Northern Trust Corp (NTRSO) 2007 Q1 法說會逐字稿

Good day, everyone, and welcome to the Northern Trust Corporation first quarter 2007 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 open -- opening remarks and introductions. Please go ahead, Bev.

Thank you, Sheila. Good morning, everyone, and thank you for joining us to review Northern Trust's first quarter 2007 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 first quarter earnings press release or our financial trend report by e-mail this morning, they are both available on our website at northerntrust.com. In addition this April 17th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through April 24th. 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 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 2006 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 your joining us for Northern Trust's first quarter 2007 earnings conference call. Earlier this morning Northern Trust reported very strong first quarter 2007 earnings of $0.84 per share up 14% compared to the $0.74 we reported in the first quarter of 2006. Net income for the quarter equaled a record $186.7 million up 15% year-over-year. This was our ninth consecutive quarter of double-digit year-over-year growth in earnings per share and our eighth consecutive quarter of double-digit year-over-year growth in net income.

Asset accumulation also continued at a record pace. Assets under custody equaled $3.8 trillion, up 20% or $629 billion compared with one year ago and up 6% or $209 billion sequentially. This very strong performance in aggregating assets under custody was mirrored in the assets that we manage on behalf of our clients. Assets under management equaled a record $756 billion at the end of the first quarter, up 16% or $103 billion versus one year ago and up 8% or $59 billion sequentially. Our focus today will be on discussing with you the key drivers of our financial performance in the first quarter. To that end, we have organized today's call to address two basic areas. First, I'll review our financial performance focusing on those areas that most impacted the first quarter's strong results. And second, I'll offer a few thoughts on our positioning and the related opportunities that we see for -- in the future for Northern Trust. As always, Bev and I will then be pleased to answer your questions.

Let me begin with a review of the quarter's key performance drivers. I'll start with revenues, focusing on the major items that impacted our results. Total revenues equaled $824 million in the first quarter, up a strong 11% or $81 million compared to last year's first quarter. Revenue growth was very strong on a sequential quarter basis as well, increasing 6% or $48 million when compared with the fourth quarter. Recall that our first quarter results last year included a $4.5 million revenue accrual in C&IS custody fees. This item was nonrecurring in nature, representing an adjustment from prior periods and was a one-time increase to C&IS custody fees in the first quarter of last year. Excluding the impact of that nonrecurring item, total revenues increased 12% year-over-year. Our largest revenue line item is trust, investment and other servicing fees, which represented 59% of total revenues in the first quarter. We are very pleased with our growth in this critical revenue category across both our private client and institutional businesses. Trust investment and other servicing fees increased 10% or $46 million compared to the first quarter of last year, and accounted for over 50% the total increase in revenues. Excluding the impact of last year's first quarter a -- accrual adjustment, total trust investment and other servicing fees increased 12% or $51 million year-over-year.

Fees in PFS, our private client business, were very strong in the first quarter reaching a record $215 million. This represented an increase of 14% or $26 million compared with the year-ago quarter and 5% or $11 million sequentially. This excellent growth reflects strong net new business results in the quarter. PFS net new business in the first quarter was our second best quarterly result since the fourth quarter of 2001, surpassed only by our strong performance reported to you last quarter. Recall that all PFS states are on a consistent monthly fee methodology. Using this monthly methodology, the S&P 500 was up 11.9% compared to last year and 3.6% compared to last quarter. Recall too that PFS manages balanced accounts for clients. The asset allocation of PFS managed assets as of March 31 was 48% equity, 33% fixed income, and 19% cash and other. Our growth in PFS fees is driven by our ability to meet the needs of our private clients, which in turn fuels growth in the assets that we manage and/or custody for these clients.

Asset growth in our personal business was strong in the first quarter. PFS assets under management equaled a record $139 billion at March 31, up 15% or $18 billion from a year ago and up 3% or $5 billion sequentially. Assets under custody in PFS also equaled a record, reaching $292 billion at quarter end. PFS assets under custody increased 24% or $56 billion from a year ago and were up 4% or $10 billion sequentially.

Our Wealth Management Group continues to be an outstanding contributor to our growth in PFS. Wealth Management serves the complex needs of some of the fam -- world's wealthiest families, focusing on servicing families with assets of $75 million or more. We currently serve approximately 22% of the Forbes 400 wealthiest families in America, all of whom are billionaires. The average size of our custody relationship with the approximately 380 families served in our Wealth Management Group was over $400 million at March 31. Fees in our Wealth Management Group for the first quarter equaled $33 million, an increase of 24% or $6 million year-over-year and 13% or $4 million sequentially. Our success in the marketplace fueled excellent growth in client assets. Custody assets in Wealth Management equaled $166 billion at March 31, up 39% or $47 billion from one year ago and up 4% or $7 billion sequentially.

Managed assets in Wealth Management totaled $29 billion at March 31, up 28% or $6 billion year-over-year, and up 6% or $2 billion as compared to year end. Fees in C&IS, our institutional business unit, also reached record levels in the first quarter. C&IS fees equaled $274 million, an increase of 8% or $21 million year-over-year and 8% or $20 million sequentially. Excluding last year's first quarter nonrecurring accrual adjustment increase, C&IS fees would have increased 10% year-over-year. C&IS fees incorporate three primary revenue areas: custody and fund administration, institutional asset management, and securities lending. Let me briefly discuss the performance of each in the first quarter.

