in 2002, a sizable loss of revenue due to an external factor. Net interest income is positioned to benefit from a higher rate environment in the medium to long term.

While we can offer no guidance into when or if rates will rise, this is an important element to understand in our business model. Second, let me comment on the excellent momentum in our C&IS business. Our institutional custody and asset management businesses are exhibiting success in the marketplace.

We are expanding relationships with long time Northern Trust clients and delivering more value added services to meet their needs. We are seeing success in new geographies, in new client segments, for example with fund managers and new product offerings, for example, in the outsourcing space.

Our international successes are particularly visible as best exemplified by the 73% increase in global custody assets over the past year. Finally, the past we took to build out a broader array of investment management capabilities in recent years is contributing to results. We experienced strong new business in index management, hedge funds, and multi manager programs amongst other areas as we enhanced our corp selling activities with existing clients.

Third, an observation on new business performance in PFS. Improving investor sentiment has been slow to translate to our core private client business. We have seen this in the muted PFS new business results over the past two years.In the first quarter, however, we recorded our best net new business results since the second quarter of last year, and began to see encouraging sign that investor attitude and decision making is improving.

Our New York and Stanford offices have been well received in their markets, and the pipeline of high-profile opportunities is strong. Our Wealth Management Group, which serves the country's wealthiest families, is also showing excellent growth, with custody assets up 45% versus one year ago and managed assets up 28% for the same period. Lastly, let me make a comment on the expensing of stock options.

We continue to account for stock based incentives under Accounting Principles Board opinion Number 25 and to disclose pro forma impact under financial accounting standards Number 123. Our first quarter Form 10-Q filing shows the pro forma impact of expensing stock option was four cents per share in the first quarter in 2004 versus six cents per share in the first quarter of 2003.

The lower pro forma impact in the current quarter reflects the elimination of the use of stock options as a component of our Annual Bonus Program, and the elimination of broad-based options program originally introduced in 2002. We have elected not to expense stock options at this time, because we believe that methodologies are not consistently applied thereby reducing comparability amongst companies. We will start expensing stock options in 2005, when the final guidelines are issued.

In summary, we had a strong first quarter and overcame the challenges of low interest rates and the processing loss through a combination of strong top-line growth, improving new business levels, and excellent credit quality.

Now, Steve, please open the call for questions or comments from our participants

Thank you, sir.

[OPERATOR INSTRUCTIONS].

We'll go first to Nancy Bush, NAB Research.

Hi, good morning. I have two questions for you. The first one regards the mortgage business. If you could kind of brings up to date since the conditions for -- you know, into the mortgage generation -- mortgage productions have changed somewhat, and I wondered if you could give us some color on how things look right now as that has been a growth area for you.

Thank you, Nancy. I think the first quarter, our home mortgage loan demand flattened. Due to the 2003 refinancing activity. So I -- I think it is softer than it has been. But we are still seeing on the personal side, good improvement on the personal loans.

OK, and secondly -- could you just clarify on this options you've -- you've said you eliminated stock options as part of your bonus, and you've eliminated the program that was introduced a couple of years ago. So what -- what is sort of the -- the guideline for issuance of options now. I am assuming that you have not stopped issuing options in entirety.

No, we have not stopped issuing options. The 10-Q will show for the first quarter, 4 cents versus the 6 cents last year. And really it's the incentive plan design changes, which, as you may recall; we have introduced options into our bonus program. And we had had the broad-based plan.

Right.

So it's the change in eliminating those and the change in the investing.

So is it likely the pro forma impact will continue to decline over the next few quarters until there is a recognition of the expense?

I have no comments on where it would go in the future. We are still, Nancy, using executive stock options, but I don't have a comment on where we would go in the future.

Thank you.

We will go next to Brian Bidell of Merrill Lynch.

Good morning, talk about the outlook for the foreign exchange trading. Was a large portion of the increase in the quarter due to the volatility in the beginning of the quarter? Or do you view it as actually good cross sell to your existing clients?

