Northern Trust Corp (NTRSO) 2011 Q3 法說會逐字稿

Good day everyone and welcome to the Northern Trust Corporation third quarter 2011 earnings conference call. Today's call is being recorded. At this time, I would like to turn the conference over to the Director of Investor Relations, Bev Fleming, for opening remarks and introductions. Please go ahead.

Thank you, Cindy. Welcome to Northern Trust Corporation's third-quarter 2011 earnings conference call. Joining me on our call this morning are Bill Morrison, Northern Trust's President and Chief Operating Officer, Mike O'Grady, Chief Financial Officer, Eileen Blake, Controller, and Allison Quaintance from our Investor Relations team. For those of you who did not receive our third-quarter earnings press release or financial trends report via e-mail this morning, they are both available on our website at NorthernTrust.com. In addition, October 19th call is being Webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through November 16th. 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 everyone. My pleasure this morning to introduce Northern Trust's new Chief Financial Officer, Mike O'Grady. As we mentioned during last quarter's conference call, Mike joined Northern Trust in mid-August, and assumed the CFO role on October 1st, at which time I became President and Chief Operating Officer. Mike and I have worked together closely over the last 2 months and his familiarity with Northern Trust is well in evidence. He's been a terrific addition to our leadership team, and I know you'll enjoy working with him in the years to come.

Before Mike reviews our third-quarter performance, let me set the stage with a few themes that continue to be quite relevant to our performance this year. First, the challenging global economic environment continues to impact our results. Very low interest rates, difficult equity markets, and a weak global economy have dampened our results and seem likely to persist.

Second, though our profitability has been adversely impacted by these conditions, we continue to invest in our businesses for the future, and in support of new and existing clients. Against this backdrop of macroeconomic headwinds, we continue to focus even more aggressively on driving improved financial performance returns and efficiencies. As Rick Waddell and I have previously mentioned, we'll discuss actions to position the Company for better near-term performance and continued long-term success in our January earnings conference call.

The third theme is a positive 1. Despite the environment, Northern Trust continues to win in the marketplace at a healthy, and in some instances, a record pace. I'll provide some specifics on our new business success in my closing comments, but I'd ask you to please keep these 3 themes in mind as Mike discusses our third-quarter results. Mike?

Thank you, Bill and good morning everyone. Let me join Bill in welcoming you to Northern Trust's third-quarter 2011 earnings conference call. It's been a very busy and rewarding 2 months, and I'm delighted to be a member of the Northern Trust team. I look forward to meeting many of you in the coming months. Earlier this morning, Northern Trust announced third-quarter net income of $170 million, an increase of 10% over last year and 12% over last quarter. Earnings per share were $0.70, which was 9% better than the $0.64 last year, and 13% better than the $0.62 last quarter.

Before getting into the details, let me make some summary comments regarding the third quarter. Despite the environment, we continue to grow revenues. There are several factors behind this. New business was strong, as we continued to add both personal and institutional clients and assets. The acquisitions of Bank of Ireland Security Services, which closed last quarter and the Omnium Hedge Fund administration business, which closed this quarter, also contributed to our revenue growth, adding $33 million in revenue in the quarter. Given that these acquisitions had an equal level of expense, there was no impact on the bottom line. Both acquisitions provide us with attractive clients, as well as new capabilities that will drive future new business.

The equity markets were weak in the third quarter, generally dampening our market base fees. The S&P 500 down 14% sequentially, and the EFA down 16%. As you recall, some of our custody and wealth management fees are calculated based on a 1 quarter lag methodology. Given that markets were essentially flat in the second quarter, these fees were less impacted. Our PFS regions used a 1 month lag methodology and on that basis, equity markets were down 5% on a sequential quarter basis in the third quarter.

Low short-term interest rates, coupled with persistent narrow spreads at the short end of the yield curve continued to negatively impact net interest income and money market mutual fund fees. For example, overnight interest rates in the US averaged only 8 basis points in the third quarter, down from an already low 9 basis points in the second quarter, and 3-month LIBOR averaged 30 basis points, still very low by historical standards. Short-term interest rates for the Sterling and the Euro also remained low. As a result, our net interest margin was stable, but remains under pressure and money market fee waivers were $29 million in the third quarter, compared to $23 million in the second quarter, and $13 million 1 year ago.

Foreign exchange benefited from the recent volatility, although was it still below last year's levels, and securities lending fees were down in the quarter, reflecting seasonality in the second quarter, due to the international dividend season. Expenses in the third quarter were up over last year, but relatively flat compared to last quarter. We've continued to add people and build out the platform to support the new business and wins, and while expenses were relatively flat for the quarter, we are increasing our focus on business process optimization, and expense management, as Bill mentioned.

Finally, our balance sheet remains very strong. Loan quality was slightly better in the quarter, although we expect this to continue to be bumpy given the uncertain economic outlook. We continue to take a conservative approach to our securities portfolio, and deposits with banks, and work to mitigate our exposure to areas of higher risk. And, we maintain a very healthy capital base. Our clients recognize this, and placed more demand deposits with us during the quarter, which lowers our cost of funds.

With that background and summary, let me get into the details behind our third-quarter results. Revenues on a fully taxable equivalent basis were $981 million, up 9% year-over-year, and 3% sequentially. Non-interest income was $715 million, representing 73% of our total revenues and was up 9% year-over-year, and 2% sequentially. The largest component of non-interest income is trust, investment and other servicing fees, which were $555 million for the quarter, up 7% year-over-year, and essentially flat sequentially.

