Northern Trust Corp (NTRSO) 2008 Q2 法說會逐字稿

Good day everyone and welcome to the Northern Trust Corp. second quarter 2008 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.

Thank you Shawn, and welcome to everyone listening to the Northern Trust Corporation second quarter 2008 earnings conference call. Joining me on the call this morning are Steve Fradkin, Northern Trust's Chief Financial Officer, and Preeti Sullivan from our Investor Relations team.

For those of you who did not receive our second quarter earnings press release or financial trend report by e-mail this morning, they are both available on our website at northerntrust.com. In addition this July 16th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through July 23rd. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now for our Safe Harbor statement. What we say during today's conference call may include forward-looking statements, which are Northern Trust's current estimates or expectations of future events or future results. Actual results, of course, could differ materially from those indicated by these statements because the realization of those results is subject to many risks and uncertainties. I urge you to read our 2007 financial Annual Report, and our periodic reports to the Securities and Exchange Commission for detailed information about factors that could affect actual results.

Again thank you for your time today. Let me turn the call over to Steve Fradkin.

Good morning everyone. Let me join Bev in welcoming all of you listening to the Northern Trust second quarter 2008 earnings conference call. We are very pleased with the financial results that we reported to you via press release earlier this morning.

For the second quarter, operating revenues were at record levels, and exceeded $1 billion for the first time in our history. Trust investment and other servicing fees, foreign exchange trading income, and net interest income, which together equaled 93% of total revenues, all exhibited very strong double-digit growth in the second quarter.

We were also very pleased to report excellent balance in the quarter between revenue growth and expense growth. We achieved over 800 basis points of positive operating leverage, during a challenging time for our industry. This success was due in no small part to our continued adherence to a very focused strategy built around some extraordinarily attractive businesses, coupled with very strong operating execution in the quarter.

It was in summary an excellent quarter for Northern Trust. As with prior calls, we have organized today's remarks to address four basic areas -- first, I will outline one item that you should consider as you analyze our second quarter financial results. Second, I will review our financial performance in some detail, focusing on those items that most impacted top and bottom line results. Third, I will offer a few perspectives on the business momentum of Northern Trust, particularly when juxtaposed against the difficult market and economic environment currently facing the financial services industry. And finally, Bev and I will be pleased to answer your questions.

Let me begin by highlighting one item you should consider as you assess our performance. As discussed in our earnings press release issued earlier this morning, our second quarter net income was reduced by $87 million, or $0.39 per share, due to adjustments made within our structured leasing portfolio. These adjustments relate to structured leasing transactions that we have discussed with you in the past, and have previously disclosed in our filings with the SEC.

The $87 million after tax amount impacted two line items on our income statement. First, net interest income was reduced by $29 million. This represents the reallocation of lease income under revised assumptions regarding the timing of income tax cash flows related to certain leveraged leases. In accounting terminology this is our so-called FSP13-2 adjustment.

Second we increased our income tax provision by $58 million for potential interest and penalties associated with certain structured leasing transactions. We made these adjustments after evaluating recent court cases against other taxpayers that were decided in favor of the Internal Revenue Service, which has challenged the industry's tax position on certain structured leases. We continue to believe that our transactions are valid leases for U.S. tax purposes, and we will continue to defend our position vigorously.

With that background, let me review the second quarter's key performance drivers beginning with revenues. We are very pleased with our top line performance in the second quarter of 2008. Particularly when compared with the extremely challenging conditions that have beset financial institutions across the globe.

Revenues in the second quarter equaled $1.1 billion, up a very strong 24%, or $212 million compared to last year's second quarter. For perspective I might add that last year's second quarter revenues established a record level at that time. Revenues grew an equally strong 12%, or $116 million on a sequential quarter basis. The key line items that contributed to revenue growth in the second quarter were trust investment and other servicing fees, foreign exchange trading income, and net interest income.

Trust investment and other servicing fees increased 21% year-over-year, or $112 million to $645 million. In our institutional business, C&IS Trust investment and other servicing fees equaled $409 million in the second quarter, an increase of 32%, or $100 million year-over-year, and an increase of $111 million, or 37% on a sequential quarter basis. C&IS fees include three primary revenue areas, custody and fund administration, institutional asset management, and securities lending.

Let me discuss the performance of each in the second quarter. C&IS custody and fund administration fees equaled $172 million in the second quarter, up 17%, or $25 million year-over-year. This strong, double-digit custody and fund administration fee growth was driven by new business, particularly in global custody and fund administration, and by higher year-over-year transaction volumes during the quarter. These strong, positive trends were partially offset by the negative impact of unfavorable markets.

Recall that C&IS custody fees are built primarily on a one quarter lag basis, thus our 17% year-over-year growth in custody fees experienced significant market related headwinds, as evidenced by quarter lag year-over-year declines in the S&P 500 of 6.9%, and in the EAFE index of 16.9%. On a sequential quarter basis, C&IS custody and fund administration fees decreased 1%, or $2 million as the impact of new business was more than offset by the challenging equity market environment.

Recall that on a quarter lag sequential quarter basis, the S&P 500 was down 9.9% and the EAFE index was down 15.5%. An important contributor to growth in C&IS custody fees is our ability to successfully aggregate client assets. Institutional assets under custody equaled $3.6 trillion at quarter end, down 1%, or $34 billion from a year ago, and down 0.7%, or $24 billion versus last quarter.

