Northern Trust Corp (NTRSO) 2007 Q2 法說會逐字稿

Good day, and welcome to the Northern Trust Corporation second 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 opening remarks and introductions, please go ahead.

Thank you, Lindsey. Good morning and thank you everyone for joining us to review Northern Trust second quarter 2007, financial results. Joining me this morning are Steve Fradkin, our Chief Financial Officer, Aileen Blake, Controller, and [Presay] Sullivan from our Investor Relations Team. For those of you who have not received our second 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 July 18 call is being webcast live on Northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through July 25. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now for your 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 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 you joining us for Northern Trust's second quarter 2007 earnings conference call. Earlier this morning, Northern Trust reported very strong second quarter 2007 earnings of $0.92 per share, up 21%, compared to the $0.76 that we reported in the second quarter of 2006. Net income for the quarter exceeded $200 million for the first time in our history, equalling a record $207 million, up 23% year-over-year. This was our tenth consecutive quarter of double-digit year-over-year growth in earnings per share and your ninth consecutive quarter of double-digit year-over-year growth in net income.

Accumulation of client assets both custody and managed also continued at a record pace. Assets under custody equalled $4 trillion up 26% or $829 billion compared with one year ago, and up 6% or $235 billion sequentially. This very strong performance in aggregating assets under custody was mirrored in that assets that we manage on behalf of our clients. Assets under management equalled a record $766 billion at the end of the second quarter, up 20% or $126 billion versus one year ago, and up 1% or $11 billion sequentially. We have organized today's call to address three areas. First, for the benefit of those of you who maintain detailed models on Northern Trust, I will outline a few items that you should consider as you analyze our second quarter results. Second, I will review our financial performance, focusing on those areas that most impacted the second quarter's strong results. And third, I'll offer a few perspectives on the competitive positioning of Northern Trust in the very attractive markets on which we continue to focus. As always, Bev and I will then be pleased to answer your questions at the conclusion of my prepared remarks.

As you evaluate our second quarter financial performance, I want to draw your attention to six items that impacted our results. First, during the second quarter, we recorded $4.9 million in gains related to the sale of certain leased equipment. These sales occurred in the normal course of events at the end of scheduled lease term, and are recorded as part of other operating income.

Second, and also included in other operating income is a $3 million loss on the sale of a subsidiary located on the Isle of Man. This loss on sale was taken in connection with a strategic disposition of a very specialized fund administration business that came to us in 2005, as part of our acquisition of the Financial Services Group of Baring Asset Management. The Isle of Man business was small, employing 17 staff, and generating annual revenues of approximately $6 million. This business was not the target of our original strategic acquisition rational. Quite simply it did not fit with our broader market and fund administration strategy.

Third item occurred within net interest income. Net interest income in the quarter was reduced by approximately $7 million, reflecting the entire first half year impact of our adoption of FASB staff position 13-2 more commonly referred to as FSP 13-2. Recall, as outlined in our first quarter Form 10-Q, that FSP 13-2 requires recalculation of lease income if the expected timing of leveraged-leased income tax cash flows is revised. We expect that across full-year 2007, net interest income will be reduce by a total of approximately $14 million with the remaining 2007, approximate reduction of net interest income of $3.5 million in the third quarter, and $3.5 million in the fourth quarter.

Our fourth item was recorded on the equipment and software expense line where we wrote down $3 million of computer software. Our fifth item was on the occupancy line, where we incurred a $3 million one-time charge for rent adjustments. And finally, our income tax provision this quarter included a $3.5 million tax benefit related to lower state taxes on leveraged leased cash flows. Recall that our results in the second quarter of last year, included $15 million in additional tax reserves related to our leveraged leased portfolio.

Now let me review the quarter's key performance drivers. I'll start with revenues, focusing on the major items that impacted our results. Total revenues equalled $882 million in the second quarter, up a strong 11% or $90 million compared to last year's second quarter. Revenue growth was very strong on a sequential quarter basis as well, increasing 7% or $59 million when compared with the first quarter. Our largest revenue line item, trust investment and other servicing fees, which represented 60% of total revenues in the second quarter -- represented 60% of total revenues in the second quarter.

We are extremely pleased with our growth in this important revenue category, across both our private client and institutional businesses. Trust investment and other servicing fees increased 18% or $80 million to $534 million compared to the second quarter of last year. Fee's in PFS our private client business were very strong in the second quarter reaching a record $224 million. This represented an increase of 16% or $31 million compared with the year ago quarter, and 4% or $9 million sequentially. This excellent growth reflects strong net new business results in the quarter. PFS net new business in the second quarter represented our third best quarterly result since the fourth quarter of 2001, surpassed only by our strong performance reported to you in the prior two quarters. Our new business success in PFS across the last three quarters is very gratifying. We believe this success has been driven by a number of factors, including our fiduciary expertise, industry-leading technology and the efforts we have undertaken in recent years to broaden the spectrum of both proprietary and external investment solutions that we can harness to meet specific client objectives.