Trust, investment and other servicing fees in C&IS, our institutional business, totaled $311 million in the third quarter, up 6% year-over-year and 1% on a sequential quarter basis. As you know, C&IS fees include 3 primary categories. Custody and fund administration, institutional asset management, and securities lending. Let me discuss each of those. C&IS custody and fund administration fees were $206 million in the third quarter, up 29% year-over-year, and 8% sequentially. The increase primarily reflects the recent acquisitions, which together added $29 million in custody and fund administration fees this quarter. Recall that our second-quarter fees included only 1 month of 1 acquisition, or about $5 million.

Institutional assets under custody were $3.8 trillion at quarter end, representing an increase of 7% or $256 billion year-over-year, and a decrease of 5% or $215 billion sequentially. The sequential decline in assets under custody primarily reflects lower equity market values and foreign currency translation, offset by the impact of acquisitions and new business. For similar reasons global custody assets, the subcomponent of assets under custody, were $2.4 trillion, up 9% or $203 billion year-over-year and down 6% or $155 billion on a sequential quarter basis.

C&IS investment management fees were $65 million in the third quarter, up 6% year-over-year but down 8% sequentially. Year-over-year growth reflects new business in our indexed management, manager of manager, and short duration businesses, as well as higher year-over-year market fees, offset by higher money market fee waivers. Sequentially, new business was more than offset by lower market values, and higher fee waivers. Waived fees associated with institutional money market mutual funds were $10 million in the third quarter, up from $7.5 million in the second quarter, and $2.5 million in last year's third quarter.

Managed assets for institutional clients were $481 billion at quarter end, down 5% or $28 billion compared with 1 year ago, and down 6% or $31 billion sequentially. The sequential decline is due primarily to lower equity market values, as well as a 6% decline in securities lending collateral. Securities lending fees equaled $20 million in the third quarter, down from $56 million in last year's third quarter, and $31 million last quarter. As you recall, our securities lending fees in last year's third quarter included $39 million in positive marks associated with the 1 mark-to-market fund used by certain securities lending clients. The fund was liquidated in the third quarter of 2010, and therefore does not impact the sequential comparison. Excluding these marks, securities lending fees were up 19% year-over-year, reflecting wider spreads. On a sequential basis, securities lending fees decreased $10 million, primarily reflecting the traditional second-quarter international dividend season.

Let's move on to Personal Financial Services. Trust investment and other servicing fees in PFS were $244 million in the third quarter, up 8% year-over-year, but down 2% on a sequential quarter basis. Year-over-year growth was driven by strong new business, offset partially by a higher level of money market fee waivers. The sequential quarter decline of PFS fees was also the result of higher money market fee waivers, which reduced PFS fees by $19 million in the third quarter compared with $10 million in the year-earlier quarter, and $15 million in the second quarter. PFS assets under management were $163 billion at quarter end, up 10% compared with a year ago, and down 5% versus last quarter, primarily due to lower equity market values.

Foreign exchange trading income was $87 million in the third quarter, down 2% year-over-year, and up 8% compared with last quarter, reflecting higher volatility during the latter part of the third quarter. Other operating income of $42.5 million increased 53% year-over-year, and 1% sequentially. The year-over-year increase reflects gains in the current quarter from currency translation, as compared with losses in last year's third quarter, which also included pretax losses from the discontinuation of certain cash flow hedges. Finally, in the third quarter, we recorded $1.3 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. This was $13 million lower than the OTTI charge in the third quarter of last year, and $16 million lower than the OTTI charge last quarter.

Net interest income was $267 million in the third quarter, up 10% year-over-year, and 4% sequentially, and the net interest margin was 1.25%. The year-over-year increase in net interest income was a result of 26% growth in average earning assets, offset partially by a 19 basis point decline in the net interest margin. Our balance sheet has grown significantly over the past year because of strong deposit growth, but soft loan demand has resulted in those deposits being invested in lower-yielding assets such as Federal Reserve deposits, interest-bearing deposits with banks and investment securities.

In addition, maturing securities have been reinvested at lower rates, leading to the net interest margin decline on a year-over-year basis. The sequential increase in net interest income, on the other hand, was due to a slightly higher net interest margin, which was up 2 basis points compared with the last quarter, and slightly higher average earning assets. The sequential increase in our net interest margin was due primarily to a shift in our funding mix. During the third quarter, average demand in non-interest bearing deposits increased significantly, up $6 billion or 53%, replacing short-term borrowings.

Now let's look at third quarter expenses. Total expenses were $701 million in the third quarter, up 13% year-over-year, but down 1% sequentially. Third-quarter expenses included $4.2 million in charges associated with integration and restructuring activities, compared to $22.6 million in the second quarter. Expenses adjusted for acquisitions and for integration and restructuring charges were up 7% year-over-year, and down 2% sequentially. While the rate of growth in expenses has slowed, it is still a key focus of management, as Bill mentioned earlier.

More specifically, compensation expense was $311 million, up 14% year-over-year, and down 3% sequentially. The year-over-year increase in compensation was driven by higher staff levels, with about half of the increase in staff related to acquisitions. Adjusting for $18.4 million in severance-related charges last quarter, and $1.4 million this quarter, compensation expense was up 3% sequentially. The sequential quarter increase was also a result of the acquisitions, offset partially by lower incentive compensation. Employee benefit expense was $67 million in the third quarter, up 11% year-over-year, reflecting higher staff levels and the impact of recent acquisitions, and was down 1% sequentially.

Outside services expense was $140 million in the third quarter, up 26% year-over-year, and 4% sequentially, primarily due to higher technical services, again due to acquisitions and higher investment manager sub-advisory fees. Equipment and software expense was $76 million, up 5% year-over-year, and down 8% sequentially. The sequential decline reflects lower depreciation, equipment, maintenance, and rental expense.

