Northern Trust Corp (NTRSO) 2016 Q1 法說會逐字稿

Good day, everyone, and welcome to the Northern Trust Corporation first-quarter 2016 earnings conference call. Today's call is being recorded. At this time, I would like to turn the call over to the Director of Investor Relations, Bev Fleming, for opening remarks and introductions. Please go ahead.

Thank you, Zach. Good morning, everyone, and welcome to Northern Trust Corporation's first quarter 2016 earnings conference call. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Jane Karpinski, our Controller; Mark Bette, our incoming Director of Investor Relations; and Kelly Moen from our Investor Relations team.

For those of you who did not receive our first quarter earnings press release and financial trends report via 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 April 19 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 May 17. 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 2015 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.

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 first-quarter 2016 earnings conference call. Starting on page 2 of our quarterly earnings review presentation, this morning we reported first quarter net income of $242 million, earnings per share were $1.01, and our return on common equity was 11.4%.

A number of environmental factors impact our businesses, as well as our clients. Let me review how some of these factors unfolded during the first quarter.

Equity markets rebounded in March after a volatile and negative start to the year. In US markets, the S&P 500 ended the quarter down 4/10 of 1% year-over-year, and up 8/10 of 1% sequentially.

In international markets, the MSCI EAFE Index was down 10.7% year-over-year, and down 3.7% sequentially. Recall that some of our fees are based on lagged market values, and fourth quarter 2015 markets were generally higher.

In bond markets, the Barclays US Aggregate Index was lower year-over-year and higher sequentially. Currency volatility, as measured by the G7 index was 2% higher than the first quarter of last year, and 12% higher sequentially. Foreign exchange market volumes were varied in first quarter. As measured by two of the inner bank brokers, volumes were down 11% to 14% year-over-year, and up 19% to 24% sequentially.

You'll recall that currency volatility and client activity influence 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. Dollar strength, primarily versus the British pound sterling tempered custody asset growth and related fee growth, while benefiting expense growth.

US short-term interest rates were higher, following the Federal Reserve rate increase in December. Three-month LIBOR and the Fed funds effective rate averaged 62 and 37 basis points, respectively, both higher sequentially. The overnight repo rate was also higher, averaging 46 basis points in the quarter.

Let's move to page 3, and review the financial highlights of the first quarter. Year-over-year, revenue increased 5% with non-interest income up a modest 1%, and net interest income up a strong 18%. Expenses also increased 5%. The provision for credit losses was $2 million. Net income was 5% higher year-over-year.

In the sequential comparison, revenue increased 3% with non-interest income up 2%, and net interest income up 6%. Expenses were essentially flat, when compared with the fourth quarter. Net income was 1% higher sequentially.

Client assets under custody of $6.2 trillion increased 2%, both year-over-year and sequentially. In the year-over-year comparison, strong new business was partially offset by lower international equity markets, and the currency translation impact of a strong dollar. In the sequential quarter comparison, new business, favorable quarter-end equity markets, and currency translation were all contributors to asset growth.

Assets under management were $900 billion, down 6% year-over-year. Lower equity assets were the primary driver due to outflows from certain sovereign wealth fund clients and weaker global equity markets. In addition, fixed income assets were lower, primarily due to the loss of one passive mandate from a non-US institutional client which I mentioned last quarter. Assets under management increased 3% sequentially, primarily driven by higher cash and equity balances.

Let's look at the results in greater detail, starting with the revenue on page 4. First quarter revenue on a fully taxable equivalent basis was approximately $1.2 billion, up 5% year-over-year, and up 3% sequentially. Trust investment and other servicing fees represent the largest component of our revenue and were $748 million in the first quarter, up 3% year-over-year and essentially unchanged sequentially.

Lower money market mutual fund fee waivers were an important driver this quarter. Fee waivers were approximately $8 million in the first quarter, lower by $25 million year-over-year, and $13 million sequentially. I'll go into further detail on trust and investment fees shortly.

