Northern Trust Corp (NTRSO) 2011 Q2 法說會逐字稿

Good day, everyone. Welcome to the Northern Trust Corporation second quarter 2011 earnings conference call. As a reminder today's call is being recorded.

At this time, I'd like to turn the call over to the Director of Investor Relations, Bev Fleming, for opening remarks and introductions. Please go ahead, ma'am.

Thank you, Kevin. Welcome to Northern Trust Corporation's second quarter 2011 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 you who did not receive our second quarter financial press release or financial trends report via email this morning, they are both available on our website at northerntrust.com. In addition this July 20, call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available through August 17. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

Now, for our Safe Harbor statement. What we say during today's conference call may include forward-looking statements which are Northern Trust's current estimates 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 you to read our 2010 Annual Report and our periodic reports to the Securities and Exchange Commission for detailed information about factors that could affect actual results.

Thank you again for joining us today. Let me turn the call over to Bill Morrison.

Thank you, Bev, and good morning, everybody. It's my pleasure to speak with you today about Northern Trust's second quarter earnings. Earlier this morning, Northern Trust announced second quarter net income of $152 million and earnings per share of $0.62. Our results this quarter included $22.6 million or $0.08 per share in expenses associated with restructuring, acquisition and integration activities. Specifically these expenses relate to integration activities in connection with our June 1, acquisition of the fund administration business of the Bank of Ireland. As well as related restructuring activities in our global fund services business in Ireland and in the United Kingdom. And the expenses related to the pending acquisition of Omnium, the hedge fund administration business of Citadel which we expect will close in the third quarter.

Adjusting for the restructuring, acquisition and integration expenses incurred in the second quarter, earnings would have been approximately $0.70 per share. This compares with operating earnings per share of $0.78 in the year earlier quarter and $0.59 in the first quarter of 2011. Recall that our results last year and last quarter each included an expense credit related to the 2008 IPO of Visa which impacted all Visa member banks. We presented operating results in those prior periods which excluded Visa related items. Our results this quarter were not impacted by any Visa related items.

As is customary in our earnings conference call, I want to briefly discuss how the macroeconomic environment, specifically interest rates and equity markets, impacted our results. Low short-term interest rates coupled with narrow spreads at the short end of the yield curve continued to negatively impact net interest income, some investment management fees and securities lending revenues. Overnight interest rates in the United States averaged only 9 basis points in the second quarter, down from an already low 16 basis points in the first quarter. 3-month LIBOR averaged 26 basis points, a decrease of 5 basis points sequentially. Short-term interest rates for the euro and sterling were also at low levels by historical standards. Although short-term interest rates in the euro rose in the second quarter following the decision by the European Central Bank to increase its key interest rate by 25 basis points on both April 13 and July 13.

Equity markets were essentially unchanged as of June 30 when compared to March 31. However equity markets as measured by the S&P 500 index rose 5.4% in the first quarter which is relevant to fees that we earned in C&IS custody and PFS Wealth Management, our businesses which primarily use a quarter lag methodology in calculating some fees. Using the 1-month lag methodology, which is relevant to fees that we earn in PFS excluding Wealth Management, equity markets improved 4.2% in the second quarter. So all in all, the impact of the equity markets on our second quarter results was mixed with current markets having little impact and lag markets providing some support to SF values and to related fees.

With that background let me get into the detail behind our second quarter numbers. Revenues on a fully taxable equivalent basis were $955 million in the second quarter, down 2% year-over-year and up 5% on a sequential quarter basis. Trust investment and other servicing fees were the largest component of our revenue mix, and represented 58% of total fully taxable equivalent revenues in the second quarter. Trust investment and other servicing fees of $558 million were up 3% year-over-year and up 8% sequentially. In our institutional business, C&IS trust investment and other servicing fees totaled $309 million in the second quarter, down 2% year-over-year and up 14% on a sequential quarter basis. C&IS fees include 3 primary categories. Custody and fund administration, institutional asset management, and securities lending. And let me spend a moment on each of those briefly.

C&IS custody and fund administration fees were $190 million in the second quarter, up 17% year-over-year and 12% sequentially. The increase reflects strong new business success year-to-date in global custody, fund administration, investment operations outsourcing, and domestic custody. As well as higher market values year-over-year and the impact of the Bank of Ireland Securities Services acquisition. Institutional assets under custody were a record $4 trillion at quarter end, representing an increase of 25% or $800 billion year-over-year. And 1% or $60 billion sequentially. The sequential growth in assets under custody primarily reflects higher fixed income values, currency translation, and new business. Global custody assets, a sub component of assets under custody, were also a record at $2.5 trillion, up 34% or $641 billion year-over-year, and 2% or $47 billion on a sequential quarter basis.

C&IS Investment management fees were $70 million in the second quarter, up 1% year-over-year and up 4% sequentially. Waived fees associated with institutional money-market mutual funds were $7.5 million in the second quarter, up significantly from the $4.6 million in the first quarter and $2.6 million in last year's second quarter. The higher level of waived fees reflects lower yields on the funds due to lower interest rates in the short end of the yield curve. Absent fee waivers, C&IS investment management fees were up 8% both year-over-year and sequentially, reflecting new business in our indexed management, manager of manager, and short duration businesses, as well as higher year-over-year market levels. Managed assets for institutional clients were $512 billion at quarter end, up 11%, or $51 billion compared with a year ago. And up $18 billion or 4% sequentially. We're very pleased with the new business results across our C&IS custody, fund administration and investment management businesses this quarter. Net new business recorded this quarter was the third best on record and reflects the transition of new clients to Northern Trust, as well as outstanding cross-selling results to existing clients.

