Northern Trust Corp (NTRSO) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to the Northern Trust Corporation second-quarter 2013 earnings conference call. Today's call is being recorded and at this time I would like to turn the call over to Director of Investor Relations, Bev Fleming, for opening remarks and introductions. Please go ahead.

Thank you, Beth. Good morning, everyone, and welcome to Northern Trust Corporation's second-quarter 2013 earnings conference call. Joining me on our call this morning are Mike O'Grady, Northern Trust's Chief Financial Officer, and Jane Karpinski, our Controller. For those of you who did not receive our second 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, and also on our website, you will find our quarterly earnings review presentation which we will use to guide today's conference call. This July 17 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is a the replay that will be available through August 15. 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 2012 annual report and our periodic reports to the Securities and Exchange Commission for detailed information about factors that could affect actual results.

During today's question-and-answer session, we ask that you limit your initial query to one question and one related follow-up. This will allow us to move through the queue and allow as many people as possible the opportunity to ask questions as time permits. Thank you again for joining us today. Let me turn the call over to Mike O'Grady.

Thank you, Bev. Good morning everyone, and welcome to Northern Trust's second-quarter 2013 earnings conference call. As usual, we've organized today's call into three sections. I'll review our second quarter results, update you on our Driving Performance initiative and comment on our capital. Bev and I would then be pleased to answer your questions.

Starting with some overview comments on slide 2, this morning we reported second quarter net income of $191 million, and earnings per share of $0.78. In the second quarter, we were successful in growing the business and revenues while improving productivity, profitability and returns. Our value proposition continues to resonate with clients and we grew both our personal and institutional businesses. Wealth management clients continue to build confidence and we remain well positioned as a valued advisor. With institutional clients we're seeing a good pace of activity across global regions, products and client segments.

The operating environment continued to be mixed with both positive and negative implications on our business. Equity markets in the US and Europe were generally higher and supplemented our strong new business results. However, lower fixed income markets detracted from client asset values. The S&P 500 was up 18% year over year and 2% sequentially, while the EAFE Index was up 15% year over year but down 2% sequentially. The Barclays Aggregate Bond Index was down 4% year over year and 3% sequentially. Client assets under custody ended the quarter at $5 trillion, up 9% over last year and assets under management ended at $803 billion, up 14%. On a sequential basis client custody and managed asset levels were both down 1%. Currency volatility increased for the second quarter in a row, combined with higher client trading volumes to positively impact our foreign exchange trading income.

Short-term interest rates remain low despite an increase in longer-term rates at the end of the quarter. This placed continued pressure on our net interest margin and also resulted in ongoing fee waivers in connection with our money market mutual funds. We continued to successfully execute on the Driving Performance initiatives announced in early 2012, further improving our productivity and profitability and enhancing our capacity for investment in future growth regardless of the macro environment. The net effect of all these factors was a return on equity of 10%, the first time we've been within our target range of 10% to 15% since the second quarter of 2010.

Let's move to page 3 and discuss the financial highlights of the second quarter. As I mentioned, earnings per share was $0.78 for the quarter, an increase of 7% year over year and 16% sequentially, exhibiting solid improvement in both comparisons. On a year-over-year basis, revenues were up 3%, and expenses were up 2%. Revenue growth was a result of trust investment and other services fees increasing 8% and foreign exchange trading income increasing 20%, but being offset by a 14% reduction in net interest income. Expenses were up only 2%, due the impact of Driving Performance and good expense control across categories.

Year-over-year, our loan loss provision was unchanged at $5 million. As a result, net income was 6% higher than last year's second quarter. Compared to last quarter, revenues were up 5%, and expenses were essentially flat. Higher Trust, Investment and Other Servicing Fees and Foreign Exchange Trading Income were again offset by lower net interest income. Flat expenses on a sequential basis primarily reflect higher compensation and outside services expenses offset by lower business promotion and other expenses. As a result, net income was 17% higher sequentially. Our return on equity of 10% for the second quarter was higher than both comparable periods and was at the lower end of our longer-term target. With that background and summary, let's get into more detail behind our second quarter results.

Beginning on page 4, second-quarter revenues on a fully taxable equivalent basis were $1 billion, up 3% year over year and 5% sequentially. Trust, Investment and Other Servicing Fees, the largest component of revenues, were $657 million in the quarter, up 8% year over year and 4% sequentially. Higher equity markets and new business were both drivers of the increases. I'll go into further detail on Trust Fees shortly. Foreign Exchange Trading Income was $71 million in the second quarter, up 20% both year over year and sequentially, with higher currency market volatility in most major currencies and higher trading volume both contributing to the improved results. Other operating income of $36 million for the quarter increased 6% year over year, and 47% sequentially. The year-over-year growth was due to various miscellaneous items including higher income on employee benefit assets held in trust. The sequential quarter increase reflects a $12.4 million write-off of certain receivables in the first quarter. Net interest income of $228 million in the second quarter was down 14% year over year, and 2% sequentially, primarily due to a lower net interest margin, which I'll discuss in more detail as well.

Moving to page 5, let's look at the components of our fee revenues. For our Corporate and Institutional Services business, fees totaled $364 million in the second quarter, up 8% year over year and 4% sequentially. Custody and Fund Administration Fees, the largest component of C&IS fees were $234 million in the second quarter, up 9% year over year and 5% sequentially. The year-over-year increase was primarily the result of higher equity markets, new business, and favorable results of our driving performance revenue initiatives offset partially by lower sub-custodian recoveries. In the sequential quarter comparison, strong equity markets in the first quarter combined with new business did drive the increase. Assets under custody for C&IS clients were $4.5 trillion at quarter end, up 9% year over year, and down 1% sequentially. The year-over-year increase reflects higher equity markets and new business, offset partially by the negative impact of currency translations. The sequential decline reflects higher equity markets and new business being more than offset by the impact of lower fixed income markets and currency translations.

