Northern Trust Corp (NTRS) — Q4 2017 Earnings Call Transcript

Thank you, Hanna. Good morning, everyone, and welcome to the Northern Trust Corporation's fourth quarter 2017 earnings conference call. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Aileen Blake, our Controller; and Kelly Moen Lernihan from our Investor Relations team. For those of you who did not receive our fourth quarter earnings press release and financial trends report via email this morning, they are both available on our website at northerntrust.com. Also, on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This January 24th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through February 21st. 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 2016 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 our fourth quarter 2017 earnings conference call. Starting on page two of our quarterly earnings review presentation. This morning, we reported fourth quarter net income of $356.6 million, earnings per share were $1.51, and our return on common equity was 15.1%. As noted on the second page of our earnings release, this quarter's results included a net $53.1 million tax benefit associated with the Tax Cuts and Jobs Act, a $12.9 million expense related to special one-time employee cash bonuses paid in connection with the Tax Cuts and Jobs Act, and a $17.6 million charge associated with severance and restructuring charges. This is also the first quarter which includes the impact from our acquisition of UBS Asset Management’s fund administration unit in Luxembourg and Switzerland. The quarter included $21.1 million in fee revenue and $24.2 million in expense, which was inclusive of integration and transaction expenses. In regards to our effective tax rate following tax reform, we currently expect our ongoing effective tax rate to be approximately 23% to 24%. Of course, it should be noted that a number of factors can and do impact our effective tax rate from quarter to quarter. Before going through our results in detail, I would note that macro factors impacting our business and clients during the quarter were generally positive. Both domestic and global equity markets were favorable. Short-term interest rates continued to increase during the quarter, driven by rate hikes from both the Federal Reserve and the Bank of England. Currency rates influence the translation of non-U.S. currencies to the U.S. dollar and therefore impact client assets and certain revenues and expenses. The British pound and euro ended the quarter up 9% and 14%, respectively versus the prior year as compared to the U.S. dollar. On a sequential basis, the British pound and euro also strengthened. The strengthening of these currencies compared to the U.S. dollar favorably impacted revenue but had an unfavorable impact on our expense. Let’s move to page three and review the financial highlights of the fourth quarter. Year-over-year, revenue increased 16% with non-interest income up 14% and net interest income up 20%. Expenses increased 15% from last year. The provision for credit losses was a credit of $13 million. Net income including the tax benefit associated with the Tax Cuts and Jobs Act was 34% higher year-over-year. In the sequential comparison, revenue was up 6% with non-interest income up 5% and net interest income up 8%. Expenses were up 7% compared to the prior quarter. Net income was 19% higher sequentially, including the tax benefit. Return on average common equity was at 15.1% for the quarter, up from 11.9% one year ago and up from 12.2% in the prior quarter. The return on average common equity during the quarter benefited by approximately 1.5% from the tax benefit net of the expenses associated with severance and one-time bonuses. Assets under custody/administration of $10.7 trillion increased 26% compared to one year ago and 11% on a sequential basis. Included in assets under custody/administration is $568 million relating to the acquisition of UBS Asset Management fund administration units in Luxembourg and Switzerland. Assets under custody of $8.1 trillion increased 20% compared to one year ago and 4% on a sequential basis. For both the year-over-year and sequential comparisons, favorable market impacts, strong new business, and favorable moves and currency exchange rates were the drivers. Assets under management were $1.2 trillion, up 23% year-over-year and up 3% on a sequential basis. The year-over-year and the sequential increases were primarily driven by favorable markets and net new business flows. Let’s look at the results in greater detail, starting with revenue on page four. Fourth quarter revenue on a fully taxable equivalent basis was $1.4 billion, up 16% from last year and up 6% sequentially. Excluding the acquisition, revenue was up 14% from last year and up 5% sequentially. The favorable translation impact of changes in the currency rates benefited year-over-year revenue growth by approximately 1%. Trust, investment and other servicing fees represent the largest component of our revenue and were $910 million in the fourth quarter, up 15% year-over-year and up 5% from the prior quarter. Excluding the acquisition, fees were up 12% year-over-year and up 2% sequentially. Foreign exchange trading income was $63 million in the fourth quarter, up 8% year-over-year and up 28% sequentially. The increases were primarily due to higher volumes. Other non-interest income was $72 million in the fourth quarter, up 11% compared to one year ago and down 3% sequentially. This increase from one year ago was primarily driven by a loss in our lease portfolio in last year’s result. The sequential decline was primarily due to lower