Securities lending fees totaled $31 million in the second quarter, down from $66 million in last year's second quarter and up from $17 million reported last quarter. Recall that our securities lending fees in last year's second quarter included $37 million in positive marks associated with the one mark-to-market investment fund used by certain securities lending clients. All remaining securities in that fund were sold in the third quarter of 2010 so there have been no mark-to-market impacts since the third quarter of 2010. Adjusting for the prior year impact of these marks, our securities lending fees increased 5% year-over-year, primarily reflecting wider spreads. On a sequential quarter basis, C&IS securities lending fees increased a strong 82%, primarily reflecting the traditional second quarter impact of the international dividend season which resulted in wider spreads. Securities lending collateral was $106 billion at quarter end, down 3% both year-over-year and sequentially. Securities lending collateral averaged $117 billion in the second quarter, down 6% year-over-year but up 6% sequentially.

Let's now move to our Personal Financial Services business. Trust investment and other servicing fees in PFS were $249 million in the second quarter, an increase of 10% year-over-year and 2% on a sequential quarter basis. Growth was driven by improved market values and strong new business, offset partially by a higher level of money-market fund fee waivers due to the very low level of short-term interest rates. These fee waivers reduced PFS fees by $15.2 million in the second quarter compared with $12.9 million in the year earlier quarter, and $12.1 million in the first quarter. PFS net new business in the second quarter was our best second quarter results since we've been tracking this metric. And PFS net new business in the first half of 2011 was the best 6-month period results ever.

Our PFS regions, meaning Midwest, Southeast, West, and Northeast, had trust investment and other servicing fees of $219 million, up 12% year-over-year and up 3% sequentially. The wealth management group, which as you know focuses on the family office segment, had fees of $30 million, down 3% year-over-year and down 4% sequentially. During the second quarter we reassigned several relationships from the wealth management group to our wealth advisory teams primarily in our Midwest region. And this reassignment had no impact on overall PFS fees but did shift some of the fees and assets out of the wealth management group and into our regional results.

PFS assets under management were a record $172 billion at quarter end, up 22% or $31 billion compared with a year ago, and up 2% or $4 billion compared to last quarter. Assets under custody in PFS were also a record at $388 billion at quarter end, up 18% or $60 billion year-over-year, and up 1% or $3 billion sequentially. Approximately 37% of PFS managed assets were invested in equity securities at quarter end, unchanged from the prior quarter.

Net interest income was $257 million in the second quarter and the net interest margin was 1.23%. Net interest income increased 6% year-over-year and 5% sequentially. The year-over-year increase was driven primarily by a 27% increase in average earning assets, partially offset by a 24 basis point decline in our net interest margin. Growth in earning assets was concentrated in lower yielding assets such as Federal Reserve deposits, interest-bearing deposits with banks, and investment securities. Loan demand remains soft. Average loans increased only 3% year-over-year and represented 31% of average assets in the quarter, down from 37% in the second quarter of last year. The 24 basis point decline in our net interest margin was driven by the mix shift on our balance sheet toward lower yielding asset classes and categories.

Sequentially, net interest income increased 5% with sequential drivers are similar to what I just mentioned in the year-over-year commentary. Average earning asset growth of 11% sequentially was similarly concentrated in lower yielding assets as average loans increased only by 2% on a sequential quarter basis. Foreign exchange trading income was $81 million, down 30% compared with the second quarter of 2010, and down 5% compared with last quarter, reflecting mix to lower volatility, offset partially by slightly higher client volumes. Other operating income of $42 million increased 13% year-over-year and 18% sequentially, reflecting higher banking relating fees and other miscellaneous income.

In the second quarter, we recorded $17 million in credit related other than temporary impairment charges on residential mortgage-backed investment securities held within our balance sheet securities portfolio, primarily reflecting additional deterioration on previously identified impaired securities. Notwithstanding the impairment charge this quarter, the quality of our balance sheet securities portfolio remains strong, with 81% of the portfolio rated AAA as of June 30th. Our available for sale securities portfolio had a net unrealized pre-tax gain of $50 million at quarter end.

Our loan loss provision was $10 million in the second quarter, down from $50 million recorded in the second quarter of 2010 and $15 million recorded last quarter. Net charge-offs were $15 million, down from $38 million last year and from $21.5 million last quarter. Non-performing loans increased $3 million sequentially to $328 million at quarter end. Other real estate owned decreased by $25 million on a net basis sequentially and was carried at $31 million at quarter end. The net result was a decrease of $22 million in non-performing assets to $359 million or 1.26% of total loans and other real estate owned. A ratio that continues to position Northern Trust Corporation favorably among our banking industry peers.

Let me now shift my comments to a review of the second quarter expenses. In all comparisons, I'll be referring to operating expenses which include the prior period Visa items that I mentioned earlier. Total operating expenses were $705 million in the second quarter, representing an increase of 12% year-over-year and 6% sequentially. Our results this quarter included $22.6 million in expenses associated with restructuring, acquisition and integration initiatives. Acquisition and integration related expenses were $3.8 million last quarter. Our expense growth adjusted for those items and a benefit expense reversal last quarter was 9% year-over-year and 2% sequentially. Compensation expense was $320 million, up 15% or $42 million year-over-year, and 9% or $26 million sequentially. Included within compensation expense this quarter was $18 million in severance related restructuring charges. Adjusting for this charge, compensation expense increased 8% year-over-year and 3% sequentially. Higher salaries associated with annual merit increases and higher staff levels were the primary drivers of the increase, both year-over-year and sequentially. Staff levels at quarter end totaled 13,600 full-time equivalent positions, representing an increase of 8% year-over-year and 4% sequentially. Approximately 60% of the sequential quarter increase in staffing was due to the Bank of Ireland Securities Services acquisition.

