Northern Trust Corp (NTRSO) 2015 Q2 法說會逐字稿

Good day, everyone, and welcome to the Northern Trust Corporation second-quarter 2015 earnings conference.

Today's conference is being recorded.

At this time, I would like to turn the conference over to Director of Investor Relations, Bev Fleming, for opening remarks and introductions.

Please go ahead, ma'am.

Thank you, Lisa, and good morning, everyone.

Welcome to Northern Trust Corporation's second-quarter 2015 earnings conference call. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Jane Karpinski, our Controller; and Allison Quaintance from our Investor Relations team.

For those of you who did not receive our second-quarter earnings press release and financial trends report by e-mail this morning, they are both available on our website at NorthernTrust.com. Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This July 22 call is being Webcast live on NorthernTrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through August 20. 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 expressed or implied by these statements, because a realization of those results is subject to many risks and uncertainties that are difficult to predict. I urge you to read our 2014 Annual Report on Form 10-K, and other reports filed with 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 enable as many people as possible the opportunity to ask questions as time permits.

So thank you again for joining us today. Let me turn the call over to Biff Bowman.

Thanks, Bev. Good morning, everyone. Let me join Bev in welcoming you to Northern Trust's second-quarter 2015 earnings conference call. Today I will review our results for the quarter, after which Bev and I would be happy to answer your questions.

Starting on page 2 of our quarterly earnings review presentation, this morning, we reported second-quarter net income of $269 million. Earnings per share were $1.10 and our return on common equity was 12.8%.

As outlined in our press release, our results in the second quarter included three items, which I would like to highlight for you today. First, we recorded a pretax gain of $99.9 million on the sale of 1 million Class B Visa shares. This gain is reflected on our income statement in the other operating income line.

The sale reduces our ownership position in Visa Class B shares to 5.23 million shares as of the end of the second quarter. At the current conversion rate, this is equivalent to 8.62 million Class A shares of Visa. These shares are recorded on our balance sheet at their original cost basis of zero.

Second, we recorded a pretax charge of $45.8 million related to voluntary cash contributions to four constant dollar net asset value funds. This charge is reflected on our income statement in the other operating expense line. While the market based net asset values of the four funds were well above the prescribed threshold for transactions to occur at $1, this voluntary action offsets legacy losses realized by the funds during the financial crisis. The market-based NAVs now approximate 1 across all four funds.

Third, we recorded a $17.8 million impairment of the residual value of eight aircraft under leverage lease arrangements. This impairment charge is reflected on our income statement in net interest income. Excluding these three items, second-quarter net income was $247 million, earnings per share were $1.01, and our return on common equity was 11.8%.

Recall that our results in the second quarter of 2014 included pretax charges and write-offs of $42.3 million. Excluding both the current quarter and prior-year quarter's items that I just mentioned, earnings per share increased a strong 16% year over year.

Let me also review environmental factors, which impact our businesses and our clients. US equity markets were higher year over year, with the S&P 500 up 5%, yet international equities as measured by the MSCI EFA index were down 6.6% year over year, impacted by a stronger US dollar. In the sequential quarter comparison, both US and international equities were down modestly. In bond markets, the Barclay US aggregate index was lower by 1.5% year over year, and 2.5% sequentially.

Currency markets had mixed impacts in the quarter. Currency volatility, as measured by the G7 index, was 62% higher than the second quarter of last year, yet was 3% lower than last quarter. Currency volatility influences our foreign exchange trading income, as does the level of client activity.

Currency rates, which influence the translation of non-US currencies to the US dollar, impact client assets and our revenues and expenses. The dollar was stronger year over year, which tempered custody asset growth and related fee growth, but benefited expense growth. Sequentially, the dollar weakened, particularly versus the Sterling and Euro.

US short-term interest rates rose slightly, yet remained at very low levels, continuing to pressure our net interest margin, and resulting in fee waivers on our money-market mutual funds. Three-month LIBOR and the Fed fund's effective rate both increased 2 basis points sequentially to 28 and 13 basis points respectively, and the overnight repo rate increased 3 basis points to 18 basis points.

Let's move to page 3 and review the financial highlights of the second quarter. My comments are on an adjusted basis, which excludes the prior year and current quarter's item I mentioned in my opening comments. On an adjusted basis year over year, revenue increased 8%, with non-interest income up 8%, and net interest income up 9%. Expenses increased 5%. The provision for credit losses was a credit of $10 million in the quarter, primarily reflecting ongoing improvement in credit quality.

Adjusted net income was 18% higher year over year. On an adjusted basis compared to last quarter, revenue increased 3% with non-interest income up 4%, and net interest income up 3%. Expenses increased 3%. Adjusted net income was 7% higher sequentially.

Client assets under custody of $6.2 trillion increased 3% year over year, and 1% sequentially. In the year over year comparison, strong new business was partially offset by the currency impact of a strong dollar, as I mentioned earlier, as well as lower bond markets. In the sequential quarter comparison, the positive impact of new business and currency translation was partially offset by lower international equity markets and lower global bond markets.