As you evaluate our strong growth in PFS fees in the second quarter, recall that all PFS fees are on a consistent monthly fee methodology. Using this monthly methodology the S&P 500 was up 14.4% compared to last year, and 4% compared to last quarter. Keep in mind, too, that PFS manages broadly diversified portfolios for clients. The asset allocation of PFS Managed Assets as of June 30, was 49% equities, 24% fixed income, and 27% cash and other asset classes. In the private client business, fee growth is derived largely from growth in client assets. We have been very pleased with our ability to aggregate private client assets at attractive rates of growth. PFS Assets Under Management equaled a record $144 billion at June 30, up 17%, or $21 billion from a year- ago, and up 4%, or $5 billion sequentially. Assets Under Custody in PFS also equalled a record, reaching $319 billion at quarter-end. PFS Assets Under Custody increased 36% or $84 billion from a year- ago, and were up 7% or $22 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 world's wealthiest families. 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 well over $400 million at June 30. Fees in our Wealth Management Group for the second quarter equalled $34 million, an increase of 26% or $7 million year-over-year, and 4%, or $1 million sequentially. Our success in the marketplace has fueled excellent growth in Wealth Management client assets. Custody assets in Wealth Management equalled $185 billion at June 30, up 55% or $66 billion from one year- ago and up 5% or $9 billion sequentially.

We also manage a portion of the assets that our Wealth Management clients have placed in custody at Northern Trust. Managed assets in Wealth Management totaled $30 billion at June 30, up 29%, or $7 billion year-over-year and up 7% or $2 billion as compared to the first quarter. Fees in C&IS, our Institutional business unit also reached record levels in the second quarter. C&IS fees equalled $309 million, an increase of 19% or $49 million year-over-year, and 13% or $35 million sequentially. C&IS fees incorporates three primary revenue areas. Custody and fund administration, institutional asset management, and securities lending.

Let me briefly discuss the performance of each in the second quarter. C&IS custody and fund administration fees equalled $148 million in the second quarter, up 21% or $26 million year-over-year. This strong double-digit custody fee growth was driven by new business, particularly in global custody and market growth. Sequential growth in C&IS custody fees was also strong up 5% or $7 million compared with the first quarter driven primarily by new business. Recall that C&IS custody fees are billed primarily on a one-quarter lag basis. For the year-over-year comparison, the S&P 500 was up 9.7% versus the prior year on a one-quarter lag basis and the EFAE Index was up 8.7%. Market growth on a quarter-lag sequential basis was less strong with the S&P 500 essentially flat in the first quarter and the EFAE Index up 2.8%. Investment management fees in C&IS equalled $71.4 million in the second quarter, an increase of 15% or $9 million year-over-year. This 15% year-over-year growth rate surpasses our strong growth last quarter, and represents the highest growth rate we have achieved in this category since the first quarter of 2004.

New business results were very strong in quantitative management, manager of managers, and short duration, including institutional mutual funds and cash sweet products. Institutional Investment fees were essentially flat on a sequential quarter basis. Securities lending results were also very strong in the second quarter with fees equalling a record $73 million, up 21% or $12.5 million versus one year ago. The year-over-year increase was driven by significantly higher volumes. Securities lending collateral equalled $300 billion at June 30, up 27% or $64 billion versus one year ago. On a sequential quarter basis securities lending fees were up 61% or $28 million compared to the first quarter. Seasonally strong second quarter performance reflects the traditional peak in securities lending associated with the international dividend season. On the asset accumulation front, we continued to achieve very strong growth trends in the second quarter of 2007. Institutional assets under custody equalled a record $3.7 trillion at June 30, up 25% or $745 billion from a year ago, and up 6% or $214 billion versus last quarter. Asset growth both year-over-year and sequential reflects continued new business success, particularly in international markets, and higher equity market valuations.

Our strong competitive positioning and ongoing success outside the United States continued in the second quarter. Global custody assets equalled $1.9 trillion at June 30, an increase of 34% from a year ago, or $485 billion. The second quarter represents the seventieth 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 8% or $136 billion. The assets that we manage on behalf of institutional clients also exhibited strong year-over-year and sequential growth. Managed assets, for institutional clients equalled a record $622 billion at June 30, up 20% or $105 billion from last year, and up 1% or $6 billion sequentially. In summary, our growth in trust investment and other servicing fees in the second quarter was very strong, and broad-based across our mix of businesses.

Net interest income in the second quarter equalled $209 million, an increase of 5% or $10 million compared with last year. On a sequential-quarter basis, net interest income declined $2 million or 1%. The driver of the year-over-year increase in net interest income was balance sheet growth, off-set partially by a lower net interest margin. Average earning assets equalled $53 billion in the second quarter, an increase of 15% or $7 billion year-over-year. Growth in average earning assets was broad-based with money market assets up 19%, securities up 17%, and loans up 10%. Client oriented growth on the liability side of the balance sheet continued to fuel the increase in earning assets. Once again, and consist went trends in prior quarters, liability growth was driven by non-U.S. office time deposits which averaged $28 billion in the second quarter, up 27% or $6 billion versus last year. This strong growth in non-U.S. 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 second quarter equalled 1.58%, down 15 basis points from the prior year, and down 10 basis points sequentially. Two factors contributed to the decline in our net interest margin on both a year-over-year and sequential-quarter basis. First, as I mentioned at the beginning of this call, net interest income was reduced by $7 million during the second quarter, representing the entire first half impact of our adoption of FSP 13-2. Recall as outlined in our first quarter Form 10-Q that FSP 13-2 requires recalculation of lease income if the expected timing of leveraged lease income tax cash flows is revised. We expect that across full-year 2007, net interest income will be reduced by a total of approximately $14 million, with the remaining 2007 approximate reduction in net interest income of $3.5 million in the third quarter, and $3.5 million in the fourth quarter. This second quarter 2007 item had the most significant impact on both year-over-year and sequential declines in the net interest margin. The second factor contributing to our lower net interest margin was higher funding costs. Non-U.S. office deposit costs increased both year-over-year, and sequentially, due primarily to rising rates in the Euro and Sterling. The cost of savings deposits also increased primarily due to a very competitive banking environment for retail deposits.

