Northern Trust Corp (NTRSO) 2013 Q3 法說會逐字稿

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

Thank you, Marquita. Good morning, everyone, and welcome to Northern Trust Corporation's third-quarter 2013 earnings conference call. Joining me on our call this morning are Mike O'Grady, Northern Trust's Chief Financial Officer; Jane Karpinski, our 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 by email 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 presentation -- earnings review presentation, which we will use to guide today's conference call. This October 16 call is being webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available through November 14. 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 Corp'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, please 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.

Thanks, Bev. Good morning, everyone, and welcome to Northern Trust's third-quarter 2013 earnings conference call. On today's call, I'll review our third-quarter results, update you on our driving performance initiatives, and comment on our capital. Bev and I would then be glad to answer your questions.

Before I review our results, I want to point out that our Board of Directors, at its meeting yesterday, approved the name change of two of our business units, Personal Financial Services to Wealth Management and Northern Trust Global Investments to Asset Management. These changes more accurately reflect the nature of our businesses and provide greater clarity around what we do for our clients in those segments. The names of our other two business units, Corporate and Institutional Services and Operations and Technology remain unchanged.

Moving to our third-quarter results on page 2, this morning, we reported third-quarter net income of $206 million and earnings per share of $0.84. Our reported results included a gain of $33 million on the sale of our Miami office building. Excluding the gain, net income would have been $186 million, and earnings per share would have been $0.76.

The operating environment in the third quarter continued to be mixed with both positive and negative implications for our business. Equity markets in the US and Europe were higher which supplemented our strong new business results while fixed income markets were a modest headwind. The S&P 500 was up 17% year-over-year and 5% sequentially. While the EAFE Index was up 25% year-over-year and 7% sequentially. The Barclays US Aggregate Bond Index was down 5% year-over-year and essentially flat sequentially. Client assets under custody ended the quarter at $5.2 trillion, up 10% over last year. And, assets under management ended at $846 billion, up 13%. On a sequential basis, client custody and managed asset levels were both up 5%.

Currency volatility and client trading volumes, both of which influence Foreign Exchange Trading Income, were lower in the third quarter which is not uncommon for summer months but were still higher year over year. Short-term interest rates declined further in the quarter, remaining at very low levels. Average levels in the quarter for three-month LIBOR, Fed funds and overnight repo were all down 1 to 5 basis points. This placed continued pressure on our net interest margin and also resulted in higher fee waivers in connection with our money market mutual funds. We continued to successfully execute on the driving performance initiatives announced in early 2012, enhancing our capacity for investment and growth and other initiatives, regardless of the macro environment. The net effect of all these factors was a reported return on equity of 10.6%. Excluding the gain, our return on equity would have been 9.6%, short of our target range of 10% to 15%. Let's move to page 3 and discuss the financial highlights of the third quarter.

First, I'll compare the third quarter excluding the gain to last year's third quarter. Revenues were up 4%, and expenses were up 6%. Revenue growth was a result of Trust Investment and Other Servicing Fees increasing 8% and Foreign Exchange Trading Income increasing 43%, offset by a 5% reduction in net interest income and a 26% decrease in Other Operating Income. Expenses were up 6% due to higher outside services and equipment and software expenses. Our loan loss provision was $5 million in the quarter, down from $10 million last year. As a result, net income was 4% higher than last year's third quarter. Compared to last quarter, revenues, excluding the gain, were down 1%, and expenses were up 2%. Lower Trust Investment and Other Servicing Fees and Foreign Exchange Trading Income were largely offset by higher net interest income. Expense growth on a sequential basis, similar to the year-over-year comparison, reflects higher outside services and Equipment and Software expenses. As a result, net income excluding the gain, would have been 3% lower sequentially.

Earnings per share was $0.84 on a reported basis and $0.76 excluding the gain compared to $0.73 last year and $0.78 last quarter. Our return on equity of 10.6% for the third quarter would have been 9.6%, excluding the gain, unchanged year-over-year and lower than the second quarter. With that background and summary, let's get into more details behind our third-quarter results.

Beginning on page 4, third-quarter revenues on a fully taxable equivalent basis were approximately $1 billion, up 7% year-over-year and 3% sequentially. As I mentioned, excluding the gain, revenues would have been up 4% year-over-year and down 1% sequentially. Trust, Investment and Other Servicing Fees, the largest component of revenues, were $648 million in the quarter, up 8% year-over-year and down 1% sequentially. Higher equity markets and new business were both drivers of growth with higher money market fund fee waivers offsetting. Money market fund fee waivers were approximately $32 million in the third quarter, an increase of $16 million over last year and $9 million over last quarter. The increase was primarily due to the gross yield of the Funds declining by approximately 4 basis points on average from the second quarter. I'll go into further detail on Trust Fees shortly.

Foreign Exchange Trading Income was $63 million in the third quarter, up 43% year-over-year and down 12% sequentially. Higher currency market volatility and higher trading volumes both drove the improved results year-over-year. On a sequential quarter basis, both volatility and volumes were lower. Other non-interest income of $99 million for the quarter included the $33 million gain. Absent the gain, other non-interest income would have been $67 million, down 18% year-over-year and 7% sequentially. Last year's results included a $5.3 million gain related to hedges of certain investments in our foreign currency-denominated subsidiaries. Both comparisons also reflect lower income on Employee Benefit assets held in trust. Net interest income, which I will also discuss in more detail later, was $245 million in the third quarter, down 5% year-over-year and up 7% sequentially. With that backdrop, let's look at the components of our fee revenues on page 5.

