Northern Trust Corp (NTRSO) 2006 Q3 法說會逐字稿

Good day everyone, and welcome to the Northern Trust Corporation third quarter, 2006 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, Bev Fleming for opening remarks and introductions. Please go ahead, Bev.

Thank you. Good morning and thank you, everyone, for joining us to review Northern Trust third quarter 2006 financial results. Joining me this morning are Steve Fradkin, our Chief Financial Officer; Aileen Blake, Controller; and [Prizi Sullivan] from our Investor Relations team. For those of you who might not have received our third quarter earnings press release or financial trend report by e-mail this morning, they are both available on our website at NorthernTrust.com. In addition, this October 18, call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through October 25. Northern Trust disclaims any continuing accuracy of this 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 2005 financial annual report and our periodic reports to the SEC for detailed information about factors that could affect actual results. Now let me hand the call over to Steve Fradkin.

Thank you, Bev, and good morning to everyone. Let me extend my welcome to all of you listening to Northern Trust's third quarter 2006 earnings conference call. Earlier this morning, Northern Trust reported third quarter 2006 earnings of $0.74 per share, up 10% compared to the $0.67 we reported in the third quarter of 2005. Net income for the quarter equaled $163.7 million, up 11% year-over-year. This was our seventh consecutive quarter of double digit year-over-year growth in earnings per share and our sixth consecutive quarter of double digit year-over-year growth in net income.

Our performance in the third quarter met all four of our long-term across-cycle strategic financial targets. We achieved revenue growth of 9%, positive operating leverage, double digit growth in earnings per share, and a return on equity of 17%. We've organized today's remarks into four sections.

First, I will review our financial performance in some level of detail. Second, I'll offer some perspective on a few corporate level themes we are seeing that cut across each of our businesses. Third, I'll comment on the addition we announced yesterday to our executive management team and the rotation of responsibilities we made within the team. And then lastly, as always, Bev and I will be pleased to answer your questions.

Let me start with the review of the quarter's financial performance, beginning with our key revenue drivers. Total revenues equaled $750 million in the third quarter, up 9% or $64 million compared to last year's third quarter. Trust investment and other servicing fees in both C&IS and PFS grew at double digit rates and were the biggest contributor to the quarterly growth in revenues, increasing $41.5 million or 10% compared to the third quarter of last year. Trust investment and other servicing fees represented 58% of total revenues in the third quarter of 2006, and accounted for almost two-thirds of the total increase in revenues. Fees in our C&IS business unit of $243.5 million increased 11% or $24 million year-over-year. C&IS fees incorporate three primary revenue areas--custody and funded administration, securities lending, and institutional asset management. Let me briefly discuss the performance of each in the third quarter.

The custody and funded administration component of C&IS fees increased 14% or $16 million year-over-year to $124 million. Net new business, particularly from international clients accounted for approximately two-thirds of the year-over-year improvement with market growth representing the remaining one-third of the increase. Recall that C&IS custody fees are built primarily on a one quarter lag basis. At June 30, the S&P was up 6.6% versus the prior year and the EAFE Index was up 23.7%.

On a sequential quarter basis, custody fees in C&IS increased 3%, or $3 million, primarily reflecting net new business. Again for perspective, you should note that the quarter lag equity markets as exemplified by the S&P were actually down and therefore a drag on current quarter fees.

The second subcomponent of C&IS fees is securities lending. Securities lendings fees equaled $41 million in the second quarter -- or in the quarter, up 15% or $5 million versus one year ago. The year-over-year increase was driven entirely by higher volumes. Securities lending collateral equaled $248 billion at September 30, up 16.5% or $35 billion versus one year ago.

On a sequential quarter basis, securities lending fees were down 33% or $20 million compared to the second quarter. The sequential decline in securities lending fees is not unexpected and represents the normal aftereffect of the traditional second quarter seasonal peak due to the international dividend season. Looking back over the last five years, the average second quarter to third quarter decline in securities lending fees was 29%, which is in-line with our results this quarter. Securities lending collateral values equaled -- ended the third quarter strong, increasing $12 billion or 5% compared to the June 30, values. On an average daily basis, however, collateral values fell $8 billion or 3% when compared with the second quarter of this year.

Investment management fees pertaining to our institutional clients are another subcomponent of total C&IS fees. Investment management fees equaled $63 million in the third quarter, an increase of 3% or $2 million versus one year ago and 2% or $1 million sequentially. The year-over-year growth in C&IS investment management fees was driven by institutional money market funds, international cash funds, and index management as well as higher equity markets.

Shifting now from fees to assets, C&IS assets under custody equaled a record $3.1 trillion at September 30, up 17% or $438 billion from a year ago and up 5% or $140.5 billion versus June 30. The year-over-year growth reflects continued new business success, particularly in international markets and higher equity market valuations. Sequential growth in C&IS custody assets this quarter was driven by higher equity markets and currency trends. The net new business and currency translation.

Global custody assets are an important and fast-growing component of total C&IS assets under custody. Global custody assets increased 30% or $356 billion to reach $1.5 trillion on September 30, reflecting our outstanding international results. Global custody assets were up 7% or $100 billion sequentially and now represent slightly more than 50% of total C&IS assets under custody. C&IS managed assets equaled a record $539 billion at September 30, up 9% or $46 billion from last year and up 4% or $22 billion sequentially. Approximately three quarters of the year-over-year increase in C&IS managed assets was the result of the outstanding growth in our securities lending business, with the remainder primarily emanating from our international and global asset management activities.

