Northern Trust Corp (NTRSO) 2010 Q2 法說會逐字稿

Good day, everyone and welcome to the Northern Trust Corporation second quarter 2010 earnings conference call. Today's conference is being recorded. At this time, I would like to turn the call over to Director of Investor Relations, Bev Fleming, for opening remarks and introductions. Please go ahead.

Thank you, Cynthia. Welcome to Northern Trust Corporation's second quarter 2010 earnings conference call. Joining me on our call this morning are Bill Morrison, Northern Trust's Chief Financial Officer, Eileen Blake, our Controller, and Allison Quaintance from our Investor Relations team. For those of who you who did not receive our second quarter earnings press release or a financial trends report via email this morning, they're both available on our website at NorthernTrust.com. In addition, this July 21st call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through July 28th. Northern Trust disclaims any continuing accuracy of the information provided on 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 and 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 to you read our 2009 Annual Report and our periodic reports to the Securities & 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 Bill Morrison.

Thank you, Bev, and good morning, everybody. It is my pleasure to speak with you today on Northern Trust's second quarter earnings conference call. Earlier this morning, Northern Trust reported second quarter net income of $200 million. Reported earnings equaled $0.82 per share. Our second quarter results included an expense credit of $0.04 per share, related to the 2008 IPO of Visa, which impacted all Visa member banks.

In our press release issued earlier today, we provided operating results, which are exclusive of this Visa-related item. We believe operating results provide a clearer indication of the results and trends in our core businesses, therefore our commentary for the remainder of today's conference call will focus on operating results, which are exclusive only of the Visa-related item. To that end Northern Trust today announced second quarter operating net income of $192 million, operating earnings equaled $0.78 per share.

To help you evaluate our performance for this quarter, I will begin with a brief overview of market conditions that influenced our results, specifically equity markets and interest rates. Equity markets, as you know, deteriorated during the second quarter with the S&P 500 and EFA indices both falling approximately 12%. Let me review the impact of these equity market trends on fees earned by Northern Trust. Equity market performance calculated on a one quarter lag basis is the methodology used for calculating C&IS custody and PFS wealth management fees. The S&P 500 increased 46% year-over-year on a one-quarter lag basis. On a sequential quarter basis, the one quarter lag markets increased 5%.

Using the one month lag methodology that applies to PFS fees, excluding wealth management, the S&P 500 was up 33% versus the prior year, and up 4.6% versus the first quarter. Short-term interest rates remained at extremely low levels throughout the second quarter. For example, in the United States, overnight interest rates averaged only 19 basis points in the second quarter, a modest improvement from 14 basis points in the first quarter. Three month rates averaged 44 basis points, a welcome increase of 18 basis points sequentially, but still 40 basis points below one year ago. Short-term interest rates for the Euro and Sterling were also at low levels by historical standards.

Our Chief Economist, Paul Kasriel, recently pushed out his forecast for Fed tightening from early 2011 to mid-2011, and noted that the first tightening might not take place until early 2012. As many of you know, low interest rates have impacted our recent performance most noticeably by pressuring both our net interest margin and the fees we earn on money market mutual funds. I will discuss both of those impacts in more detail later in the call.

With that environmental back drop, let me review our second quarter results. Revenues in the second quarter equaled $974 million, down 7% compared to last year's second quarter, but up 7% sequentially. Trust investment and other servicing fees are the largest component of our revenues, representing 56% of total revenues in the second quarter. Trust investment and other servicing fees of $544 million decreased 10% or $75 million year-over-year.

Virtually the entire decline reflects the year-over-year change in positive marks associated with the one mark-to-market fund used by certain securities lending clients. Positive marks impacted our fees in the second quarter of last year by $129 million, compared to $37 million in this year's second quarter, or a $92 million year-over-year difference. Adjusting for these positive marks in both years, trust fees increased 7% year-over-year. On a sequential quarter basis, trust fees increased 6%.

In our institutional business, C&IS trust investment and other servicing fees totaled $316 million in the second quarter, down 19% year-over-year, but up 6% on a sequential quarter basis. Adjusting for the impact of positive marks in both years, C&IS fees were up 7% year-over-year. C&IS fees include three primary revenue categories, custody and fund administration, institutional asset management, and securities lending.

Let's take a look at the performance of each of those in the second quarter. C&IS custody and fund administration fees were $162 million in the second quarter, up a strong 15% year-over-year and up 2% sequentially, reflecting our best quarterly results since the third quarter since 2008. The year-over-year increase reflects improving markets and new business success in global custody and fund administration. The sequential quarter increase primarily reflects new business in global custody and fund administration.

We're very pleased with our C&IS new business efforts thus far in 2010, with a strong pipeline of committed transitions and a very healthy pipeline globally of new business opportunities. Representative examples of new clients include announced wins from KLP, one of Norway's largest life insurance companies, and West Sussex Pension Fund, one of the largest pension funds in the United Kingdom. We also recently announced the successful migration of Hermes fund managers to our investment operations platform. Cross-selling to existing clients a longstanding and important contributor to C&IS fee growth was particularly strong on both a year-over-year and sequential comparison. C&IS investment management fees equaled $69 million in the second quarter, up 14% year-over-year and up 9% compared with last quarter representing our best quarter since the second quarter of 2008.

