Northern Trust Corp (NTRSO) 2015 Q4 法說會逐字稿

Good day, everyone, and welcome to the Northern Trust Corporation fourth-quarter 2015 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, ma'am.

Thank you, Zach. Good morning, everyone, and welcome to Northern Trust Corporation's fourth-quarter 2015 earnings conference call. Joining me on our call this morning are Biff Bowman, our Chief financial Officer; Jane Karpinski, our Controller; and Kelly Moen from our Investor Relations team.

For those of you who did not receive our fourth-quarter earnings press release and financial trends report by email 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 January 20 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 February 18. 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 the 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 10K 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.

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

Good morning, everyone. Let me join Bev in welcoming you to Northern Trust's fourth-quarter 2015 earnings conference call. Today I will review our results for the quarter and the year, 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 fourth-quarter net income of $239 million. Earnings per share were $0.99 and our return on common equity was 11.1%. A number of environmental factors impact our businesses as well as our clients. Let me review how some of those factors unfolded during the quarter.

Equity markets were lower year over year but higher sequentially. In US markets, the S&P 500 was down 1% year over year and up 6.5% sequentially. In international markets, the MSCI EAFA Index was down about 3% year over year and up 4.4% sequentially, with the year-over-year decline being driven by the impact of a stronger US dollar. Recall too that some of our fees are based on lagged market values and the third-quarter 2015 markets were generally lower.

In bond markets, the Barclays US aggregate index was lower both year over year and sequentially. Currency volatility as measured by the G7 index was 11% higher than the fourth quarter of last year. In the sequential comparison, currency volatility was 4% lower.

Foreign exchange market volumes as measured by two of the inner bank brokers, were down over 20% year over year and down about 13% sequentially. You will recall that currency volatility and client activity influenced our foreign exchange trading income. Currency rates influenced the translation of non-US currencies to the US dollar and therefore impact client assets and certain 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 was stronger against most major currencies except the Australian dollar and Swedish kroner.

US short-term interest rates rose on the heals of the first Federal Reserve rate increase in nearly a decade. Three-month LIBOR and the Fed funds effective rate averaged 41 and 16 basis points respectively, both higher sequentially. The overnight repo rate was also higher, averaging 22 basis points in the quarter.

Before I move to the highlights of the quarter, allow me to mention one item discussed in our press release. In the fourth quarter we sold approximately $550 million of non-strategic leases and loans for a net gain of $26 million. We also wrote down by approximately $27 million certain held-for-sale leases which had a book value of $112 million at year end. The net effect of these two items on other operating income was essentially nil.

Let's move to page 3 and review the financial highlights of the fourth quarter. Year-over-year revenue increased 2%, with non-interest income essentially unchanged and net interest income up 9%. Expenses increased 6%.

The provision for credit losses was a credit of $18.5 million in the quarter, reflecting a change in the estimation methodology for inherent losses and improving credit quality. I'll explain the methodology change later on this call.

Net income was 2% lower year over year. In the sequential comparison, revenue was essentially flat, with non-interest income down 2% and net interest income up 8%. Expenses increased 2%. Net income was 2% higher sequentially.

Client assets under custody of $6.1 trillion increased 2% both year over year and sequentially. In the year-over-year comparison strong new business was partially offset by the currency translation impact of a strong dollar. In the sequential quarter comparison, favorable equity markets and new business were partially offset by the impact of a stronger dollar against most major currencies.

Assets under management were $875 billion, down 6% year over year. A decline in equity assets was the primary driver due primarily to outflows from certain sovereign wealth fund clients in light of economic conditions in their regions, a continuation of the trend we mentioned last quarter. In addition, fixed income assets were lower year over year primarily due to the loss of one sizeable passive mandate from a non-US institutional client which I mentioned last quarter. Assets under management decreased 1% sequentially primarily driven by lower securities lending collateral.

Let's look at the results in greater detail starting with revenue on page 4. Fourth-quarter revenue on a fully taxable equivalent basis was approximately $1.2 billion, up 2% year over year and unchanged sequentially. Trust investment and other servicing fees represent the largest component of our revenue and were $747 million in the fourth quarter, up 3% year over year and essentially unchanged sequentially.

New business and lower money market mutual fund waivers were the primary drivers of year-over-year growth, with currency translation as I mentioned earlier, detracting from overall fee growth by about 1 percentage point. Fee waivers were approximately $20.5 million in the fourth quarter, lower by $12.5 million year over year and $7 million sequentially. I'll go into further detail on trust and investment fees shortly.

Foreign exchange trading income was $53 million in the fourth quarter, down 13% year over year and 16% sequentially. Lower client volumes drove the year-over-year decline while the sequential decline reflects lower volumes and volatility.

Other non-interest income was $68 million in the fourth quarter, down 12% from last year and down 9% sequentially. The primary driver of the decline was other operating income which at $33 million was 20% lower year over year and 13% lower sequentially, reflecting decreases in various categories.

