Northern Trust Corp (NTRSO) 2008 Q3 法說會逐字稿

Good day, everyone. Welcome to the Northern Trust Corporation 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. Please go ahead.

Thank you, Enola. Welcome to Northern Trust Corporation's third quarter 2008 earnings conference call. Joining me on our call this morning are Steve Fradkin, Northern Trust's Chief Financial Officer; Aileen Blake, Controller; and Preeti Sullivan from our Investor Relations team. For those of you who did not receive our third quarter earnings press release or financial trends report by e-mail this morning, they're both available on our website at NorthernTrust.com. In addition, this October 22nd call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through October 29th. 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 now turn the call over to Steve Fradkin.

Good morning, everyone. Let me join Bev in welcoming all of you to Northern Trust's third quarter 2008 earnings conference call. As everyone listening to this call knows all too well, the economic climate in which we and others are operating has been extremely challenging since August of 2007. Whether exemplified by stock market gyrations, shifting interest rates, a weakening credit environment, currency volatility, or other factors, this environment has provided formidable challenges to all sorts of businesses within the financial services industry and beyond.

As we have said many times before, Northern Trust is not immune to this contagion. Our objective has been to successfully navigate through these challenges, balancing our near term results and the attractive opportunities we see as we move beyond this period. Our track record of managing through these ever shifting factors has been extremely strong, even including our performance reported to you earlier today in our third quarter earnings press release.

For the third quarter, Northern Trust reported a net loss of $129 million or $0.58 per share. Our results were significantly impacted by previously announced pretax charges totaling $561.5 million or $1.59 per share, which I will describe in more detail during this call. To assist you in understanding our performance this quarter, we have organized today's remarks into the following sections -- first, I will provide you with an overview of the key market conditions that impacted our results in the third quarter. Second, I will outline five items that you should consider as you analyze our third quarter financial results. Third, I will review our financial performance in some detail, focusing on those items that most impacted top and bottom line results. Fourth, I will offer a few perspectives on the current environment and the positioning of Northern Trust. And then finally, Bev and I will be pleased to answer your questions.

Let me begin by providing you with a brief overview of the key market conditions that impacted our results in the third quarter. First, the equity market environment was very weak in the third quarter of 2008. The S&P 500, Dow Jones Industrial Average, IFA, and many other indices around the world declined for the fourth straight quarter. The S&P 500, which is a good indicative data point for some parts of our business, fell 9% in the third quarter and was down 23.7% compared with one year ago. Equity markets as measured by the S&P 500 were also down on a quarter lag basis by 3.2%, which negatively impacts our institutional and wealth management custody fees. Similarly, using the month lag methodology that applied to our PFS fees excluding wealth management, the S&P 500 was down 13.6% versus the prior year and 6.8% versus the second quarter. All told, the equity market environment exerted significant headwinds across our businesses.

Second, the credit markets continue to show considerable stress despite numerous actions by the US Treasury Department and the Federal Reserve Bank. Fixed income markets, including short term markets, have experienced significant illiquidity, spread widening, and related volatility. This unprecedented environment in fixed income markets has also weighed on the industry and Northern Trust for the better part of one year. These market factors, equity and fixed income, combined to impact both the value of client assets that is we report in assets under management and assets under custody and as well, the fees that we earn for services provided to clients. As we have demonstrated in the past, through various cycles both up and down, we were successful in this challenging climate in adding new clients and doing more for existing clients which served as a partial offset to market related headwinds.

Now let me highlight five items you should consider as you evaluate our performance in the third quarter. The first three were previously disclosed with estimates as of that time in a press release issued by Northern Trust on September 29th. First, other operating expense in the third quarter included a pretax charge of $314 million, equal to $0.89 per share after tax, related to our decision to support clients by increasing certain existing capital support agreements and adding a new capital support agreement for one additional fund. Secondly, we recorded charges totaling $168 million pretax equal to $0.47 per share aftertax in support of securities lending clients that had collateral invested in five constant dollar commingled investment pools. Third, we recorded a pretax charge of $80 million, equal to $0.23 per share aftertax related to the establishment of a program to purchase certain illiquid auction rate securities that were purchased through Northern Trust for clients under investment discretion or that were acquired by PFS clients from our broker dealer.

In addition to these three items which impacted other operating expense, our third quarter net interest income was reduced by $9.5 million pretax due to adjustments made within our structured leasing portfolio. These adjustments relate to structuring leasing transactions we have discussed with you in the past, including in the second quarter, and have previously disclosed in our Form 10-Q and 10-K filings with the SEC. The net interest income reduction represents our so-called FSP 13-2 adjustment. In connection with this adjustment, we also increased our income tax provision by $3 million for certain structured lease transactions. The per share impact of these lease related items was $0.06 aftertax.

Finally, in the third quarter, we recorded a $17 million pretax charge equal to $0.05 per share aftertax relating to an other than temporary impairment of two asset backed securities in our balance sheet investment portfolio. These two securities have a PAR value of $27 million and represent uninsured second lien mortgages. The $17 million charge reflects the difference between amortized cost and the current market value. We believe we will ultimately recover a significant portion of the charge as the securities pay off over the next few years. However, in compliance with generally accepted accounting principles, specifically FAS 115, we recognize the entire difference between the amortized cost and the estimated fair value as of the date the securities were deemed to be other than temporarily impaired.