Waived fees associated with institutional money market mutual funds equaled $2.6 million in the second quarter, up from only $300,000 one year ago, and down from $4.2 million in the first quarter. Absent fee waivers, C&IS investment management fees were up 17% year-over-year, and 6% sequentially. This growth reflects improving markets on a year-over-year basis and new business in our manager of managers and index management business, offset by lower client balances in some institutional cash investment products.

Securities lending fees equaled $66 million in the second quarter, including approximately $37 million in positive marks associated with one mark-to-market investment fund used by certain securities lending clients. As I mentioned earlier, this compares with $129 million in positive marks in the second quarter of 2009, and $38 million in positive marks last quarter. The second quarter's positive impact of $37 million reduces to approximately $20 million, the cumulative impact that negative marks have had on our securities lending fees, going back to the third quarter of 2007. Excluding the impact of the mark-to-market fund across all periods, C&IS securities lending fees declined approximately 33% year-over-year, reflecting lower spreads as maturing investments were reinvested at very low interest rates. On a sequential quarter basis, adjusted C&IS securities lending fees increased a strong 66%, primarily reflecting the traditional second quarter impact of the international dividend season, as well as slightly wider spreads.

The three components of our institutional fees that I just discussed are all impacted by the value of assets that we custody, administer, or manage for our institutional clients. Let me review our various institutional client asset levels. Institutional assets under custody were $3.2 trillion at quarter end, representing an increase of 11% versus last year, and a decrease of 4% sequentially. Global custody assets, a subcomponent of assets under custody, were $1.9 trillion, up 14% year-over-year, but down 4% on a sequential quarter basis.

In both cases, the sequential quarter decline reflects lower equity market values, and the weakening of the euro relative to the US dollar, offset partially by new business wins. Managed assets for institutional clients were $462 billion at quarter end, up 9% compared with one year ago, and down 7% sequentially. Securities lending collateral equaled $110 billion at quarter end, up 9% year-over-year yet down 9% sequentially. On an average daily basis, securities lending collateral equaled $124 billion in the second quarter, up 2% sequentially.

Now let me switch to our personal financial services business. Trust investment and other servicing fees in PFS were $228 million in the second quarter, reflecting our best quarterly results since the third quarter of 2008. PFS fees increased 8% year-over-year, and 4% on a sequential quarter basis. Year-over-year PFS fee growth was driven by improved markets in new business, offset partially by the impact of fee waivers on PFS money market mutual funds, due again to the very low level of short-term interest rates.

Sequential quarter PFS fee growth was driven equally by improved markets and by new business. Money market fund fee waivers reduced PFS fees by $12.9 million in the second quarter, compared with PFS fee waivers of $16 million in the first quarter, and $3.6 million in the second quarter of 2009. The sequential decline in fee waivers reflects the net yield improvement in the relevant funds, due to higher second quarter short-term interest rates. Our net new business results in PFS moderated from the very strong first quarter results that we talked with you about in April.

We have seen that equity market volatility has created a degree of unease with some perspective clients and a slower more cautious transition to new investment providers and strategies. That said, our PFS net new business results for the first half of 2010 increased more than 20% from the level experienced in the first half of 2009. Fees in PFS are derived from the assets that we manage and custody for personal clients, PFS assets under management were $142 billion at quarter end, up 3% compared with a year ago, and yet down 5% from last quarter.

Assets under custody and PFS were $328 billion at quarter end, up 9% year-over-year, and down 4% from last quarter. Approximately 33% of PFS managed assets, and 41% of PFS custody assets were equity securities at quarter end, both lower than last quarter by several percentage points, due to lower market equity levels or equity market levels. Net interest income equaled $242 million in the second quarter, down 7% when compared to the second quarter of 2009. Our net interest margin of 1.47% in the current quarter was 12 basis points lower than the year-over-year comparison. Interest rates remain near historical lows and spreads were tighter year-over-year at the short end of the yield curve.

For example, the spread between the overnight Fed effective rate and three-month LIBOR averaged only 25 basis points in the second quarter compared with 66 basis points in the second quarter of 2009. Lower rates, tighter spreads year-over-year, and the reduced value of noninterest related funds continued to pressure net interest income, and the net interest margin. On a sequential quarter basis, net interest income increased 1% and the net interest margin increased by 3 basis points. The sequential increase in net interest income was primarily driven by one additional day during the second quarter as compared to the first quarter. Foreign exchange trading income was $115 million, down 14% compared to the second quarter of 2009, but up 45% compared with last quarter.

The year-over-year decline reflected heightened volatility in the year earlier quarter, related to the credit crisis. The sequential quarter improvement reflects renewed volatility in recent months, associated with the financial uncertainty in the euro zone and concerns about the pace of global economic recovery. In the second quarter our loan loss provision was $50 million, $10 million lower than our $60 million provision in last year's second quarter, but $10 million higher than our provision in the first quarter. Net charge-offs were $38 million, down $6 million year-over-year, but up $8 million sequentially.