Foreign exchange trading income was $61 million in the first quarter, down 15% year-over-year, and up 15% sequentially. Lower client volumes drove the year-over-year decline, while the sequential improvements reflect higher volumes and volatility. Other non-interest income was $74 million in the first quarter, down 2% from last year, and up 9% sequentially. The sequential increase primarily reflects higher other operating income.

In the first quarter, we recorded a net gain of $2.3 million related to our decision to exit a portion of a non-strategic loan and lease portfolio, which I mentioned on this call last quarter. Our fourth quarter results included a $1.1 million net loss in other operating income related to the same decision. Net interest income, which I will discuss in more detail later, was $314 million in the first quarter increasing 18% year-over-year, and 6% 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 $433 million in the first quarter, up 6% year-over-year, and 1% sequentially. Custody and fund administration fees, the largest component of C&IS fees were $286 million, up 3% year-over-year and unchanged sequentially.

Assets under custody for C&IS clients were $5.7 trillion at quarter-end, up 2% both year-over-year and sequentially. These results primarily reflect new business, partially offset by the unfavorable impact of equity markets and currency translation. Recall that lagged market values factor into the quarter's fees, with both quarter lag and month lagged markets impacting our C&IS custody and fund administration fees.

Investment management fees in C&IS of $89 million in the first quarter were up 17% year-over-year and 4% sequentially, driven in large part by lower money market mutual fund fee waivers. Fee waivers in C&IS were approximately $2 million, lower by $13 million year-over-year and $6 million sequentially, driven primarily by higher gross yields in the fund (inaudible). Assets under management for C&IS clients were $670 billion, down 8% year-over-year primarily reflecting outflows that I mentioned earlier, and up 3% sequentially due primarily to a $[15] billion increase in cash balances, and a $5 billion increase in equities.

Securities lending fees were $23 million in the first quarter, 5% higher than last year, and 1% higher sequentially, primarily reflecting higher spreads. Securities lending collateral was $106 billion at quarter-end, and averaged $115 billion across the quarter. Average collateral levels decreased 9% year-over-year and 7% sequentially, primarily reflecting lower loan volumes in US treasuries. This asset class has been most impacted by the regulatory landscape, as actions have been taken by agent lenders and borrowers to calibrate capital usage in the securities lending business.

Other fees in C&IS were $35 million in the first quarter, up 10% year-over-year reflecting higher fees from investment risk and analytical services and other ancillary services. In the sequential quarter comparison, other fees were up 4%, reflecting normal seasonal pattern in our benefit payments business.

Moving to our wealth management business. Trust investment and other servicing fees were $315 million in the first quarter, down 2% year-over-year and 1% sequentially. Within wealth management, the global family office business had strong performance with fees increasing 13% year-over-year and 6% sequentially due to solid new business and lower money market mutual fund fee waivers.

Performance in the regions was lower in both comparisons, as lower money market mutual fund fee waivers were more than offset by the impact of unfavorable lagged markets and lower fees on equity mutual funds. Recall that fees within the regions are based on month lagged asset values, so the difficult equity markets in January and February negatively influenced first quarter fees.

Money market mutual fund fee waivers in wealth management totaled approximately $6 million in the current quarter, down $12 million year-over-year and $7 million sequentially, primarily reflecting the impact of higher short-term interest rates on the gross yields in the underlying funds. Assets under management for wealth management clients were $230 billion at quarter-end, down 1% year-over-year, and up 1% sequentially.

Moving to page 6. Net interest income was $314 million in the first quarter, up 18% year-over-year driven by higher level of earning assets, and a higher net interest margin. Earning assets averaged $105 billion in the first quarter, up 6% versus last year driven by a higher level of deposits.

Demand deposits which averaged $26 billion increased 19% year-over-year, and non-US office interest bearing deposits which averaged $49 billion, were up 4% year-over-year. We saw solid loan growth again, as loan balance averaged $34 billion in the first quarter, up 6% year-over-year.