Thanks, Brian. You know, I think foreign exchange, as you have seen across many quarters, has a volatility to it. It's a function of client flow; it is a function of volatility within the markets. The markets this quarter was attractive, as you note.

Volatility throughout the quarter was helpful. And at the end in the Yen, I think you are also seeing the growth and global custody assets. So anecdotally, there is certainly a correlation to client flow. But itis always a line that will move around depending on market conditions.

OK and just one question on outsourcing. You mentioned that as more of a -- a new segment.

Can you comment on what your view of that is for Northern Trust versus what we've been seeing at other trust banks like Bank of New York and Maryland with their full outsourcing platforms would sometimes involve lift outs of back and middle offices.

Sure, we see Brian that the outsourcing trend is a very real one. It is definite; I think it is something that is going to stick around. Northern Trust currently provides all outsourcing to a number of global asset management firms.

I think from our perspective, we are not interested in all outsourcing mandates. Generally speaking we're looking at ones where the clients will operate on our platform, the clients have global assets as opposed to domestic U.S. or domestic other assets.

The client has material levels of pooled funds for which we might be the custodians. And the client is looking for a broader relationship.

So I don't really have any comments on what the others are doing and what their prioritization is. But our focus has been more on organic growth on our platform versus lift outs. I would not rule out a lift out in the future. But directionally, that's the way we do it.

OK and just the shifts to equities within the NVR -- in the PFS segment, are you seeing more of a shift in the first quarter than in the fourth quarter? Supply and demand?

Brian, this is Bev. The equity mix of managed assets with PFS remain the same at 50%.

OK great. Thanks very much.

Thank you, Brian.

And we will go next to Brian Harvey of Fox-Pitt, Kelton.

Thank you. Good morning just had a couple of questions. We heard a lot of discussion from some of your competitors about the expense pressures in the market.

Can you talk about the pricing environment and what you're seeing and in terms of your business, expense pressures in terms of the business continuity spending or additional investment spending for this year?

Sure, I think the pricing environment in both of our businesses continues to be an aggressive one. We haven't seen a material shift in pricing that I can discern, so it is -- these are competitive businesses. They continue to be competitive businesses.

And at least on a -- on a year-over-year or quarterly basis, I don't -- I don't see a material change there. As to our overall expense profile, as you'll recall, we took a decision a year ago to reduce our non interest expenses on an annualized basis by $75 million.

That program has continued and essentially is complete now with a few drifts and drafts between now and June.

That has helped us to manage our expense base. And throughout that period, we've had to beef up for redundancy and some of the thing that others are talking about.

But I don't see anything on the horizon that I can think of on the -- on the redundancy backup front that would material increase our expenses going forward.

OK, a second question.

Can you talk about the -- the other purchase funds that seem to have moved down pretty materially on the quarter and the last couple of quarters? Is there any sort of changes you're making to the balance sheet?

No, nothing in particular there, Brian.

Thank you very much.

Next to Tom Macrolin (ph) with Fulcrum Global Partners.

Hi, good morning.

Hi, Tom.

Do you have a pretext operating margin goal?

No, we do not have a pretext operating margin goal

OK then you have do you have any comments on where you see the current level of operating margins that kind of where you would like to be going forward this year?

I think if you look at the trend report on a year-over-year basis, that's improved. I don't know really have a comment on whether it's where we like it to be. We want it to go up.

OK. And on the PFS side, it -- you look like you had some decent growth sequentially this quarter. But your comments -- the macro comments you said still slow to kind of translate to that business and you're still kind of muted business results.

What's the growth you're expecting? Obviously higher than what you saw? But how much greater do you think it can go?

I don't know how much greater it can go. I will say that you're correct in noting -- you know, when you look at the PFS net new business on both a year-over-year and sequential basis, the growth was good; the sequential growth was particularly good.

My point was really only, Tom, that on a historic basis, we're not at the level that is we were at. So we feel positively about the direction.

