Northern Trust Corp (NTRSO) 2009 Q2 法說會逐字稿

Good day everyone, and welcome to the Northern Trust Corporation second quarter's earnings conference call. Today's call is being recorded.

At this time, I would like to turn the conference over to the Director of Investor Relations, Bev Fleming. Please go ahead.

Thank you, Daryl, and welcome to Northern Trust Corporation's second quarter 2009 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 second quarter earnings press release or financial trends report by e-mail this morning, they are both available on our website at NorthernTrust.com. In addition, this July 22 call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through July 29. 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 includes 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 2008 Annual Report, and periodic reports to the Securities and Exchange Commission, for detailed information about factors that could affect actual results. Thank you again for your time today.

Let me turn the call over to Steve Fradkin.

Good morning everyone and let me join Bev in welcoming you all to Northern Trust's second quarter 2009 conference call. Reported second quarter 2009 net income of $314 million, an increase of 46% versus a year ago period.

Net income applicable to common stock which includes the impact of both dividends and discount accretion related to the redemption of preferred shares in the quarter equaled $226 million, or $0.95 per common share. This compares with net income of $216 million or $0.96 per share earned in last year's second quarter. To assist you in understanding our performance this quarter we have organized today's remarks into the following sections.

First, I will highlight several items that you should be mindful of as you evaluate our performance. Second, I will profile certain second quarter market conditions that impacted our performance. Third, I will review our financial performance focusing on those items that most impacted our results. Fourth, I will offer a few perspectives on the operating environment and on the strategic and financial positioning of Northern Trust. And, finally, Bev and I will be pleased to answer your questions.

Let me begin by highlighting six items that you should be mindful of, as you evaluate our performance this quarter. Fiscal, during the second quarter Northern Trust successfully completed an issuance of new common stock, which increased our capital base by approximately $835 million. Shares outstanding increased from 223.7 million on March 31 to 241.4 million on June 30, an increase of 17.7 million shares. In addition we successfully issued $500 million in Senior Notes.

Second, the combination of the common stock offering and debt issuance along with additional resources position Northern Trust to be one of the first large banks to redeem the preferred shares sold to the US Treasury, as part of the TARP capital purchase program. We successfully repurchased 1.576 billion of preferred shares on June 17th.

As previously announced, our second quarter financial results were reduced by $0.37 per share, associated with the preferred stock. This reduction was comprised of $68.6 million, or $0.29 per share of accelerated discount accretion associated with the redemption, and $19.5 million, or $0.08 per share in preferred dividends recorded through the June 17th redemption date.

Third, our trust investment and other servicing fees in the Corporate & Institutional Services business units, benefited from improved fixed income market conditions in the second quarter. Specifically, our securities lending fees equaled $172.5 million in the second quarter, which included approximately $129 million in positive marks, associated with one mark-to-market investment fund used by certain security funding clients.

This compares with $25 million in positive marks in the second quarter of 2008, and $52 million in negative marks in the first quarter of this year. On a cumulative basis, dating back to the third quarter of 2007, the second quarter's positive impact of $129 million, reduces to approximately $222 million, the cumulative impact that negative marks have had on our securities lending fees. Fourth, on April 1st, Northern Trust adopted Financial Accounting Standards Board's Staff Position 115-2 and 124-2, which are designed to create greater clarity and consistency in the industry for impairment losses on securities.

Adoption of this guidance impacted our results in three ways. First, we recorded $18 million, or $0.05 per share in Other Than Temporary Impairment through the income statement, related to credit losses on certain residential mortgage backed securities. $4 million of that amount related to further credit impairment of three securities that were previously determined to be impaired in 2008. $14 million related to five additional securities, on which we have taken credit loss impairment in the second quarter.

Second, the noncredit portion of impairment previously recognized in 2008, and equal to $15 million pretax, was reclassified from retained earnings to accumulated other comprehensive income. This reclassification had no impact on capital as it was a reallocation from one capital category, retained earnings to another, accumulated other comprehensive income. Third, we recorded $40 million of noncredit related losses in the second quarter to other comprehensive income.

Moving on to the fifth item that impacted our second quarter results, other operating expense included $130 million of decrease in expense associated with the fair value of our liability, under the capital support agreements that we entered into in early 2008. During the second quarter the Whistlejacket structured investment vehicle, a security held in certain funds covered by the capital support agreements, completed it's restructuring and final settlement.

Per the terms of the capital support agreements Northern Trust made cash payments totaling $67 million to the covered funds, and therefore extinguished seven of the nine capital support agreements. Two capital support agreements remain, with the maturity date of November 6, 2009, and an aggregate maximum remaining exposure of $200 million. The current fair value associated with our remaining $200 million liability is approximately $125 million.

And finally other operating expense included approximately $20 million in expense, payable to the Federal Deposit Insurance Corporation, in connection with an industry-wide special assessment imposed on all insured banks. Let me now profile certain second quarter market conditions, to provide context for our trust investment and other servicing fees, which represented 58% of total revenues in the second quarter. The equity market environment showed signs of improvements in the second quarter, but remains at levels well below one year ago. The S&P 500 was down 28.2% on June 30 when compared with the prior year, but improved 15.2% during the second quarter.

Because some of our trust investment and other servicing fees are earned based on the lag market values, let me review for you those impacts. Equity market performance calculated on a one quarter lag basis, which is the methodology used for calculating C&IS custody and PFS wealth management fees was weak, as the S&P declined by 39.7% year-over-year, and declined by 11.7% sequentially on a one quarter lag basis.

Using the month lag methodology that applies to PFS fees excluding wealth management, the S&P 500 was down 37% versus the prior year, but increased 5.1% versus the first quarter. Equity market levels also impact the value of client assets that we report, both in assets under management, and assets under custody. This in turn impacts the fees that we earn for those services provided to clients. While we are encouraged by improvement in the equity markets during the second quarter, the impact of that improvement is muted in the near term, due to the lagged nature of certain fees.