On a sequential quarter basis, net interest income increased 6%, primarily driven by a higher net interest margin as average earning assets were unchanged sequentially. The net interest margin was 1.21% in the first quarter, up 11 basis points year-over-year, and up 10 basis points sequentially.

The improvement in the net interest margin primarily reflects a higher yield on earning assets, as short-term interest rates rose following the Fed's move in December. In the sequential quarter comparison, the benefit of higher interest rates was partially offset by higher premium amortization in our mortgage-backed securities portfolio. Premium amortization was $6 million in the first quarter, up from less than $1 million in the fourth quarter.

Turning to page 7. Expenses were $829 million in the first quarter, up 5% year-over-year, and essentially flat sequentially. Compensation expense of $379 million increased 7% year-over-year, primarily reflecting staff growth, the impact of last year's annual base pay adjustments, and a higher accrual for incentive compensation partially offset by the favorable translation impact of changes in currency rates.

Staff levels increased approximately 5% year-over-year, with more than 60% of the growth emanating from our global operating centers in Bangalore, Manila, and Limerick. On a sequential basis, compensation expense increased 4% primarily reflecting higher performance-based incentive compensation, including the requirement to immediately expense options granted to retirement eligible employees, and the immediate vesting of certain restricted stock units awarded in the first quarter.

Employee benefit expense of $71 million decreased 3% year-over-year, primarily reflecting lower pension expense. On a sequential quarter basis, employee benefit expense increased 2% due primarily to seasonally higher payroll taxes, partially offset by lower medical and lower pension expense.

Outside services expense of $150 million was 11% higher year-over-year. The increase primarily reflects higher technical services expense, and higher consulting expense due to evolving regulatory requirements. On a sequential quarter basis, outside services expense declined 3%, primarily reflecting lower consulting expense.

Equipment and software expense of $114 million was up 3% year-over-year, primarily reflecting higher software-related costs in support of client and regulatory technology initiatives. In the sequential comparison, equipment software expense was down 2%, primarily reflecting lower equipment-related expense.

Other operating expense of $74 million increased 1% year-over-year, and was unchanged sequentially. In the sequential comparison, seasonally higher business promotion expense related to the Northern Trust Open was offset by lower expense in various other categories.

Our loan loss provision was $2 million in the first quarter. This compares to a provision credit of $4.5 million in the year earlier quarter, and a provision credit of $18.5 million in the fourth quarter.

Recall that we changed our methodology for estimating inherent losses effective December 31, 2015. This change resulted in the provision credit of $18.5 million last quarter. Loan quality remains very strong, with non-performing assets of $174 million at quarter-end, down 7% versus year-end, and the ratio of non-performing loans to total loans equal to only 48 basis points at quarter-end. The effective income tax rate in first quarter was 32.7%.

Turning to page 8, 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 expense 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 where it was previously, as high as 131% in 2011, to the levels we see today is a key contributor to the improvement in our return on equity.

We have seen the ratio hold steady, or move slightly upward over the most recent quarters, as both macro and seasonal factors can impact this measure in the short-term. This metric remains an important barometer of our progress, and we remain committed to lowering it on a sustainable basis going forward, through continuing to win new business to drive fee growth, and drive productivity within our expense base, by our ongoing initiatives focused on location, strategy, procurement and technology.

Turning to page 9. Our capital ratios remain solid, with Common Equity Tier1 ratios of 11.6% and 10.6%, respectively, calculated on a transition basis for both advanced and standardized. On a fully phased-in basis, our Common Equity Tier1 capital ratio under the advanced approach would be approximately 11.4%, and under the standardized approach would be approximately 10.3%. 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 6.1%, and at the bank was 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 first quarter, we repurchased 2.3 million shares at a cost of $140 million. Our 2015 capital plan provides for the repurchase of up to an additional 145 million of common stock through June of 2016.