Investment management fees in C&IS were $74 million in the second quarter, up 3% year over year and down 2% sequentially. The year-over-year increase reflects the impact of higher equity markets on our Index and Multi-Manager business and new business primarily in index management and mutual funds, partially offset by higher money market fund fee waivers. The sequential quarter decline reflects lower AUM levels which I'll discuss shortly and slightly higher money market fund fee waivers. Waivers impacting C&IS fees equaled $10 million in the second quarter, slightly higher year over year and sequentially, primarily reflecting lower gross yields achieved in the underlying funds as repo and short-term rates were lower in the second quarter. Assets under management for C&IS clients were $600 billion at quarter end, up 14% year over year, primarily reflecting higher equity markets and new business. Sequentially, C&IS AUM declined 1%, as higher equity markets were more than offset by lower fixed income markets, out-flows from institutional money market and fixed income mutual funds and lower securities lending collateral.

Other fees in C&IS were $25 million in the second quarter, up 19% year over year, and down 8% sequentially. The year-over-year increase reflects a number of items, the largest of which is growth in Investment, Risk and Analytical Services. The sequential decline reflects a normal seasonal pattern where fees associated with benefit payment services are typically lower in the second quarter. Securities Lending fees were $31 million in the second quarter, up 1% year over year, and 39% sequentially. The sequential quarter increase reflects the traditional second quarter impact of the international dividend season which resulted in wider spreads.

Moving to our personal business. PFS trust investment and other servicing fees were $293 million in the second quarter, up 10% year over year and 4% sequentially. The growth, both year over year and sequentially, reflects strong new business and higher equity markets. Money market fund fee waivers in PFS were up slightly in the second quarter, to $13 million. Assets under management for PFS clients were $202 billion at quarter end, up 15% year over year and down 2% sequentially. In the sequential-quarter comparison, a $4 billion decline in cash balances drove the decrease. PFS assets under custody were $453 billion at quarter end, up 10% year over year, and down 1% sequentially. The sequential decline again reflects lower cash and fixed income balances.

Moving to page 6. Net interest income was $228 million in the second quarter, down 14% year over year, and 2% sequentially. Earning assets averaged $83 billion in the quarter, essentially unchanged year over year, and up 1% sequentially. The net interest margin was 1.10% in the second quarter, down 18 basis points year over year, and 5 basis points sequentially. The lower margin reflects lower yields across earning asset categories, as short-term interest rates continued to climb. For example, average three month LIBOR was down 19 basis points year over year and declined further in the second quarter. Overnight repo rates were also lower. More specifically, looking at the sequential decline by earning asset category, the yield on interest bearing deposits with banks declined 2 basis points, with the biggest impact being a 15-basis-point drop in overnight rates in the Australian dollar. The yield on the securities portfolio declined 13 basis points, primarily reflecting higher premium amortization in our Mortgage Backed Securities portfolio due to changes in prepayment speed assumptions. As the overall yield on the loan portfolio declined by 6 basis points, as over half of the portfolio is floating rate and new loans and leases are coming on our balance sheet at lower yields than those rolling off. These declines in earning asset yields were partially offset by slightly lower cost of funds.

Turning to page 7. Expenses were $730 million in the second quarter, up 2% year over year and flat sequentially. Let's take a look at the trends in expenses by category. Compensation expense was up 4% year over year and 2% sequentially, primarily reflecting staff growth and pay adjustments. Staff increases have been mostly in our Global Fund Services business in C&IS, which is growing rapidly, and in certain corporate areas which are requiring additional resources to meet increasing regulatory developments and requirements. Employee Benefit expense decreased 1% year over year, and was up 1% sequentially. The year-over-year decline primarily reflects a lower level of healthcare expense while the sequential increase reflects higher FICA insurance expense.

Outside Services expenses increased 2% year over year and 5% sequentially, with higher consulting expense driving both the year-over-year and sequential growth in this expense category. As we've discussed, this category generally includes costs for third parties that we contract for services such as sub-custodians, technical services contractors, consultants, lawyers and others. The expense level can vary both with client activity levels in particular periods as well as corporate needs, such as regulatory projects and initiatives. Depending on the specific circumstances, we occasionally engage external resources to supplement internal staff working on these initiatives. Increasing requirements related to CCAR, resolution planning, AIFMD and other initiatives, resulted in higher expenses for certain components of outside services this quarter, and we anticipate this to continue through the remainder of the year.

Equipment and Software expenses was lower by 7% year over year, and relatively unchanged sequentially. The second quarter of last year included a $10.5 million software write-off. Absent that item, Equipment and Software expense increased 4% year over year, primarily reflecting depreciation and amortization of ongoing investments in technology. This growth is lower than we've experienced in previous quarters, as we benefited from lower maintenance costs this quarter. However, we would expect the longer-term trend we've been experiencing for this category to continue going forward, as it reflects the higher level of investment we are making in our technology platform.

Other Operating expense increased 6% year over year, with the largest item being an increase in expenses associated with employee benefit assets held in trust. As I mentioned earlier, this expense is offset in higher Other Operating Income. Sequentially, Other Operating expense decreased 17%, due primarily to seasonally higher first-quarter costs associated with the Northern Trust Open, and lower charges associated with account servicing activities in the second quarter. Occupancy expense increased 2% year over year, and was unchanged sequentially. On Monday, we announced plans to relocate our Florida headquarters in Miami later this year. And in conjunction with that we have sold our current building and expect to report a gain on that sale in the third quarter of approximately $30 million. This is an exciting move for our clients and colleagues in Florida but going forward will result in higher rent expense associated with the new location.

In sum, expense control was particularly good again in the second quarter. While our expense base fluctuates from quarter to quarter for various reasons, it generally tracks with longer-term trends of our fee revenues. Given the continued success we've had in adding new clients, our current objective is to grow our expenses at a lower rate than the growth rate of our fee revenues. We were successful in achieving this for 2012 and to date in 2013. However, we do expect expenses to fluctuate for various reasons and we will continue to experience expense growth pressures.