Other operating expenses were $62 million in the third quarter, down 1% year-over-year, and up 9% sequential. The sequential increase primarily reflects higher charges associated with account servicing activities, FDIC premiums, and intangible amortization, offset by lower business promotion expense. Our effective tax rate in the third quarter was 32.6%, and was lower both year-over-year and sequentially because a higher portion of income is being generated in lower tax jurisdictions.

Switching to credit quality, credit quality was better in the third quarter with slight improvement in commercial and industrial loans, but continued deterioration in real estate lending. Non-performing loans decreased $20 million sequentially to $308 million at quarter-end. Other real estate owned decreased $1 million on a net basis sequentially, and was carried at $30 million at quarter end. The net result was non-performing assets were 1.18% of total loans and other real estate owned, down from 1.26% in the second quarter. Net charge-offs were $29 million, which compares with $30 million last year, and $15 million last quarter. Our loan loss provision was $17.5 million in the third quarter, down from $30 million recorded in the third quarter of 2010, and up from $10 million recorded last quarter. As a result, the allowance for credit losses assigned to loans and leases was $298 million at quarter-end, representing 1.04% of total loans and leases and 1 times our non-performing loans.

Let me wrap up by covering 2 current topics of interest relative to our balance sheet. First, Euro zone exposures and second, capital. With respect to the Euro zone, let me walk through our balance sheet exposures. We have a total of $51 billion in securities, deposits at other banks and due from balances on our balance sheet.

Our bank and sovereign exposures within those balance sheet assets are as follows. We have no bank or sovereign exposure to Portugal, Ireland, Italy, Greece or Spain, other than a de minimis amount on deposit with the Irish subsidiary of a UK bank for regulatory purposes. We have approximately $1.1 billion in exposures to France, and $900 million to Germany, and approximately $2.7 billion exposures to other Euro zone countries primarily the Netherlands and Finland. Our Euro zone exposures are approximately 92% deposits at banks, and 8% sovereign.

We have an additional $8.8 billion in European exposures outside the Euro zone, primarily in the United Kingdom, Sweden, Switzerland, Norway and Denmark. We have approximately $9.3 billion in exposures in Asian countries, primarily Australia, Singapore and Japan. These exposures are about 89% deposits at banks and 11% sovereign. The remaining $29 billion in exposures across the securities portfolio, deposits with banks and due from balances are in North America, to the United States and Canada. During the third quarter we continued to shift our exposures to stronger banks, and to shortened tenures.

On capital, our capital levels remain very strong, with Tier 1 capital and Tier 1 common ratios of 12.2% and 11.8% respectively. And we estimate that our Tier 1 common ratio under the Basel III framework, at least as we currently understand the regulations, would equal 11.8%, exceeding all regulatory requirements. We continue to invest in our business, deploying capital to support our clients' needs and through strategic acquisitions, including the 2 completed earlier this year. We maintained our dividend throughout the financial crisis, and have paid $205 million in dividends so far this year, for a dividend payout ratio of 43%.

We also reinstituted our share repurchase program in the first quarter, and have bought back approximately 1.6 million shares year-to-date, at a cost of $78 million, virtually all in the first half of the year. As we said last quarter, we have returned to our historical practice of repurchasing shares issued under equity compensation programs, including the catch-up in the first half of this year for shares issued under equity compensation plans, dating back to May of 2009. Dividends and share repurchases combined, our total payout ratio was 60% for the first 3 quarters of 2011. Capital strength is, and will continue to be, a hallmark of Northern Trust, and a key point of differentiation.

Before we open up the line for questions, let me hand the call back to Bill for some closing comments. Bill?

Thank you, Mike. Let me close by reiterating 2 of the themes that I mentioned at the outset of today's remarks. Our new business continues to be very strong, from clients new to Northern Trust and from existing clients. In PFS, net new business year-to-date in 2011 was a record. And in C&IS, the best across the last decade.

The solutions we offer our clients, the expertise of our people, the resiliency of our global brand, and our integrated global operating platform have all contributed to the excellent new business results we've achieved this year. Publicized new business wins in recent weeks have included the Commonwealth Superannuation Corporation, a fund with AUD24 billion for which we will be providing a range of master custody and related services. Also, RCM, a Company of Allianz Global Advisors, selected Northern Trust for investment operations outsourcing for investment teams in Asia, Europe, and North America. And Lancashire County Council, 1 of the UK's largest local government pension schemes, selected us for global custody and related services for their GBP4.6 billion assets.

Our success in the marketplace is extremely gratifying, and reflects our consistent strategic focus, client centricity, and attractive competitive positioning. While our client-focused business is in excellent shape, and our financial condition is very sound, the macroeconomic environment, as we've said, continues to restrain revenues and returns. We expect the environment to be challenging for the foreseeable future. And as a result, we've begun to take more significant actions to improve our efficiency and productivity.

Some of these initiatives already underway include office consolidations in our personal business, and an international optimization of our institutional fund administration operations in EMEA. We've also recently engaged consultants to assist our internal team in identifying additional opportunities to improve our near-term financial performance and to position us for continued long-term success. We're continuing with these and other efforts and will provide more details during our January earnings conference call.

Thank you again for your time today. Mike, Bev and I would be happy to answer your questions. Cindy, would you open the line for questions, please.

(Operator Instructions). Our first question today comes from Howard Chen with Credit Suisse.

Good morning. Hello, Bill, hello, Mike.

Good morning.

Hello, Howard.

We've seen a pretty outsized balance sheet growth and provisional deposit inflows in peers. I know you have a meaningful PFS business, but just on the asset servicing side, could you just refresh us if there's anything specific to your management philosophy or business mix that would suggest why you don't see as much in the way of kind of temporal in-flows?