net hedge-related income, partially offset by higher security commissions and trading income. Net interest income, which I will discuss in more detail later, was $396 million in the fourth quarter, increasing 20% year-over-year and up 8% sequentially. Let’s look at the components of our trust and investment fees on page five. For our corporate and institutional services business, fees totaled $533 million in the fourth quarter, up 17% year-over-year and up 6% on sequential basis. The quarter included $21.1 million in fees relating to the acquisition of UBS Asset Management's fund administration business in Luxembourg and Switzerland. Excluding the acquisition, C&IS fees were up 12% compared to the prior year and up 2% sequentially. Custody and fund administration fees, the largest component of C&IS fees were $369 million, up 22% compared to the prior year and up 9% sequentially. This line does include the acquisition-related fees. Excluding the acquisitions, fees were up 15% compared to the prior year and up 3% sequentially. Both increases were driven by strong net new business, favorable markets, and a benefit from currency exchange rates. Assets under custody and administration for C&IS clients were $10.1 trillion at quarter-end, up 26% year-over-year and 11% sequentially. These results include $568 billion relating to the UBS fund administration acquisition. Excluding the acquisition, the increases primarily reflect favorable markets, new business, and the benefit of moves in currency exchange rates. Recall that lagged market values factor into the quarter’s fees with both quarter lag and month lag markets impacting our C&IS custody and fund administration fees. Investment management fees in C&IS of $106 million in the fourth quarter were up 13% year-over-year and up 2% sequentially. Both the year-over-year and sequential comparisons were primarily driven by favorable markets and net new business flows. Assets under management of C&IS clients were $871 billion, up 26% year-over-year and 4% sequentially. Favorable market impacts and net new business were the drivers of the year-over-year growth while the sequential growth was driven by favorable markets. Securities lending fees were $25 million in the fourth quarter, flat with the prior year and up 11% sequentially. On a year-over-year basis, higher volumes were offset by lower spreads. For the sequential comparison, higher volumes were partially offset by lower spreads. Securities lending collateral was $168 billion at quarter-end and averaged $173 billion across the quarter. Average collateral levels increased 45% year-over-year and 16% sequentially. The growth in volumes compared to the year-ago was driven by demand for U.S. treasuries. The sequential volume increase was driven by U.S. treasuries and U.S. equities. Other fees in C&IS were $33 million in the fourth quarter, down 4% year-over-year and down 9% sequentially. The year-over-year decline reflects lower sub-advisor fees, partially offset by higher fees from investment risk and analytical services. The sequential decline was primarily attributable to lower sub-advisor fees. This decline in sub-advisor fees has a corresponding impact within expenses and the outside services category. Moving to our wealth management business. Trust, investment, and other servicing fees were $377 million in the fourth quarter, up 12% year-over-year and 3% sequentially. Within wealth management, the global family office business had strong performance with fees increasing 17% year-over-year and 3% sequentially. Each of the regions also performed well during the quarter. Across the global family office and each of the regions, both year-over-year and sequential growth was driven by favorable markets and new business. Assets under management for wealth management clients were $290 billion at quarter-end, up 17% year-over-year and up 2% sequentially. Moving to page six. Net interest income was $396 million in the fourth quarter, up 20% year-over-year. Earning assets averaged $113 billion in the fourth quarter, up 4% versus last year. Total deposits averaged $97 billion and were up 3% year-over-year. Interest-bearing deposits increased 11% from one year ago to $76 billion. This growth was partially offset by an 18% decline in non-interest-bearing deposits which averaged $21 billion during the fourth quarter. Loan balances averaged $33 billion in the fourth quarter and were down 2% compared to one year ago. The net interest margin was 1.39% in the fourth quarter and was up 19 basis points from a year ago. The improvement in net interest margin compared to the prior year primarily reflects the impact of higher short-term interest rates, partially offset by the change in the mix of our balance sheet. On a sequential quarter basis, net interest income was up $30 million or 8%. Average earning assets increased 1% sequentially, funded by increases in interest-bearing deposits and short-term borrowings, partially offset by a slight decline in non-interest-bearing deposits. On a sequential basis, the net interest margin increased by 10 basis points with the benefit of higher short-term interest rates and lower premium amortization being partially offset by the change in the mix of our balance sheet. Net interest income for the quarter included a $4 million sequential benefit due to the accounting for certain tax-advantaged investments. This benefit was offset in the fully taxable equivalent line. Looking at the currency mix of our balance sheet, for the fourth quarter, U.S. dollar deposits represented 70% of our total deposits, this compared to 74% one year ago, but was in line with where we were in the