Employee benefit expense was $67 million in the second quarter, up 14% or $8 million year-over-year, and 23% or $12 million sequentially. Recall that in the first quarter, we recorded a $9.7 million reversal of an employee benefit accrual for which the 2010 goal had not been met. Absent that reversal last quarter, employee benefit expense increased 4% or $2 million sequentially. The year-over-year increase in employment benefit expense primarily reflects higher staff levels, pension expense and FICA insurance. The adjusted sequential quarter increase primarily reflects higher FICA insurance expense.

Outside services expense was $135 million in the second quarter, up 18% or $20 million compared with last year. And up 9% or $11 million sequentially, primarily due to higher technical investment manager sub-advisory and acquisition related integration expense. Equipment and software expense was $83 million in the second quarter, up 19% or $13 million year-over-year. And 13% or $10 million sequentially, primarily due to higher depreciation expense associated with ongoing capital investments in technology. Other operating expenses were $57 million in the second quarter, a decrease of 11% or $7 million year-over-year, reflecting a UK bonus tax accrual in last year's second quarter, as well as lower FDIC premiums and charges associated with account servicing activities. On a sequential quarter basis, other operating expenses decreased 24% or $17.5 million. The sequential decrease primarily reflects lower business promotion expense and charges associated with account servicing activities.

Our effective tax rate in the second quarter was 33.8% compared with 34.3% in the first quarter. Recall that our first quarter tax rate included deferred tax adjustments relating to the Illinois corporate income tax increase enacted in January of 2011.

Before we open the line for questions, let me make a few closing comments. First of all, I mentioned our net new business success in both personal and institutional clients in my earlier remarks. All 3 of our client-focused business units -- and that would be PFS, C&IS, and NTGI -- are seeing strong success in our target markets as a result of the expertise and the quality solutions that we offer to our clients. This success is being recognized more broadly in a marketplace, garnering extensive industry recognition. For example, we're the best private bank in North America for 2 years running, and the best private bank for innovation according to publications of the Financial Times group. We've been named Best Global Investor Services House at the Euro Money Awards For Excellence. Best Client Relationship Manager at the ICFA America's Service Provider Awards. Custodian of the Year at the Professional Pensions UK Pensions Award. Best Administrator for UCITS Funds at the HFM Week European Hedge Fund Service Awards. And winner of the Global Custody Award at the UK Financial Times Pension and Investment Provider Awards.

In the Asia Pacific region, the Asset Magazine named Northern Trust best custody specialist for the third consecutive year. And we won the Best Specialist Global Custodian in Asia Pacific Award in Asia Asset Management Magazine's Annual Best of the Best Awards. In our institutional asset management business, Northern Trust was recognized by Institutional Investor as US Equity Indexer of the Year for 2011. This recognition across our Company is indicative of our strong competitive positioning in personal financial services, global custody, fund administration and asset management. And was reflected in our excellent new business results and flows this quarter.

Second, our capital levels continue to be very strong with Tier 1 capital and tier 2 common ratios of 12.8% and 12.3%, respectively. Under the Basel III framework, as we currently understand the regulations, we estimate that our current capital levels would exceed all regulatory requirements. We continue to deploy capital through strategic acquisitions including 2 completed or announced already this year. We maintained our dividend throughout the financial crisis and have paid $137 million in dividends so far this year for a dividend payout ratio of 45%. We instituted our share repurchase program in the first quarter and bought back approximately 1.5 million shares in the first half at a cost of around $77 million. While we have returned to our historical practice of repurchasing shares issued under equity compensation programs, a large percentage of our first half repurchases were catch up in nature, covering shares issued under equity compensation plans dating back to May of 2009.

Third, while our client franchise and financial positions are in excellent shape, the macroeconomic environment, again in particular, extremely low short-term interest rates, has restrained revenue generation. Despite efforts that we've had in place to manage our cost base, it's been very difficult to achieve our goal of positive operating leverage given the revenue headwinds that we've been experiencing. We are actively pursuing expense initiatives that will slow the rate of expense growth in the second half of 2011 and in 2012. The restructuring charge that we announced today is a first step in that direction.

Finally, as we announced yesterday that Mike O' Grady will join Northern Trust in August and assume the role of Chief Financial Officer effective October 1. Mike joins us from the Financial Institution's Investment Banking Group at Bank of America/Merrill Lynch where he's been since 1992. I've spent a good deal of time with Mike in recent months and he's been well known to our executive leadership team over many years. He's quite familiar with Northern Trust and will be a great addition to our already outstanding leadership team. When Mike assumes the CFO role on October 1, I will move into the President and Chief Operating Officer role, working closely with our CEO, Rick Waddell, and with our business unit Presidents. Let me say that I've thoroughly enjoyed working with all of you during my time as CFO and look forward to maintaining our relationship in the years to come.

Thank you, again, for your time today. Bev and I would now be happy to answer your questions. Kevin, if you could please open the line for questions.

(Operator Instructions) Howard Chen with Credit Suisse.

Hi, good morning, Bill, good morning, Bev. Bill, congratulations on yesterday's announcement. Bill, on the headcount increase, outside that 60% related to acquisitions, where are you hiring across the franchise? And how do you think about incremental hiring needs in the context in some of the productivity and expense management initiatives that you and Rick have been alluding to?