On the balance sheet?

Right, just frictional deposits from clients, Bill.

I think we've seen pretty strong growth over the last 12 months. In fact, I think our institutional business, specifically non-US, has really been the largest driver of an approximately 26% growth in earning assets year over year. There's also been some, I think, respectable growth domestically in the PFS business, in terms of deposits and then resulting asset growth as well. But I would say that the large majority of the balance sheet growth, that 26% in earning asset growth that I just spoke about, has come from our institutional business, principally non-US. So it's there.

Okay. Thanks. Understand you, on the new business installation it was more -- I got the sense that some of your peers may have seen just more temporal things, given all that was going on in the macro environment. I guess second question, Bill, just -- and Mike. Given all the disruptions this quarter, maybe I was hoping you could speak to some of the unique factors that may have kind of temporarily impacted NIM either positive or negative, just so we can kind of get a feel for how we should think about this going forward.

Sure. This is Mike. On the NIM, as you saw, our NIM sequentially went up by 2 basis points. Clearly, it's a challenge to maintain the NIM and keep it stable there. And what you saw in the quarter, Howard, is that while yields came down, and that's as a result of our need to continue to reinvest what rolls off the investment portfolio, we've been able to offset that by reducing our funding costs.

And so if you really look deeper into that, you could see that not only have our deposit rates come down on money markets and savings accounts, but also with the influx we saw in demand deposits and non-interest bearing accounts where that was up $6 billion on average during the quarter, obviously at no cost there, we were able to replace funding that had some cost and reduce the funding side. So I think that what you saw there, as you say, is kind of a volatile market with low rates. Our expectation is that we'll have to just continue to do that going forward.

Great. That's helpful. Thanks, Mike. And final one from me. I everyone's business mix is different, and pipeline is unique, but your FX revenues just haven't been as robust as some of the peers in recent quarters. Just curious, is that something that you all look at and how much do you care about that and what would you attribute that to? Thanks.

Well, it's Bill, Howard. First, I would just respond by saying that our third-quarter results were a bit of an anomaly in that they were up vis-a-vis our second-quarter results, speaking in terms of FX revenues. So normally the third quarter is a down quarter, relatively speaking, so we were pleased with our own results, really can't speak to why some of the other comps were up a little stronger than we were in the third quarter.

Okay. Great. Many thanks for taking the questions.

We'll take our next question from Ken Usdin with Jefferies.

Thanks. Sorry about that. Thanks, guys. Can I ask you a question just about the acquisitions that happened? I know you gave it to us in the percent changes but within the custody line, can you help us understand how much within custody came from the Omnium and Bank of Ireland acquisitions?

I don't have the custody breakdown between the 2 but I do have the total fee breakdown between the 2. For the Bank of Ireland it was $18.6 million, of course that's the full quarter and for the Omnium it was $14 million, and that would just be 2 months.

We should see the carryover of that into the next quarter. And is it mostly custody, and then spread out through the other stuff, as far as where it's located?

It is, Ken, I think $29 million of the $33 million was related to custody and fund administration. There would be other bits of it in other income statement. But $29 million of the $33 million was in custody.

Perfect. And a bigger picture question for either Bill or Mike, just when we think about the -- when we think about the expense planning that you guys are going through, I know we're going to get the explicit details in January but could you just walk us through how you start to think about magnitude versus the environment, are you going to think about it in absolute dollar amounts or relative to profitability, and just how deep are you going across the Company to really reassess the cost base versus your comments earlier about the challenging revenue environment?

It's Bill. I would tell you that the way we think about this is a combination of approaches, really. Number 1, we have our own views as to general parameters around the level that we need, all other things being equal, to get our financial performance back to where we think it should be, and by that I mean in the short to intermediate term. So that's 1 lens.

Also, we're taking a look at but not really guided by what other companies have done. We understand the ranges that large bank peers have set in their announcements and we're informed by those. So at this point, I would tell you that we've got a fairly broad range, which as we've said before, we're not willing to describe specifically, but we've got a fairly broad range of dollar impact in mind and the process that we have described before, and which perhaps we can talk a little bit more about today, is ongoing. And as we've said before, we'll be much more specific about that at the end of the fourth quarter.

So Bill, just one follow-up on that. When you talk about getting back to historical levels of performance, part of that is always going to be driven by the market environment. So part of it you can engineer through the cost side. Should we be -- should we think about then in terms of driving to an efficiency ratio or pretax margin, kind of all things equal manner?

If I said back to historical levels of performance, I misspoke. I meant to -- I think I may have said that we want these initiatives to drive us closer to a level of performance that we expect in this environment, because to get back to historical levels of performance, we're going to need some improvement in the macroeconomic environment, no question about that.

Sure. And I guess I'm just trying to get at as -- because the environment has stayed harder for longer, have you changed at all the metrics that you think are most important to kind of track back toward, if not too directly, like you focus more on just profitability or generating an ROE, or is there any mind change with regards to that?

All of the above. I would just add to what I've said, that 1 of the complications in this initiative, and obviously all of the companies that are going through this have it, but we have it in particular focus. We need to preserve the qualities that are in place at Northern Trust today that drive the new business successes that we've been talking about quarter after quarter here.

These record levels of new business, on both sides of the business, and frankly we've been talking about now for 4 consecutive quarters, results from an environment that we think we need to retain. So it's a complicated balance. I hate to not be able to answer your question more specifically, Ken, but I just don't have the answers today. We'll be more specific at the end of the quarter.

Okay. That's fine. Thanks a lot, Bill.