Our personal financial services business unit reported record third quarter fees of $195 million, an increase of 10% or $18 million compared with the year-ago quarter. This 10% growth well outpaced market growth and reflects solid new business results. Recall that all PFS states are on a consistent, monthly fee methodology. Using this monthly methodology, the equity markets using the S&P 500 as a proxy were up 5.6% compared to last year.

On a sequential quarter basis, PFS fees were up 1% or $2 million. The primary driver of the sequential growth was net new business, as the month lag equity markets used as the basis for fee billing across all PFS states actually declined this quarter represented by a 0.6% downward movement in the S&P 500. Total assets under custody in PFS at September 30, equaled a record $243 billion, up 11% or $24 billion from a year ago. PFS assets under custody increased 3% or $8 billion sequentially. Managed assets in PFS also equaled a record $128 billion, up 12% from a year ago and 4% sequentially.

Our wealth management group continues to be a strong contributor to PFS results. This group serves wealthy families with assets of $75 million or more. The average size of our custody relationship with the 350 families served by wealth management is approximately $355 million, signifying the very high end of the market that we serve. Wealth management fees in the third quarter equaled $29 million, an increase of 20% or $5 million year-over-year and 4% or $1 million sequentially. Custody assets in wealth management equaled $124 billion at September 30, up 14% or $15 billion from one year ago and up 4% or $5 billion sequentially. Managed assets in wealth management totaled $24.6 billion at September 30, up 19% year-over-year and up 4.5% as compared to June 30.

Foreign exchange trading income equaled $53 million in the third quarter, up 14% or $6 million versus last year. Foreign exchange trading income was down 37% or $32 million sequentially. The primary driver of the year-over-year increase was higher client volume. Currency volatility was lower when compared with the third quarter of 2005. The sequential decline reflects three factors.

First, we reported exceptionally strong record results in this year's second quarter. Recall that our second quarter results of $84.4 million exceeded our prior quarterly record of foreign exchange by more than $30 million. In addition, lower currency volatility and the normal seasonal pattern, which has historically shown a slowdown in foreign exchange during the summer months both contributed to the sequential decline. Other operating income equaled $28 million in the third quarter, an increase of 4% or $1 million compared with last year. Other operating income increased 22% or $5 million sequentially, primarily reflecting an increase in custody-related overdraft income.

Net interest income in the third quarter equaled $199 million, up 8% or $15 million from a year ago. Net interest income was essentially flat sequentially. The primary driver of the year-over-year increase in net interest income was balance sheet growth. Average earning assets equaled $45 billion in the third quarter, an increase of 13% or $5 billion year-over-year. Growth in earning assets was broad-based with securities up 17% to average $11 billion in the quarter, loans up 10% to average $21 billion, and money market assets up 15% to average $13 billion. Residential mortgages increased 4% versus last year to $8.6 billion and represented 41% of our total average loan portfolio in the third quarter.

Commercial loans increased 28% from a year ago to average $4.6 billion. Commercial loan growth was fueled by new business in C&IS large corporate lending and PFS middle market lending. Commercial loan growth was driven by new client relationships and by demands for loans to fund capital expansion and acquisitions. Growth on the liability side of the balance sheet continued to fuel the increase in earning assets and once again was driven by foreign office time deposits, which averaged $22 billion in the third quarter, up 22% or almost $4 billion versus last year. Foreign office time deposits represented 54% of total interest related funding in the third quarter. Continued growth in foreign office time deposits is directly related to our global custody success.

Our net interest margin equaled 1.73% in the third quarter, down 8 basis points compared with one year ago and unchanged sequentially. The decline in our net interest margin when compared with last year was primarily attributable to the same phenomenon that we've discussed with you in recent quarters. The growth in our balance sheet driven by foreign office time deposits is being invested on the asset side of the balance sheet in lower margin, short-term money market assets and securities as compared with higher margin loans.

Credit quality at Northern Trust continues to be excellent. Nonperforming loans totaled only $32 million at September 30, down $2 million from one year ago. We recorded a loan loss provision of $6 million in the third quarter compared with $2.5 million taken in the third quarter of 2005 and a provision of $3 million last quarter. The $6 million loan loss provision primarily reflects commercial loan growth and certain rating downgrades that occurred during the third quarter. We recorded $100,000 of net charge-offs as compared with $5.3 million in net charge-offs one year ago.

Now let me shift my comments to a review of expenses. Expenses during the third quarter of 2006 equaled $477 million, up 8% or $35 million from the year-ago quarter. On a sequential quarter basis, expenses were down 3% or $15 million. Compensation expense accounted for almost 50% of the year-over-year increase in total expenses. Compensation expense equaled $215.5 million and increased 9% or $17 million from the year-ago period. The year-over-year increase in compensation expense reflects additional staff to accommodate growth in expansion, the April 2006 annual salary merit increases, market and promotional increases, and stock option expense.

Staffing levels equaled approximately 9500 full-time equivalent positions at September 30, up 6% from the year earlier period. When compared with the second quarter, compensation expense decreased 2.5% or $6 million. This sequential decline in quarterly compensation expense primarily reflects a reduction in our incentive compensation accrual, which is based on corporate performance. Employee benefit expenses equaled $53 million in the third quarter, up 10% or $5 million versus last year and down 6% or $3 million sequentially. The year-over-year increase of $5 million reflects higher costs associated with our pension and 401K plans, FICA insurance, and health care expense. The sequential decline in employee benefit expenses of $3 million reflects an accrual reduction in our 401K contribution and normal seasonal declines in FICA insurance.