Nonperforming assets increased $25 million sequentially to $390 million. Of the $25 million increase in nonperforming assets, $19 million was in the residential real estate portfolio, and $5 million was in the commercial real estate portfolio. At quarter end, nonperforming assets equaled 1.37% of total loans, a ratio that continues to position Northern Trust very favorably among our banking industry peers.

Now let me shift my comments to a review of the key expense categories that impacted our second quarter performance. Operating expenses, which exclude the Visa benefit that I mentioned earlier, equaled $627 million in the second quarter, representing an increase of 25% year-over-year. Recall that two items had a significant impact on our second quarter 2009 expenses. First, we recorded a $130 million expense reduction related to the capital support agreements in place at that time. Second, we recorded $20 million in additional expense related to the FDIC special assessment.

Adjusting for those two items, operating expenses increased 2% year-over-year. On a sequential quarter basis, operating expenses increased 1%. Compensation expense equaled $278 million, down 3% year-over-year, and up 1% sequentially. Salaries and incentives were lower year-over-year, despite annual merit increases. The sequential quarter increase was driven by higher accruals for cash-based incentives.

Staffing levels equaled approximately 12,600 full time equivalent positions at quarter end, an increase of 2% year-over-year and less than 1% sequentially. New staff positions were concentrated in the Asia-Pacific region. Employee benefit expense equaled $59 million in the second quarter, down 5% year-over-year, and 7% sequentially. In both comparisons, the decline in employee benefit expense was broad based across pension, FICA insurance, and other benefit categories.

Outside services expense equaled $115 million in the second quarter, an increase of 12% compared with last year and 8% sequentially. The year-over-year increase primarily reflected higher investment management subadvisory and subcustodian fees, which are influenced by higher market values and higher technical services. These sequential increases primarily reflects higher subcustodian and subadvisory fees along with higher legal and technical services costs.

Equipment and software expense equaled $70 million in the second quarter, up 14% year-over-year and 5% sequentially, in both comparisons the increase reflects depreciation expense associated with ongoing investments in technology. Other operating expense equaled $64 million in the second quarter, compared with a negative $51 million in the second quarter last year and $67 million last quarter. Recall my earlier comments that our second quarter 2009 results included a $130 million expense reduction related to the capital support agreements, and $20 million in expense related to the FDIC special assessment.

Adjusting for those two items, other operating expense increased 8% year-over-year. The year-over-year increase reflects a number of items, including the UK bonus tax which we estimate will be $0.01 to $0.02 a share and higher business promotion, offset partially by a lower level of charges related to account servicing activities. The sequential quarter decline of 5% reflects lower business promotion and advertising expense.

At our Investor Day in May, we spoke about the excellent strategic positioning of our businesses and the many growth opportunities we see for the future. We also discussed how the current environment, particularly very low interest rates, is negatively impacting our revenues. I want to close today with an update on those two important topics. Strategically, Northern Trust enjoys a position of leadership in the businesses in which we have chosen to compete.

PFS is the market leader in the United States, in serving the financial needs of wealthy individuals and their families. C&IS is one of only a handful of global banks that conserve the sophisticated needs of complex institutional clients. NTGI is one of the largest asset managers in the world, focusing its expertise on the investment management needs of our target personal and institutional clients. And our operations and technology platform offers our clients an integrated global infrastructure.

Our clients are among the best in the world, and are the envy of many in the industry. Demographic trends that affect the markets we serve are supportive of a strong growth outlook. Likewise, continued globalization creates complexity for our clients and growth opportunities for us.

This strong positioning in great businesses is currently being masked, however, by extremely low short-term interest rates. First, low rates mean that is our money market mutual funds cannot generate sufficient yield to cover the management fees. Second, our net interest margin of 1.4% in the second quarter was significantly lower than the longer term average of 1.74%, and in securities lending, the relationship between our annual fees and average collateral levels was the lowest across the past decade in the first quarter, and while rebounding slightly in the second quarter, due to traditional seasonality and some pickup in spreads, was still below historical averages.

Altogether, the extremely low interest rate environment reduced second quarter revenues by about $70 million when compared with historical averages, equal to about $0.19 in quarterly earnings per share. I share this updated perspective with you simply to demonstrate again as we did at our Investor Day how the low interest rate environment is negatively impacting our revenues. Our focus at Northern Trust remains on our clients, and on the very attractive businesses within which we compete. We continue to feel positively about the long-term positioning of Northern Trust.

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

Thank you. (Operator Instructions). We will take our first question from Brian Foran with Goldman Sachs.

How are you?

Good morning, Brian.

I guess appreciating the comments you made about the adjusted expenses and how the growth is really fairly very modest year-over-year on that basis, I feel like one of the concerns people always have is just the dollars of expenses creeping up, and against that risk if the volatility environment goes back down, or the SEC lending environment goes back down, that you would have negative operating leverage, so maybe can you touch on are you managing to a rate of growth, or are you managing to a dollar level, and if we do have a drop off in something like FX trading, what kind of operating leverage should we expect and then maybe on the flip side, in the more optimistic scenario where revenue growth accelerates in that scenario, could you continue to grow expenses at this kind of very modest year-over-year rate, or should we expect some pent-up investments or salary increases or something like that to kick in?