Remember, and as I said in the comments, a little more than 300 of the people we added in the quarter came from the Bank of Ireland acquisition. And we're restructuring that organization, as we've said. If you step back and look at where the majority of the hiring has been in the quarter, most of it continues to be in the Asia Pacific region. Although I would say that in the quarter, our PFS business did fulfill some of their commitments against strategic hiring. And when you see the segment and the regional hiring statistics you'll see some growth in the US in PFS.

To your question around our thoughts and initiatives around productivity, we have disclosed previously that we're working to slow the rate of growth in expenses in a business like ours that requires a reduction in the rate of growth of compensation. And, while we don't have specific targets today, know that we have put in place steps in the second quarter that will slow the rate of growth for the remainder of the year.

And, at the same time we have started a series of, I'd call them exploratory initiatives, to see if we can restructure or reposition our businesses to work in a more productive way both from a revenue and from an expense point of view going forward. It's a bit early in our journey down that road so we don't have targets or specific initiatives, but as we said during the second quarter, we have started specific reviews and will develop specific targets as we go forward through the balance of the year.

Okay, thanks. Looking forward to hearing more about that. Switching gears, Bill. Last quarter, you mentioned the impact of hedging practices partially dampening the CNIS fee realization. Just curious, what was the impact of that this quarter and what should we all be watching to try to figure that out going forward?

Howard, this is Bev. That really wasn't the impact this quarter that it was last quarter. On a sequential quarter basis we had spot rates and hedge rates basically moving in the same direction. And, you'll recall last quarter that was not the case. So, it really wasn't the impact this quarter that we had spoken with you about in the first quarter.

Okay, thanks, Bev. Finally, Bill, you mentioned capital management. Could you just give an update on if you have approval from the Fed on your capital plan that you submitted? And given we now have a little bit more clarity on Basel III from a capital perspective, how are you thinking about finding that balance of being conservative and returning capital with your 12.5%-ish Basel III Tier 1?

Howard, as you know, we did file a plan in the first quarter of this year. We were not part of the 19 bank SCAT group. We were probably the 20th bank. So, the process that we followed was a bit different. But directionally it was the same, so, we filed a plan in late February. It's been reviewed by the Fed and we've been told they have no objections to our plan.

As you have seen, and everybody else in your business on the call has seen, there has been some new regulatory proposal floated in terms of who would have to file detailed capital plans on a going forward basis. And basically it's proposed that all banks with assets over $50 billion, beginning early in 2012, would have to file capital plans on basically the same basis.

So, the quick answer to your question is that our plans for the initial 2-year capital plan we filed in the first quarter were not objected to by the Fed. But, more recently they have suggested that we'll all have to file annual plans. So, effectively, I think what we've got is an approval of the first year of our 2-year capital plan.

Okay, thanks. And, then when you think about that capital plan in the context of having a 12.5% Basel III Tier 1 and much higher Basel 1 Tier 1 common, how are you thinking about the right number to both achieve conservatism and actively return capital?

Yes, it's very hard to pin down a number on this. As you know, we and most of the other banks you're covering are still going through the Basel II parallel run, still validating our risk management and our risk-rated asset driving systems. We get a little bit of clarity around what the Basel III minimum levels will be for well-capitalized banks, including the SIFI adjustments. But, in my opinion, we've still got some time to go. And I would just say that when we do get clarity around what those SIFI surcharges will be, we will probably maintain our historical approach of keeping a margin over what that minimum is described to be for a well-capitalized bank. So, too early to tell, I'm sorry to say.

John Stilmar with SunTrust.

Good afternoon, Bill and Bev. Thank you for allowing me to ask my questions. The first 1 has to do with just wondering, we can obviously look to last quarter's Q4 exposure with regards to Europe. Was wondering if you might be able to provide us with an update of the exposures that you might have in either some of your SEC lending funds or throughout the franchise. And I was wondering if you could give us an update on that as Europe has had some changes in the past quarter.

Sure, we would be happy to. First, just a general commentary that our credit policy people have been working on Eurozone exposures, both in our client accounts and on our balance sheet for now almost 2 years so this is not a new initiative at Northern Trust. Over the past couple years, we've been reducing exposure that existed in the more challenged Eurozone countries and the banking entities in those countries.

And we have been moving to the strongest counterparties that we can identify in the strongest countries. So, generally speaking, our exposure to the Eurozone is lower. It's concentrated in stronger providers. And it's generally out of what you would consider to be the troubled countries directly.

At the same time, we've also shortened our tenor on both sides, meaning in the client funds and also on our balance sheet, to what I think you would consider to be quite short tenors. To be specific and on our own balance sheet, we had total European bank money-market exposures of a little north of $10 billion. And about $5.5 billion of that exposure runs to both sovereign and direct bank exposures to countries such as France, Spain, a relatively small amount in Italy, Germany, and a quite small amount in Belgium.

Now again, those are the money-market placements that you see on the asset side of our balance sheet. Obviously, we also have some smaller FX related and other counter party exposures but the bigger dollars are in the money-market placements.

On the cash investment fund side of the house, and I'd ask you to think when I speak about cash investment funds that I'm talking about the combination of our money-market funds, our collective and common funds, our securities lending pools, including money-market funds, our 2a-7 funds. So, aggregately I'm talking about cash funds, client money of about $190 billion.

Again, we've been working through the same type of exposure reduction initiatives in this area that I talked about on the balance sheet that's been going on for quite some time. Nonetheless, at June 30, that $190 billion collection of cash funds held about 30% of its assets in European bank exposure. Again, we've got fund limits for banks and we have no more than 2% to any 1 bank and any 1 fund.