Assets under management were $946 billion, up 2% year over year, and down 2% sequentially. Versus last year, higher fixed income, cash, and securities lending collateral were partially offset by lower equity assets, driven in part by the stronger dollar. Versus last quarter, cash and securities lending collateral were both down modestly, and the decline in equity assets resulted from certain clients rebalancing out of equity index mandates.

Let's look at the results in greater detail, starting with revenue on page 4. Second-quarter revenue on a fully taxable equivalent basis was approximately $1.3 billion. Adjusted for the gain I mentioned earlier, revenue was approximately $1.2 billion, up 8% year over year, and 3% sequentially. Trust, investment, and other servicing fees, the largest component of revenue, were $757 million, up 7% year over year and 4% sequentially.

Fees in our corporate and institutional services business increased 9% year over year, and 6% sequentially, while fees in our wealth management business grew 4% year over year and 1% sequentially. New business and higher equity markets were drivers of growth but currency translation, as I mentioned earlier, detracted from overall fee growth in the year over year comparison by approximately 2 percentage points.

Lower money-market mutual fund waivers also contributed to growth this quarter. Fee waivers were approximately $28 million in the second quarter, down $2.5 million year over year and $5 million sequentially. I'll go into further detail on trust and investment fees shortly.

Foreign exchange trading income was $75 million in the second quarter, up 41% year over year, and 5% sequentially. Currency volatility and client trading volumes were higher versus last year, but were muted versus last quarter.

Other non-interest income, excluding the Visa gain, was $73 million in the second quarter down 3% from last year, and 2% sequentially. Within other non-interest income, securities commission and trading income was $20 million, up 12% year over year, due to higher referral fees and income on interest rate protection products used by our personal clients. Sequentially, security commissions and trading income increased 2%, primarily due to higher referral fees.

Excluding the Visa gain, other operating income of $38 million in the quarter decreased 7% year over year and 3% sequentially, reflecting a number of miscellaneous income categories including, for example, lower loan and banking-related fees and currency hedges. Net interest income, which I will also discuss in more detail later, was $275 million in the second quarter when adjusted for the lease impairment, increasing 9% year over year, and 3% sequentially.

Let's look at the components of our fee revenues on page 5. For our corporate and institutional services business, fees totaled $432 million in the second quarter, up 9% year over year and 6% sequentially. Custody and fund administration fees, the largest component of C&IS fees, were $294 million in the second quarter, up 12% year over year and 6% sequentially while assets under custody for C&IS clients were $5.7 trillion at quarter-end, up 3% year over year and 2% sequentially.

In the year over year comparison, strong growth primarily reflects new business and higher equity markets, partially offset by the impact of a stronger US dollar. In the sequential comparison, new business was again a primary driver of growth. Recall too that some custody and fund administration fees in C&IS are based on one quarter lagged asset values. Higher first-quarter markets therefore helped second-quarter fee growth, while lower current period equity in bond markets negatively impacted client asset values.

Investment management fees in C&IS of $81 million in the second quarter were up 4% year over year and 5% sequentially, primarily due to new business and lower fee waivers. Money-market mutual fund fee waivers in C&IS were $14 million, 8% lower year over year, and 11% lower sequentially, driven primarily by higher gross yields in the funds. Assets under management for C&IS clients were $714 billion, up 2% year over year, and down 2% sequentially. As I alluded to earlier, a small number of clients, specifically sovereign wealth funds, rebalanced their portfolios in the second quarter, moving out of equity index mandates.

Securities lending fees were $27 million in the second quarter, 11% lower than last year and 24% higher sequentially. The year over year decrease reflects lower fee splits and spreads, partially offset by higher volumes. The sequential quarter increase primarily reflects the traditional second-quarter impact of the international dividend season, which resulted in wider spreads.

Securities lending collateral was $120 billion at quarter end, up 3% year over year, and down 2% sequentially. Other fees in C&IS were $31 million in the second quarter, up 16% year over year, and down 4% sequentially. The year over year increase reflects a number of items, including higher fees from benefit payments, and investment risk and analytical services. The sequential quarter decrease primarily reflects seasonally higher revenue for benefit payment services typically seen in the first quarter.

Moving to our Wealth Management Business, trust, investment and other servicing fees were $325 million in the second quarter, up 4% year over year, reflecting higher equity markets and new business. Growth was relatively consistent across the regions, and particularly strong in the global family office. Wealth management fees increased 1% sequentially. Recall that wealth management fees are based primarily on month or quarter lagged asset values, thus higher equity markets in the first quarter resulted in a favorable sequential fee comparison.

In addition, waived fees in money-market mutual funds were lower. Money-market mutual fund fee waivers in wealth management totaled $15 million in the current quarter, down 8% year over year, and 17% sequentially. Assets under management for wealth management clients were $232 billion at quarter end, up 4% year over year, and down slightly sequentially.

Moving to page 6, net interest income was $258 million in the second quarter up 2% year over year, and down 3% compared to the first quarter. Recall from my opening comments that the $17.8 million lease impairment is reflected in net interest income. Excluding that item, net interest income was $275 million, up 9% year over year and 3% sequentially.