Let's move to page 8 to discuss Driving Performance a little more. In the second quarter we produced over $65 million in pretax operating income improvement from Driving Performance initiatives. Positive impacts from revenue initiatives were, similar to last quarter, primarily the result of successful pricing and cross-sell efforts in C&IS, as well as incremental pricing actions in PFS. On expenses, increased benefits were primarily the result of continued success in our procurement effort. This effort addresses a broad range of categories including market data, print, and IT contract labor, to name just a few, and savings are based on sustainable actions in vendor and demand management.

Going forward in 2013, we expect that process optimization and revenue efforts will drive increasing benefits from quarter to quarter. Based on the results achieved to date, we remain on track to achieve our Driving Performance target of $250 million in 2013. We are pleased with these efforts and believe that we are creating sustainable improvements to our operating model. Given the environment, we will continue to pursue meaningful efforts to improve productivity beyond our original Driving Performance targets and embed this practice in the ongoing management of the business.

Capital, outlined on page 9, remained very strong with Tier 1 Common and Tier 1 Capital ratios of 12.6% and 13.1%, respectively. Based on preliminary interpretation of the final Basel III rules released by the Federal Reserve on July 2, our Tier 1 Common-Capital ratio based on the advanced approach on a fully phased-in basis would be 12.8%. Under the standardized approach, the Tier 1 Common-Capital ratio is estimated at 10.3%. Both of these ratios are well above the fully phased-in requirement of 7% which includes the capital conservation buffer. Additionally, the supplementary leverage ratio is estimated to be approximately 5.5% at the holding company, and approximately 5% at the bank. Both of these are above the requirements applicable to Northern Trust. In the second quarter, we repurchased 281,000 shares at a cost of $15 million. Our capital plan provides for the repurchase of up to 385 million of common stock between July of 2013 and March of 2014.

A few thoughts in closing. The second quarter again demonstrated the continued execution of our strategy of providing exceptional service, expertise, and advice to our clients around the world. Noteworthy on that front in the second quarter, was our announcement that ATP, the largest pension fund in Denmark had appointed Northern Trust to provide custody and related services for $106 billion in assets. We also established an office in Frankfurt, Germany as part of a continuing commitment to serve clients in the markets in which they operate. Our Frankfurt presence will provide Investment Operations Outsourcing services to Allianz Global Investors, a firm with which we have a strong existing global relationship.

We also achieved our objectives in the second quarter of growing the business and improving our productivity, profitability and returns. Growth in our Trust fees more than offset the lowest level of net interest income we've experienced in over five years. A very modest increase in our expenses resulted in higher pretax margins and we produced a return on equity just within our long-term target range. We feel we have good momentum across our businesses and remain focused on executing our strategy in order to continue to serve our clients, grow our business, and improve our financial performance. Thank you again for participating in Northern Trust's second quarter earnings conference call today. Beth, please open up the line for questions.

Thank you.

(Operator Instructions)

Alex Blostein, Goldman Sachs.

So Mike, appreciate your comments around the margins and the fact that you guys are progressing nicely on the cost initiatives. But if I look at the first half of '13 versus the first half of '12, the core fees relative to core expenses, so when you exclude the noise with software write-off, et cetera, I see core fee revenues up a little over 2% and expenses ex these one-offs up a little bit more than that. And again, I understand there's a mismatch between the business wins and the timing of the revenues coming in and then expenses associated with that. You guys are going through lots of regulatory change, et cetera. But from our perspective, all we see from the outside looking in, is you guys are almost through the cost cutting program but the core margins haven't really moved. So maybe you could provide your thoughts on what incrementally you could do to actually improve the profitability of the business from here. And also if you could potentially size maybe some of the revenue tailwinds that you could get that are not flowing through the model yet, but the expenses are, I think that would be helpful.

Okay. Let me try to answer that, Alex. So when we look at it, as I mentioned, and I think you were headed there, we're looking at the growth in our fees. And for the first half of 2013 our fees grew about 9%. Now, again, some of that has been benefited by the positive equity markets, but the remainder of that has been through additional growth, new business, organic growth. And at the same time, we've grown total expenses basically this year at a little over 1%. So that type of growth on the fee side, relative to what I would consider pretty modest growth on the expense side, is the type of productivity where we think we have the ability to control it.

Now, outside of the fees, so foreign exchange, net interest income, we certainly look to maximize those revenues as well, within the environment. But those revenue streams have less in the way of marginal or incremental costs associated with them. So that's how we've been driving these initiatives. Now, even with that said, Alex, we have been successful in executing on the Driving Performance initiatives so far this year. We'll certainly be running through the tape on those through the end of the year, but we plan to continue to look for and add new initiatives that will play through in 2014 and beyond. And are already in the process of beginning a number of those initiatives. So we look at the opportunity to improve the margins and the overall profitability of the business to just continue as we go forward. What we can't control is interest rates, market volatility, et cetera. And yet, to the extent that improves, we think that the bottom line will benefit proportionately.

Okay. So maybe just as a summary, I guess as follow-up, flat markets, flat rates, flat volatility, given the project spend that you have planned, do margins go up or down next year?

Our objective would be that they go up.

Okay.

Because our objective is to continue to grow the business organically, markets aside, and to not allow our expense growth to exceed that.

Got it. Thanks, guys.

Luke Montgomery, Sanford Bernstein.

So I think it was early to see some better trends in FX this quarter. It wasn't really a surprise either, though. It's still a fairly depressed revenue line by historical standards. And I assume some of the structural challenges that were incited by others, but they perversely have been hurting you the most, are still an issue. I was wondering if you'd given more consideration to what response you might pursue to mitigate the loss of those standing instruction FX revenues. And how are you managing through the changes in client behavior about how and where they want to execute FX?