Yes. Well, first, and as we said in May in our Investor Day, we have tried to strike a balance between managing our expenses in a method that most would expect in this kind of environment, and continuing to invest in our businesses, and by investing in our businesses, and as we mentioned before, we mean keeping our client service teams in tact, continuing to maintain and in fact grow rather significantly our investment in technology to support our global infrastructure, and to add capability to our services provided to both sides of the house, and I think, Brian, so far, we have been able to strike a pretty good balance, and that speaks to the history of the expense growth. I think we need to continue to invest in our business, and I think in the near term, we will do that.

As to your question about a more difficult environment and can we adjust our expenses accordingly, yes, we always can, and that's a subject that we monitor every month and every quarter, as you would imagine. The other part of your question, envisioning a more optimistic environment and the possibility that our expense rates would continue to run at these levels is pretty hard to think about. I really haven't thought that much about a much improved environment at least in the very near term. Some day we'll get one. It is down the road.

I think our expenses will probably go up from today's level, our expense growth would go up in a more positive environment, as we would bring forward some of the initiatives that we put on the back burner in this low interest rate environment. Hope that answers your question.

It does. Thank you. If I could ask one follow-up.

Sure.

I know there is no run rate or perfect way to predict FX trading, but is there any sense you can give us on how concentrated the improvement was maybe in May, versus how was the June run rate similar to May, or just any kind of color around trends within the quarter that can help us extrapolate out what the current environment looks like?

Our revenues through May and June were pretty consistent, so through the end of the quarter, I think both volatility and volumes helped us right on through the close.

Great. Thank you.

Moving onto Betsy Graseck with Morgan Stanley.

Good morning or good afternoon now. Just wanted to get a sense on the net in-flows and the impact that that had on the AUM in the quarter?

Well, again, Betsy, we don't disclose in-flows per se. Most of the AUM in the quarter, the roughly 7% decline in AUM in the sequential quarter was a result of declines in the market, the equity market, and then we did have some declines in our short duration business, our cash business, and you can see some of that in the trend report we sent out. A portion of that came out of our wealth management business, and you will recall that's our business that deals with family offices and very high net worth individuals, so there obviously is new business in the AUM, but I would tell you that some of that was offset by reductions in our short duration business.

Okay . And then separately on the SEC lending business can you give us a sense of the pipeline that you have there for bringing new clients on? I know there has been a lot of changes in the construct of the offering, and I am wondering if we're at a new run rate at this stage or if there is still kind of a backlog of investors that are interested in signing

It is really too early to tell. We have had a number of clients who exited, meaning our clients, who exited SEC lending back in late 2008, come back in and reinitiate a program. We haven't had much new SEC lending business from new clients, because as you know, we have been ahead of our competitors in terms of allowing our clients to exit and they haven't been able to exit some other places until quite recently, so the outflow has been modest. We have had some clients come back. The SEC lending business from other providers we're hoping will come, but we don't really have a pipeline to report on that.

Okay. Thank you.

Howard Chen with Credit Suisse has our next question.

Hi, Bill. Hi, Bev.

Hi, Howard.

Bill, kicking off where you left on SEC lending you noted the acceleration and the gates coming down for others. How do you position the franchise for that opportunity and are you anticipating any meaningful share shifts, not only for SEC lending but for broader asset servicing mandates as these gates come down?

Too early to tell. This news of gates coming down is what two weeks old now, and just too early to tell. We would certainly hope that we would pick up some significant levels of new business, but I think if Steve Fradkin were here, he would tell you the same thing, it is too early.

Thanks. And then separately just nothing changes in the third quarter, what's the trajectory of the money market fee waivers?

Well, if nothing changes, they should be the same.

Okay. I guess I was getting to if we saw that LIBOR expansion like halfway through the second quarter, do we get a full quarter's benefit and see another step down there?

I would say only that we have started to share some of the increase in rates in those funds with our clients, as we said to you all last quarter we would do, and so even if yields continue to run at the level that is they were, I would think our rebates would be roughly the same.

Okay. Thanks. Final one for me. On credit quality, I know in your prepared remarks you mentioned the uptick in NPAs related to residential real estate. Was just hoping you could give us a little bit more color there and also just on the charge-offs and reserve build as well.

Yes. If you look at the detail in the charge offs and in the increase in nonperformers, as we said in the prepared remarks, the majority of the increase in nonperformers was in residential loans and the rest was in commercial real estate. The rest of our loan categories seem to be in pretty good shape. Commercial loans, personal secured loans, really don't have the same kind of problematic characteristics. The residential loan market is still tough. I remind you all that while our loans are distributed across the United States, we do have a significant presence in some difficult markets, Florida, Arizona being key among them, while residential trends have improved a little bit, obviously there is still problematic in those markets. Commercial real estate, while we have been pretty a aggressive in dealing with our exposure at least in terms of our now nonperforming loans in the commercial real estate area, we have seen some new situations come up as loans have matured, and new appraisals are being received and evaluated. Again, substantially all of the charge-off activity was in those two categories, more in residential loans and commercial real estate loans.

