Northern Trust Corp (NTRSO) 2006 Q4 法說會逐字稿

Good day everyone, and welcome to the Northern Trust Corporation fourth quarter 2006 earnings conference call. Today's call is being recorded and at this time I'd 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 for joining us to review Northern Trust's fourth quarter 2006 financial results. Joining me this morning are Steve Fradkin, our Chief Financial Officer; Aileen Blake, Controller; and [Prithi] Sullivan from our Investor Relations team. For those of you who might not have received our fourth 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 January 17, call is being webcast live on NorthernTrust.Com. The only authorized rebroadcast of this call is the replay that will be available through January 24. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Now for our Safe Harbor statement.

What we say during today's conference call may include forward-looking statements, which are Northern Trust's current estimates or expectations of future events or future results. Actual results of course could differ materially from those indicated by these statements because the realization of those results is subject to many risks and uncertainties. I urge you to read our 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. We appreciate you joining us for Northern Trust's fourth quarter 2006 earnings conference call. Earlier this morning Northern Trust reported fourth quarter 2006 earnings of $0.77 per share, up 15% compared to the $0.67 we reported in the fourth quarter of 2005. Net income for the quarter equaled a record $170.8 million, up 16% year-over-year. This was our eighth consecutive quarter of double digit year-over-year growth in earnings per share and our seventh consecutive quarter of double digit year-over-year growth in net income. On a full year basis, Northern Trust earned $3 per share in 2006, an increase of 14% as compared to the $2.64 we earned in 2005. Net income in 2006 equaled a record $665 million, also up 14% when compared with the prior year. Our performance in 2006 met all four of our long term across cycle strategic financial targets. For the year, we achieved strong revenue growth of 14%, 115 basis points of positive operating leverage, double digit 14% growth in earnings per share, and a return on common equity of 17.6%.

Our focus today will be on discussing with you the key drivers of our financial performance in the fourth quarter. To that end, we have organized today's call to address three basic areas. First, I will outline two tax items that you should be mindful of as you analyze our fourth quarter results. Second, I will review our financial performance focusing on those areas that most impacted the quarter's results. And finally, I will offer a few perspectives on our full year performance and the competitive positioning of our client focused businesses. As always, Bev and I will then be pleased to answer your questions.

Let me start with the tax related items. As you analyze our fourth quarter results, you will want to keep in mind two items that impacted our income tax expense in the fourth quarter of 2006. First, Northern Trust made a strategic decision during the fourth quarter to indefinitely reinvest the 2006 earnings of certain non-U.S. subsidiaries. This decision resulted in income tax benefits equal to $7.9 million in the fourth quarter consistent with the tax accounting provisions contained within APB Opinion Number 23. I'll provide additional detail on this decision later in the call.

Second, during the fourth quarter, we also recorded additional income tax benefits of $2 million separate and apart from the APB 23 related decision that I just mentioned. Recall that in the fourth quarter of 2005, we repatriated $51 million under the terms of the American Jobs Creation Act of 2004. In last year's fourth quarter, we recognized $3.5 million in tax benefits related to this action. A portion of the earnings that were repatriated in 2005 were from 2005 earnings. Accordingly, we needed to finalize the 2005 income tax returns for those foreign subsidiaries in order to compute the final actual benefit. This action was expected and resulted in the $2 million trueup which was recorded in this fourth quarter.

With that backdrop, let me begin the review of the quarter's key performance drivers. I will start with revenues focusing on the major items that impacted our results. Total revenues equaled $776 million in the fourth quarter, up a strong 12% or $84 million compared to last year's fourth quarter. Our largest revenue line item is trust, investment, and other servicing fees which represented 59% of total revenues in the fourth quarter. We are very pleased with our growth in this critical revenue category, both across our private client and institutional business. Trust investment and other servicing fees increased 14% or $55 million compared to the fourth quarter of last year and accounted for 2/3 of the total increase in revenues. Fees in our C&IS or our institutional business unit equaled $254 million, an increase of 15% or $34 million year-over-year and 4% or $10 million sequentially. Year-over-year growth was led by an 18% or $20 million increase in custody and fund administration fees, which represented almost 60% of the increase in C&IS fees from last year.

Sequential growth was also strong up 4% or $5 million compared with the third quarter. Net new business driven by our global custody product accounted for approximately 60% of the year-over-year increase in custody fees with market growth representing the remainder. Recall that C&IS custody fees are built primarily on a one quarter lag basis. At year-end, the S&P 500 was up 8.7% on a quarter lag basis versus the prior year and the EAFE Index was up 13.9% on a quarter lag local currency basis. Securities lending was the second largest contributor to the increase in institutional fees. Securities lending increased 28% or $9 million versus one year ago and 3% or $1 million sequentially. The majority of this increase was driven by higher securities lending collateral volume which equaled $248 billion at year-end up 14% or $30 billion versus year-end 2005.

Institutional Investment Management also contributed nicely to the overall increase in C&IS fees. Investment Management fees increased 9% or $5 million compared with with last year's fourth quarter and 6% or almost $4 million sequentially. New business results were solid in institutional cash, fixed income, mutual funds, and quantitative products.