I think you describe the situation well, Luke, and this is something that we began to respond to quite a while ago, within the business, and are beginning to see the benefit of that. And what it is primarily is, first of all, really looking to expand the client base in which we do FX with. So as you mentioned, traditionally our business has been focused on almost exclusively our custody clients. And what we've been attempting to do is expand that to more third party. There are a number of our clients, for example, in the global funds services business where we're their fund administrator but we may not be their custodian. And yet we haven't been doing much in the way of FX with that client base. So that when I say third party, it's not necessarily institutions that we don't have relationships with, it's just that we haven't been transacting foreign exchange with them. So that is the primary area that we've been focused on.

Now, there are some resource requirements around that, which we've been making, both in the way of the systems and platform around that, which we continue to further enhance what we have. And then also with regard to client service, so that if we're going to cover a broader set of clients, we need people to do that and those people are on board. And then finally, it's a whole new set of counterparties that we're dealing with and so we need to make sure that we've underwritten the additional counterparties in a way that we're comfortable with. So all of this work, well under way. And as I mentioned, just beginning to see the benefit of it such that a quarter like this, the 20% improvement that you saw is almost exclusively from the benefit of the markets. But going forward we would expect to also have the benefit from these initiatives on that front.

Okay. Helpful. Thanks. And I guess while we're on ad valorem revenues, a quick question on securities lending. I know it's not as big a revenue item for you guys, but you do get a nice bump every second quarter from the dividend arbitrage season in Europe. I know recently there's been a lot of talk about eliminating the discriminatory tax treatment that makes those trades possible in the first place, with France leading the way and other countries are expected to follow, possibly. Do you have any insight on how that situation's developing and what your current thinking about the continuation of that seasonal benefit going forward?

Clearly, there are developments on that front and the regulation around that. And we do believe that it could have an impact on the business. And there are number of things that can impact that business as well as others. But I would say at this point, we don't have any particular insights as to the direction. Frankly, we were pleased with the level of activity in the second quarter here. As you saw, it was up significantly, obviously from the previous quarter, but also relatively consistent with where we were a year ago, which in our minds just demonstrated, at least from a client perspective, the level of engagement and activity we've had has not diminished.

Great. Okay. Thanks for taking my questions.

Howard Chen, Credit Suisse.

Mike, on the latest capital rules and proposals from a US regulator perspective, it seems like Northern will not be held to the same level of standards that maybe many of your competitors will. I realize it's in management's DNA to be really conservative. Do you agree there's a potential gap? And how do you think about that as a competitive advantage in winning business?

Clearly, with some of the most recently proposed rules around the supplemental leverage ratio, they've created a line of delineation between the eight largest banks and ourselves and other banks. And I did mention our supplemental leverage ratio at 5.5%, so again, even on a fully phased-in basis, we would be above even that 5% level at the holdco. So we feel very well positioned for that, Howard. As far as does that difference create a competitive advantage for us? I don't necessarily think so. We don't look at that as some type of capital arbitrage that's been created, because it's important for us to have strong capitalization both as we determine it internally, but also in a way that compares favorably with our competitors. And so we're observant not only of those regulations that apply directly to us, but also those that apply to the industry.

Great. Thanks, Mike. And my follow-up, given the very conservative risk profile and shorter duration nature of your investment portfolio, can you give us an update on how you think about Treasury management in this transitory period for rates? Maybe if rates don't change from here, is this the floor for core net interest margin? And can we see an inflection upwards? Thanks.

Sure. So on net interest margin, we certainly can't necessarily say it's a floor because as much as the majority of our balance sheet is either floating rate or very short duration, there are still parts of the portfolio, both the securities portfolio and the loan portfolio, that roll off over time. And as we originate new loans, they come on at the current rates, which even the long-term rates with the recent move are lower than some of the longer-term rates where they were historically. So we can't say that we're at the lowest level. Having said that, we've seen the longer end of the curve move up to the extent that that eventually moves down to the shorter end, we would certainly benefit much more, given the nature of our balance sheet.

Great. Thanks for taking the questions.

Robert Lee, KBW Securities.

First question I had, it's really on deposit growth. You clearly had pretty good new business growth in both C&IS and PFS. Yet you've seen deposits really flat-line for the better part of the last year or so. I guess normally you would have assumed there would be even some modest growth as you expand client relationships in both sides of the business. So, is it by choice you're trying to limit that? Or is there any color you could provide on why you wouldn't see even some modest growth in deposits the last year and-a-half or so with all the new business wins?

I think you've described the environment well and what's occurred. And yet, I would say so far that's actually met up with our expectations. And what I mean by that is, the environment that we were in before was more conservative, if you will, from our clients' perspective. And so they were placing more deposits with us and as a result, our deposit levels went up. And what we've seen more recently here is a greater comfort level to deploy those deposits. And so whether that's into some of our funds or, frankly, in certain cases with either the corporate or particularly some of our largest wealth clients, they deploy that into businesses that they may have and other activities. And we saw some of that here in the second quarter. So it definitely is not something that we look to move one direction or the other. It's up to our clients' preferences as to how they want to deploy their liquidity. And basically we want to be able to work with them to do that. And that's what we've seen over the last several quarters.

All right. Great. As my follow-up, was curious in the Investment Management revenue in C&IS, understanding there was a slight tick-up in money funds fee waivers sequentially. But it does seem like, at least the way I calculate it, the fee rate certainly has been trending down for the last four or five quarters straight. Talk a little bit about some of the underlying mix that you're seeing. Obviously I know the Index business has been growing, but I'd also thought that some of your managers and tactical allocation had been growing with a little bit higher fee rates. Could you talk about that a bit?