For our Corporate and Institutional Services business, fees totaled $360 million in the third quarter, up 8% year-over-year, and down 1% sequentially. Custody and fund administration fees, the largest component of C&IS fees, were $239 million in the third quarter, up 12% year-over-year and 2% sequentially. The year-over-year increase was primarily the result of higher equity markets, new business, and favorable results from our driving performance revenue initiatives. In the sequential quarter comparison, new business drove the increase. Assets under custody for C&IS clients were $4.8 trillion at quarter-end, up 10% year-over-year and 5% sequentially. The increases reflect higher equity markets, and new business, and the favorable impact of currency translations sequentially.

Investment management fees in C&IS of $71 million in the third quarter were down 3% year-over-year and 4% sequentially, despite assets under management for C&IS clients increasing 12% year-over-year and 6% sequentially. New business, primarily mutual funds and index management and higher equity markets, were more than offset by higher money market fund fee waivers. Waivers impacting C&IS fees equaled $15 million in the third quarter, $9 million higher year-over-year, and $5 million higher sequentially, primarily reflecting the lower gross yields achieved in the underlying funds as I previously mentioned.

Securities Lending fees were $23 million in the third quarter, down 5% year-over-year and 27% sequentially. The sequential quarter decrease reflects the traditional second-quarter impact of the international dividend season which resulted in wider spreads last quarter. Securities Lending collateral of $105 billion at quarter-end, up 7% both year-over-year and sequentially. Other fees in C&IS were $26 million in the third quarter, up 15% year-over-year and 6% sequentially, primarily reflecting growth in investment risk and Analytical Services and benefit payments.

Moving to our wealth management business. Trust, Investment and Other Servicing Fees were $288 million in the third quarter, up 8% year-over-year and down 2% sequentially. The year-over-year growth reflects strong new business in higher equity markets while the sequential quarter comparison primarily reflects new business. Both the year-over-year and sequential comparisons were impacted by higher money market fund fee waivers, which at $17 million were $7 million higher compared with last year, and $4 million higher than last quarter. Assets under management for wealth management clients were $212 billion at quarter-end, up 15% year-over-year and 4% sequentially, reflecting higher equity markets and new business. Wealth management assets under custody were $470 billion at quarter-end, up 10% year-over-year and 4% sequentially.

Moving to page 6, net interest income was $245 million in the third quarter, down 5% year-over-year and up 7% sequentially. The net interest margin was 1.14% in the third quarter, down 7 basis points year-over-year and up 4 basis points sequentially, while earning assets averaged $86 billion in the quarter, up 1% year-over-year and 3% sequentially. The lower margin compared with last year primarily reflects lower yields across earning asset categories as short-term interest rates continued to decline. For example, average three-month LIBOR was down 17 basis points year-over-year. The higher margin compared with last quarter primarily reflects lower premium amortization in our mortgage-backed securities portfolio due to changes in prepayment speed assumptions.

Premium amortization was $5 million in the third quarter, down from $15 million in the second quarter. As a result, the yield on the securities portfolio increased 16 basis points sequentially. In addition, the yield on interest-bearing deposits with banks increased 5 basis points sequentially primarily due to higher proportion of deposits denominated in the Australian dollar where interest rates remain relatively high versus other currencies. Offsetting those increases was a lower overall yield on the loan portfolio, which declined 3 basis points as over 50% of the portfolio is floating rate, and new loans and leases are coming on our balance sheet at lower yields than those rolling off. The cost of funds declined 3 basis points sequentially, with all categories but senior notes declining. The higher cost of senior notes was largely due to the maturity in the third quarter of a note with a comparatively low rate.

Turning to page 7, expenses were $741 million in the third quarter, up 6% year-over-year and 2% sequentially. Let's take a look at the trends and expenses by category. Compensation expense was up 3% year-over-year and down 1% sequentially. The year-over-year increase primarily reflects staff growth, which also increased 3%, and was driven by hiring in our Global Fund Services business in C&IS which is growing rapidly and in our operational centers in India and Ireland. Employee Benefit expense increased 4% year-over-year and was down 1% sequentially. Employee medical expenses were higher in the quarter but were offset sequentially by the lower FICA insurance.

Outside services expenses increased 15%, or $19 million year-over-year, and 7%, or $10 million sequentially with higher consulting, technical services, and sub-custodian expense driving both the year-over-year and sequential growth. As we have discussed, this category of expenses for third-party providers can vary both with client activity levels in a particular period as well as for corporate needs such as regulatory projects and initiatives, increasing requirements related to CCAR, resolution planning, AIFMD and other initiatives resulted in higher expenses for certain components of outside services this quarter. For example, consulting expenses were $15 million in the third quarter, about three times as much as in the same quarter last year and twice as much as in the last quarter. We anticipate this level of activity will continue, and so we will also be carefully managing the related resources and costs.

Equipment and Software expense was higher by 11% year-over-year and 4% sequentially. This growth was expected and reflects the higher level of investment we are making in our technology platform. For example, during the third quarter, we rolled out new mobile offerings for our wealth management clients for Apple and Android smartphones and tablets. We also launched the first phase of streamlining client account opening for institutional clients and implemented a new front office trading platform in foreign exchange.