In the year-over-year comparison recall that the fourth quarter of 2014 included two quarters of income associated with a third-party servicing agreement which was modified in late 2014. Net interest income, which I will discuss in more detail later, was $296 million in the fourth quarter, increasing 9% year over year and 8% sequentially.

Let's look at the components of our trust and investment fees on page 5. For our corporate and institutional services business, fees totaled $428 million in the fourth quarter, up 5% year over year and essentially unchanged sequentially. Custody and fund administration fees, the largest component of CNIS fees, were $286 million in the fourth quarter, up 2% year over year and down 3% sequentially, while assets under custody for C&IS clients were $5.6 trillion at quarter end, up 2% both year over year and sequentially.

The year-over-year growth in custody and fund administration fees primarily reflects new business partially offset by the unfavorable currency translation impact of a stronger US dollar. In the sequential comparison, new business was more than offset by lower quarter-lag equity markets, lower transaction volumes and unfavorable currency translation.

Investment management fees in C&IS of $86 million in the fourth quarter were up 10% year over year and 4% sequentially, driven in large part by lower money market mutual fund fee waivers. Fee waivers in C&IS were $8 million, lower by $9 million year over year and $4 million sequentially, driven primarily by higher gross yields in the funds. Assets under management for C&IS clients were $648 billion, down 9% year over year and 2% sequentially, primarily reflecting outflows that I mentioned earlier.

Securities lending fees were $22 million in the fourth quarter, 3% higher than last year and 13% higher sequentially, primarily reflecting higher spreads. Securities lending collateral was $104 billion at year end but averaged $124 billion across the quarter. Average collateral levels increased 3% year over year and 1% sequentially.

Other fees in C&IS were $34 million in the fourth quarter, up 19% year over year and 1% sequentially, reflecting higher fees from investment risk and analytical servers and benefit payments. The year-over-year increase also reflects higher sub-advisory fees.

Moving to our wealth management business, trust investment and other servicing fees were $319 million in the fourth quarter, essentially unchanged both year over year and sequentially. In both comparisons, new business and lower money market mutual fund fee waivers were offset by the impact of unfavorable lagged markets.

Money market mutual fund fee waivers in wealth management totaled $13 million in the current quarter, down $4 million year over year and $3 million sequentially, primarily reflecting higher gross yields in the underlying funds. Assets under management for wealth management clients were $227 billion at year end, up 1% both year over year and sequentially.

Moving to page 6. Net interest income was $296 million in the fourth quarter, up 9% year over year and up 8% compared to the third quarter. Growth was driven by a higher level of earning assets and a higher net interest margin.

Earning assets averaged $106 billion in the quarter, up 6% versus last year and 5% sequentially. In both comparisons driven in part by the level of client demand deposits which averaged $26 billion, up 20% year over year and 7% sequentially.

We saw solid loan growth again this quarter. Loan balances averaged $34 billion in the fourth quarter, up 8% year over year and 2% sequentially.

The net interest margin was 1.11% in the fourth quarter, up 3 basis points both year over year and sequentially. The improvement in the net interest margin primarily reflects a higher yield on the securities portfolio due to lower premium amortization in our mortgage-backed portfolio. Premium amortization was less than $1 million in the fourth quarter compared to $14 million in the third quarter and $7 million one year ago.

Turning to Page 7. Expenses were $825 million in the fourth quarter, up 6% year over year and 2% sequentially. Compensation expense of $366 million increased 3% year over year primarily reflecting staff growth and the impact of annual base pay adjustments, partially offset by the favorable translation impact of changes in currency rates and a lower accrual for incentive compensation.

Staff levels increased approximately 5% year over year with more than 85% of the growth emanating from our global operating centers in Bangalore, Manila and Limerick and our newest operating center in Tempe, Arizona. On a sequential basis compensation expense increased 1%, primarily reflecting staff growth.

Employee benefit expense of $69 million increased 11% year over year, reflecting higher pension expense and employee medical expense. On a sequential-quarter basis, employee benefit expense decreased 1% due primarily to seasonally lower payroll taxes.

Outside services expense of $155 million was 8% higher year over year. The increase primarily reflects higher technical services expense and higher consulting expense due to evolving regulatory requirements. Outside services expense declined 2% sequentially, primarily reflecting lower third-party sub-advisory expense.

Equipment and software expense of $117 million was up 13% year over year and 3% sequentially, primarily reflecting higher software-related costs in support of client and regulatory technology initiatives. Higher depreciation expense also contributed to the sequential increase. Other operating expense of $74 million increased 5% year over year and 14% sequentially, primarily driven by higher business promotion expense and other miscellaneous expenses.

The effective income tax rate in the fourth quarter was 31.7%. Our fourth-quarter results include a $5.5 million income tax benefit related to our decision to reinvest the earnings of certain additional foreign subsidiaries indefinitely outside the United States. This decision under APB Opinion Number 23 reflects the continued growth and success of our business outside the US and is consistent with similar assertions made in the past. Excluding this income tax benefit, the effective tax rate was 33.6% and earnings per share were $0.96.

