Northern Trust Corp (NTRSO) 2016 Q3 法說會逐字稿

Good day, everyone. Welcome to the Northern Trust Corporation third-quarter 2016 earnings conference call. Today's call is being recorded.

At this time, I'd like to turn the call over to Director of Investor Relations Mark Bette for opening remarks and introductions. Please go ahead.

Thank you, Lisa. Good morning, everyone. Welcome to Northern Trust Corporation's third-quarter 2016 earnings conference call.

Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Jane Karpinski, our Controller; and Kelly Mullen, from our Investor Relations Team. For those of you who did not receive our third-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 as a guide for today's call.

This October 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 November 16. Northern Trust disclaims any continuing accuracy of the information provided in this call after today.

In the current quarter, we elected to early adopt a new accounting standard issued earlier this year that made certain changes for stock-based compensation. One of the most significant changes requires that excess tax benefits and deficiencies be recorded as part of income tax expense rather than as part of additional paid in capital. This change has been made for all periods in 2016.

The impact resulted in a tax benefit of $6.4 million in the third-quarter results and a benefit of $12.3 million on a year-to-date basis. Please see page 11 of our earnings release for more information on the impact to our first- and second-quarter 2016 results.

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 Mark in welcoming you to the Northern Trust third-quarter 2016 earnings conference call.

Starting on page 2 of the quarterly earnings review presentation, this morning we reported third-quarter net income of $258 million. Earnings per share were $1.08 and our return on common equity was 11.7%.

Our Assets under custody increased 13% compared to one year ago, and 6% sequentially. Our Assets under management were up 7% compared to one year ago, and up 4% sequentially.

The current quarter results include two items I wanted to highlighted. First, the quarter included $5.4 million of impairment charges and loss on sales related to a non-strategic loan and lease portfolio. Second, we had a $3.5 million charge in connection with the settlement of our remaining securities lending litigation. All securities lending litigation stemming from the 2008 financial crisis is now resolved, subject to final court approval. I will highlight these items again as we walk through our detailed results.

A number of environmental factors impact our businesses as well as our clients. Before going through our results in detail, let me review how some of those factors unfolded during the third quarter.

Equity Markets performed well in the quarter. In US markets the S&P 500 ended the quarter up 12.9% year over year, and up 3.3% sequentially. In international markets the MSCI EAFE index was up 1.6% year over year, and up 5.4% sequentially.

Recall that some of our fees are based on lagged market values and second-quarter markets were not as strong as the third quarter. In bond markets the Barclays US aggregate index was higher for the year-over-year comparison, but lower for the sequential comparison. Currency volatility as measured by the G7 index was 2.6% higher than the third quarter of last year, but 8.4% lower sequentially.

Foreign exchange market volumes were down in the third quarter. As measured by two of the inner bank brokers, volumes were down 14% to 17% year over year, and down 9% to 11% 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, particularly in the year-over-year comparison, tempered custody asset growth and related fee growth while benefiting expense growth. The most significant move was in the British pound, which ended the third quarter 14% lower than one year ago.

Short-term interest rates were mixed during the quarter. US short-term rates were higher than one year ago and also moved higher sequentially, most evident in the three-month LIBOR, which averaged 79 basis points during the quarter. In the UK, however, short-term rates declined, driven by the Bank of England's August rate reduction of 25 basis points.

Let's move to page 3 and review the financial highlights of the third quarter. Year over year, revenue increased 5%, with noninterest income up 3% and net interest income up 13%. Expenses increased 4%, which drove 1.3 points of positive operating leverage.

The provision for credit losses was a credit of $3 million, reflecting ongoing improvement in credit quality. Net income was 10% higher year over year. In the sequential comparison, recall several items which were reported to you last quarter.

A pretax gain of $118.2 million on the sale of 1.1 million Class B Visa shares; a pretax charge of $46.5 million in connection with certain securities lending related litigation; a pretax loss of $21.6 million associated with our loan and lease portfolio; a pretax charge of $18.6 million relating to contractual modifications associated with existing CNIS asset servicing clients; and a pretax charge of $17.5 million related to severance and personnel-related costs. On an adjusted basis, excluding the second-quarter items, revenue declined with non-interest income down 1% and net interest income slightly higher. Expenses were flat compared to the prior quarter, and net income was 1% higher sequentially.

Return on average common equity was at 11.7% for the quarter, up from the 10.9% reported one year ago, but down from the 12.3% in the prior quarter. Adjusting for the previously mentioned second-quarter items, the third quarter's return on average common equity was down from 11.9% in the prior quarter. Client Assets under custody of $6.7 trillion increased 13% compared to one year ago, and 6% on a sequential basis.

In both the year-over-year and sequential comparisons, strong new business and favorable market impacts were partially offset by the currency translation impact of a stronger dollar. Assets under management were $946 billion, up 7% year over year and 4% sequentially. Favorable market impacts and new business drove the growth in both comparisons.