Success in the global marketplace fueled our strong institutional fee growth. This success entails winning new clients, retaining existing clients, and doing more for our existing clients across a broad product offering. To that end, our accumulation of institutional assets was also very strong in the fourth quarter. Institutional assets under custody equaled a record $3.3 trillion at year-end, up 21% or $564 billion from a year ago and up 7% or $198 billion versus September 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 was driven by higher equity markets, net new business, and currency translations.

As I mentioned last quarter, our achievement in leadership in international markets has been particularly strong and highly rewarding in recent years. Global custody assets in the fourth quarter increased 36% from a year ago or $451 billion to reach $1.7 trillion at year-end reflecting our outstanding international results. Global custody assets were up 10% or $152 billion sequentially and now represent 52% of total C&IS assets under custody. The assets that we manage on behalf of institutional clients also exhibited strong year-over-year and sequential growth. Managed assets for institutional clients equaled a record $562.5 billion at year-end up 12% or $62 billion from last year and up 4% or $23 billion sequentially.

Fees in our PFS private client business were also strong in the fourth quarter, reaching a record $204 million, an increase of 11% or $21 million compared with the year ago quarter and 5% or $10 million sequentially. This growth reflects excellent net new business results in the quarter. Net new business in the fourth quarter was the best quarterly result we have seen in PFS since the year 2000. All of our PFS regions contributed to the strong fee results that we achieved in the fourth quarter. Growth in assets that we manage and/or custody for our peak private clients is important to our continued strong growth in fees. As with our institutional business, asset growth in our personal business was strong in the fourth quarter. PFS assets under management at year-end equaled a record $135 billion up 15% or $18 billion from a year ago and up 5% or $7 billion sequentially. Assets under custody in PFS also equaled a record reaching reaching $282 billion at year-end. PFS assets under custody increased 25% or $56 billion from a year ago and were up 16% or $39 billion sequentially.

Our wealth management group continues to be an outstanding contributor to our growth in PFS. Wealth management serves the complex needs of the world's wealthiest families leveraging the sophisticated technology and product offering that is delivered to our institutional clients. The wealth management group focuses on serving families with assets of $75 million or more; however, many of the nearly 370 families that we serve in wealth management have assets far in excess of that stated minimum. To put this in perspective, we currently serve approximately 22% of the Forbes 400 wealthiest families in America, all of whom are billionaires. The average, and let me repeat, the average -- this is the average size of our custody relationship with families in our wealth management group, which was over $400 million at year-end.

I should add that while we report on our wealth management group as a distinct line item, it's important to remember that it is deeply intertwined with our broader, private client office network across PFS, which also contributes importantly to the success of our wealth management group. In many instances, our first point of contact with these ultra wealthy families is made through our local offices or via outside professionals who often act as key advisors to many of our local clients and prospective clients.

Fees in our wealth management group for the fourth quarter equaled $30 million, an increase of 15% or $4 million year-over-year, and 3% or $1 million sequentially. During the fourth quarter, we added 16 new client relationships in the wealth management group. This success in the marketplace fueled excellent growth in client assets. Custody assets in wealth management equaled $160 billion at year-end, up 40% or $46 billion from one year ago and up 28% or $35 billion sequentially. Managed assets in wealth management totaled $27.5 billion at year-end, up 23% or $5 billion year-over-year and up 12% or $3 billion as compared to September 30. In sum, our consolidated trust investment and other servicing fees in the fourth quarter grew a very strong 14% or $55 million year-over-year with both our private client and institutional businesses contributing healthy gains.

The second biggest contributor to the revenue growth in the fourth quarter was net interest income. We recorded $270 million in net interest income in the fourth quarter up 10% or $19 million from a year ago and up 4% or $8 million sequentially. The primary driver of the year-over-year increase in net interest income was balance sheet growth. Average earning assets equaled $49 billion in the fourth quarter, an increase of 19% or $8 billion year-over-year. Growth in earning assets was broad based with money-market assets up 30%, securities up 24%, and loans up 10%.

Growth on the liability side of the balance sheet continued to fuel the increase in earning assets. Once again, and consistent with prior quarters, this growth was driven by foreign office time deposits which averaged $24 billion in the fourth quarter, up 37% or almost $6.5 billion versus last year. Foreign office time deposits represented 55% of total interest related funding in the fourth quarter. Continued growth in foreign office time deposits is directly related to our international success which I discussed earlier. Our net interest margin in the fourth quarter equaled 1.67%, a decline of 13 basis points from the prior year and 6 basis points sequentially. The lower net interest margin primarily reflects the success of one of our core growth strategies of continuing to build the cross border business we undertake in support of our clients needs.

Our global business has grown at a very high rate as reflected by a compound annual growth rate in global custody assets up 32% in the 15 years since 1991. As this business has grown, our clients place their short-term cash on our balance sheet in foreign office time deposits. These deposits in turn have been predominantly invested on the asset side of our balance sheet in lower margin, short-term money-market assets and securities which profile differently when compared with the relatively higher margins associated with traditional loans. This mix shift in earning assets, which is directly linked to the success of one of our core growth strategies, is the primary reason for the decline we have reported in our net interest margins.

The final revenue line item that most significantly impacted the fourth quarter's performance was foreign exchange trading income. In the fourth quarter, foreign exchange trading income equaled $54 million, up 23% or $10 million versus last year and up 3% or $1.5 million sequentially. The primary driver of the year-over-year and sequential increases was higher client volume. Volatility while lower across the fourth quarter did increase toward the end of the year.