As I mentioned earlier, our loan loss provision was a credit of $18.5 million in the fourth quarter. This reflects not only improving credit quality as evidenced by a 9% or $19 million sequential reduction in non-performing assets, but also a change effective December 31 in our methodology for estimating inherent losses.

The new estimation methodology is more quantitatively focused and leverages work developed for regulatory purposes. This change resulted in a decrease in the inherent loss estimate for commercial and institutional loan portfolio, partially offset by an increase in the allowance for off balance sheet commitments.

Turning to the full year, our results in 2015 are summarized on page 8. Net income was $974 million and earnings per share were $3.99, both up 20% compared with 2014. During 2015 we recorded a $99.9 million gain on the sale of a portion of our holdings in Visa shares, a $45.8 million charge for voluntary cash contributions to certain constant dollars NAV funds and a lease impairment of $17.8 million.

Excluding these items, net income was $951 million and earnings per share were $3.90. We achieved a return on equity for the year of 11.5%, adjusted for the items I just noted, better than 10% in 2014 and within our target range of 10% to 15%.

Full year revenue and expense trends are outlined on page 9. Trust investment and other servicing fees grew 5% in 2015. New business across segments and geographies contributed to this result.

Foreign exchange trading income increased 25%, primarily reflecting higher currency volatility. Net interest income increased 6%, primarily driven by 7% growth in earning assets. The net result was 8% growth in overall revenue in 2015. Expenses were 5% higher in 2015 reflecting investments in staffing and technology to support the growth of the business, as well as to comply with evolving regulatory requirements.

Turning to page 10. A key focus has been on sustainably enhancing profitability and returns. This slide reflects the progress we have made in recent years to improve the expenses-to-fees ratio, pretax margin and ultimately our return on equity.

The ratio of expenses to trust and investment fees is a particularly important measure of our progress, as it addresses what we can most directly control. Reducing this measure from 131% in 2011 to 110% in 2015 has been a key contributor to the improvement in our return on equity from 8.6% to 11.5% across the same time period. This metric remains an important barometer of our progress and we remain committed to lowering it on a sustainable basis going forward.

Turning to page 11. Our capital ratios remain solid with common equity tier 1 ratios of 11.9% and 10.8%, 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 11.5% and under the standardized approach would be approximately 10.5%. 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 6.2% 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 90% minimum requirement effective as of January 1, 2016 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 fourth quarter we repurchased 2.1 million shares at a cost of $152 million. Our 2015 capital plan provides for the repurchase of up to an additional 285 million of common stock through June 2016. For the full year we returned $830 million in capital to shareholders via common dividends of $333 million and share repurchases of $497 million. Our total pay out ratio for the year was 87% which we believe continues to position Northern Trust among the highest rates of capital return across large US banks.

In closing, in 2015, we continue to grow the firm profitably for our shareholders, deliver comprehensive solutions for our clients and improve our technology and infrastructure to insure the sustainability of our momentum. From a financial perspective, we delivered an 11.5% return on equity for the full year, moving further into our target range of 10% to 15%. In addition, we returned $830 million to our shareholders through dividends and stock repurchases while maintaining strong capital and liquidity levels.

Our C&IS business delivered strong profitable growth in 2015. New business success was balanced both globally and across client and product types.

During the year, C&IS introduced several new or enhanced capabilities for its clients. For example, we launched our complete FX service and outsourced foreign exchange execution service for investment managers which provides flexible execution options and operational efficiency.

We also announced the agreement to acquire Aviate Global LLP, an institutional-focused equity brokerage firm which will expand our existing capabilities to the EMEA and APAC regions. Our wealth management business grew revenues 4% year over year and continued to produce attractive margins, achieving a pretax margin for the year of 36%.

Product innovation and support of our personal clients continued in 2015. For an example, in response to an increase in demand for art advisory services and how art fits in a client's asset allocation, we have expanded our expertise in providing leverage against collections to preserve liquidity in a client's portfolio and estate.

Also in 2015 we implemented a first-generation bank-by-text platform. Clients are now able to check balances, view their net worth summary, transfer money, locate ATMs and perform other frequently used banking functions via text on their mobile devices.

Our asset management business also has been successful in creating innovative client solutions. We expect to launch soon a new generation of target date funds designed to improve retirement outcomes by leveraging our engineered equity expertise.

Lastly, our investment in technology and infrastructure facilitated the growth we produced in 2015. An example of our investment was acknowledged in December when we were awarded Best Cloud and Best Analytical Initiatives by Waters Magazine which recognizes financial services technology excellence.

Thank you again for participating in Northern Trust's fourth-quarter earnings conference call today. Bev and I would be happy to answer your questions. Zach, please open the line.

(Operator Instructions)

We'll take our first question from Adam Beatty of Bank of America.

Thank you and good morning. Wanted to get some color on AUM flows, particularly on the wealth management side. Maybe you could provide some detail around what you're seeing in terms of equity and fixed income. And also maybe a comment on trend within the quarter, whether December was significantly worse or pretty much run rate. Thank you.