Let's look at the results in greater detail, starting with revenue on page 4. Third-quarter revenue on a fully taxable equivalent basis was approximately $1.2 billion, up 5% from last year but down 8% sequentially. Adjusted for the second-quarter items that I mentioned earlier, revenue was down 1% sequentially. Trust investment and other servicing fees represent the largest component of our revenue, and were $788 million in the third quarter, up 5% year over year and up 1% from the prior quarter.

Lower money-market mutual fund fee waivers were an important driver of the performance compared to last year. Fee waivers were essentially zero in the third quarter, compared to $28 million one year ago. Fee waivers were not a factor in the sequential comparison.

Foreign exchange trading income was $54 million in the third quarter, down 15% year over year and down 17% sequentially. Lower client volumes drove the year-over-year decline, while the sequential decline reflected lower volatility as well as lower client volumes. Other noninterest income was $69 million in the third quarter, down 8% from last year and down 10% sequentially, when adjusting for the second-quarter items I mentioned previously.

The current quarter's results include $4.7 million in revenue associated with the Aviate acquisition, which closed during the second quarter. The prior quarter's results included $2.6 million of Aviate-associated revenue. Both the year-over-year and sequential declines were primarily driven by a $5.4 million loss associated with our lease portfolio; a $2.3 million loss associated with the mark-to-market of our Visa-related swaps; as well as lower brokerage and credit-related fees. Net interest income, which I will discuss in more detail later, was $310 million in the third quarter, increasing 13% year over year and up 1% 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 $451 million in the third quarter, up 5% year over year and 1% on a sequential basis. Custody and fund administration fees, the largest component of CNIS fees, were $299 million up 2%, both on a year-over-year and sequential basis. Assets under custody for CNIS clients were $6.2 trillion at quarter end, up 13% year over year and up 6% sequentially.

These results primarily reflect new business and favorable markets, partially offset by the unfavorable currency exchange rates. Recall that lag market values factor into the quarter's fees with both quarter-lag and month-lag markets impacting our CNIS custody and fund administration fees. Investment Management fees in CNIS of $94 million in the third quarter were up 14% year over year, and flat sequentially.

The year-over-year growth was driven in large part by lower money-market mutual fund fee waivers. As was the case last quarter, fee waivers in CNIS were essentially zero during the third quarter, compared to $12 million one year ago. Assets under management for CNIS clients were $704 billion, up 6% year over year and 5% sequentially.

Securities lending fees were $23 million in the third quarter, 14% lower than the prior quarter but up 17% year over year. The sequential-quarter decline reflects the typical seasonal pattern, with the international dividend season driving wider spreads in the second quarter of each year. The year-over-year increase was driven by increased spreads, primarily relating to the widening of the spread between three-month LIBOR and Fed funds.

Securities lending collateral was $114 billion at quarter end and averaged $113 billion across the quarter. Average collateral levels decreased 7% year over year and were down 3% sequentially. The decline in loan volumes, compared to the prior year, was across most asset classes.

Security lending activity has been impacted by the regulatory landscape as actions have been taken by agent lenders and borrowers to calibrate capital usage. Other fees and CNIS were $34 million in the third quarter, up 1% year over year and up 4% sequentially, reflecting higher fees from investment risk and analytical services, benefit payments and other ancillary services.

Moving to our Wealth Management business, trust investment and other servicing fees were $338 million in the third quarter, up 6% year over year and 2% sequentially. Within Wealth Management, the global family office business had strong performance with fees increasing 12% year over year and 2% sequentially, due to lower money-market mutual fund fee waivers, compared to one year ago, as well as favorable markets and new business.

Performance within the regions also benefited from lower money-market fee waivers, compared to last year as well as favorable markets in new business. Money-market mutual fund fee waivers in Wealth Management were essentially zero in the current quarter, which was equal to the prior quarter and down $15 million year over year. Assets under management for Wealth Management clients were $242 billion at quarter end, up 8% year over year and 4% sequentially.

Moving to page 6. Net interest income was $310 million in the third quarter, up 13% year over year. Earning assets averaged $108 billion in the third quarter, up 7% versus last year, driven by a higher level of deposits and short-term borrowings. Demand deposits which averaged $26 billion increased 6% year over year, and non-US office interest bearing deposits which averaged $51 billion were up 3% year over year. Loan balances averaged $34 billion in the third quarter, up 2% compared to one year ago.

The net interest margin was 1.14% in the third quarter and was up 6 basis points from a year ago. The improvement in the net interest margin compared to the prior year primarily reflects a higher yield on earning assets, as short-term interest rates rose following the Fed's move in December. On a sequential-quarter basis, excluding the previously mentioned $2.7 million impairment in the prior quarter, net interest income was up slightly as average earning assets were up 1% while the net interest margin was down three basis points sequentially.

While our net interest margin saw a benefit due to higher US short-term interest rates, mainly the one-month LIBOR, this was offset by the Bank of England rate cut of 25 basis points in August and the change in our overall earning asset mix. Day count also had a slight detrimental impact on our net interest margin in the third quarter. Premium amortization was $20 million in the third quarter, up from $14 million one year ago, but flat with the second quarter.

Turning to page 7. Expenses were $843 million in the third quarter, up 4% year over year and down 9% sequentially. Excluding the second-quarter items I mentioned earlier, expenses were essentially flat on a sequential basis.