Okay. Thanks so much.

Nancy Bush with NAB Research has our next question.

Hi, guys, how are you?

Hi, Nancy.

Question on the NPAs. You are, as I recall, it was either last quarter or the quarter before you had a couple of large residential loans go nonperforming as well. As I recall, they were in Florida. Your situation with regard to nonperforming real estate is a little bit different, because I am sort of making the assumption here that these are high net worth individuals whose perhaps net worth isn't quite as high as it used to be. How do you work with these borrowers? What is the resolution process for these large residential real estate loans?

Well, once they're in nonperforming status, we obviously try to get them out, but the fact of the matter of these days is that once in most don't come out, and so we conclude the foreclosure process. We take title to the property. We carry no RE, and we actively market it. Now, we have talked before about our largest single piece of residential real estate owned being in Florida. We have been marketing that property for, and by the way it is on the West Coast of Florida, we have been marketing that property for about nine months, without any kind of meaningful activity. On the other side of the coin, we have had some success recently in marketing a property in California.

That's part of the problem, Nancy. Once we get these loans in nonperforming status, and I am talking about through residential and commercial real estate loans generally, they're not going out as quickly as they traditionally have. We're not finding buyers as quickly as we traditionally have, and we're not able to deal with either the residential real estate owned or the commercial real estate owned within the time frames that we're used to, and that's really part of the problem.

Is most of this portfolio, this nonperforming residential real estate portfolio, is it mostly a Florida portfolio, Florida and California? Can you just put some color on the geography?

No. It is really not. It is spread around. Our largest exposure regionally is first to Illinois, second to Florida, and then it diminishes from there as you go across the country, and I would tell you that we've got almost as many residential loan challenges in Illinois as we do in Florida. The prospects of resolving those loans in Illinois is I think a little better than it is in Florida, the problems in Florida being well known as they are.

Nancy --

I guess you're not doing loan modifications, huh?

We're doing some, but not too many. We've got a chunk of troubled debt restructurings in the residential side that we're trying to get back on a performing basis and working with borrowers. Recall that we've got borrowers at every level of the economic scale in every state.

Okay.

Nancy, one-way from public filings that you can get a little bit at the geography would be to look at the call reports that we file. We file three -- we have three legal entity banks, the Northern Trust company, which is Chicago headquartered, Northern Trust NA, which is Florida, and then we have a Northern Trust FSB, so if you want to dig a little deeper into geography, that would be one-way you could do it.

Thank you. Also, you made some comments, Bill, about the PFS business, the new business, sort of some people backing off after the events of the second quarter, and I am assuming you mean the flash crash and some other things that happened. As you ended the quarter, did you see any kind of rebuild there, or is it still the same extreme level of caution?

Let me try to quantify the reduction. Notwithstanding a slight fall off in the second quarter, the first six months, Nancy, were very, very strong, so I don't mean to suggest we have a problem. We had one of our best quarters ever in the first quarter, and we were slightly weaker, underline slightly, in the second quarter as people were put off by the flash crash, and volatility in the equity markets, and frankly that doesn't surprise me. I would hope that the momentum that we had in the first quarter, which carried over to some degree in the second quarter would reassert itself as people gain a little more confidence, and hopefully in the absence of volatility in the equity markets, but we'll see.

Okay. Thank you.

Moving on to Robert Lee with KBW.

Thanks. Good afternoon, everyone. I have a question in PFS, if I look at the some of the geographic breakdown of growth of fees last quarter, one of the things that kind of jumps out is that you haven't seen the rebound in the wealth management segment as you have in some of the others where I guess the servicing fees are actually I guess kind of down from six quarters ago compared to all the other segments where I guess they have benefited from combination of some rebound in markets as well as in the Kline acquisition. Any color you can give on that? You seem --

Yes, sure can. First for others on the call, remember that our wealth management group is focused on family offices globally and very high net worth individuals, and historically, that group of clients have had a little different asset allocation than the typical PFS client. Rob, you mentioned a year-and-a-half ago. A year-and-a-half ago, 50% of the average or well of our total AUM in the wealth management group, was in cash or short duration assets. Much, much higher levels of cash than the rest of our PFS business.

What we have seen over the last six months and there were some acceleration in the first -- well, the last six quarters, and some acceleration in the first six months of this year, is a reallocation of that cash and short duration business to riskier asset allocation groupings, hedge funds, private equity, equity all across the board, and several of those reinvestments have not been in Northern Trust products. We retain the custody where they're custody-able assets, but the shift is just that. We have seen a reduction in asset allocation of about 7% from 50 to about 43% over the last six quarters out of cash. And recall in the cash environment we're getting an investment management fee and when that money moves to a riskier investment and we don't manage it, we either get a custody fee in lieu of an asset management fee or we get just a line item carrying fee if it is a private equity investment. So I think that speaks for the difference and the lack of growth relatively in wealth management versus the rest of PFS.