In closing, the first quarter of 2016 was characterized by volatile markets, low commodity prices, low and even negative interest rates, and geopolitical uncertainty. Despite that difficult backdrop, Northern Trust produced solid financial results, growing earnings per share 7% year-over-year, and delivering a return on equity of 11.4%. Our sequential performance demonstrated our commitment to improving our operating efficiency.

Expenses were essentially flat to the fourth quarter, even with the seasonal uplift that results from the Northern Trust Open, and annual equity compensation grants. In addition, we returned $234 million to our shareholders through dividends and stock repurchases, while maintaining strong capital ratios and funding our growth. Our wealth management business grew revenues 3% year-over-year, and continued to produce attractive returns, achieving a pretax margin of 34% in the first quarter.

Our ability to serve complex client needs and create sophisticated solutions for our clients was evident within our global family office business, which serves ultra high net worth individuals and family offices. Global family office had strong new business, and 13% trust fee growth in the quarter.

C&IS continued to grow as well. One growth driver over the last couple of years has been providing services to help our clients meet new regulatory requirements. For example, we provide depositary services, so clients can meet their AIFMD, UCITS V and other asset safety-related regulations.

Another growth driver has been providing new tools and technology to enhance our client's oversight of their increasing investments and alternatives. We recently announced an exclusive agreement with AltX to offer our clients access to the largest amount of data for hedge funds on a single platform. These are just a couple of examples of how we are growing our business, by doing more for our clients.

I'd like to take a moment to acknowledge that this will be Bev Fleming's last earnings call, after a remarkable 15 years as our Director of Investor Relations. So many of us within Northern Trust have relied on her expertise. Her wisdom, advice, and counsel will most certainly be missed. Please join me in wishing her well in retirement.

We are also fortunate to have Mark Bette joining Investor Relations. Mark joined Northern Trust in 1994, and has served in a number of leadership roles within finance, including a senior financial analyst in Investor Relations from 2001 to 2006. He brings a wealth of knowledge about the Firm to the role.

Before I conclude, as is customary for our first quarter earnings call, we will need to end today's call to allow sufficient time for all of us to get to our annual meeting, which begins at 10:30 Central Time this morning. Please accept our apologies, in the event that we have to close off the question and answer period earlier than our normal practice.

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

Thank you.

(Operator Instructions)

We'll take our first question from Ashley Serrao with Credit Suisse.

Good morning, Biff.

Good morning, Ashley.

So first question, just on a couple expense line items. I wanted to get a sense, if you feel that outside services expense has finally normalized somewhat? And also, if you could share some color on what drove the reduction in occupancy, despite all of the growth efforts?

Yes, I'll take the first part of that on outside services, in terms of normalizing. The regulatory environment still remains robust, and we need to continue to make investment in that. But we will continue to get feedback from the regulators as our CCAR was submitted last week, April 5, and as we sense that.

But there are other line items inside outside services that I think we demonstrated control of in the quarter. And those include I would say, non-regulatory consulting spend, legal spend, and other items inside of that category that I think we demonstrated good discipline during the quarter. So I'm hesitant to tell you where that run rate will go, but I think the vigilance around the most controllable items inside of that, we remain steadfast on.

The second part of your question was around -- ?

Occupancy expense.

Occupancy expense in the quarter. From, in any given quarter, we could have certain leases that we need to advance the accounting, or make changes to the accounting that could move it by a modest amount. In this quarter, certain leases in Europe were adjusted, but the -- that's essentially what we did in the quarter.

Okay, thanks for the color there. And just one clean up question on expenses. Can you quantify the seasonally higher comp items this quarter, what were they're in total?

So seasonally, we do have, as we said in the script, we have certain equity expense that relates to the vesting of retirement-eligible individuals. That is a first quarter seasonal expense that we experience, that deal with our retirement-eligible employees option expense for them.