C&IS fee growth in the first quarter of 2007 was led by excellent growth in custody and fund administration fees. Institutional custody fees equaled $141 million in the first quarter, up 12% or $15 million year-over-year. Growth in custody fees represented 75% of the increase in total C&IS trust fees from last year. Sequential growth in C&IS custody fees was also strong, up 8 % or $10 million compared with the fourth 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 13.6% versus the prior year on a one quarter lag basis, and the [EFA] index was up 13.8%. While market tailwinds were an important driver of our strong custody fee growth in the first quarter, net new business drove the majority of the quarter's growth in institutional custody fees.

Institutional Investment Management was the second largest contributor to the increase in total C&IS fees this quarter. Investment Management fees in C&IS equaled $71.5 million in the first quarter, an increase of 12% or $8 million year-over-year. This represents the highest growth rate we have achieved in this category since the first quarter of 2004. In addition, sequential growth was also very strong, up 7% or $4.5 million compared with the fourth quarter. This was our highest sequential growth in Institutional Investment Management fees since the second quarter of 2003.

New business results were excellent in institutional mutual funds, cash, and manager of manager products. Securities lending fees and other important component of C&IS total trust fees equaled $46 million in the first quarter. Securities lending fees declined 6% or $3 million year-over-year, driven primarily by narrower spreads, offset by higher collateral volumes. Recall that our securities lending performance in last years first quarter was particularly strong driven by wider spreads at that time, thus making for a difficult year-over-year comparison. On a sequential quarter basis, however, securities lending fees increased 9% or $4 million, due primarily to higher collateral volumes. Securities lending collateral equaled $297 billion on March 31, up 24% or $57 billion year-over-year and up 20% or $49 billion sequentially.

Our accumulation of institutional assets was very strong in the first quarter of 2007. Institutional assets under custody equaled a record $3.5 trillion at March 31, up 20% or $573 billion from a year ago and up 6% or $199 billion versus year end. The year-over-year growth reflects continued new business success, particularly in international markets and higher equity market valuations. Approximately 50% of the sequential growth in C&IS custody assets was driven by net new business, with the remainder due to market impact and growth insecurities lending collateral. A consistent theme within our institutional business in recent years has been our success outside the United States. Global custody assets in the first quarter increased 30% from a year ago or $413 billion to reach $1.8 trillion at March 31. Once again reflecting our outstanding international results.

The first quarter represents the 16th consecutive quarter that we have reported double digit year-over-year growth in global custody assets. On a sequential quarter basis, global custody assets were up 6% or $97 billion, 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 $616.5 billion at March 31, up 16% or $85 billion from last year and up 10% or $54 billion sequentially. In summary, our growth in trust investment and other servicing fees in the first quarter was very gratifying and broad based across our mix of businesses.

The second biggest contributor to the revenue growth in the first quarter was net interest income. We recorded $210 million in net interest income in the first quarter, up 10% or $20 million from a year ago and up 2% or $4 million sequentially. The primary driver of the year-over-year increase in net interest income was balance sheet growth. Average earning assets equaled $51 billion in the first quarter, an increase of 18% or $8 billion year-over-year. Growth in average earning assets was broad based with money-market assets up 36%, securities up 13% and loans up 9%. Growth on the liability side of the balance sheet continued to fuel the increase in earning assets. Once again, and consistent with the trend from prior quarters, this growth was driven by foreign office time deposits, which averaged $27 billion in the first quarter, up 41% or $8 billion versus last year.

Continued growth in foreign office time deposits is directly related to our international success in the institutional custody business, which I discussed earlier. Our net interest margin in the first quarter equaled 1.68%, a decline of 11 basis points from the prior year. Our net interest margin improved by 1 basis -- basis point as compared with last quarter. Our lower year-over-year net interest margin once again reflects the liability-driven nature of our balance sheet. One of our core growth strategies has been to continue to build the cross-border custody and related asset servicing business that we administer on behalf of our clients. Our global business has grown at a very high rate, as reflected by a compound annual growth rate in global custody assets of over 33% in the 15 years since 1992. As this business grows, our clients place their short-term cash on our balance sheet in the form of 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 margin.

The next revenue item that significantly impacted first quarter -- the first quarter's strong performance was foreign exchange trading income. In the first quarter, foreign exchange trading in -- income equaled $67 million, up 20% or $11 million versus last year and up 24% or $13 million sequentially. The primary driver of the year-over-year and sequential increases was higher client volumes.

The final revenue line item that contributed to the strong growth this quarter was other operating income, which equaled $27 million in the first quarter, up 26% or $6 million year-over-year and up 9% or $2 million sequentially. Two factors drove the year-over-year increase in other operating income. The first represents the foreign exchange rate impact of translating nonU.S. dollar denominated assets and liabilities. The second reflects a higher level of custody-related overdraft income, which represents fees that we earn from our clients when they overdraw their accounts for a short period of time due to occasional funding mismatches. Both of these contributors to the increase in other operating income, foreign exchange translation impacts and overdraft income relate primarily to our international activities.

Credit quality remains outstanding at Northern Trust. During the first quarter we recorded no loan loss provision, compared with the provision of $4 million in the first quarter of last year and a $2 million provision in the fourth quarter. Nonperforming loans totaled $35 million at quarter end and equaled only 16 basis points of total loans as of March 31st. We recorded 2 -- a 2 -- $2.2 million in net charge offs during the first quarter, primarily reflecting partial charge off of one loan for which we maintain 100% reserve coverage.