A larger balance sheet was a primary driver of growth in net interest income. Earning assets averaged $104 billion in the quarter, up 9% versus last year, and 5% versus last quarter. Total deposits averaged $92 billion in the quarter, up 9% year over year and 7% sequentially, with strong growth in non-interest bearing demand deposits.

We also saw solid loan growth this quarter, particularly in private client and commercial real estate lending. Loan balances averaged $33 billion in the second quarter, up 10% year over year and 3% sequentially. The net interest margin was 1.06% when adjusted for the lease impairment, flat compared to the prior year's second quarter and down 4 basis points sequentially. The sequential decline in the net interest margin primarily reflects a lower yield on the loan portfolio, as mix shifts to lower-yielding products, and a lower yield on the securities portfolio, due to higher premium amortization in our mortgage-backed securities portfolio. Premium amortization in the second quarter was $15 million compared to $10 million in the first quarter.

Turning to page 7, expenses were $855 million in the second quarter, up 5% year over year, and 8% sequentially. Adjusting for the second-quarter items both this year and last year, expenses were 5% higher year over year, and 2% higher sequentially. Compensation expense adjusted for the prior year's charges increased 4% year over year, primarily reflecting higher incentive comp, the impact of annual merit increases, and staff growth, partially offset by the favorable impact of movements and currency rates.

Staff levels increased approximately 4% year over year, with more than 80% of that growth emanating from our global operating centers in Bangalore, Manila, and Limerick. On a sequential basis, compensation expense increased 2%, due primarily to annual merit increases, and staff growth was 1%. Employee benefit expense increased 10% year over year when adjusted for prior year charges, primarily driven by higher pension and employee medical expense. On a sequential quarter basis, employee benefit expense was essentially flat.

Outside service expense was 3% higher year over year, adjusted for prior-year charges and 9% higher sequentially. The year over year increase primarily reflects higher technical service expense. The sequential increase primarily reflects higher expenditures for consultants, sub custodians and legal. Equipment and software expense was up 7% year over year when adjusted for the prior-year software write-offs, and 4% sequentially reflecting ongoing support of client and regulatory technology initiatives.

Other operating expense includes the $45.8 million charge associated with our voluntary cash contributions to four constant dollar NAV funds. Excluding that item, other operating expense increased 11% year over year, primarily driven by higher charitable donations and higher charges associated with account servicing activities. In the sequential comparison other operating expense decreased 6%, reflecting seasonally lower business promotion and marketing costs.

Turning to page 8, we continue to make progress on our goal to improve core profitability and returns. We closely track the ratio of expenses to trust and investment fees, and remain focused on driving that ratio lower. As shown on page 8, this important barometer of our progress improved to 107% in the second quarter on an adjusted basis, excluding charges. This, combined with the growth in other revenue categories, produced meaningful operating leverage again this quarter, resulting in improvements in our adjusted pretax margin to 32% and in our adjusted return on equity to 11.8%.

Turning to page 9 our capital ratios remained solid, with common equity Tier 1 ratios of 12% and 10.7% respectively, calculated on a transition basis for both advanced and standardized. On a fully phased-in basis, our common equity Tier 1 capital ratio under the advanced approach would be approximately 11.7%, and under the standardized approach, would be approximately 10.4%. All of these ratios are well above the fully phased-in requirement of 7%, which includes the capital conservation buffer. The supplementary leverage ratio at the Corporation was 6.3% and at the Bank was 5.6%, both of which exceed the 3% requirement, which will be applicable to Northern Trust in 2018.

With respect to the liquidity coverage ratio, Northern Trust is above the 80% minimum requirement effective as of January 1, 2015, and is also above the 100% minimum requirement that will become effective on January 1, 2017. As Northern Trust progresses through fully phased in Basel III implementation, there could be additional enhancements to our models and further guidance from the regulators on the implementation of the final rule, which could change the calculation of our regulatory ratios under the final Basel III rules.

In the second quarter, we repurchased 1.3 million shares at a cost of $97 million. Our 2015 capital plan provides for the repurchase of up to an additional $578 million of Common Stock through June of 2016.

In closing, Northern Trust continued to perform well this quarter. Disciplined execution around both growth and productivity priorities remain solid, as evidenced by our strong operating leverage and our expense to trust and investment fee ratio of 107%. As I mentioned earlier, when adjusted for this quarter's items, our pretax margin was 32% and our return on common equity was 11.8%, both reaching five-year highs.

In our institutional business, C&IS continues to perform well, with growth coming from both existing and new clients. For example, we recently began providing global custody to Queensland Investment Corporation, a client for whom we first began providing fund administration in 2011.

The third and second Swedish National Pension Funds, or AP3 and AP2 as they are known, recently announced they have each appointed Northern Trust as their global custodian. This is a reappointment from AP3, a long-time client, and the beginning of a new relationship with AP2. Other announced wins include RPMI Railpen in the United Kingdom and the University System of Maryland Foundation. These wins signify the momentum in our institutional business, as well as the diversity of new business globally across products, and by client segments.