With that background, let me review our third quarter results, beginning with revenues. Revenues in the third quarter equaled $938.5 million, up 5% or $46 million compared to last year. Revenues declined 14% or $156 million on a sequential quarter basis. The key line items that influenced revenue performance in the third quarter were trust investment and other servicing fees, foreign exchange trading income, and net interest income, which together represented 94% of total revenues. Trust investment and other servicing fees decreased 7% year-over-year or $34 million to $475 million. In our institutional business, C&IS trust investment and other servicing fees equaled $244.5 million in the third quarter, a decrease of 13% or $37.5 million year-over-year and a decrease of 40% or $165 million 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 of these in the third quarter. C&IS custody and fund administration fees equaled $164 million in the third quarter, up 3% or $5 million year-over-year. Custody fees achieved this 3% growth in a very unfavorable market environment as new business driven by global custody and fund administration more than offset the impact of negative year-over-year quarter lag markets. On a sequential quarter basis, C&IS custody and fund administration fees decreased 5% or $8 million as the impact of new business was more than offset by the challenging quarter lag equity market environment. Investment management fees in C&IS equaled $68 million in the third quarter, a decrease of 6% or $4 million year-over-year. On a sequential quarter basis, investment management fees declined 5% or $4 million. In both the year-over-year and sequential quarter comparisons, the weak market environment served as a considerable headwind for investment management fees. New business, however, helped to offset those headwinds, particularly in our manager of manager and quantitative businesses.

C&IS securities lending fees equaled a negative $4.6 million in the third quarter as compared with $33 million last year and $150 million in the second quarter. Once again, and similar to the results we reported to you in three of the last four quarters, our securities lending fees reflect the ongoing dislocation in the fixed income markets. For us, this again, took the form of negative pricing marks in one mark to market securities lending collateral fund. The impact of the negative marks on our third quarter securities lending fees equaled $96 million, which compares with a negative impact from these marks of $36 million one year ago, and a positive mark impact of $25 million last quarter.

Let me offer a few reminders about the mark to market fund as we have done in the past. 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, the fund is managed with a conservative interest rate sensitivity of 47 days, and a credit based weighted average maturity of 1.97 years as of September 30th. And finally, 71% 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.

The fund's negative pricing marks reflect the sharp reduction in trading activity as well as credit spread widening with certain issuers. Additionally, in the third quarter, the weakening economy caused a general deterioration in fundamental credit quality and pricing. More specifically, three holdings in the fund were deemed to be permanently impaired during the third quarter, including securities issued by Lehman Brothers. Those holdings have been segregated from the fund into a liquidating portfolio. The impact of the impairment of these holdings is reflected in the securities lending results we are reporting to you this quarter.

Excluding the impact of the mark to market fund, our securities lending fees would have equaled $91 million in the third quarter of 2008, representing an increase of 33% year-over-year and a decrease of 27% compared with the second quarter of 2008. Again, for context recall that the second quarter typically exhibits seasonal strength as a result of the international dividend season which occurs in that quarter.

Institutional assets under custody equaled $3.2 trillion at quarter end, down 15% or $571 billion from a year ago, and down 11.5% or $419 billion versus last quarter. Global custody assets, which are a component of total C&IS assets under custody equaled $1.7 trillion on September 30th, down 15% on both a year-over-year and sequential quarter basis. The year-over-year and sequential quarter declines reflect the quarter's low market values as the S&P 500 fell 23.7% year-over-year and 9% in the third quarter and the IFA index declined 30.9% year-over-year and 13.6% in the third quarter. In addition, the lower level of institutional assets under custody is also negatively impacted by the stronger US dollar.

Managed assets for institutional clients equaled $511 billion at quarter end, down 17% or $103 billion compared with one year ago and down 16% or $97 billion sequentially. Excluding securities lending collateral from C&IS assets under management, which I will discuss in a moment, managed assets for institutional clients were essentially flat year-over-year and down 11% sequentially. Securities lending collateral equaled $182 billion at quarter end, down 36% or $102 billion versus one year ago and down 24% or $56 billion compared with June 30th. On an average daily basis, securities lending collateral was down 26% year-over-year and 13% versus last quarter. The lower level of securities lending collateral reflected in our institutional assets under management reflects three factors. First, lower market values due to weak equity and fixed income markets; second, a reduction in borrower demand due to deleveraging and the typical second to third quarter seasonal pattern as a result of the international dividend season, and third client imposed restrictions or suspensions during this turbulent market environment.

Let me now switch to our personal business, which we refer to as personal financial services or PFS. Trust investment and other servicing fees in PFS equaled $230 million in the third quarter, representing an increase of 2% or $4 million year-over-year. Similar to our custody fees in C&IS, PFS new business results helped to partially offset the weak month lag market environment. New business in PFS was again very strong in the third quarter, representing our best quarterly results since the fourth quarter of the year 2000. We have seen a significant increase in money in motion in the private client market. Our experience in this arena, expertise, and overall position of competitive strength has fueled growth in new business and opportunities with prospects matching our PFS profile.

On a sequential quarter basis, PFS fees decreased 2% or $5.5 million. The positive impact of new business in the third quarter was not enough to offset weak month lag equity markets. Fees in PFS are derived from the assets we manage and/or custody for personal clients. PFS assets under management equaled $141 billion at quarter end, down 4% or $6 billion from a year ago. Assets under custody in PFS equaled $314 billion on September 30th, down 5% or $15 billion year-over-year. This performance compares once again with the backdrop of a tough market environment, which saw a 24% decline in the S&P 500 year-over-year. On a sequential quarter basis, PFS assets under management were down 1% or $2 billion while PFS assets under custody were down 4% or $12 billion since June 30th. Again, when compared with the decline of 9% in the S&P 500 during the third quarter, our performance on a relative basis reflects the strong PFS new business results that I mentioned earlier.

Net interest income equaled $266 million in the third quarter, representing a 15% increase when compared to the third quarter of 2007. On a sequential quarter basis, net interest income increased 7% or $17 million. As I mentioned earlier, third quarter net interest income included a $9.5 million reduction related to our lease portfolio adjustment. Excluding this adjustment, net interest income would have equaled $275 million, an increase of 17% or $41 million compared with the similar adjusted net interest income for last year. On a sequential quarter basis, and adjusting both second and third quarter net interest income for lease related items, net interest income would have decreased 1% or $3 million.