Thank you. When we look at our wealth management AUM, what we have continued to see is movement from equity and other higher-yielding products into lower basis point products over the cycle. That's been true for the whole year. I think that trend continued at about the same pace in the fourth quarter. So as clients look at their portfolios, the movement from equity into passive solutions and/or lower basis point yielding products continued throughout the quarter.

Great, thank you. And a follow-up on the money market fee waivers. Short rates came up significantly mid quarter. Was wondering either what the run rate looked like at the end of the quarter or whether you would expect continuing diminution of the waivers? Thanks.

We saw the gross yields in many of our funds improve with the short rate movement. I would position that as it was later in the quarter, not the mid point in the quarter, but tended to occur more in December and then throughout December.

So we certainly saw the waivers abate meaningfully throughout the month of December. And the run rate of waivers, the diminution that you talked about, really occurred the week or two before the Fed announcement and then post that we began to see the gross yields and funds move up meaningfully. So the waiver rate was very back-loaded in the quarter.

That's helpful, much appreciated.

We'll take our next question from Luke Montgomery with Bernstein Research.

Hey, good morning. A quick question on the NIM expansion. Looks like the yield on Fed deposits seems to have benefited from the Fed hike, so similar to the money market question. Am I right to think that if you run rate that for the full quarter the dynamic would be a tailwind for Q1? And then also it seems like the biggest driver this quarter was the spike in the GSE book, the yields there. You cited the premium amortization, so maybe you could remind me if that's a one-off benefit that goes away next quarter and what the NIM was excluding that benefit?

Let me address the Fed first. Your analysis is correct, we benefited obviously from a brief two weeks of that. And you can project the forward benefit of that going forward in your models.

In terms of the securities portfolio improvement, if you will, in the spread, that was driven by -- the premium amortization that you described was a meaningful component of that during the period. It has some seasonality but it's more impacted by factors such as movement in the housing market and/or rates in any given period. We do typically see a slowdown in housing activity in the fourth quarter.

We generally have better amortization in that period, if you will. But as we mentioned in the script, in the first part of the prepared remarks, it was slightly larger than last year's, or more than slightly. It was about $13 million difference quarter over quarter.

Okay, great, thanks. And then a question on what you're seeing in credit quality. It looks the markets pricing a recession here. You released reserves for the fourth quarter in a row and net charge-offs are near historical lows.

I wondered if underneath that you're seeing signs of stress at all. And I think maybe ask it in a leading way, period-end loan balances ticked down for the first time in over two years. I know you called out that the loan sales but I'm wondering if you're getting a little tighter about extending credit, given your outlook on the environment? Or is that just reading too much into it?

You might be reading a little too much into it. Some of it was the $550 million of loans and leases that ran off during the period, so that's a portion of it.

In terms of our own credit quality, it's important to remember this: our mix in our credit portfolio, as we have slowed or we have negative growth if you will in residential real estate, the growth is largely coming from areas that are investment account secured or large C&I-type loans where the credit quality remains very robust and very strong right now. The mix in our portfolio has driven improvement in the overall credit quality.

I think we referenced the 9% sequential improvement in non-performing assets. And I think on a year-over-year basis the non-performing assets were closer to 19% better. We have experienced strength in our own credit portfolio.

Okay, thanks very much.

We'll go next to Marty Mosby with Vining Sparks.

Hey, Bev, good morning.

Good morning, Marty.

Wanted to ask you a question again, if you look at the rate-sensitive pieces that were favorable this quarter, if you back out the $13 million from the prepayment speeds, about $8 million net impact on NII and about $7 million on waived fees. Thinking that's about a total of $15 million but yet only really a month out of our quarter, you can move that up to be about $45 million in total once you get to the full run rate. Just want to make sure I was looking at that right.

You have that and you also have to look at volume and consider volume in there. But your math is accurate.

Okay. And then the other question was when you look at the balance sheet, inflows of deposits, especially non-interest bearing deposits, were really still very strong. So your cash position continued to expand and securities came down a little bit. You've been trying to do the other which has put more securities on utilizing. Given what you've seen in deposit characteristics, do you feel comfortable you can still expand securities faster so that you can bring some of that cash position down going forward through 2016?

Yes, the growth in those deposits can often be lumpy, if we get significantly high deposits from hedge funds and/or endowments or other large institutional-type deposits. And we have, particularly at near period ends, we will typically place that at the Fed. Over a long period of time the migration, and looking at our ability to move some of those into the securities portfolio, remains something that our asset liability committee is focused on. We do believe we can do that. In any given short time period we may have the need to put those with the Fed and that helps with the LCR as well.

Thank you.

We will go next to Glenn Schorr with Evercore ISI.

Hey there. I want to be careful and not overly focus on one quarter because the full-year revenue expense relationship was good. And as you pointed out the expense-to-trust fee relationship continued to improve.

But if you look at the quarter specifically, I think some people worried that there's a little bit of a reversal of trend. Some of the expense items you pointed out are higher and the ratio gave back a little bit.