Now let me shift my comments to a review of the key expense categories that impacted our first quarter performance. Expenses during the first quarter of 2006 equaled $526 million, up 11% or $53 million from the year ago quarter. On a sequential quarter basis, expenses were up 2% or $11 million. Compensation and employee benefit expenses accounted for over 50% of the year-over-year increase in total expenses. Compensation expense equaled $245 million, and increased 13% or $28 million from the year-ago period. The year-over-year increase in compensation expense of $28 million reflects additional staff to accommodate growth in expansion, higher cash-based incentives, our April 2006 annual salary merit increases, and market and promotional increases. Staffing levels equaled approximately 9,900 full-time equivalent positions at quarter end, up 9% from the year earlier period. On a sequential quarter basis, compensation expense increased 10% or $21 million, primarily reflecting higher first quarter stock-based incentives, cash-based incentives, and increased staff levels.

During the first quarter, stock option expense equaled $9.2 million, as compared to $2.4 million in the fourth quarter. Stock option expense is typically higher in the first quarter of each year due to the requirement to immediately expense options granted to retirement eligible employees. Employee benefit expenses equaled $57 million in the first quarter, up 2% or $1 million versus last year and 5% or $3 million sequentially. The year-over-year increase of $1 million reflects increased staff levels. The sequential increase of $3 million reflects higher medical and FICA insurance as well as certain ex-patriot cost in nonU.S. offices. You should note that we have expanded our disclosures this quarter to include outside services as a separate -- separate line item on our income statement. Previously, outside services had been a component of other operating expense. Previous periods have been restated in both our press release tables and in our financial trends report to reflect this expanded disclosure.

During the first quarter of 2007, outside services equaled $84 million, an increase of $9 million or 12% year-over-year. The year-over-year increase of $9 million primarily reflects expense categories that are driven by client volumes, such as global subcustodian fees and investment management subadvisory fees. In addition, technical and consulting services increased year-over-year, partially offset by lower legal expense. Outside services decreased $5 million or 5% as compared with the fourth quarter. This sequential decline was led by a lower level of professional services including legal and consulting expense. Occupancy expense in the first quarter equaled $38 million, up 8% or $3 million year-over-year and up 2% or $1 million sequentially. The year-over-year increase of $3 million primarily represents higher rent and building operations expense, as well as higher real estate taxes due to a real estate tax refund received in last year's first quarter. The sequential increase represents higher rent expense.

We have also enhanced our disclosure of equipment expense this quarter, expanding the definition of this line item to include software expense, which previously had been included in other operating expense. Prior periods for this change have also been restated. Equipment and software-related expense equaled $51 million in the first quarter, up 6% or $3 million year-over-year, yet down 10% or $6 million sequentially. The year-over-year increase reflects higher software expense due to our continued investment in technology. The sequential decline represents the typical annual pattern where the expense associated with the depreciation and amortization of equipment and capitalized software is typically lower in the first half of the year compared to the second half. Other operating expenses equaled $52 million in the first quarter, an increase of 19% or 18 -- $8 million year-over-year. The majority of the $8 million year-over-year increase was attributable to a litigation reserve accrual during the first quarter.

Other operating expenses decreased 5% or $3 million sequentially. The sequential decline reflected lower travel, hiring, and employee relocation expenses in the first quarter of 2007, when compared with the fourth quarter of 2006. Our first quarter results included approximately $3.8 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 March 31, we employed over 350 staff in India, up from 90 one year ago and approximately 270 at year-end 2006. Our provision for income taxes in the first quarter equaled $96 million and our tax rate equaled 33.9%. This compared with the tax provision of $87 million and a tax rate of 35% in the first quarter of last year. The lower tax rate reflects our decision to reinvest the earnings of certain nonU.S. subsidiaries indefinitely.

Our tax provision in the fourth quarter of 2006 equaled $71 million reflecting a tax rate of 29.5%. Recall that we recorded total tax benefits in the fourth quarter of approximately $9.9 million, including $7.9 million that represented the full-year impact of the nonU.S. subsidiary reinvestment decision that I mentioned earlier. In response to the recent adoption of two new accounting standards, we purchased only 43,000 shares under our stock buyback program in the first quarter at a cost of $2.7 million. Both of these new accounting standards resulted in the charge to capital. The first new accounting standard, SFAS 158, was adopted on December 31, 2006, and relates to pension fund accounting and the new requirement to record unrecognized actuarial gains or losses and accumulated other comprehensive income. The adoption of SFAS 158 reduced common equity by $160.8 million. The second new accounting standard, FAS 13.2 was adopted on January 1, 2007, and relates to the accounting for projected changes in leveraged lease cash flows. The adoption of FAS 13.2 reduced retained earnings by $72.3 million. We can purchase an additional 11.9 million shares under our buyback authorization approved by our Board of Directors in October of 2006. Diluted shares averaged 223.2 million up 900,000 shares from last quarter. In keeping with our practice, we increased average common equity by 9% versus one year ago to a record $3.9 billion at March 31. This represents the 76th consecutive quarter that Northern Trust has increased average common equity.