These year-over-year and sequential quarter declines reflect the quarter's lower equity market values, as the S&P fell 14.9% year-over-year, and 3.2% in the second quarter, and the EAFE index declined 22.4% year-over-year, and 2.1% in the second quarter. Our success in international markets continued to drive growth in C&IS global custody assets. Global custody assets equaled $2 trillion at June 30th, up 4.6%, or $89 billion year-over-year. This growth compares very favorably, when you consider that the market environment declined significantly versus last year.

For example, the EAFE index fell 22.4% from June 30th, 2007 to June 30th, 2008. On a sequential quarter basis global custody assets were essentially flat, as new business offset lower equity market, as evidenced by a sequential quarter decline of 2.1% in the EAFE Index. Investment management fees in C&IS equaled $72 million in the second quarter, an increase of 1%, or $1 million year-over-year.

On a sequential quarter basis investment management fees declined 4%, as new business in our mutual fund, manager of manager, and quantitative management businesses was more than offset by the weak market environment. Managed assets for institutional clients equaled $609 billion at quarter end, down 2%, or $14 billion, compared with one year ago, and down 4% or $24 billion sequentially.

Excluding securities lending collateral from C&IS assets under management which I will discuss in a moment, managed assets for institutional clients actually increased 15% year-over-year, and 1.5% sequentially, which represents very strong results in the down market environment. C&IS security lending fees equaled $150 million in the second quarter, representing an increase of 104%, or $77 million year-over-year, and an increase of 370%, or $118 million sequentially.

Our securities lending performance in the second quarter benefited from wider spreads on a year-over-year basis, which were driven primarily by reductions in the federal funds rate over the past year. On a sequential quarter basis, the traditional positive impact of the international dividend season was offset by narrower spreads on U.S. Treasury securities.

In addition both the year-over-year and sequential quarter comparisons were impacted by positive marks in one mark to market securities lending collateral fund, which benefited our second quarter performance by approximately $25 million. As we have done in the three most recent quarters, let me pause for a moment and provide you with some perspective around our securities lending performance in the current market environment.

First, let me start by reminding you that the unusually high level of credit market dislocation beginning in the summer of 2007, negatively impacted the Securities lending results that we reported to you in the three prior quarters, beginning in the third quarter of 2007. Returns achieved in one mark to market cash collateral investment fund used for securities lending were weak in those prior three quarters, as pricing pressure on fixed income securities persisted, and asset value markdowns flowed directly through to the total return of this fund.

In each of those three prior quarters, we discussed with you our belief that there did not exist any permanent impairment of any holdings, and that all of the asset markdowns recorded in the fund during those prior quarters were unrealized. We said that we expected given what we knew at that time, that all of the funds holdings would mature at par, and that any future positive marks would be reflected in the yield on the fund, and in the result in security lending revenues reported by Northern Trust.

That phenomenon is precisely what happened, and added to our strong performance in the second quarter of 2008. Positive marks recorded in the fund during the second quarter benefited our Securities lending performance in the quarter by approximately $25 million, representing about 14% of the negative impact recorded in the prior three quarters. This $25 million represented approximately $0.07 of benefit to earnings per share in the quarter.

The positive impact of wider spreads and the $25 million mark to market benefit were partially offset by our lower levels of securities lending collateral. Securities lending collateral equaled $238 billion at quarter end down 21%, or $62 billion versus one year ago, and down 11%, or $29 billion compared with March 31.

On an average daily basis, securities lending collateral was down 15% year-over-year, and 2% versus last quarter. The lower level of collateral on both the year-over-year and sequential quarter basis can be explained primarily by two factors. First, borrower demand for securities was lower, because of de-leveraging and borrower balance sheet constraints. Second, market depreciation was a factor in the lower valuation of loan securities globally.

Let me close this discussion of our securities lending performance with a few reminders that we have discussed with you in the past, about the one mark to market fund that has influenced our performance in recent quarters. First, this mark to market fund has followed its investment guidelines consistently and appropriately.

No atypical portfolio management decisions have been made in the fund. Second, the fund does not use leverage. Third, 65% of the securities held in the fund are rated either AAA or AA, and approximately 70% of the funds portfolio is invested in corporate notes, with the remainder invested in asset backed securities and cash. Fourth, the fund is managed with the conservative interest rate sensitivity of 50 days, and a credit based weighted average maturity of 1.6 years as of June 30th.

Lastly, there does not exist at this time any permanent impairment of any holdings. Asset value markdowns continue to be unrealized. We continue to expect, given what we know at this time, that all of the funds holdings will mature at par. Therefore, as we experienced in the second quarter, any additional future positive marks will be reflected in the yield on the fund, and in our resultant securities lending revenues.

Switching to our personal business, PFS Trust investment and other servicing fees equaled $236 million in the second quarter, representing an increase of 5%, or $12 million year-over-year. Fee growth in PFS is driven in part by our success in retaining and growing our relationships with existing personal clients, while at the same time winning new clients to PFS. Net new business in PFS was again strong in the second quarter, representing our best quarterly result since the fourth quarter of the year 2000.

Offsetting our strong new business was a weaker equity market environment. Our PFS states which represented approximately 85% of total PFS fees, earned fees primarily via a methodology that lags current markets by one month. Based upon this methodology the S&P 500 declined 7.3% year-over-year for the purposes of our second quarter fees, which resulted in a significant headwind to PFS fee growth in the second quarter.