Our maximum maturity for issuers in these markets is 30 days. And if you break it down further, and look at exposures to issuers from France, Spain, Germany and Belgium, we total about 8%, again back to that $190 billion in cash investment funds. So, I hope that provides some clarity to you.

And John, just if I could add 1 point, to be clear and make sure this is incorporated into the transcript. Within our cash investment funds, the client funds that Bill just went through, we have no direct sovereign or bank exposure to Greece, Portugal, Italy or Ireland.

And then likewise on our balance sheet, so the money-market assets Bill was talking about at the beginning, we have no direct sovereign exposure on our balance sheet related to Greece, Portugal, Italy or Spain. We have no direct bank exposure on our balance sheet to Greece or Portugal, and a de minimis amount to the Irish subsidiary of a non-Irish bank.

Perfect. Guys, thank you very much for that clarity. And while we're talking about the balance sheet, my second question is, 1, can you characterize, obviously liquidity, as we've seen, liquidity has increased across many of the other custody banks, which is not surprising given the environment that we're in. Can you characterize for me at least the types of surges that you're seeing in liquidity? We can obviously look at your balance sheet but does this feel like 2008 or 2009 again? And what are the types of things you're seeing and hearing both geographically and the type of customers that are increasing the amount of deposits with you guys?

No, it doesn't feel like 2008. I think it's quite different. But having said that, there is a ton of liquidity out there and you all have seen from the other banks who have reported already that there was a particular surge in liquidity around quarter end. And so, if you look at our end of period balance sheet, you'll see it's a bit bigger than the prior quarter end.

And you'll see the average levels of earning assets -- and I commented on this earlier-- are about $8 billion higher on average. I would say about half of that is client-driven deposits. Most of it coming from our non-US clients. However, we continue to have growth in our personal deposits in the United States, as well.

And the other half is short-term leverage that we've created ourselves, as funding costs are exceedingly low. And we've been placing that money with the Fed and in other very short, very liquid categories on the asset side of the balance sheet.

I had a quick question. What is the logic behind, with all of the liquidity coming in, increasing the amount of short-term borrowings? Is it just a way that, taking advantage of even more liquidity to leverage your competencies on the balance sheet? Or what's the strategy behind some of the near-term liquidity, increased discretionary on your part?

It's pretty simple. We don't have much loan demand. In fact, loan demand is quite flat. We don't see significant long-term opportunity in the investment securities category. And, we see a short-term opportunity to borrow money at 5 basis points and lay it off overnight at 25.

It's clearly not a very deep and long-term strategy, but it is an overnight opportunity and we've taken advantage of it as and when we can. We've got plenty of capital to do it. We don't have any restraints really to doing a little more of that on a short-term basis.

Nancy Bush with NAB Research.

Good morning, guys. Just a question for you about preferences in PFS. In this last go-round after the crisis, I think you alluded to the fact that your PFS customers were reluctant to go back into equities. They had shown a marked preference for fixed income and other investment vehicles. Are you seeing a return to this historical pattern where when markets go up people get more amenable to equities, or are we still equity averse out there?

Not this time, Nancy. And I'm a little surprised that we haven't seen that kind of reaction. But, if you look quarter to quarter for the past few quarters, there is a slight increase in the allocation of personal client investment programs to equity but it's all market driven. So, notwithstanding the fact that we're encouraging a bit more risk, and have been for basically the last year-and-a-half or more, clients are very slow on the uptake.

Should that change, Bill? Would that make a marked difference in profitability in PFS?

Small difference. Not really significant. It depends on where they go. If they go to alternative products, it might be a bit better for us, and equity products a touch better than cash, obviously. But, we've got pretty balanced fee arrangements on most of our client accounts so we wouldn't have a huge pick up, Nancy.

Brian Bedell with ISI Group.

Good morning, folks, or good afternoon. Also congrats, Bill, on your new role, as well. Just a few questions. On the custody line, or more broadly on revenues in general, can you tell us what the contribution from Bank of Ireland Security Services is on revenue and expenses in the quarter?

Generally, the revenue, remember it was only 1 month. We closed on June 1, so, revenue was in the $5.5 million range and expenses were just a bit less than that. So, the BoISS acquisition was not a big driver in our revenue for our margin for the quarter.

And the $5.5 million, is that mostly in the custody services fee line?

Yes.

Great. And then just also in terms of expenses going forward, you're still in the formative stages of thinking about some cost control in the second half. Are acquisitions a considerable part of that plan in terms of synergies that you might be getting from this and potentially Omnium?

No, I wouldn't say so, although obviously we have taken some steps where we can in the BoISS acquisition. Omnium is a little bit of a different situation, since it's a brand new capability for us. The Ireland acquisition, as you know, was a common business acquisition and a common community, so there were overlaps.

Not so in Omnium. And it's hard to project what future acquisitions will look like and what those opportunities will be. I would say that, while we look at the opportunities and the acquisitions that we've done and will do, we'll be looking more closely at our existing businesses.

Okay, that's helpful. And just 1 quick one on the tax rate, as well. You're getting some benefits from the, I think you said last quarter on the Illinois side. Could you just refresh us what that benefit will be in, I think it was 2012 starts?

Actually, we took a provision in the first quarter of, I believe it was $3.4 million, to get a head start on the deferred tax account impact on the Illinois state income tax increase. And we said that while we took $3.4 million in the first quarter, the subsequent quarter impacts of that would be about $1 million.

And that's what's happened. And then this quarter, we reduced a state income tax reserve of about $2.5 million. But, that's really about all that's in the tax line this quarter.