Now let me review our second quarter results beginning with revenues. Revenues in the second quarter equaled $1.05 billion, representing a decline of 4%, or $49 million compared to last year. Revenues increased 16%, or $141 million on a sequential quarter basis. Trust investment and other servicing fees of $601 million decreased 7% year-over-year, or a decline of $44 million.

On a sequential quarter basis, trust investment and other servicing fees increased 46%, or $191 million. In our institutional business, C&IS trust investment and other servicing fees equaled $391 million in the second quarter, a decrease of 4%, or $18 million year-over-year, but an increase of 89%, or $184 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 in the second quarter. C&IS custody and fund administration fees equaled $141 million in the second quarter, down 19%, or $32 million year-over-year. On a sequential quarter basis C&IS custody and fund administration fees increased 3%, or $4 million. Our year-over-year results reflect our ability to partially offset the negative impact of significant market value declines, with new business wins in global and domestic custody, and in fund administration. On a sequential quarter basis, fee growth also reflects our new business successes, partially tempered by still weak quarter lag markets.

Investment management fees in C&IS equaled $61 million in the second quarter, a decrease of 15%, or $11 million year-over-year. The weak equity market environment on a year-over-year basis served as a considerable headwind for institutional investment management fees. New business however helped to offset those headwinds, particularly in our quantitative management, cash, and institutional mutual fund businesses. On a sequential quarter basis, investment management fees increased 1%, or $1 million.

As I mentioned in my opening comments C&IS securities lending fees equaled $172.5 million in the second quarter. Results this quarter were significantly impacted by the $120 million in positive marks in the mark-to-market securities lending collateral fund. Excluding the impact of the mark-to-mark fund across all periods, C&IS securities lending fees declined 65% year-over-year, and 1% sequentially. On an adjusted basis the year-over-year decline was primarily attributable to lower average volumes, as market depreciation contracted the value of securities on loan, and borrower demand was significantly lower than a year ago. The modest sequential decline was also due to lower average volumes, partially offset by the traditional seasonal uplift of the securities lending international dividend season.

Let me offer a few reminders on the mark-to-market fund, that was the source of the positive marks this quarter. First, we have only one mark-to-market collateral investment fund for our securities lending business. This mark-to-market fund has followed it's 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 38 days, and a credit based weighted-average maturity of 1.65 years as of quarter end. 34% of the securities held in the fund are rated either AAA or AA. The fund is 25% invested in corporate notes issued by the banking sector, 35% issued by finance and insurance companies, 6% in other corporate notes, and the remainder in asset-backed securities and cash.

Last quarter we brought to your attention an index, which has corresponded reasonably well but not perfectly with the performance of this mark-to-market fund. While the Merrill Lynch US Corporate Master Index is not a match for the fund, it's monthly returns over the last few years have related reasonably well to the monthly returns of the mark-to-market fund.

This proved to be directionally helpful in the second quarter, as the Merrill Lynch Index and our mark-to-market fund both had strong performance in the second quarter, on the heels of improving fixed income markets. The three components of our institutional fees that I just discussed, are all impacted by the value of assets that we custody, administer, and manage for our institutional clients.

Let me take a minute to review our various client asset levels with you. Institutional assets under custody equaled $2.9 trillion at quarter end, down 20% from a year ago, yet up 14% versus last quarter. Global custody assets, which are a component of total C&IS assets under custody equaled $1.6 trillion at quarter end, down 19% year-over-year, and up 21% on a sequential quarter basis.

The year-over-year decline primarily reflects lower market values, as the S&P 500 fell 28.2% year-over-year, and the EAFE Index declined 27.9%. The sequential quarter increase in institutional assets under custody, represents improving equity markets, as the S&P 500 was up 15.2% in the quarter, and the EAFE Index was up 15.4%. In addition the higher sequential quarter level of institutional assets under custody, was positively impacted by the weaker US dollar.

The weaker US dollar in the second quarter positively impacted the US dollar equivalent market value of global assets that we custody for clients. Recall, that global custody assets represent more than 50% of our total C&IS assets under custody. Managed assets for institutional clients equaled $422 billion at quarter end, down 31% with one year ago, yet up 8% sequentially. Excluding securities lending collateral from C&IS assets under management, managed assets for institutional clients were down 13% year-over-year, and up 8% sequentially.

Securities lending collateral equaled $101 billion at quarter end, down 58% versus a year ago, and up 6% compared with March 31, compared with one year ago the lower level of securities lending collateral reflects three factors. First, lower market values, second, a reduction in borrower demand, and third, client decisions to reduce or suspend their securities lending activities during the difficult market environment. Market appreciation in the second quarter was the primary driver of the sequential quarter increase in securities lending collateral, offset partially by the impact of lower borrower demand.

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 fees equaled $211 million in the second quarter, representing a decrease of 11%, or $25 million year-over-year. On sequential quarter basis PFS fees increased 3%, or $7 million.

Our PFS net new business results were on par with that experienced in last year's second quarter, and were 13% higher than the level achieved in this year's first quarter. Net new business in Florida was particularly strong, coming in at twice the level won last quarter. Fees in PFS are derived from the assets that we manage and custody for personal clients. PFS assets under management equaled $137 billion at quarter end, down 4% from a year ago, and up 5% from last quarter. Assets under custody in PFS equaled $300 billion on June 30, down 8% year-over-year, and up 7% from last quarter.

The year-over-year performance compares once again with the backdrop of a very difficult market environment, which saw 28.2% decline in the S&P 500 year-over-year. Market improvement during the second quarter combined with recent new business success fueled the higher levels of PFS client assets at June 30. Net interest income equaled $260 million in the second quarter, up 5% when compared to the second quarter of 2008, excluding a leasing related adjustment of $29.4 million recorded in last year's second quarter, net interest income decreased 7% on a year-over-year basis. The net interest margin equaled 1.59% in the second quarter, 19 basis points lower than the leasing adjusted net interest margin of 1.78% last year.