The current-quarter's expenses included $6.6 million in costs associated with the Aviate acquisition, compared to $3.4 million in the prior quarter. This quarter's expenses also included the $3.5 million charge relating to the settlement of certain securities lending related litigation, as I mentioned in the beginning of my comments.

Now let's go through the components of expense. My comments going forward will exclude the second quarter items I mentioned earlier, totaling $82.6 million.

Compensation expense of $382 million increased 6% year over year, primarily reflecting staff growth and higher performance-based compensation, partially offset by the favorable translation impact of changes in currency rates. Staff levels increased approximately 5% year over year. The growth in staff was all attributable to lower cost locations, which include India, Manila, Limerick and Tempe, Arizona.

On a sequential basis, compensation expense increased 1%, driven by the impact of current-quarter severance charges, staff growth, and higher performance-based incentive accruals. Recall that the annual base pay adjustments were deferred from earlier in the year and were made effective October 1, which we expect will result in a $7 million lift to compensation expense in the fourth quarter.

Employee benefit expense of $73 million was up 5% year over year, primarily reflecting higher medical costs, partially offset by lower pension expense. On a sequential-quarter basis employee benefit expense was up 4%, driven by higher medical costs. Outside services expense of $158 million was flat compared to the prior year, as higher technical services, Aviate-related expense and sub-custodian costs were offset by lower consulting related spend and third-party advisor fees year over year.

On a sequential-quarter basis outside service expense was also flat, as higher levels of technical services, legal and sub-custodian costs were offset by lower levels of consulting spend. Equipment and software expense of $115 million was up 1% from one year ago, but down 3% sequentially. The year-over-year growth was due to higher software-related expense. The sequential decline was driven by software amortization and computer maintenance and rental related costs. Spending and support of our technology strategy continues as we invest to support clients, improve employee efficiency and meet regulatory and compliance requirements.

Other operating expense of $71 million increased 9% year over year, primarily related to the previously mentioned $3.5 million securities lending litigation settlement and higher FDIC costs of $3 million, associated with the newly implemented assessment surcharge on banks with consolidated assets of $10 billion or more.

Sequentially, other operating expense declined 3% on an adjusted basis. Declines associated with asset servicing amortized cost, the timing of charitable contributions and other miscellaneous expenses, more than offset increases from the securities lending litigation settlement and a $2 million sequential increase in FDIC expense.

Our loan-loss provision was a credit of $3 million in the third quarter. This compares to a provision credit of $3 million in the prior quarter and a credit of $10 million in the prior year. The credit provision in the current quarter was primarily driven by a reduction in outstanding loans and improved credit quality in the residential real estate portfolio, partially offset by an increase in the specific reserve requirement for the commercial portfolio.

Non-performing assets of $181 million were up from $166 million in the prior quarter, but down from the $207 million one year ago. Loan quality remains very strong with the ratio of non-performing loans to total loans equal to only 52 basis points at quarter end.

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. As you can see on this page, our performance in the current quarter has continued to drive the ratio lower and is now at 107%.

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 driving productivity within our expense base through our ongoing initiatives focused on location, strategy, procurement and technology.

Turning to page 9 our capital ratios remain solid with Common Equity Tier 1 ratios of 11.8% and 11.2% 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 11.6% and under the standardized approach would be approximately 11%. 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 6.6% and at the bank was 5.9%. 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 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. During the third quarter Northern Trust issued $500 million in perpetual preferred stock at an initial fixed dividend rate of 4.6% through October 1, 2026. Fixed-rate dividends for this new issuance are expected to be paid on a semiannual basis, with the first dividend anticipated to be declared at the January 2017 Board of Directors meeting, and paid April 1, 2017.

Given the early August issuance, the initial preferred dividend payment will cover eight months and therefore is expected to equal $14.9 million in the first quarter of 2017. Going forward, these fixed-rate dividends are expected to be paid every other quarter in the amount of $11.5 million.

Beginning October 1, 2026, dividends on this issuance are expected to be paid quarterly at a floating rate equal to three-month LIBOR, plus 3.202%. In the third quarter, we repurchased 950,000 shares of common stock at a cost of $65 million. During the quarter, we increased our quarterly cash dividend by 6% to $0.38 per common share.

In closing, the global macroeconomic environment continued to produce a difficult operating environment in the third quarter of 2016. Low and even negative interest rates around the globe; post-Brexit uncertainty; election uncertainty; and debate over central bank actions characterized the quarter. Despite that challenging backdrop, Northern Trust produced solid financial results, growing our earnings per share 13% year over year.

We also produced 1.3 points of positive operating leverage and importantly drove our expense-to-fee ratio to 107%. Our return on equity of 11.7% represents an 80 basis point improvement over one year ago. Our Wealth Management business grew total revenue 7% year over year, with fees up 6%.

This business had a pretax margin of 41%. New business success in our highest net worth categories remain strong. Our CNIS business generated 6% revenue growth and 5% fee growth.