Occupancy expense in the third quarter equaled $34 million, up 1% compared with last year. On a sequential quarter basis, however, occupancy expense was down 14%, or $5 million compared with last quarter. Recall that our second quarter 2006 results included a $4.8 million charge related to the exit of a lease. Other operating expenses of $155 million were up 9% or $13 million year-over-year and down 1% or $2 million sequentially. The largest contributors to the $13 million year-over-year increase were expenses associated with market values and volumes, such as global subcustodian, asset management subadvisory, and brokerage clearing fees. In addition, we experienced higher technical services and software amortization during the quarter, offset by lower expenses associated with both consulting and legal services.

Two final comments about expense items. Our third quarter results included approximately $2 million in expense associated with our new operations center in Bangalore, India. This compares with approximately $2 million in the second quarter and $1.5 million in the first quarter. Our Bangalore facility supplements our existing North American and European operation centers in Chicago and London, respectively. At September 30, we employed over 200 staff in India, up from 75 at year-end 2005 and approximately 110 last quarter. Our staff, which had been working from interim facilities when we reported to you last quarter, moved into our new 43,000 square foot building in late August.

Our third quarter result also included approximately $2.4 million in integration expense associated with our March 31, 2005, acquisition of the financial services group of Baring Asset Management. Year-to-date, total integration expense equaled approximately $9 million. We expect that full-year integration expense in 2006 will equal between 11 and $14 million, slightly lower than our previous expectation. Integration activities continued to progress well and are winding down as expected. Northern Trust repurchased 446,000 shares of common stock in the third quarter at a cost of $25 million. Diluted shares averaged 221.8 million, essentially unchanged from last quarter. We can purchase an additional 12 million shares under a buyback authorization approved by our Board of Directors yesterday. In keeping with our practice, we increased average common equity by 10% versus one year ago to a record $3.8 billion at September 30. This represents the 74th consecutive quarter that Northern Trust has increased average common equity.

Let me now shift the dialogue from our current quarter results to a broader perspective on two key corporate level themes that continue to create growth opportunities for Northern Trust. The first theme is one that we all are hearing about continuously, that of globalization. As Tom Friedman of the New York Times has written, the world is indeed flat. Lightning-swift advances in technology and communications are connecting people around the world as never before. Northern Trust has experienced this phenomenon firsthand and the implications have been profound. We have quietly and consistently evolved over the last decade or so from a very successful domestic business to a truly dynamic and global enterprise. Let me briefly provide some context on this powerful shift.

You can see the impact of Northern Trust's successful globalization in a variety of financial metrics. For example, global custody assets, as I mentioned earlier, now represent over 50% of the institutional custody assets at Northern Trust, up from less than 15% a decade ago. Global custody assets have grown at a compound annual growth rate of 31% over the past 15 years versus comparable growth in the S&P 500 and EAFE Indices of 8.6% and 5.4%, respectively. Net income from our non-U.S. businesses represented almost 30% of our total bottom line in 2005, up from just 16% in 1996.

You can see the impact of Northern Trust's successful globalization in the broadened geographic footprint of our client basis. C&IS clients are now located in over 40 countries around the globe, while our PFS wealth management business now serves families in 15 countries. In 1990, we had C&IS clients located in less than five countries and no families served by our wealth management business located outside the United States.

You can see the impact of Northern Trusts successful globalization in our new business. For example, in late September, we announced that the multibillion dollar Abu Dhabi pensions and benefits retirement fund had selected Northern Trust has sole global custodian. Among other reasons for our selection was the value that they placed on Northern Trusts experience in the Middle East. And just last week, China's multibillion dollar National Social Security Fund announced that Northern Trust was appointed to administer some of the funds overseas investments. Northern Trust has a strong relationship with the National Social Security Fund and has been working with the Fund since 2002 on a consulting basis. To put this achievement in perspective, China's National Social Security Fund is one of the largest and most prominent funds in all of Asia. Just 11 years ago, Northern Trust did not have any offices in the entire Asia Pacific region. Today we have offices in Tokyo, Beijing, Hong Kong, Bangalore, and Singapore from which we serve some of the largest and most sophisticated institutional investors in the region and in the world, for that matter.

You can see the impact of Northern Trust's successful globalization in the extensive international distribution and subadvisory relationships that we've established in Northern Trust global investments. We now have distribution and subadvisory relationships for a wide variety of investment products with firm in countries including Germany, the Netherlands, Japan, Canada, Ireland, the Nordic region, and Switzerland. Assets under management across these relationships totaled over $8 billion as of September 30. You can also see the impact of Northern Trusts successful globalization in our operational infrastructure which has grown and evolved over time to meet the needs of our clients. On a worldwide basis, more than 20% of our workforce is now located outside the United States. In 1996, only 5% of our staff was based outside the United States.

In London, our location on Canary Wharf serves as the headquarters of our worldwide custody operation. We employee over 1400 people in London, making it our largest concentration of staff outside our headquarters in downtown Chicago. In Dublin, 400 staff members moved into a new building during the third quarter, successfully completing the integration of our fund administration staff in Ireland. We are now one of the largest and fastest-growing fund administrators in Ireland. And to further facilitate our growth in our fund administration, we announced plans during the third quarter to open a second operation center, which will be located in Limerick, approximately 100 miles from Dublin.