Let me add one final comment on our revenues to help you understand our results. Other operating income equaled $25 million in the fourth quarter of 2006, down $4 million from the prior year. This decrease primarily reflects the $4.5 million in gains recorded in last year's fourth quarter driven by our sale and partial lease back of an office building in Florida. Other operating income was down $3 million sequentially, reflecting several items including a higher level of custody related overdraft income recorded in the third quarter of 2006.

Credit quality remains outstanding at Northern Trust. During the fourth quarter, we recorded a loan loss provision of $2 million compared with no provision in the fourth quarter of last year and a $6 million provision in the third quarter. Non-performing loans totaled $36 million at year-end, up $3.6 million from September 30. The increase reflects one secured loan for which we believe we have adequate collateral to fully cover our position. We recorded only $400,000 in net charge-offs during the fourth quarter.

Now let me shift my comments to a review of the key expense categories that impacted our fourth quarter performance. Expenses during the fourth quarter of 2006 equaled $515 million, up 13% or $58 million from the year ago quarter. On a sequential quarter basis, expenses were up 8% or $38 million. Compensation and employee benefit expenses accounted for half of the year-over-year increase in total expenses. Compensation expense equaled $223 million and increased 11% or $23 million from the year ago period.

The year-over-year increase in compensation expense reflects additional staff to accommodate growth and expansion, our April 2006 annual merit increases, higher incentives, market and promotional increases, and stock option expense. Staffing levels equaled approximately 9,700 full-time equivalent positions at year-end, up 8% from the year earlier period. Compensation expense increased 4% or $8 million on a sequential quarter basis, primarily reflecting higher staff levels. Employee benefit expenses equaled $54 million in the fourth quarter, up 14% or $6 million versus last year and 2% or $1 million sequentially. The year-over-year increase of $6 million reflects higher costs associated with our pension and higher FICA insurance. The sequential increase of $1 million in employee benefit expenses primarily reflects a trueup of the UK equivalent of FICA insurance reflecting additional accruals for payroll taxes associated with cash based incentives.

Other operating expenses of $177 million were up 19% or $28 million year-over-year and 15% or $23 million sequentially. The largest contributors to the $28 million year-over-year increase were expenses associated with our international success in growth including global subcustodian fees, technical and consulting services, hiring, employee relocation, and expatriate expense, and travel. In addition, software amortization was higher due to our continued investment in technology.

Our fourth quarter results included approximately $3 million in expense associated with our new operation center in Bangalore, India. Our Bangalore facility supplements our existing North American and European operation centers in Chicago and London respectively. At year-end, we employed over 270 staff in India, up from 75 at year-end 2005 and approximately 200 last quarter. Our fourth quarter results 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. Total integration expense equaled approximately $11 million in 2006 consistent with our earlier estimates.

As I mentioned earlier, we recorded total tax benefits in the fourth quarter of approximately $9.9 million. $2 million of that total reflects the the final trueup of tax benefits related to last year's repatriation of $51 million under the American Jobs Creation Act of 2004. The remaining $7.9 million reflects our decision to indefinitely reinvest the 2006 earnings of certain non-U.S. subsidiaries. This decision relates to the increasingly global nature of Northern Trust business, a topic that I discussed with you during our third quarter earnings conference call. Historically, Northern Trust has recorded a federal income tax provision on earnings of foreign subsidiaries using the federal statutory income tax rate of 35%. Any differential between the 35% federal income tax rate and the local country tax rate was recorded as deferred federal income taxes that would be paid if and when the foreign subsidiaries earnings are repatriated to the United States.

Until recently, this tax rate differential was not significant because many of our foreign businesses operated as branches of our lead bank, the Northern Trust Company, or were not as profitable as they are today. Our recent fund administration acquisition in Europe combined with the outstanding and profitable growth of our international businesses overall has changed this calculus and resulted in a steady increase in profits of certain foreign subsidiaries. APB Opinion Number 23 allows corporations to record an income tax provision on the earnings of their foreign subsidiaries using only their local country income tax rate if the Corporation decides to indefinitely reinvest those earnings outside the United States. Given the growth, success, and sustainable presence of our operations outside the United States, Northern Trust has decided to indefinitely reinvest outside the United States the earnings of certain foreign subsidiaries.

We expect to make similar decisions in future years which could increase the benefit from the 2006 level of $7.9 million if and as the earnings of our businesses outside the United States grow. I also want to emphasize that the $7.9 million figure reflects the full year 2006 impact of this decision which was recorded in the fourth quarter due to the timing of our decision. In future years, we expect any benefit to be spread out across each year's calendar quarters.

We purchased 83,000 shares under our stock buyback program in the fourth quarter at a cost of $5 million. The lower level of shares repurchased this quarter was driven in part by our preparation during the fourth quarter for the adoption of a new accounting standard related to defined benefit pension and other post-retirement plans. Our December 31, 2006 adoption of this accounting standard, the so-called SFAS Number 158 reduced common equity by $160 million. This reduction was anticipated and discussed in our third quarter 10-Q filing. The reduction is a consequence of the SFAS Number 158 requirement to record unrecognized actuarial gains or losses in accumulated other comprehensive income. We can purchase an additional 11.9 million shares under a buyback authorization approved by our Board of Directors in October. Diluted shares average 222.3 million, up 500,000 shares from last quarter. In keeping with our practice, we increased average common equity by 10% versus one year ago to a record $3.9 billion at year-end. This represents the 75th consecutive quarter that Northern Trust has increased average common equity.