The current quarter's lower net interest income and net interest margin on an adjusted basis, primarily reflect the low interest rate environment, which diminished the value of noninterest related funding. On a sequential quarter basis, net interest income decreased 10% and the net interest margin declined by nine basis points. Average earning assets declined 5% on a sequential quarter basis, primarily reflecting decisions by C&IS international clients, to place a lower level of cash in nonUS deposit accounts, as the markets rose during the quarter, which in turn drove a lower level of investment in money market assets. In addition the net interest spread declined nine basis points sequentially, reflecting spread tightening at the short end of the yield curve.

Foreign exchange trading income equaled $134 million, up 6% compared with the second quarter of last year. This represents our third best quarter every in foreign exchange trading income. On a sequential quarter basis foreign exchange trading income increased 2%. Currency volatility remained elevated compared to historical levels, but declined over the course of the second quarter as markets stabilized.

On a sequential quarter basis, client volumes increased on the back of the recovering market environment. Other operating income equaled $28 million in the second quarter down 19% year-over-year. The decrease primarily reflects the lower value of certain credit default swaps, and lower custody related deposit revenues, partially offset by higher commercial loan fees. On a sequential quarter basis, other operating income declined 24%.

The first quarter of 2009 included $7.8 million in gains, resulting from the sale of leased equipment. Adjusting for that item, other operating income would have decreased 4% sequentially, primarily reflecting the lower value of credit default swaps. During the second quarter we recorded a loan loss provision of $60 million, compared with a $10 million provision last year, and a $55 million provision in the first quarter. Our reserve for credit losses equaled $319 million at June 30, up 74%, or $136 million from June 30 last year, reflecting the weak economic climate.

Nonperforming assets equaled $234 million at quarter end, an increase of $62 million in the quarter, and represented 81 basis points of total loans at quarter end. Net charge-offs equaled $44 million. Despite elevated levels of nonperforming assets and charge-offs off a very low historic base, Northern Trust's conservative and focused lending practices, have allowed us to weather this credit cycle better than many industry peers.

Credit quality within our balance sheet investment portfolio continues to profile very well when compared with industry peers. Gross unrealized losses on our $16 billion available for sale securities portfolio, equaled approximately $230 million pretax on June 30, down 29%, or $94 million, from $324 million on March 31.

Let me shift my commence to a review of key expense categories that impacted our second quarter performance. Expenses equaled $503 million in the second quarter, representing a decrease of 22% year-over-year, and 15% sequentially. Recall my earlier comments regarding two especially noteworthy items that impacted second quarter expenses. The first noteworthy item was a $130 million decrease in expense, associated with the fair value of our liability under the capital support agreements that we entered into in early 2008. The second was a $20 million increase related to a Special Deposit Insurance assessment levied by the FDIC. Absent these two items expenses would have decreased 5% year-over-year, and increased 3% sequentially. Compensation expense equaled $288 million, and decreased 6%, or $18 million from the year ago period.

The year-over-year decrease in compensation expense reflects lower incentive compensation, partially offset by higher year-over-year staffing levels, and annual merit salary increases. Staffing levels equaled approximately 12,400 full time equivalent positions at quarter end, an increase of 5% year-over-year, and 1% sequentially. New staff positions on both a year-over-year and sequential quarter basis are concentrated in the Asia Pacific region.

On a sequential quarter basis compensation expense increased 12%, or $30 million, primarily reflecting higher incentive compensation accruals. Employee benefit expenses equaled $62 million in the second quarter, a decrease of 2%, or $1 million versus last year, and 6%, or $4 million sequentially. The year-over-year decline primarily reflects lower contribution plan expense. The sequential quarter decline primarily reflects lower defined contribution plan expense and FICA insurance expense.

Outside services expense equaled $102 million, a decrease of 4%, or $4 million, compared with last year. The year-over-year decrease reflects the impact of lower market values on sub custodian, and investment management sub advisory expenses. Outside services expense was up 7%, or $6 million sequentially, resulting primarily from the impact of higher market values on sub custody and sub advisory expenses, as well as higher legal expense and technical services expense.

Other operating expense equaled a negative $50.8 million in the second quarter, compared with $72 million one year ago, and $70 million last quarter. Recall from my other comments, that the other operating expense included a $130 million decrease in expense associated with the fair value of our liability under the capital support agreements that we entered into in early 2008. Excluding the impact of this item from all periods, other operating expense would have equaled $79 million, up 12%, or $9 million year-over-year, and up 28%, or $17 million sequentially. The increase in both periods primarily reflects the higher FDIC insurance expense that I discussed earlier, offset by lower business promotion expense.

Let me wrap up today's call by offering a few thoughts on the environment, and on the strategic and financial positioning of Northern Trust. The overall environment within which Northern Trust operated in the second quarter, displayed a variety of cross currents, sending very mixed signals. On the one hand and to the positive, equity markets began to revive, as exemplified by the quarters 15% increase in the S&P 500 Index. This was a most welcome sign, but does not immediately and fully benefit many of Northern Trust's revenue streams, given the lag nature of some of our fee billing practices.

Another welcome sign during the quarter was overall improvement in the fixed income market. The second quarter saw investors move back into many sectors of the fixed income market. The value of some corporate bonds and asset-backed securities, for example, recovered to levels not seen since before the September 2008 financial crisis. This shift in fixed income market sentiment had a meaningful impact on our results in the quarter, including significant reversals of prior year period negative marks in securities lending, and a reduction in the fair value cost of our liability under the capital support agreements.

On the other hand and to the negative, equity markets continue to be significantly below year ago levels, and as again exemplified by the S&P 500, which notwithstanding it's rise in the quarter, was still 28% below the year ago period. Lower year-over-year equity markets in tandem with very low interest rates, continue to provide headwinds for some of our largest revenue streams.