Other strategic investments in our global infrastructure in recent years include our operation center in Bangalore, India, a representative office in China, our fund administration office in Luxembourg, a client servicing office in the Netherlands, and our presence in the Channel Islands. Globalization, and with it, our success around the world is clearly an exciting opportunity, creating continued growth potential for Northern Trust. The second broad theme impacting our business is the ever increasing complexity faced by our private and institutional clients. Complexity creates opportunity. Complexity confronts our clients in many different ways, from the increased speed of the markets, to the depth of information available, to the interdependency of so many decisions facing our clients. Complexity affords us the opportunity to creatively and diligently transform data into information, thereby allowing our clients to focus on what really matters to them.

In our private client business, for example, our expertise as one of the leading manager of manager firms in the world has allowed us to construct end to end investment solutions spanning the full spectrum of risk/reward possibilities for clients who want world-class investment capabilities, extensive due diligence, and transparency. In our wealth management business, family office clients are challenged with investment reporting and technology concerns related to a myriad of complex global and alternative assets that are contained within their investment portfolios. Wealth Passport, our client assessable technology solution provides an industry-leading platform with robust functionality designed to address the specialized needs of ultrahigh net worth families and the family officers and advisers who serve them.

On the institutional side of our business, global asset managers are also wrestling with complexity. They're seeking solutions to simplify their infrastructures, whether through the outsourcing of investment operations or support in private equity, property, and hedge fund administration. In the pension arena, clients are dealing with the complexity associated with global plans and new accounting requirements that are dramatically altering investment and plan structures. Northern Trust has a position of industry leadership in cross border pension pooling for multinational clients and we are at the forefront on developing liability-driven investment solutions to help our clients immunize the funded portion of their plans. These are just a few examples of how complexity creates opportunity for Northern Trust to offer clients important, strategic solutions to their day to day challenges. Serving the complex needs of our clients is an important, competitive opportunity and advantage for Northern Trust and continues to evolve as a key theme contributing to our growth.

As I wrap up, let me comment on a number of executive management changes we announced yesterday. Tim Theriault, who formerly served as President of our worldwide technology and business operations unit has been named President of C&IS. Tim replaces Rick Waddell, who was named President and Chief Operating Officer several months ago. Tim is a 22 year veteran of Northern Trust and was Chief Technology Officer prior to being named head of Worldwide Operations and Technology in 2002. Tim's technical background and strong client skills position him well to lead our institutional business into the future.

Jana Schreuder, who is a member of our management committee has been named President of Worldwide Operations and Technology, replacing Tim. Jana is a 26-year veteran of Northern Trust. Across her extensive career, Jana has managed securities operations and information delivery in addition to her current role as head of Corporate Risk Management. In addition, she was group head of our Public Entities and Institution segment in C&IS and also served as our eCommerce Director. Her experience with clients, operations, and technology position Jana well to lead our operations and technology efforts.

Our risk management activities previously managed by Jana will now report up to Kelly Walsh, our General Counsel. For those of you who have not met Kelly, he joined Northern Trust in July of 2000. He was formerly General Counsel of AmeriTech Corporation and the Corporation Counsel for th city of Chicago.

In addition, Steve Potter, head of our C&IS international business joins our management committee. Steve will continue to reside in London, where he and the team he represents will guide our business in the International arena. We welcome Steve to our executive leadership team and look forward to his contributions.

A key takeaway. Northern Trust continues to have a deep and seasoned team with multidisciplinary experience. The combined tenure of Tim, Jana, Kelly, and Steve at Northern Trust alone is in excess of 78 years. This, of course, excludes the long tenures of Bill Osborn, Rick Waddell, and other members of our management committee. We continue to build a team that has a rich and diversified mix of functional, geographic, client, and operational experiences, all of which contribute importantly to our management decision making.

In closing, we're pleased with our results in the third quarter. Year-over-year revenue growth across all key line items combined with effective expense management resulted in attractive double digit earnings per share and net income growth. Our globalization and management of the complex needs of our clients continues, and we look forward to updating you on these and other developments in future calls. Now Bev and I would be happy to answer your questions. Please open the call for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Mark Fitzgibbon with Sandler O'Neill and Partners.

Good afternoon and thank you for taking my question. Steve, you mentioned in the press release that the provision went up due to certain loans migrating to higher risk credit rates. Could you maybe put a little more detail on that? Why did the ratings drop and what kinds of loans these were and the size of the loans, that kind of stuff?

Well, thank you, Mark. As we've always said, if Northern Trust records a provision, sometimes it can be taken out of context. The way that we -- our methodology works we apply loss factors to our credit exposures based on the type of loan and its credit rating. For residential mortgage loans, they have a lower factor applied to them than do commercial loans. The primary driver of the provision that we took was really related to our commercial loan growth, note that our loan growth was up 10% year-over-year and commercial loans were up 28% year-over-year. What I would say is our strong asset quality continues, the favorable market conditions continue, and we don't see any negative trends, it's just a reflection of the growth in our overall portfolio.

Okay. And then secondly, I'm wondering if you can maybe talk about the number and the size of new business wins you had in the second quarter in both asset management and custody?

Sure. I think what we're seeing in new business, as you know, we're not permitted to disclose net new business per se, but I'll break this down into the business units, if you will. I would characterize the net new business in PFS during the third quarter as strong. It was the best we've seen since the first quarter of 2005. I think we had particularly strong performances in the Midwest and in the wealth management group. We are seeing a higher level of sales activity, and I think we're seeing better penetration at the larger end of the market, the $25 million and above. So we were pleased with the PFS results and kind of what's been going on in that segment of our business.