Right, so the normalized tax rate is about 33% going forward?

For now, if everything stays the same as the second quarter in terms of revenue contribution from overseas and domestic sources.

Right, on this portfolio. And then, just if you can talk a little bit about your credit outlook, with obviously provisions coming down quite nicely. Are you seeing broad improvement in credit trends within the CRE book or is that something you're concerned about?

We've seen measurable improvement, and we've talked about this in prior quarters, in our commercial and industrial book and in our clients within that book specifically. And we've also seen a pick up in demand for credit from that group.

So, I'd take the commercial and industrial group and some of the private client loan groups, which are largely secured by marketable securities, and say that in the C&I group, it's dramatically improved in the marketable securities. Secured stuff has always been strong but the demand in both categories is improving. Those 2 groups look good.

The offset to that is the commercial real estate outstandings and the residential real estate loan outstandings which, in some regions, are getting a little better, but I think in both categories remain challenging. So, I think the good news is that about half of the portfolio has improved pretty significantly. The other half of the portfolio is unchanged with some challenges.

I'll go a step further and say, those comments notwithstanding, you saw the activity in our other real estate owned area this quarter. And effectively on a gross basis we sold half of the other real estate owned portfolio in the second quarter.

And what we're seeing is people who have been on the sidelines for quite some time in terms of buying principally more expensive homes, have stepped in and exhibited an attitude-- if not now, when. And taken down 5 or 6 of our largest ORE holdings. So, there seems to be an attitude change in many of our markets about the willingness to buy and hold real estate, which is encouraging.

But, I would leave you and other listeners on the call with the impression that yes, asset quality expressed in terms of charge-offs and provision expenses quite a bit lower this quarter, and we feel that certain components of our loan portfolio have improved dramatically. There still is risk out there.

Northern Trust makes relatively large loans taken as a percentage of our total non-performing assets. So, I'm always a little uncomfortable with forecasting particularly the very low levels that we see this quarter because 1 or 2 loans can dramatically improve or dramatically change the level of non-performers in the Company.

Right, so it could still be a little bit lumpy.

Yes, it could be lumpy.

And while we're talking about the loans, are you seeing better demand on the private banking side and small business side?

A little bit. I think most of the increase in demand has been in the large corporate side, middle market corporation side. I think you're hearing that from other companies, as well.

We've had a very significant generation of loan commitments but we still have, I think, at the end of the quarter 26% utilization rate on our commitments in our corporate group. So, we're still at historical lows of clients stepping in and drawing down on their approved facilities.

And then just very last question, on foreign exchange trading, it was down a little bit in the quarter. I know the volatility was a little weaker. Any change in how you're managing that business, maybe shortening positions for the principal part of it at all? Or do you just not see as much seasonal uptake?

No, I don't think so. Obviously, the quarter was a little weaker than we had thought. When we've looked at it we see that volatility is very mixed, or was very mixed. The Euro was a bit volatile, but some of the other key currencies that our clients maintain positions in were not so volatile. So, no, I don't see any significant changes. We will be looking at the business closely though.

Looking at the business closely in terms of what, actually?

Just trying to understand a little better what happened in the quarter.

Alex Blostein with Goldman Sachs.

Great. Thanks, everybody. So, a question just on the expense side maybe one more time. If we strip out the one-off this quarter, it looks like we were at $683 million. From here on, should we think about that as more in line growth with revenue, slower growth in revenue, stable? What's maybe a more direct outlook there for expenses?

In comments that Rick Waddell has made publicly, we've talked about trying to get back to neutral or positive operating leverage in the foreseeable future. We look at adjusted expenses in the quarter at about the same number you do, that $683 million, which is up about 2%.

When we look at the individual adjusted categories, there's some categories that are high and that we're going to go back, and are going back, and taking a closer look at. It's hard to say what kind of expense growth rate to look for over the next couple of quarters except to say that we're working hard to keep them constrained.

Got you, thanks. And then maybe on the balance sheet, I think most of us probably understand the dynamic fairly well as far as the mix shift. But if you just look out maybe again for the next few quarters and assume that rates are not going up, and you obviously have a view on what your investment risk looks like, can you give us a sense if this is the trough for net interest margin or there might be some risks for further compression? Again assuming that mix shift doesn't really change from here.

And then as a follow-up to that, what's your updated view, maybe on extending duration given that I think the futures curve now implies rates going up maybe back half of 2012? And that's a maybe, I guess.

Yes, and our forecast is a little later than that. So, we're doing things as and when we can to try to hedge a little bit against that. And as you recall, we extended duration in our securities portfolio at the end of 2010, beginning of 2011.

We took another shot at that toward the end of the second quarter of this year. Effectively, we have extended our duration to about 2 years and extended our repricing frequency to about 8 months. So, in both duration extension programs that we put in place, we use the highest quality securities so there's no credit diminution, no reaching for yield through credit diminution at all.

We think that will help with declines from here in our net interest margin, but there's some rates out there that right now are exceedingly low, even by the standards that we've seen for the last 2 years. And I would say that if the environment stays exactly like it is today out into the future, we won't be able to prohibit some slight margin deterioration.

Understood. And then maybe shifting gears a little bit on the business and looking at assets under management for this quarter. It looked like you guys had pretty nice growth in equity assets despite the market still obviously being pretty choppy. Obviously it suggests flows were pretty strong.

I'm just curious to hear, is that really just investors putting more money into equity index product that are using that as a little bit of a placeholder, something we've heard from a few other managers and trust banks over the last few days? Or, do you think this is more of a sticky money, just new business activity? And the view maybe on RFPs in general for the institutional money out there.