Foreign exchange trading income in the second quarter equalled $81 million, down 4% or $3 million compared with our very strong record results in the second quarter of 2006. On a sequential-quarter basis, foreign exchange trading income was up 21% or $14 million, driven by higher client volumes. The final revenue line item that contributed to our growth this quarter was other operating income, which equalled $29 million in the second quarter, up 24% or $6 million year-over-year, and up 6% or $2 million sequentially. Other operating income in the second quarter included two items that I mentioned earlier, $4.9 million in gains on the sale of leased equipment and the end of scheduled lease terms, partially offset by a $3 million loss on the sale of a specialists fund administration business on the Isle of Man. Excluding those two items, other operating income would have increased 16% year-over-year. Credit quality continued to be excellent at Northern Trust. During the second quarter, we recorded a loan-loss provision of $4 million, compared with the provision of $3 million in the second quarter of last year, and no provision in the first quarter of this year.

Non-performing assets totaled $32 million at quarter-end, down $5 million from $37 million on March 31, and equalled only 13 basis points of total loans on June 30. We recorded $2.3 million in net charge-offs during the second quarter. Now let me shift my comments to a review of the key expense categories that impacted our second quarter performance. Expenses during the second quarter of 2007, equalled $555 million, up 13% or $63 million from the year ago quarter. On a sequential-quarter basis, expenses were up 6% or $29 million. Compensation expense equalled $251 million, and increased 14% or $30 million from the year ago period. The year-over-year increase in compensation expense reflects additional staff to accommodate growth in expansion, our April 2007 annual salary merit increases, higher incentive compensation, and market and promotional increases.

Staffing levels equalled approximately 10,250 full-time equivalent positions at quarter-end, including approximately 500 staff at our operation center in Bangalore, India. Total staff count was up 10% from last year. On a sequential-quarter basis compensation expense increased 3% or $7 million, primarily reflecting the April 2007 annual salary merit increase, and increased staff levels, offset by lower stock option expense. Recall that stock-option expense is typically highest in the first quarter of each year reflecting the accounting requirement to expense all options granted to retirement eligible employees in the quarter in which they are granted. Employee benefit expenses equalled $59 million in the second quarter up 5% or $3 million versus last year and 4% or $2 million sequentially. The year-over-year and sequential increases were primarily driven by higher staff levels.

Outside services equalled $94 million, an increase of 22%, or $17 million compared with last year, and 11% or $10 million sequentially. The year-over-year increase primarily reflects expense categories that are driven by increasing client volumes, such as global sub custodian and investment management sub advisory fees. In addition, technical services increased year-over-year, offset partially by lower legal expense. The sequential increase was driven by higher asset values and transaction volumes, which drove higher global sub custodian fees and sub advisory fees. Occupancy expense in the second quarter equalled $42 million, up 7% or $3 million year-over-year, and up 11% or $4 million sequentially. Recall, as I stated earlier, that occupancy expense included a $3 million rent expense adjustment in the second quarter, representing catch-up related to certain rent escalation clauses in existing leases.

In addition, occupancy expense in last year's second quarter included a $4.8 million one-time charge related to the exit of a lease prior to expiration. Excluding those items, occupancy expense would have been up 14% year-over-year and 3% sequentially. Equipment and software-related expense equalled $56 million in the second quarter, up 13% or $7 million year-over-year and up 9% or $5 million sequentially. This category also included an item that I mentioned earlier, a $3 million software write-down. Excluding that item, equipment and software expense would have increased 7% year-over-year, and 3% sequentially. Our provision for income taxes in the second quarter equalled $103 million resulting in a tax rate equal to 33.2%. This compares to $113 million in the second quarter of 2006, when we recorded $15 million in additional tax reserves, as I mentioned earlier.

Second quarter 2007 taxes included a one-time tax benefit of $3.5 million, reflecting the cumulative effect of reduced state taxes on certain leveraged lease transactions. Without that item, our tax rate in the second quarter of 2007 would have been 34.3%. Northern Trust repurchased, 798,000 shares of common stock in the second quarter at a cost of $51 million. Diluted shares averaged 224 million, an increase of 1 million shares from last quarter. We can purchase an additional 11.1 million shares under a buy-back authorization approved by our Board of Directors in October of 2006.

In keeping with our practice, we increased average common equity by 10% versus one year ago, to a record 4.1 billion at June 30. This represents the seventy seventieth consecutive quarter that Northern Trust has increased average common equity. That, by the way, and just to make the point clear, translates into more than 19 consecutive years.

Let me close with a few thoughts on our competitive positioning in the very attractive markets on which we continue to focus. At the highest level, we continue to enjoy a very distinctive position within the financial services arena. We are executing well and continue to be very sharply focused on serving the complex and ever-evolving needs of a very strategically targeted set of clients. I should add that the expected growth demographic, for the segments and specific client types that we target and serve continues to be very attractive. We are also seeing significant disruption in the personal and institutional markets that we serve. In our experience over many years, disruption, whether caused by mergers, acquisitions, competitor financial challenges, or shifts in leadership or strategies, creates opportunities for us to dislodge attractive clients from our competitors. This phenomenon in addition to the overall attractive profile of our target markets is one we will continue to try and capitalize on in the years to come. From a business-unit perspective, the word that I used last quarter, gratifying, again applies to our excellent performance in PFS.