On the C&IS front, third quarter new business was strong, very consistent, very steady. We had good new business both internationally and domestically and we're seeing a nice balance between cross selling into the existing clients and new names. The pipeline is active in both domestically and internationally and again, I think the Chinese Social Security system and the Abu Dhabi retirement fund are good examples of our ability to succeed anywhere in the world, and so we feel good about that. In the asset management front, NTGI, we've had good new business in the transition management in multi-adviser funds, in the enhanced and tax advantaged equity areas and in mutual -- and muni bonds, rather. We've also seen good success internationally. So as we always say in the new business front, it's going to be episodic, it's going to be choppy, but I would say, on balance, we like what we saw across both business units and our asset management activities in the third quarter.

Last question, Steve. Linked quarter, other income was up about 5.1 million or 22% and I apologize if you covered it, but why was that?

That was largely driven by the overdraft. And again, that's a number that's going to move around. I wouldn't draw too much -- client custody overdrafts -- I wouldn't draw too much trend on that one way or the other.

Terrific, thank you.

Andrew Collins with Piper Jaffray.

Good morning.

Hi, Andy.

You mentioned that your non-U.S. business was about 30% of net income in '05. I wonder if you could tell us, maybe update us how it's tracking for '06, and then also what you think the Company can get to long-term, if not a goal?

Sure, we don't break that out until we come to the 10-K, so I can't give you a number per se. I think what I would say is, as I referred to earlier, this trend toward globalization, this steady march has been very consistent as you've seen us move up the curve. And it's juxtaposed against a growing PFS franchise, so it's not as though the domestic activities of the Northern haven't grown, but it's just the international piece is growing, has been growing at a more rapid clip. As evidenced by the many statistics I gave you. I can't give you a forecast, but we continue to see momentum, success, and opportunity internationally. It will move up and down in any given year, but we're closing in on a third, and that's a powerful trend for this company.

Okay. Second unrelated question, net interest margins held in pretty nicely here. Just wondering if you could tell us why that is relative to your competitors? And then also give us some feel for what's going to happen going forward.

Well, if you look at net interest income, we've always said that a flat or inverted curve has a relatively modest impact on us, and that's because we try not to actively take interest rate risks by funding longer term assets with short-term borrowings. So as a result, a narrowing or an inversion of the spread between long rates and short rates has a relatively modest impact on our net interest income and the net interest margin. As a case in point, if you look at the third quarter of 2005, the spread between the Fed funds and the ten-year treasury was 75 basis points. In the third quarter of this year, the spread between the Fed funds and the ten-year treasury inverted to a negative 35 basis points. So that's 110 basis points narrower than the prior year.

Despite this dramatic flattening and then the inversion of the yield curve, our net interest margin in the third quarter of 2006 equaled 1.73%, down only 8 basis points from the prior year's quarter. So I think this is very much in line with the philosophy and approach that we've deployed consistently and it has served us well. It's a tougher environment and we'd rather not have an inverted yield curve, but it has not affected us, as you know, the way it has affected others.

And then lastly, foreign exchange trading, that was a bit weaker than we were looking for, but certainly not a complete surprise. Just wondering how that may be tracking so far here in the fourth quarter and what are going to be the drivers of continued growth there?

Well, we're going to continue to have variability in the foreign exchange line. As we've always noted, there's a client flow volume -- or a client flow issue and a market volatility issue. A couple of things to remember. One, we were up 14% year-over-year and I think that's a good result, very good result under the circumstances. Two, when you look at the second quarter, as I alluded to, the second quarter was just outstanding, $84.4 million, $30 million higher than anything we had ever seen in any other quarter. I think it would be misleading to look at the sequential decline as indicative of anything dramatic other than we just had an outstanding second quarter.

In terms of the third -- the fourth quarter, rather, we don't really comment on the forward look, so as always, you're going to have to sort of draw your own conclusions as to what's going on there and how you think we'll perform. I would say on balance, overall, on average, across time, however you want to frame it, our foreign exchange trading income has done very well and it's been directionally consistent with our international growth and success.

Great, thank you.

You're welcome.

Mike Mayo with Prudential Equity Group.

How much did the currency translation impact earnings?

Not a significant factor this quarter.

Okay. Any other one-timers. I guess merger expenses cost $0.01. You increased the provision, that'd be $0.01. Anything else that would be a little unusual?

No, nothing of significance.

Okay. Separately, I know your formula, every 10% increase in the stock market increases trust fees by 4% which increases total revenues by 2%, is that still correct?

That is the directional guidance that we give. Obviously, it's going to move around, but that's directional.

So since the market's up about 5% through last quarter through today, roughly, that means, all else equal, if the market stays here, revenues should be up in the ballpark of 1% next quarter?

Sorry, say that again, Mike. I just want to make sure I got it.

Well, just to extrapolate your formula, since the stock market is up about 5% last quarter and including this month to date, then your revenues should be up 1% next quarter, all else equal, roughly?

Yes. Always remember the timing of the way our fees are calculated and the fact that C&IS fees and wealth management fees are on quarter lag markets, PFS, the states are on the month lag, and asset management fees are generally contemporaneous quarters. You'll have a little noise in the way that we calculate fees, but if you take that into account, your statement would b holding all else equal, directionally correct.

And taking it one step further, every 10% increase the market increases the revenues by 2%, what does it do to your earnings?

We don't offer any guidance on that.

Okay. Presumably more than the revenue increase?