I'm more looking for a higher level comment of how much of that is just one quarter in the fourth quarter specifically. I know the market's breaking down but as a general comment, should we continue to look for that relationship to improve? Because it feels like some of the expense items are elevating.

Yes, thanks. We still think of the expense-to-fees ratio. It's an important barometer of our progress towards sustainably improving profitability and returns. And we remain committed to improving that ratio.

But as you noted, in the short term and on a quarterly progress there can be a variety of factors. I would say, Glenn, as you pointed out on an annualized basis we've improved that since 2011 every year. We, like I said, remain committed to that improvement.

Also, there is a numerator and a denominator in that equation, in that ratio, as you know. And a difficult macro environment certainly makes the pace at which we can improve that challenging, particularly if you look across a very short time frame, like a quarter.

We're focused on the areas that we can drive that and that's new business on the top line and fee growth on the top line. And the success continues there, very strong new business results for the firm.

On the expense side, on the denominator, if you will -- or excuse me in the numerator on the expense side, we've got several initiatives that we continue to work on: our location strategy, procurement optimization, technology optimization. Those are still in force and still moving at pace. You see some of that investment in our equipment and software line. And the depreciation, we hope has long-term benefits for us.

A little longer answer but it's the question that I know that matters there. We are committed to continuing to drive that ratio down. As fee growth slows, we have to recalibrate our business to address that on the expense side.

Yes, understood and appreciate the one quarter versus one year. The only related follow-up I have is when you look at expense items that you lined up between employee-related stuff, outside services, equipment, on a gross dollar basis, are those the best guesstimates we have for a starting point for the year? Is there any seasonal component that we should be thinking about?

We have some seasonal components in the first quarter around other expense which is business promotion around the Northern Trust Open. And there is some modest compensation, first-quarter impacts from what we set our compensation awards. The Northern Trust Open being -- the business promotion being -- probably the most seasonal of those expenses. The rest are relatively balanced and is a good launch point.

Okay, thanks so much.

We'll go next to Brennan Hawken with UBS.

Yes, thanks for taking the question. Following up on Glenn's question there on the expense front, if we continue to see these difficult market conditions, downward pressure in equity markets and the like, can you talk about how you think about your expense flexibility? How you're approaching your budgeting process this year? Obviously you've got some pressure on the regulatory front as you've laid out some of those line items, so how do you balance all of that?

Sure. Parts of our business, as you know, are -- on the expense side are actually also tied to market levels. So we have a natural movement either up or down based on market levels. So there's a component in our expense base that moves relative to those markets. So it's not all fixed cost, if you will, into our expense base.

As we think about the year going forward, we certainly run multiple iterations of macro factors impacting our business, such as markets up X or down X, rate hikes coming or not coming and we run multiple iterations. We try very hard to run our business without macro factors being major inputs to the success of the firm's business going forward which means we are not overly reliant on either rates or markets in any given period. And so that's how we build our process. We hope that not being overly reliant allows us to be flexible in our ability to react to large macro events, particularly in your question, on the expense side.

Okay. Is it paraphrasing it correctly, Biff, here, to say that you feel good about your expense flexibility? And you feel like you've embedded some in your budgeting process? Am I taking too much of a leap there?

I would phrase it this way. I would say that part of our expense base is variable based on market levels. Part is we have access to maneuver that in this environment. And part is, quite frankly, investment that needs to continue to support the growth on the new business side.

It's parts of all three of your question are true in that. We don't have complete flexibility on the expense side. It's not a 100% variable expense base.

Sure. Okay, thanks for the color, Biff. And then one question, if it's possible for you to give us a little more color on the change of methodology for the provision and how much of that credit and provision we should assume is one-time. Does this mean that there would be less credits running through that line on a go-forward basis due to the change in methodology?

I think you mentioned it was a regulatory issue driving it or feedback from regulators. If you could give a little more color there, that would be great.

I'll start with that last statement. It was not the regulators driving it. It was our use of the models and methodologies we use in CCAR to help guide us, to help build this model to drive our loan loss reserve policy. It was not something the regulators drove us to do.

I will give you a little bit of color. At December 31, that was the first time that we applied the new methodology and it produced the $18.5 million release that you talked about. Your characterization of we've now set that baseline and that's established and in any given quarter based on the credit quality and the factors that we look at from the model perspective, we will see provision or release based on that modeled approach going forward. But it certainly was one quarter where we employed the methodology and got the number to at least a level that allows us to move forward based on how the actual credit quality and other factors are moving in the future. So we rebased, if you will.

Got it, thanks a lot.

We'll go next to Ken Usdin with Jefferies.

Hi, Biff, how are you?

Good, Ken.

Biff, can I ask a question about the interchange between NII and fees? Specifically, you had another outstanding growth quarter for the size of the balance sheet. And I'm wondering, can you talk us through the inflows that you're continuing to see into deposits? Is that new client money? Is it flight to safety?

Or is it money coming out of your existing clients and maybe showing up in NII but not so much showing up in fees? Just trying to get the interplay between money flows across the franchise. Is it a net positive or is it more of a hedge against the total revenue?