Occupancy expense was essentially flat both year-over-year and sequentially. Other Operating Expense increased 8% year-over-year and 1% sequentially due to a number of miscellaneous factors. In sum, while our expense base fluctuates from quarter to quarter for various reasons, it generally tracks with the longer term trend of our fee revenues as we continue adding new clients. Our objective is to grow our expenses at a lower rate than the growth rate of our fee revenues. We were successful in achieving this in 2012 and in 2013 year-to-date.

Let's move to page 8 and discuss Driving Performance. In the third quarter, we produced over $70 million in pretax income improvement from Driving Performance initiatives, split roughly 40%-60% between revenue and expense. Relative to last quarter, incremental positive impacts resulted from a range of pricing and business-building initiatives as well as further progress on our process optimization efforts such as client administration. With $190 million in benefits achieved year-to-date, we are on track to exceed our driving performance target of $250 million for 2013.

All else equal, these benefits have improved our pretax margin in 2013 year-to-date compared to 2011. However, the full impact of these benefits is not evident in our bottom line because much of the total has been used to absorb the decline in net interest income and Foreign Exchange Trading Income, which have each declined approximately $60 million compared to the same year-to-date period in 2011. Driving Performance is creating sustainable improvements to our operating model which are critical to our future financial performance. We will continue to pursue meaningful efforts to further improve productivity beyond our original targets.

Capital, outlined on page 9, remained very strong with Tier 1 Common and Tier 1 Capital ratios of 13.1% and 13.6%, respectively. Based on our 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 approximately 13%. Under the standardized approach, the Tier 1 Common Capital ratio would be approximately 11%. 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, which is above the requirement applicable to Northern Trust. In the third quarter, we repurchased 1.7 million shares at a cost of $97 million. Our capital plan provides for the repurchase of up to $287 million of common stock between October, 2013 and March, 2014.

A few thoughts in closing. We continue to execute on our strategy of providing exceptional service, expertise, and advice to clients around the world. Our third-quarter results build on progress made earlier in the year. As a result, through the first nine months of 2013, we're achieving our objectives of growing the business and improving our productivity, profitability, and returns. Trust Fees have grown at approximately 9%, and expenses as a percentage of Trust Fees are down over 5%. Although these improvements have been offset by the impact of declining short-term interest rates producing only modest growth in income, we continue to better position the Company financially for the future. We feel very confident in our strategic and competitive position and are keenly focused on continuing to execute. Thank you again for participating in Northern Trust's third-quarter earnings conference call today. Marquita, please open the line for questions.

(Operator Instructions)

We'll take our first question from Luke Montgomery with Sanford Bernstein.

Hey, thanks. Good morning. In terms of foreign exchange, it's still a very depressed revenue line, but I think it was better than I expected anyway. Maybe some of that has to do with volumes being better than some of the gauges indicated. I know you've been taking steps to replace some of the revenues that were lost due to transparency and lower spreads. I'm wondering if those steps had an impact this quarter? If not, what is your expectation about when we might see some of the benefits? I guess you could review the steps as well?

Sure. So, you're right. We have taken some steps in the foreign exchange area, and these go back about a year ago where we changed a couple of the folks that are running that business and as part of that, they did, I would say, two things primarily. The first is, really taking a hard look at how we provide this service to our existing clients and looking to make sure that we are providing the best level of service and execution for them. Part of that is from a service personnel perspective, but part of it also is from a technology perspective. And, as you heard me mention earlier, in the quarter, we put into place a new front office trading platform for FX, which I think has enabled us to better serve our existing clients on the custody side, and as a result, see some improvement in our market share there.

The other big step that we've taken is to look to grow the business outside of our custody clients. To do more third-party FX trading with some of our Fund services clients, and on that front, we've made progress. But, I would tell you from a financial perspective, we're only seeing a very modest impact in the third quarter and would expect that we'll see much more down the line.

Okay. Great. That's helpful. And then, my follow-up question, I know I've been harping on this a bit lately. Have you given more thought to increasing the disclosures around the components of net new business in organic growth. It seems like, to me, that you have a good story to tell here since your organic growth is better than peers. I think that gives you a good opportunity to set the disclosure bar for the industry. I'd like to know what considerations you're mulling over, and whether we could expect that?

We definitely take your considerations and others into account on that front. As you can imagine, the primary objective for us, first, would be to make sure that any information that we provide to you is accurate and reliable. And, on that front, when it comes to looking at new business, we look at new business in a number of different ways. Whether that's assets that are coming in the door. Whether that's the associated revenues that come in the door with that, and we also carefully tracked business that can either be lost or where the revenue streams are decreasing.

What we don't want to do is paint a picture with the data on the front end, saying here's this new business we have, but not have that appropriately correlate with what you're seeing in our actual financial reporting. And so, that's what we've been trying to make sure that is aligned as much as possible. The other part around that is making some advancements again on the technology front, to be able to track whether it's assets under management, assets under administration, assets under custody at a very detailed level, all the in-flows and out-flows, so Operator will help us be able to provide some of that information that you're looking for.

Okay. Great. Thanks for taking my call.

Our next question comes from Alex Blostein with Goldman Sachs.