We'll take our next question from Brian Bedell with ISI Group.

Hi, good morning, folks.

Hi, Brian.

Just a couple questions. One on the Omnium business. I think that was $70 billion in assets under administration. Is that correct?

Brian, that's not a number that I have in front of me so I can't confirm that.

Okay. Round numbers, that's correct.

Yes.

Okay. And so that would not be in your custody number, right, as you disclosed it?

Yes, that's correct.

Okay. So calculating about a $7 million monthly revenue, calculating around a 12 basis point sort of fee realization rate so that's obviously helping your overall revenue generation. Can you talk a little bit about the profitability. Sounds like at least at the outset the expenses are fairly matched to the revenues. Maybe talk about what type of intermediate term accretion you expect to get from both the Omnium and the Bank of Ireland securities deals?

It's Bill. We really haven't disclosed that, and I don't think we will, other than to say that for the rest of this year, we wouldn't expect any contribution. And as we move into next year, and following years, we would expect both of the businesses to be accretive, and I think we'll just leave it at that.

I guess the philosophy there is to expand the client base that's using those services, or at least on the Omnium side. Is that correct?

Yes, absolutely. The acquisition really will be driven in terms of its success by the new business, in terms of third-party clients that we're able to bring on. But also there's an important cross-sell ingredient to that business, on the existing clients that Omnium had, including those that are in the process of transition now. We're finding that interest in our other services from those clients is pretty high, so there's an opportunity there as well.

Great. Great. That's excellent. Just on the balance sheet, just a couple more specific areas to focus on, on the loans and leases. Can you explain what drove the decline of 346 BPs to 322 BPs in the second to third quarter?

Yes, Brian, I'll take that one and you might remember that there was something similar that happened in the opposite direction a few quarters ago.

Yes.

We saw Australian dollar cash collateral posted against FX trades for 1 of our large clients and that cash collateral was lower in the third quarter than it was in the second quarter. And basically since we account for that, we account for the interest income in loans and leases, and then we have a matching currency on the liability side as well and that interest expense is paid out of non-US office time deposits so what I would encourage you to do is when you look at that shift in the yield on loans and leases, likewise look at the shift in the cost of non-US dollar -- non-US office time deposits and you see they moved in a similar fashion.

Yes.

Both tied to this FX cash collateral issue, and again, the collateral was lower in the third quarter than it was in the second, very similar to what happened a couple of quarters ago, but a couple quarters ago, it moved in the other direction.

Yes, noted, just wanted to make sure. That's helpful. And then on the incremental gross yields that you're investing in the US governments and the government sponsored agency lines, roughly what types of yields are you getting right now on that?

Sure. It's Mike, Brian. So with the lower rates, obviously what we're looking to do is to try to maintain that yield on the portfolio as much as possible. And to do that, it's a combination of extending out the maturities a little bit, but making sure that we do it within the parameters from a credit standpoint, that we've always been comfortable with. So right now, you are seeing the pressure on the yield there, because where we've reinvested in combination is a lower level than what it is before, and so for the quarter, when we redeployed, we were somewhere in the neighborhood of about 70 basis points that we were redeploying all-in.

That's helpful. Just last, on organic growth. You mentioned the big deals. On the RCM deal, looks like you're doing it throughout on a global basis, they manage over $150 billion. I was wondering if you're capturing the bulk of that or just some of that?

We have not disclosed the dollar amount of the total relationship but it does not represent the totality of RCM's AUM.

Okay. Great. Thank you.

We'll take our next question from Alex Blostein with Goldman Sachs.

Thanks. Good morning, everybody.

Hi, Alex.

Quick follow-up on expenses I guess. You guys are doing about $700 million in non-interest expense a quarter right now. And then, Bill, you mentioned there's going to be a couple moving parts I guess in the near term with some of the branches consolidating, and then you guys hiring consultants. How much of that is I guess already in the run rate in that $700 million? And then when you're looking out into next year, once you decide how you're going to go about some savings, is the goal really then to slow down the pace of growth in that $700 million number, or to bring down the actual dollar amount?

Well, number one, the majority of the issues that we're contemplating and in the process of implementing I would say have not materially reduced the expense level. With the exception of the special charges we took in the second quarter. But that -- we've talked about that before. So the reductions in expense and also the increases in revenue, because I would remind you all that our focus on this is focused both on sustainable revenue increases and also on expense related productivity initiatives are mostly in the future for us.

Okay. And then on capital management, was a little surprising that you guys did not buy back much of the stock this quarter, given the -- sort of the stock performance. Can you just give us a sense, why aren't you being more aggressive with the stock buyback here, given the fact that you guys still have about 5 million or so left shares for repurchase. And looking out into next year, what I guess would be your preference, dividend versus buyback?

Well, number one, I'd take you back to Mike's comments where he said that our payout ratio so far this year has been 60%. That's a combination of our dividend payout, and stock buybacks. Recall that we and other banks are operating under capital plans, that for us at least began in terms of a first filing in the first quarter of this year and our activities have been within the guidelines that we planned.

And as far as the preference going forward?

I think we've got to work through that internally and we've got to involve our Board in that. We've got to go, as you know well, through another capital planning process for the benefit of our principal regulator on the same time line that we did last year, so -- and I should add that we continue to be differentiated in the process here from the scat banks in that the so-called scat banks are required to file a capital plan on January 5th. We anticipate filing our plan sometime late in January, after our regularly-scheduled Board meeting, and we've got some work to do internally and with our Board before we submit that plan. So I really can't answer your question.

Okay. Shifting gears maybe a little bit. Sizable wins this quarter, you mentioned a couple big Australian wins you guys received. How much of that is already in the run rate this quarter or should we really think of that coming in over the next few quarters? And maybe helping offset some of this market weakness that I guess will hit you guys next quarter because of the lag?