So I think you somewhat asked your question and began to answer it there as well, which is as we see the mix of our assets under management on the Institutional side change and evolve over time, that is impacting the average fee that we earn on those assets that we're managing. And as you mentioned, we've been very successful in growing our Index business, in particular, our Equity Index business. And as a result, we've seen the average fee come down. So even looking year over year at the strong growth, I believe that our assets under management on the C&IS side was up over $80 billion, and over $60 billion of that was in Equity, and most of that is Equity Index. Both as a result of the market as well as new business, and that brought down the average fee. So again, we saw greater growth in the AUM level than we did in the fee level. And then you also mentioned in there the fact that we had higher money market fund fee waivers, which also brought that growth down a little bit.

I'll get back in the queue.

(Operator Instructions)

Casey Haire, Jefferies.

It's Ken. I wanted to ask you guys about, Mike, could you elaborate a little more on that GSA portfolio, and talk about -- you mentioned premium amortization was up this quarter, but given where rates are going I would think that that would start to go down over time. Two different parts of the question. One is can you talk to us about how much of an effect that was specifically? And then the second point is it also looks like your end of period balances were quite lower than the average. Can you talk to us about portfolio strategy and how you're thinking about re-investments given the rate environment?

Sure. So on the premium amortization, our mortgage-backed portfolio is about $5 billion, or at least securities that relate to having premium is about $5 billion. As I mentioned in the note there, we had greater premium amortization in the time period. It was $15 million in the second quarter which compared to $7 million last quarter. And that was a result of prepayment speeds. The methodology we use is a three-month trailing average.

There you go.

And so as you can imagine with the activity in the quarter, that increased the speeds, reduced the estimated lives and therefore the amount of amortization went up. So based on your view now with rates going up, what the implications could be there, we'll have to see how it plays out. But we have $94 million of premium at this point on that portfolio, and the average life is a little bit under four years. So that's essentially the rate that we have and the amount that would ultimately go through.

And then if you elaborate in terms of how you're positioning the portfolio. Because it looked like you moved out of that GSA bucket into Other. How are you thinking about re-investments? And where are you moving the book to? And are those yields coming in better than at least what's coming off at this point?

The yields that we re-invested in the quarter were just about on top of what the average yield was for the portfolio. So we were at 75 basis points and we came in just a little bit higher with our re-investments in the portfolio. And I would say the mix of securities, largely the same. We do look across the categories that we have and from time to time we have more opportunity. But really, what we're trying to do is beyond making sure that we have the best credit quality, is looking to maintain right now the duration in about the same place that we've been. So last quarter we were a little over a year in index duration, and we are at this point as well. So we've maintained about the same duration, same credit quality and that's why to the extent that rates do move up, we're likely to benefit.

Okay. And then lastly, I notice that the buyback really slowed this quarter. I just wanted to make sure that you're compelled to continue to complete the use it or lose it context from the approval, why you might have slowed it this quarter.

Sure. When we look at share repurchase, we take into account a number of factors. First, certainly, is our capital position and determining if we have the capital both for our current needs and our anticipated needs. Second is our authorizations, whether that's from the Board or it's our capital plan. And you mentioned we still have plenty of capacity there and our capital position is very strong. And then third, we look at the return that we would expect to get relative to other opportunities we may have, whether that's acquisitions or other things. And then finally, we look at the market price which fluctuates day-to-day. And our objective, of course, is to buy back as many shares as we can with that authorization that we have. So taking that all into account as you mentioned, we repurchased about 15 million in the quarter and we still have the 385 in capacity. And certainly our intent to distribute that to shareholders one way or the other.

Thanks, Mike.

Mike Mayo, CLSA.

Hi. My question relates to the Driving Performance program in a couple parts. One is, I'm just looking at slide 8, so it seems like you're already at your $250 million of benefit in 2013. Is that right? $55 million plus $65 million. If you just stay at $65 million for the last two quarters, then you're there at $250 million. So I'm just wondering if I'm doing the math wrong or if there's anything more.

Your math is correct, Mike. We'll count it when it's in the bank. We have every expectation, yes, to hit that number and to exceed it.

Okay, but the $65 million from the second quarter, that's a run rate now, right? So in a way you've already achieved it?

That's right. We've been doing it internally here as an in-year benefit. But on a run rate, yes, we're already exceeding that level. And there's nothing about the $65 million, Mike, that we would expect that it goes down. These are recurring benefits.

So my question really relates to what's next. I know you said you'll review this over time, but what's the end game? You said improve the margins. I'm looking at page 1 of the supplement and I guess you have profit margin pretax here of $28.6 million in the second quarter. Is there an end goal to achieve in one, two or three years?

Not on the margin, per se. We're looking to increase that margin but as you know, the nature of some of our revenues, such as spread income or FX, is that the margins on those are much higher and yet our ability to determine or control those levels is also less. And so that's has a significant effect on the margin. So where we've been focused on is the expenses relative to our fees. And we've continued to drive that down and did again this quarter. With the objective that to the extent we can do that, that not only will it make us more profitable if nothing else changes, but to the extent that the environment gets better, that that will drop to the pretax margin that you talked about.

And so what is your goal for expenses to fees over time? In other words, for those of us on the outside, we want to see if you guys achieve your targets or not. What kind of targets should we think about to see if you're achieving what you wanted to achieve?

We don't have a set margin or set ratio, other than to continually improve on that. So we've brought that down from the mid-120%s, down to this quarter it was at 111%. It's not going to go down every single quarter lock step, but certainly over time that is what we're looking to continue to move down. What you're balancing that with of course, is we also want to continue to invest in the business. So it's being able to create additional Driving Performance opportunities that create capacity for us to invest in the business. And it's that balancing going forward, but it's not a set number or target ratio.

Thank you.

Brian Bedell, ISI Group.

Can you talk a little about the organic growth trends in the second quarter, how they related to prior periods? Were they up from the first quarter or at record levels as they had been in some of the last several quarters through the three different businesses, the C&IS Servicing, C&IS Management and then the PFS business. And then describe, if you will, how you think about expenses going forward related to initiatives to generate organic growth. When I say going forward, I mean really over the next, say, couple quarters. Thanks.