I think there are a variety of factors that move into that -- the markets, and certainly the anecdotal evidence seems positive. But we need to continue to press on that front.

Great, thank you very much.

Thank you.

The next question comes from Joel Gomberg from William Blair.

Joel Gomberg Thanks, Steve. Your concluding comments about encouraging signs in PFS -- maybe flush out a little bit about what you plan to spend a little more on marketing in that area this year and maybe comment on plans for new office openings?

Sure, thanks, Joel. We continue to spend aggressively and ingrain ourselves in our targeted communities. We now have an 82-office franchise across 15 states, and we are within 30 minutes of approximately 40% of millionaire households.

Our strategy of working closely with community-based groups has been working and we continue to spend a lot of money on that front. I think also in the PFS business, we're seeing a few of the trends that come to my mind are -- we're seeing increased demand in the wealth advisory space, so that open architecture for higher end personal clients, we're seeing increasing demands for financial consulting as opposed to just looking at a private banking or asset management, there seems to be more demand on a comprehensive relationship that brings things together.

And we're seeing increasing interest in things like our alternative products -- private equity and hedge funds.

So I would say that our core strategy of ingraining ourselves in the community continues. In terms of new office openings, we've indicated that we like the demographic profile that we have today. We have not made new office openings a priority on to itself, but we do continue to look for opportunities in demographics that fit our profile.

So we have no target for new offices, but we'll continue to be opportunistic as things come up. You see that, you know, last year into Atlanta, into New York, into Stanford this year, and continuing our entry into Boston. So, that is by no means a closed book.

OK, and the PFS new business, I know you've done well in the higher-end, you know, the wealth higher ultra area and it's been a little bit slower in the $1 to $5 million area. Have you seen an incremental uptick in the $1 to $5 million segment?

Joe, we are seeing an uptick. And certainly the anecdotal evidence suggests that is positive. But that clearly we're seeing the top end come in very strong. So we're positive about the $1 to $5 million range and we'll just have to see how it comes in subsequent quarters.

Thanks.

Thank you.

David McLaughlin of McLaughlin Investment Group.

Thank you for taking the question. It's just a follow-up on the previous question on the high network.

You had mentioned earlier families of $75 million and above. I thought the minimum for that category was a $100 million. Did I miss that change in policy earlier, or is that a new policy?

No, that's $75 million has been our -- I wouldn't say it's a policy. It's an indicator of the typical profile. But there's not been a change in that.

So $100 million was never a number.

Not that I recall.

OK, thank you.

Let me go to Robert Rachel with Prudential.

Hi, good morning. A couple of questions, the first one would be on the reserve coverage. Looks like it's relatively low compared to historical. And I would just wondering where that could go?

No, our reserve coverage is actually quite good. It's the best that we've had in quite sometime. We're at -

Are you talking about the .84%, Rob?

Yeah.

I think the more important way to look the reserve coverage is really to look at the reserve as it covers the net charge-offs and that's where you'll see Northern Trust relative to our industry peers is really standing out.

We have simply not had the charge-off history that necessitates significant reserve. Actually our reserve position at the 0.84% is pretty much in line with I'm looking at year-end numbers for the last five years. It's very much in line with what we've experienced over the last five years.

Right, so that's basically what we should expect going forward?

We've made no changes in our philosophy with respect to reserve coverage --no.

My second question, related to the balance sheet positioning for changing interest rates going forward, could you comment on that?

Well, we continue to feel the low rate environment has hurt net interest income, as you know we have a significant securities portfolio.

We are positioned at the short end. So we believe that an improvement in rates would translate into a positive for us.

Now, as always, it depends how quickly they rise, but as a general proposition, we feel positively -- positively positioned relative to a rise in the medium to longer term.

Could we expect your duration to increase with rates increasing?

I have no comment on that at this point.

Thank you.

Thank you, Rob.

As there are no further questions at this time, I would like to turn the call back over to Steve Fradkin for any closing comments.

Well we want to thank you all for participating and we look forward to speaking to you at the end of next quarter. Thank you very much.