Let me close with a few thoughts on our competitive positioning and related opportunities that we see in the future for Northern Trust. From a financial perspective, Northern Trust continues to profile very well. Our financial condition is excellent, as measured across a wide variety of metrics. Profit margins, return on equity, credit quality, capital strength, interest rate sensitivity, revenue momentum, and many other metrics demonstrate the very sound financial footing evident at Northern Trust. In the first quarter we reported neutral operating leverage, despite absorbing the normal first quarter spike in stock option expense and the litigation reserve accrual. From a strategic perspective, we continue to be highly -- a highly focused financial services organization with a very strong brand identity. This focus and consistency, I think, is increasingly rare in the financial services industry. The market segments that we target exclusively are highly attractive from a demographic perspective, notably, the high growth affluent market in the United States and abroad and the vast pools of cross-border institutional assets globally. Our mission is to serve our personal and institutional clients with asset servicing and asset management solutions that exceed their expectations, which results in a total asset gathering model, whereby clients entrust us with ever-growing assets to administer and manage on their behalf. The opportunities in our businesses are excellent and bode well for our future growth and success.

From a business unit perspective, the first quarter was particularly gratifying for our Personal Financial Services unit. PFS trust investment and other servicing fees increased 14% in the first quarter, the highest year-over-year growth rate that we have achieved since the third quarter of the year 2000. As I mentioned earlier, PFS net new business in the first quarter was our second best quarterly result since the fourth quarter of 2001, surpassed only by our strong performance reported to you in the prior quarter. These outstanding results are a testament to the leadership position that PFS enjoys in the private banking community as best exemplified by Northern Trust being named the best private bank in the United States by "Euro Money Magazine" in March of 2007.

In addition, our growth and success in the first quarter emanates significantly from the many initiatives undertaken in recent years to better position our product offering and a wide array of proprietary and external investment solutions for our clients. In corporate and institutional services we continue to be extremely well positioned to win in the dynamic global marketplace. Our global custody assets reached $1.8 trillion at the end of the first quarter, an increase of 30% compared with last year, and 6% compared with year end. International activities now contribute 35% of the corporation's bottom line net income, having grown steadily over the years from just 7% in 1992. As further evidence of our success and positioning, Northern Trust was named European Pension Fund Custodian of the year for the fourth consecutive year by "International Custody & Fund Administration" magazine. We also received the award for the client relationship management team of the year at the same time. Our publicized new business wins in the first quarter demonstrate our success in the geographic markets and business segments that we focus on around the world. Recent publicized wins include: The El Paso Firemen and Policemen's Pension Fund, Texas A&M Foundation, Hampshire County and East Riding Of Yorkshire and London Borough of Hounslow Councils in the United Kingdom, the New Zealand Superannuation Fund, Dutch Pension Fund SBZ for health insurers and Generation Investment Management.

Finally, let me welcome Joyce St. Clair, a 15-year veteran of Northern Trust, to our executive team. Joyce was named Head of Corporate Risk Management in early April, and will relocate back to Chicago from London, where she has been heading the integration of the Financial Services group acquisition since early 2005. Joyce brings substantial industry experience and global operating knowledge to the vital role of risk management and is a welcome addition to our executive leadership team.

Now, before I conclude, I want to point out that our annual shareholders meeting begins at 10:30 central time this morning. As is customary for our first quarter calls, I will need to end today's call, allowing sufficient time for all of us to get to the annual meeting. Accordingly, please accept my apologies in advance in the event that we have to close off the question and answer period earlier than we would otherwise normally do. And now, Bev and I would be happy to answer your questions. Sheila, please open the call for questions.

Yes, sir, thank you. [OPERATOR INSTRUCTIONS] And we'll pause for just a moment to give everyone the opportunity to signal for questions. And we'll take our first question from Nancy Bush, NAB Research, LLC. Please go ahead.

Good morning, Steve, how are you?

Hi, Nancy. Very well. I hope you --

Question, we've had sort of trust and processing reporting morning this morning and the results have been very strong across the board. It certainly gives the appearance that a few companies are really dominating most aspects of the trust and processing world, although I know there are a lot of new entrants and -- and everybody's trying to get into the space to some degree or other. I would just ask if the pricing pressures or the -- the competitive pricing that we have seen in the last few years has abated any. If you could just give us your view of the pricing environment, particularly in the -- the custody businesses.

Sure. Well, I think first and foremost, you're right. There's been a tremendous consolidation in this business over the last 15 years or so, going from hundreds of players to a -- a relative -- from our perspective, a relatively small group of players, and all throughout that time, there has been downward pressure and we're referring here to the -- principally the custody fee line within our C&IS trust investment and other servicing fees. I don't think that has abated. We've had to battle that every quarter, every year for the last 15 plus that I can remember, and yet if you look at our trend report, that number has never -- the absolute number has never gone down, so I think the pressure continues to be there.

I don't think we're seeing a -- a slowing of that, but the key at least from our perspective, Nancy, is the bundle and not looking at that fee line unto itself. And the way that Northern Trust has managed this business is trying to make sure that, that fee line is in the context of a broader relationship, and in that respect, if you look at us from a margin perspective at the corporate level, at the -- at the -- or at the business unit level for C&IS, you'll see our margins have consistently been very high and very strong and we haven't seen that abate. So, yes, there is pressure, but we've been able to manage our way through that by balancing and broadening our relationships with clients.

Could you just also speak, while we're on the subject, to pricing on the personal side? I mean is it -- there's always been a recognition that that is a more price inelastic business, but is there greater awareness of fees, etc? Nancy, I think we have not -- the personal business has always been competitive and like any business, fees do matter, but in our experience clients hate to pick second best when it comes to handling their personal investment, fiduciary and related needs, and so as long as you are competitive, it's rare that the clients say the lowest price was X and if you don't match it I'm going to leave. So I would say that there's pressure there, but again, our margins have held up very nicely and the pressure is to make sure you're competitive, not rock bottom. Thank you.