Are you asking about the institutional business specifically?

Correct, yes, because it looks like the retail was up a little bit but I don't think there's a ton of rerisking into equities out there. But the institutional (inaudible) equities was up quite nicely.

Yes, I think it's a combination of things. One is what you just suggested. But there's 2 other things at work here. And that is that in 2 of the last 3 quarters, we've had the strongest new business, as we measure it, on record in our institutional business. Obviously that includes investment management business.

There's some flow on to the fee line as a result of that. And secondly, as we've discussed before, we're in the process in our institutional business of going on a client by client basis and reviewing pricing today vis-a-vis the bundled pricing program we may have put in for those clients in prior periods. And one of the ways that we can improve that, other than just raising the fees on a per item or on a transaction basis, is to cross-sell better.

We've had good experience in going to those clients and cross-selling investment management business. So, I'd say in the institutional side, it's the sum of those 3 initiatives working together. Bev, would you add anything?

The only thing I would add, Alex, to give you a few statistics, we did end the quarter with global index AUM at just shy of $296 billion. And that was up almost $7 billion sequentially. As you're well aware, we didn't get a lot of support from the equity markets to support that $7 billion increase. So most of that was flows, and a lot of those flows were from non-US clients.

Glenn Schorr with Nomura.

Hi, thanks. I wonder if we could talk quickly just about the outside services expense line. If you look at a multi-year progression, it's gone up and you definitely had gotten a little more acquisitive lately. In your prepared remarks you mentioned higher acquisition and integration costs. As these businesses get integrated the question is, is should we expect to see a near-term fall off or is there integration behind the scenes post-closing that would make that drag on a little longer?

There are a couple components to that category, 1 of which would be the acquisition related expenses that you just described. And the other would be all of the regulatory driven consulting expense that we've taken on.

I would say that consulting and related expenses, assuming that we don't do any more acquisitions here in the next couple of quarters, would decline. The regulatory component of that, though, I don't think is quite to the level that we can expect declines. Coming soon I hope but I wouldn't forecast it for the current quarter.

Very much appreciate that. Any way to pars out how big of a contributor the acquisition piece is because big difference if you have 135 a quarter versus 100.

Of the $22.6 million in acquisition restructuring and integration charges that we took in the quarter, we said that $18.4 million of that was in compensation expense. And a large amount of the remainder would have been in outside services. Not all of it but a lot of it.

Also remember that we've got our subadvisor fees in there for our manager of managers business, and those have been going up pretty significantly as the market has gone up here over the last year or so. We don't get some of that back, but that's part of the problem, as well.

Understood. Don't get too excited is the message.

Yes.

Okay. And then could you remind us, on the RMBS portfolio that you took the CCI hits, could you refresh my memory on size, anything about geography and quality statistics and average mark?

I'll give that a shot. If you look at our entire non-agency RMBS portfolio, it totals $238 million after these charges. Back to the beginning of OTTI for us, we have charged 17 different securities, a total of $115 million in OTTI. So, the majority of those are either subordinated liens or they're subprime.

And there are 1 or 2 in there that we have classified as senior but they have big positions and are substantially all option ARM credits, some of them in tough markets. So, it's been an asset class that hasn't been all that great for us, obviously, but the good news is it's relatively small. 29 total securities with a current amortized cost of $238 million.

Okay, got it. And then maybe my last 1 is I heard your comments loud and clear on improving credit, following NPAs, but the lumpy nature of it. I've asked this before and I know the answer but are coverage ratios now below 1 times? Is that where you'll run around that 1 times, no need to build cushion beyond a reserve to NPA of 1 times?

I think in the circumstances that existed at the end of the quarter, we're comfortable with that coverage ratio being less than 1. Of course, we look at, and I participate in this personally, we look at all of our large non-performing assets and consider the improvement or deterioration in those assets individually and collectively each quarter.

At the end of this quarter, obviously we felt a little better about that portfolio and so, we're comfortable with the coverage that you're referring to being less than 1. I think generally, depending where you are in the cycle, for a bank with the credit risk that this bank has, you should be right around 1.

We'll go next to Ken Usdin with Jefferies.

Hi, Bill and Bev. How are you? The custody revenue line really had a great break out quarter, even excluding the Bank of Ireland. I was just wondering, can you give us a little more color on, was this a big conversion quarter or was this a highly transactional quarter, to start?

It's a combination of both. We did bring on quite a number of new clients during the quarter. And I would tell you that there are a few IOO implementations in the quarter. Unfortunately, we don't have permission to name those clients but there are several.

Our IOO business is building and is projected to build as we go forward here. But, this is not just an IOO story. We've had strong wins in the custody business, in the other parts of our GFS business, so it's an across-the-board success story in this quarter.

And you touched on before, Bill, about the strength in net new and investment management. I was just wondering if you can run us across the businesses in terms of the magnitude of net new business across the Company?

I really don't know how to do that except to reiterate what I said before. And that is that on the personal side of the business, the best 6-month period we've ever had. And again, remember, when we talk about new business we're talking about net new business which is the annualized fee of a piece of new business, against which we deduct lost business, the annualized fee lost in the same period. So, in our personal business we're referring to recurring fees.

We don't charge specifically for fiduciary services. And our estate settlement and related fees are not recurring. They are non-recurring so they are not included. So, substantially all of that net new revenue is a function of new AUM on the personal side of the business. And I would tell you that our new business on the personal side is strong in every region throughout the United States including the wealth management business. And so that's largely asset under management fulfillment, or add-on of AUM, except for the wealth management business which, of course, is largely AUC driven.