Sure. So as far as the growth, I would say that it's been consistent across the businesses. So within the Personal business, PFS, we continue to have very healthy growth there. The second quarter was another good quarter for us. And I would say that in addition to it being in each of the regions, our Global Family Office part of the business saw particularly strong growth in the quarter. So again, very good. That would be an area that I would highlight where we're servicing the largest of our clients there.

On the C&IS front, again, there's a number of businesses within that, that also are doing well. I talked about expanding into Frankfurt. That's our investment outsourcing business. So, continued growth there. We also had some clients that we've talked about that have been in the transitioning phase, which came on-board during the quarter. So that helped the growth specifically quarter over quarter in that line of business. We've also continued to be very successful in the healthcare and not-for-profit area. You've seen some of the announcements there as well. We've added Emory University and we've added some others in that space as well and have had just a very high hit rate in that space.

And then certainly in thinking about core Custody and Admin business, the ATP win outside of the US there is a very large new mandate for us at over $100 billion. So very broad-based. In previous quarters we've talked about Hedge Fund Services doing very well. That continues to grow, I would say, at basically the same pace that it has before and we expect that to continue. That will experience some lumpiness in the growth in the sense that a lot of the new business there can be mid-sized firms and then we can have very large new clients like Bridgewater, which we previously announced, but is not in the numbers now and doesn't come in until next year. Relatively broad-based at this point, is the way I would characterize it across the businesses. And I failed to mention, but on the Asset Management front institutionally also have been successful in the quarter. I talked a little bit earlier in the call about a number of the wins we've had in the Indexing business, particularly the Equity Indexing side. So continued momentum on that front as well.

And then I think your second question was around expenses and how to think about that. It's something where if we win in ATP, as an example, there are more people that we need to hire to service that business. That's different than some of the other areas where I would say that the growth is more leverageable, if you will. So as we win new business in PFS for every new client we're not adding new individuals on that front. And that's why with some of the headcount growth you've seen, you've seen more on the C&IS side than you've seen on the PFS side. That gives you some idea as to what happens with the people. As far as some of the other expense categories, we mentioned what we're doing in Florida with regard to our headquarters, which that's, again, it's nice that we were able to sell that property for a nice gain. And we're going to move into some very nice space down in Miami, but there will be some incremental cost that goes with that. As you know, we expanded into Washington, DC recently. There's the investment for that. And when we expand into Frankfurt or we open up an office in Saudi Arabia, those all are investments in the sense of expenses that come online as a part of that.

And then I would be remiss on the investment side without talking about technology, where our technology spend will continue to be healthy and it's very much related to the business growth and being able to serve these clients. It's important that not only on the client front are we able to provide mobile applications and things like that, but that we also are spending on the infrastructure side to be able to have strong, stable systems to service the clients, as well as have high levels of security in the environment that we're in right now. So hopefully that gives a little more color on where the incremental expense growth comes from.

Yes, it's very helpful. Just a follow-up, you talked about potentially extending the Driving Performance program where as you think about it as a core operating principle. Can you describe the revenue component of that versus the expense component? I guess what I'm really driving at is, is there ability to basically capture more revenue across your businesses on a fee-based basis by either changing pricing or charging differently for the mix of services that you do?

There definitely is going forward. We've had the balance in Driving Performance between revenue and expense at about 40% revenue, 60% expense, which we've been pleased that that balance has held up. And going forward whether it's exactly that same proportions, not clear. But all the same, initiatives on both the fronts. With regard to the revenue side, as I mentioned with PFS, we have had further improvements there. And that was less with an across the board change in our fee structure, which we did going back to the beginning of this program. But it's more around specific areas and specific relationships where we have different discounting practices. And we've been able to better align as we've talked about the value proposition that we're delivering with the fees on a more granular level with our clients.

And then with C&IS, I would say, as I mentioned again, we saw the benefit of some of the early work that was done in trying to align certain relationships where the economics or the financials did not match up with the level of service that we were providing. And frankly, that's been a good exercise as we've gone through it, because I think it helps beyond the financial impact. It helps with the client relation aspect of it to make sure that we are providing services that they want and that when they appreciate that level, I think, they're more inclined to pay for it. So we expect to continue -- that's an ongoing process as we go through the various relationships, because in this business none of it is static and so you have to constantly do it.

Great. That's helpful color. Thanks so much.

Cynthia Mayer, Bank of America Merrill Lynch

Question on the loans and leases. It looked like they decreased in the quarter, they decreased last quarter too. And I'm just wondering what would it take to get that moving in a positive direction? I know it's net, but maybe if you'd just talk a little about what it would take.

Sure. You are correct, and that is something that has been sluggish on the lending side, not due to lack of effort and focus on our part there. Because we do believe that there's an opportunity and much of it is going to be based on the market demand and need for that. We are more and more, on the PFS side, looking to tailor our lending to our core client base. And so there will be some transition as a result of that. And what I mean by that is, as opposed to on the mortgage front, for example, looking to lend to a very broad market or audience, we're very focused on those clients that are or will be investment management clients, and be able to take advantage of the full suite of services. So that further narrowing in could cause some decrease in the near term for us.

But longer term, we not only think that there's growth but we think that the overall client relationships will be that much more profitable for us. With the PFS side, it is definitely not just with mortgages as well. We are looking and have been looking to lend to our clients across their needs. And the client base that we go off of have much broader borrowing needs beyond just mortgages, but certainly for businesses that they own and other needs that they may have. And then on the C&IS side, I would say likewise we look to offer a complete set of products and services for our client base. And really on that front, it has more to do with their ultimate demand and the utilization of the facilities that we do provide them. And, frankly, with the economy growing at the slow pace that it has, we just haven't seen the pick-up on the demand side at this point.

Great. Thanks a lot. And then for a follow-up, a question on asset management. A nichier question on your ETFs. Although they're small it looks like they've had relatively good organic growth, including in the second quarter. And I'm just wondering, are the flows from PFS clients? Or are they from Institutional clients that you have? Or are you attracting money from investors who are totally outside of Northern?