On a sequential quarter basis PFS fees increased 3%, or $8 million. The positive impact of new business in the second quarter was partially offset by weak equity markets. The S&P 500 was down 1.6% using our PFS month lag fee methodology, constituting a moderate headwind for PFS fees on a sequential quarter basis. Fees in PFS are derived from asset that we manage for custody for personal clients. PFS assets under management equaled $143 billion at quarter end, down 1%, or $2 billion from a year ago.

Assets under custody in PFS equaled $[236] billion on June 30th, up 2%, or $7 billion year-over-year. Sorry, $326 billion, excuse me, in custody assets. It is important to note that once again the backdrop of a tough market environment, which saw a 14.9% decline in the S&P 500 year-over-year.

On a sequential quarter basis PFS assets under management were down 2%, or $3 billion while PFS assets under custody were up 1%, or $4 billion since March 31st. Again, when compared with the decline of 3.2% in the S&P 500 during the second quarter, our performance on a relative basis reflects the strong PFS new business results that I mentioned earlier.

Let me now shift the discussion to our other key revenue line items starting with net interest income. Net interest income equaled $249 billion in the second quarter, representing a 19% increase when compared to the second quarter of 2007. As I mentioned earlier, second quarter net interest income included a $29 million reduction related to our lease portfolio adjustment.

Without this adjustment, net interest income would have equaled $278 million, an increase of 33%, or $69 million compared with last year. The year-over-year increase in net interest net income was attributable primarily to two items. First, our net interest margin in the second quarter equaled 1.59% on a reported basis, and 1.78% if the leasing adjustment is excluded.

Our adjusted net interest margin increased 19 basis points from the prior year, driven by wider spreads between overnight rates, and 1 to 3 month rates. Recall that the Federal Reserve has reduced the Fed funds rate by 325 basis points since September of 2007, including a 25 basis point reduction in the second quarter of 2008 on April 30th. Second, average earning assets equaled $63 billion in the second quarter, an increase of 19%, or $10 billion year-over-year.

Our balance sheet growth remains liability driven, which in turn drives this strong growth in earning assets. Non US-office timed deposits continue to be a significant driver of growth in our balance sheet, averaging $36 billion in the second quarter, an increase of 29%, or $8 billion versus last year. This strong growth in non-US-office timed deposits is directly related to our international success in the institutional custody business, which I described earlier.

The final significant contributor to revenue growth in the second quarter was foreign exchange trading income, which equaled a record $127 million, up 56%, or $46 million compared with the second quarter of 2007. On a sequential quarter basis, foreign exchange trading income increased 12%, or $13 million. The key drivers of our quarterly results in foreign exchange were volume and volatility. Both remained high in the second quarter, driven by uncertain economic conditions, and highly volatile assets, energy and commodity prices.

Other operating income equaled $35 million in the second quarter, an increase of 23%, or $6.5 million year-over-year, and 9%, or $3 million sequentially. The year-over-year results include $2.8 million of valuation gains recorded on credit default swap contracts, used to mitigate credit risks associated with certain commercial loans. In addition, the year-over-year results include a gain on the redemption of an equity investment, and higher custody related deposit revenues. The sequential quarter increase was driven primarily by the equity investment gain, and higher custody related deposit income.

During the second quarter, we recorded a loan loss provision of $10 million, compared with the $4 million provision in the second quarter of last year, and a $20 million provision in the first quarter of 2008. The majority of the $10 million provision reflects strong commercial loan growth this quarter. Credit quality has remained very strong at quarter end, with non performing assets equal to only $34 million, down $1.3 million, or 4% from the prior quarter. Non performing assets equaled only 12 basis points of total loans at quarter end.

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 2008 equaled $643 million, representing an increase of 16%, or $88 million from a year ago quarter. On a sequential quarter basis excluding the first quarter's non operating item related to our membership in Visa USA, expenses were up 5%, or $32 million.

Compensation expense equaled $306 million, an increase of 22%, or $55 million from the year ago period. The year-over-year increase in compensation expense reflects higher staffing levels, an increased level of incentive compensation due to improved corporate performance, and annual merit increases.

Staffing levels equaled approximately 11,800 full-time equivalent positions at quarter end, up 15% year-over-year. Our office in Bangalore India now employees over 1,000 staff members, double the staff level we had in India one year ago. On a sequential quarter basis compensation expense increase 7% or $20 million primarily reflecting higher incentive compensation, our April 2008 merit increases, and increased staffing levels.

Employee benefit expenses equaled $63 million in the second quarter, up 7%, or $4 million versus last year, and up 9% or $5 million sequentially. The year-over-year increase of $4 million primarily reflects higher FICA insurance due to increased staffing levels. The sequential quarter increase of $5 million, primarily reflects a higher discretionary match for our 401-K plan, driven by improved corporate performance, and higher FICA insurance due to increased staffing levels.

Outside services equaled $106 million, an increase of 13%, or $13 million compared with last year, and an increase of 13%, or $12 million sequentially. The $13 million year-over-year increase resulted from higher consulting and technical expense. The $12 million sequential increase primarily reflects higher depository sub custodian and consulting expense.

Other operating expense equaled $72 million, an increase of 34%, or $18 million compared with last year. On a sequential quarter basis excluding the first quarter 2008 Visa related benefit, other operating expense decreased 8%, or $7 million. The year-over-year increase is primarily the result of higher charges associated with account servicing.