Okay. That's helpful. And maybe shifting to C&IS and I apologize if you mentioned this earlier on the call. I jumped on it'll a bit late. Can you give color on what kind of new BSI trends are like particularly starting with the asset management business and are you continuing to -- have you continued to see net in-flows into kind of passive products or have institutional investors kind of paused if you will the last couple of months with all the volatility?

Well, I think our flows in the institutional business have been pretty consistent, and we haven't seen any change in the composition. I think that institutional clients don't have the same reaction at least thus far in our numbers that the personal clients have had, the smaller personal clients.

Okay. And can you maybe again, I apologize if you mentioned this earlier, but any kind of color in kind of the asset servicing side of C&IS, just if you had to characterize business opportunities today versus last quarter, two quarters ago, is it continuing to build or just any kind of color you can give around the pipeline there?

I tried to cover that in the comments in the text by saying how strong our pipelines are in all parts of our business. We have won quite a number of pieces of business that have not yet transitioned and expect those in subsequent quarters, but again, were Steve Fradkin here, I think he would be quite positive in his description of opportunities really around the globe both in Asia and Europe and in the United States in all parts of our business. Realize you can't see that in the current quarter results, but the pipelines are as I said in the prepared remarks, very strong.

All right. That was it. Thank you very much.

Moving onto Mike Mayo with CLSA.

Hi.

Hi, Mike.

Can you quantify the pipeline? I never know what to make of all of this, pipelines are strong, so as a percentage of assets under custody or revenues or bigger than last quarter --

Can't do it Mike. Sorry.

Bigger than a Red Box? You feel good about the momentum? We heard you there. Who are you winning the new business from? Is it the other big four or five players or is it from lesser players or is it from existing clients?

It is a mix. It is really across the board. In each region the answer to that question would be different, but I wouldn't point to an individual provider, Mike, and say we're taking more business from that provider than others. It is pretty broad based. Again, depends on the region.

Okay. Now it is official. All the big processing banks have said they're gaining business and they're winning from other big players among others, and I just don't know how that is.

I understand the question. A lot of business out there and we're in some markets that we haven't been in before. We have got some product offerings that we're stronger at and more proven at, the IOO business within fund administration as an example, than we had been previously, and we're starting to get the kind of recognition globally that we would expect, but it is a huge prospect universe as you well know, and I think there is plenty of business out there for three or four providers to be talking about significant new wins.

Can you talk about non-US? I mean, the pipeline, is it disproportionate outside the US now and if so where?

I would say it is a little stronger outside the US than domestically, but we have some very significant domestic prospects as well, but the pipeline is stronger, particularly in Europe.

Acquisitions or potential acquisitions in Europe with everything the European banks are going through, I guess some properties could come up for sale according to some press reports. What's your appetite?

We would be enthusiastic about evaluating those opportunities when they come up.

And shifting gears PFS, to new business good link quarter growth. Who are you winning that from, or is it existing clients giving you more money?

It is a combination of both, actually a pretty good percentage of our new business in the second quarter was from existing clients, higher than normal. I would ascribe that phenomenon more to the recent segmentation that we have done in the business and getting more focused on client's share of wallet. I think we're doing a better job of that.

And last question, you did answer the month to month question earlier, saying that revenue is pretty even throughout the quarter, but as you got late in the quarter, volumes and volatility certainly went down quite a bit, so you're an exception to much of the industry, and I don't know, maybe this is a small example of your model generally, but why is business keeping up through the end of June, and I am guessing still through this month? I don't know when it has fallen off at so many other financial service firms.

Mike, just one clarification. The question that we had earlier on trends, I believe had more to do with the fee waivers. I don't think we spoke in total revenues.

No, FX.

FX as well. I don't think we spoke about total revenues.

We didn't.

Yes.

I misunderstood that. I would imagine the monthly trend on revenues wouldn't have been quite as strong during the tougher times of the quarter, but you don't usually answer that question so I will let that be. Thanks.

Thank you.

Thanks, Mike.

Moving onto Ken Usdin with Banc of America, Merrill Lynch.

Hi, Bill and Bev. Further question on custody. The line was up a couple million dollars and you did have the benefits from the positive lags this quarter. Just wondering, Bill, can you give a little bit more color on was this a big conversion quarter and how was transaction activity versus the prior quarter?

No. I would say it was not a big conversion quarter. I think I will leave it at that. Just not big by our own standards historically.

And any comment on just transaction activity which tends to be pretty healthy chunk of that line?

Not a meaningful driver.

Mostly just the markets, then?

Right.

And my second question relates to the balance sheet and net interest margins, so you had the margin go up it'll a little bit, and it is plus or minus the last couple of quarters but just wondering if you changed anything with regards to how you are reinvesting now, and if that helped out all and how much did the change in short-term rates and the LIBOR increase possibly add to this quarter's margin?

It helped us a little bit in the reinvestment of some of our non-US deposits, but obviously it wasn't a huge driver in dollars, the big impact was the additional day, and the additional three bips of margin, while it is nice to see an increase in net interest margin, really not material. No, we have not changed our investment parameters either in the money market field or in the investment security category, and our loan yields have stayed relatively constant, so not much movement really.