Our net interest margin in the third quarter equaled 1.62% on a reported basis and 1.68% if the leasing adjustment is excluded. This compares with similarly adjusted net interest margins of 1.74% last year and 1.78% in the second quarter. The decline in our net interest margin resulted from mix changes in both earning assets and funding liabilities. Average earning assets equaled a record $65 billion in the third quarter, an increase of 22% or $12 billion year-over-year and 4% or $2 billion sequentially.

Our balance sheet growth has been significant. Non-US office time deposits continue to be the largest driver of growth in our balance sheet, averaging $39 billion in the third quarter, an increase of 40% or $11 billion versus last year and 8% or $3 billion sequentially. This strong growth in non US office time deposits reflects both our success in growing our global custody business and our ability to aggregate client assets during this turbulent market environment.

Foreign exchange trading income equaled a record $142 million, up 54% or $50 million compared with the third quarter of 2007. On a sequential quarter basis, foreign exchange trading income increased 12% or $15 million. The key drivers of our quarterly results in foreign exchange were volume and volatility. Both remained high in the third quarter, driven by market turmoil all around the globe. Other operating income equaled $36 million in the third quarter, an increase of 89% or $17 million year-over-year, and 4% or $1 million sequentially. The year-over-year results include $7 million of valuation gains recorded on credit default swap contracts as well as higher commercial loan related fees.

During the third quarter, we recorded a loan loss provision of $25 million, compared with a $6 million provision in the third quarter of last year and a $10 million provision in the second quarter of 2008. The third quarter's loan loss provision reflects broad based loan growth and continued weakness in the overall economy. Loans at quarter end equaled almost $30 billion, an increase of $1.2 billion compared with the prior quarter.

Credit quality remains strong at quarter end, particularly given the challenging economic climate. Within our loan portfolio, nonperforming assets equaled $61.5 million at September 30th, representing only 21 basis points of total loans at quarter end. Nonperforming assets increased $27 million in the quarter, with the bulk or 95% of the increase being accounted for by only two loans. Within our $12 billion available for sale balance sheet investment portfolio, credit risk also continues to be very strong and profiles well when compared with banking industry peers. Our unrealized losses on available for sale securities equaled only $200 million pretax on September 30th compared with $159 million pretax on June 30th.

Now let me shift my comments to a review of the key expense categories that impacted the third quarter performance. For purposes of the discussion that follows, the previously announced charges of $561.5 million that I discussed earlier have been excluded. Expenses, exclusive of the previously announced charges, equaled $563 million, representing a decrease of 1% or $4 million from the year ago quarter. On a sequential quarter basis, expenses were down 13% or $81 million. Compensation expense equaled $230 million and decreased 11% or $29 million from the year ago period. The year-over-year decrease in compensation expense reflects a lower level of incentive compensation due to projected corporate performance, offset by higher staff levels and annual merit increases.

Staffing levels equaled approximately 12,100 full time equivalent positions at quarter end, up 14% year-over-year. Our office in Bangalore, India now employs over 1,200 staff members, almost double the staff level we had in India one year ago. On a sequential quarter basis, compensation expense decreased 25% or $76 million, primarily reflecting lower incentive compensation offset by increased staffing levels. Employee benefit expenses equaled $52 million in the third quarter, down 8% or $5 million versus last year, and down 16% or $10 million sequentially. The year-over-year decrease primarily reflects lower defined contribution plan expense and lower pension expense, partially offset by higher FICA insurance expense. The sequential quarter decrease was driven primarily by lower defined contribution plan expense and by lower medical and FICA insurance expense.

Outside services expense equaled $106 million, an increase of 7% or $7 million compared with last year. The year-over-year increase resulted from higher technical, legal, and consulting expense. Outside services expense was flat sequentially. Equipment and software expense equaled $61 million, up 13% or $7 million year-over-year and 7% or $4 million sequentially. The year-over-year increase primarily reflects increases in amortization and maintenance expense driven by increased levels of technology investment. The sequential increase represents the typical annual pattern, where expense associated with depreciation and amortization of equipment and capitalized software is typically higher in the second half of the year.

Other operating expense, excluding the client support related charges outlined earlier, equaled $71 million, an increase of 23% or $13 million compared with last year. The year-over-year increase was primarily due to the settlement of a longstanding legal matter and higher business promotion expense. On a sequential quarter basis, other operating expense decreased 1% or $600,000.

An income tax benefit of $93 million was recorded in the third quarter due to the pretax loss of $210 million. Excluding the impact of the client support related charges and the lease related items, the third quarter effective tax rate would have been 32%. Northern Trust repurchased 49,000 shares of common stock in the third quarter at a cost of $4 million. Diluted shares averaged 221.9 million. We can purchase an additional 7.7 million shares under a buyback authorization approved by our board of directors in October of 2006.

Before I wrap up, let me comment briefly on the continued strength of Northern Trust's capital position. Northern Trust regulatory capital ratios remain very strong, considerably in excess of the well capitalized level set by bank regulators. Our Tier 1 capital ratio for example equaled 9.2% at September 30th, well ahead of the 6% minimum for the well capitalized designation. Maintaining a strong and conservative level of capital has long been a hallmark of Northern Trust, a fundamental tenet of our company that is serving our clients and shareholders very well in this difficult market environment.