prior quarter. Premium amortization was zero in the fourth quarter, compared to $10 million one year ago, and $19 million in the third quarter. As we have discussed, previously beginning with 2018, we are shifting our remaining life assumption methodology for premium amortization, which will lead to a more consistent quarterly amount that we would expect to be within the $10 million to $12 million range. In this first quarter that we change over to the new method, there is a one-time true-up to align the remaining amortization. We currently expect this one-time true-up to result in additional amortization of $10 million to $13 million, bringing the overall expected premium amortization in the first quarter to a range of $20 million to $25 million. Turning to page seven. Expenses were $1 billion in the fourth and were 15% higher than the prior year and 7% higher sequentially. As previously mentioned and as outlined on the second page of our earnings release, the current quarter included $24.2 million in expense associated with the acquisition. As outlined earlier, the current quarter also included $30.5 million in expense associated with severance and other charges, as well as the special one-time employee cash bonus. In the prior quarter, we had $7 million of severance and personnel charges. Excluding both the acquisition and called-out expense items, expense for the quarter was 8% higher than a year ago and 2% higher sequentially. Now, keeping to total non-interest expense, I would like to decompose those growth rates further. Starting with the adjusted 8% year-over-year increase, approximately 1.5 points of growth was from the unfavorable translation impact of changes in currency rates, primarily the British pound and euro, which strengthened versus the U.S. dollar by 9% and 14%, respectively. Excluding currency impact, therefore, our year-over-year expense growth rate was approximately 6.5%. Of the remaining increase in year-over-year expense growth, the following items were key drivers within the categories. Compensation was higher, driven by staff growth, base pay adjustments from April of this year, and higher cash-based incentive accruals. Benefits were higher, primarily due to an increase in medical costs and higher payroll taxable withholding compared to the prior year. Occupancy-related costs were higher compared to the prior year, due to accelerated depreciation related to a previously announced facility exit in one of our Chicago locations and a one-time provision relating to our London location. Equipment and software expenses were up year-over-year due to higher software amortization and equipment depreciation. Outside service costs were higher, driven primarily by sub-custody and technical services including market data costs, partially offset by lower consulting and sub-advisor expenses. And other operating expenses were higher due to increases in certain miscellaneous expense categories, partially offset by lower business promotion and staff-related costs. Shifting to the sequential expense view. As I mentioned, excluding the acquisition, the expense charges in both the current and prior quarter and the impact of one-time bonuses, expenses increased 2% from the prior quarter with compensation, benefits, and occupancy costs being the principal drivers. Compensation was higher due to the higher cash-based incentive accruals and higher salaries from staff growth; benefits were higher sequentially primarily due to higher medical costs; and occupancy-related costs were higher sequentially primarily due to the Chicago and London occupancy actions I highlighted in the year-over-year explanation. Elsewhere, outside service costs were down sequentially, primarily relating to the lower sub-advisor costs. The decline in these costs had a direct offset in lower C&IS other trust fees. Other operating expenses declined from the prior period, primarily due to lower business promotional spend due to the third quarter Northern Trust-sponsored golf event. This decline was partially offset by higher miscellaneous expenses within the category. Staff levels increased approximately 6% year-over-year and 2% sequentially. The growth includes the addition of approximately 230 partners as a result of the acquisition. The remainder of the growth was all attributable to staff increases in lower cost locations which include India; Manila; Limerick, Ireland; and Tempe, Arizona. Turning to the full year, our results in 2017 are summarized on page eight. Net income was $1.2 billion, up 16% compared with 2016 and earnings per share were $4.92, up 14% compared with the prior year. On the right margin of this page, we outlined the non-recurring impacts that were called out for both years. For 2017, this includes the fourth quarter net tax benefit of $53.1 million as well as $60.3 million in expense items, which include the one-time employee bonuses and severance and restructuring charges. The third quarter also included a tax benefit of $17.6 million related to federal and state research tax credits. For 2016, this includes a net revenue impact of $96.6 million while the expense-related charges were a total of $82.6 million. We achieved the return on equity for the year of 12.6%. This performance was within our target range of 10% to 15% and an improvement from our 2016 performance of 11.9%. Full year revenue and expense trends are outlined on page nine. Trust, investment, and other servicing fees grew 10% in 2017. Favorable markets and new business across segments and geographies contributed to this result. Foreign exchange trading income declined 11%, primarily reflecting lower volatility across the year