PFS trust investment and other servicing fees increased 16% in the second quarter, the highest year-over-year growth rate that we have achieved since the third quarter of 2000, and surpassing our strong 14% growth last quarter. PFS net new business results across the past three quarters have been consistently strong and are at the best levels we have seen since the year 2001. In PFS, we continue to invest in our business across multiple fronts, including our physical presence. During the second quarter we announced the opening of our eighty fifth office in Wheaton, Illinois. We are one of the last remaining, truly home town financial institutions in Chicago. This new office brings our location count in Illinois to 19, positioning us extremely well to service the most trusted provider of financial services to our target markets and to the attractive and growing corridor of effluents in the western suburbs of Chicago. We have also continued to strengthen and enhance our brand in PFS through event marketing, strategic philanthropy and the continuation of ongoing initiative like our television and print advertising campaign. One recently announced example was our decision to continue as national sponsor of the King Tut common exhibit when that blockbuster event returns to the United States in 2008. The exhibit will travel from 2008 to 2011 to nine cities where we have PFS office presence.

In corporate and institutional services we continue to like our positioning in this attractive and continuously consolidating marketplace of providers. Our institutional business experienced significant new business success in the second quarter as exemplified by a number of publicly announced wins, including the $29 billion State of Tennessee Consolidated Retirement System, the University of Kentucky Endowment, the City of Fort Worth Retirement Fund, Fund Total Asset Management, Go-Tex Fund Management, and in the largest custody mandate ever to be awarded out of Australia, the U. S. dollar or $42 billion or Australian dollar $51 billion Australian Government Future Fund, which was established to accumulate sufficient financial assets to offset the Australian Government's unfunded super annulation or pension liability over time.

We were also pleased to see during the quarter, external acknowledgement of the strong competitive positioning that we enjoy around the globe. In earlier this month, Northern Trust received the Global Investor Editorial Award for Fund Administrator of the Year. In we were named as the Third-Party Administrator with the most consistent performance across all areas of fund administration. Just last week, Northern Trust was named Best Investor Services House at the 2007 Euro Money Magazine Awards of Excellence held in London. The award cited our notable international mandate wins, our world-class custody business, and our leadership in the fund administration space. These awards signify the investments we have made and continue to make in both people and technology to support our growing global business.

Northern Trust Global Investments, our asset management business continues to be well positioned to serve the investment needs of our personal and institutional clients. Our broad product lineup covers a wide array of asset classes and styles, offering our clients a variety of solutions that incorporate both proprietary and external managers. With $766 billion in total assets under management, Northern Trust Global Investments ranks as one of the largest managers in the world. We remain the third largest institutional index manager and are one of the largest manager of manager firms as well. In fact the quality of our manager of manager businesses was acknowledged in April when we received the Multi-Manager of the Year Award at the 2007 UK Pensions Awards in London. As with both PFS and C&IS, Northern Trust Global Investments remains well positioned to meet the needs of our target clients.

In closing, we are very pleased with our results in the second quarter, we demonstrated strong top-line revenue growth and achieved attractive double-digit earnings per share and net income growth while also investing in people, capabilities, technology, and physical presence that is important for our continued long-term success. And now, Bev and I would be happy to answer your questions. Lindsey, please open the cal for questions.

Thank you. (OPERATOR INSTRUCTIONS). we'll take our first question from Mike Mayo.

Hi. How are you doing?

Hi, Mike.

First question relates to U.S. versus non-U.S., I think if I look at this correctly, late quarter you had 8% custody growth outside the U.S., and 5% inside the U.S. Can you talk about some of the non-U.S. custody growth and what is driving that?

Mike, as you know we -- the growth of our international business over the last 15 years has been very consistent. And we have in general have seen at the corporate level, a growth rate, depending on whether you want to look at revenues, pre-tax income, net income or asset accumulation of growing 3 to 4 -- 3 to 4 times faster outside the United States than our growth inside the United States, and I think what you are seeing is just the continuation of that trend. It's manifested, I think geographically, we continue to see outstanding growth in Europe, but we have also been very strong across the Asia-Pacific, including Australia and New Zealand , and in the Middle East as well. It's a continuation of the strong trends that we have had going on for quite

Separately, asset management was flat in some very up markets. What was going on with that?

I don't really see anything in the asset management side of note. I think one thing you have to remember, Mike, when you look at our assets under management, and just to remind everyone, 766 billion, up 20% year-over-year, and up 1% sequentially, we have a different mix than a lot of other investment managers. We have a wide array of styles. We are not exclusively an equity manager. At the end of the second quarter, for example, 36% of our assets were equity. And 53% were cash and other. So, we continue to like what is going on there. We had record assets under management in PFS and C&IS. We had record quantitative assets under management. We had record mutual fund assets under management. So we like the opportunities we're seeing, and I think when you compare us relative to markets and others, you just have to keep in mind the mix differential that we have got relative to others.

That last question, expenses 6%, link quarter growth is not great. Anything else that is discretionary? You mentioned the 6 negative one-time charges for rate adjustments and software but anything else?

I think the -- as you point out, there were a number of items in there, but I think the watch words, if you will, are volume associated with growth, complexity, globalization, and regulation. We got a lot going on, and these are -- if you will, good-news expense problems. We have got a very dynamically growing business, both in PFS and in C&IS. And we -- so -- so part of our expense challenge is the volumes associated with that as manifested in sub custodian and sub advisory fees, those kinds of things.