That's what you're in the game of figuring out, Mike. Sorry, I can't help you on that one.

Okay for the non-U.S. custody growth, you said two thirds of the growth is outside the U.S. Are the margins better outside the U.S.? It's 7% linked quarter growth outside the U.S., even while you did FSG Baring. If you can give any color on some of the tail winds there?

Well, I think, we've had the strong growth outside the United States. In general, we believe that that business creates better margin opportunities, because we're generally getting a broader set of capabilities from clients, FX and so forth. So we like the dynamic that international growth and international clients present and that's why you've seen this steady march to the point where now over half our assets in C&IS are coming from international clients. So hard to predict margin in any given quarter, but I think directionally that's a positive thing for us.

And the FSG Baring integration, you're moving people but you still had the growth. Does that mean now that's closer to being done, you should have faster growth. How do you feel about that?

Well, I think we like what we're seeing there. We like the pipeline of prospect activity. It's particularly focused in the alternative asset space, which is what we had expected and hoped. I don't know that I can forecast what it's going to do in any given quarter, but I think if you look at it from our perspective, this was the largest acquisition in our history by a factor of three. It was international, it was taking on a new set of capabilities that we didn't have a great depth of history in and I think we've executed very well and it's being received nicely by our client base and by new prospects that are coming along. So we feel good about what we're doing there.

And then last question, in PFS, as you mentioned, is being driven by the very high end. But when we look at some of the other areas like Florida, just isn't doing much. What are you seeing in the higher end mass affluent? Are they just not picking up their pace of business, or what?

Well, I think, one, we're pleased with the results in PFS. We've had double digit fee growth and as you may recall, we weren't in that position a year or so ago and we've picked up the pace and we're happy about that. Two, at the top end, wealth management very strong. We've had fees up 20% versus a year ago and we continue to carve out just a fabulous position in that top end of the marketplace.

In the middle bracket that we refer to as wealth advisory, again, we are seeing very good traction, albeit off a slow base, but our open architecture wealth advisory for clients typically in the 10 to $75 million is really picking up steam and we like the pipelines there. In the private client business, we had strong performance in the Midwest. Florida was definitely softer. But I think -- I don't know that I can point to any one thing. There is definitely a lot of competition in the Florida market. But Florida has for us been at times extremely strong and we're going through a patch where it's a little softer. But I don't think there's anything systemic to the market. We certainly like the demographics in Florida and we've got to continue to focus on our execution there. I don't think there's any magic to what's going on down there.

Okay, thank you.

You're welcome.

Nancy Bush with NAB Research.

Hi, good afternoon.

Hi, Nancy.

Steve, you addressed the -- on the provision issue, you addressed the growth part of it, but there remains the statement in the text about the migration of loans to certain higher-risk credit ratings. Could you just -- can you kind of split the provision between the two of those issues?

Nancy, the internal downgrades that we do was largely driven by one loan, so I wouldn't draw any trend from that. And of course, we do have loans during any given quarter that move around and we have a rating system and it's not perfect, but we do the best that we can. So again, it is what it is and I can't give you more than that. I'd just say that our overall view of the portfolio continues to be extremely high quality and no trend or sense on our side, at least at this point in time of a change in the quality of the portfolio.

Okay. Secondly, I would just ask, I realize that you reached your goal of double digit earnings growth, but you sort of decelerated from 11 to 12% growth which you've seen over the past several quarters just to 10%. Is it just a function of the third quarter, which is a soft quarter historically, or are we now looking at 10% being more sort of the normal growth rate. Was there something about the third quarter other than the provision that you look at and you say, perhaps it was a little weak here?

No. I think, look, this is an imperfect science. We don't get to manage right to what we want to do every quarter. We feel like it is a solid quarter. Some quarters we're going to be a little above where people have us and some quarters a little bit below. But we feel that this is a center-cut solid performance, we don't think it portends anything. As always, we have to operate within the environment that we're dealing with, whether it's interest rates, markets and so forth, but no, we feel this is a solid performance.

Thank you.

Robert, Lee with KBW.

Thanks, good morning.

Hi, Rob.

Just a couple questions. First one, Steve, understanding that most of the growth is coming from the global businesses, could you maybe update us on the state of the domestic market. I mean, I guess assets -- domestic assets have been growing sort of a 5, 6% rate. Could you just bring us up to speed on what you're seeing there, and from your own perspective, have you maybe in some ways de-emphasized domestic to more resources globally?

Sure. And we're talking about the domestic C&IS market?

Yes.

I think each market has, if you will, a different point in the cycle. And the domestic market continues to be one of opportunity, we continue to aggregate names, but it is absolutely clear that that is at a more mature stage in its cycle. Again, just to give you a very brief historical reminder. If you would have gone back 15 years ago, there were 100 providers of custody services bidding for business in the U.S., and now we're down to, you pick the number, but half dozen would be maximum in our view.

So this is a business that has, is at that point in its cycle and it's more about cross-selling and bringing new capabilities. It absolutely will be at a more mature rate of growth, still growing, but a more mature rate of growth relative to what we see outside the United States. But we still like it, we have a great franchise there and it's essential that we continue to keep that franchise and build where we can.

Okay. I'm curious, you mentioned, in securities lending that the year-over-year increase is driven predominantly by volumes. Clearly, rates are higher year-over-year. Are you seeing any change in how you have to split -- more pressure on how you have to split profits with the securities owner or any change in the pricing dynamic there, is it just one of those things this quarter?