Let me close with a few final perspectives on our full year 2006 performance and on the competitive positioning of our client focused businesses. We are pleased with our performance in 2006 across a wide array of fronts. Top line growth was strong with double digit fee growth in both our PFS private client business and our C&IS institutional business.

Asset accumulation, which is an important metric for us that ultimately fuels our future fee growth, was also very strong in 2006. We very successfully grew assets that we manage and custody for clients at attractive double digit rates. We also achieved positive operating leverage for the year, which is one of our long term strategic financial targets. These successes and many others notwithstanding, we were not satisfied with the growth rate of our expenses in the fourth quarter, and we'll be giving that some additional attention as we move forward in 2007. Credit quality remains excellent, reflecting our longstanding conservative approach to client oriented lending.

During 2006, we also made significant progress on a number of important strategic initiatives placing us in a very strong competitive position as we enter 2007. On the institutional side of our business, we completed as planned, the multi-faceted efforts we had under way to integrate our fund administration acquisition. That task is now essentially complete. We are well positioned to serve the full breadth of fund administration needs of global fund managers across Europe, the Americas, and the Asia Pacific region, including their needs with both traditional funds and in the growing alternative asset class arena.

At year-end 2006, we also successfully completed the migration of Insight Investment Management on to our investment outsourcing -- or our investment operations outsourcing platform. We now manage their operations as the official book of record for $190 billion in assets which is more than triple the $60 billion in assets that the we custodied for Insight before announcing this milestone outsourcing relationship in early 2005. Northern Trust provides Insight Investment Management with every aspect of post-trade execution support including trade processing and settlement, data management, reconciliation, portfolio record keeping, client valuations and reporting, and performance measurement and attribution. This was an important milestone both with respect to our committment to Insight and in relation to our positioning to support additional outsourced clients in the future.

In C&IS, we also forged ahead with an impressive array of product innovations to support some of the world's most sophisticated investors. Just one example includes the very complex work to manage the cross border pooling interests of our clients. These achievements and advances were concurrent with and contributed to our success in winning major asset servicing mandates around the globe, including wins in the United States, Canada, the Asia Pacific region, Europe, and in the Middle East.

On the personal side of our business, we also advanced our positioning with a number of important achievements. PFS trust fees grew at double digit rates fueled by the best year-over-year growth in PFS assets under management since the first quarter of 2004 and the best year-over-year growth in PFS assets under custody that we have experienced since the third quarter of 2000.

Our new business results were also strong, finishing 2006 at the best level we have seen since 2001. Our strong PFS new business performance for the year reflects a number of factors, including significantly expanded investment solutions for clients and the broadening of our open architecture platform, coupled with our strong fiduciary it expertise, innovative technology, and attention to service detail. Northern Trust continues to be uniquely positions in the affluent market segments that we serve.

And lastly, as we reflect on 2006, I would be remiss if I did not mention several important initiatives that we worked on aimed at delivering on our commitments to clients. Throughout the year, we continued to invest in the people and technology required to support the complex needs of our clients. For example, in the areas of alternative asset servicing and derivatives. We also announced plans for an operation center in Limerick, Ireland, and we continued to buildout the buildout of our operation center in Bangalore, India, which is now staffed with 270 Northern Trust partners. Throughout 2006, we focused on continued investment in our technology, global operating model, and attracting and retaining the best people to execute around our commitments to clients.

In sum, 2006 was a year of exciting accomplishments at Northern Trust. The financial strength of the Corporation is as solid as ever. The growth demographics of the businesses in which we compete are attractive, and our competitive positioning remains distinctive. We thank you for your interest in Northern Trust and look forward to updating you throughout 2007 on our continued progress. And now Bev and I would be happy to answer your questions. Please open the call for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] And we'll go first to Mike Mayo with Prudential Equity Group.

Good afternoon.

Good afternoon.

Good morning for you. First, you said you weren't satisfied with the expenses in the fourth quarter and I guess you had 32% annualized expense growth in the fourth quarter. So that might set an almost record there. Now, I'm guessing some of that might be non-permanent and specifically, the other expense category went up 23 million and you detailed the year-over-year change but could you detail the linked quarter change, kind of what you think might not be permanent that's in the expenses this quarter?

Sure, Mike. I think when you look at expense management, let me start with some general observations and then I'll come to the other operating expenses. At least from our standpoint, we have a longstanding record of disciplined expense management. We've had very consistent results on an annual basis of delivering positive operating leverage and we formalize that in our long term strategic financial targets in May of this year; however, long before that, we've been achieving it in practice and we've had, as you know, neutral or positive operating leverage 13 out of the last 16 years and remember two of the years that we didn't were years following September 11, with the down markets and lower interest rates. I should remind you that we had positive operating leverage this year with 14% revenue growth and 13% expense growth and there's nothing that occurred this quarter that would change that calculus at least in the eyes of management relative to our plans for 2007.