Let me now close with a few perspectives on the current environment and the positioning of Northern Trust. As I suggested at the outset of this call, from an environmental perspective, conditions in the third quarter and actually year-to-date in 2008 have been extraordinarily difficult. These difficulties have touched virtually all markets and geographies. A downstream consequence of this crisis has been a remarkable series of dramatic events ranging from high profile corporate bankruptcies to orchestrated acquisitions, from conservatorships to the departures of seniormost executives, and to a host of unprecedented government initiatives both here in the United States and around the globe.

Northern Trust, as we have always said, is not immune to these events. While we posted very strong results for full-year 2007, and performed at record levels for the first six months of 2008, this third quarter and really the month of September in particular posed extraordinary challenges for our clients and as a result, for us. The third quarter 2008 represents the first quarterly loss for Northern Trust since the fourth quarter of 1987.

The driver of this loss is, we think, very important to understand. Our underlying business fundamentals remain sound. However, reflecting on our position of capital strength and the importance we place on the health of our long term client franchise, we elected to incur $561.5 million of charges related to client support actions. This decision caused our loss for the quarter. It was not an easy choice, but we believe it was the right decision as we balanced the corporation's near term results with the attractive opportunities we see as we move beyond this period.

Northern Trust continues to be highly differentiated. Indeed, the current environment may in the end serve to further heighten Northern Trust's unique positioning. As we move forward, we will continue to focus on the businesses we know so well, which continue to have attractive long-term demographics and growth prospects. This focus, coupled with our conservative financial strategies and client centricity, will remain as a top priority.

In sum, while we are disappointed to report a quarterly loss to you today, we remain focused on the businesses and focused on our clients in this extremely difficult environment. Now Bev and I would be happy to answer your questions. Enola, please open the call for questions.

Thank you. (Operator Instructions) We will pause just for a moment to assemble our roster. We will take our first question from Robert Rutschow with Deutsche Bank.

Hi, good morning.

Morning.

First question I wanted to ask about was -- the impact of foreign exchange on your core custody results and the level of custody assets that you reported.

I think -- I don't know that we can quantify that for you. I guess the -- in terms of our assets under custody, just as a reminder, the C&I assets were $3.2 trillion, down 15% year-over-year and 11.5% sequentially. The global piece, the subcomponent of that, $1.7 trillion down 15% year-over-year and sequentially. I think the way I would put that in context is if you look at the S&P, down 24% year-over-year and 9% sequentially, and the IFA down 31% year-over-year and 14% sequentially, I think we look pretty good. Remember in proportionate terms, Northern Trust has the biggest proportion of global assets, which we think generally serves us well from a business standpoint, generating foreign exchange and the like. However, in terms of assets under custody this quarter, with IFA down significantly more than the S&P, that really hurts us. And then you combine that with the translation to the US dollar, and it hurts us some more. So we think actually our assets under custody number are quite good this quarter.

Maybe if I can help put in order the drivers for you. The biggest driver of the decline -- the sequential decline in our assets under custody was as you could imagine the market impact. The second largest driver was the currency impact because of the stronger US dollar, and the third driver in order would be the fact that our securities lending collateral declined. That would be the order with which each of the drivers contributed to the decline in assets under custody on a sequential quarter basis.

Okay. That's helpful. In terms of securities lending, can you give us an idea of the profitability of that business, as we think about the $96 million in mark to market losses?

We don't disclose any profitability on security lending, but historically it has been an attractive business for us.

Can you give us any idea of how many people you may employ in that business?

No.

Okay. And you took a charge for the auction rate securities this quarter. Does that essentially cover your exposure to the auction rate securities? Are there customers that have some that are not covered by this charge, and would you expect to recover any of this amount over time either from third parties or by these securities returning to more fair value?

We think the auction rate charge that we took which was $80 million pretax in the quarter should cover us in that area. In terms of possible recoveries, very difficult to say. Essentially what we are doing here, for those clients that want it is purchasing those securities from clients at PAR, and then we will be the holder of securities and we will decide what to do with those and/or whether we have actions against other parties. But I think for your purposes, you should assume that essentially takes care of it from our side.

You mentioned lower incentive compensation in the third quarter. Can you give us an idea of what the actual level of incentive comp was in third quarter and second quarter?

We don't break that out. So I can't give you that, but what I would say is that if you look at our performance, we had a very strong first half of the year, and we are always calibrating our incentives relative to our projected full year performance. Clearly, with this quarter's performance we have to take that down, because we are projecting our full year results to be weaker than we had planned.

Okay. And one last question, you built a reserve this quarter. I am wondering if you can give us an idea of what you feel the appropriate reserve level is, and if you can give us any sense for what your watch list looks like relative to the NPA level at this point?

Well, I think that the reserve level is what we deem to be appropriate now. We are not building it beyond what we think appropriate. I would say that our -- what we refer to as our 7 and 8 rated loans, which are the loans in our weakest categories, have increased considerably -- as you might expect the environment is tough. Our 7 and 8 rated loans at the end of the third quarter equaled $260 million, which was up $138 million from last quarter. So clearly we are seeing some degradation in loan quality. I should add that just for perspective, that in terms of the increase, that really represented order of magnitude a dozen borrowers. So it is not as broad based as the whole portfolio. You have got it focused on a few key places. And I guess to put our 7 and 8 rated loans in context, that $260 million would compare with a recent peak in recent years of about $319 million. So, we have very, very high loan quality. And as we have always said, when the environment degrades we will feel some of that. But our credit metrics remain outstanding, though they're moving up and typically they're triggered by a small number of loans.

Are there any particular industries for those 7 and 8 rated?

Nothing that I would point out at this point in time.

Okay. Thank you very much.

You're welcome.

We will go next to Glenn Schorr with UBS.

Thanks. Hi, Steve.

Hi, Glenn.

Can we talk a little more about the deposits? You had great growth. You gave a little color on that quarter on quarter, year on year. Can you talk about where it's coming from, what type of clients -- are they new clients, current clients, just so we can get a thought process around what we can expect to stick around going forward?