And the last question on the balance sheet is, there was a lot of moving parts that pretty much netted out on the liability side, but looks like you had good growth in the kind of core deposits and that was offset by a pretty sharp decline in the free funding and just wondering is that specific to anything in the marketplace? Is that client activity or is that just what happened?

Well, we exited the transaction account guarantee program at the end of June and of course we notified our clients well before that as you might have expected, so we did lose some money, and we expected it as a result of discontinuing the tag program.

And did that money come back in? Was that the money that also then flowed back in on the deposit side? Did the client shift or did that money end up leaving the firm?

Most of those clients did not go into other deposits. Some of them went into short duration assets management products and some of them left the Company. One in particular left the Company because they wanted to be in a place where, one large client by the way, wanted to be in a Tag-insured program. Very few big banks left in the program, and we evaluated the risk of losing that deposit versus the cost of staying in the program and made the decision to exit.

Okay. So the growth in just the total interest-bearing deposits is just real just core business growth largely? Is that fair to say?

That's fair.

Okay. Great. Thanks a lot.

Moving onto Brian Bedell with ISI Group.

Good morning, Bill and Bev.

Hi, Brian.

A couple of housekeeping things. First of all, can we do the breakout of the C&IS assets under management and PFS AUM between equities fixed and cash?

C&IS equities 42%, fixed income 17%, short duration 41%.

Okay.

Within PFS AUM, the numbers were 33% equity, 35% fixed income, and 32% short duration.

Great. What was the 41% that Bill referred to? I think he said PFS assets under custody. Is that the entire PFS business or is it the wealth management?

That would just be AUC.

For --

AUM.

Got it. 41 is the AUC for the PFS segment.

That's correct.

Got it. Okay. In the C&IS asset management business, anything else unusual that boosted fees say maybe to the transition management revenue or anything else? Seemed like that was pretty good -- No. Actually it was a pretty normal quarter, and I didn't go back and look at the first quarter late period transactions that would have flowed into the second quarter, but no pretty standard month, pretty standard quarter.

And just for clarification, transition management revenues for us would be in a different line item.

Securities trading.

Correct.

Commissions, yes, got it. Didn't know if you were parking extra assets there temporarily. Sounds like it is really core new business and that basic level of fee generation should continue into the third quarter, right?

Other than market impact.

Of course. Yes. Couple other things. On the net interest margin, looks like on the average balance sheet, you did shift some more into security which is are high yielding of course and obviously naturally good strategy in its environment, but it looks like on just the rate on the average balance sheet, on the government and other taxable securities of 147 basis points looks high. I was wondering if that's a typo, or if that's the actual yield, because when I compute that through I get higher than 199 basis points on the earning assets and it looks like that number should be more like around 120ish, so just for modeling going forward, did you actually get a really big improvement in that yield or do you think that might be a typo?

I don't believe it is a typo. Brian, I will look into that and we can take that off line.

Okay. So I guess a more generic question would be is there more room to allocate into securities going forward to help the yield or do you try to keep a certain level of assets in the money market bucket?

Well, the majority of the assets in the money market bucket come from specific deposits from our non-US clients, so that's pretty much client driven. When our US based funding increases, if we don't have loan demand, that money goes into securities, and whether it is 147 or 124, those numbers are going to be coming down when the assets that are currently out there roll over and get reinvested.

Right.

I would say that's -- unless we change our strategy around how we invest our securities portfolio, and I don't think we will, I don't see much of an opportunity there.

That yield should be moving down, obviously trending down from the 130s and 120 last year and a little --

Yes. It will keep coming down for a while.

Right. Okay. Just quickly on the SEC lending product, is it actually possible because that's a variable NAV product and I know you have 18 million left to get back to par on that. Is it possible to actually book gains over and above $1 NAV or is that not possible?

I think one of the things I would point out, Brian, recall that we started talking about this particular fund in the third quarter of 2007.

Right.

We're not going to land on the head of a pin in terms of one day reaching zero and being done with it, so it is possible, yes.

Okay, so it is -- how big is that product now if you can disclose that.

$2.9 billion. You become relatively small against our $110 billion quarter end collateral level.

Right, right. Okay. A couple other housekeeping things. The UK bonus tax of $0.01 to $0.02, is that in this quarter or are you putting that in next quarter?

That's in this quarter.

That's in the staff line? The compensation line?

It is in other operating expense.

That is in other. Got it. And then while we're on expenses, the outside services of the 114, I know you mentioned there were some legal and technical costs in there. Is that something that was extra inflated in the second quarter, or were you sort of closer to that run rate in the next quarter or two?

The bigger drivers were actually subcustodian and subadvisory fees which tend to move with the markets.

Yes.

Those were the bigger drivers.

And you would expect those to adjust to lower market levels at some point.