You're welcome.

We'll take our next question from Mike Mayo, Deutsche Bank. Please go ahead.

Good morning.

Hi, Mike.

Can you talk about PFS and this quarter it looks like the high end did better than the lower end and last quarter the lower end did better. So which parts of PFS are seeing the greatest strength?

Mike, I think our PFS success really was very broad based, whether you want to look at it on a geographic basis across the United States in particular, or a segment basis in using the segment terms we use, the private client segment, the wealth advisory segment and the wealth management. One trend that you've been seeing for a very long time is the very consistent strong growth at the top end of the market in our wealth management business, but I think what we're seeing across the array is a demand for total solutions, credit, brokerage, fiduciary and asset management, and so we're -- we're very pleased with the results across the board and even in -- in states like Illinois, which is where we are headquartered and where we were founded and have been since 1889, we had very good results in the first quarter. So I'd characterize it as quite broad based.

And do you think some of the growth is a result of less interest in deposits? I mean, you're at a -- you're at the intersection of the two. Are are you seeing some of your clients say we'll take money out of the deposits and put it into the stock market or in other assets?

We -- we had had been seeing some run-off in deposits, but they rebounded nicely in the first quarter. Savings deposits equaled $9.2 billion up 11%, so we've seen competition for retail deposits, but the other thing that we saw even when our deposits were reducing and again, they were up in the first quarter, was that we saw significant increases in our money-market mutual fund balances, which again to just put that in perspective, our Northern Funds mutual funds -- money-market funds were up 14% year-over-year. So there has been certainly competition for deposits, but we had a nice rebound in the first quarter and also had good growth in our -- our mutual funds.

And the foreign office time deposits, those are a securities processing customers who choose to give you more deposits in lieu of fees?

No. Part right. Those are large -- very largely driven by the by the global custody clients that we have, who are paying us fees, but as part of their cash management they are sweeping residual cash onto our balance sheet. So it's not a question of in lieu of, it's a question of in addition to.

So why is that doing so much better?

Because as we continue to aggregate global custody assets, and you've heard the numbers up 30% and 33% compound annual growth rate over the 15 years, as we aggregate more client assets, there is more residual cash slushing around from time to time and they will ask us to manage that. So it's -- it's directly related to the growth in our global custody business.

Thank you.

You're welcome.

And we'll take our next question from Glenn Schorr, UBS. Please go ahead.

Hi, Steve.

Hi, Glenn.

Just a follow on to the foreign policy issue. I apologize for asking this again. It feels like there's variability, but similar to underlying steady asset under custody growth or on the global custody assets, it seems to be a rising tide of stable, if you will, foreign deposits as -- as well. I know it bounces around, but you're massing a pretty large base there. Any thoughts on going a little bit further on the risk curve than just putting it into money markets? Obviously, watching the net interest margin just hang out there feels like you're leaving a little money on the table in terms of maximizing balance sheet.

Well, one, you're right, but that has consistently grown. Two, you're right that, that notwithstanding there is some variability to it and -- but it -- but I would still characterize the base, if you will, as stable just because of the overall growth. We continue to evaluate the securities portfolio and -- and where we want to be and how we want to deploy that, but I don't have any -- any changes to advance at this point in time.

Okay. One other question. Looking at comp and -- and maybe getting rid of the noise from the sequential trends given first quarter, you look at it over year-over-year and comp is growing a little faster than revenues. You outlined the reasons of performance and healthcare cost and -- and higher staff levels. Head count was up 9% year-over-year. You're growing great, but curious on your thoughts on the ability to -- to control that line within reason, given the revenue environment and how that translates, obviously to operating leverage goals.

Sure. Well, one, I would say whether you want to look at our operating leverage sequentially or year-over-year, we feel good about the rebound in the first quarter. Two, I think our comp expense has been generally well managed. As you know, at different points in the cycle, we do see different competitive dynamics which -- so part of it is just a growing business and growing staff. Part of it is also the environment for people and the competition for people, and so -- and I would characterize the current environment as one of those competitive bubbles. So I think that's a factor, but we have always been mindful of the balance, and I think we can manage that equation effectively. So, again, we've seen these spikes before, but I think we can manage through it.

Okay. Thanks, Steve.

You're welcome.

And we'll take our next question from Robert Lee, Keefe, Bruyette, Woods. Please go ahead.

Thanks, good morning, good morning, Steve.

Hi, Rob.

Two quick questions. I think I missed the comment. Was there an $8 million litigation reserve in the current quarter in the other expense?

No.

That's a comparison to last quarter?

Yes, well, let me clarify. In our first quarter other operating expenses increased by $8 million year-over-year. The majority of that increase was related to a litigation reserve, so it's not an $8 million litigation reserve. It's a majority of the increase.

Okay. And could you maybe comment a little bit on asset servicing in the U.S.? Clearly, you've seen -- continue to see very strong growth outside the U.S. But it seems like the domestic assets have been growing at fairly, pretty moderate pace. Could you maybe give -- bring us up to speed on what your pipeline or sort of what you're seeing in the competitive environment in the U.S.? And have you made any kind of maybe a conscience decision to allocate more resources outside the U.S. versus -- versus the U.S. in that business?