All that noted, it's right to say we did not achieve positive operating leverage this quarter and again, in and of itself, that's not a concern to us, but let me talk a little bit about the other operating expenses and give you the color that I can on that. First of all, that category encompasses a wide array of individual line items. There's consulting technical services, subcustody, legal expense, travel, advertising, relocation, a whole host of things that are in that bucket, and the way I sort of think about that line in aggregate is that we have a host of volume related expenses, things such as subcustody and subadvisor fees that grow as our volume of business grows, which it did this quarter, we had some technology related expense there, software amortization as we continue to invest in our capabilities. We have a variety of consulting and, if you will, technical expenses that come in there on various projects that we undertake from time to time, and then there's kind of a bucket of what I'll call client related activity, travel, entertainment, advertising, moving our staff around, relocations, and so fourth.

So this is a panoply of things and there's no one major item to anchor to. We have had quarters in the past where we've had this kind of increase and we manage our way through it, but as always, we're trying to balance the needs of our clients and our strategic business imperatives with the operating leverage that we seek to attain and I think I would come back and say we have consistently delivered that on an annual basis. We did it this year. There's nothing special in the fourth quarter. It's just a panoply of things and we'll march forward in 2007 with the same kind of objectives that we've had in the past.

Well, you said 3 million for new operation center in India , 2.4 million for the integration expenses for Barings, and I guess I'm hearing maybe there's some additional year-end clean up?

But Mike, to be fair, those are embedded in a variety of lines, so I wouldn't want you to take the 2.4 or the 3 and attribute those to other operating expenses, exclusively.

And Mike I should also point out that the FSG integration expense has been relatively stable throughout all four quarters of 2006 as has the India expense. The India expense was slightly higher in the fourth quarter but those expenses are already into the run rate.

I know you don't give a whole lot of guidance but should we be modeling 177 million for other operating expense as a quarterly run rate now?

Well, we don't give any guidance.

Okay.

I can't help you with that one.

And Mike let me help you with one other question you asked about the sequential increase in other operating expenses. Just to give you a little, you'll see this in the annual report because we do provide a table in our annual report and our 10-Q's which break down that item. About half of the sequential increase was in the category Steve described as outside services purchased which includes consulting, technical, the volume related globals of custodian fees, legal, et cetera. So about half of the increase was in that one line item. The remaining three line items that are the biggest would be software amortization, business promotion, which includes travel and advertising, and then staff related which is hiring, relocation, expat costs, et cetera. And those three categories which make up the rest of other operating sequentially increased about in equal amounts.

And that's helpful. Is some of that seasonal? I mean it sort of looks that way, but--?

Well, I wouldn't want to characterize it as seasonal. I would be hesitant, Mike, to imply in any way that it's a quarterly event or an annual trueup or anything. There's always a lot of noise across these categories but as I say, there's no one event that I would anchor -- sometimes when we've had negative operating leverage in a quarter there's one specific one or two items that you anchor to. I wouldn't do that in this case.

I'll queue up for my other questions. Thanks.

Thank you.

We'll go next to Gerard Cassidy of RBC Capital Markets.

Good afternoon, guys.

Hi, Gerard.

On the tax rate, I jumped on a little late so I apologize if you addressed this already, but going -- you had the one-time items that you mentioned in the fourth quarter. Should we use from a reported basis, the third quarter of '06 as the more normalized tax rate for you folks or have you actually brought it down permanently to a lower level?

I think Gerard, as you know, we don't offer guidance but I think as a general statement, holding all else constant, we would expect a modest improvement in our effective tax rate in 2007 as a result of the implementation of APB 23.

Okay.

Gerard, in terms of the two items that you saw, the 2 million relates to a trueup of what we did last year in the fourth quarter.

Correct.

So that's said and done. The 7.9 million in the fourth quarter is the item that we would expect to see in the future as well.

Good. And then second, it looked like you reported that your per share book value declined sequentially even though you had obviously strong earnings in the quarter. What caused the reported book value to go to 1803 from 1806?

I'd have to look at it. I don't know, Gerard.

Well, we did have the $160 million charge--.

Pension charge.

Related to pension, Gerard, and our share count did increase a little bit because our buyback was less in the fourth quarter than it has been traditionally. I haven't done that math, but I wouldn't be surprised if those two factors aren't what contributed to that number.

Okay. And finally, I know lending is not a real big area for the Company, obviously, with the fee based businesses driving the revenues here, but loan growth you did experience, any areas that drove that number?

No. We have seen relative to past years, Gerard, we have seen growth in our large corporate business and C&IS. We've seen growth in our middle market business but I don't think there was anything that it anchored to this quarter. It has definitely been better relative to past years.

Great. And just on the corporate business, do you guys do much, if any at all, in the syndicated leverage loan business as a participant?

No.

Okay, thank you.

And we'll go next to Jason Goldberg with Lehman Brothers.

Thank you. I guess during the last month or two there's been two major transactions among competitors with Bank of New York and Mellon most impacting your servicing business and then Bank of New Orleans servicing side and Banc of America U.S. Trust on a PFS side and can you just talk to any specific initiatives you have as you think about 2007 to go after any potential customer disruption or just your thoughts surrounding those transactions in general?

Sure. I'll start with the Bank of New York Mellon and I think some of the comments will be paralleled into the Banc of America U.S. Trust transaction, but the Bank of New York Mellon transaction puts together two competitors that we consistently compete with all around the globe so in our C&IS business, it's a global business. We have a core group of competitors and we're going from two to one within that group. So we like that. That's one less bidder in every situation that we are in.