No. It always moves around a little bit, depending on your client base and what's going on, but I don't see any substantive change there. A big driver for us is building the right book of clients with the right assets and clients who are willing to lend those. That's something we've concentrated on and executed on, I think, quite well over the last couple of years. So no, I don't see any substantive change there.

Lastly, you pointed out that a lot of the balance sheet growth was coming from foreign time deposits and year-over-year it's grown nicely, but it seems like sequentially the last couple of quarters, the rate of change has decelerated. Is there anything going on there? Are you seeing any shift in client behavior in terms of where they're directing their cash flow?

Nothing that I could pinpoint as a trend. The fact is that our -- what's happening with our foreign office time deposits is a function of how much cash our clients have, how much they're staying in cash, and how much they're keeping with us. So at any given point, sometimes they're a little heavier, sometimes they're a little lighter, sometimes they're redeploying it because of their view of the market. So it will move around, though, as we've noted in prior calls, directionally it does seem to move up pretty consistently with the growth in our low custody assets. So I think sequentially, you're right, it was not as robust, but at least at this point I wouldn't draw any conclusion from that.

And maybe one last related question. As more of your funding comes from outside the U.S., how is it changing how you're thinking about managing the -- your asset base? Are you thinking about maybe more a non-U.S. securities in the mix? Does it cause you to change it at all? Or think of changing it?

Rob, this is Bev, let me add a little perspective on that. I think this relates to a question that was asked during our last conference call as well. Which is how do we make a decision between whether we're going to invest these incremental deposits on, in the securities portfolio or in the money market asset portfolio. I would say that there has been a little bit of a shift there. The outstanding growth in foreign office time deposits, some of that's coming to us in U.S. dollars, some of that's coming to us in non-U.S. dollars. And so what we're doing, is when it comes to us in U.S. dollars, we would invest the majority of that in our securities portfolio, which is primarily a U.S. dollar denominated, government agency securities.

When it comes to us in non-U.S. dollars, which primarily would be the euro and the pound sterling, we're investing those in time deposits with banks, which are really multicurrency placements in the interbank market with international banks. So when you're looking -- it was a question that was asked last quarter about the yields that we pay on security versus money market assets and how we make the decision where to invest, it's really more of a currency issue than it is looking to maximize the yield, because we are not going to take currency risk in the way we're investing those foreign office time deposits.

All right, great. Thanks very much. Appreciate it.

Brian Bedell with Merrill Lynch.

Good afternoon.

Hi, Brian.

A question on the global custody growth that was quite strong. Just in terms of looking into the next couple of quarters, was there any one particular large mandate that drove that, and was the conversion of that sort of later in the third quarter?

No, Brian. There's no major anchor tenant that happened that I can think of. In terms of when conversions happen during the quarter, I don't know of anything -- I don't track it closely enough to know what the timing was by month. So we've got that, but, no, there's nothing that I know of that was significant or drove us there. Sometimes they come in a little later in the month, sometimes earlier, but there's no dramatic announcement that I can think of that would shape your thinking on that.

What I'm getting at is you should have a good increase in custody fees in the fourth quarter given your lagged quarter pricing and the markets were so strong in the fourth quarter, and then if you add to that very good organic growth in the third quarter, which would allow that revenue to tail into the fourth quarter, should give you a pretty good tail wind. Is that a reasonable assessment?

I hope that's what happens, but unfortunately, I can't give you any guidance on that.

That's okay. And then just in FX, a couple of questions. Number one, if you can just touch on your view of your progress in cross sell as you continue to grow globally cross selling FX mandates into those custody and asset servicing relationships versus the volume and volatility factors that you see in FX every quarter, maybe just directionally?

Well, I think our team has done a terrific job. Again, as we have commented in a variety of formats, not all assets and not all clients are created equally. What we have tried to do is focus on those clients where we can add value and really bring a diverse mix of our capabilities to the fore. And I think the FX team, our relationship management staff, our sales staff have done an excellent job of profiling clients, understanding what their needs are, understanding what they are willing or desirous of doing with Northern Trust, and what they are not. And I think you see that exemplified in the growth in global assets, the growth in FX trading profits, the general directional correlation between those. And again, in any given quarter, you're going to have noise of volume and volatility, but I think it's very clear when you look at it on average over time that I think we've executed well on that front.

Yes, I would agree. Just maybe on that second quarter of '06, clearly we had good volatility in that quarter and volumes and also seasonal increases, but in terms of the extra wide margin of record revenue that you recorded in that quarter, what do you think was the main driver?

I think market conditions were very attractive, and there was a lot of differing view as to what to do and what was happening and there were a number geopolitical events that happened where markets were moving intraday and clients had to make decisions and called on us to help them with that. And I think you saw that, if you look at not only our results, but the results of others who have posted, you're generally seeing a significant difference environmentally between second and third quarter.

And maybe just lastly, you painted a very good picture on the backdrop of Europe and Asia. If you had to think about over the next three to five years, clearly from a lower base Asia is going to have a higher growth rate naturally, but in terms of magnitude of dollars coming on, how far out is a very good material contribution from Asia relative to the growth you're seeing right now in Europe?

Well, I'd say today we have a very material contribution coming from Asia, but it's coming in the form of a smaller group of clients, because the market for what we offer there is a relatively smaller in terms of number of clients. So Europe will still continue to be over the relatively near term, I think, bigger for us, but make no mistake, our business in Asia as I alluded to in the discussion of globalization is already today significant. No offices eleven years ago, offices all up and down the Asia Pacific dealing with funds like the National Social Security Fund of China. Asia is significant and is growing and will be an important dynamic for Northern Trust as we look out both in the three-year and certainly in the ten-year context.