The other thing is we are continuing to invest in the infrastructure that we need to support that, whether it's people, capabilities, technology, geographic expansion in PFS in Wheaton and in Australia and Melbourne. The operational resiliency in both the Bangalore and Limerick or a host of infrastructure initiatives. So expenses were high. But -- so as been the growth rate. So we -- we're trying to manage that equation as effectively as we can.

Thank you.

You're welcome.

Next question comes from Brian Bedell with Merrill Lynch.

Hi. Thank you, good morning.

Hi, Brian.

Couple of questions on the fantastic growth rates we're seeing and the improvement in momentum of the growth rates that we're seeing on the fee side in the custody business, and the PFS business. To what degree -- just over the last two or three quarters, we have seen increases in the year-over-year growth rate that are pretty substantial. To what degree is that being fueled by some of the disruption that you talked about at peers in both businesses?

Brian, it's a good question. It's hard to quantify. What we have said is our tone around disruption is long-term. I do not believe that -- that has been a significant factor fueling our near-term success. Many of those transactions just recently closed, so, the -- the traditional disruption that we have seen on average over time associated with those if it happens is likely to happen over the coming months and years, candidly. I put a lot of this growth at excellent and execution. We have been executing very well in both C&IS and PFS, and I don't see a significant trend today, nor would we have expected to see emanating from disruption.

Okay. And is there -- are some of the wins that you referenced in the institutional business included in the second quarter revenue run rate yet?

They come in throughout the quarter, Brian. So the assets are included, because we -- in fact won those clients, but some of them could have started on the first day and some could start on the last day of the quarter. So I guess the answer would be they are not fully included.

Right. Okay. We should see a little bit of a bump up in the third quarter in terms of funding of new ends?

Yes, we would hope so.

Okay. And then just on the balance sheet, can you just talk about how you invest your foreign office time deposits? On the offsetting side and the asset side? Do you tend to keep them in the countries where you are getting them? I guess, what I'm getting at is looking at the two asset lines on the average balance sheet, the government and other taxable securities, and also the money market asset. The money market asset yields have been improving pretty significantly. But the government securities have not. Is that mostly U.S.?

Yes. The way we think about our investment strategy, relative to this, is, we have had outstanding growth in our non-U.S. office time deposits, and you have to remember that those -- those deposits are denominated both in U.S. dollars and in other currencies. The majority of our securities portfolio is invested in U.S. dollars denominated government agency securities. So Federal Home Loan Bank or Federal Farm Credit Notes. Those notes are typically short-term, 1 to 12 months and highly rated. The majority of our money market assets are invested in time deposits with banks and these are primarily short-term overnight to three-months, multi-currency placements. I think the key thing to remember is we do not take currency risks with our balance sheet investment strategy. The deposits are invested in light currency on the asset side of the balance sheet. So for the U.S. dollar and agency securities, and for non-U.S. dollar deposits in money market assets. And therefore, the yield reflected on our trend report for money market assets, reflects the blended rates related primarily to the Euro and Sterling. The key, really is that the spread that we earn on U.S. dollar deposits invested primarily in U.S. Government Agency Securities is comparable to the spread that we earn on Euro on Pound Sterling deposits invested in time deposits.

Right. Right. As European Central Bank, including the Bank of England are raising rates, we should see both -- I guess continued pressure on the foreign office time deposit costs, but also somewhat of a corresponding increase in money market asset yields as well.

Brain, that's exactly right. And that's why you see the sequential increase in the cost the funding cost of your non-U.S. office time deposit were up 16 base points sequentially, and that's because of exactly the phenomenon that you just laid out. Rising rates primarily in the Sterling and the Euro.

Okay. And just a couple of other questions, loan growth was pretty good this quarter. Wondering if there's any kind of strategic shift in how you are thinking about lending, whether it be in the PFS business or linked on the commercial side, and do things like going back to disruption -- LaSalle is a very good commercial banking organization, certainly gives the opportunity to take commercial bankers if there is any kind of disruption there. Any kind of strategic shift there or just a good quarter in loan growth.

We have had no strategic shift in the way we are approaching loans, and as you saw the quality continues to be outstanding. I think there just have been good opportunities, and we have been able to take advantage of our relationships to garner those. I think in terms of the LaSalle situation, which is another example of disruption, kind of, particularly focused here locally in the Chicago and Michigan area, I don't think -- like many disruptive things, I don't think that has impacted us yet. There is obviously a lot of talk and -- it's impacted us in terms of people and people we have had access to and who have joined us, but at the client level, I don't think it has changed at all so --

Brian, one other thing I would point out on loan growth, and you will see this detail when we issue our 10-Q in a few weeks, but when you see the loan growth broken down by line item you'll see that the line item that has the largest growth both in dollars and percent was the non-U.S. line item and I'd make two points there. First of all, that would be yet another reflection of the growth of this Company and our business from a non- U.S. perspective, that would be first, and secondly, to recognize that a relatively significant portion of those non-U.S., quote unquote, loans, are actually what we call trust overdraft loans or short duration advances to custody clients.

Right. Right.

Directly related to the global custody business that for us has been a wonderful growth business.

Great. That answers the question. Great. Great. Thanks so much.

Thank you Brian.

We'll take the next question from Mark Fitzgibbon with Sandler O'Neill.

Thanks for taking my question, Steve. Anecdotally, are you hearing about more business opportunities as a result of the Bank of New York Mellon deal or State Street Investors deal and maybe even the U.S. Trust deal?