These market factors coupled with increasing unemployment and other economic strain on both individuals and businesses, add to the negative cross currents. While we at Northern Trust are proud of our track record of effective business and risk management across many fronts, we are not immune to these environmental difficulties. We remain focused on a heightened level of vigilance, amidst encouraging signs of improvement on the one hand, and a still fragile and tenuous environment on the other.

From a strategic perspective, we continue to be very well-positioned in attractive businesses where we have distinctive competitive advantages. We focus on two excellent segments of the financial services industry, serving affluent private clients primarily in the United States, and institutional clients globally. We support our clients with a broad array of asset servicing, investment management, fiduciary and banking solutions, and have been viewed by many as a provider of choice throughout the financial crisis. Our strategic position of strength has fueled strong new business results across the past year.

And from a financial perspective, we continue to be extremely well capitalized in absolute terms, relative to our industry peers, and relative to our conservative risk profile and appetite. This is not a new phenomenon embarked on during the recent financial crisis. This has been the longstanding heritage of Northern Trust, that has served our shareholders and our clients well across the years.

Just a few examples on this front. Our capital ratios remain very strong at the end of the second quarter, even after redeeming the preferred shares. The corporation's Tier One capital ratio was 12.6% at quarter end, an increase from 9.8% in the year ago period.

The corporation's total capital ratio was 15%, up from 11.7% a year ago. The corporation's Tier One common equity ratio stood at 12.1% at the end of the second quarter, compared with 9.3% in the comparable period last year, and our tangible common equity ratio equaled 7.6%, compared with 6% last year. Recall too that Northern Trust is one of only two banks in the Top 25 in the United States, that did not reduce it's dividend throughout the current financial crisis. In sum, from a financial perspective we continue to be very strong, and very uniquely positioned.

And lastly we are maintaining our relentless focus on our clients. Market conditions have created strain for everyone, including our personal and institutional clients. While we wish these conditions and the related pressures did not exist, we continue to focus very acutely on helping our clients to navigate through these storms, charting the best possible course. Within every crisis, there is opportunity. We remain focused on helping our clients with capabilities, service, and incite, that become even more important in times of strife.

Let me again thank you for joining Northern Trust for the second quarter 2009 conference call, and now Bev and I would be happy to answer your questions. Please open the call for questions.

Thank you. (Operator Instructions). First question, Brian Foran, Goldman Sachs. Please go ahead sir.

I apologize I joined late, so if I missed this in the prepared remarks, but in the past you have talked about the market share gains in PFS not translating to revenue, because a lot of clients were sitting in cash. Are you still experiencing the same level of market share gains, and if you are, or I guess either way, are the market share gains over the past nine months still sitting in cash, or is that a potential revenue tailwind in the future?

Brian, I would just quibble a little bit with the term market share gains, only because our General Counsel would not like that term. Market share is very hard to gain, but I think I would instead say, momentum and very good performance, in terms of winning, but I can't technically prove to you market share. With that caveat, I would say that I guess two observations, one, our new business in PFS continues to be strong. And we feel very good about that.

And on the margin, I think as the S&P 500 rose in the quarter, and as you saw through a variety of metrics that we talked about, there was an appetite to get back in the market. I will caveat that by saying, I think there still are some scars out there, and people have been wounded, and so cash is still, if you will, a desirable commodity. But I would say on the margin it was an improvement from a quarter ago period, in terms of moving into the markets.

Thank you.

You are welcome.

We will take our next question with Mike Mayo with CLSA. Please go ahead.

Good afternoon, I guess it is still morning for you. The margin and spread revenues is down for you, it is down for all of the trust banks, can you just give us some context of what is driving that, and where you think the spread revenues go? You are kind of retracing from the steps you took over the past couple of years, in terms of NII?

Sure, Mike. I think you know we have a longstanding and conservative philosophy vis-a-vis our securities portfolio. And I think it is fair to say as exemplified by recent results, relative to the industry that that philosophy on average over time has served us very, very well. We haven't changed that philosophy, and we are not seeking additional risk in our investment portfolio in a quest for higher yield.

On the securities portfolio, we are continuing to purchase the highest quality securities, agency debentures, agency mortgages, government guaranteed debt, and on average these assets have a repricing characteristic for us, of less than 90s days. Speaking to the net interest margin more directly, as I said it was at 1.59%, down 9 basis points from 168 last quarter, and down 19 basis points from a year ago, if you adjust the year ago period for that one-time leasing issue. While we can't provide any guidance, as you know, let me offer a couple of observations that I hope will help.

First I would say that very low interest rates adversely impact the value of our noninterest related funding, and an example of that, would be the value of our noninterest related funding averaged about 38 basis points across the first three quarters of 2008, versus 18 basis points in this most recent second quarter.

As you know Mike, the very low rates also compress spreads earned on the value of our nonUS office time deposits. When the rates are at absolutely low levels, there is just very little room for taking deposit rates lower. That same phenomenon holds true for our PFS deposit rates. And then of course as the investment portfolio matures, we are reinvesting at lower rates. So there can be upsides to our net interest income to offset this, in the form of pricing power on the loan portfolio and growth in the volume of deposits, but as we saw in the second quarter, as the equity markets surged, deposits particularly our nonUS deposits within the C&IS business, rotated off the sidelines and into the market, which is something we would expect to see.

And the noninterest related fees, those are deposits your customers leave with you, and you get kind of an imputed benefit from that? Is that right?

Yes, the so-called nonUS, or foreign office time deposits, are if you will the cash, residual cash, or cash as an asset class, that principally our nonUS clients leave with us.

I know this is not a new situation, but to the extent that you are making less money from the deposits your customers leave with you, is there a way to charge them more fees to compensate?