Sure. Well, our overall interest bearing deposits were up 35% year-over-year and we saw savings deposit growth of 11%, but the big driver was the non US time deposits, which increased by 43% or $12 billion year-over-year to reach $41 billion. So, translating that into clientspeak, that's really largely the institutional clients outside the United States placing their cash with us. That has been a high growth area for us and that continued in the third quarter.

Is that an allocation away from someone else? Is that how we should think of that in terms of share shift, or are they just growing?

It is hard to validate that empirically because that can be asset allocation shifts, just more cash. It can be deposits gathered that are being placed with us from elsewhere. If I had my gut reaction, I would say it is both, just clients' transactional activity, but I think there was on a variety of fronts and this is one -- what I will call a flight to quality in the third quarter to stronger balance sheets. But I can't empirically prove that to you.

On the cost side, you notice the big drop in comp, and but also in -- interestingly a reasonable pickup in head count considering the environment we are in. On a go forward basis, can you just marry those two thoughts?

Well, I think -- I guess I'd offer a couple of perspectives. For a business like ours, it is always difficult to align revenue growth and expense growth when you have sharply declining markets. Remember, we will have more clients this quarter than last quarter and a year ago, but the basis upon which we get paid for the services we offer to clients is going the other way. So it is a tough balance to manage in the very short term. Remember 70% -- approximately 70% of our fees and 50% of our total revenues are coming from trust investment and other servicing fees, so when the market values decline, that's a significant challenge.

I guess the way I would respond, Glenn, is we obviously have to do all we can to manage our expense base carefully. We have more several years now been building up some of our activities in India which help us geographically and help us on a cost base, as we harmonize that. Looking forward, 55% to 60% of our expense base is in people -- salaries, incentives, and benefits -- so clearly we will have to be very judicious about our human capital growth going forward. About 15% of our expense base is in outside services, some of which relate to volume, some custody expense, subadvisory and the like. And obviously we will be tightening that as much as we can. So, in the environment that we are in, we are going to do all that we can to manage our expense growth consistent with the revenue profile. But again, we are trying to walk that balancing act between the way we get compensated for services being down very a period of time, yet the volume of work and activity that we have rising. So it is just an artful balance.

I hear you. Good luck with that.

Thank you.

Last one. You have obviously done a great job being real conservative on the balance sheet. Your unrealized loss is pretty tiny all things considered. So I guess it is not much of an issue, but I figured I would ask the question anyway. Do any of the Treasury capital investment program TARP facilities -- out of all of the five or six major things that have been announced recently, could you talk about the ones that might have the biggest impact for Northern Trust?

I think a lot has been written about the government's decision to inject capital into the banking system, and as you quite rightly note, Glenn, our capital ratios are strong, and very well in excess of regulatory capital guidelines. That said, this is a healthy bank program, and we are interested in participating in the purchase program. So I think we are continuing to discuss this with regulators as part of our normal capital planning process and we will make a decision as we go forward, but that's the piece that I would say is most applicable and interesting to us at this point in time.

So just so we are clear, most likely you will hand in your application before the mid November deadline?

Yes.

Okay. That's cool. Thank you very much.

You're welcome.

We will go next to Mark Fitzgibbon with Sandler O'Neill.

Hi, Steve, how are you?

Hi, Mark.

I know you typically don't talk about the future, but given the volatile period we're in, I wondered if maybe you could share with us what's happened to deposit flows, on those foreign office time deposits as well as some of your custody flow since the end of the quarter?

We really don't, I would say, Mark, it is difficult because there's a lot of fluidity to that. I would be remiss in trying to talk about where we are since the end of the quarter, and I prefer to just stick with our quarterly results.

Okay. Secondly, I wondered if you could give us a little bit more color on those two large NPAs you had this quarter -- maybe what type of credit they are, what geography or industry they are in?

Mark, I can give you a little bit of perspective on that, although not a lot because obviously we have got client confidentiality to deal with here. But one of them is a family-owned manufacturer and distributor. And it has been a client of Northern Trust for decades. And their biggest issue right mow is dealing with some of the economic downturn, generally speaking. The other one is a West Coast based manufacturer as well. And they too have been suffering from the current economic environment. So that's about all I can say.

I think Mark, the thing I would remind you and you know well about us is that again the overall portfolio looks to be in very good shape, both in absolute and relative terms, but as will always the be the case for us, when you come off very pristine levels of credit quality, anything will show up as a blip. For now, that's what we are experiencing this quarter.

Just the last question, State Street has -- seems to have essentially said they may support other funds that they manage that become troubled. Bank of New York has said that they won't. I am curious where does Northern Trust stand on providing additional support to its various funds? Is there a point at which you will say we are going to stop supporting these funds if we have done everything right?

What we have done is -- speaks for itself. We have stepped up and provided support in a number of forms, whether it's capital support agreements that the securities lending constant dollar collateral pools or the auction rate. We think it was the right thing to do based on the long term health of our franchise, but that is all we have committed to and we have not committed to doing anything else. We will assess facts and circumstances as they exist, but that is clearly all we have committed to at this point in time.

Thank you.

You're welcome.

Mr. Fitzgibbon, was that all for you?

That's it. Thank you.

We'll go next to Jason Goldberg with Barclays Capital.

Thank you. Steve, you mentioned the $96 million average impact in sec lending tied to that mark to market fund. I guess how much of that was realized versus unrealized?

We don't break that out. That is the total net effect in the quarter, Jason.

Okay. But I guess, all right. I guess even without knowing that piece, it still looks like you have a fair amount of unrealized losses tied to that piece. Can you just -- you talked about your thoughts on eventually recouping that over time.