compared to the prior year. Other non-interest income was down 21% from last year, but up 7% if adjusted for the items I called out on the prior page. Net interest income increased 17%. The growth in net interest income was primarily driven by higher short-term interest rates coupled with earnings asset growth. The net result was 9% growth in overall revenue on a reported basis in 2017 and 11% excluding the 2016 items I called out on the prior page. On a reported basis, expenses were up 9% from the prior year. Adjusting for the expense charges in both 2016 and 2017 that I mentioned in the prior pages, expenses were also up 9% from 2016, reflecting investments in staffing and technology to support the growth of the business, as well as to comply with evolving regulatory requirements. Turning to page 10. A key focus has been on sustainably enhancing profitability and returns. This slide reflects the progress we have made in recent years to improve the expense to fee 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. Turning to page 11. Our capital ratios remained very strong with common equity Tier 1 ratios of 13.5% and 12.6%, respectively, calculated on a transition basis for both advanced and standardized approaches. On a fully phased-in basis, our common equity Tier 1 capital ratio under the advanced approach would be approximately 13.3% and under the standardized approach would be approximately 12.4%. All of these ratios are well above the fully phased-in requirement of 7% which includes the capital conservation buffer. The supplementary leverage ratio at the corporation was 6.8% and at the bank was 6.1%, both of which exceed the 3% requirement, which is applicable in Northern Trust in 2018. With respect to the liquidity coverage ratio, Northern Trust is above the 100% minimum requirement which became effective at the start of 2017. As Northern Trust progresses through fully phased-in Basel III implementation, there could be additional enhancements to our models and further guidance from the regulators on the implementation of the final rule which could change the calculation of our regulatory ratios under the final Basel III rules. In the fourth quarter, we repurchased 1.8 million shares of common stock at a cost of $171 million. We remain focused on our value for spend initiative. As we highlighted on our third quarter call, we are focused on realigning our expense base in the short term. Expenses throughout the company with an emphasis on non-client facing functions are under review. A portfolio of initiatives will support profitable growth by permanently taking expense out of our operating model. We expect to realize $250 million in expense run rate savings by 2020. Through these efforts, we expect to slow our expense growth to be more closely aligned with our organic fee growth. We will begin to provide more specific updates on our progress beginning with our first quarter earnings. Let me provide you some examples of actions that we have been taking which demonstrate our commitment to the value for spend initiative. Over the last three quarters, we have taken severance and restructuring charges of $47 million. On a combined basis, these charges will create approximately $35 million in annualized net savings, and we expect these savings to be fully realized by the first quarter of 2019. Within our technology group, we are in the process of moving to a managed services approach for certain technology services. Select support services are in the process of transitioning to new third-party vendors, while Northern Trust retains infrastructure engineering, application development, and core architecture functions. Through these efforts, we will have enhanced alignment and flexibility for our global operating model as well as a better optimized use of partner skills, knowledge, and experience. In closing, in 2017, we continued to grow the firm profitably for our shareholders, deliver comprehensive solutions for our clients, and improve our technology and infrastructure to support the sustainability of our momentum. From a financial perspective, we delivered a return on average common equity of 12.6% for the full year, moving further into our target range of 10% to 15%, and we produced $1.2 billion of net income. In addition, we returned $196 million to our common shareholders through dividends and stock repurchases, while maintaining strong capital and liquidity ratios. Our C&IS business continued to demonstrate strong growth during the year. We closed on the acquisition of UBS Asset Management's fund administration units in Luxembourg and Switzerland, which further underpins our growth strategy in continental Europe. In wealth management, we continued to grow the business and build out our goals-driven approach, while continuing to produce attractive margins, achieving a 40% pretax margin for the year. We were also pleased to be named the best private bank in the U.S. by the Financial Times Group for the 8th time in the last nine years. In asset management, we surpassed $1 trillion in assets under management during the year. We continue to see significant growth in our strategic offerings such as FlexShares, our exchange-traded fund family. FlexShares assets ended the year at $16 billion, representing growth of 37% for the year and a doubling of assets since the end of 2015. As we move into 2018, we are confident in our competitive positioning as well as our focus on profitably growing our business. Thank you again for participating in Northern Trust's fourth quarter earnings conference call today. Mark and I would be happy to answer your questions. Hanna, please open the line.