I think -- I guess what I would say is that historically that is in fact what happens. It's very early and there's a lot of swirls, obviously people in firms involved in transactions are talking to their clients, and their clients are in turn talking to other perspective vendors, so there's definitely swirl going on. What I would say, Mark, is whether you want to look at our C&IS business, where we have seen this happen as Banker Trust and Barclay's and Deutsche, and First Chicago and Lloyds and Nat West and the old JP Morgan and so forth, or, U.S. Trust going Schwab, those kinds of things. There tends to be a typical pattern, and pattern is that the starting point is clients don't want to move, they selected the firm that they initially hired for a reason and it's their intention to stick. And they get reassurance from the acquirer, that everything not only going to stay the same but it will get better but these things are usually difficult to execute on and to execute well on, and as you consolidate, as you cut out people and all of the rest of it, things happen. And so we think that -- again, how much -- how much opportunity these events will cause is, we'll just have to see. But it will be a multi-year -- these are big transactions, and the bumps and bruises will be multi-year. It's not going to happen in one quarter. So are we talking to people? Absolutely. Do we see people who are going out to bid? Absolutely. But we also see a lot of people who will sit on the sidelines and wait, and hope that disruption is minimal and they'll stay where they are. So we will just have to see how it goes. But either way we like the demographics of our business and opportunity set, and by our way of thinking, disruption is just additive to the opportunity set.

And do you think there will be opportunities or have you already done some of this of plucking out individuals or teams from some of these organizations?

Yes, we have already seen that. Clearly here in Chicago with what is going on in LaSalle, we have made numerous hires already across a variety of fronts. We recently announced that Pete [Gurwitch] joined us from State Street, joining in our C&IS Group. So, yes, there are definitely -- I can't say Pete's joining was a result of that, I should add. But yes, we are seeing access to talented people as a consequence of this. Both in C&IS and in PFS.

Okay. The last question I have for you, Steve is can you give a sense of what the normalized tax rate will be going forward?

We have traditionally run 35%ish on average over time. We had said, Mark, that with the adoption of APB 23, that we expected that that would probably shave on average overtime holding lots of things constant about a point, and I think that still holds, so we're more likely, we think, to be in the 34% range. But again, this caveat is on average over time, and if our international business continues to grow at the rate it grows, that would be advantageous for us, of course, depending on where within our international business that grows. But we think that the adoption of APB 23 has been a good thing and helped us manage the tax rate a little bit better.

Thank you.

You're welcome.

We will take our next question from Tom McCrohan with Janney Montgomery Scott.

Thank you, good afternoon.

Hi, Tom.

Can you update us, Steve, with any of your thoughts regarding any plans to extend your current domestic high net work business to locations outside of the United States?

Sure. As most of you know, our high net worth business has really been centered on the United States, where we are founded and based for many years. Over the last 10, 15 years, we have gone from sort of a regional, Chicago, and Florida firm, to a national firm, with 85 offices located in 18 states. And we have seen a particular sky rocketing growth in our wealth management business, that group that is families with $75 million or more in assets. And what has happened is that as that group in particular has grown, we have added clients all around the world. It's a -- sort of a very small set of individuals and families and they talk to one another, so it wasn't so much, Tom, that we were marketing in Europe or the Middle East or Asia, but that one family new another, and talked to them, and the next thing you know families outside the United States wanted to do business with us. But today in our wealth management business, we have clients in 14 or 15 countries, and what we have said is that -- and we have a wealth management physical presence in London that handles our clients in Europe and the Middle East. Our focus on the PFS side outs the United States is at that top-top end. So we are not trying to go into the UK and target people with 1 to $5 million but we do believe that at that super high end, $75 million and above, outside the United States is and will continue to be an opportunity. So a that's where we're focused at the present time. Obviously over the very long-term, it's easier to go down than up scale, so to the extent that we're successful at that top end of the market, we may well in due course move down to different levels of wealth, but nothing on that front is contemplated at the present time.

That's helpful. As far as new office openings in the United States, kind of at the margin one a year, kind of, should we plan for that type of growth?

That's traditionally where we have been. Again, depending on disruption and opportunities, that may move around, but I think that's good over time.

Great. Can you reiterate, Steve, in your prepared remarks you talked about a loss related to bearings. What the dollar amount was related to that?

It's really just a loss on the sale of a small piece of the FSG business. In 2005 we acquired Baring, SFG's Administration business, with that came a small business on the Isle of Man, which annualized revenues of $6 million. And fine business, but the growth demographics for that business, and its linkage to our other clients just wasn't there, so we disposed of that, and the loss on the sale of that was about $3 million.

That's pre-tax?

Yes.

Great. And just your thoughts on operating leverage. My last question, excluding some of the one timers this quarter, you probably would have been flat on an operating leverage basis, how confident are you through like on an annual basis that you'll be able to manage your staff-growth expenses to the same growth that you are seeing, say, on fee income?

We talk about operating a leverage a lot, and our desire on average over time to have positive operating leverage every year, not every quarter.

Yes.

And we have a very good track record on that front over the last 20 years, but, you know, we'll have to see how things play out. We are in -- it's easier to manage operating leverage when your growth rate is sort of at a steady-state rate of growth. It's harder to manage it when you are dynamically growing both in PFS and C&IS, C&IS globally and PFS domestically. I'm not hitting at what it will be in any way I'm just saying we are in a very attractive growth phase, and we're going to have to do some things to serve our clients well and position us for that. So I think we're doing a good job thus far year to date, but we'll have to see how things play out in the second half.

Fair enough. Thank you.

Thank you.