And Ashley, this is Bev. Those numbers will be disclosed in our 10-Q. So I'd ask you to refer to that. There is a table in the 10-Q that will provide you some of that information, and that's probably the best way to get to the exact figures that you're looking for.

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

Thank you, and good morning. Couple questions on asset servicing, particularly hedge funds and mutual funds. I wanted to get your thoughts on the recent FSOC update, which seems to call for greater data collection, and also assurance around third-parties? And then, maybe get your thoughts as well, on the termination of Aurora 50 South, and how you're thinking about M&A in that area? Thank you.

Let me take the second part of your question first. Alternative investments really remain a strategic priority for Northern and 50 South Capital, our alternative arm. I don't really have anything to offer beyond what was announced in the press release. After consideration from all parties, we mutually agreed to terminate the agreement.

In terms of the second part of yours, was the FSOC on certain data requirements for mutual funds. I think -- can we get back to you on that question? Bev and I will, and Mark will follow-up with you, Adam, on that one.

Sure, that's fine. Yes, just maybe a follow-up on Aurora and 50 South. Do you feel as though M&A continues to be a good way to expand your asset servicing and hedge fund servicing business, or are you looking more around partnerships or expanding services organically? Thanks.

So our general philosophy on growth has been to do it through organic means; however, when opportunities to either fill a product gap, a geographic gap, a technological gap or a regional gap, as I said our geographic gap -- as I said, we will be opportunistic in those. But we really, fundamentally still have a organic growth bias. And so in this space, discussions with Aurora were based on filling client and product needs, and we will continue to look at the strategies I laid out for you.

And we'll go next to Glenn Schorr with Evercore ISI.

Hi. Two quickies, related to net interest income. Hi, Biff. The two were, you mentioned I think, $5 million of premium amortization. Just curious, what the impact was on the NIM in the quarter, because it was a big jump up.

And the other part was, with average securities up 8%, curious on what you're buying on the asset side these days? And what the change in duration if any, of the overall securities portfolio was?

Okay. The premium amortization as we described in the quarter, it was up sequentially from the fourth quarter. I think it was $6 million in the quarter. We have discussed in the past, that amortization is typically $9 million to $10 million in a quarter. It can move, so it was slightly better than the normal run rate, but in the fourth quarter of 2015, we actually experienced kind of a low at only $1 million of premium amortization.

So sequentially, it actually hurt the returns. On a year-over-year basis, it actually helped by a small amount actually, a modest amount. So that's a little bit of color on premium amortization.

In terms of what we're buying, and the improvement in the security portfolio? First of all, I would say, we benefited from the rate move in the portfolio. We did add about -- you could see about $1 billion of Treasury securities. Those were largely five to seven year duration purchases, but swapped back to something closer to three months. So the duration in the portfolio was really not extended but we were able to get some enhanced [yield] there.

We did have a small portion of that $1 billion, that we went out a little longer in duration. So the overall duration, of the index duration of the portfolio only increased modestly.

Okay. So I don't want to put words in your mouth, but it sounds like this is the most rational jumping off point we have for the NIM going forward?

Yes, that's a reasonable assumption.

Excellent. Okay, thanks, Biff, and Bev, you're the best.

Thanks, Glenn. (laughter).

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

Thanks. Hey, good morning, guys. So just picking up the discussion around NII and NIM. So Biff, it sounds like the securities portfolio, obviously, a very short duration, and there might be an additional benefit, just as the security portfolio reprices, even I guess, if we don't get that many more hikes this year.

Can you help us understand that dynamic a little bit more? So if [1.20%] is kind of a decent starting off point assuming no more rate hikes, how meaningful of a benefit could we still see to the NIM from the initial hike?

And the follow-up, also around the net interest income discussion. It looks like the ending balance sheet ended a bit higher than the average. So just wondering, whether it's the timing of the kind of net new business that came in a little bit later in the quarter, or is it just the typical end quarter stuff, so the balance sheet was a little bit lower, but the average should normalize, as we look into the second quarter?