Great. Hey, good morning. Mike, you've been loud and clear around the burden of some of the regulatory and compliance-related items on your expense base this year. That's obviously coming through in the numbers, but as we try to think about 2014, it sounds like the incremental build might not be as onerous as it has been, I guess, this year. So, when you think about the expense growth heading into 2014, should we, I guess, expect to see some easing at least from that bucket?

Sure. So, one of the things -- with regard to new regulations, for example, whether that's CCAR, resolution planning, et cetera -- we first of all want to make sure that we are building the capabilities in-house to be able to continue to comply with those requirements, as they increase as well. But, at the same time, at certain time periods, it's necessary and frankly even more financially appropriate to use outside resources to do that. And, in 2013, with the higher level of either new regulations or new levels -- so for example for us to go from CAFR to CCAR -- and also submitting our resolution plan for the first time. We have had to supplement the internal resources with more external resources. That is what you've seen.

Going forward, what we don't know is both the increase in level of the existing regulations-- so for example, with the CCAR and the capital planning, do they raise the bar even further going forward which we think they will do. And, also, you have other regulations which we're still frankly in the earlier days of. So, AIFMD in Europe is still in the early days, and really we'll see more of that implementation in 2014. So, at this point, we're hesitant to say that those external costs, if you will, are necessarily going to go down when we don't know exactly what the requirements will be next year.

Having said that, Alex, it is something where you can imagine, we are very keenly focused on trying to be as financially careful as possible in how we manage those costs through the process. I think it would be easier, frankly, to hire significantly more external resources just to get these various initiatives completed. We've tried to balance that with building the capabilities and doing it in a cost-effective way, and we'll certainly do that going forward, too. We would like to bring some of those down.

Got it. All right. I guess I was just trying to get to if they don't go down which I don't think many people are, I guess, too hopeful that they would. But, if they don't go down, given the fact that you had a big ramp this year, I guess the pace of that ramp might slow next year. Is that the way to think about it?

I think that's a fair expectation.

Great. And then, my second question was just on Securities Lending business, and I think this is something we haven't actually talked about in a while. I guess if I look at the collateral balances for you this quarter, they're at the highest level we've seen in almost 2.5 years. I know for the industry in general, there has obviously been a struggle with a lack of demand from the end users. Are you starting to see, I guess, a shift in that? Or, what would you attribute the growth in the balances to this quarter?

I would say that the shift in the balances has to do as much with just the mix of -- the mix of the demand, the type of securities. So, areas where we've just had more demand than we have in previous periods, but I would not say that overall we're seeing a significant shift in the demand for this. And, as much as you do see that somewhat in volumes, you also really see it in spreads as well because if there's greater demand for particular types of securities, that's when our clients are able to get a greater spread on that. So, at this point, I would say we're still in the pretty muted environment that we've been in for a while.

Got you. Thanks so much.

We'll go next to Howard Chen with Credit Suisse.

Hi, Mike. Hi, Bev.

Howard.

Howard.

With respect to the net interest margin, thanks for the disclosure on the premium amortization. Putting that aside for a minute, Mike, can you just talk about what you and the team are investing the portfolio in today? And, what were the nature of those modest securities losses this quarter? Thanks.

Sure. Just to hit the securities losses first, that's really -- we just sold one particular security, Howard, where we had a gain in the security. We happened to also have an offsetting position in a hedge, and so as a result, it had no net impact. It just showed up on two different line items, and it just had to do with the effectiveness of the hedge that we had in place which was going to create further volatility going forward. So, we decided easier just to sell that security essentially at no gain or loss.

But, to your bigger, broader question with regard to the portfolio, as you saw in the period there, putting the premium amortization aside, I would say that the yield on the portfolio remains pretty consistent. And, our strategy remains consistent there as well. Our average duration on the portfolio is still just a little bit over a year, and when we look to reinvest the proceeds that are rolling off of the portfolio, we're balancing it between a portion that's very short term for liquidity purposes and then a portion that has to be extended in order to maintain that duration. But, even with that extension, Howard, it's in the kind of two- to three-year duration. So, we're definitely not looking to significantly extend the duration of the portfolio at this time, and I would say from a credit perspective, we continue to be very consistent with the credit profile that we're looking at which as you know is very high quality.

Great. Thanks, Mike. My follow-up, just over the next few years as the operating backdrop improves, we have higher short rates, better client engagement. Can you just refresh us about how you all think about the incremental margins on that potentially outsize revenue growth, and where would you all like to invest that you might be holding back on today? Thanks.

Sure. So, we hope you're right about the environment improving in the near term here. And, it's an important point, Howard, because the revenues that are related to the environment there -- so for example, with short-term interest rates. Whether that's the spread that we can earn on the investment portfolio, or the short-term investments that we make with bank deposits. Or, it's a reduction in the money market fund fee waivers -- those are all relatively high margins. Very high margins relative to the business overall. And so, to the extent that happens, that will have a meaningful impact on our overall pretax margins.

Now, as you point out, we continue to make investments, but I would say with those investments, we've been careful through the more difficult time period in making sure that the investments that we make -- whether that's in our Global Fund Services business. Whether that's things like ETFs that we're doing, whether that's the technology investments that we're making -- that these are really important, critical investments to our business that will produce the type of returns that we expect going forward. And so, that standard, if you will, won't change. So, we're not necessarily looking to make significantly more investments just because the environment is going to be better. And, in fact, that's really the driver behind Driving Performance, is to be able to create capacity to be able to invest through cycles as opposed to being more cyclical in the investments that we make.