From our standpoint, we're going to continue to focus on the clients and we'll let the chips fall where they may. I think if you use the past as a guide post, you'd find that transactions like this have created opportunities for other parties and we're going to focus on the clients that we want and we're kind of excited about it. We think it's a good thing for us and we're going to make the most of it. From a timing standpoint, I think that that will play out over an 18 to 24 month period. I don't think you're going to see material change in the fourth quarter. Remember the transaction, if it closes on schedule, doesn't close, if my memory serves correctly, until July, and so there's a lot of jockeying and it will take some time and until some actions are undertaken, we'll have to see what the clients decide but we like the opportunity that that presents for us, and I'd say, Jason, that U.S. Trust is a similar situation with relative to our PFS business.

U.S. Trust has been with a longstanding competitor and I think it would be fair to say over the last 5 to 8 years there has been a lot of change there, so this is not new to them in some ways, but it does, it is disruptive. It does create opportunity and we're hopeful that we can take advantage of it with those clients that we want to secure. So we'll see how things play out.

Sounds good. Thanks.

Thank you.

We'll go next to Nancy Bush of NAB Research.

Hi, guys, how are you?

Hi, Nancy.

I have sort of a philosophical question for you. You've seen these increased flows which are -- on the balance sheet which you're putting into short-term instruments which are hurting your net interest margin. One of your competitors has become a more active balance sheet manager than they have historically been and you have said in the past that you're not going to do that. I wonder if these slows continue, if there's any thought about going a little bit out on the yield curve on the risk curve and being more active in balance sheet management?

Well, I think, Nancy, we continuously review all of our strategies in light of the circumstances we face. I think our over arching philosophy remains the same, but of course, if we think that there's a benefit to doing that on a risk adjusted basis, we would absolutely consider that, but to date, we've made no change and we feel good about where we are and as a reminder, since you asked it philosophically, philosophically, we have always said that we want to make our best in the businesses that we feel investors are investing in, the PFS business, the C&IS business, our asset management activity, and be careful with what we do on the balance sheet because that's not where we feel people are investing. But -- so in sum, I would say we should -- we can and do always consider what's the appropriate thing for us to do, but no change to date.

Okay. If I could also ask, Steve, just the whole issue of expense control and expense prediction, I guess as you would call it. Where you do have kind of a surprise quarter like this one and apparently it's a surprise to you as well, is the greater component of international business playing into that? Is it more difficult to predict and control the expenses that you get with these global operations?

I think if you harken back and this is more coincidence than insight on our part, but if you listen back to our call last quarter where we talked about globalization and we talked about complexity, I think those are two themes that do run to this, but again, Nancy, we have seen this. This is not a new phenomenon. We have seen this. We don't manage the business for quarterly operating leverage. We would love to do that, but there are a lot of things that happen that we have to deal with. Client situations, operating challenges, credit situations and so fourth, so we've been here before and I'm sure we'll be here again in the future. This is probably a little further than we would have wanted it to be, but as I say, it's sometimes just how things come together. I don't think that's unique to the globalization but we've had a lot of growth and a lot of complexity and we're managing our way through it.

Thank you.

You're welcome.

We'll go next to Brian Bedell with Merrill Lynch.

Thanks, guys. Just to talk about the other expenses, again, I guess a couple components of it and not looking at future predictions or anything like that but you mentioned, Bev, that the outside services purchase were -- you accounted for half of the sequential increase in other operating expenses. Can you just talk about what type of outside services you're purchasing and is that sort of a continual number or based on some certain growth initiative?

Well, there, and again I want to be careful and it's difficult to generalize but there is a whole host of consulting related expenses that go to various projects. Some are short in duration. Others are longer in duration, so again, if I felt that there was one that was absolutely spiking this and it's going away and we can pinpoint that, I would do that for you. There definitely are some that will go away, but I just don't want to anchor to that at this stage.

When you say consulting, is that related to say the conversion for Insight?

It can be using consultants on a specific client transaction. It can be using consultants to help us to review a strategic initiative or an opportunity. There are a whole host of ways that we utilize outside help.

Are you complete, you said you mentioned you completed the integration. Should we expect therefore a decline in the conversion expenses for Insight?

Well, we haven't talked in any way about the expenses associated with Insight as a separate item and again, those, like FSG, like Bangalore, those -- the expenses that we apply in support of Insight are spread across compensation, employee benefits and so fourth, so there is no one line item that you can say it's converted and therefore, it goes away.

Right, but I mean, as you do convert it, you do improve your operating efficiency on that book of business; right? Because you no longer have those conversion expenses.

Yes, one would hope so.

Right. And then the Bangalore, the 3 million that was in the fourth quarter, just again, is that sort of an ongoing rate and increasing rate or is the 3 million in essence--?

Well, it has, and again that's compensation benefits. It's mixed in a variety of lines as opposed to just other operating expenses. It has moved up on an upward trend as we have built up from 75 people last year to closing in on 300 this year, and we expect our operations in Bangalore to continue to grow as we move into 2007.

And then FSG integration expenses complete; right?

Correct.

And then if you could just talk about the -- just two areas, within C&IS, your pipeline of European custody related mandates, now versus say a quarter ago and then I'll follow-up with a PFS question.