The sequential decline was driven by a lower level of advertising and business promotion expense, as first quarter expenses in these categories were higher due to the Northern Trust Open golf tournament. In addition, other operating expense in the second quarter included $1.2 million in incremental expense, associated with the fair value of our liability under the capital support agreements that we entered into on February 21st, to support certain cash funds that invest in the Whistlejacket structured investment vehicle.

You will recall that in the first quarter of 2008 we recorded $8.7 million in expense representing that quarter's fair value of the capital support agreements. The additional $1.2 million represents a mark to market of the fair value of our liability under the capital support agreements in accordance with Financial Accounting Standards Board Statement No. 133. In-line with this Accounting Standard, we will continue to mark to market the fair value of our capital support agreements each quarter until those agreements expire.

Speaking of expiration, we also announced in our earnings press release this morning, that we have extended the expiration date of the capital support agreements to February 28, 2009, in order to allow the restructuring of Whistlejacket to reach resolution. I should add that no capital contributions have been made to any of the funds as of June 30th.

Our provision for income taxes in the second quarter equaled $212 million, resulting in a reported effective tax rate equal to 49.6%. On an adjusted basis excluding the incremental tax provision associated with the lease portfolio, our effective tax rate equaled 33.8% in the second quarter. This compares to an effective tax rate of 33.2% in the second quarter of last year.

Northern Trust repurchased 40,000 shares of common stock in the second quarter, at a cost of $3 million. Diluted shares averaged 225 million. We can purchase an additional 7.7 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 19% versus one year ago to a record $4.9 billion at quarter end. This performance represented our 81st consecutive quarter of increasing common equity, which equates to over 20 consecutive years.

Let me close with a few over arching perspectives on Northern Trust's positioning in this challenging environment. From where we sit, it is indeed a challenging macro environment across many fronts. There are very few areas of refuge. Difficulties in the sub prime sector, significant equity market declines, diminished liquidity in fixed income markets, overall market volatility, and an increasingly stressed credit environment, represent just a sampling of some of the challenges.

At Northern Trust we have always believed that the organization we represent is uniquely positioned within the financial services industry. That belief is probably more in evidence today across a variety of metrics, than at any time we can recall in recent history. Like others, we are very mindful of the difficult market conditions, and certainly not immune to the challenges these conditions can inflict.

In times such as these, it is sometimes worth reflecting upon just a few of the underpinnings of our distinctive positioning. For Northern Trust that starts with an extremely tight business model. We continue to be a very focused company, targeting market opportunities with very attractive demographics and balanced risk profiles. We serve the needs of large global institutional investors in C&IS, and affluent families and individuals in PFS.

This focus on growth markets and real clients with real ongoing needs, is at the core of what we do, and positions us well for future growth opportunities. Our success in earning the middle office outsourcing, fund administration and custody business of Hermes fund managers in the United Kingdom this quarter, is one example of that opportunity and our success. With this win, we were awarded the business of the largest pension fund in the United Kingdom, the BT Pension Scheme, which is the owner of Hermes.

In serving Hermes we will provide a full array of capabilities, ranging from middle office outsourcing, to fund administration, and accounting to custody. Our focus was also in evidence in our personal business, where we continue to invest in markets, where we see attractive opportunities.

During the quarter we announced the acquisition of Lakepoint Investment Partners, a private wealth management firm located in Cleveland Ohio. This acquisition will build on our important base of clients in Ohio, and strengthens our positioning in the attractive affluent market place in that state. Also as I mentioned earlier, the second quarter of 2008 proved to be our best quarter for net new business in PFS since the fourth quarter of the year 2000. This is particularly noteworthy as an achievement, when considered in the context of a challenging market environment, which typically slows down prospect decision making.

We also remain focused on the conservative management practices and philosophies that have served us well across many cycles, and over many years. Again, while certainly not immune from the challenging credit cycle that is currently plaguing the lending and securities portfolios of many, we believe that our conservativism has placed us in a far better position than most to manage through the current storm.

For example, the second quarter of 2008 represented our 81st consecutive quarter of growth in common equity, just one example of our distinctive positioning relative to peers, and of course, we remain focused on serving the needs of our clients. Whether building new capabilities, providing consultative advice, or simply working with clients to weather the storm, clients have always been, and will continue to be our #1 priority. Working with clients in good times and amidst more challenging periods, is what allows us to forge long-term, enduring, and value-added relationships. In sum, we are very pleased with our current positioning from many vantage points, and are gratified to be able to report strong financial results to you for the second quarter of 2008.

Now, Bev and I would be happy to answer your questions. Shawn, please open the call for questions

Thank you. (OPERATOR INSTRUCTIONS).

Glenn Schorr of UBS.

How are you? Can you hear me okay?

Yes we can.

I like the streamlined version. So just talk about the sec lending fund for a second. I want to make sure, first on collateral you mentioned that obviously the balances are down 11% sequentially, but just 2% on an average daily balance. I am not asking you to comment necessarily on July, but obviously we should see a little follow-through, plus the typical seasonality on sec lending collateral in the third quarter?

Remember you have to look at that in my view in the context of the market decline, which brings the value down in totality. When you talk about the seasonality, remember that on average over the last five years, our securities lending revenues have declined by 19%. So yes, there is a seasonal effect that will impact fees, but I think in terms of collateral levels, there is a big market value dimension.