Yes, so the growth as you mentioned has been very strong. So we were over $5 billion in assets in that category, and that is after basically a year-and-a-half from the launch. So it's one of the fastest growing ETF families of funds and the growth has come from a number of sources. Definitely a significant contributor to that is our current PFS client base, but it also very much is balanced with new clients to Northern. And those new clients at this point have been mostly Personal clients as opposed to Institutional, but it is a part of the investment management product offering for our Institutional clients. So it is different sources but so far it's been mostly existing clients and then new Personal clients to Northern.

Great. Thanks a lot.

Marty Mosby, Guggenheim.

I wanted to drill down a little bit into the prepayment speeds and the yields on the securities portfolio. Last year we were defending the securities yield at around 1%, and that was kind of a goal that we had talked about. Then since then as rates dropped even lower, you really got those prepayment speeds coming in, which look like took out anywhere from 15 to 20 basis points on the yield, which puts you kind of where you're at today. As those prepayment speeds are slowing, is the yield going to go -- can you see it move back towards at least 90 basis points, somewhere in that range? And are you willing to, now that rates are a little bit higher, start to extend a little bit into duration because you were probably just avoiding the low interest rates that you had up until this point?

So I think you're correct on the impact of the prepayment speeds. Pretty significant impact on the portfolio, approximately 10 basis points just on the securities portfolio on a sequential basis. So meaningful, and to the extent, yes, that it goes the other way, we will see that impact. We use a constant yield methodology, so to the extent that the lives are shortened or extended, we have to make the adjustment in order to remain on that constant yield. And as far as the portfolio overall, as I mentioned earlier, we're a little over a year in that index duration, and you're correct that we've been reticent to do too much when rates are at very, very low levels. But it's certainly something as we see the longer end of the curve move up, it's something that we watch closely, because it has provided opportunities for us to be able to add at higher yields than where we were adding. So very much an opportunistic strategy that fits within the broader parameters that we have for managing a conservative portfolio.

Thanks. And then as a follow-up over on the expense side, we had the $6 million uptick in the Outside Services Consulting expenses. You really cited a lot of regulatory pressures. Are you in the cusp as you get into CCAR and get into some of the larger bank types of requirements? Is this kind of a transitional year for you that might require an elevated cost level for a year or so but then after that you might be able to accomplish most of those requirements and see that come back down?

We did see, as you mentioned, higher levels of consulting expenses in the quarter and because of this transition, which I think is a fair characterization, where we have been a capper bank, we are now a CCAR bank or our capital plan will be under the CCAR framework. That has definitely caused an increase in the requirements on our side, both ongoing requirements in the sense of hiring additional internal resources, but also external resources. And to your point, difficult to determine which of those are permanent or ongoing, but there's no question that we are in this transition period. I just can't predict whether there will be future transition periods. But this year there's no question that there are a number of either transitions like that or first time projects, like resolution planning, that just didn't exist in the past but require both internal and external resources.

Thanks.

Vivek Juneja, JPMorgan.

Couple of questions, Mike. One, how much was the stock option expense in the first quarter? And how much was it this quarter? So just looking at the comp excluding that.

Bev, do you want to give those numbers?

Share-based compensation in the quarter, if you're looking at the year over year, so we had share based compensation was --

I'm looking at linked quarter, meaning first quarter versus second quarter because that tends to be higher in the first quarter.

Right. So I believe it declined sequentially $7 million.

Right.

Last year. And this year it only declined $2 million.

Right.

From Q1 to Q2. Okay.

Yes. And your observation is consistent with some changes in our compensation. Whereas previously there's a greater proportion of the share-based compensation that was in options, and as a result when we had the first quarter there's a higher level of expense related to options to retirement-eligible employees. This more recent year we've had a lower proportion of that share-based compensation in options and as a result the first quarter level was less and, therefore, the step down to the second quarter was less. So it creates about a $5 million difference.

Okay. Got it. Second question, going back to the buyback question. Since you laid out what you would use your capital for and given that stock prices haven't been going down, so it's not like you're waiting to time it for stop prices, I'm sure. What are you seeing in terms of acquisition opportunities? Is the chatter picking up? Are you seeing more things? Is there any increased activity on that front?

Yes, I would say it's consistent with what we would normally see. As our history has demonstrated, we are very selective on acquisitions. But from time to time, there are opportunities for us to acquire strategic businesses or capabilities. And I would say, we continue to see with all of our businesses, meaning PFS, C&IS, as well as on the asset management front, various opportunities, not necessarily significant in size but potentially interesting to us that to the extent that they can be both strategically attractive after we've done due diligence and we can acquire them at a price that is financially attractive, that we would consider proceeding on.

Okay. So nothing different. Because I'm trying to still understand why the buybacks are so slow this quarter, if there wasn't an uptick in at least the opportunities to look at. Because if you start to see more stuff, that makes you want to hold back for that. But given that you're not seeing that, your balance sheet growth isn't accelerating, I'm still struggling with why the buybacks are so soft.

As far as the buybacks, I mentioned the framework with which we think about those. And as a result, that does not result in a consistent level of repurchases, either week by week, month by month or quarter by quarter. And it's something that -- our objective if we are going to repurchase stock, as I mentioned, is to buy more stock when we perceive the price to be lower, and less when we perceive it to be higher. So it really is, it's about buying more shares in with the total amount that we have to deploy. And so that has not changed and that will still be our objective going forward here.

Okay. So you're waiting for the price to come down. Okay. Got it. Okay. Thanks.

Andrew Marquardt, Evercore.

Just following up on that line of questioning in terms of capital. Did I hear you right in terms of when you were reviewing the Basel III Tier 1 common ratios, 12.8% on the advanced approach, 10.3% on the standardized?

Correct.

And which is the constraining factor, is it the lower of the two or --?