Mike, if I put all of what you just said together, is that a 50% incremental margin? 75%? 90%? Is there a way that we can kind of more broadly think about that?

Yes. It's a little difficult to say exactly what the margin is on those, but it is going to be greater than 50%. Just taking one of them, for example, Howard, would be on the money market fund fee waivers. As you can imagine, there aren't many costs that are up against waiving fees. So, the vast majority of that should drop straight to the bottom line. That's not necessarily true of all of the other revenue streams that are impacted, but that gives you some idea.

Okay. Thanks for taking the questions.

We'll go next to Ken Usdin with Jefferies.

Thanks. Good morning. Mike, just a follow-up on expenses. You earlier in the quarter had gone out of your way to just make sure that people understood some of these incremental step-ups. Given that we see the results now and following on Alex's question earlier, have we gotten the right run rates as far as some of these incremental step-ups? Understanding that there's still likely to be a growth rate from here, but have the items that you were specifically talking to with regards to outside services and Equipment and Software and net occupancy -- have we caught up to that now? Or, is there still a build that really still has to happen in some of those areas from here?

It does depend a little bit on the line item that you're looking at. So, for example, in outside services, we did see this -- I would call -- significant ramp in the time period, and where I talk about consulting expenses being three times what they were a year ago in this quarter, that ramp aspect of it would certainly like to think that we've seen the ramp -- certainly, there can be growth. But, that is not something that we would expect to continue at a very high growth rate. Whereas if you look at Equipment and Software, as we talked about the reason why that's growing at a higher growth rate is because we are making greater capital investments, capital expenditures, with a lot of that around software development. And, that's something where we do expect to continue at a higher growth rate than our average growth rate overall. So, overall, the expense growth rate so far for the first nine months of the year is about 3%. Whereas I would expect that with Equipment and Software, that will continue at a higher growth rate. Hopefully that helps.

And, the building in Miami, is that now in there on the occupancy side?

Yes, that is in there. That's -- again, another example where we're able to invest in the new office space in Miami. We're able to open up an office in Saudi Arabia. We're able to open a new office in Frankfurt. And, yet, if you've seen, our occupancy expenses have grown at a rate that's below that 3% that I mentioned, and that's because of things we've done on the driving performance side to carefully rationalize our office footprint overall. And so, as you've known, previously we've had places where we've reduced our footprint to make it more efficient and more aligned with the business at this point.

Okay. And then, Mike, on the forward, we know you've also been spending to on-board these two very large clients that you've publicly announced, Bridgewater and ATP. Is there any way you could help us as we get closer to 2014 understand when these bigger contracts online. And, I know you're not going to be able to help us with the magnitude, but just trying to understand, is there an accelerating growth rate in the future in the C&IS side? Just versus what's been happening this year on the cost side?

Sure. So, just taking the two that you mentioned there. First, ATP, that's a client that will be on-boarded here in the fourth quarter. We'll begin to see that in our run rate in the current quarter and then going forward. Bridgewater, which as we've talked about -- a much more complex on-boarding, and one that's we've been making additional investments into the technology and also being ready just to take on a fund manager of that size. That will come on next year, at this point targeted for second quarter of next year. And, at that point, we'll have the revenue impact, and we'll also have the full expense impact of bringing Bridgewater on at that time. Because that is a long-term agreement, it's structured in a way such that some of the expenses that we have related to that on-boarding -- we're able to defer those until we begin recognizing the revenue as well. So, that will happen at the same time.

Last quick one from me. On PFS, ex the fee waiver delta, it looked like that line dipped a little bit sequentially even with a good lagging mark. Just wondering if there was either an activity thing? Or, some outflows that you can just talk us through on the wealth management PFS side?

Sure. The biggest factor definitely was the money market fee waivers. So, on a sequential basis, it accounts essentially for the decline that you saw sequentially. And, I would say outside of that, you did have some modest pick-up because of the markets -- some of the equity markets. That was largely offset by the bond markets having a negative impact during the period. And then, also, I would say that there were certain PFS fees. A modest amount but that in the second quarter were kind of one-time in nature that were not recurring in the third quarter. But, that was a small amount. The driver definitely more is the money market fee waivers.

Got it. Okay. Thank you.

We'll go next to Robert Lee with KBW.

Thanks. Good afternoon, everyone, or good morning. Maybe a quick question on to start off on kind of the capital and CCAR process. Understanding that this is new to the CCAR process, clearly spending the money on it, and we don't have the -- I guess the stressed environment yet that the Feds will want you to look at. But, given your prodigious capital build or very strong capital position and build over time, what is the -- your current thought process? Unless you get thrown a curve ball at the stress environment, is it kind of thinking that, gee, we feel pretty good about where we are against any perspective? Even though it's not finalized? Supplemental leverage ratio, Basel III? Kind of pick your ratio that you may be thinking that it's coming up to a point where you're more comfortable asking to return larger portions of cash generation?

Sure. So as you know, we're just going to be getting into the really heavy decision-making part of the capital plan going forward, and ultimately, it's the Board that will make those type of decisions on the ultimate capital actions that they'll ask for. Having said that, let me just walk you through the framework that we have as we approach that. The first is definitely our capital position going into the CCAR process, and as you mentioned, but as you can see from the numbers here as well, we feel very good about our capital position going -- really, looking at any of the ratios. And, we can talk through how they measure risks differently and can be impacted by different things happening going forward. But, I would say we feel good about our capital position across the board, despite how you might measure it -- or, regardless of how you measure it.