In our personal business, wealth management remains well-positioned in the affluent market, offering comprehensive solutions to our clients. For example, solid loan growth of 7% demonstrates the success of our customized lending strategy, as we support client demand, while maintaining excellent credit quality.

Wealth management also continues to manage expenses very well, driving further growth in pretax profit margins, which have consistently exceeded that of peers. Our commitment to returning capital to shareholders continues, as we increased our common dividend by 9%, and returned $182 million to common shareholders through dividends and stock repurchases. This was accomplished while continuing to maintain strong capital ratios that support our growing business.

Thank you again for participating in Northern Trust's second-quarter earnings conference call today. Bev and I would be happy to answer your questions. Lisa? Please open the lines.

(Operator Instructions)

We will take our first question from Betsy Graseck from Morgan Stanley.

A couple of questions. Just one clean up question. I know you mentioned the one-time charge for the NAV, stable NAV product. I guess I just wanted to make sure I understood why that was happening now?

Sure, Betsy. We constantly evaluate our liquidity products and suite of products that we provide to our clients, and as you're well aware, there's a lot of SEC reform and other items that have been up there. And so as we went through the evaluation process, we looked at some of the legacy issues that existed in four funds, and made the determination as a management team that the right time to address the legacy issues, losses in there was now. I'll be clear, all four funds traded above the $0.995 NAV price that is required. These top-ups will bring them to $1.

Okay, got it, and is that at all in preparation for the money market fund reform that's going to be coming into effect next year in October?

That is a part of it, but it was also, as we're looking at our array of liquidity products and offerings to our clients, in conjunction with that reform, we felt that this was the right time.

Just separately on Omnium, I'm not sure if you mentioned it too much during this conference call, but I just wanted to get a sense as to how important that platform is for some of the wins that you mentioned just now, as well as the trajectory in accelerated AUC growth that you've been having?

It is very important to some of the wins that we've talked about. The platform and the capabilities there has, first of all, allowed us to have meaningful dialogues with significant hedge funds and other large asset managers. Equally important is the capability is very attractive to very large, for instance, sovereign wealth funds, large foundations or endowments, particularly around its capabilities to handle complex and alternative investment instruments. So it's been powerful not only to hedge fund clients, but to other more traditional type clients as well.

There's more product and services you'll be able to layer into that platform over time?

So we continually look at its applicability and its functionality to integrate into the broader Northern Trust offering, and that's ongoing and something that we are clearly investing in right now.

Okay, thanks so much.

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

Question for you guys on operating leverage. Clearly, a really nice job so far, driving that ratio consistently lower on a year-over-year basis. Two part question, I guess, A, bigger picture how should we think about that heading into the back half of the year? And I guess as my follow-up, was wondering if you guys could address a little bit more some of the specific items and expenses, i.e., outside services and equipment both seem to be a little bit more elevated this quarter. So I'm not sure if you can give us a little more color on whether anything one-off drove in over the course of the quarter, particularly maybe related to some of the new business wins?

Thanks, Alex. Sure. First, we would say the 8% revenue growth that you saw, it requires some investment and some expense to grow with it. But as you pointed out, maintaining that leverage as we grow is very important to us. So we're focused on that, and continue, as you saw, drive the expense to trust fees ratio down and produce this quarter 300 points of operating leverage.

But specifically around some of the expense line items, let me talk about outside services. What I want to highlight here is that much of the sequential growth that was seen was really directly attributable to the revenue growth that you saw. So for instance, sequentially, on our outside services line, you saw that it grew about $19.7 million. More than half of that is directly attributable to growth. For instance, in lines like sub custodian expense, depository expense, those are directly related to the revenue growth that you see above.

I would also suggest that other lines in there are also attributable to growth. For instance, we could use consulting or legal spend to help that new products and capabilities. So much of that growth is directly attributable to the revenue line you see above. On the compensation line in expenses, much of that is supporting that growth that you see, and as I highlighted in the prepared remarks, we're able to do that in the appropriate type cost centers, with over 80% of our hires being in Manila, Bangalore, and Limerick, and we've also announced now a new operating center that we're starting in Tempe, so we're getting the cost to serve those in the right locations.

Got you, and just in equipment and software?

So the equipment and software line reflects the investment we've made. We do need to, and we do invest in technology and capital. It's an important part of our value proposition to our clients, and that investment has, as we have previously said, led to 7-ish or higher expense growth rate, which is higher than the rest of the expense growth rate, but it reflects the investment in our platforms.

Got it, thanks.

We'll take our next question from Brennan Hawken from UBS.

Quick one on FX. Remarkably strong here quarter-over-quarter, actually a stand out in being up sequentially versus some others who have reported. Can you speak to what drove that strength, and whether or not we should view that as sustainable?

I would highlight two items around that. The first, is our trading results, they don't always exactly align with the broader market trends, as our business is focused on our custody clients and their needs and their unique trading patterns in a quarter. I would also say that we've talked about, in previous quarters, our development and our utilization of FX e-commerce capabilities to provide excellent execution for those clients, but it's also allowed us to enhance our efficiencies through more automation. So we believe that led to some of the performance that you saw in the second quarter

Okay, thanks for that. And then fee waivers came down here, which is certainly encouraging. I know that you all have expressed some concerns about the ability to fully recapture fee waivers. Now that we're getting closer to the Fed actually providing lift-off here on the short-term rates, can you provide an update with your view on fee waivers, and what you think about the potential risks to any recoveries there?