Understood. Understood. And then this is definitely not the typical Northern thing to do, but heck, I will ask it anyway. Obviously you have a lot of confidence in the underlying collateral, and that these are temporary impairments, nothing permanent in terms of the unrealized markets. You have such killer capital ratios, any thoughts of adding similar assets on balance sheet in the securities portfolio?

I think it is funny Glenn, over the years we have had dialogue about the securities portfolio, and what we should do, and how we should manage the securities portfolio, if you go back a couple of years, there were moments where we were critiqued for being too short duration, too conservative, and so forth. We always said at that time that the securities portfolio is not our primary business, our primary business is serving large global institutional investors, and high net worth clients, and we want to keep that securities portfolio safe, warm, and dry.

I think that has been proven to be a very good strategy for us. So we always consider all of the alternatives and optimizing things, but I would say that in all probability, we will stick to the same thing that has served us well, particularly in this environment.

Fair enough, Steve. I told you I take back the hundred times that I accused you of being too conservative. I take it all back.

Fair enough. Thank you.

Last question, a reasonable decline and what you have had on deposits, just curious with your outlook, how much flexibility you might think from here forward?

It is really hard to offer any real insight into it, Glenn. I don't think I could add any color at this point.

No worries. Thanks.

Our next question is from Mike Mayo from Deutsche Bank.

Good afternoon, or good morning for you, I guess still. This might not be so easy, or maybe it is. Can you disaggregate the core growth in C&IS if you back out the market value adjustment?

Well, I think I will let you do the math. I think the one thing that I would say about, well, let me back up. This is a terrific quarter and we have got terrific results year-to-date, and we feel very good, as I outlined in my remarks. The one thing I would say about C&IS which we did highlight for you, on the C&IS fee side you have got $25 million of positive marks that are impacting us this quarter. To the extent that you view that as non core, and I think you absolutely could, I would bear that in mind as you evaluate our results.

Or maybe just under assets under custody, it is only flat, and you mentioned the EAFE Index down 2%. I guess core growth is 2%?

I think, Mike, I am going off the top of my head here, because I don't have all of the statistics in front of me. I think what we have seen is the degradation in the S&P 500 pulled our overall assets down considerably. But you are continuing to see on the global side of our business, even notwithstanding a substantial decline in EIFA year-over-year growth. You will have to cut your numbers the way you want to cut them, but we feel very good about the growth, both on the fee side and on the asset side, assets under custody that is, juxtaposed against the environment.

Mike, one thing I might add to help you out there, if you look at our total assets under custody on a sequential quarter basis, they dropped by about $20 billion, but keep in mind that the securities lending collateral dropped by about $29 billion, so more than the total amount of the decline was the result of securities lending.

If you take that out of the equation, you can see that clearly we would have had net new business that came in, and flowed in through custody assets that more than offset the market impact.

I just thought it might be a little bit more. Did it kind of meet your own expectations?

I think we are satisfied.

Going to the positive side, who are you winning the PFS business from? Where is that coming from? Best quarter since 2000.

Our PFS business has really been on a roll. If you look at it in context, not just for the quarter, if you look where we came from 2001, 2002, 2003, when the markets were all down, our year-over-year growth in PFS fees was essentially flat. If you look in '04 it was up 8.5% year-over-year, '05-09%, '06-10%, and '07-15%.

We are seeing wins across the board. I think it is some combination of the normal things we have got, which is a great set of capabilities and service, and also the environment. There is no question that the, what I will call the normal way we think about disruption from a client perspective, which is mergers, acquisitions, change of a relationship manager, that sort of stuff, there is some of that, but we are also seeing a new kind of description, which is what I will call, financial disruption, and safety and security, flight to quality, that sort of thing.

The wins are across the board, they are in all regions, they are in our wealth management group. As I alluded to in my call when typically we see in a more difficult environment, a slow down of decision making, so I think the new business success in the second quarter is really reflective of some very differentiated performance.

Lastly, the flight to quality, who would that be from in particular? Is that from other trust banks, or wealth managers, or banks, or who?

I think the wins are across the board, small institutions and large institutions. I would rather not pick out any names in particular. You can form your own judgments about the environment, and who is struggling the most.

Thank you.

You are welcome.

All right. Our next question comes from Nancy Bush with NAB Research.

Good afternoon, guys. A couple of questions, #1) Steve, did you say that the 25 million that was regained on the collateralized fund, or whatever it was, was 14% of what you have given up there? Was that correct?

Let me restate that, so everyone is on the same page. Over the prior three quarters, we had accumulated total negative marks of approximately $184 million. This quarter, we have the reverse phenomenon of a positive mark of $25 million. So I am giving you round numbers, but approximately then what we have clawed back of those negative marks accumulated over the three quarters is 14%.

Okay. Your statements there, you anticipate coming out without impairment, on par, et cetera, et cetera, means there is still 86% to be regained at some point down the road?

That is correct, subject to all the caveats that nothing gets impaired, so on and so forth, but yes that is correct.

Bigger question, given that it looks like the Fed has stopped lowering rates, and may indeed start raising rates at some point in the future, although we don't know when that will be. Can you take us through the geography of the P&L, about how the Fed's new posture of doing nothing is going to impact you in the coming quarters?