The second thing that we'll look at is certainly the environment going into the process. And, at this point as we know, the economy continues to improve but very slowly. We are through a time period here where there's uncertainty in Washington, which can have an impact on the economy. We could certainly tell you right now that even the uncertainty we've had over the last several weeks has had an impact on our business. It just causes our clients to be more uncertain about their moves and slow down in some of the activity that they would have. We would have to take into account whatever the exact current environment is at the time.

The third piece, as you mentioned, is from a regulatory perspective and from our perspective, stress testing is a critical component of this. While we're doing some of our own stress testing right now, we're obviously going to have to see the stressed scenarios that are presented to us and see what the impact is by the time we run it through our process and our models. And then, the fourth component is certainly looking at the robustness of our process and making sure that we feel that we have all of the components in place that delivers a very reliable output and one likewise that the regulators would agree with regard to the process that we've gone through and how we've documented that process for them. And, I think when we take all that into account, that will guide us as to ultimately what will be recommended to the Board, and what they'll decide on as far as capital returns.

Thanks. And maybe as my follow-up, I'm just kind of curious if I look back at your balance sheet over the last 1.5 to 2 years, you've had -- it seems like pretty good new business trends, whether it's in the private client, whether it's in C&IS. And, I guess I would have thought that maybe that would have translated into a little bit more -- maybe not a lot, but a little bit more kind of natural growth in the balance sheet? Whether it's just deposit taking, just kind of the flow from clients, and yet it has been pretty stagnant, notwithstanding some modest increase this quarter. Maybe is there some type of mix taking place that you bring a new client on board, but whether it's in PFS, maybe it's not as deposit driven? Or, they're changing the nature of their relationships? Maybe it's a type of business you're seeing in C&IS just isn't as -- there are fewer deposits associated with it? I'm just trying to get a sense for maybe what's holding back a little bit of more balance sheet growth?

You mentioned a number of the factors that are involved there. I'm going to approach it from two different perspectives. The first is just with regard to the balance sheet overall and just deposits over time kind of longer term trends, and how they can somewhat mask what may be going on underneath that. And, that is the fact that we saw our deposits go up very significantly through the financial crisis. And, they really hung in at that higher level until the tag program was rolled off, and since then, we saw kind of a very immediate dropdown in the first quarter. And then, we've seen some moderate decreases from that time period going forward. And, while the balance sheet and earning assets have been relatively stable, some of that is new clients putting deposits on while other clients reducing the amount of deposits they have.

The other thing I will say about that is when we go through a time period where we are right now, with the situation in DC, we do see our clients again come back the opposite direction. So, we have seen some inflow of deposits from very large institutional clients preferring to put more deposits on the balance sheet. So, that can -- those types of trends can mask kind of the underlying growth that you may have with deposits.

But, then the other way that I would approach it, which is a little bit of where you were going, is where we are primarily focused with the business, and that is on the C&IS side, it really is a balance between what I would consider some of the more traditional, defined benefit type-clients that do have significant balances, particularly outside the US. But, as you know, a lot of our growth is coming through our fund services business, and with the Global Fund Services business, it's not as deposit-intensive if you will. And so, that changing nature, you can see a faster growth in the assets under administration or custody than you will in balance sheet assets. And, there's a little bit of that on the wealth side as well that you really have to look at the specific segments and the nature of their needs if you will, where we look to focus upmarket, that may involve less deposits than some of the just below that end of the market.

And then, at the same time, global family office cash management is a significant need. However, they balance between what they do on our balance sheet with what they put into our funds, and that can move around a fair amount. So, lots of trends over time, but I would say that you put it all together, and we've been in this relatively stable level of deposits. And, for the time being, that's where we think we'll be.

Great. Thanks for taking my questions.

We'll go next to Mike Mayo with CLSA.

Hi. I'm going to ask my expense question two different ways. One is a way which you can kind of brag about Northern, and the other way is a bit more critical. I'll start with the positive question. And, that is, isn't it ironic that you have all these extra compliance and regulatory costs when you've been one of the most safe banks in the industry, and in some way that's might not seem so fair. How do you think about that? All these new regulations to make you safer, yet you should be an example for others if you're simply talking about safety.

Well, I guess it's not about fairness, per se. It's about compliance, and from a regulatory perspective as you know, they're focused on the entire system and have a single standard, I would say. Maybe that's not perfectly correct in the sense that they do differentiate by size. Once you're of size, if you will, their expectation is for our processes and our risk management infrastructure to be the same as the largest banks. And so, on that front, we have to make the changes, make the investments in order to get to that level, and so that's what we're doing.

All right. That seems like you're penalized for being in that same grouping. But, my other question relates to your delivery on expenses, and I'm looking at quarter over quarter, year over year, 3 years, 5 years, 10 years. I know most of that predates you. But, when I'm looking at total revenue growth versus expense growth, I'm seeing negative operating leverage almost over any time frame that I look at. And, I know you said that the goal is to grow fees roughly in line with the expenses, but I'm not sure about that as a target. Shouldn't you evaluate the entire client relationship, which includes deposits, and therefore, net interest income?