Our new business in the quarter helped us grow organically and was exemplified with wins such as Rothesay Life and the expansion of relationships with existing clients, such as the New Zealand Superannuation Fund. In our Asset Management business we celebrated the fifth anniversary of our ETF franchise [with iShares]. Since its launch five years ago, the suite of ETFs has grown from four funds to 24, and attracted more than $10 billion in assets.

During the quarter, we once again had positive flows that outstripped industry averages. Lastly, in the quarter we successfully executed the issue an of $500 million in preferred stock taking advantage of attractive market pricing and creating capital flexibility for the Firm going forward.

Thank you again for participating in Northern Trust third-quarter earnings conference call today. Mark and I would like would be happy to answer your questions. Lisa, please open the line.

Thank you, sir.

(Operator Instructions)

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

Hi, Ashley.

Hi, Biff, how are you?

Good.

I just wanted to dig a little deeper into NIM dynamics. First, just wanted to confirm if the decline in yields within the Federal Reserve and other central bank deposit bucket was due to the Bank of England rate cut, and then just an update on the usage of short-term borrowings and how you're managing the current reinvestment environment with a potential rate hike on the horizon?

Sure. So, the first part of your question around the central bank deposit yield was largely driven by the Bank of England's move cutting the rates from 50 to 25 basis points, so you are accurate that, that was a primary driver of that decline.

As we think about using short-term borrowings that you'd described, what you would see on our balance sheet in short-term borrowings or funding sources we can from time to time use federal home loan borrowings. They have an advantage, if you will, around our liquidity needs, so we use them to manage our balance sheet liquidity from time to time, and they help, if you will, with LCR compliance and other issues, so that's how we think about the short-term borrowings that in any given period we can utilize for those types of purposes.

And just to follow up on the last part, I've been thinking about the current reinvestment environment, with a potential rate hike on the horizon?

Yes, as we think about the potential rate rise, as you know, our portfolio has typically remained short in duration. We would expect that if a rate rise were to happen in November, or more likely December, based on market prognostication, that we would benefit from that. What is important to remember is how do the markets react in advance of that?

How well telegraphed is that rate increase? So, if it's unexpected, we would anticipate seeing the benefit to come perhaps in the first quarter or second quarter of next year. If the markets anticipate that, well, then we could see some of that benefit in the fourth quarter.

And then the last component that I would highlight here is, it also then matters greatly as to how the deposit pricing reacts to that anticipated rate hike. As you know, in the last rate hike the deposit beta remained low. We will wait to observe how it unfolds this time.

Okay, thanks for taking my questions.

Our next question comes from Alex Blostein with Goldman Sachs.

Hi, Alex.

Hi, guys, good morning, thanks. Just staying on the NIM and NII discussion for a second, just an important clarification, Biff.

I think last quarter you guys had a fairly elevated amount of premium amortization running through the numbers. It looks like the yields on the guidance didn't really move. So was this quarter somewhat elevated as well, and again kind of create a little bit of a bigger drag on the NIM or 114 basis point is a fairly decent run rate for us to start thinking about Q4?

Yes, so we did see comparable levels of premium amortization in the second and third quarters. In absolute amounts in both the second and third quarter our premium amortization was approximately $20 million in both quarters. In 2015, our premium amortization in the third quarter was $14 million, so we did not see the seasonal decline that we had in previous cycles, in fact a year before that it was $13 million.

So we did not see the premium amortization seasonal decline that we've typically experienced in the third quarter. Traditionally, in the fourth quarter and first quarter we see our lowest levels of premium amortization, but again, in this third quarter we saw slightly elevated premium amortization and less benefit from the seasonal decline.

Got you, okay, so all else equal if rates don't really change we should think about the normal seasonal patterns for Q4 and 1Q?

Yes. All things being equal, right? Refinance levels, market dynamics, housing markets, et cetera, but all things we should see we typically see seasonal decline in the fourth quarter.

Fair enough. And then my second question was around the balance as well, but think about the loan growth dynamic, you guys obviously had a little bit of decline sequentially probably due to the charge, but bigger picture, the bucket has been kind of range bound at these levels for the last couple of quarters after seeing a couple of years of really nice loan growth.

How should we think about that on the forward basis? I know part of your capital return plan I think was contemplating the fact that you guys are growing and loan growth could be one of the components of why the capital return dynamic was lower than we had expected, so maybe kind of tie it together for us as we think about the loan growth outlook.

Sure, let me -- you're right. Our loan growth year over year was 2%, but I think we have to decompose that a little bit. First of all, residential real estate loans declined 12% year over year and that's strategically an initiative that we've been on as we look at our wholesale designation and really our upmarket practice in our Wealth Management Business, so that's a conscience decision on residential real estate, so that has been a drag against that loan growth.

The second thing as we look year over year at loan growth, our C&I loans are actually up 6%, commercial real estate is up 11%, and private client lending is up 17%, so we actually have seen loan growth in the areas that we've targeted and I think is important. Sequentially, if you look at that, the residential real estate continued its decline, C&I did decline and I think we're seeing that across the industry from what I've seen in C&I loans.