Hi. Thanks guys. Hey, Biff. Maybe the first question, just you mentioned the tax guidance. But, when we think about maybe uses whether it's from an expense standpoint or capital priorities, has anything changed given that you're operating at that lower rate? And on the flip side, you guys have been investing quite a bit over the past years and you’re focused on the value for spend, but I just want to frame that dynamic with the lower tax benefit and how much you expect to drop to the bottom line?

Thanks. I appreciate it, Mike. Tax reform is expected to be meaningfully beneficial to our firm and its shareholders and that it will favorably impact our financial performance. It does allow us to grow, as you said, and it does allow us to reinvest in our business and our people and our communities in which we operate. What it doesn’t do, what the tax change doesn’t do is it doesn’t alter our strategic focus on profitable growth, our value for spend initiative, and quite frankly, driving more leverage into our business. That is our focus; that is the strategy of the firm. If we accomplish that, if we continue to drive more leverage into our business and we increase the profitability as a result of that and we apply the lower tax rate you just cited, that should lead to much improved returns for our shareholders. But, all other constituent groups may benefit from that as well. But, certainly, as I outlined, it will drive more profitable growth for the firm.

And then, just follow-up on net interest income. You mentioned the benefit in the quarter in the lower premium amortization. Just when we think about going forward, given the organic growth of the company, what you think you can kind of grow from the deposits coming in? And then, also, where you think about managing the capital ratios, how should we be thinking about that going into 2018-2019, like both those dynamics? Obviously, the rate environment is where it is and deposit betas seem like those have been trending in line with expectations. But just how to be thinking about more the balance sheet growth with the capital ratios?

Sure. There are a couple of questions here. First, when examining the balance sheet and considering net interest income and the net interest margin as we ended the year, it provides a reasonable foundation for next year's considerations. However, I want to emphasize a few important points, including both positive and negative influencing factors. You mentioned one factor that can be seen as either positive or negative, depending on how betas develop throughout the year. If we analyze our betas over the last 12 months from the fourth quarter of 2016 to the fourth quarter of 2017, the institutional side has been slightly higher but generally aligns with what our competitors have reported. On the wealth side, betas have been low over that time frame, but after the recent rate increase, we did observe an uptick in beta on the retail side for the first time. Thus, how betas perform next year will be crucial. While we have seen some increase, there has also been discipline in the rate of those increases. We need to monitor how this plays out and ensure we remain competitive. Currently, when looking at combined betas for wealth and institutional, our beta for the past year is under 50%. This indicates that there is still potential for net interest margin expansion, provided that this holds true and betas rise at a consistent rate. Additionally, the size and mix of the balance sheet are critical factors to consider. Our organic growth rate has been notably high, typically leading to an increase in deposits and liabilities. Consequently, our balance sheet has grown in the range of 4% to 5%. While we don’t provide forward guidance, we do expect to maintain a 4% to 5% organic growth rate, which we have historically communicated. This will lead to some balance sheet expansion, but the mix may change between non-interest bearing and interest bearing, so we must keep an eye on that moving forward. Overall, there is a balanced outlook regarding the positives and negatives affecting the balance sheet, but we believe there remains potential for net interest margin expansion and net interest income growth as we look ahead.