Well, C&IS, as you've seen in the accumulation of global custody assets and a whole host of statistics, our international growth continues to be very strong. Our net new business in the fourth quarter was kind of the highest levels we've seen since about the third quarter of 2005. There's been terrific cross-selling to existing clients. We had a number of new announcements during the fourth quarter in Abu Dhabi, in Norway, in the United States, in China, pipeline remains active so we feel good about what we've got going there and the opportunities are plentiful so we're excited about it.

Anything unusual in the FX trading this quarter?

No.

And then just within PFS, you had very strong momentum in custody assets in PFS, which I assume is largely related to wealth management. Should we see more of a benefit of that in the first half going into '07 and then if you can also just comment on seasonality within PFS. I think typically you book some more fees in the first half?

Yes. In wealth management just had an outstanding performance. PFS overall was very good and we're happy with the way the trend lined there and the way that has improved year-over-year. Within PFS, the wealth management group and I stress that comes across as a little bit more of an artificial divide on these calls than is our reality because it is an integral part and leverages off our franchise but wealth management had an outstanding quarter. 16 new clients, huge growth in assets, it's quite clear that the growth in assets is not going to drive proportionate growth in fees in 2006 or 2007, so I wouldn't -- there's obviously some big clients mixed in there, but no, we should benefit on the fee side from the assets that were booked in in the fourth quarter.

Okay, great and then just seasonality in PFS, if you could just comment on what you typically see in the first and second quarter with the tax planning and things?

Yes. We typically do see a little bit of a spike related to tax planning fees and so fourth early in the year, but I don't think there's anything unusual that I would look at sitting here today that suggests that would be anything more than we've normally seen in the past.

Great. Thank you.

Okay thanks, Brian.

We'll go next to Andrew Collins with Piper Jaffray.

Good afternoon.

Hi, Andy.

Just on C&IS, you talked a little bit about the lag and with the markets being up fairly strong in the fourth quarter, how much of that C&IS revenues would be lagged into the first quarter, if you will?

Well, I think it's a good point. When you're looking at our C&IS fee growth, we do both for C&IS and wealth management calculate fees on a quarter lag basis, so we have not taken into account the fourth quarter markets on the fees that you saw this quarter, but we don't give you a number as to what that would be, and I'm referring there, Andy, to the custody fees.

Right.

Investment management fees and so fourth generally are current with the markets but it's the custody fees both for wealth management and C&IS that are on a quarter lag.

Okay. And then secondarily, unrelated question. You also announced net new businesses is strongest since I guess some quarter in 2000. I was just wondering when that new business might potentially be coming online?

Well, when I make that comment, it's the business that we actually booked in the fourth quarter, but we'll feel the benefit, usually the fees, you don't get much when it's coming in in November, December, so we expect to feel the benefit of that as we move forward in 2007.

Great. Thank you.

You're welcome.

And we'll go next to Robert Lee of KBW.

Thanks, good morning or good afternoon.

Hi, Rob.

Just a couple quick questions. In PFS, I mean, as you said wealth management and some of the businesses look like they're doing well and business picked up, but I mean, Florida as a region seems to continue to sort of generate in the pretty favorable environment sort of modest growth. Could you talk a little bit about in that specific market maybe what you're seeing there or maybe related to that how you feel about the open architecture initiative you talked about in your conference in Boston in May?

Yes. Florida has been historically a very good market for us. We saw the growth moderate post-bubble, and -- but we saw good growth sequentially in Florida and so Florida like the rest of the PFS franchise, I don't want to call a quarter a trend, but it feels to be picking up, so we're positive on Florida. And I think on a sequential quarter basis, their fees there were up 2, $3 million so we like what we're seeing. The other thing to remember, Andy, is that when you talk about this wealth management business, some of our biggest client successes have been in California, Florida, and New York and many of those successes do not get booked into Florida because of the way we do our internal geography so that's just the way we do it but it's a point worth noting.

Fair enough. And I guess one quick question I had is looking at the balance sheet, it looked like maybe this was just a year-end phenomenon but it looked like demand deposits had pretty sharp jump versus the average. Was that just sort of year-end cash on balance sheet that sort of flows away after -- on the first or is there something else going on there?

Yes. I don't think there was anything that comes to my mind that was significant that drove that. So that would be my gut reaction.

Okay. Those were my only questions. Thanks.

Thank you.

And we'll go next to a follow-up from Mike Mayo of Prudential.

Hello, again.

Hi, Mike.

I'm going to go with two different questions and go back to the expenses if I can. First, would you say the retail investor is back? This was the best increase in the private client segment in a few years. I mean, wealth management has already come back so are you saying the retail investor is back or is this a one quarter blip or what?

Well, I think, -- I don't know about the retail investor but the high net worth investor that we target, we have seen a strengthening of PFS throughout the year. I can never forecast where it's going to go in the future, but at least our instinct vis-a-vis what we're seeing in the marketplace, the way we're executing around it, the way we've made some changes seems to be working, so the opportunities seem to be there and we've been taking advantage of that, so that's probably as far as I want to go.

Okay. Assets under custody were up 7% but custody revenues were only up 4%.

Yes.

Is that because or why is that?

Well, remember you always have a timing issue. We have clients that come in, they don't come in at the beginning of every quarter, so there's always a timing mismatch as assets come on between how much in fees we're getting for those assets so you have clients transitioning in November and December and so fourth, so you can't match those two items.

So first quarter you should see the double pick up from market values along with additional clients?

Yes.