Well, the markets are extremely fluid. So I am loathe to make any predictions on timing, as I think you can fully appreciate. We do have $255 million in accumulated negative marks. So, that is we are sitting on. And our ability to predict the timing of that is suspect at best.

Okay. Did I mention the duration of that is about two years?

That's correct.

Okay. Thank you.

You're welcome.

We will go next to Brian Bedell with Merrill Lynch.

Thanks, good morning.

Good morning.

As I usually ask every quarter, Bev, can you disclose the AUN and assets under custody breakouts by asset class?

Sure. For assets under management, equity was 38%, fixed income was 15% and short duration was 47%.

Okay.

For assets under custody, equity was 46%, fixed income was 31%, and short duration was 23%.

Great. Thank you. Then just a little more color on the ABS portfolio, looking at your second quarter Q where you do break out the credit ratings of that and you describe then as mostly floating rate. Can you give a little more detail about the nature of those securities and whether that ratings distribution in the second quarter still holds as of the third quarter?

Sure, Brian. Well, as of September 30th, we had a $13.4 billion securities portfolio. As you know, it is very high quality, very short duration. 90% of that is AAA. Of the $13.4 billion, about 13% or $1.8 billion represents asset backed securities -- and again, very high quality, 86% of the asset backed securities are AAA, which is down a little bit from last quarter when they were at 91%. Sorry. Of the $1.8 billion in asset backs, only $349 million represent subprime asset backed securities and 62% of the subprime asset backed securities are AAA. We continue to feel quite good about our securities portfolio.

And then the remaining part of that $1.8 billion is just residential mortgage backed securities of prime nature?

No, Brian we've got asset backed securities in the credit card space, the auto space, the student loan space, and the mortgage space.

Right. Okay. Pretty well diversified between those?

Yes.

Yes.

Okay. Great. If you could just talk about just Jason's question on the unrealized versus realized losses, the $255 million of the negative marks -- does -- the way I think about that is that is your unrealized losses in the securities lending mark to market product that you have the potential to recoup. But we should really think about all of that as recoupable given -- or if we presume that you won't be sharing realized losses with clients, because you are not contractually obligated to share realized losses with clients. Is that correct?

That's correct.

Okay. So the only way you could not recoup that $255 million is if you decide -- if you personally decide to share some of those losses with the clients.

Yes, that's correct. We have not done that.

Great. Okay. What's the size of that mark to market portfolio at September 30th?

Security -- it is about a $9 billion fund.

$9 billion. Okay. Great. And then if you could just talk about the -- just how your pension plan clients are thinking. Obviously it has been a crazy market in securities lending, and you have been able to recoup the collateral in terms of some of the issues. I know this has been for all of the trust banks. So things have stabilized for now, but are, do you feel that there are ramifications -- are those pension plan clients likely to come back into securities lending programs or are they going to remain on the sidelines for a while, do you think?

If you think about the market drivers, we think at least securities lending is really essential to running of efficient capital markets. It is an important part of a broadly functioning market. That said, from a supply side, getting to your question, whether it is pension funds or others, clearly in the environment that we are in, we are going to see temporary suspensions. We are going to see loan balance capping, borrower restrictions and the like for a whole host of reasons. So we do expect some moderation at least for a period of time, but I think overall -- and again this is more a personal opinion than anything fact-based. We expect it to slow down and probably slow down reasonably considerably for a period of time until the markets sort themselves out. But I think there will be plenty of opportunities for people who want to lend their securities in due course.

What proportion of your sec lending book is equities?

It is about 50/50, Brian, from a lending perspective.

Right.

Moves around a little bit, but 50/50 is a good way to think about it, equity versus fixed income.

Great. Then just on the high net worth, or the PFS business, and you don't give out the flow information, but based on market movements I would calculate anywhere from depending on what kind of return assumptions you use, anywhere from $5 billion to $10 billion of inflows in the quarter. First of all, is that in the ballpark, and secondly should we expect a lift in the fourth quarter given that those inflows have come in during the quarter and [have] not been all realized into revenue yet?

We don't give any inflow validation or perspective. So I can't help you with that one. In terms of the fourth quarter, again, the question is whether you will see it based on what happens to market conditions. Clearly we had a very strong third quarter and that was terrific news for our PFS business, but depending on where markets go, much like you saw this quarter, it is hard to see it.

But your momentum in new business given the dislocation you've been talking about you would describe as potentially even improving into the fourth quarter -- excluding, market levels.

Well, I don't want to be predictive about the fourth quarter we don't offer guidance. What I'll say is the last two quarters in particular have been extremely strong. If you think about it in historic terms, historically, when the markets start dropping in the personal business, decision making slows down a bit. So we wouldn't, in -- I will call it normalized softer markets expect our new business to accelerate. We would expect it to moderate, because people sit on their hands. They don't want to make decisions -- they're not sure where the markets are going. This -- in the third quarter and in the second quarter of the year, we had a very different phenomenon which was really, in my judgment, a significant and pronounced flight to quality. So instead of sitting on their hands, they moved and moved to quality. Now again I can't prove that to you, but that is my strong sense based on anecdotal evidence and the numbers of what happened. Where people will be in the fourth quarter, very difficult to predict. But so far this year, very good results in PFS new business.

I would think that would certainly persist for at least a time here. Just last question, on the TARP and related programs, were you referring to the essentially applying for the preferred investment, that I guess banks are eligible to up to 3% of risk-weighted assets?

That's correct.

Any decision on what level you would apply for, the 1% or more like the 3%?

We have not decided.

Okay. Thanks very much.

Thank you, Brian.

We will go next to Nancy Bush with NAB Research.

Hi guys, how are you?

Hi, Nancy.

A couple of questions. Number one, I believe in the second quarter you said that the PFS trends in Florida had been quite strong. I am wondering if that has continued into the third quarter, given what looks like an accelerating problem in the housing market there?