Commercial Real Estate was 1% and private client was up 3% sequentially, so we had the right mix of that. As it relates to RWA growth or use of capital and capital returns, what we're disciplined around is not using our capital to put on whether it's loans or any other risk-weighted asset growth items that aren't generating the right level of returns. So, we won't just use it to grow the balance sheet for non-strategic RWA growth, and in this case, as I highlighted for you in the case of residential real estate for us, the slowing there is something that we're targeting strategically.

Got you, great. Thanks very much.

Our next question comes from Ken Usdin with Jefferies.

Hi, Ken.

Hi, Biff, how you doing? This quarter you had really good just core business growth metrics AUM, AUC, AUA. Of course, the market was up and international was up a little bit more, but I was wondering if you could break us out just an understanding; was there notable good net new business this quarter, was it more about mix and where the dollars came from, just thinking about kind of underlying organic growth and wins.

So, when we decompose those growth rates, which were strong, approximately 50% was driven by the market levels that you described, but 50% was really driven by what I would say positive flows and/or new business. So, at the core, we saw good, strong new business across the franchise, both in Wealth, Asset Management and C&IS.

We saw very, very good strong growth. I would say generally across the globe. So, whether it was in Asia Pacific region and Australia or in our European region, where we had substantial new wins, or even here in North America in our C&IS business.

And in Wealth, largely across our geographies, we continue to see, I think, accelerated success in some of our large market investments, like New York City, that's growing double or triple the overall Wealth Management averages to date. So, I think it was a broad-based set of successes that really drove that, not just a market-driven beat, like I said about 50% was from new business and/or flows.

Okay, got it, great, thanks for that. And separately, can you just talk a little bit about the market-sensitive revenues, obviously we saw the market environment for FX be kind of weak and in the summer quarters can you help us understand. Do you think that it was more driven by low volume or low volatility, and what about the mix of channel, if it was core custody and on the electronic piece that you've been building?

Yes, so, we're still heavily linked to both volatility and volume. You're right, we've absolutely tried to invest in our e-platforms for FX trading, but we're still directionally moving in lock step with both volatility and volume. I would say volatility would be mixed, whether year over year or sequentially.

We had negative sequential volatility but positive year over year. It also matters, Ken, in whether it's emerging market currencies or it's G7 currencies, and the volatility between the two. So, most of our FX, though, the vast majority of FX is really driven by our core custody business.

It's in relation to supporting the asset managers that are supporting our clients or our clients' needs. There's not a proprietary trading element to this. It's just in support of that, so it will be in move lock step with volumes and volatility in general.

Thanks, Biff.

Thanks.

Our next question comes from Brian Bedell with Deutsche Bank.

Hi, Brian.

Good afternoon. Hi, how are you? Maybe just going to the fourth quarter, I think you mentioned the $7 million increase in [comped] linked quarter, but if you could just touch on seasonality trends in the fourth quarter, typically there is usually growth in outside services and equipment and software expense, just wanted to see if that still seems to be the general trend, and also the tax rate in the fourth quarter with the accounting change.

Let me break out outside services first for you. Real quickly, our outside service category, which totaled about $158 million in the third quarter, approximately one-third of that is directly related to what I would say are market activities, if items such as sub custodian expense, third party advisor fees, brokerage, clearing expense, et cetera. So it will move as the markets move in that quarter, and you -- can stay linked to that.

About half is what I would say is what we call technical services, and it's generally linked to business activity. It's things like market data, use of market data systems and processing, client customization work, but it's generally linked, if you will, to the directional revenue of the firm in that. The third part, probably the part that we're talking about here is about 20%, and that's the most discretionary, that's things like consulting spend.

We would -- in the third quarter we saw a meaningful decline in our consulting spend. We're going to work hard to maintain that discipline in the fourth quarter, as well around that component of outside services. And then you also had a question on the tax rate as well?

Yes, with the equipment and software expense as well on that (multiple speakers) -- deadline.

The equipment and software, if you look at past and seasonal trends, those have a small or a modest increase typically in the fourth quarter.

Usually, Ken, that would be with the software amortization continuing trends.

And the tax rate? Yes, the tax rate. So, that is dependent on A, the amount of equity that would either vest or be exercised and the value of the stock at the point of that exercise, that's how that tax rate works.

If the price of the equity exercised is higher than at the point when it was granted it will be a favorable tax benefit, and if it's not, then it won't. I can't predict how that will play out in the fourth quarter, but as you know, this is a practice we would have had to adapt 1/1/17, either way.

Right, great. And then maybe just longer term question on investment in the business and technology you mentioned a little bit about that as well, but just think about the asset servicing business and what some of the competitors are doing, State Street with project Beacon and Bank of New York with its digital efforts. How do you feel your asset servicing business is positioned from a technological perspective, and is there only more investment required in that and are you able to leverage the Omnium platform across your franchise more effectively?

Yes, so we've made substantial technological advancements and investments, as has our industry and our space in the industry, as you described. We really are looking at a series of initiatives to invest in that we think will A, first enhance our clients' experience in terms of the mobile applications or the interface they may have when they come into the firm, but also drive efficiency inside the firm, and that could be efforts around robotics or other efficiencies inside the firm.