Well, I think we look at it as we are constantly navigating through environmental changes, and we don't generally go to our clients and say, because interest rates are at very low levels, we are going to increase your fees tomorrow. I think if we thought that was going to be a sustained ongoing factor that would be irreversible, if you will, we would probably have to think about that on average over time. But we think this is a market phenomenon, and we will move through it.

Global assets under custody grew 21%, is any of that in Asia, and is there a way for you to expand in Asia, and more aggressively, and in which companies if were to do so?

Our asset accumulation has been strong, and that has been a global phenomenon across North America, the European, Middle East and African region, and across the Asia Pacific. So I guess my first answer is, yes, we are expanding and successfully so in Asia. Some of the things that have been public that you have seen most recently, would be our success in places like Australia and New Zealand, across that region, but the successes have been broader than that.

So Asia Pacific has been important to us.

Last question PFS or just generally assets under management up 7%, that is fine, but I thought had you the chance to go gangbusters, in terms of all the dislocation in the market, between some banks going away, and all the mergers, and you mentioned Florida is doing well. Shouldn't you be investing a lot more aggressively there, and can you just elaborate whether it is Florida or other markets, where you are seeing the best growth?

Mike, let me offer a couple of thoughts, and Bev may have some as well. But if you look at our PFS assets under management year-over-year they are down 4.2%, but that compares with a 28% decline in the S&P 500. So we feel very, very good about our success in PFS, our asset accumulation, and I think you just have to keep it in the context of what has happened to the broader markets.

One statistic that might help you, Mike, is that as of the end of June the asset allocation of our PFS assets under management was 31% equities, 31% fixed income, and 38% short duration. Very important to recognize that less than a third of our PFS assets under management are invested in equities.

Has that changed from two years ago?

Absolutely.

What was it two years ago? I just trying to get a sense on how well you got your clients out of the market or whatever, two years ago it was what?

Not just our clients, it is not just us making tactical asset allocation changes in our client's portfolios, but also just the fact that the markets have gone down so much. Mike, ask me that question off-line, or anybody else that wants to, but I want to say that 50, north of 50% equity at some point over the course of the last four or five years, something like that.

All right. Thank you.

I think, in the aggregate we have done well for clients relative to their objectives.

Okay. Thank you.

Next question, Glenn Schorr with UBS. Please go ahead sir.

Hello. Two quickies, digging underneath the covers and the NIM compression, actually it might not feel it, but it was better than I thought, and I think it is isolated to the yield on money markets, as painful as a 1.12% yield is, it could have been worse. I am just curious, anecdotally what kind of money funds are you sitting in? I know that I am getting killed, I am getting 20 basis points.

Well, the first thing that I would say, and then I will let Steve get to your question, the money market assets on the asset side of earning assets is primarily time deposits with banks. So your reference to money funds, I wouldn't necessarily characterize it that way.

That explains. And then in terms of the competitive environment, I feel as Mike just pointed out, your assets are growing at above market appreciation rates, so it is clear that especially on the global side, you have done well for many years, taking share there. You have done it through JVs at times, but mostly on the organic front. My question is there are plenty of owners of these businesses that have their own share of issues, and need to delever and raise capital. You certainly are more than capable of winning them one client at a time, like you always have. But any thoughts on more of a bulk deal along the way?

Sure, we feel obviously well positioned vis-a-vis capital and flexibility. As you know, our story for a long period of time, has been one of organic growth, and we are proud of that story, and we think candidly that while we have had modest acquisitions over the years, we think we have side-stepped a lot of problems, by not jumping into some acquisitions that did not turn out so well.

That said, we are always looking at opportunities, and as we have said on more recent calls, the number of opportunities out there is more, and the pricing on those opportunities is better. I would say Glenn that there is no fundamental shift in our view, which is we know how to grow this business organically, and we have proven that consistently over time, so we are going to be very judicious, to the extent that we issue on M&A transactions as another avenue for growth. We definitely will not rule that out.

I appreciate that. I was looking for the confirmation on there is stuff out there, and it sounds like there is.

Yes.

Thanks very much.

You are welcome.

We will take our next question with Nancy Bush with NAB Research. Please go ahead.

Hi, guys, how are you? Two questions, one of your competitors in reporting earnings mentioned that some SEC lending clients who dropped out of the program came back during the quarter, and indeed they picked up some new ones. Did you see a similar phenomenon, and could you comment on your view of SEC lending has changed at all?

Our view really hasn't changed. I don't have the specific numbers, but our sense is that would be an accurate statement. It is always difficult to call the bottom, but we are feeling better about the environment, and clearly the fixed income markets, whether you saw that in the growth, or the benefit, the reversal on the mark to market fund, or otherwise, probably gave a little shot of adrenaline. So I think that would probably be a fair characterization. My only caveat to that is, we are still living in very interesting times, and I think we will wait to make a final call on where the bottom was, until we can look back with the benefit of real history.

Right. Speaking of interesting times you guys had the dubious distinction of becoming one of the TARP poster children, because of the golf course, golf tournament brouhaha, and I am just wondering, even though that you are out of TARP now, is there any thought that promotions are going to have to be scaled back, or any of those kind of things until we get out of this hyper-political environment?

No, I think, look, we never said, we will continue with the Northern Trust Open in February of next year, and we are excited about it. As always, we want to be thought full and in-line with what os going on in the world, but we are excited about doing that, and we have a number of other things we do, so we clearly want to balance expense management, but that is part of our overall plan with clients and prospects, and we will continue that.

Okay. Thank you.

You are welcome.

We will take our next question with Tom McCrohan with Janney Montgomery Scott. Please go ahead.

Hi, Steve, hi, Bev. I guess the general sentiment we are all hearing from the custody bank management teams, is that things fortunately have stabilized somewhat, and directionally the fee income trends have improved, at least relative to the first quarter. So I mean directionally, do you feel that stabilization is kind of the term to kind of use here, and what in your mind is the risk to this trend not continuing for the back half of the year?