And back to the topic of expenses. Your stock is kind of a stand out today, it's down not quite 3 points or over 4% and I got a few e-mails back after my first question saying some people weren't happy with the answer to the expense question. You guys are long term oriented so I understand that, but I guess in looking at the K, you do break out some of these categories so if you could just break out third quarter to fourth quarter say for the software amortization, business promotion, some of the subcategories that might be helpful.

Well, Mike, those are the figures that I gave earlier, where I said that half of the sequential increase related to the category called outside services purchased, and then the remaining three categories were equal in amount, roughly, between software amortization, business promotion, and staff related.

Okay. And so the increase was there.

Yes.

And were you surprised, just during one of the questions, the answers you gave of the questioner said apparently you were surprised. Were you surprised by the expenses? Are expenses under control or was this -- that's the impression you might be giving right now.

Well, I think expenses are under control but we have a lot of initiatives that are going on and this is -- unfortunately, this is a little different than managing my personal budget where I know what's on my credit card. We've got thousands of people all over the world with things that we're striving to do to position ourselves properly and there are always going to be things out there that we have to deal with. So I think expenses are under control. It's not stuff we didn't know about or didn't think were going on. It just came in a little higher than we had hoped and as I say, we've had that happen before and we got to work our way through that.

You did make one comment saying definitely some is going away. Anything you could do, I mean, it's the topic of the day, is the expense control at Northern Trust. Any ballpark figure, like what you mean by "some"?

We don't give any forward-looking statements.

Well, just with regard to the fourth quarter itself -- all right, I guess I've tried a few times here.

Yes, you keep coming. I think, Mike, again, what I would remind you of is we have a very longstanding and I think very solid track record on this front. We have consistently said, even when we have positive operating leverage, that there will be quarters that we have negative leverage and that's fine with us, but we try and manage it over the continuum and there's no change in that.

All right thank you.

Welcome.

And we'll go next to Mark Fitzgibbon with Sandler O'Neill.

Most of my questions have been answered, Steve, but one I was curious. Could you detail for us what performance related fees were in the fourth quarter?

There was nothing significant in the investment performance related fees in the fourth quarter, Mark.

Okay, great. Thank you so much.

Welcome.

And we'll go next to Tom McCrohan with Janney Montgomery Scott.

Thanks. All my questions have been asked and answered. Thank you.

We'll move on to Ken Usdin with Banc of America Securities.

Hi, Steve and Bev. Just one question on the balance sheet if I may. Just looking at the trends especially on the liability side, obviously the balance sheet grew a meaningful amount this quarter between 4.5 and 5 billion on average. The one thing I notice is that you had a significant increase in the purchased funds category and I just want to ask if you can just distinguish that between is that still core deposit growth or is that just supplementing on what you're getting from the custody base and what's the mechanism of why that line has been becoming an increasing percentage of the liability base?

Ken, I don't know if I'm going to have an answer for you on that. We're going to have to get back to you on that, Ken. I don't have the -- I don't have an answer that I think is satisfactory to give you on that.

Okay.

I apologize for that.

All right, thanks. I'll follow-up.

We'll take a follow-up question from Brian Bedell of Merrill Lynch.

Hi. Steve, I think you mentioned, you talked briefly about derivatives processing. Maybe if you could just dive into a little bit more detail about when you began investing in processing capabilities for derivatives, sort of where you are in that growth initiative and then also just on your plans to use some of the alternative processing capabilities that you got in the FSG acquisition to bring back to clients in the U.S.

Sure. Well, Brian, as you know, as part of our asset servicing business, we are always having to adapt to the changing needs of our clients, whether it's domestic investment, international investment, whether it's traditional asset classes to alternative asset classes and so forth, over the last 18 to 24 months, we have seen a real pick up in the use of derivatives and as you can appreciate, the accounting, valuation, settlement, and so forth process related to derivatives is quite a bit different than when our clients simply buy 100 shares of IBM and ask us to hold that, and so as we've had to do in many other contexts, we've had to adapt to our clients needs to make sure we've got the valuations right, the reconciliations right and so fourth, and that's been a theme of ours throughout 2006 and I'm sure it will continue in 2007 and we'll adapt to something else. So that's been a building and changing part of the asset servicing business both for us and others. I think in relation to FSG, we have started to leverage the alternative asset fund administration capabilities and have ported those into the United States, but that's a slightly different question or a different capability than what I'm talking about in terms of the core settlement accounting and reporting for derivatives transactions.

Right. Would you say you started to bring that toward the U.S. ? Is that in the very very early stages? Should we expect to see a number of mandates won in '07 using that new Barings platform?

Well, I think we saw good success in the FSG platform with clients in a variety of regions. We have the strongest history and client connectivity and so forth, obviously, in Europe because that's where the business has been but we've gotten good receptivity in our discussions here in the United States and we expect that we'll be able to win clients not only in Europe but here in the United States and elsewhere because the capabilities are portable. So we're excited about that and the overall growth opportunity that that gives us in what we call our global fund services business.

And that platform is largely built already, correct?

That is correct.

Great. Thank you.

You're welcome.

And gentlemen, I'm sorry, Mr. Fradkin, we have no further questions at this time. I'll turn the call back over to you for any additional remarks.

Well, thank you very much for chiming in. We'll look forward to updating you at the end of our first quarter in April. Thank you very much.

And that does conclude today's conference call. Thank you for your participation. You may disconnect at this time.