The 2 that I mentioned specifically, RCM and the Commonwealth Superannuation Corporation are not in the run rate. They are won but not yet transitioned, so neither are they in the new business high levels that I talked about earlier, because as you know, it's our practice not to include new business in the new business category until it's actually funded. So neither one of those businesses are in, and I would say that there are a reasonably large number of other situations, not just in Australia, and not just IOO related businesses that have been won and not transitioned. Unfortunately, we don't have permission to disclose those names, but there's some very attractive names over all of our products and in all of our regions that are in a similar position as these 2, and that is won but not yet transitioned.

Got you. And then maybe just the last one from me. When I'm looking at fee waivers, obviously up, because of the difficult rate environment, but if we're looking out into the fourth quarter, could you just remind us what do you think is the best proxy to use for the direction of the fee waivers, given the direction of the profile of your money market book. LIBOR is up, so should we think that the fee waivers should lighten up a little bit in the fourth quarter, or LIBOR is not the best proxy for it.

As far as proxies, I'm not sure, Alex. Let me make a couple comments. I think the fourth-quarter -- excuse me, the third-quarter run rate of $29 million represents not only the amount that we're waiving but also the asset levels that we have in the funds. What's going to drive that is, as you mentioned what happens with rates, which we don't know, but then also what happens with the asset levels in those funds. The other comment I would make on that is as you've seen, these waivers have gone up each quarter, going back to last year. There is an ultimate limit in what those can be, so we're well through what the size of the fee waivers will be in a quarter, but that doesn't mean that they can't be larger.

Understood. Thanks.

We'll take our next question from Mike Mayo with CLSA.

Hi.

Hi, Mike.

Hi, Mike.

First, you're not expanding your balance sheet as much as some of your peers, just remind us of your philosophy.

Our philosophy is to accommodate our clients, plain and simply, Mike. Frankly, we anticipated a little bit more significant take-up of our balance sheet through the deposit side in August than we got. We ran down some of our leverage in anticipation of that run-up, but I think the quick answer to your question is that we've seen nice increases and you heard my earlier comments about the growth in earning assets year over year from our clients, but we didn't see the huge in-flows during August, particularly around the debt ceiling issue that some of the other banks did see.

Okay. And then separately, say your core custody revenues, if we strip out $29 million from acquisitions, assume you had $5 million in last quarter, so we take out $24 million difference, it looks like core custody revenues were down 7% linked quarter and that seems a little bit worse than some others, and that's before the lag pricing. So can you make us feel a little bit better about the core trend, or correct my math.

We saw it pretty close. We see the -- we see our custody assets down about 6% sequentially. So I guess we would view that pretty near what we would expect, Mike.

Okay. And just --

Bev has something to add.

Maybe it would make sense for us to take the math offline because I've got some statistics in front of me where if we strip out the impact of acquisitions, the fee realization on assets under custody actually went up a little bit on a sequential quarter basis. So let's compare math and decide where that takes us.

I'll need that clarification. Just philosophically, the question's coming up more and more, what's the value of having asset servicing under the same umbrella as asset management? And if you can just remind us, give us any hard numbers that you have on the benefits of having them both together?

Well, we all have seen that recently, haven't we? I can't comment on how the value proposition works for others. For Northern Trust, though, with our quite significant personal business, firstly, we think an asset management business is imperative to growing the business. An internally-owned and run asset management business. We do have different market penetrations, institutional and personal, vis-a-vis some of our peers, Mike, as you well know. I think I'll just leave it at that.

And then last question, let me just go back to the asset servicing. So based on your numbers, Bev, sounds like it might have been a little better than what I calculated. What I'm really getting to, is pricing getting better? We've been talking about this for 3 years now, or is it still as competitive as it's been?

I think on a case-by-case basis, Mike, as you've heard us say before, we're making good progress and improving our relationship pricing on the C&I side of the business. I think as you look at the business overall, price competition is still quite strong, and we see that in our new business presentations, price competition is still tough.

What does it take to have you guys stop beating each other up? It's what we hear too.

Good question. Can't speak for the others. We're working hard on cross-selling our relationships and repricing where we can and where appropriate and we're looking out for ourselves.

All right, thank you.

Taking one at a time.

We'll take our next question from Jeff Hopson with Stifel.

Thanks. My question relates to Europe, and obviously what clients are doing there and what competitors are doing there, and if you think that you're going to see or have seen a flight to quality from clients and any thoughts on how the competitive framework might change there, and how you would position yourself to participate or benefit from either M&A or I guess organic growth.

Sure. Jeff, it's Mike. I'll take that. As you mentioned, there's obviously a lot of volatility and dislocation over in Europe and there could be more. Certainly from a client standpoint, that presents opportunity for us on the business side, which we're aggressively pursuing and on the risk side as I went through with our exposures, making sure that we have mitigated as much as possible the exposure that we would have to any downside scenarios there.

On the M&A front, we do expect that there will continue to be dislocation and potential separation of businesses, which you've already started to see there. I would just say that whether that presents opportunity or not is just a question of whether those opportunities fall into the strategic profile that Northern has always had. And I think that the history on that front is very consistent with what we would look to do going forward. So when you look at the 2 recent acquisitions, they had to do with acquiring clients and acquiring capabilities. And they were of a size that fit with our size profile. I don't think that necessarily changes as we look at what might happen over in Europe.

Okay. Would you say that net-net, as some of your competitors have had challenges, do you see this playing out to your benefit?