Well, I don't know if I'd -- I'd characterize it as a trade off between international and North America, but I would say that we have, as you know, Rob, had a longstanding dialogue with the importance to growing the international business. And the reason for that being the profitability dynamics and growth dynamics that we like, and we've been quite successful on that and we -- we continue to see strong momentum and good pipelines there. In terms of the domestic, and, again we're talking about the C&IS business, our pipelines look good across all the seg -- segments, and I think we're seeing a little bit of a pick up in terms of opportunities in the wake of some of the merger announcements. We're also going to see later this year, or we expect to see later this year, a significant growth in the pipeline with public funds, because a lot of -- a lot of public funds unlike every other segment of our business are on contracts that go out for rebid. So we like what we're seeing domestically and the opportunities to -- to grow that side of our business at a higher rate.

Okay, great. That was it. Thank you.

You're welcome.

And we'll take our next question from Brian Bedell, Merrill Lynch. Please go ahead.

Hi, good morning.

Hi, Brian.

One quick question, on the operating expenses, just looking back at the fourth quarter, maybe you said this and I missed it, but what was the reason for the increase in outside services from third quarter to fourth quarter?

From the third quarter to the fourth quarter.

$76 million to $89 million?

Yes. I think what we had talked about was it -- was, Brian, that it was broad based across a variety of categories and there was no one driver for the sequential increase third to fourth.

Okay, and is it something that just going forward that you -- that we -- you think we'll see seasonally in the fourth quarter or kind of not predictable?

No. I think we certainly have not suggested that there's any seasonality to it. As you know, our business ebbs and flows and we have a wide array of initiatives, whether it's expanding our activities and alternative asset pricing, whether it's building out our open architecture, whether it's expanding our operations in Bangalore and Limerick and risk management infrastructure and the like. So, and so the expense is associated with that ebb and flow, but I don't think there's any trend to it.

Right. Do -- do you feel that you've made a lot of investments in 2006 across your businesses that you think you'll be able to better leverage in '07, or should we see continued really strong pace of investment spend in the businesses?

I think, Brian, we'd love to say that we put our investments down this year and then it diminishes what we have to do in the subsequent years, but it just never seems that way.

Right.

Which isn't to say they don't pay off, but you have to juxtapose investments we put down today as against a growing business, nationally, internationally, with product types, with client types, and so we -- and a business that has a big technology component, which is -- which is always dynamic. So, no, I expect that we'll continue to have to invest in this business and I don't expect a drop off on that front.

Right. Okay. And that kind of leads into my next question. Just looking at this sequential -- or not sequential, I'm sorry, the year-over-year quarterly growth progression in PFS fees, the global custody assets, and C&IS investment management, we've seen a pretty good pick up. PFS has gone from high single-digit growth in '05 into '06, and now we're looking at low teens growth over the last couple quarters. C&IS has had a big turn in the last -- when I say C&IS, I mean C&IS investment management, has had a big turn from mid single-digits to high single, low double-digit growth in the last couple quarters and global custody continues to grow at 30% plus rates. If you could just touch on a couple -- maybe just one or two major things that you guys think you've done in terms of executing in those areas, like particularly PFS and C&IS, that have turned that around, and whether you think that momentum is relatively sustainable given reasonable equity markets.

Well, I can never predict the future, so I'll -- I'll pass on that one. But what I would say, Brian, is remember that our asset accumulation growth is the output of serving clients well and having products that are performing well. So it doesn't start with global custody growth or PFS asset growth and so forth. It starts with client centricity, executing well on what is expected of us, and that in turn fuels the growth, and I think it is in that context that I would focus and say that I think we have done a very good job of serving clients across all our business units, if you want to look at it that way, PFS, C&IS and Northern Trust Global Investments and that is important. The other thing is that we have continually, in terms of asset management capabilities, expanded the spectrum of what we offer and are also continuing to improve the performance in quality. So I think the asset accumulation, if you will, is the outgrowth of good service and relevant and well-performing products, and we need to keep that up, but if we do that, I think the growth in assets will come.

Right, and it sounds like your execution has definitely improved in the last few quarters relative to say back in '05 and '06.

Yes, I think it has.

Right. Okay, great. And maybe just very lastly, just on the global custody business, your growth in Europe, is that still primarily in the Netherlands and the Nordic region and in the UK?

It is broad based, but yes, we've had terrific growth there. We've also had terrific growth in the Middle East and in the Asia Pacific region. So it is -- Europe is the biggest of those three regions, but make no mistake, the -- the growth is broad based.

Right, and then, but within Europe, you still foresee the pipeline being pretty -- pretty good going forward?

Yes. The pipelines continue to be very solid, so there -- there will always be fluid it to the timing of decisions and transitions as we've absolutely seen quarter to quarter, but, no, we like what we see out there and we just need to execute.

Great. Great. Thanks very much.

You're welcome, Brian.

We'll take our next question from Gerard Cassidy, RBC Capital Markets. Please go ahead.

Good morning, Steve.

Hi, Gerard.

A couple questions. The first is on the PFS area. Obviously, you guys reported very strong year-over-year growth in that area, and in the numbers that you've given us in the past when you break out the different areas,whether it's Illinois or Florida, Florida has in the past lagged the growth of the total growth of PFS. It seemed to lag a little more this quarter than in prior years. Any -- is the real estate market having any impact on the business down there?