So I'll take the second part of the question first. The ending balance sheet is just traditional quarter-end balance sheet maintenance that can happen. It can move, as you know on March 31 or any quarter-end period, based on client activity, et cetera. So I would say there's nothing unusual about that movement, from our perspective.

In terms of the NIM and the expansion, or potential expansion of the NIM, two components that I want to address there. First is, you have to remember that approximately half of our balance sheet is in foreign office time deposits. And in some of those places, we're experiencing negative spreads, and others where that compression is not impacted by necessarily by Treasury rates.

In the US, two things to consider there. If there are no further rate hikes, many of our assets repriced in the first three months of this [year] or since the rate hike, but there are still some repricing opportunities left inside of that portfolio. Remember it's of a short duration, so there is some benefit in there.

So I would say, we're going to wait and see how that plays out. But to date, as you rightly saw in the NIM, the beta has been relatively close to zero, and the assets have been able to reprice. So we've been able to capture that 11 basis point increase in the NIM.

Got it. That's all for me. Thanks again, and --

Thanks.

We'll go next to Ken Usdin with Jefferies.

Hi, thanks. Good morning. Biff, on the trust fee side, you've got a great benefit, obviously, also from the first hike on the fee waiver side. Can you just help us understand if we got another hike, do you anticipate at this point now, seeing experience of the first hike that, you'd get the rest of the [$7 million] and change back?

Yes, we did get a majority of the waivers back with the first hike, and our anticipation would be that we would get a significant portion with a second hike that remains. But we have, as you can deduce, we had a meaningful movement, with just the first 25 basis point hike in that.

And Ken, another way to think about that is, is the fees on the funds for the retail fund family, 35 basis points, for the institutional fund family, 22 basis points. So I think that should help answer your question.

Yes. Okay. And then, my second follow-up is just on the -- just to follow-up on the wealth management business which -- and this come up in the last couple quarters -- but you mentioned the mutual fund pricing in there. And I'm just wondering, if you could give us some of the underlying growth dynamics? Because if we take out that fee waiver recovery in wealth management, the growth rate of wealth continues to be slower than the positive growth rate that we're seeing in C&IS.

So just any other dynamics to just help us understand, in terms of whether it's pricing or activity, on top of that clear, explicit one you mentioned on the mutual funds one?

Sure. So in the quarter, new business and lower money market mutual fund fee waivers weren't really sufficient to offset the drag from -- remember, we have month lagged equity markets. So the fees are based on February month end, which was still quite down, and the lower fees on equity mutual funds, as you discussed.

If you think about this, there's an ongoing and broad industry trend towards passive management, as investors continue to face lower overall returns. And they look to control what they can control, which is namely fees. So we have seen that kind of fee pressure in our funds, into lower cost alternatives.

So the combination of the month lag in the fees, the migration if you will to lower fee structured products, was not enough to offset the positive fee waiver in the quarter. We do still think relative to the industry, that the growth rates are healthy, and that the business is indeed is strong. It's just a difficult macro environment for that business.

Understood. Best of luck, Bev.

Thanks, Ken.

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

Great, and congrats, Bev also, and welcome back Mark. The first question is just on -- just trying to get a better handle on the expense trends going into second quarter. You mentioned on the occupancy side, the [lease] adjustment. And so, as we think about some of the cost cutting that you've had, and then I guess merit increases, I think were postponed to 3Q, I believe, if that's correct? And if you could just talk a little bit about that trajectory coming into the second quarter, given that you're through the CCAR process as well?

Yes. So if you think about, let me start with the first quarter. There is some seasonality in the first quarter that you can see, if you look historically. As it relates specifically to the occupancy expense, I think looking at a longer period of quarters in the past, probably gives you a better indication of the run rate in our occupancy expense. So that line item, as you look historically has remained fairly consistent, and that's probably your better trending.