I think Nancy the way, typically we benefit both in our net interest income and securities lending businesses, when the Fed cuts rates, and particularly when the Fed cuts rates in an unexpected manner. But that phenomenon for us is relatively short-term, because we are very short in our portfolio. There is no question that we have benefited, along with others, from those rate cuts, more so than if you will, the normalized environment. Holding all else constant, I would expect some diminution of those kinds of growth rates.

In a normalized environment, we still have seen at least over time, this phenomenon of the growing size of the balance sheet. Even when our net interest margin can be relatively flat, we tend to grow net interest income, if the phenomenon of our growth in global custody assets, and the foreign office timed deposits, and the redeployment works in our favor. It is a long way of saying the Fed rate cuts have helped us, but I think we still feel very good about our ability to grow our businesses, and hopefully grow net interest income along with that.

Should they raise rates which would be insane, but they keep making those noises in an 'unexpected manner,' do you, therefore, get hit?

Yes, an unexpected increase in rates would diminish us. Again, the same phenomenon, typically within a quarter, that phenomenon is through, because we are just very short.

Okay. You filed an 8-K today on the capital support. Was that just for the extension of the capital support?

That is correct. All we did, same terms, same everything, we just extended the period. It was going to expire at the end of July, and we extended it to the end of February next year.

Thank you very much.

You are welcome.

Our next question comes from Brian Bedell with Merrill Lynch.

Can I start out with a break out of the equity fixed income and cash in the CIA, NS and PFS and asset businesses? Do you have them?

In the C&IS institutional assets under management, equities were 38%. Fixed income was 10%, and short duration was 52%. In the personal business, PFS assets under management, the breakdown was 43% equities, 25% fixed, and 32% short duration.

Great, thank you. Just on the securities lending portfolio, is the size of that the same, at around 13 billion, or is that smaller at this stage?

You mean the mark to market fund?

Yes, the mark to market fund, right.

I think it is 11 billion-ish, if I recall.

Okay. So the driver of the recoupment of the 25 million, was that due more to a reversal of unrealized losses, or was it due more to paydowns from the securities, or even security sales from the fund?

Brian, I don't think it had anything to do with security sales for the funds. I think it was some reversal, and there may have been some paydowns, I am not sure.

The majority would have been the market environment, and then current pricing on existing securities in the portfolio.

You saw on those particular securities, you really saw credit spreads tighten?

Right, again, remember, this can move around a lot. We have seen it move around in the prior three quarters, and so we are pleased that it worked our way. It is still pretty volatile out there.

Going forward, tell me if I am wrong on this basis, essentially as you are moving closer to the 1.5 year of average maturity, the paydowns in the securities should become a larger force, and potentially overwhelm any kind of negative marks that you would see. I know it will be a lumpy quarter to quarter, but directionally we should see that.

Yes, that is correct on average, remember the duration is an average, but yes in theory that is right, as you get closer to maturity, you would expect holding all else constant that they would be positive.

Great. On the new business trends, can you talk about for both businesses really, and maybe start with the PFS business, the flight to quality aspect, whether you think there is a lag in those assets moving over? Clearly the environment has been a little tough for two or three quarters here. Have you seen a lot of those assets kind of already move? Are you in conversations with potential clients, where you think that will actually accelerate over the next couple quarters or so?

I would say in terms of projecting the future, it is extremely difficult as you know. One day you look at the screen and it is all red, and everyone is dour, and the next day it is green, and people are hoping we are in a different world. We always have difficulty forecasting this. I think the over arching view on PFS would be, really rounded it is a very strong quarter, the strongest since the fourth quarter of 2000.

PFS net new business was up 20% year-over-year, and 6% sequentially. We really saw very good new business in the Midwest, and in the Southeast, and the increases there were strong double-digit increases. I think some of the drivers behind that are really around this notion of safety and security of assets.

We have got more sales activity going on. I think we have gotten better at penetrating clients at the $25 million and above level. We have had lower lost business. So there are a variety of factors that are contributing to this success. I don't think I can anchor to any one in particular. Summarizing those in aggregate, I think we have just got good momentum, and we are pretty well positioned in that space.

Sounds like it is more of your own doing, rather than the environment and the environment is sort of gravy on top of that?

Yes, I think that is a fair characterization.

Can you make a broadbrush statement on the C&IS business, in terms of the new business there. I imagine most of that is from outside of the U.S., can you characterize whether you are seeing RFPs increase—the momentum in RFPs increase?

The C&IS business was softer in the quarter but again, as we always say with our net new business, it is pretty lumpy in terms of what we say. Year-to-date through the second quarter, we are pretty consistent with where we were last year.

International is a huge driver. Cross selling to existing clients, be they domestic or international, continues to be very important. The pipeline is active. You will have seen that we have announced a number of wins with the [auto] fund to funds, hedge fund administration, Puerto Rico Electric Power, Hermes that I referred to, [Hargrave] lands down for fund administration. I think the story there is much the same.

We continue to be well positioned. We are winning extremely attractive mandates and again, Hermes, we have long had market share in the UK of the Top 200 pension funds of over 20% and even a higher percentage of the top local authorities, but Hermes is a really terrific win. That is a brand name, as good as you can get in the UK. We are excited about the momentum we have got, and the pipeline still strikes us as attractive.

Good, okay. Speaking of the foreign business. What do you think your flexibility to continue to reduce the rates on the foreign deposits, is at this stage?

I think, Brian, we are competing for those deposits, and while we have a stronger credit rating than many, and we do get a flight to quality dimension, these are large sophisticated institutional investors, and we have got to be competitive to earn their confidence. I don't think we have disproportionate pricing power if you put it that way.