Yes. I don't think it's the real estate market. Just to put it in perspective, our fees in Florida were about $50 million in the first quarter, up 7% year-over-year and 2% sequentially, and that was of our -- relative to Illinois wealth management and our other areas the slowest growing, but growing piece of our franchise. I think our Florida franchise continues to be excellent. It continues to grow. This noted, there is no question that there has been a build up of competition in Florida, and that that competition is intense, and so we clearly are seeing that. But I would say we've seen bumps and bruises in all parts of our business over time, and I still feel quite good about Florida and the opportunities, but I think it's fair to say there's definitely a lot of financial institutions that have been flooding into Florida over the last five years or so.

Okay. And then the second question, back to the net interest margin that held in there very nicely, considering the net interest spread dropped sequentially a fair amount. How are you guys able to offset the compression in the net interest spread by putting -- by delivering a higher net interest margin?

Sorry, Gerard. Could you repeat the question?

Sure. I notice the net interest spread, it seemed to have declined in the quarter sequentially by 15 basis points, and in the past it seemed like when your spread was coming down, your margin would also come down, not as much, but it would be under pressure, and this quarter you were able reverse that trend in the margin even though the spread continued to decline. I didn't know if there was a greater emphasis on particular higher-yielding asset that you had in there, or greater percentage of lower-cost deposits that -- that helped boost that margin?

Hi, Gerard -- Gerard, it's Bev speaking here.

Yes.

I think partially what you're seeing there is a slight deleveraging of the balance sheet this quarter, and that is a phenomenon that as -- as Steve said earlier can ebb and flow. So, I think that what you're seeing, actually if you look at a few of the line items on the balance sheet, I'm looking at averages, for example, other purchase funds were down on a sequential quarter basis, on an average basis. So, I think that's what you're seeing there, which again is something that can ebb and flow, in particular taking into account year-end balances that might be on and off the balance sheet. So, I think that's actually what you're -- what you're primarily seeing there.

Thank you.

You're welcome.

And we'll take our next question from Tom McCrohan, Janney Montgomery Scott. Please go ahead.

Hi, Steve. Hi, Bev.

Hi, Tom.

Quick question on securities lending and I had a follow up on the balance sheet. The securities and lending collateral's really was up sequentially, pretty materially up about $50 million. Just wondering if you had any comments on what was driving that and what the implications can be for the fees you earn on that collateral going forward.

I think, Tom, a lot of that is -- is -- it's really two things. One, it's clients coming in -- aggregating new clients, winning new assets and a subset of those clients participating in our securities lending portfolio, or program rather, and the second piece is just the market growth. So, I think it -- well, I won't say it portends for good things, but I think we continue to see demand from our clients for securities lending, and we continue to build out the collateral pools, which also makes us a more attractive firm to borrow from, so we're -- we're pleased with that.

Was there anything in particular that happened this quarter, because it's been kind of bumping about $240 million to $247 million the last -- looking at your trend report, and really $50 million sequential increase for the quarter is pretty substantial. So, is there anything going on in particular this quarter on the new business front, or something with the collateral pools?

There was no one-time event. It's more likely just growth in markets and -- and the -- if you will, the ad hoc participation of our clients. There's certainly no one event that drove it.

Okay. And in connection with the balance sheet, just want to get a sense for directionally how we should model the growth of the balance sheet going forward, and you've talked in the past about there is somewhat of a correlation between the growth in assets with the custody and how that results in deposits, and that funds the growth of the balance sheet. What -- what rate of growth should we be modeling for, for your balance sheet going forward? And is that the way we should be thinking about it, somewhat of a correlation with assets under custody? And secondly, if you do see like a sequential decline in your balance sheet for a quarter like we saw with your competitors today, what would drive that? I mean, what would drive a sequential drop in your balance sheet going forward? I know it can -- the direction it's going up, it's going higher, but sometimes we see these one quarter drops and it just kind of mystifies me on why that happens.

Well, I think in terms of balance sheet growth, I'll -- I'll let you model that out as you see fit. It's not something that I would be in a position to comment on or predict. As a general proposition, I think you do want to think about the -- how you view our global custody business and the growth in that and the related foreign office time deposits that come on the balance sheet, but that's going to ebb and flow, but -- but directionally I think it's been positive. In terms of a drop, at a competitor, I think I'll -- I'll leave that for them to discuss and I don't think I want to comment on that one.

And now -- and I want you to comment from here, just in your own business mix, if you have, Steve, say 20% growth in assets under custody this year, in what situations could we actually see a decline in the balance sheet from Northern Trust?

Well, I -- I think it's too hypothetical. Obviously if people took cash away or converted cash into funds in a significant way, you could do that, but it -- I'm hesitant to go farther than that, Tom, because of the hypothetical nature of it and we haven't seen that.

Yes, okay. I'm just trying to understand the dynamics and how that works. And then on the pricing or the yields that you're paying on foreign office time deposits, is it fair to say all the custodians are all competing and should be subject to the same directional trends in the yields on foreign office time deposits, or is that a market you guys are making?

Well, I don't know that it's only the global custodians. I mean, there's a -- there's an interbank market for deposits and we and our direct competitors and others are a part of that. But no. There -- there's -- there's certainly a competitive dynamic to -- that we have to be in line with and I'm sure they do as well.

Is there a reference rate that we should be using as a proxy for the directional trend in foreign office time deposits?

No. It does move around.

So does that suggest you guys actually make the market there instead of you not being price takers?

Well --

If it moves around, what's making it move around? It's not subject to the market?