Sure. There's several factors that weigh in the recovery of fee waivers. First will be any pricing that goes on in that market, and our competitive ability to match, or the need to compete in that marketplace. The second is, if you will, is there a sharing with the clients that will go on, or how will that unfold in terms of as the rates rise?

How will we discuss that rise with the clients, and share on the rate up? Obviously the amount and the size of balances in our accounts will also impact the fee waivers as we move forward. We're still waiting for some of that to unfold. I hope you're right, that the rate rise is on the horizon, but we're taking proactive actions to look at this, to model this out, and as we have said, we still think that we will be able to recoup a majority of those fee waivers in a rising rate environment.

Thanks for the color.

We'll now take a question from Ken Usdin from Jefferies.

Biff, I was wondering if you could talk a little bit about the really big growth in the balance sheet, especially led by the deposit side, non-interest bearing, and then your non-US offices. Can you characterize the sources of that? Whether it's coming from other large institutions or it's client driven, and any color on geographic orientation?

It is client driven and it's large deposits held by what you consider to be large asset holders, so our sovereign wealth funds, central banks, all our (technical difficulty) pension client types. It was meaningfully focused in Europe, as you saw on the balance sheet we presented some of their activities as they went through the quarter, looking at their balancing, but it also reflects just growth in our core business, where we've had tremendous success, particularly in Europe.

So if you're presuming that this is mostly client oriented and sticky, can you also then give us an update on reinvestment strategy, where you've taken duration to, and what type of investment yields are you getting on new investments versus what's still running off?

Yes, so Ken, if you look at the balance sheet and other items, you can see that we moved some into interest bearing deposits with banks, so a slightly longer duration than overnight, if they're shorter term CDs, and those monies in there that we felt weren't operational deposits but were in effect some type of excess deposit, we've kept in very short type Bank of England or other type investments in the marketplace. So we have put it to work a little longer for those that we viewed was core operational deposit. What we just described in any of those others that we felt were shorter term in nature we've applied appropriately into more central bank type deposits.

Just within the securities portfolio, any changes in terms of your strategy or reinvestment interest?

I would say our asset sensitivity did not change much sequentially, and it remains, the duration in the portfolio remains very short, around one year. So no significant change there.

Okay, understood. Thank you, Biff.

We'll now take a question from Ashley Serrao from Credit Suisse.

So first question, just on NII, curious if you expect some of the drag from the premium amortization to abate in 3Q, just trying to get a sense of any lags here that we should be mindful of?

As I will highlight here for you, we had about a 2 basis point drag to the NIM in the second quarter, and traditionally in the third quarter, we've seen that improve. However, it is really tied to the underlying mortgages and assets that we hold in that portfolio. It's going to be much more impacted by where the rate environment moves in the quarter, and right now, last quarter, we were in the third quarter, as you would have seen in ours, it was flattish. We'll have to see how that plays out. I think there's other factors too. There's the housing market, there's seasonality and other items that we think about. The second quarter traditionally has a little bit more premium amortization than others.

Okay, and then just on FX, can you just give us some sort of sense of the penetration of your e-commerce FX capabilities? I'm just trying to ultimately understand like how much of this year-over-year improvement is driven by greater penetration or versus some of your unique client trading behavior?

So we continue to try to capture more and more share by bringing the right products and services to our clients. So whether those are electronic solutions or other automated solutions, and we have been successful in that. It's hard for me to attribute exactly how much of the FX performance you saw this quarter was due to that. We have continued to improve our market share with our clients, and we think some of those products and capabilities we're investing in are helping make that difference.

Okay, thanks for taking my questions.

We'll now take a question from Luke Montgomery from Bernstein Research.

Good afternoon. So on the expense to core fees ratio that was down a little bit this quarter, you've put a goal out there of 100%, but I think you also recently said that the progress gets harder to achieve from here. When you think about what inning you are in with the various revenue expense initiatives you have in place, whether that's location strategy, driving down legal and consulting expense, or capturing more third-party FX, do you have a strong sense of the pace and path to getting to that 100% target, and if you assume for example, there's no change in the environment, could you do it in a year, two years?

So I'll start with this. We haven't put a 100% target out there, for a number of reasons. First of all is, if we get to a 100%, that may not be enough with all of the investment that we are making and all of the productivity that we are trying to drive, so we have not stated a public target of 100%. But we're at 107% today, and we have said we want to continue to drive that down, so I'll answer your question in that framework.

It does get a little more difficult, and you need a balance of revenue growth and expense growth, as you've seen, with the leverage we've demonstrated here, to help achieve that. That being said, we do think there are a number of initiatives that are ongoing and still in the first five innings of our game, where we can make more progress, and while we talk about location strategy, there is still a lot of meaningful effort that the bank can do around looking at where it provides services. That's one example of where we can do that. Consolidating platforms and systems, using fewer pricing vendors, there are numerous examples of where we've made progress, and that we think we can continue to drive that ratio down.