Well, our trust fees in Florida were $52 million in the third quarter. They were down 1% year-over-year and 4% sequentially, which compares quite favorably, Nancy, with the month lag markets, which were down almost 14% year-over-year and almost 7% sequentially. Our new business in Florida in the third quarter was strong. It was up about 40% compared with the third quarter of 2007. And Florida we also saw good growth in loans and deposits, again reflective of this flight to quality phenomenon. So Florida was quite strong for us in the third quarter.

Okay. And second question is a bit more broad and I guess philosophical, Steve. The last time you guys really got into a bad market was 2000 to 2001. We had several quarters and I guess a couple of years of bad market results then. What is the biggest difference this time around? Is it the global aspect of the company or what will make this time different?

Well, I think if I were to contrast last time, you had a phenomenon where you had, what I will call a consistent relatively slowly paced change. So you had markets -- equity markets go down three years in a row. That hadn't happened since World War II. The first year is tough based on the business model where you get paid to some extent based on the market value of assets. The second year it is tougher and the third year it is -- you are really starting to feel the pinch.

If I were to contrast that with what we are seeing right now, and again this is just a Northern Trust perspective, the month of July and the month of August were very good months for us, performing very well. It is a three week window in the month of September, where just an unbelievable amount of things happened. Let's just remember what happened within three weeks. We saw Lehman Brothers go bankrupt. We saw Merrill Lynch get acquired. We saw the government step in and provide varying levels of support or conservatorships for Freddie, Fannie, and AIG. We saw them inject -- or announce their intention to inject $250 billion into the banking industry. We saw Goldman and Morgan Stanley become bank holding companies and Mitsubishi take a 21% stake of Morgan Stanley. We saw Wachovia get acquired by Wells or the announcement and Washington Mutual get acquired by JPMorgan Chase. That's in three weeks.

So again I know it is all stuff that you know, but the volatility and variability around that is just off the charts relative to anything we have seen. So, what does that mean for us? I think we are living in a very, very difficult time. I think many of the underlying premises of Northern Trust, the strong capital and conservative disposition whether it is it is in our securities portfolio or loan portfolio are serving us well, but when markets move that rapidly with that much volatility or illiquidity, it causes problem, and so we're having to steer that -- all the while having more work and more clients to deal with. So it's a much more intense -- like taking three years and putting it in three weeks is one way of putting it.

Well, that explains why I look so much older at this point.

All of us.

I guess I'll just ask -- some of the things that you talked about there should be particularly relevant to Northern Trust going forward, and of course that's Merrill Lynch being acquired by Banc of America and the failure of Lehman and some of the other issues around brokerage firms and asset managers. Are you seeing the direct inflow from those events, and do you expect it to perhaps accelerate from here as these companies are integrated?

The way I would answer that is, clearly -- and I can't definitely prove to you why clients move, but there's no question that in our judgment there was significant money in motion in our PFS business. There was a significant uptick in money in motion from the broker dealers. That's clear, and understandable given that which I just outlined. In terms of the go forward, again we like our position in this personal business. 119 years, very focused on it. Very nimble, broad array of capabilities, and we have always competed well against what I'll call the money center banks, the very very large institutions in that space. So to the extent that you're assuming that in the world of big, big is getting very, very much bigger, we think that will be an advantage for our PFS business, but of course we will have to see.

Thank you.

You're welcome.

We will go next to Tom McCrohan with Janney Montgomery.

Hi.

Hi.

Most of my questions have been asked. I have two more clarification questions. On the deposit side, although you had strong growth in interest bearing [foreign time] deposits, the noninterest bearing deposits declined sequentially, down about 12% or about $1 billion in dollar terms. By comparison, your peers BK and Stacey were flooded with non interest bearing deposits, particularly in the last few weeks of September month. So I am wondering if you can compare and contrast why your non interest bearing deposits were not equally up substantially.

The explanation has to do more with where our deposits were on June 30th. We had an abnormal position in terms of non interest bearing deposits on June 30th. So it does make the sequential quarter decline look a little unusual.

Okay. And as far as trends in securities lending, can you just elaborate on the difference between the $96 million valuation loss this quarter and the separate $167 million charge to help support sec lending clients? I'm having a hard time distinguishing between.

Those are two really separate items, Tom. If you think about the -- I guess the way I'll try and explain this. Within securities lending, think about two buckets -- one where collateral is invested in constant dollar and AV funds. That's where the $167.6 million charge or whatever took place where we decided to support those funds. The other piece of securities lending, which is much smaller but has been much more volatile since the third quarter of last year, is where we have this mark to market phenomenon and the $96 million negative mark happens. So they're entirely separate. Both within securities lending, but entirely separate phenomena if you will.

If I remember correctly, last quarter, there was a $25 million recovery within security lending fees related to previously recorded unrealized losses.

That is correct. So you have on a sequential quarter basis, not only do you have big negative marks in the third quarter, but they're compared to the second quarter against the opposite phenomenon to the tune of $25 million stronger than they otherwise would have been, because we recouped some of the marks.

Tom, we had disclosed that comparable figure in each of the last five quarters. And in four of the five, we did have a scenario where the mark to market fund had a negative impact on our securities lending fees and in one, which was just the last quarter as you pointed out, there was a bit of a reversal and we had a positive impact.

Okay. And my last question is on just to see if -- the capital support agreements, just trying to see the moving parts there. Back in February you disclosed about $230 million of CSAs, about seven of them -- back last month you talked about increasing the 7 to 8. But I couldn't find in today's press release what the total dollar value is today, as of today in the eight outstanding capital support agreements so you can clarify that?

$550 million. That is the maximum exposure under our capital support agreement.