Other line items, you suggested, we did defer salary increases to October 1 for all employees. So that, we did April of 2015, we did merit salary increases. We will not have that in this sequential comparison, and we continue to be vigilant on business promotion, non-regulatory consulting spend, and all other key discretionary line items. And there's a continued focus on that line item as we enter Q2 and beyond.

Great. And then, just the follow-up would be, just on customer behavior. I guess, first of all, on the deposit side, you've said the deposit beta was extremely low, in terms of passing on rates. Do you see any impact on deposit behavior?

And then, similarly you mentioned within wealth management, obviously, continued shifts towards passive products. Do you see that trend across your wealth management franchise continuing, and are you selling more of your own manufacture products such as the FlexShares into that client base? And should we expect the revenue yields -- you're obviously capturing that on the passive side, but the revenue yields would potentially be pressured longer term in that trend?

Yes. So in terms of the client behavior, first part of your question on deposit behavior, we did not see any exodus of clients based on our deposit beta that we push through. So we did not really see that, and you can see that from sequentially a very stable balance sheet size, and even growth on a year-over-year basis, which is really driven by I would say our core organic growth rate. So no real behavior changes.

In terms of the migration from active to passive, what I would say first is, that in some cases, it's from higher fee to lower fee solutions, as our clients have struggled to get returns. They focus on what they can control, which is the fee portion of that, so they're looking for lower fee opportunities. And in some cases, along that [spectra] from active to passive, there are our product and capabilities that we continue to discuss with our clients. Those could be FlexShares. Those could be engineered beta, or engineered equity offerings. So we do have products along the spectrum if you will, between fully active and fully passive that help mute some of that fee compression that we talked about.

Helpful. Thank you.

We'll go next to David Long with Raymond James.

Good morning, guys.

Good morning.

Yes, we were talking about the change in active versus passive. And my question, just looking at the corporate institutional services, the custody fees, and the investment management fees, given the strength in the markets and the decline in the fee waivers, I would've expected those lines to be a little bit stronger. Is that, or does this just go back to that mix shift change, why those lines maybe didn't have that full benefit?

So in the C&IS business, it was a smaller AUM. As we talked about in the past, sovereign wealth fund migrations as they've needed to convert those assets, for whatever those reasons were for those sovereign wealth funds. So we've seen a lower base on those, so smaller AUM. And I think that's probably driven -- more than offset, migrations into passive solutions at this point.

Though the sovereign wealth fund, an example, was down almost 33% from a year-over-year, the AUM, down to I believe $46 billion, and down 32% as I said year-over-year. So they're low basis point realization products, but high AUM.

Okay, got it. And then, as a follow-up, the effective tax rate was down 32.7% in the quarter, it seems a little bit lighter than where it was has been running. And any reason for that, and should we expect it to normalize?

I would say that it was normal actions that could be taken in any quarter. Typically, those could be APB 23 actions. They could be the release of a small reserve in a region or something like that, but it will typically be normal. If you look historically, that's probably the right rate to put into your thinking.

Great. Thanks, Biff.

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

Hi, good morning.

Hi, Betsy.

I was just wondering about the buybacks. And I heard what you did this quarter, but I was wondering if you included within that some incremental, like we've seen some of the other institutions this quarter, a de minimus addition to what was approved last year?

Betsy, we did not. Our total pay out ratio as you can see, is very high and we did not utilize the de minimus exception.

And just wondered, if you would consider doing that in the future? Or was there a reason why you chose not to do that, given the strength of the capital ratios that you have?

Yes. First of all, I think we already have a very high pay out ratio as we look at this. And our capital ratios, if you look at our Common Equity Tier1, it's sort of in the median of the CCAR banks, and we view that as the prudent level, in terms of right now, how we think about that. Won't say we will never use it, but we didn't use it last quarter.

Okay. And is there any consideration for potentially issuing pref, and doing buyback just to use that bucket, which some other people have used? Wondering if -- how you think about that?

We always evaluate our capital structure. And in fact, obviously spent meaningful time evaluating it, as a part of our submission of our capital plan, and we think about all of the ways we could maximize our capital structure.