One of the advantages we have, we believe, is that our organic growth strategy over time has allowed us to have largely single platforms for all of the areas we need to process on, and so our ability to deploy capital is pretty efficient. So, we think that our spend, which we do highlight, I think, total capital and technological expense is about $2.4 billion over a three-year cycle. So, we think that's enough to keep us competitive and on peer or above our competition.

Great, that's helpful, thanks so much.

Our next question comes from Mike Mayo with CLSA.

Hi, can you discuss Europe a little bit? With the restructuring of some global banks, are you seeing market share potential, do you see potential to pursue deals in Europe, are you looking to add in Europe, are you repositioning in Europe between what's happening with the European banks and Brexit and everything else?

Good question. We certainly do see a lot of movement in Europe right now, as many of the large globally systemic important banks are revisiting their business models. We've had tremendous success in Europe, particularly in our GFS business, where we've grown substantially over the last decade, and we are always open and have understanding of what businesses we're interested in.

As we've stated before, our approach to any of those opportunities is always first around a client capability and second about really filling a geographic gap, and then third I think a technological gap. But I think the market right now is experiencing some whitewater, and we stand ready to have dialogues and those that fit our strategic needs will certainly have dialogues.

If I go on just briefly, and with Brexit, a little bit linked to your question, but while there is still a great deal of uncertainty on the UK exit, we have formulated plans to establish a full subsidiary in the EU. We have meaningful presence in Ireland and Luxembourg and several other locations today and we will evaluate all those for where the optimal location is for us, but we are actively engaging in that planning right now.

So, does Brexit cost you money then, or it's not that big a deal since you're elsewhere in Europe?

So, we have physical presence in many of those locations and talent in those locations, but I am sure there would be some element of cost to look at incorporation and all the legal work that we would have to do with that. We think that's at a very manageable level, though, relative to our overall financial position.

All right, thank you.

Our next question comes from Glenn Schorr with Evercore.

Hi, Glenn.

Hello there. Forgive if this is a little repetitive, but on the decision on taking down the payout ratio, part of it was for [rate agencies] part of it was to have a better positioning in your -- with your capital ratios, and part of it was for the investment in growth, some of the stuff we talked about here. But I'm curious to revisit, where are we going to see the benefits of that decision?

Will it be as simple as higher capital ratio but should we see higher growth rates relative to peers? Some of this is technology and some it is actual growth in the business?

I think that we need to demonstrate that it's driving higher growth ratings than our peers and higher returns on our capital over time, because the businesses we're choosing to invest in and that. And as we've said on previous calls, if we don't see the opportunity for that growth, we have an annual opportunity to revisit our capital distribution strategy and we do with our Board and our regulators, we revisit that.

When we did that process three -- six months ago really in the planning phases of that, we had certain growth trajectories built into our planning and modeling, and we continue to execute on those. If those don't manifest, then we will revisit that plan in the 2017 submission cycle.

What I said earlier, though, I'd reiterate is, there's a discipline about not just using that retained capital, if you will, to put on any assets or any risk-weighted assets, so any loan or any other risk-weighted asset. It is a disciplined approach for those that we think can generate superior returns over time.

Fair enough, just one followup. In Inside Wealth Management, curious, you have these differentiated growth rates across the regions and especially in Global Family. I wonder how much of that relates to the money-market fee waiver recapture and how much of that is just pure business mix of the different type of customer?

So, in the Global Family Office, money-market fee waivers is a meaningful portion of that driver. As you might imagine, those are large, very high net worth families that often look more like an institutional type investor and may have had large cash balances in their portfolio, so fee waivers for them was a meaningful driver. Across the other regions, I'd say that's a better mix of fee waiver benefit and actual new business and flows.

Okay, thanks, Biff.

Our next question comes from Geoffrey Elliott with Autonomous Research.

Hi, Geoffrey.

Hi, thank you for taking the question. Could you give us an update on the Department of Labor fiduciary rule as you work through the detail of that, how is its impact shaping up relative to your initial expectations?

Sure. We are continuing, if you will, to evaluate the impact of the fiduciary rule and we've spent a lot of time and energy, as you might have suspected, in that evaluation and continue together with outside counsel and consulting experts on the DOL fiduciary standards. At this time, we expect that any changes to our business model and product offerings will be limited and that the costs associated with the design, implementation and ongoing monitoring of compliance will be moderate.

We continue to wait for further guidance along with our industry and further clarifications. I think we anticipate perhaps some Q&As and other items to come out to give us further guidance, but at this point in time, as I said, we think that it will be a moderate impact and limited business model changes is what we're anticipating.

And then just to check on one of the previous questions that I understood what you were saying correctly. When you're asked about this location among European banks and the impact of that it kind of sounds like that's an area you're focusing on when you're thinking about M&A opportunities. Did I understand that right?

No, I would say that we focus on three areas when we think about where we can grow, and in your case you're asking inorganically. The first is, is it filling a client need or gap, is there a product gap? Second is, is there a geography or a regional gap in our array of capabilities, and third is there a technological or talent gap in those?