On the institutional side of the business, the contribution is much more varied because we've got all the GFS business included in the IOO business there. But, again, 2 out of 3 quarters, that being the fourth and the second, on the same basis of definitional new business, 2 of the best 3 quarters we've ever had.

So, it's very strong, very well distributed across the 2 businesses. In the PFS side, largely driven by clients giving us more money to manage AUM. An the institutional side, a blend of recurring revenues throughout the custody side, the investment side, and the GFS side.

Okay. And then is it possible for you to size for us the general magnitude of the Omnium business that's going to come onboard, revenues or profitability or however you might be able to box it for us?

When we announced the Omnium acquisition in May, we disclosed that it would be bringing us approximately $70 billion in AUA. And we disclosed the initial purchase price of $100 million. But we didn't provide any other financial disclosures beyond that.

Remember that that business has a considerably sized earnout opportunity that runs with it. And to be honest, it's going to be as successful as our ability to sell to new clients. So, just from a standalone point of view, I wouldn't think that the business would generate much. It's all a function of how well we do with that technology and how effectively we sell it to hedge funds, and then how well we cross-sell that hedge fund business.

Right, so you get the platform and now you execute against it.

We get the platform with, as Bev said, about $70 billion of existing administration but the real measure of success in the business is how we do from there.

Okay. And my last clarification question is could you break out for us how much of the 1-time charges were related to the restructuring and pending expense initiatives versus the Bank of Ireland merger integration cost?

I would say that, just round numbers, about 85% of it was related to our GFS business in Ireland and nearby countries, which is largely the Bank of Ireland. And then the rest of it is non-recurring expenses taken in the quarter for the Omnium transaction.

Time for 1 more?

Mike Mayo with CLSA.

Hi. My question is on the restructuring. First, as it relates to the client by client pricing review, at least before this quarter, the revenues on assets under custody were pretty low the way at least we look at it, given the low rate environment.

And you can either get more other activities with the clients or you can charge more for the core custody services. Might you start charging more for those core custody services? I know I asked you guys at your conferences the past couple years and everybody says they're going to do it and that they are doing it but we haven't seen it in the results.

Yes, I take your point. As we've said before, if Steve Fradkin were here, I think he would say it this way. That this is a 1 at a time business in terms of getting out there and meeting with the clients, discussing perhaps what used to be a bundled pricing solution, and trying to get back to where we think our margins should be on a client by client basis. Either through charging for things we didn't charge before, and effectively unbundling the relationships. Or cross selling. And I mentioned this earlier in response to somebody else's question. We've done a pretty good job of cross selling other services to, just as an example, pure custody clients.

So, Mike, while we all wish, we at Northern Trust probably at the top of the line, that this pacing was going more quickly, I can tell you that it is going, and we have anecdotal evidence of a number of client relationships. And there seem to be more and more of those as we go where we're improving our pricing. But it is a 1 by 1, 1 at a time success measurement process. It's slow.

And then a follow-up. Is this restructuring a cultural change? This is the first time Northern's named a CFO from outside the Company in at least the last 25 years. And I might even guess since 1889 but I wasn't able to check that. So, you announced a restructuring charge this quarter and at the same time you announced someone from the outside coming in as the new CFO in a few months. So is it a cultural change? And then, also, why now did you choose to do this?

I'll just say that the 2 are totally and completely unrelated. The restructuring charge, Mike, has to do with what I said earlier and that is that we bought a business in a market where we already had a similar business. The 2 businesses are common size, round numbers 500 people each, a touch less than that.

We do the same things. We do the same things in an office that's set apart geographically by a very small distance. So obviously there are a lot of opportunities for expense synergies and also revenue synergies. But, that's not what you're interested in. So, I would tell you that if we hadn't done the BoISS acquisition, we probably wouldn't have taken this charge at this time.

Okay, that's clear.

Right. And then on the other subject, again it is totally unrelated to the restructuring charge. Not really a cultural difference. If you go back far enough, and I think you remember these days when we last had a COO and a CEO. And that was Barry Hastings and Bill Osborne.

And, Mike, you recall that. There are some reasons that we think that the responsibilities of the CEO should be divided a bit and some of those responsibilities handed to a Chief Operating Officer, so that the CEO can spend more time on strategic issues.

That's clear. It's more the CFO having been hired from outside. It's not unique in the industry. I just see it as a little more unique for the Northern.

It is different, I would agree. But keep in mind we're looking at building the stable of up-and-coming executives within the Company. We've got a few people at senior levels in the Company who in the next 4 or 5 years will probably be retired.

We're trying to build our strength. We've hired a number of people from the outside and this just happens to be one of them. So, I would encourage you not to think of this as a cultural change. I don't think of it that way at all.

It might help having a fresh look from the outside at a time when you're trying to reengineer the revenues and expenses. Is that fair to say?

Yes, it is but that's not the reason we made this change.

Okay. And lastly, what's the name of the expense program? Do you have a title to it?

We haven't titled it yet. Eileen Blake, who is here with us, and Rick and I and others are working on that, as we speak.

And will there be a day when you announce to all of us what your plans are with targets?

Yes, there will, and it will probably be not this quarter, probably before the end of the year.

That will conclude our question and answer session. I'd now like to turn the call back over to Bev and Bill for any additional or closing remarks.

Just thanks to everybody. We'll talk to you again at the end of our third quarter when we will update our performance and that is scheduled for October 19. We'll see many of you before then. Thanks so much for your time today.

Again, that does conclude today's call. We do appreciate everyone's participation.