I would describe it as primarily driven by growth in our organic business underlying. So these clients may come to us and become a global fund services client and use our firm for fee-based services and then place an additional $1 billion deposit with us after that relationship has strengthened over time. So it adds, if you will, to the deposit base and I would say that they're linked.

There are some deposits that are probably a flight to safety but I would not say that's the majority of what we've seen in our growth. Most are existing clients and other fee-based lines in the firm. And in fact, what I would add is generally we have not taken on large deposits that we've talked about, if they don't have broader relationships because the return dynamic is less attractive.

And then my follow-up. If you could split the businesses for a second and just talk about, then, any changes in either the pipelines or client activity that you're seeing given the sentiment change that we've witnessed now for going on a couple months in the marketplace? If you can disaggregate that into the C&IS components and wealth management.

I'll start with C&IS. The pipeline remains very strong. When I say that, it's really globally strong, strength in Asia particularly in Australia and other parts of Asia. In Europe very strong demand in pipeline there. And then in the US, a balanced pipeline between our global funds services business, servicing asset managers and institutional investors, as we call them, think pensions, foundations, endowments, et cetera. A very balanced set of existing wins and pipelines in both of those businesses.

On the wealth side, we talked about our investment in certain markets, in Texas and Houston specifically, and New York. I can say that both of those experienced meaningful outsized growth versus the rest of the wealth management franchise. So that investment in their pipeline in those regions is very important. We made a key hire we announced in New York just this week, or the 11th we announced. I would say both pipelines are very, very solid and we feel good about the pipelines.

Okay, thank you, Biff.

We'll go next to Brian Bedell with Deutsche Bank.

Hi, good morning, folks. Biff, can you comment a little bit more about the passive investing gains that we're seeing? And maybe across your wealth management franchise, how are some of the recommendations to clients changing? Are you recommending passive strategies over active?

And then on the new target date funds, are those going to be invested in Northern Trust passive products or active? And the risk posture of the wealth management client base, how you're recommending allocations in this market.

We have a very robust IPC committee, and investment policy committee, made up of professionals from our asset management expertise. And Katie Nixon on the wealth management side looks at a diversified investment portfolio for our wealth clients which does make tactical asset allocations during any given period but is largely a well-diversified portfolio across all array of investments.

When you ask the question about passive versus active, it's really a question around diversified versus commitments to large components. You can get large cap equity exposure through active or passive but it's about being diversified across that portfolio mix that's important.

That's a very independent committee that helps make that decision for our clients. They do make some tactical decisions if they are concerned about a region or an asset class but they generally stick to what I would say is a very well diversified global portfolio mix for the clients.

Is that shifting more towards passive only because, in a legacy basis, it may have been more active? Or not necessarily?

It may not. But as the price point difference between the passive and the actives and then the performance comparison has changed, for those clients to get S&P 500 exposure or large cap exposure, the cost point for them could be quite different. They continue to evaluate that cost point. So they do evaluate that and there has been some migration from, say, active equity to passive equity.

We focus first and foremost on the diversification of the portfolio. And then whether that's delivered actively or passively is something that we talk with our clients and in our policy.

Shifting to the balance sheet. There was pretty strong growth in the short-term borrowings in the fourth quarter. Is that episodic or is that in line with the commentary that you gave around deposit growth? And then if you can talk about how you're thinking about deposit betas moving into the New Year with the higher short-term rates in December. And then also on the loan book, if you can remind us what portion of your loans are floating rate and what lags to, I think it's LIBOR for the most part we'll see. Trying to get a sense of how that might move in (technical difficulty).

I'll try and get all three of those in there.

Brian, let me take a couple of the factual questions that you asked. In terms of the loan portfolio, about 70% floating, the remainder fixed. That's one of the things you were interested about.

And then in terms of pricing, it depends on the loan category you're talking about. Clearly for example, our commercial loans would be generally LIBOR based. Our private client loans also LIBOR based, although a few could be at prime.

And then of course, the real estate portfolios would be based off of Treasury. So it depends on the category you're referring to.

And then on the commentary on your sense of the deposit betas into 1Q?

We're watching the market, like many. Like others, we did not pass the 25 basis points on to the clients on that. But we continue to watch the market and I think we'll have a much better idea how that unfolds over time.

Okay, fair enough, thank you.

We'll go next to Alex Blostein with Goldman Sachs.

Thanks, good afternoon, guys. Couple of quick questions sticking within the NII and balance sheet discussion. Seasonally we shouldn't expect that there was an elevated level of activity towards quarter end so like 105 average earning balance is a decent starting point for next year. And then again, the organic growth that we've seen in the past is a reasonable way to think about it?

Yes.

Okay, easy enough. My other question was around the security lending business. You mentioned the drop-off in collateral balances happened towards the end of the quarter. Again just want to understand whether or not it was something episodic or what drove the decline.

As a follow-up to that, given the fact that we've seen, obviously, a pick up in market volatility and a more challenging back drop quarter to date, wondering if you're seeing any change in demand spreads or something that could help the security lending business as we look out into 2016? Thanks.