I think clearly, Tom, I tried to convey this in the remarks, there are cross currents. It is undeniable that the second quarter with the S&P 500 moving up nicely, and credit spreads improving that everyone felt better.

But a quarter does not make a year. A quarter does not end a cycle, and there are other cross currents that make it more challenging. So, I think the way we are thinking about it is, that is great and we feel good about that, and we hope that continues, but one has to be vigilant, and I think everyone, not just the trust banks but others, are still signaling at least from what I am seeing, that the environment is still tricky out there. So there is going to be some navigation. We do feel better, but we are not ready to call it a victory yet.

That makes sense. I guess one of the potholes I have seen on the road ahead is related to the credit side, and I was wondering if you can potentially talk to kind of reserve levels, and what do you think is a reasonable level? You ended the quarter at about 1% of reserves to loans, and if you look back in history for you guys, I mean there has been plenty of years where you have had reserves well above 2%. So what has changed in your opinion, if anything, that would preclude reserves to loans, not going up to 2% of loans over the next year or so?

You build reserves and then as things get bad, some of those reserves come down in the form of nonperformers. We feel very comfortable with the loan portfolio. Again, when you think about our portfolio it is quite different from many other banks. We are about 37% residential real estate, and that is our high net worth client base, 25% commercial, 11% commercial real estate, 17% personal loans, and then 10% other. The quality of the portfolio continues to be very sound, but relative to year ago levels, and two years ago it is clearly a 'worse as would you expect' in this environment. But I think in the context of our total $29 billion portfolio, we still feel good.

Tom, I was just going to make one other point, which is the 1% figure that you are talking about is the highest level that it has been in five years. So I think to 2% figure that you are citing is dating farther back in time, than prior to 2004, which is what I have got in front of me.

Yes, it does. I went back all the way to 1990 just looking at levels. You have had consecutive years close to 3%. I am sure the loan portfolio has changed dramatically. I am just trying to draw comparisons to the composition of the loan portfolio today, relative to other prior five year ago periods, when had you higher reserve levels, is it today's portfolio more higher quality, less lumpy C&I loans, and therefore you are justified to have a lower reserve level, that is what I was trying to drive at?

I would say to is that we have continuously gotten more strategic focus over the years tied to relationships, and so we would like to think that we are considerably better than we were back in the early '90s on this problem.

I do think a higher proportion of our loan portfolio today versus the year 1990 would be related to personal clients, that is for sure.

Got it. Thanks very much.

You are welcome.

We will take our next question with Robert Lee with KBW. Please go ahead.

Thanks, hi, Bev. Hi Steve. It has been a while, right.

Welcome back.

Thank you. Sorry about that. In any case, quick question on just what you are seeing out there, in terms of decision making on the institutional side of the business, I mean certainly for many different places that decision-making process is getting kind of pushed out, yet despite that you seem like you have had pretty good new business trends, are you starting to see any rumblings that maybe people are starting to make decisions a little quicker than they were, or maybe RFP pipelines in some businesses are starting to kind of build up again?

Sure, Rob, I think it is probably good news from our standpoint, in the sense that new business is good, even though decisions have still been pushed out. So I think we would echo that sentiment, that amidst a crisis that this may note be, that asset servicing and so forth, may not be the top decision people want to deal with, so we have seen some decisions pushed out, but we have done well notwithstanding that. So as you know, it is lumpy even when 'decisions' aren't being pushed out. So we don't worry too much about that. Our pipelines are solid. Our new business has been good. Yes, there have been some decisions pushed out. But we still have got plenty to work on, and plenty of opportunities.

Okay. Maybe a follow-up. I mean if you look over the past year or so you guys have done, taking advantage of dislocations out there, and competitors pulling back, and growing your loan portfolio in a couple of different places, just curious if how you feel about that, if you still are seeing that there is much opportunity at this point, or is that just that the economy maybe it has flattened out some, as that stays pretty rough that maybe your appetite for growing some of those has diminished, as you kind of for lack of a better way of putting it, taking kind of the low-hanging fruit?

Well, Rob, the loan portfolio is up about 1% on a year-over-year basis. I think what you might be talking about is that there was a period of time over the last couple of quarters, where we did see some opportunities come our way, because other lenders were not as active in the market. So you did see an increase in our commercial loans, for example, and in some opportunities, for example, in the healthcare and not for profit world, associated with the auction rate securities market seizing up. Actually much of that did flow off the books this particular quarter. So our lending strategy is the same as it has always been, relationship oriented, and we have the opportunity in recent quarters, to help some of our clients who needed some credit, and we were happy to help if they were creditworthy. But I wouldn't say that you should think of that as a new trend, in terms of our lending, because the strategy has not changed at all.

Just to put an exclamation point on it, same strategy, client driven, so even as there is disruption, and there are if you will, more opportunities for a bank with a strong balance sheet, we are not interested in capitalizing on those for opportunities sake. It has got to be part of the broader scheme, and we have been very zealously consistent about that.

Fair enough. Maybe just one last question on the PFS business. I think you may have touched on this earlier, but certainly you guys have benefited from the issues that many competitors have had, and picked up market share? I won't use the word market share, you picked up clients, and what not. But as the markets have done better the last four or five months, and maybe some of the large mergers, and other things, have kind of taken place already, are you starting to see that maybe potential PFS clients are becoming a little more complacent, that maybe there is a little less urgency to some movement, and you are expect the pace of that to slow down?