Can I ask one more question?

Sure.

On the commercial loan growth that has been accelerating in the last couple of quarters, or actually loans over all were sort of growing at about twice the pace so far in the first half, as we have in the last couple of years. Is that due to bringing over some folks from LaSalle, or is there a different sort of philosophy about how aggressive you guys will be about lending going forward?

I think it is not, for the rest of the group BofA's acquisition of LaSalle here in the Chicago area resulted in a number of their bankers going to many competitors. We were fortunate enough to pick up many people from LaSalle, though not that many in the lending space. So our experience there is not a function of picking up new bankers. I think it is more of a function of our capital strength, and capacity and relationships being disrupted elsewhere. We are in a position of strength.

I think if you would have looked back a couple of years ago, we were consciously managing down the growth in our loan portfolio, because we didn't like the terms and we didn't like the way terms were extending and covenants were weakening, and we managed lower loan growth, but we always said, if the environment turns and is more attractive, we will jump in and capitalize. I think that is what we have been doing. It really has been a function of our interest in opportunities under these conditions, and our capacity to take it out.

Great, thank you very much.

You are welcome.

Your next question comes from Mark Fitzgibbon with Sandler O'Neill.

Good morning Steve. First, I was wondering if you could size for us the amount of new business wins you had in the second quarter in C&IS?

Because net new business and the way it is calculated is a non-GAAP number, we have stopped releasing those numbers, but I would say, Mark, the best I can give you, it is very consistent with where we were in the first half of -- sorry. Our net new business for the first half of 2008 is very consistent with where we have been for the first half of 2007. Unfortunately, we don't disclose numbers anymore.

Steve, your credit quality has been great. Are there any areas of your loan portfolio that you are concerned about, are monitoring or trying to pare back?

I think our credit quality has been really outstanding, and we feel good about that. That said, it is a very difficult environment, and we are not immune to that environment. I think you have heard some others talk about Florida and Arizona, and we are seeing stress in the real estate markets generally. We are seeing a disproportionate amount of stress in the west coast of Florida, but again, I want you to keep that in perspective, our asset quality metrics despite that, continue to be far superior overall.

It is tough out there. But we are still feeling okay, and I guess if I had to pick a place, I would pick the west coast of Florida, as the one we have to keep the closest eye on.

Related to the CSA, given that you have recorded to date only a contingent liability of only about 9, just under 10 million, did you contemplate kind of downsizing that CSA when you decided to extend it, do you think it is likely that it will end up being a lot smaller than the 229 million?

I think we did contemplate it, Mark, it would probably cause more disruption and noise than is appropriate. I don't know what a final number will be, but had we decided, even if we had thought we could downsize it, had we downsized it, there would be a lot, how did you get to that number, and so forth, and so on. So I think our view is we have to just let this thing play its way out, and in the end the number will be what it will be.

Thank you.

Our next question comes from Robert Lee of KBW.

Thanks. Good afternoon at this point I guess. Most of mine have been asked, but I am curious, the announcement [yesterday] from the SEC on the changes of short selling rules, if that was to be applied more broadly, do you in any way expect that that would have any kind of impact on your sec lending business, in terms of reduced rebates, or reduced volumes?

Rob, I think it is too early. There are dimensions of it that actually could be positive. Given that that was just announced, and we haven't had a chance to fully vet it. I would probably refrain from giving you an answer at this stage.

Fair enough, another question, I apologize if you went through this before, because I had to step off for a moment. Could you maybe give us some color on what you are seeing in the domestic C&IS business? You talk obviously the global business continues to go well, with some large win as you mentioned. Can you talk a little bit about the competitive landscape in the U.S., particularly in the pension business?

We continue to see opportunities, the domestic pension business is certainly more mature as a business, and at a different point in the cycle, than opportunities outside the U.S. But we continue to see some terrific opportunities, whether it is the result of public fund rebids, or other factors. We continue to see terrific opportunities, particularly on the cross sell side. There are different ways to grow.

One way is to win new clients, and we are doing that, and another way is to bring more products to existing clients, and we have seen some great examples, particularly on the asset management side, of bringing to our custody clients asset management capabilities. We are very positive about it. We are also, although your question, Rob, was focused on the pension funds, we are seeing very good growth in Global Fund Services, which is the fund manager piece of both the domestic market, and the markets outside the United States. We are still quite positive about the C&IS business, both in and outside the United States.

Great. That was it. Thanks a lot.

Our next question comes from Ken Usdin of Banc of America Securities.

Thanks. Steve, just one quick question for you. The results in investment management on the CNS side were a little lighter this quarter even with equity market comps a little bit higher. Any moving parts on that business line, and some color on how that business is acting?

Remember, when you look at the assets under management, you want to take a look at how the securities lending collateral influenced that. Our assets under management excluding the downdraft in securities lending collateral, were actually up very nicely. So I think that is one thing to take a look at there, Ken. Anecdotally, we feel good about the asset management business. We have got Steve Potter firmly entrenched in his new role as President of NTGI.

The pipelines there look good. I think one of the challenges is people are trying to figure out what to do in this market environment, and that can slow down decision making. We feel good.

What were the driver of revenues being down sequentially then, if you have core underlying asset growth and positive equity comps, understanding that equities aren't the entirety of the assets under management?