Talking about the balances and the difference between the average balance sheet and the end. That was a borrower- or a demand-driven phenomenon. I will presume that was those institutions looking at their own balance sheets at year end as they did what they needed to, to make their balance sheets and ratios look appropriate at year-end.

It benefited us in the sense that if you looked at our standardized ratio, we had a 40 basis point improvement. Much of that was a reduction from the standardized approach, as I said. Much of that was a risk-weighted asset improvement driven by lower security lending balances at quarter end.

In terms of what have we seen so far into 2016, more of the same trends that you saw late in Q4 for us. Nothing that I would call out at this point.

Okay, thanks.

We'll go next to Betsy Graseck with Morgan Stanley.

Hi, thanks. Okay, so that was just a one-off client event for the securities lending book?

It was not a one-off client. It was just demand in general. I'm guessing that our clients were working on their own balance sheets at quarter end and it was really a quarter-end phenomena.

Okay. And then a follow-up question on the reserve methodology changes. Just want to make sure I understand what drove the decision to do this. Is it, as you indicated, a reset the bar? So from here changes in credit outlook Q on Q on Q is going to drive changes in reserving or net charge-offs, any legacy reserve benefit or reserve release has been coming through this quarter with reserve methodology change?

I'll take the second part and answer it. That is accurate. It is the new methodologies approach has been approved and utilized in this quarter and has, I think, put it at the run rate. And then quarter-on-quarter credit quality will become the variable.

In terms of the why now, we've worked to build out the model over the course of the year. And we want it to leverage the work we had done with CCAR to use a much more quantitatively-oriented model to do this. We also work with our accountants and others to make sure that the reserve is as quantified as possible. This allowed us to get to that level of a much more quantified approach and that was the trigger.

And do you think there is any impact in the volatility of provisioning going forward with the model change? Is there anything in that nature that we should be thinking about?

It will just depend on overall the credit quality of the portfolio, so hesitant to say yes or no. If the credit trends continue then it should be well reserved and if there's something in the portfolio then it will move. I think it is reasonable, unless there meaningful improvement or degradation in the portfolio, that large releases are unlikely to happen.

Okay, thanks.

We'll go next to Mike Mayo with CLSA.

Hi. Well, Biff, I guess your timing for $500 million of government bonds was pretty good. You probably have a gain on those purchases from the fourth quarter. (laughter) So I'm not sure if we'll see gains on those down the road but my question relates to the funding of some of the purchases. I know you're asked before; I missed the answer.

The short-term borrowings were up $1.7 billion and I'm trying to understand the balance sheet dynamics a little bit more. Earning assets grew at an annualized pace of 20% and you have short-term borrowings up quite a bit. Why? A lot of questions have touched on this but I want to make sure I have the right answer.

Part of that was a federal home loan bank borrowing that we took advantage of which was a very attractive borrowing rate. That was a meaningful portion of the increase in short-term borrowings, if you will, that you described there.

In terms of the timing of the purchase, again, Mike, we have an asset liability committee that has a view on where we should take investment decisions. We thought maybe right after the rate hike it may be opportunistic. I don't know if that's right in the long term but it's an attractive trade through today.

And the federal home loan bank borrowing rate, could you elaborate on that? What is that, if you're allowed to disclose the rate? How often does this come up? Is this something you've never seen before or you see it every so often?

We've had access to that borrowing in the past. I don't know if we can disclose the borrowing rate, so I'm unsure. I will say that it is very low. Very low effective borrowing rate.

So part of the quarter was simply an advantageous situation where you took advantage of a very low borrowing rate at a good time when you thought it might make sense to load up on some more government security. Is that correct?

Not completely that. I think part of it was we liked -- the federal home loan borrowings is attractive from an LCR perspective as well. So that borrowing allowed us to also strengthen some liquidity measures. And then we were able to take advantage of some of that borrowing and create some yield.

Last follow-up. You had 8% growth in NII linked quarter which is pretty impressive. Should we consider that to be sticky? Should we consider the potential for a growth in NII like that again in upcoming quarters?

I think that there was, obviously, the amortization benefits in there that has seasonality and deals with macro factors like rates and/or housing starts. So that tailwind is unlikely to maintain itself during the entire course of a year. It tends to be worse in the second and third quarters.

Okay, so we should see that come down a little bit from the first quarter level?

I'm hesitant to say one way or the other. I don't know what the premium amortization and mortgage-backed securities will do in the period.

Okay, that's fine, thanks a lot.

We'll go next to Geoffrey Elliott with Autonomous.

Hello. I wanted to come back to the securities lending collateral move because I heard at one point you were saying this was a quarter-end phenomenon. And then I also thought I heard you say something about the behavior that you'd seen at the end of the fourth quarter had continued into the first. So could you clarify the drop in lending collateral?

Is that something that happened around December 31, it probably comes back, it's not going to impact the P&L? Or has there been some sort of change in customer behavior that maybe lasts a bit longer?