Okay, thanks. And then it looks like in C&IS custody fees as a percentage of client assets, that ticked up nicely this quarter. I calculated about 212 basis points. That's the highest it's been in a long time, so I was wondering maybe if you could speak to whether that's business mix, pricing, anything unusual that I'm not considering, and whether you think that could be sustained from here?

It reflects a few items. First, it reflects very strong new business that we have talked about on previous calls, and continues to come in. It's both global and across segments. That's helping drive the majority of that. You do have a full run rate of Bridgewater in this year's, so that is a portion of that versus last year, where we would not have had a full run rate for Bridgewater in that. And I would largely just say that it's the success of the new business momentum across the globe.

Okay, but it's new business, but it's coming on at higher fees as a percentage of assets?

We've seen some of the pricing, while I won't say move far north, we've seen the pricing stabilize across many of those clients, and we think that's helped drive some of the improvement that you see.

Luke, this is Bev. One thing to keep in mind as well is the calculus there, which is custody and fund administration fees to assets under custody. So to the extent that we continue to be successful in growing our global fund services business, which serves asset managers, be they traditional asset managers or hedge funds, that will help the fee line, and that has certainly been a significant contributor to the fee growth there. But it won't be reflected necessarily in the denominator in assets under custody, because what's coming in, in some cases, would be assets under administration.

Okay, got it. Thank you very much.

We'll take our next question from Brian Bedell from Deutsche Bank.

If you can maybe just talk a little bit about the lending strategy, you mentioned the loan growth was very strong. First of all, the charge I assume is coming out of the loan bucket on the average balance sheet. Is that the leasing aircraft lease charge. It looks like the yield was fairly constant on a core basis, so if you can verify that. And then secondarily, if you can talk a little bit about the leverage to higher rates in terms of loan pricing, the lag of resets on both your commercial and residential books to higher rates?

Okay, first as you said, the lease impairment charge, the lease impairment charge was flowed through the NII, and as you rightly said, our loan yield actually was down 2 basis points, driven by mix. So to the first question, the loan strategy there, we have shrunk the residential real estate by approximately 6% quarter over quarter, but if you look at C&I, if you look at commercial real estate and you look at personal loans, which we would typically be secured by the investment assets of our client, all of those had growth rates in the teens up to the mid 20s, so across those portfolios, we had very high growth.

They produced slightly lower yields, because of the secured nature and the credit quality, which is strong in those, so that was 2 basis points of the NIM, and I previously talked about the premium amortization, that's pretty much your 4 basis points of NIM. So that's the loan growth strategy that we've seen, is supplying that into largely our wealth management franchise. Your second question, I think, was around the leverage to rates and movement of rates.

Approximately two-thirds of the portfolio, entire portfolio is floating, and so we will have a positive reaction to that, in that nature. Because our residential real estate is shrinking as you might suspect, that's tied probably closer to the 10 year or something, a 5 to 10 year type rate. That is declining, so it makes it slightly less sensitive to those moves. I would just highlight that roughly two-thirds of the portfolio is floating in nature, and likely to be sensitive to the rate moves.

And do you have a sense of the average lag after rates go up, in terms of those resets on the floating part?

I don't really have that available. I don't know, Bev, if you have that?

I don't, Brian.

Okay, no worries. And just to follow-up would be back to the expenses, and obviously very good traction there. Biff, you talked a little bit about the technology investments, numerous investments that you're making in the platforms. Can you talk a little bit about, to what extent you think over the long term those enhancements are revenue-producing versus just expense reduction?

Well they're both. They are clearly both. Many of these are investments, for instance, in technology that will allow our wealth partners to be able to deliver services and capabilities to our clients in a more effective and holistic manner. Others are, quite frankly, investments in processing platforms, that will allow us to be more efficient. So it is a blend of those that we believe will generate ultimately revenue, and those that generate operating efficiencies, and it is not just an operating efficiency-type investment for those technologies.

So that would dovetail with the comments of getting that 107%, continue to drive the 107% down, even in the near term?

Yes.

Okay, thank you.

We'll now take a question from Geoffrey Elliott from Autonomous Research.

On the money market fee waivers, why are they down this quarter?

So money market fee waivers were down for two reasons in the quarter. One was primarily because the yields are up and short-term rates have risen, if you look across overnight repo rates in particular moving up, so that's one factor, and we had slightly lower cash balances in those funds available. So the combination of those two were the drivers, but I would highlight that rate, the short end of the rate curve moving up does help produce lower fee waivers.

And does the fact that you've been able to get a bit of a benefit from a very small move in the short end of the curve, does that give you more confidence on your ability to recapture a higher proportion of the fee waivers, or is it still too early to tell?

I would describe it as too early to tell, because I think we need to see probably a more pronounced move, as opposed to the 1 to 2 to 3 basis point type moves we've seen, that likely will come with any kind of central bank action that may move rates up.

Great, thank you.

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

What caused the changes in the fee arrangements in sec lending? How broad-based was that? Was that part of a broad change across the whole book? Just curious on how that unfolded.