I think you have to remember also the timing, assets can go up, but if they come in late in the quarter, you won't have any fees associated with that. I can't land on the head of a pin for you, but that is typically the phenomenon we have seen in the past, when you will see, if you will, core underlying asset growth, but not as much fee growth, it is usually a lag in when the assets arrive.

On the new business that you are seeing in PFS, any noted areas of the country where you are seeing either some incremental benefits from other weakened financial institutions, or where you are kind of seeing a flight to quality benefit?

It is really national. Ken, I could give you ten anecdotal stories, but they would be from every region of the country. I think that phenomenon is national.

Great. Thanks a lot, Steve.

We will go next to Tom McCrohan of Janney Montgomery Scott.

Are you seeing any market opportunities given the obvious weaknesses out there to possibly acquire/enter any new markets on the PFS side?

I think we didn't enter a new market, because we have been in Cleveland for some time. We did take advantage of some opportunities in that market, with an acquisition this quarter of Lakepoint. I think the environment is disruptive. We are always looking at M&A opportunities. As you know, we are not a big acquirer in general.

We look at a lot of things, and we will consider all opportunities, and there are certainly plenty around there. But we have done this transaction in Cleveland. We want to get that one firmly in and running well, and we will continue to look at opportunities. So I would say we are steady on that front, but there is no shortage of opportunities to at least look.

It sounds like the opportunities haven't increased, just kind of stayed steady?

I would say the opportunities have probably increased. The number that we have availed ourselves of is pretty steady.

Fair enough. Can you quantify a little bit on the SIV exposures, there was another story out, some of the news agencies are picking up, there was another SIV Cheyne that was also in default, that looks like they will have a replacement agent. It looks like Goldman Sachs, they are valuing those securities like $0.60 to $0.62 on the dollar. Can you give us an update on how Whistlejacket, is that getting close to resolution where they will have a new replacement agent? Any indication of what they are going to value those securities at? That would be helpful.

One, our SIV exposure overall has come down dramatically, as some of these have matured. But we still have some. I can't comment on the Cheyne and Whistlejacket, Deloitte is the receiver, they are working through that. We are on the Creditor Committee, and actively involved with them, but I really can't give you any information beyond that at this time.

On the credit side, it has just been a phenomenal story for you guys, holding line on credit costs, can you remind us on the residential mortgage portfolio, since you did bring up western Florida and Arizona, how much of your residential mortgages is concentrated in those two areas in any metric, like loan to value, that you can share with us would be helpful?

I don't know if I have that, Tom. Our residential mortgage portfolio in aggregate is typically in the high 30% of our total loan portfolio. I don't think we have anything on what piece is Florida. Then you have got a big chuck in the Midwest in Illinois, and then Florida is significant for us but again, I want to make sure our comments are in the right context.

The question that I was answering was where do you see the most stress today in the loan portfolio, and that I think it is accurate to say the west coast of Florida. Our credit metrics are very, very strong. So that is a relative response.

Tom, I don't think it would surprise you to hear that we have very conservative loan to value policies and ratios, and that our business as with all of our other businesses, is relationship oriented targeting traditional PFS clients. Even in the mortgage portfolio, you would expect the mortgage portfolio would profile along the lines of what a traditional PFS high net worth client would look like.

Great, thanks for taking my questions.

We have another question from Brian Bedell.

Just a quick follow-up, just on expenses, a couple of things on the outside services, whether we should be thinking of that as sort of an inflated trend for second quarter, or more a normalized run rate at this stage? And in conjunction with that, just what you are seeing in terms of your ability to hire staff, to service the new business, particularly in PFS, if there are any kind of strains there?

I think one, our staffing overall, Brian, we have been building, we are up order of magnitude 15% year-over-year in staff across the company, so at least from my vantage point we are building. I would say in that regard, we are getting access to tremendous talent. We always try to bring talent into the Company. The environment is such that I think we are feeling particularly good about the profile of the kinds of people that we are able to bring into this enterprise.

In terms of consulting expense, it really does vary. So I know that I couldn't give you a run rate on that. It seems as though when we finish one project, we are onto the next. So difficult to forecast, kind of what is the embedded run rate. I think overall, expenses year-over-year up 16%. When you look at those relative to our revenue growth, they are very well managed. We are mindful of the environment, and trying to do the best we can there.

I think we are doing a pretty good job of managing the discretionary expenses well within the context of revenues, of building the staff to enable to deliver on the commitments that we are making to clients. Each quarter will bring it's next new challenge. We feel good for now, but onto the next one.

It sounds like, at least on the outside services, you can look at the [through] the current revenue environment, and toggle that to some degree, unless you embark on some gigantic projects.

To some degree, but it is very difficult, the ship is sailing through the water, and it is very difficult to make a hard right-hand turn. You have to remember, many of the initiatives where we have consultants, and so forth. They are not initiatives that you start in the quarter and end in the quarter. They tend to be significant projects that roll off over time. Can we throttle our expenses? Absolutely to some degree, but we can't turn them on a dime.

Right, okay. Thanks so much.

We have no further questions on the phone at this time. I would like to turn the conference over to Steve Fradkin for closing remarks.

Let me again thank you for joining Northern Trust for the second quarter 2008 conference call, and we will look forward to updating you on our third quarter financial results on October 22nd. Have a great day. Thank you.

Ladies and gentlemen, that does conclude today's presentation. Thank you for your participation, you may disconnect at this time.