Well, it's what -- what our judgment about what competitive rates are to earn balances of clients, and under different conditions those rates will move a little bit. But I certainly wouldn't want to suggest that we are the market. I think there's a very real competitive dynamic.

Okay. So -- and sorry to keep drilling down this. So, can you in a way, Steve, control the amount of deposits on your balance sheet based upon the yield you're providing customers, is that fair to say on foreign --

No, I don't think so, Tom, because one dimension is competitive rates, another dimension is just how much they have in cash.

Yes.

And that's a function of what they're doing with their broader investment portfolios. So, there -- there -- there can be variability in what they have with us at any given point, but again, in our case at least, as we have continued to dynamically grow the growth in global custody assets in the aggregate, even to the extent that a client's cash balances are moving up and down and might move down because they are more invested in the market, the overall growth for us is far outstripped that, so we haven't seen a drop.

Got you. Okay, thanks very much.

You're welcome.

We'll take our next question from Ken Usdin, Banc of America Securities. Please go ahead.

Thanks, good morning.

Hi, Ken.

Steve, I was wondering if you could just give us some updated thoughts on the dislocation in the markets on both the asset servicing side and the private banking side. I mean, five or six deals out there on both sides, just wondering if, A, you have seen anything to date on either side as far as in potential new business wins. And B, how you'd expect that to play out over time?

Sure. Well, historically, Ken, we have found that larger scale M&A transactions have been disruptive for clients, and therefore, that has been good for Northern Trust in terms of dislodging opportunities. And we've seen this in both our personal business and our institutional business, and over the years if you were just going to throw out examples they would include: Bankers Trust and Barclays and Deutsche Bank and First Chicago, Lloyds, NatWest, various JPMorgan amalgamations, U.S. Trust to Schwab. And the reason that we found this to be good for us, at least, has been that large scale M&A transactions generally are difficult to execute well and integrate without impacting clients. When we look at the environment today, we do see higher levels of potentially disruptive activity in the marketplace that we target, so you're well aware of the Bank of New York-Mellon transaction, State Street's acquisition of Investors Financial, we've got ABN Amro, and I mention them because of the ABN Amro-Mellon joint venture, kind of in play with Barclays and RBS -- the RBS consortium. You've got Citigroup going through a variety of issues, you've got Schwab -- on the personal side, you've got Schwab selling U.S. Trust to Banc of America, you've got First Republic having been purchased by Merrill Lynch. So, there's a lot of stuff that is going on, and if it is to be consistent with the past, that will generally auger well for us.

Now remember it doesn't happen on the day of an announcement. It takes time, transactions haven't closed, even after transactions closed you have to have disruption and degradation of service and turnover of people and all that sort of stuff. So we'll see how it goes, but generally speaking, I would characterize this as a positive oppor -- potential opportunity for Northern Trust.

Thanks a lot, Steve.

You're welcome.

And we do have a follow-up question at this time from Nancy Bush, NAB Research, LLC. Please go ahead.

Steve, just a quick question on Bangalore. I think you said you were at 350 people at the end of the first quarter, and, as I recall, was -- wasn't that about sort of the upper end of the people that you were going to have employed there? If you could just comment on sort of the buildout of Bangalore, and how much more there may be there.

Well, we -- we haven't really set an upper end, and I doubt, frankly, Nancy, that 350 will be the upper end, as we continue to grow and as the performance of of our team in Bangalore continues to be excellent, which it has been to date, we're excited about the opportunities there. So -- so, there's no upper bound. I think 350 directionally was probably consistent with our early dialogue on the subject of directionally where we would be, but we're certainly not capping that and I expect that that number will grow on average over time.

Do you have the space there now to support sort of ever-growing head count there? Is there a possibility you may have to add more space?

Well, we did -- when we initially set up our Bangalore facility, we took a big chunk of space and we took an option on some additional space and we did exercise that option and have built that out. So we, at least as of now, I think, are in good shape from a physical capacity perspective.

Alright, thanks very much.

You're welcome.

And we do have a follow-up question from Robert Lee, Keefe, Bruyette & Woods. Please go ahead.

Thanks, Steve. I'm just curious. I mean, the FSG acquisition is, I guess, pretty much in house at this point and it's been a year or two, and when you look at your product portfolio or your capabilities, do you -- are you -- do you see any area where you either feel there is a hole at this point, or a capability where you think you do need to perhaps add some additional scale, whether it's an alternative fund administration or something?

Robert, it's a good question. There are always things we can do better, but I'd actually probably turn that around and say, we are so pleased that we made that acquisition, because had we not done it we would not have been in the position that we're in today vis-a-vis private equity administration and hedge fund administration, and that has been an important growth opportunity for us. So, I would actually probably turn it the other way and say that there are always going to be things on the continuum that either we don't have and want to have, or have but want to improve, or have changed, but I think the FSG acquisition has really been important for us in dealing with this world shift to alternative investments. So, I'd view it quite positively thus far.

Okay. But there's nothing that jumps out that this is a space or a capability that you need to bulk up in, maybe is the way to put it, in relatively short-term and you think it pretty much has the products you need at this point in time?

That's correct.

Okay. Thank you.

You're welcome.

And at this time we have no further questions. I would like to turn the conference back over to the speakers for any additional or closing remarks.

Well, thank you very much for joining us, and we will look forward to updating you at the end of our second quarter. So have a great day. Thank you.

That concludes today's presentation. We thank you for your participation. You may now disconnect.