Next question comes from Gerard Cassidy with RBC Capital Markets.

High, Steve, hi, Bev.

Hi, Gerard.

On the institutional business is there any particular line of business that you find from past experience you have a better opportunity of winning from this disruption in the market? Whether it's the State Street -- (Inaudible) or the Bank of New York Mellon transactions?

I think all of the segments that we are completing in Gerard -- we don't complete this all segments, but the ones we compete in we compete in very well. So we feel confident going in any of our core businesses. I would say that -- and this is less a disruption comment and more just a reality. In the U.S. public fund market, there are a lot of public funds coming to bid over the next year, 18 months. And as you know, Gerard, that's one of the only segments of our business where clients tend to be on fixed-term contracts. Three- five years and then they go out for bid. And whether there's disruption or not, that creates opportunity for everyone in the marketplace. When our clients contracts come up for expiration as well as everyone else's. That phenomenon we see is a little bit stronger than it has been in the past years, but bottom line I think we feel good about competing on all of the fronts in which we're focused.

Moving over -- similar question on the PFS trust side, when you look at the three channels that you guys focused on, private client, wealth advisory, and wealth management. Is there more opportunities in one of those channels when there is disruption out there? Is it easier to grab clients or competitors, customers in wealth advisory over wealth management or vis-versa or private client?

I think we see, Gerard the disruption in the institutional business as a little bit easier to capitalize on and easy being a relative term, just in the sense that you have a much smaller set of competitors. So if one or the other of the competitors has trouble of whatever that happens to be there's relatively limited set of providers who can capitalize on that. Whereas in the PFS world the competition is very much broader, and that doesn't mean we don't benefit from disruption, but who a personal prospect will call in LA will differ relative to Chicago or Miami or New York. So I would say the disruption events there are a little less straight line to us than in the institutional business.

Okay. And finally, I know credits never been an issue for you folks, so it's good to get a perspective how you guys see it. What are you seeing in the Midwest, which seems economically to be the weakest part of the United States at this time?

Well, I don't want to comment on behalf of others. What I would say is, something that we have echoed in the past, which is A , we're not a good proxy for the rest of the banking sector as you know because our exposure is really driven by our PFS high-net worth clients and a very strong segment of C&IS clients. The credit environment has been skipping sub prime, has been very attractive, and it continues to be for us, but I think as you know, if you look at it relative to historic norms, it's probably unlikely that's going to stay as strong as it has been. And I can't tell you which quarter it's going to impact, but it's hard to believe that we can -- we, the industry -- can continue at this kind of pace on a consistent

And then finally, I know in the past you guys have pointed out that as part of the institutional business with some of your customers, you are participated in their lines of credit at the holding company. Do you guys have any credit exposure to any of the major home builders in the United States, the publicly traded ones?

I don't have that data available, so I don't think I can give you that answer. I -- we -- we don't feel -- as a general pop situation, though, I can say, we don't feel heavy exposure to home builders, and heavy concern. The other thing I could say, Gerard, as a general comment, because I don't have the data in front of me, but as a general comment, we also do periodically make use of credit default swaps. Even in sectors or specific company contexts where we -- for a variety of relationship reasons, we want to maintain those relationships we do make use of credit default swaps to manage that risk. We feel good about the credit portfolio across all sectors for us.

Thank you.

You're welcome.

Next question comes from Robert Lee with KBW.

Thanks, good morning, Steve and Bev.

Hi, Rob.

Just wanted to follow up on a an earlier question sort of related to cost. Obviously you have been building out your facility in Bangalore, but can you maybe update us on what your thoughts are -- it's pretty expensive doing business in London and Dublin and pretty big demand for people there. Are you given any more thought to starting to move operations outside of the central cities in those locations or other things maybe undertaking to keep some of the pressure off of the comp cost there?

I think, Rob, you raise a good point. If you look at our staff, we increased by about 960 people or 10% year-over-year. So, significant growth. If you kind of thought about that from a U.S. domestic and international perspective, order of magnitude, two thirds of that, maybe a little bit more, related to our staff outside the United States. And of that total increase, about 40% was in Bangalore. I think it is fair to say that the costs of staff in Europe in particular are extremely high. Anything we can do to manage our efficiency and find lower cost talented labor pools is great. But the other thing we have to deal with and contend with is the talent. And ours are expertise-based businesses, so it's not just going to low-cost centers, it's people with expertise. And we have done things like that -- using Ireland as an example. We had -- I can't remember the exact numbers -- but 400 odd people in Dublin and we opened up a new facility in Limerick, Ireland where we could get a number of talented people, and in fact, a number of our staff transferred but at a relatively lower cost. Yes, we continue to manage that equation and try to balance it, but at the end of the day, we have got to be attendant to having the expertise that we need, wherever that is.

Also was wondering if you would update us a little bit on your efforts to expand the hedge fund administration business. If I remember correctly you were also trying to bring that in a way back from Europe in to the U.S. Can you just update us on how that maybe going?

Sure. In the hedge fund administration business as if of you know is a growing sector for everyone, and we -- the underpinnings of our rational of acquiring the FSG business in 2005 was to really get a robust alternative asset administration, including hedge fund capability. And Baring had that. We have thus far done very well in A, maintaining those clients, and B, building on that book of business aggressively. We do plan to port that capability, if you will, into -- for U.S. hedge funds, and that's just going to take time. It is not so much a systems issue but you still need people and experience and technology, and we doing that with hedge funds. We're doing that with private equity, and we'll continue our efforts on that front. But no specific numbers I would report to you today.