So, I'm questioning the efficiency -- or expense target that you have, and if it should be a little bit more clarified? I mean, State Street, I'm not saying it's one-size-fits-all, but State Street has a margin target. Other banks have more clearly identified efficiency targets. Other banks will include all the revenues in line with the expenses. Given -- from my perspective, it looks like a poor efficiency record over many time frames. Shouldn't you revise your efficiency target? And also, now that you're on set to get delivering performance, what's the next step? Thanks.

Sure. So, the perspective on operating margin and whether to look at the pretax margin or some other ratio -- certainly at the end of the day, I would agree that it's about delivering the bottom line results. And, by no means do we look at that differently. That is the final determination, and we think at the bottom of all that is return on equity which takes into account the margins as well as how well you manage your capital. The reason why we look at the expenses relative to fees is because the nature of the fee revenues is very different than the other revenues -- net interest income, FX, et cetera. And, as a result, we think it's most appropriate to look at how those expenses line up with those fees. Particularly, I would say on an incremental basis, right.

So, certainly there are costs associated with generating net interest income or generating FX. It's just the fact that when interest rates change or FX change up or down, there's not that much we can do on the expense front that's directly related to that. Whereas with the fee revenues, they're very highly correlated. When we bring on a new client or lose a client, we do have more or less work to do. And so, the reason why we focus on the metric we have is because that's where we think we have the most control over it.

It doesn't mean that we ignore the others, it's just recognizing the fact that they have a different nature -- a nature that is much higher margin as we talked about with one of the previous questions. And, we think that over time if we can focus on that, we're going to deliver better operating performance and better pretax margins over multiple cycles. We feel that if you look at just the pretax margin itself, that there's the risk on the upside, I'll say, to not be as disciplined around the expenses when you have revenue streams that are going up that really don't require more work. And, it can take the eye off the ball, if you will, on trying to continue to be more productive. So, that's how we look at it.

Now, with regard to Driving Performance going forward, as you point out, we're going to surpass our goal here through the end of the year. What's next. There are still a number of the more end-to-end type initiatives that we have that both require further work but have greater opportunities going forward. So, things like the client administration that we talked about, we're still in the earlier phases of that. We had some benefit for example in this period, but there's more going forward.

There's other things we do with regard to just serving clients and executing for them. So, for example, how we strike now, how we value derivatives. Things like that where there are opportunities for us to do that more efficiently. It's not easy to do but we can do it and generate savings from it. And then, finally, I would say as we look at our footprint, if you will -- our operational footprint, there's still opportunity to continue to have a balance that is most effective to both serve our clients and be efficient for us. So, there are more opportunities going forward, but they will continue to require more work.

All right. Thank you.

We'll take our next question from Glenn Schorr with ISI.

Hi. Thanks. A quickie on just the way I look at both average balance sheet and period end, a little bit of a mix shift between long-term debt and senior notes coming down, short-term borrowings going up. I don't know if that's a point in time? Or, if there's any specific actions you're taking, but curious if there's any explanation there?

It's more point in time. I would say, though, that you will see some shift in that from period to period, just depending on where rates are. And, I say that in the sense that to the extent that it is very efficient for us -- low cost for us to borrow on a short-term basis, and we think that we can earn a reasonable, very low-risk return on that. And, we have the capital to be able to do that, then we might do more of it in a particular time period. But, it's always going to be within a certain range. I would just expect some fluctuation. And then, as I mentioned, we did have a senior note that rolled off in the time period. That's going to change that. But, at certain points, we'll also be issuing, and that will change the level of senior debt that we have.

Okay. Appreciate that. The only other follow-up I have is, I heard all your comments on CCAR. The one thing I'm curious about is if there's -- you're one of about, what, a dozen banks that are going through it for the first time? And, I think it's consistent across the industry for those banks that are employing whether it be Oliver Wyman or McKenzie or whoever, to help guide through the process. I'm just curious, is there much of a specific back and forth with the regulators on how to -- do they provide a CCAR for Dummies book? Or, are you just following the same path that banks before you have?

Certainly, every bank has its own direct dialogue with its regulators. It's very specific to that institution, and we have that as well. But, they did put out a paper a few months ago that essentially was both the criteria, but I think importantly now that we have as a system gone through this for a few years -- what are best practices and weak practices. And, it is a very helpful document. I think both for institutions like ourselves who are stepping up to the next level because you do gain the benefit of what they view as favorable or unfavorable. But, it's also, frankly, valuable to other folks that are trying to look at the results and understand how these are being evaluated. And, frankly, why it's so much more than just the ratio that might be disclosed.

Okay. I appreciate that. Okay. Thanks.

Sure.

We'll go next to Cynthia Mayer with Bank of America-Merrill Lynch.

Hi. Thanks a lot. My question is on the share repurchase? It looks like you picked up the pace a little bit in 3Q versus previous quarter, even though the average share price wasn't that different. So, I'm just wondering what motivated you to do that? And, also, previous quarter you said you'd consider a few different forms of capital return, maybe even a special dividend? So, I'm wondering if the resumed share repurchase makes that less likely in some way?