Okay. All right. Thanks very much, and Bev, have a great retirement.

Thanks, Betsy.

Okay.

We'll go next to Gerard Cassidy with RBC.

Thank you. Good morning, guys.

Hi, Gerard.

Bev, it just seems like yesterday, you joined [Perry], so congratulations on your retirement. Biff, I apologize, I had to jump off on the call. So if you addressed this, I can read it in the transcript. But you guys have done a very good job in driving that ROE higher, as you show in slide 8 in the presentation. And I know the business, at times can be seasonal.

Are we at, the best you can do, for whether it's the margin at 30.6% or the non-interest expense as a percentage of trust and investment fees? Because when I look at first quarter 2015, to kind of give it an apples-to-apples approach, those numbers in first quarter 2015 are a little better. These are good numbers, and I recognize that, but are we at the best, or do you think there's improvement to be had?

So we are indeed committed to driving long-term improvement in the expense to fee ratio, and it remains a key strategic focus. And that obviously, has a knock-on impact to produce better ROE. Improvement in the ratio is driven by achieving positive fee operating leverage. And as is case with the operating leverage in the short-term, there can be periods of time where we have degradation in the ratio, sometimes due to seasonal impacts. This quarter, for instance, while the ratio would have benefited from lower level fee waivers, the seasonal expense impact of stock-based compensation in the Northern Trust Open more than offset the improvement in fee waivers.

Gerard, we remain focused on the two parts of that equation that we can. The first is in what I would describe as the organic growth rate of our fees, and the second is on the strategic long-term initiatives on the expense side, include location, strategy, procurement, technology. And if we focus on those things that we can control, we think we can continue to drive that down.

Thank you. And then, just as a follow-up, and again, I apologize if you have ever given us this number -- I believe many of the banks are going to see higher FDIC premiums in the third quarter, to boost up their reserves for the FDIC. Did you guys disclose what you expect your premium, or will you see a higher premium? And if you will, did you disclose what that number will be?

Yes. Right now, we anticipate in the third quarter of 2016, that we would have an incremental $3 million headwind. Obviously, balance sheet size and other things can move that around, but that's our anticipation, is about a $3 million headwind starting in Q3.

Great. Thank you.

We'll go next to Brian Kleinhanzl with KBW.

Good morning, Biff.

Good morning, Brian.

I just have a quick question. So since the last div-arb season over in Europe, there's been a lot of discussion about -- from tax regulators as well as politicians on investigations about div-arb. Have you heard anything additional about that from clients, or is there any concern that there would be less seasonality in the div-arb season this year?

At this point in time, we are entering that season, and our team anticipates a similar season to they've experienced in the past, in my conversations with them.

Okay, great. And then, some of the large [bank peers] also had a - the living will feedback given to them. Does their feedback affect how you think about the outside services fees, and how that run rates over the back of the year? I know you said, there was some increase due to the feedback that you've got from regulators from living will. So it is a fact that some of those banks have passed, and it's generally looking like there is a blueprint for the living wills process, to allow you to lower those fees over the back half of the year?

Yes. So at this point, we've not received feedback, so we haven't had a designation made in regard to Northern Trust's 2015 resolution plan. We don't have any indication as to when that determination will be announced for us, from either the Fed or the FDIC.

That being said, to answer your question, we have been in regular contact with the Fed and the FDIC. We have engaged industry expertise to help guide us through that process. And we are certainly reading the feedback given to our two closest competitors, as in that our business model is similar in structure. And if we can learn from the feedback that they've received which is public, we will incorporate that into our thinking around our resolution planning. So more to come, as we get our feedback.

Okay, thanks.

(Operator Instructions)

It appears we have no further questions at this time.

Okay. Well, thank you, appreciate it. Bev, thanks again for everything. Mark, welcome, and thanks to everyone on the call. And that's it. Thank you.

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