The competitive nature in securities lending means the we revisit the securities lending fee splits with all of our clients on a regular basis, and it remains competitive around fee splits, and we negotiate those and have dialogues with our clients on those, on a regular basis. We have seen it move modestly against the trend, meaning more is returned to our clients than ourselves in the fee splits, but it's relatively modest. It's just a competitive marketplace.

And Glenn, one thing I would add to that is it's not just the fee splits on specific clients, but it's also the proportion of revenue that we earn from different clients. And to the extent that we have a mix shift with the clients, then it could be that the overall fee split would come down, so mix plays a role in that as well.

And is that something that will take a few quarters to annualize, if you will, meaning, this quarter it shows up in your year-on-year number. Next quarter we should look to see that flow through on a year-on-year number as well?

That's a reasonable assumption, I think, Glenn.

Okay. And then just one other one was, I'm curious, the global family office has been growing at a much better pace than the regions. I don't know if that's a smaller base thing, or if there are specific things you're doing to put more resources at it? Just curious if you could talk towards that.

I would say a couple items I would highlight there is one, these are ultra high net worth family offices and others, and they tend to be chunkier in the nature of their growth, so they have very big opportunities, they come in very large size, and we have a very strong market position, in this space in particular. We have a strong position across all of our wealth management franchise, but in this area in particular, it leverages the technology that we talk about in the institutional space significantly, as many of these clients can and often look very similar to institutional investors. And so it growing similar to what you saw on the corporate and institutional side is probably not coincidental.

Okay, I follow that, thank you.

We'll now take a question from Adam Beatty from Bank of America Merrill Lynch.

Just wanted to ask about some of the equity index rebalancing by sovereign. Seems like a bit of a theme this quarter. What's your sense of what types of products, where that money went, types of products either Northern Trust or other firms, or whether it was a source of liquidity for your client? Thanks.

I don't want to speculate on all of the places, but I think they were all rebalancing from asset classes and equity, as you saw, for perhaps different reasons. It could have been their own liquidity needs, it could have been that they felt that the equity market had had a very strong run. And then third, I would say is, as you know, passive management has outperformed active over the most recent periods, and some may be taking a view that in this next environment, where perhaps we don't see the same type of heady growth, that active would begin to outperform passive. So I won't speculate any further on what their decision-making process was, but I think those three items were probably in the decision process for many of our clients.

Great, that's helpful, thanks. And I also wanted to ask about engineered equity solutions, which you highlighted as an important and growing part of your business. What's the level of interest you're seeing currently there? What kind of fee rates do you get around that business, and what's the growth outlook looking like, right now? Thank you.

We're having great dialogues and great conversations. We had a significant win in Europe around that product and capability, and we continue to have dialogues with both our wealth and our institutional clients in this space. The take up is very high, and the market, we feel, is very intellectually curious about this product and capability right now. The fee rate really ranges based on the complexity of the instrument that we're talking about. I know this won't give you all the guidance you want, and we don't give guidance, but it's certainly north of traditional passive management, and somewhere less than you would see in an active spread, and then that depends on the complexity of the product, where it is, closer to equity type -- active equity type pricing or more passive type pricing.

Got it. Much appreciated, thank you.

We will take our next question from Jim Mitchell from Buckingham Research.

Just another follow-up on the balance sheet. You guys obviously saw some strong deposit growth, and I'm just trying to get a sense of, or do you get a sense that you're grabbing some share from more leverage constrained competitors who are trying to push deposits off the balance sheet, and just want to get your thought on that, and if you view that as a long term market share opportunity, to grab some of these deposits, because you're much less leverage constrained? Thanks.

So we certainly see clients that are approaching us because of discussions they've had elsewhere around the use of other's balance sheets. I would say that we're taking a transaction by transaction approach to that, and looking at the overall breadth and nature of the relationship we can attain with those deposits, before we take -- and I'm speaking of very large deposits here, before we take those on. So if it's an opportunity, let's say a hedge fund has $1 billion, we will want to dialogue about what the other opportunities are with them, other than what we would say is a very transactional oriented deposit, or a very rate-sensitive deposit. And we're actively pursuing those in terms of deal by deal, excuse me when I said, we're looking at those deal by deal.

Okay, that's helpful. And maybe just a follow-up on wealth management. Just curious, the central region saw revenues that were down, while most others were up. So just, was there something unusual in that line item?

There were, in the first quarter, there were certain tax-related fees that were accrued in the central region. We adjusted those in the second quarter, and allocated those out amongst the other regions so it created what would appear to be a negative growth rate for the central region sequentially.

Okay, but the total number is, I guess, fine, it's just how it was allocated in the quarter?

Total number is fine.

Okay, thank you.

We'll now take a question from Gerard Cassidy from RBC.

Thank you. Can you share with us, you mentioned that you had some very good strong deposit growth in Europe. For the European deposits that had negative interest rates due to the central bank policies in certain countries over there, were those new deposits brought on with the customers having to pay you guys to hold the deposits?