And -- maybe just -- when you import your assets under custody you include the alternative assets that you are providing administration for as well in that number?

No, we don't. And Rob, I would just add that there are different -- at least from my perspective, there are different industry norms in reporting asset -- some use assets under administration, some use assets under custody. The convention that we have used is what I would call the more conservative convention which is assets under custody. And to give you some context, order of magnitude, if we instead used the assets under administration convention, we would probably be reporting another $800 billion in assets. So it's important to understand that everyone seems to report differently on this front.

Good point. One last question I think I just missed it when you went through the comments about share repurchase in the quarter.

Uh-huh.

Can you just repeat what that was.

It was about 800,000 shares, Rob.

Yes, 51 million, I think it was.

Yes.

Okay. Great. Thanks very much.

Thank you, Rob.

Next question comes from Nancy Bush with NAB Research.

Good afternoon, guys.

Hi, Nancy.

Can you update us on trends in Florida, and what is going on there. I know you were rehabilitating some offices and bringing teams back together and some other things. Can you tell us if the Florida real estate issues are having any impact or what you are seeing there.

Sure, Fees in Florida, Nancy in the second quarter were $52 million, up 11% year-over-year, and they were up 4% sequentially, so a very good performance in Florida. On the new business front? Florida, the second quarter was the best we have seen in six years. So our Florida business continues to be excellent, and growing. In terms of the real estate market in Florida, I don't feel personally qualified to speak in depth about it, but there, anecdotally, and based on my interaction with a variety of people down there, there definitely appears to be a brewing issue, but I'm talking about it generally not specific to our client base. I stand by my earlier comments on our own credit situation in Florida, which looks fine.

You were doing some things in some offices down there as I recall and sort of rejiggering some of the relationship management structures and those sort of things, is that still underway? Is that playing a part in what looks like sort of a rejuvenated trend down there?

It is a work in process I wouldn't say it is done but yes, we have been making some progress on some organizational changes down there. I think the environment has been good. As you know, when the markets are better, clients and prospects are willing to do more, and when they are not, they sit on the sidelines. I think that's a factor. And as well, I think -- again, the mix of our fiduciary capabilities, our technology, and the broader investment solutions that we're bringing to clients are all helping Florida. So we were very pleased with the results in the second quarter for Florida.

Could you also, Steve, just comment on the trends in Illinois? I know one of the-- Sherry Beret's projects had been sort of to penetrate the bank cliental there. More for asset management and wealth management services. Could you tell us how that is going?

Sure, our Illinois fees in the second quarter were 15%, and it's interesting just taking Illinois and Florida. So you got Illinois up 15% in the second quarter year-over-year, and Florida up 11%. Those are the two markets in which we are most established. Sometimes people have said to us, well, aren't they mature? And there are a lot of dynamic opportunity in both of those markets. So we feel very good about what has been happening in Illinois and in Florida. And again, I think that -- the nexus of the reasons why is the same, which is, the fiduciary dimensions are a competitive differentiator, the technology is a competitive differentiator. And I think the investment solutions where we were as we have said I think behind at one point we have put behind us. So we feel good about PFS in general, and in Illinois and in Florida specifically.

Okay. Thank you.

You're welcome.

Our last question comes from Ken Usdin with Banc of America Securities.

Thanks, Steve. I'll make this one quick to finish up. On the accounting issue, you talked about how it is 7 million this year, it's going to another, in the quarter 7 million in the second half of the year. Does it also have a future work through? And could you explain how it works through in the second half of the year as far as how we see through the margin?

Ken, this is Bev, I'll go ahead and take that question. I think first of all from beyond 2007, we're really not in a position to provide you with any perspective there. We really don't provide forward-looking guidance, as I think you and others are aware. Plus, it would be very difficult for us to predict, really, these lease cash flow recalculations that need to be done. So it's just not something we are in a position to do beyond 2007. But you do have the numbers correct for 2007, in that we took $7 million in reduced net interest income in the first -- in the second quarter, which all relates to the first half, and we'll have about $3.5 million in each of the two remaining quarters this year. One thing I would point out, if you wanted to do any adjustments to your net interest margins to take this in to account, if the $7 million that we took in the second quarter had been spread across the entire first half, both first and second quarters, you would have seen a net interest margin of 1.61 in the second quarter, and 1.65 in the first quarter. For-- it's three basis points lower in the first, and three basis points higher in the second. As you look at that second quarter, 1.61, that should really give you kind of the best indication of what might be the expectations for the next two quarters.

Got it. Great.

Again, all other things equal, because there's obviously a number of other moving parts other than just that one piece.

Sure. And one balance sheet question. It looks like the period-end deposits were lower than average. And just given the real strength in global custody asset growth, I'm just wondering -- was there anything happening at the end of the quarter or any change in the relationship between Global custody growth and deposit growth?

Ken, no change in those relationships at all. I think -- that's a line item like so many others on our balance sheet, which is client driven. We obviously can't control what our clients do on any given day. If you do look at, for example, the non-U.S. office deposits on an average basis you would see an sequential quarter increase based on averages. So we try not to get too fixated on a point in time, because of the fact that many of those line items that one in particular can be client driven and based on client actions.

Okay. Great. Thanks a lot.

Well, again, we want to thank you for joining us for Northern Trust Second Quarter 2007 Earnings Conference Call, and we'll look forward to updating you again in October at the conclusion of our third quarter. So thank you very much.

That does conclude today's conference. You may disconnect your lines at this time.