That's where we start. I think the question was phrased, there's European institutions that are contemplating their own organizational structure, so many of those may have a capability or a geography or a technological or talent gap where we have a need, so now that may manifest itself. I don't think there's an extraordinary amount of focus on Europe versus any other region in the world, but right now there's probably a lot of institutions that are contemplating their own business structures now, and we stand ready to look at any opportunities that fit the first three criteria I laid out for you.

Great, thank you.

Our next question comes from Brian Kleinhanzl with KBW.

Hi, Brian.

Hi, Biff. One quick question on the move in the pound sterling this quarter. Does it have a big impact on the revenues overall or, could you quantify that for us?

Hi, Brian, it's Mark. When you look at the P&Ls, it's important to remember that we do have a natural hedge where we have both revenue and expense in the denominated currencies, and then to the extent that there's an exposure we hedge it.

And as far as the growth rates go, when you look on a year-over-year basis, the trust fee impact would probably be the area of revenue impacted the most by about 1 to 1.5 percentage points, and then on the expense side as well you're looking at about a 1% to 1.5% benefit year over year on the currencies. Then sequentially there was also some impact there as well on both trust fees and expense were 1% or so lower, due to currency exchange rates.

Okay, great. And then I heard you say that you have $3.6 million of expenses related to the Aviate acquisition.

Was that just merger related charges or is that the increase in run rate that you were saying was $3.6 million? Sorry for the clarification there.

So, that was -- it's Mark again. That was a $3.6 million impact in the quarter. What I would say is that, that would include, well, the quarter's expense were $6.6 million.

Last quarter was $3.4 million. So, in the $6.6 million there is a modest amount of still integration expense, but we are calling that out just for the fact that the second quarter was kind of an abbreviated quarter because the acquisition closed in May.

Okay, and then just last one on the tax rate Can we at least assume that the tax rate guidance before, where I think it was 33%, that with this new accounting change it doesn't at least go over 33%?

I'm not sure we can provide any guidance on that. It's depending on, again, levels of stock that may vest and/or be exercised in the quarter, so, can't provide any guidance on that.

Okay, thanks.

Our next question comes from David Long with Raymond James.

Hi, David.

Hi, guys. Looking at the Wealth Management Business, the Assets Under Custody and Assets Under Management both this quarter exceeded the movement in the S&P 500, but if I look back over the last few years, say since year-end 2013, the growth in that Assets Under Custody and Assets Under Management has been about 7.5% and 9% respectively, when the S&P has been up about 17%. So, just curious as to how you can explain that difference in the Wealth Management Business with the Assets Under Custody and Management underperforming the moves in the equity markets?

You know, I could start, David, if you want just by talking a little bit about the allocation, and then if Biff has anything to add. Currently with Wealth Management, when we look at AUM, about 47% are in equities as of the end of the quarter, 29% in fixed income and 34% in cash -- or 24% in cash and other. So, certainly, how the assets are allocated would be part of what the driver is there.

Okay, just looking at the equity side of it, the equities were up 7.5% since then versus the 17%. Just trying to see if there's anything that we should be considering that may not be obvious.

I think just the macro trends, and this is a little off the question, but the macro trends we've seen in Wealth Management, the migration from active to passive and others have had some imputed impact on the business. As well as, quite frankly, just flows, meaning as people have used their principal to live on and others has had a drag on our Assets Under Management in particular. The Assets Under Custody in our Wealth business are driven a little bit more by our GFO business -- or excuse, me our Global Family Office business, which where you tend to have larger pools, more than the traditional Wealth business.

Got it, thanks.

Thank you.

Our next question comes from Jim Mitchell with Buckingham Research Group.

Hi, Jim.

Good morning. Most of my questions have been asked, so maybe just on money-market Mutual Fund reform.

Have you seen any change in behavior, whether it's deposit flows or in the money-market space in terms of your corporate or retail customers? Just trying to get a sense of how that's playing out.

You know, across the industry, really, over a trillion in AUM moved into government funds and what we've seen in our funds is no different. You'll be able to see the asset levels in each of our funds, on our funds website. Overall we have seen a migration from prime and/or other funds of such ilk into government and/or Treasury funds meaningfully.

Notably for us is that we didn't see our total AUM drop in that, just the mix moved dramatically into government-related funds. In fact, I think we're actually up $15 billion since -- in cash AUM since 2014, since summer of 2014, so we've seen that asset class grow, but the mix has clearly shifted into government. What we didn't see was any meaningful migration on to the balance sheet, so we did see that shift from prime and/or other gated or [Variable NAV] funds into Treasury and government funds, but not on the balance sheet.

That's interesting, it really just stayed within the money-market complex, didn't shift to deposits?

That is what we have seen through the third week in October. (laughter)

Okay, great, thank you.

Our next question comes from Marty Mosby with Vining Sparks.

Hi, Marty.

Hi. Wanted to ask you a little bit about the premium amortization in the sense that prepayments kicked up over the last couple of quarters.

Is that real time, is there any lag? So, as we expect that from a seasonal standpoint going down, but also just from prepayment speeds slowing, I would expect that some of that premium amortization would also be kind of drift lower because of that as well.