So the answer to that would depend on the currency in which those deposits came in. In the Swiss, Swedish, Danish, and Euro market the answer to that would be yes. Not in Sterling, but in the other currencies, the answer to that would be yes. We've moved to negative rates in the currencies I discussed.

Okay, so that's the existing customers and the new ones that came in as well, correct?

It would be both.

Okay good. And second, and this is more longer term. It was decided that they were not going to include selected Chinese stocks in the MSCI world indexes. Should that happen at some point in the future, is that an opportunity for you guys to see a bump in the index funds and everybody having to move to buy those securities to match the MSCI world indexes, and to drive revenues for a quarter or two, as they even out to the new weightings?

We haven't factored that in. That would make intuitive sense, that there could be a bump with the purchase of those securities in there, but I wouldn't be able to give you any indication of what the magnitude of that impact would be for us.

Great. I appreciate it. Thank you.

We'll now take a question from Mike Mayo from CLSA.

Can you elaborate more on the increase in demand in other non-interest bearing deposits? What is that, and why is it going up so much?

It's generally just growth in the business, and growth in our clients, both domestically and internationally, and some probably have some temporary nature to it, but the majority of it is operating oriented deposits that's reflective of our success across the regions.

Could you make it a little bit more concrete, because these aren't the interest bearing deposits. It's not savings and money market or that category, and it's a little bit further down in your liability and stockholders' equity category. Just any one concrete example would be helpful because it's up one-third year over year, and up a couple billion just linked quarter.

Yes, I mean, there is clients that are large fund clients or others that have put large balances with us, because the nature of perhaps we have a GFS relationship or some other, where it will not be interest bearing. They have just left the funds cash, or some other portion of that cash on our balance sheet, and we were trying to determine the interest rate sensitivity to those as we enter a rising rate environment, but it's probably large GFS or our asset manager-type clients, where that balance has grown.

And just preliminarily, how sticky do you think those deposits are? Do those flee with higher rates or what?

So the operational component clearly won't, Mike, but we think it will be reasonably rate-sensitive, as rates rise.

Okay, and redeploying those funds because it went up so much, I guess you put a bit more into securities. Is that the main usage of these additional funds?

So most of it is in deposits with banks, as you would see. I don't know that we've put -- our securities portfolio has both long and short-term components to it, and some could be in the very short-term components of the securities portfolio.

All right, thank you.

We'll now take a question from Vivek Juneja from JPMorgan.

Just to follow-up on the question that was asked earlier about deposits from being shared by other banks. So did you actually see, did any of the growth this quarter come from that?

A modest amount really came from what we would say were out flow from others. Most of it was really either our existing clients increasing their balances with us, or just growth in general from our franchise. So there are probably some modest amount of that, but most of it was just core growth.

Okay, and one last thing, just your timing on when you're planning to start disclosing, Bev, what you referred to earlier as the assets under custody and administration?

Vivek, that's something that we continue to work on, and to make sure we have everything aligned internally to get to the point where we want to do public disclosure of that, so it's something that we continue to work on.

Why is it taking so long, since you've been talking about it for a while now?

Vivek, I think we want to make sure that we have this right for not only reporting here, but for SEC reporting, and all of the other documentation that's important to go around it. And we continue to invest in it, and we'll move it forward when it's ready to be moved forward.

Because I'm sure you track this yourselves, so it's a little surprising that you've been talking for so long and it's not yet out.

Internal management reporting, however, is different than external. When we're ready to move it forward we will.

Thanks.

We'll take a question now from Brian Kleinhanzl from KBW.

I just had a quick question on your opening comments about the advanced approaches and the Fed checking the model. I was curious as to why you mentioned that. Is there something imminent? I know the Fed's always reviewing those models, so have you had recent communication or something that would indicate that there's going to be changes coming soon?

No. That's a standard statement, but as we evaluate our models under the advanced approaches, any change in the parameters of the models themselves can produce changes in our advanced approaches ratio so we cover that off with that statement, to acknowledge that particularly things around operational risk, for instance, could be changed with different parameters, or different events being in the database could change those numbers in any given quarter.

But just to emphasize, our commentary this quarter was no different than it had been for the last several quarters.

Okay, and then just a follow-up question. On those remaining Visa shares, could you walk through the internal thought process on when you sell those? It sounds like it represents about 8% of your tangible equity there?

So the decision this quarter was clearly an investment decision that we took as an organization. We have not sold any Visa shares, any of our Class B shares held to date, but we've seen a meaningful increase in the Visa stock over that period of time, and felt it was time to monetize, if you will, a portion of our gain. So we do still have remaining post sale about 5.23 million Class B shares, and that at today's conversion rate is about 8.6 million A shares. At this point, we make investment decisions on a regular basis, and we will evaluate those on a regular basis.

Okay, thanks very much.

With no more questions currently in the queue, I'd like to turn the conference back over to today's moderators for any additional or closing remarks.

Well thank you, Lisa and thank you all for joining us today. We look forward to speaking with you after we report third-quarter results in the month of October, if not sooner. Thank you so much. Have a good day.

Thanks.

Ladies and gentlemen, this does conclude today's conference and we do thank you for your participation.