Hard to say vis-a-vis the competitors. I do think that the other likely beneficiaries over in Europe will be the same competitors that we face every day.

Okay. Thank you.

We'll take our next question from Robert Lee with KBW.

Thank you. Good afternoon.

Hi, Rob.

Hi, Rob.

Hey. I apologize. You may have gone over this. I was a little late getting to the call. But can you talk a little bit about some of the trends you've seen in the -- what drove business in the -- institutional asset management business in the quarter, and particularly interested in kind of any color you can give on maybe the pattern of business activity there? Any sense that starting to see more institutional clients kind of hold off for the time being from making decisions that maybe you were expecting them to make? Just trying to get some flavor for how business has progressed there.

Rob, we did talk a little bit about that earlier. We detailed some of the wins that we've publicized recently. But generally, I would just say that our activity on the institutional side of the business has been quite strong. You might have heard Mike's comments earlier where -- well, he and I both talked about the fact that our C&IS net new business was for the first 9 months, was the best in this decade.

We've had, what I would consider to be not only strong growth, but strong pipelines in our GFS business, in our custody business, and that strength has been consistent across the businesses, across the regions, rather, that we do business in, North America, EMEA, and the Asia-Pacific. I wish we could disclose a few of the names that we recently won but unfortunately, we can't. But the business has been quite strong, and we don't see clients on the institutional side waiting to make a decision. We're out there, soliciting the business, and they are signing and moving to us at a good pace.

Thanks. I guess I was trying to focus a tiny bit more on kind of the asset management part of the business, in terms of a complexion, if it was kind of the fiduciary management part of the business that had more momentum, or is it passive or kind of just pretty evenly split? And then I also just wanted to catch up. I know you've kind of talked about trying to be in the ETF business, then backing away, then still a business you want to be in, if you could maybe update us on where you stand with that initiative?

With the ETF business?

Yes.

Be happy to. We launched our first group of products last month under the brand Flex Shares. And as of yesterday, we had about $300 million in AUM in those products, so that's off to a good start. As we mentioned around the PR, around our initiation of those ETF products, those are at the present time, focused on our personal clients and prospects principally, and as time goes by, we'll market those products a little more broadly. But so far, so good. The ETFs are off to a good start.

Okay. Thank you.

We'll take our next question from John Stilmar with SunTrust.

Good afternoon. Thank you for letting me on the call. Go back to the topic of pipeline, and apologize if I'm beating a dead horse, but you said that in the C&IS if I'm correct over the past 9 months, have been the best in a decade. Those were for the most period of time, a relatively constructive capital markets environment. As we move to a more challenged, or choppy, or unknown environment, does that environment itself increase or decrease the velocity of new business wins? Wondering to try and put the kind of future market outlook in the context of business performance. Wondering if you could help me with that.

That's a good question. I'm not sure I can give you the answer, but I'll tell you how I think about it. We've been, for the last 3 years, in one of the more difficult macroeconomic environments that I've ever seen. I've been around for a while. And our business -- new business growth on the institutional side of the business and the personal side of the business, both, have been pretty remarkable, pretty resilient through all but the first part of that period.

We've commented on our personal and institutional business successes in kind of a macro context, and you've heard our descriptions around records or near records for the last 4 quarters, and frankly, things were reasonably strong and building prior to that. So I think the last couple of years, from my own perspective, will turn out to be kind of similar to the next couple of years, in terms of environment, hope it turns out better than that, but that's what we're thinking. And if the past is an indicator of the future, we should have strong new business going forward as well, in both sides of the business.

Okay. Would you say that it's probably more business wins than sales are more driven your own abilities, and your own product that you're offering, rather than maybe the macro environment, that the macro environment isn't as much of a catalyst to new business wins?

It's Mike. It's a combination of those 2. And just my impression certainly is that the opportunity set out there is as active as it has been, so as Bill said, I don't think that clients, or I should say potential clients are holding back on making decisions for either putting business out, or considering switching, and then to your second point, though, absolutely at the end of the day, winning the business comes down to our own capabilities.

Perfect. Very helpful. And then Mike, I think you talked a little bit about the deposit in-flows and while it may not be as much as others, certainly non-interest bearing deposits on an average basis is up, nearly 40% in the quarter. And I guess as a manager, how do you look at that as to how much of that is core deposits that will probably stick around for a while that you can invest in a securities portfolio, versus money that might be coming back out, and that you would probably want to put with the Fed. Wondering if you can think about how you -- asset liability management given the volatility in deposits.

First thing I would say it we have an out-flow committee that very much focuses on the question that you're asking there and first and foremost as far as the objective there, is to make sure that we do have adequate liquidity, and I think you can see from our balance sheet and any type of ratio that might be used that we have excellent liquidity, and so we start with that. To your follow-on point, then, how do you think about the deposits that are coming in? These are core deposits. So these are coming from clients. And as to how long they'll stay there, much of that depends on what the environment is.

If you think about the environment we're in now, where buying a Treasury gets a minimal return at all, and they can alternatively also consider just putting it at a bank like ourselves, that's very high credit quality and have federally guaranteed insurance as well, you can understand why clients will look at those alternatives and decide which one is best for them. Well, that dynamic can change over time. But these are very much core deposits from clients on both the personal and the institutional side.

Okay and then my final question, did I hear you correctly that you may have taken duration up a little bit in the quarter and if so, how much more or how further out the curve would you expect to be taking the portfolio relative to this quarter?