So, traditionally, that's what we've observed into the fourth quarter, and as you rightfully pointed out, there's a series of factors other than just seasonality and generally market conditions, interest rates and a series of other factors. Our normal pattern has been to see that in the fourth quarter come off.

The $20 million of premium amortization you saw in the third quarter as I said was elevated over the previous year, 2015's third quarter by about $6 million, so we saw some modest decline in 2015 from Q2 to Q3. This year we saw basically flat between the two. And in both of those years we saw meaningful declines from Q3 to Q4.

A piece I was also trying to get at is as you've been initially this year you came in expanding your duration or lengthening duration using what looked to be like a little bit more in the mortgage-backed securities, and then you had the premium that then got hit because of the amortization and prepayments. Have you slowed down on your utilization of your balance sheet capacity to put on, has this kind of spooked you a little bit at all? I just don't see the same progression that we saw earlier this year in utilizing that capacity to increase the yield on your securities portfolio.

Yes, so, the mortgage back that you're talking about has increased, I would say, very modestly at a percent, as you described it. I would not say it was because of being spooked by premium amortization, because as you know, that plays itself out over time, so that isn't the decision criteria.

I think the duration decisions we make are just part of our regular asset liability process in our view on future rate movements, so I wouldn't say that. First of all, it hasn't moved materially in size as a portfolio, and secondly, it certainly wasn't because of, your word spooked, because of the premium amortization.

Last thing I was going to ask you is part of your capital decisioning was a fact that competitors were under pressure from regulatory capital requirements and liquidity requirements, which was helping push some incremental deposits and balance sheet your way. Do you feel like that is starting to settle as we are seeing some of the others start to have less pressure as they've accomplished a lot of the movement that they needed to over the last year?

We saw a modest amount of that, to your earlier point, we saw a modest amount of that in the period of time when perhaps the balance sheet shrinkage was at its height. We've seen, I'd say, proportionally a little bit less as you rightfully described as institutions of sort of either right size their leverage ratio or right size their LCR requirements.

I think we retain and remain committed to the discipline we had in bringing those deposits on in the first place, which is looking at each individual opportunity of any substantial size and determining what the return dynamics are of it. We may be seeing a little bit fewer of those, though.

Okay, thanks.

Our next question comes from Gerard Cassidy with RBC.

Hi, Biff. Got a question on your non-interest expense as a percentage of trust and investment fees on your slide 8.

Do you guys have any longer-term targeted goal of where you think that can get there, and as part of that question, obviously you have had success taking in from 120% down to 107% from 2012 to where we are today. The strategies used to do that, was it primarily cutting expenses rather than seeing revenue growth or was it more revenue growth? How do you see that playing out to get to an ultimate target in the next two or three years?

Yes, we would, we've not stated a public target for that ratio other than to say that we continue to try to drive it lower. So, we've not said anything further other than we're committed to driving it lower over time. The way we think about it, Gerard, is that our most reliable income source is our trust investment servicing fees, and if we continue to have that cover more and more of our operating expenses it allows for some of the other profitability line items, like foreign exchange net interest income to truly flow straight to the bottom line.

In terms of how we get after it, it really is a dual effort. It is both the revenue and the expense line. On the revenue line, we think about that as the organic growth in there is controllable by us.

So, the ability to win new business, retain clients is 100% inside of our capabilities and efforts around new products capabilities, services that we can bring to our client base is important, so we focus on the organic growth in our -- on the fee side. On the expense side we've highlighted some of those initiatives to you.

Probably most prominent over the last three to five years in driving that ratio has been our ability to locate our people in the right cost type locations. A great example is in this quarter, net -- our net headcount grew only in what we deem to be tier 2 and tier 3 locations. There are other initiatives, we've talked about procurement, we've talked about technology saves, where it's cloud-based work or storage based work et cetera.

But we really get after then the expense side, where we do believe there are still levers inside the expense base that we can continue to pull. Combination of those, we think can continue to drive that ratio lower. It is more difficult as we eliminate some of the lower hanging fruit.

Great. And then, as a followup, obviously, we're all familiar with Governor Tarullo's speech a couple weeks back about issuing an NPR on the qualitative part of CCAR for banks under $250 billion in assets not having to go through the qualitative portion.

Assuming that sticks and the qualitative portion is removed from your CCAR process, will that change your view on how much capital you'll return to shareholders? I recognize you always like to keep very strong capital levels because of your reputation, but would that still influence you guys on thinking a little differently about the return of excess capital?

Well, Gerard, actually, we're what they term a 15-18 bank. We are not exempt from that language, because while our balance sheet is lower than $250 billion, another caveat is around more than $10 billion of foreign balance sheet. We do exceed that, as you see, so we are in what they deem the large and complex bank group, which is not what Governor Tarullo was discussing in that meeting.

Okay, thank you, I appreciate that.

Still CCAR qualitative and quantitative in our requirements. Thanks.

That does conclude today's question-and-answer session. Thank you for your participation and you may now disconnect.

Thank you.