Rob, I would say no, I think it depends what data point you want to use. If you want to go to the peak of this most recent crisis post-Lehman, where people were panicking in herds, and flocking, yes, it has moderated. But we see very good pipelines, very attractive clients, and while it is true that some of the if you will, financial distribution, sometimes there is M&A description, sometimes there is competitors having financial problems, and we benefit from both. While it is true that some of that financial disruption has moderated, the third leg of that stool, is poor servicing capabilities, and we have found that some of the prospects that we have talked to, just feel underserved in some institutions, and are looking for the kind of breath, depth, stability, and consistency that we provide. So again like the C&IS new business, it will be lumpy, and it is not a flock the way it was at the peak, but the pipelines are strong, and the opportunities are absolutely there.

Great. Thanks for taking my question.

You are welcome, Rob.

Next, Ken Usdin, Bank of America. Please go ahead.

Hi Steve and Bev. Can you talk a little bit about the recovery items? My first question is, do you accrue comp for the recovery of the SEC lending marks, and the reversal of the CSAs?

The answer is no, we don't specifically link to that. We are thinking about the totality of our performance, relative to our plans and the expectations of our Board, and so that would be the driver, and when our Board considers compensation, they do think about the totality and the quality of those earnings, not just the absolute levels.

That is in regards to year end, executive comp, I mean in terms of the way you accrue it through this quarter, so had you 260 million of positive delta just from those two items, and I am just wondering, how much of that actually flowed threw on the expense side as well?

Right, but the way we think about and accrue for comp is the full year look, not just a what did you do for the quarter. It is what are our plans for the year. How are we progressing against those plans, what is the outlook, our internal outlook for where we think we are going to land, and obviously we move it around. Sometimes we are a little lower, and we have got to catch it up, and sometimes you will find that we have to reverse some, because we got ahead of where we were based on our outlook.

Right.

So think of it not as a we had a couple of unusual items, and we booked a lot of incentive comp for them. Think of it we as are constantly calibrating to the overall performance.

I was just wondering because if I tease out those items, you see compensation expense up 30 million, but revenues only grew a little bit. I was wondering if there was a correlation at all. Okay.

My other question is as far as the CSAs are concerned, can you just walk through what happens from here, meaning the 550 exposure is down to 200, with the combination of the recapture and some pay downs. So I guess what is kind of left, as far as what has been taken through the income statement, and what can still be recovered on the CSA side going forward?

So Ken, the 550 was the maximum aggregate, that 550 now goes to 200. The fair value of that as of the end of the second quarter was $125 million. That will be trued up or down between now and the expiration, which is on November 6 of this year.

The 125 million has already been flowed through as expensed.

That is what I meant. So the maximum recovery is $125 million from here?

Yes.

Theoretically.

Theoretically. If everything went according to plan, or whatever. If everything worked out well, there is 125 still in expense that could be recovered further?

That is correct, if you hold everything equal, and say everything goes perfectly well, and the CSAs expire, and they are not needed, in theory.

But what you are describing is a 'best case' scenario. The fact that we have $125 million in booked liability associated with a $200 million commitment, would suggest that as of June 30, that is what we expected the commitment to be.

And the same thing in the 'perfect world' scenario, there is 222 million in the SEC lending related marks, that if everything went perfectly, that is what is still sequentially recoverable if everything went perfectly?

Correct.

Okay. Last question on securities lending, it looked like if you do ex out the adjusted to adjusted SEC lending revenues were kind of flat first to second. So just wondering if you can give us a little bit more color, did you not see the typical seasonality? Was there pressure on core spreads, or was it a volume issue? Could you kind of talk core to core for us a little bit?

Sure. I think, one, I guess what I would say is, remember that we are in a low interest rate environment, which always compresses the value of securities lending. And as we have talked about, Ken, over the last several quarters, as leverages come out of the system, demand has come out, and some supply has come out, as clients have been less willing to participate.

Also remember that we have offered our clients a staged withdrawal feature. Some of our competitors have just put gates up and said, you can't get out, whereas at Northern Trust, we have provided clients the ability to get out in a managed way, so that no one is prejudiced. So I think those are kind of the drivers of where we were in the second quarter.

Was there seasonality? Was there international dividend seasonality underneath all of that?

Yes, there was.

All right. Thanks a lot.

You are welcome.

We will take our next question with Betsy Graseck with Morgan Stanley. Please go ahead.

Thanks. Good afternoon, Steve and Bev. Hey, just a question on capital, and I realize that there might be opportunities out there, but you are sitting with the TC to TA of 7.5, and a core Tier 1 of over 12, right? I am just wondering, to the degree that either you are not the best bid, or opportunities aren't emerging as quickly as you anticipated, at what stage do you start thinking about either raising the dividend or buying back stock? What are the triggers that would lead you to have to think about it?

Sure, I guess a variety of thoughts here, Betsy. One, across a variety of cycles it has been suggested that we are too conservative in relation to capital, and all the rest of it as you well know, and that is an observation to which we have been well accustomed, and one we try and handle gracefully.

I think 2008 sort of stressed that for a lot of people, and for all of the modeling and stress testing, and the multi-standard, the unthinkable multi-standard deviation events actually happened, and it was a moment where our capital strength truly mattered. I think the way we think about ourselves, is with a very longstanding set of philosophies and practices, to being conservative on capital on the one hand, although equally conscious about capital efficiency on the other hand, and I think we have a pretty good track record if you look at us on an ROE basis, a PE basis, over any reasonable period of time. As we sit here today, I guess I would distill our thinking down to a couple of key thoughts.

One, erring on the side of capital strength amidst this very disruptive and unpredictable environment is imperative And while the second quarter there were a lot of nice data points that made us feel better, a quarter does not end this period.

Second, it seems to us that regulators will continue to assess the well-capitalized guidelines, and I don't know what they are going to do there, but we want to be in a position of unquestionable strength and financial flexibility, if anything changes.

Third, remember that the industry and Northern Trust are working through the Basel II initiative, and we want to err on the side of solidity, rather than coming up short as that implementation approaches. And the last two points, Betsy, would be we carry industry leading credit ratings, which we think are valuable, our clients think are valuable, and one component is our capital strength, and we want to keep that well intact.