Great. Thanks so much.

You're welcome.

Gerard Cassidy with RBC Capital Markets.

Good afternoon, Steve.

Hi, Gerard.

I'm going to circle back to an answer you gave on the other operating income, why it was up in the quarter. It seems like across the industry this quarter, everybody is reporting these very strong overdraft fees. Anything that you -- what's causing that, at least with your clients?

No. I don't think there's anything systemic that caused that. Remember, too, other operating income is also kind of a mish mash of exactly what it is, it's other operating income. You have a lot of puts and takes in there, but I don't think there's anything unique to this quarter that comes to my mind in relation to overdrafts.

The one thing that I would add, Gerard, though, is that this is another manifestation of the fact that we are growing the global side of our business. Because these overdrafts that we're referring to are primarily coming out of our London operations. So as you see that business grow, to see a corresponding increase in the overdraft income is not unusual.

Okay. The second question has to do with the sequential numbers. I can understand why compensation and employee benefits are down Q3 to Q2 because of the strength of Q2 and the incentive comp that you guys probably accrued for, how come, and maybe you can address the occupancy expenses were down sequentially, anything going on there that -- is this a new trend that we should keep lower, in the low 30s per quarter rather than the high 30s?

No, that's, Gerard, largely driven by the charge we took in the second quarter, $4.8 million. In London, we had vacated some space. We've now consolidated down at Canary Wharf. We had some old space, we took a charge because we were no longer using that space and then during the third quarter, we didn't have the charge.

Great. Thank you.

Ken Usdin with Banc of America Securities.

Thanks. Hi, Steve and Bev. Quick question on PFS. The first question is, where do we see the building growth from like Boston and New York. Is that in the other component?

Sorry, Ken, the answer is yes, but it also comes into our wealth management business, because a lot of what we're doing in both Boston and New York is higher end stuff.

Okay, and then can you just -- with that then, can you just give us an update then of the Boston/New York trends? Have you seen accelerating growth and are you getting closer to break even in either of those locations? And are the buildouts done at this point?

We're very pleased -- the buildouts are done, at least in terms of those offices. We're very pleased with the pipeline, we're very pleased with the results. As I've said in the past, we were very excited about what was going on in New York and it kind of overwhelmed us in terms of volume of opportunity and I think that continues to be very strong. I've also said that I think Boston's a terrific market, but is going to be a bit slower and much to my enjoyment, we've had some good successes in Boston. Lower in terms of the volume of wins in Boston, but the quality of those wins has been extremely high. So the northeast, again, you're talking about a small handful of offices still at the relatively early stage, but we've got a really exciting dynamic going in the northeast and some terrific clients coming on stream. And you're seeing some of that in the wealth management numbers that we're putting up.

That was going to be my follow-up, is are we seeing it yet in the numbers? I would think if the increment is so good and the pipeline so great and you've been saying for quite some time that the prospects are great, but I'm just wondering when do we really start to see that?

Well, I think you are seeing -- again, remember, you've got a big animal, 84 offices in 18 states and hundreds of billions in assets and so forth. You're definitely seeing it, Ken, in our success particularly in the wealth management and wealth advisory space. And I think we've put some pretty good numbers up on the board in terms of growth statistics there, and some of that is definitely coming from the northeast.

Okay. Then my follow-up just then on the other states, are there any states in particular that are stronger or weaker or that are driving the growth there?

I'd say the Midwest -- the one that I'd point out is the Midwest and sometimes people tend to think, well, Northern's been around since 1889 and strong in the Midwest for a long time so that must be mature, and I think we've seen terrific traction in the Midwest. We saw it in the third quarter and as you know, the wealth creation and movement dynamic is a dynamic. People are constantly having wealth events in mature markets and less mature markets. We feel good about what's happened here in the Midwest in particular.

Well, Steve, do you mean -- I was talking like X Illinois. Do you mean -- when you say Midwest, do you mean X, Illinois. I'm talking about the other states.

I was referring to the Midwest in totality, but Illinois' performance was good.

Okay. Thanks a lot.

You're welcome.

Tom McCrohan with Janney Montgomery Scott.

Thanks for taking the call. Congratulations on having Lou Piniella lead the Cubs. Hopefully it won't be another 98 years.

Well, we're holding our breath.

I just had a quick question on PFS. Is there any seasonality in that business where we could suspect a positive seasonal benefit in Q4? If you look back, at least over the last couple of years, you did see a sequential Q3, Q4 increase in overall PFS fees excluding wealth management. I was wondering if there was anything going on in that business that creates some sort of seasonal pickup in Q4?

The answer is no. I'd say the only modest seasonality that we see is first to second quarter where in the first quarter, we tend to have some tax fees that we benefit from. But other than that I'd say no, there's no seasonality that comes to my mind.

So historical Q3 to Q4 pickup, we've saw it in the last few years--?

It was a functions of markets, and new business, and all the mish mash of things that you're well acquainted with.

Okay, great. Thank you.

Your welcome.

At this time, there are no further questions. Mr. Fradkin, I will turn the conference back over to you.

Thank you very much for joining us for this quarter's third quarter results and we'll look forward to updating you in January with the fourth quarter results. Thank you. Have a great day.

Ladies and gentlemen, this will conclude today's conference call. We do thank you for your participation and you may disconnect at this time.