Yes. What I -- if I said it, let me just be clear on it, which is what we're trying to do is essentially maintain a consistent duration there, so the average maturity of our portfolio is about 2 years. We also think about it as an index duration which is more thinking about how often or how soon that re-prices. That's much shorter. That's closer to 8 months, and so the point being that as maturity -- as securities mature, you need to put them out there in a way that's going to maintain that. We do that through a combination of some securities that may be shorter-term than that. As you mention, we can buy on the short end there. Also we can certainly go out longer than either the 8 months from a repricing standpoint or the 2 years overall in order to get what we think is the appropriate return.

Perfect. Thank you so much for the helpful answers.

We'll take our next question from Gerard Cassidy with RBC Capital Markets.

Thank you. Good afternoon. Bill, you mentioned that you guys paid out about 60% of earnings in the buyback and the cash dividend, and you're going to have your capital planning session for next year and of course the Federal Reserve will get a look at it. Do you have any sense whether you'll be -- for companies like your own, that are very well capitalized under Basel III, that you could actually focus with the Federal Reserve on a targeted Tier 1 common ratio rather than a percentage of earnings in terms of how you can manage your capital?

We would love to get there. That's easier said than done, and the complexity around that is the conversion for us and most of the other large banks in the country from Basel I to Basel II and then to Basel III. And I think you all know well what some of those complexities are. We're a ways, in my opinion, from concluding the conversion from Basel I to Basel II, and then I won't even get into the conversion from Basel II to Basel III. So we would love to.

It's just that we're going through a somewhat complicated process of developing, and then having others who evaluate the effectiveness of our processes opine on how our processes work. So there's more work to be done. We would love to understand, with finite clarity, exactly what the definition of well-capitalized was under Basel III in our situation, and then take the capital actions that we believe are appropriate for our Company.

Okay. And I think earlier, Mike, you mentioned, you talked about the money market mutual fund fee waivers, and what percentage of those waivers were due to rates actually falling, versus you taking in more money into those funds?

Yes, the majority of it is due to rates falling. The funds have gone up, so it contributed to the increase, but the majority of it is certainly due to rates.

Okay. And then finally, in last quarter's call, you guys talked about how you're attempting to go back to customers about pricing, about raising prices on selected products possibly. Are you gaining any traction there, or has that been a much harder road to go down than you thought?

Well, we're making progress but I would describe it 1 account at a time, 1 relationship at a time. As you can imagine, it's a very relationship-intensive process. You can't just send out a price increase. You've got to sit down and work through the development of a strategy to increase margin, sometimes that's by cross-selling a relationship that doesn't have the full suite of Northern products.

Sometimes that's where cross-selling isn't possible, just raising prices on the suite of services that the client currently uses. Our institutional relationship teams have been out doing that in the US, and outside the US now, for well over 1 year, and we've seen some good successes, but it is a 1 relationship at a time, very man-hour intensive process. And we're making progress, but not quite on a wholesale basis or as quickly as we would like to.

Thank you.

And due to time constraints we will take our last question today from Nancy Bush at NAB research.

Saving the best for last. Yes, just a couple questions. A question for Mike. I just want to make sure I'm clear on this deposit issue. Your average non-interest bearing deposits have gone up pretty considerably over the course of the year, I think if you compare Q1 to Q3, it's sort of up $7 billion or so. Both State Street and Bank of New York Mellon have talked about, quote, extraordinary deposit levels. I just want to make sure that this $7 billion or some large portion of it doesn't fall within that extraordinary deposits that are likely to run off in the near-term.

We don't look at them the same way that they've characterized them. I think we view these as being deposits from our clients. They certainly fluctuate over time, as I mentioned with what the environment is, and what the alternatives are. But we don't look at them as being, quote, unquote, excessive deposits.

Okay. So the experience with them over the course of what has been a very volatile year has been that they have stuck on the balance sheet largely.

They stick on, and then it's like I said, depending on client -- different clients at different times will have different balances but the key piece of it, I guess as I look at it is, it is our client base, it's not that we're attracting deposits that are just coming for a short time period, and then are going to move off the balance sheets within a week or some other short time period.

Okay. And question for you, Bill. You've spoken about sort of the risk-averse nature of your individual clients over the past year, and how that I guess has stayed risk averse much longer than anybody thought that it would, and I guess my observation is who can blame them. But do you -- when does this become sort of a permanent change of behavior, in the eyes of Northern Trust, and would it -- would this change in behavior drive some change in mix of business, or the way you do business, or staffing, or any of those other things?

Well, Nancy, I think the context within which we're speaking is on the personal side of the business principally, and I would agree that they have been quite risk-averse and continue to be quite risk-averse. If you look at the distribution of assets within our clients' personal accounts, equity participation, adjusted for the market, is about the same as it has been. It's down I think 3%, but as I said, market adjustment it's kind of where we expect it to be.

I think the clients are feeling a bit the way that you just articulated, and how could you blame them if I heard you right. It is tough environment. There have been a number of things recently in an area of confidence, both in the United States and in Europe, that have not inspired clients, and we don't see the resolution to those in the short term. So we think that continues for a while. As to whether we can change our product mix or our cost structure, I think our product mix is fine. I think we can take care of clients rather well, whether they intend to be quite conservative or whether they want to be a little bit more risk intensive.

But I think the products are there. We've got the right kind of advice around our relationship management, and we can take the clients where they want to be. It is a capital preservation business and most of our personal clients are interested in preservation first these days and we're well equipped to deal with that, we think. To the issue of perhaps related around expenses, we are looking at the expense of all of the offerings in our business, both personal and institutional, we'll try to deal with that within that set of initiatives. But --

Okay. Thank you.

At this time I'll turn the conference back over to Ms. Fleming.

Thank you, Cindy. We look forward to updating everyone on our fourth-quarter performance when we release earnings on January 18th. Thank you very much.

That does conclude today's conference. Thank you for your participation today.