And then lastly, our Board continues to see attractive growth opportunities, and as I mentioned to I think it was Glenn, though we are not highly acquisitive, and our growth has been fueled organically, we do want to have financial flexibility, should we see things come up. So we have kept the dividend, as we said in the call, we are one of only two banks in the Top 25 that did that. We have built upon our capital strength, and at least for now, we want the fog of the battle to clear, before any real shift in our thinking, if at all.

So you want more history, you need to get the understanding that the regulators are going to change any of their capital guidelines or not, and then as you indicate, you have got the Basel II going on. Could I just ask a little bit about the Basel II? That is something that I thought needed to be side by side for a year no later than starting 4Q '09, is that you understanding, or has anything change there?

We have the parallel run that will go through 2010. There are a lot of moving parts to Basel. And again, we and everyone else are at varying stages. So we have done a lot of work, but I guess my point was, you are not done until you are done, and we want to tread through this judiciously through this, and make sure we don't get any surprises.

Have you started that parallel run yet?

No, we have not.

But you expect that you will at least starting in Q4 '09?

In the first quarter of '10.

1Q '10. Okay, great, thanks very much.

Next question, Howard Chen with Credit Suisse. Please go ahead.

Good afternoon Steve and Bev. Thanks for taking my questions. I know there are a lot of moving parts to it, but any color on where the net interest margin exited the second quarter?

No, I don't have anything beyond that which we have said.

Okay. Thanks, Steve. And then a follow-up on the core securities lending business, and core spreads look stable to me quarter on quarter, I know some of the other industry players saw somewhat of a lift in spread, due to one particular security. I am trying to gauge a sense of whether you saw that as well, and there were other offsets, or just some of the moving parts within the spreads?

I don't think there is anything notable that comes to my mind, but we can follow up off-line if there is anything that, Bev, you find.

I don't know whether the others are referring to the seasonality that is common in the second quarter, and we did see that. So I don't have any specific securities that I would reference in that regard, but we definitely did see some seasonal uplift, as we said earlier.

Okay. Thanks, we will follow up off-line. And third and finally on my end, regarding credit quality, I know less meaningful for you and there was a question earlier, I just wanted to do get a bit more color on this quarter's tick-up and loss rate, and increase in NPAs. Steve last quarter you were pretty helpful in kind of talking about some of the concentration of a certain handful of credits, that was driving some of the uptick. Thanks.

Yes, sure, well, our nonperforming loans, Howard, went from $167.8 million last quarter, to almost $228 million, so an increase of $60 million. About 84% of that increase was due to four loans that went to nonperforming status. Several of those loans were commercial real estate related. One was a residential property. So I think if there is a theme, it is a real estate-ish theme, which probably doesn't surprise you.

Great. Thanks so much for taking my questions.

You are welcome.

We will take our next question with a John Stilmar with SunTrust. Please go ahead.

Yes, good afternoon, Steve and Bev. Just real quickly in the custody business, it seems obviously the US dollar and the ascent of the equity markets, have had a really positive impact on assets under custody. You also saw a Q over Q growth in revenue in the CIS custodial business. That seems a little counter to the one quarter lag, in which I would have expected it to decline. Is that because of the US dollar, or was there something else going on underneath, which may signal a more positive revenue trajectory?

Philosophically we try and hedge our currency exposure. Of course one can't do that perfectly, you have to sort of separate the assets under custody or assets under management, which we just translate through, what is the market value and currency effect versus our results, which we try to hedge. So I think what is going on there is less about currency, and more about performance, keeping clients, winning, and all the rest of it. So I think that would be our view.

And then shifting focus to the PFS segment, it seems like the growth in revenues for PFS fees itself, came almost exclusively from your strong footprint in Illinois and Florida. Both are very challenged states. You talked a little bit about the Florida increase. Is most of that just because of a relative asset exposure, therefore, for instance, the ascent of the equity markets, or is there something else going on underneath, other than what you briefly alluded to with Florida, and any more color there would be appreciated?

No. I think it is real new business, winning clients in the open market. As I said, Florida was an example, where the new business in the quarter, and particularly in the month of June was very, very strong. So it is good old fashioned shoe leather, getting out, taking clients, winning clients who have come on to wealth, or taking them from other places that they have been.

Okay. And then lastly as we think about the operating margin on the business as a whole, how should we think about the overall operating margin, given maybe that the first quarter revenues might be depressed by the lag basis, some of your fees, and so therefore might put some pressure on operating margin. Is this sort of in your term, trough in operating margins, or are we treading water here, or is this going to represent a platform, with which to continue to deploy expenses?

Historically, John, if you look back, you are going to see that we run at about a 35% pretax margin, very consistently on an annualized basis. On a quarterly basis, though, you are going to get a lot of movements around, based on what is happening with net interest income in the low rate environment, or what is happening with FX in a volatile currency environment. So we don't give any guidance, but what I would say is we have been very consistent on average over time, but there will be periods and environmental conditions, where we will be a little bit better, or a little bit worse.

Perfect. Thank you very much for your time.

You are welcome. I think we have got time for one last caller, Daryl, if there is anyone left.

We have one last caller, Marty Mosby with FTN Equity. Please go ahead.

Good afternoon Steve and Bev, I have one quick follow-up. What I was curious about was the $122 million or $125 million worth of expenses related to the agreement, that is your 'best case' outlook right now, so you would have to have a perfect situation to recapture that, whereas the $222 million over in the mark-to-market that you have already written down, you are going to recapture that, it is just a matter of timing?

You are correct, Marty.

I just wanted to make sure I got that right.

You have got that right. Well, I think we would like to thank everyone for participating in this second quarter call, and we will look forward to updating you on our third quarter call on October 21. Thank you very much. Have a great day.

Once again, this will conclude today's conference. We thank you for your participation.