Well, ultimately -- one of the things, Andrew, that changed between the proposed rule and the final rule was the application of buffer requirements. Previously, under the proposed rule, there were no buffers that were added to the standardized ratio in determining capital adequacy. At that point, for example, as long as your standardized was above 4.5% Tier 1 common, then to determine your adequacy relative to buffers, you would look at your advanced ratios if you're an advanced approach bank which we were. With the final rule, they're applying the buffers to both standardized and advanced. And so you need to look at both of those ratios and use the lower of the two. And so that's why we thought it appropriate in this call to give you both ratios.

As far as the constraining factor or limits, that is a very difficult -- not that it's a difficult question, it's just that it changes over time based on any number of things, because the ratios are calculated, as you know, in very different ways. The numerator side of the equation you have three different determinants for what's in the numerator, whether it's common or Tier 1 or total capital, and then now we have three different methodologies for determining the assets or the denominator. And importantly, those three different ways, so whether it's leverage or it's standardized approach or advanced approach, is impacted. First of all, they're calculated in different ways but then they're impacted by different types of risks. And so at any point in time you could theoretically have a different constraint. Our approach is very much looking at all of those combinations to ensure that we're comfortable with our capital levels, and needless to say we are very comfortable with all of the ratios at this point in time.

That's helpful. And then related, how do you guys view your own capital in terms of adequacy versus your own internal hurdle rates, based on either these new calculations and outputs or otherwise? What's the right level that you think you should be running at?

Yes. I mean, I would certainly say as the rules get finalized that it helps us move forward with looking at the various ratios. But given what I just laid out there for that framework, there is no single ratio by which we say this is our single target ratio. But rather, for each of those that we go through, we determine what is the required level and then we determine levels above each of those at which we would want to maintain our capital. And at this point, again, we're above all of those such that we have the opportunity to deploy capital either in new investments or to return capital, which we're doing. And I would say nothing in the final rules really change significantly such that we feel differently about our actual position.

Great, that's helpful. And then back to expenses, in terms of the Driving Performance, already at your all-in goal and you're going to do more than that. But when we review and go back and we look at the original premise of it was to improve operating margins 500, 600 basis points. Do you feel like you've achieved that at this point? Even though maybe we're a little bit shy of that ultimate goal in the low 30s since that was kind of an all-else-equal type framework.

I think you're right, Andrew, which is we do track what the impact has been and at this quarter's level we're basically, we're over 5.5% or 550 basis points plus benefit to the margin, relative to where we were. And again, that analysis is done on an all-else-equal basis. Obviously not everything else has been equal and we don't need to go through some of the environmental factors that have actually worsened during that time period. And certain things have been better, like equity markets. But the net impact of that has been a drag over that time period. Our objective is to make sure that not only do we hold what we have achieved here, but that we continue to improve on that and that's a combination of both approach, generally speaking, but it's also making sure that we are planning for and executing on specific initiatives like we have over the last year-and-a-half.

Great. That's helpful. And a follow-up on that point. Given the initiatives that you've laid out in terms of the ongoing investments, but then also coupled with still NIM pressure but maybe a little bit better fees, do you think that in this environment you feel confident in achieving positive operating leverage going forward and maybe for the year?

Yes. I mean, I look at whether, Andrew, it's the quarter or year-to-date. Even in this environment where year over year for the second quarter, with the lowest level of net interest income in over five years as I mentioned, causing us to have net interest income down 14% and creating a drag on revenue such that revenues are only up 3%, and yet we can still generate positive operating leverage as a result of all the things we just talked about. I feel pretty good about that.

Thank you.

Gerard Cassidy, RBC Capital Markets.

Coming back to your comments about share repurchases and such, and I assume this would be a Board decision, but if you feel that the stock price is too high and you're accumulating this capital, you cannot redeploy it, would a special dividend ever be considered as a way of returning that excess capital, but not having to buy your stock price at elevated prices?

As you mentioned, ultimately the Board has to determine all of our capital actions. But depending on the circumstances, we'd certainly consider other means of returning capital to shareholders. A special dividend is one of those alternatives. With the capital plan that we submitted, that was not a specific component of it but, again, things change over time and we're constantly looking at ways to either deploy the capital as we've talked about, or return it to shareholders through various means, be they share repurchase, dividends or something like a special dividend.

Okay. Thank you. I was thinking more for 2014, understanding that a special dividend or guessing a special dividend was not in your '13 plan. Following up on the acquisition commentary, when you are out there maybe, and we know acquisitions are episodic and you can't really predict them, but is there any line of business that you're more interested in than others? You do you a great job in private wealth management. Would you consider purchasing something there here in the US or overseas or is it more in the Institutional side? Is there any area, color you could give us on maybe what could be interesting to you guys?

Yes. It really isn't in any one particular area. And the reason why I say that is we feel good, as you can imagine, about our competitive position within each of the businesses. And it's really a matter of, are there areas where we can create new opportunities by being in a new geography, for example, or gaining a capability that we didn't have? And as opposed to speculating on different things that would be of interest to us, I think if you looked at some of the deals that we've done, they give an indication of the types of things that we would be interested in going forward, frankly. So an HFS which was largely through the Omnium acquisition is a perfect example of our ability to gain a technology and a capability really, within hedge fund administration, that is part of the broader set of service that we're offering.

So there's a lot more. You can look at the BoISS acquisition where it enabled us to grow further and faster in a part of the world, in Ireland, that we previously didn't have. So I would think about it the same way. And it is with each of the businesses. So we haven't done a lot of acquisitions in, for example, PFS. That doesn't mean that we don't look at opportunities. It just means that the screen is very tight.

Thank you.

And that does conclude our question-and-answer session for today. At this time I would like to turn the call back over to Ms. Bev Fleming for additional and closing remarks.

Well, thank you very much for joining us today and we look forward to speaking with you when we release third-quarter results in mid-October. Have a good day.

Thank you.

And that does conclude today's program. Thank you all for joining.