Sure. So, our framework or philosophy around share repurchase is consistent with what we've talked about before, and again, has to start at the highest level of just what our capital position is, how we feel about that, the needs and opportunities we have to deploy it. Then, certainly looking at the capacity that we have -- both from a Board perspective, but also from our capital plan perspective. But then, I think more to your question, Cynthia, just around -- once you've cleared those first two hurdles, how do you think about it? And, I think that the most important part to understand is that we want to have flexibility around our capital deployment including share repurchases, and in this capital plan framework that we're in right now, there is limited capacity. In other words, you put a capital plan in at the beginning of the year, and you need to essentially stick to that plan throughout the year. And so, as a result, in buying shares back from any time period to another, we want to make sure we have a little flexibility because stock prices are volatile. And, there are certainly time periods where going back over the last few years, we would have liked to be able to repurchase more shares and take advantage of where the stock price was. But, frankly, wasn't in a position just because of these limitations around it.

And so, at this point, we feel pretty good about the level of flexibility we have through the end of this capital plan period which means we have this quarter and the next quarter to repurchase. And, as much as our average repurchase price was very consistent between the last two quarters, we did have an opportunity to buy more in this quarter than we did in the previous quarter around that. So, that's how we'll continue to think about it, and specifically around other alternatives. Besides share repurchase, a special dividend, for example, as I've said I\is not specifically in our capital plan so it's something we have to go back to our regulators to discuss. I think you're right in the sense of the more that we repurchase, there's less of a rationale for necessarily having a special dividend because there just would be less to the dividend because you've utilized that capacity otherwise.

Okay. And then, just briefly on the money market fee waivers, when you look at the current yields -- and maybe your outlook which could be very different. How is it looking for the coming quarter in terms of waivers?

It's a little bit-- well, I wouldn't say a little bit. It's very difficult to project because those fee waivers are mostly driven by the shortest end of the curve, and whether you look at -- you could look at LIBOR, although that's not a great barometer. It's much more the overnight repo rates that are going to give you the best barometer. Because remember, the average life of these funds is counted in dates, if you will, or weeks is a better way to characterize it. So, much of that is invested overnight in the portfolio.

So, if you look at the overnight repo rate, it jumped around quite a bit and was down as we've seen the evidence of in the third quarter. The dynamic changes. It has been up and down so far this quarter already. But, I really have no idea where it's going to be through the remainder of the fourth quarter. It's something, frankly, that anyone can monitor as we go through the quarter and have some idea of what the expectation would be. But, it's something I think that's impossible to project.

Got it. It looks currently high, but basically, you're saying you don't really have an outlook on it because it moves around so much.

Yes, I think then if you look back just a little bit, it was pretty low. And, I think there's a lot of dynamics around that beyond just rates per se, it also has to do with available collateral and things like that, just the dynamics of that marketplace for that rate.

Okay. Thank you.

We'll take our last question from Andrew Marquardt with Evercore.

Good afternoon. On expenses, wanted to ask again, you had mentioned that based on, I guess, the way you look at it in terms of operating leverage, fee growth versus expense growth, that you've achieved that so far this year, year-to-date, as well as last year. Is that still achievable going forward in kind of still a tough operating environment that you have laid out generally? I've got a follow-up.

Yes. So, the growth rate for fees relative to expenses, we definitely look to continue to be able to achieve the improvement that we've achieved. Our fees have grown so far this year for the 9 months at 9% and our expenses closer, as I said, to 3%. So, we expect that relationship to continue. It may not be the case in every single quarter on a sequential basis, such as we experienced in this quarter. And, it's not to say that those can't be impacted by things like the equity markets. But, that the underlying organic growth rate for that fee -- fee portion of our revenues is something that really is on us to grow those at the same time that we're focused on managing the expenses.

Okay. Thanks. And then, in terms of Driving Performance, you had mentioned that you are well on your way to exceeding your ultimate goal there of [250]. You had mentioned, in terms of the kind of the full impact, in terms of the operating margin lift, I believe you were referring to right of originally kind of laid out to be 500, 600 basis points potential benefit to operating margins when you first laid it out? That those were kind of -- part of that you don't really see because it's absorbed with other factors. How do you think about it now in terms of kind of the ultimate benefit? Do you still think you can get close to that kind of ultimate benefit into the low 30% without higher rates in terms of an all-in kind of lift? Or, how should we think about it now?

At the time that we launched Driving Performance, we said all else equal because so many factors are out of our control or impossible to forecast. And so, it's the same thing going forward here, which is all else equal, the answer to your question is yes. We certainly would look to continue to improve the margin overall. So, putting aside even the metric that I put out of expenses to fees, we're looking to improve the underlying margin as well, and frankly, need to do that in order for our return on equity to be in our target range. And so, that is our expectation. Now, again, not knowing where the macro environment is going to be, that can have the same type of impact that it's had over the last two years. But, without a doubt, we expect Operator demonstrates productivity both the way we talked about it, but also increased profitability in the sense of higher margins.

So, maybe said another way, is it still achievable kind of getting from -- what is it 27%, 28% range now on an operating margin, up to the low 30% without higher rates?

Yes. Into the 30% -- definitely into the 30%, and then, where we are within that is really more driven by those other revenues, which as you point out, rates is a big driver.

Thank you.

Thank you all for joining us for the call today. If you have any follow-up questions you can contact me, Bev Fleming, or Allison Quaintance, and we look forward to speaking with you in the middle of January when we report first quarter -- fourth-quarter 2013 earnings.

Thank you.

Thank you very much.

That does conclude today's conference. We appreciate your participation. You may now disconnect.