In the third quarter probably, yes. And then just on the -- what was my last question? On the PFS -- the client allocation activity. Down to about 33% in the PFS unit. If you can characterize the general sort of appetite for investing back in equities, and what are you telling or how are you advising your clients in general and in this market environment? Are you advising them to be more cautious or to take an opportunity and get --

I go back to some of my earlier differentiation comments around the higher end of our market wealth management, and the lower end of our market. The higher end continues to be more aggressively invested, and the lower end, partially in reaction to what happened in May in the equity markets, and partially because of our direction, have become more conservative.

Okay.

We have advised and have for the last couple of months of the quarter advised our clients to take a little risk off the table.

Right.

Reduction in emerging market exposure, reduction in commodities, and things like that, and they're following us more than they have in the past, so obviously it wasn't a significant change in aggregate, though, because the level of commitment to equities sequentially is roughly changed by the market change.

Yes. Right. So the 43% you were talking about before of the wealth management group client base that's in cash right now, that's down from 50, I think you said, and --

50, six quarters ago, a year-and-a-half ago.

That 43% is moving sort of down, the trend of that is that 43% the trend of that is down.

Right.

Okay. Great. Thanks so much for answering my questions.

Pleasure.

Moving to Tom McCrohan with Janney.

Hi. Thanks for taking my question. Bill, you talked about cross-selling in your prepared remarks about being particularly strong. It doesn't sound like it was from transitions. Can you elaborate on where you are seeing good momentum on the cross-selling side?

Well, what I was referring to was PFS, and not so much institutional side of the business although it is strong on both sides. It is pretty much investment management, new business, and my comment was that the level of effective cross-selling in PFS in the second quarter was higher than it has been in historical quarters. Again, I ascribe that as I said to the segmentation that we have done and the tighter client focus of particularly in the wealth advisory segment.

Okay. As you probably are aware the SEC is looking at capping or eliminating 12 B 1 fees. Do you earn 12 B 1 fees in any of your various businesses like manager of managers, that product?

Not in a material way, no.

Great. And one last question on Florida and credit. Sorry to beat a dead horse on this. Is there any metric you can give us to give us comfort that the current reserve levels that you have for those residential loans are sufficient such as loan to value and any metric you can give us and if you can't give us the metric can you tell us what metrics you are monitoring to sufficiently make sure you have sufficient reserves in that market? Thanks.

That's a pretty tough question. We're monitoring delinquencies in our portfolio and all markets. We're monitoring our own internal watch list methodology. We're looking at the difference in appraised value on house that is we acquire through foreclosure, and obviously we're looking at the volumes of nonperforming assets in Florida and in the two problem categories in the loan portfolio generally, but frankly it is all about how we feel every quarter. We sit down and I participate in these meetings.

We sit down with our credit policy people and go over in detail what the status is within say in this case residential real estate loans in Florida and if we see a significant deterioration in that business, we will increase the inherent reserve that we have allocated to residential real estate, so I can't give you a metric that will make you feel good that's long-lasting. I will tell you, though, that we revisit the subject specifically by region, by loan quality in terms of specific reserves for individual loans and inherent reserves for the class of loans in each region.

So there is no specific leading indicator that you guys discovered over time that --

Not really. I mean, we look at the price index, Case-Shiller among others in the market that is we have the most exposure and that goes into our assessment of what our inherent reserve calculation ought to be for house prices. I would say house prices in Florida although it is not intuitive have actually been going up here for the last five or six months, so a little positive news there.

Thanks.

Cynthia, we'll take one more question.

Our final question will come from James Mitchell with Buckingham Research.

Good morning. Can I just talk a little, getting back to the balance sheet, if we look at your money market assets the yield didn't really move up a basis point yet LIBOR spreads have widened. Is it just sort of a timing issue? Should we see more of a positive impact from widening spreads, all else being equal in the third quarter, or are we not thinking about that the right way?

Depends on what happens in the Euro zone. We have shortened up our maturities quite a lot here just monitoring our exposure, so it is a little more difficult for our folks to buy longer dated liabilities from European banks so you probably got a 30 day average duration in there instead of 90.

Okay. So ate up some of the benefit of the higher spreads.

That's why you don't see it in the quarter end numbers.

Just maybe one question on the mark-to-market fund I was surprised credit spreads generally widened this quarter, particularly in financials, which what you talked about was a major ownership component of the mark to market fund. You guys had gains. Is there a way we should -- didn't seem to be a good correlation there. How do we think about that going forward?

I would encourage to you continue to look at that index that we pointed out to you a number of quarters ago, the Merrill Lynch US Corporate Master Index. My notes show that in the second quarter it was up 3.2% versus having been up 2.7% in the first quarter, so I think that I show a correlation going back to the third quarter of 2007 against that index which is still --

Bev, I hear you on that. It is just with the disclosure that most of that was financials, it seemed obviously financials widened or sold off so just surprised. I guess there is something else in there that doesn't necessarily track with global financials. But okay, I will focus on that index. Thanks.

Great.

Okay. Thanks, everybody. Appreciate you joining us today, and we look forward to talking to you again on October 21st when we update Northern Trust's third quarter performance. Thank you so much.

This does conclude our conference call today. We would like to thank you for your participation.