And how much of the $320 million some odd increase as a result of the September actions is related to the Lehman bankruptcy versus the prior issues we have talked about back in February related to Whistlejacket?

If you look at the changes in the CSAs -- the change in the value of the capital support agreements -- at June 30th, that was about $10 million. It has moved up to $324 million at September 30, and the real drivers are one, Tom, increased maximum dollar contribution. So we went from $229 million as the maximum to $550 million. Two, we have some higher net asset value support levels. Three, we have broadened the support beyond Whistlejacket for two of the CSAs. So in the original CSAs it was only related to the Whistlejacket holding. Now it is broader --

For two.

For two, sorry. And then lastly we just saw a deterioration in fixed income market conditions including the bankruptcy of Lehman et cetera. So it is a combination of those factors that makes the big move up to $324 million.

Okay. Thank you.

You're welcome.

We will go next to James Mitchell with Buckingham research.

Hi. Most of the questions were asked and answered, but maybe can we talk a little about the net interest margin? It fell 10 basis points on a normalized basis. There was a bit of a mix shift away from no interest deposits into interest bearing deposits, but how should we think about that going forward? Should we think of that normalizing -- you were in the high [17s] pretty consistently before that. What is the drivers there?

Well, I think we are not in a position to be able to give you any future guidance on where the net interest margin might go. In terms of the the net interest margin having declined a bit on a sequential quarter basis, it was primarily related to some changes in the mix on the balance sheet, both on earning assets side of the balance sheet where the mix shifted a little away from the higher yielding assets as well on the liability, the funding side of the balance sheet, where the mix shifted a bit toward some higher cost funding liabilities. So, it really was primarily a mix shift phenomenon in the third quarter that drove it down. Even an adjusted $168 million, it was pretty close to what it was for the full year 2007 where it was I believe $170 million. So, hopefully that gives you a little perspective on what happened in the third quarter, but we are not in a position the give you future perspective on it.

Fair enough. Maybe speak more broadly to the current interest rate environment and short term markets more generally, maybe not specifically about your forecasting margins or even mark to mark losses, but if we think about everything the Fed has done in the short term markets to improve things, and we have seen LIBOR come down. We have seen commercial paper spreads tighten quite a bit. Overall should we expect -- if that were to be sustained I would think that would help alleviate a lot of the pressure on the mark to market in the securities lending book. Is that a fair statement at least?

I don't know if I will answer your question, Jim. As the environment, if you want to use the term normalizes -- that will help markedly. The pace of that normalization is a significant question. A personal view is that the government and a host of regulators have really done -- if you actually look at all of the steps they have taken and we can debate which will be most effective and what you would do if you were in their chair -- they have taken unbelievably dramatic steps globally to try and stabilize this environment, and my own sense is that they're starting to get some traction. But, going from that to a prediction of where we will be three months from now, I'm --

Oh no, I am not asking you to predict even tomorrow. I just was saying if it were what we have seen over the last week or two sustained, it does seem like we have improved since the end of the quarter in some of these short early term market.

More stability is better, I guess.

Okay, thanks.

You're welcome.

We will go next to Robert Lee with KBW.

Morning.

Morning.

Just curious maybe following up -- you mentioned the -- Northern's interest in possibly tapping into the Fed's offer to buy preferred stock and some warrants. Considering your capital ratios being pretty strong and the securities portfolio being pretty good shape and the significant I guess I will call them preprovision earnings you generate, can you talk a little bit about your thought process behind that? You wouldn't seem to necessarily be at a need for it. Do you view this as more of an offensive thing, in the sense that taken the cheap capital, maybe opens up opportunities, you know, that can come along whether it is on the acquisition front or otherwise?

We think it is an attractive program. So it is efficient. In terms of some of the other normal sources for capital right now, at least for financial institutions they are -- shall we say, limited. So your other alternatives right now are not that great or accessible. Two thoughts. One offensive, one protected -- we like the position we are in. We think we have a great franchise and as we have alluded to in the PFS and otherwise, there's some terrific opportunities in this environment. Secondarily, if people have learned nothing through this crisis, it would be that very strong capital is a good thing. You never know when you are going to need it. You have heard us talk about that ad nauseum. And as you and I have discussed over the years, if there's one thing we have been critiqued for over the years, it is being too strong on capital. I think this environment, though I certainly wouldn't have predicted it, reminds you of why you want to be in that position. So to the extent it is an attractive program, we want to take a serious look at it, and obviously we haven't disclosed what we have going to do, but it is I think an attractive one. We will consider it in that vein.

I know you guys don't like to make forward-looking statements, but I will just -- if you look out ahead and presumably, what a lot of your competitors globally are going through -- presumably when the dust settles there may be more people willing to exit aspects of the asset servicing business. As an organization, do you, I mean do you see your appetite changing? In the past you really haven't done much, obviously, to the [Bearings] transaction a couple of years ago -- but as do you see more of an opportunity to play more of a role of a consolidator than you would have thought in the past?

Our number one priority is focusing on the clients, and there's no question that in this market environment, whether they're personal clients or institutional clients, it is a stressful period. That is the number one priority. That said, we like our franchise, we like the opportunity, I think it is fair to say that there will probably be more things for sale than ever before on both sides of our business. And we will continue to look at all of them to see what, if any of them, make sense to expand the capabilities we have for clients. So, we are going to look at everything.

Fair enough. Thank you.

You're welcome.

It appears we have no further questions left in the queue. Mr. Fradkin, I would like to turn the conference back for any closing or additional remarks.

Okay. Let me again thank you for joining Northern Trust for this third quarter 2008 earnings conference call. We will look forward to updating you on our fourth quarter financial results in January. Thank you very much.

Thank you, ladies and gentlemen. Once again, that does conclude today's conference. Thank you for your participation.