The collateral levels and the loan levels were quarter-end phenomenas. My comment was about -- the question was around spread, had we seen any dramatic changes in the spread and/or demand in the first part of this year. And I would say the demand and the collateral levels are closer to the averages we've talked about in the previous period. Not define it and then movement from the quarter end.

That's clear. And then to follow-up again on the institutional side, the AUM. If you take out the site lending it's not as if it's declined a lot but given equity markets are out quite a lot, we might have expected a bit more growth. So we know there are reasons why that business hasn't grown -- that AUM balance isn't growing as strongly as you might have expected given what equity markets did in the fourth quarter, are customers going elsewhere?

Yes, so one meaningful factor in that would be our sovereign wealth fund exposure that I mentioned in our prepared remarks. But we do report in P&I Magazine. A year ago I think we reported sovereign wealth balances $70 billion in that. At year end those had migrated down just to sovereign wealth funds of $50 billion, approximately $50 billion.

So we are seeing some of the pressures, if you will, on those regional economies and the need for some of those large sovereign wealth funds to use those funds, if you will, in their local environment. So that phenomena has helped drive down the AUM.

What I will say is about 95% of those are passive management mandates and generally have very low basis point fees. So while the AUM decline is meaningful, the fee impact is more muted.

Great, thank you.

We'll go next to Brian Kleinhanzl with KBW.

Yes, thanks, Biff. So a quick question on the deposit beta. I know you said it's too early to get a sense of what deposits are doing in the quarter but given you have been balancing -- or managing the balance sheet for lower for longer -- why if deposit betas are low, shouldn't we expect the securities portfolio to increase?

Well, if that is correct, we may see that happen. But we're still observing the market, I think it's digesting the first round of these. And remember, we have a variety of large clients where the deposit betas may be more bespoke, more uniquely crafted in the contract. So it's not a direct corollary that it is going to happen.

The other thing is from a liquidity standpoint, maintaining our liquidity.

Okay. And then a follow-up on the seasonality in the expenses. Not in 2016 but in 2017 when you change your title sponsorship, will that seasonality move from the first quarter into the, I assume, third or fourth quarter? And what is the magnitude of that impact on a dollar basis?

Yes, it will move to the third quarter in 2017. We don't disclose the magnitude of that but you'll be able to see in the expense run rate after the third quarter of 2017.

Okay, thanks.

We'll take our last question from Gerard Cassidy with RBC.

Thank you, good afternoon, Biff.

Hi, Gerard.

Question for you, and this isn't really directed at your loan portfolio because I don't think you have anything to really worry about with this fall in the price of oil. But can you give us some color? What are you guys looking into how this decline and the price of oil may affect some of your wealth management customers? Or are there any counter-party risks that you're trying to figure out, that you may have, that would be impacted by the decline in the price of oil?

Sure. Let me start at a high level. I just briefly -- if you look at the decline in the price of oil, many of the sovereign wealth funds that we serve are in oil producing nations, so that decline does have an impact on our business. They have lower asset levels and we certainly have seen flows out of those sovereign wealth funds as they address their issues. That's on the institutional side.

I know you also asked on the wealth side. Certainly in certain regions -- we've talked about Houston as that -- there can be secondary or tertiary impacts from low oil prices. There are people providing services to companies and others that have been impacted.

Generally, our clients, given the wealth nature of our clients, are liquid, well invested and well diversified away from those single-asset wealth creation vehicles. We generally see modest impact to them from this type of environment.

Our direct exposure, as you rightly said, is largely to large multi-national diversified firms with strong investment-grade credits. So from a overall credit quality at this point, while we certainly monitor it and look at it from a risk perspective, it has not had a significant impact on the overall credit quality of the firm.

Great. And then the second question, obviously you guys have focus on driving your return on equity higher. You're within your range of 10% to 15%. We all know the industry has had to carry a considerable more amount of equity which is permanently reduced return on equity.

If you shift over to your ROA, that obviously is not impacted by equity. Those ROA numbers are still quite a bit below where you used to be prior to the crisis. Is it primarily just that net interest margin and spread that's affecting the ROA, would you say? Or is there other factors as well?

It is the two items that you described. I would say it can be a bit of the earning asset mix, it can be some of the impacts of low net interest income margins, et cetera, that are driving that fundamentally. I will say that our business is much more liability-driven and so the focus is really on turning -- those liabilities are our fees essentially.

Those liabilities are clients placing deposits with us that we then turn into assets. So our focus is on return on equity. It just so happens that the ability to turn those liabilities into higher-earning assets has been muted in the last several years under these low environments. I think the combination of those has probably driven the ROA down. We focus really on the ROE as a primary profitability measure.

Correct, which is one of the focus -- I agree with you. Great, thank you for your input.

There are no further questions at this time.

Thank you all for joining us today. We look forward to speaking with you when we report first-quarter earnings in the middle of April which will occur on the same day as our annual meeting. Thank you very much.

Thank you.

Thank you. This does conclude today's conference. You may now disconnect and have a wonderful day.