Hi. Thanks very much. I wonder if we could talk about the acquired UBS business for a sec. I'm just curious what you can tell us about the mix of business and profitability thereof. I noticed on the revenue side, it looks like 1.5 basis points versus 2 basis points for Northern and overall, but I don't know if that's really a good apples-to-apples comparison. And then, of the $24 million in expenses this quarter, what would you consider ongoing versus integration-related, so we can just get a glimpse of profitability? Thank you.

Yes, sure. Let me take the mix question first and I'll let Mark talk to you about the ongoing expenses. But, if you think about that mix, the 1.5 basis points that you talked about, this is a pure fund administration type business and does not have a custody piece to it. So, comparing that to a more blended C&IS portfolio probably can produce different dynamics. There is obviously different product components in those items. And so, I would be hesitant to tell you that that's a perfect assessment. I think you've got to do a little bit more of a blend across. And even that 1.5 basis points may not be indicative of other fund administration business in different geographies, because they have different dynamics in different regions. So, the way I think of that is the mix matters here and the business profile matters. This is a pure fund administration capability here with no custody aligned to it. And Mark, if you want to add?

Yes. On the expenses, the $24 million, about $7.5 million of that was integration. We would say though, as you look at the $21 million in fees and $24 million in expenses as we enter 2018, there will be integration activities that are going on throughout 2018. So, both of those are probably fairly good run rates as you think about building off of the fourth quarter.

Okay, I appreciate that. One quickie on wealth management. There have been some changes to the broker protocol on the broker dealer side of wealth management. It usually wouldn't have much of an impact on Northern. But, I guess my question is, what are you doing to help drive organic growth in wealth management, both in your current client base and then in terms of attracting and growing new relationship managers?

So, my first part of that is, you’re right. We don’t really have a brokerage-led model. So, some of the nuance that you discussed there is less applicable to us. We do have the capability but it’s not the core, it's more of a fiduciary-led type model that we have in our wealth management front. In terms of growing that franchise, I think there has been significant investment in time in our goals-driven investing, comprehensive approach to the wealth profile of our clients. And we’ve seen tremendous growth and take-up in that business or that capability and approach, if I could say that. And as you could see in the growth rates in our wealth management business with double-digit fee growth and double-digit fee growth for the year in that business, while maintaining 40% margins, we’ve been very pleased with what we’ve seen in that. And then, in terms of attracting talent, it is a competitive landscape but we do believe that the Northern Trust brand is an important differentiator in attracting that talent, as is the fiduciary kind of based model, I think in some cases versus a more transactional-based model. So, it’s competitive out there but we think the brand and the performance shows we're still very focused on that business, and it had a strong performance this year.

Couple of questions, one is on the acquisition. Was there any balance sheet impact from that?

No. There is none.

And then, you did have end-of-period, noninterest-bearing deposits grow up nicely. I think on average base, it was down but EOP was up. Is that something you think can persist as we go through the next couple of quarters here?

I would say it's unlikely. Our end-of-period balance sheet can include various one-time or transactional balances. It may be more useful for you to consider the average balance sheet over the period. We observed that noninterest-bearing deposits were essentially flat sequentially, with a decrease of $300 million. As mentioned in the last call, looking at that balance of about $21 billion, we have decent visibility, and it has typically been quite stable. The remaining $5 billion is what we regularly monitor to see how sensitive it is to interest rates. It has not changed, so we believe it has a stable component in an interest-sensitive environment, but that part requires ongoing oversight. This quarter, it remained relatively stable.

Got it, okay. And then, you talked a little bit about increasing the leverage in the business model over time and the funding side of that. Could you speak a little bit to how you're thinking about stack rank, any opportunities on the deployment side?

Yes. We are considering a balance between dividends and stock buybacks, and we are currently assessing our situation. Historically, our dividend payout ratio has been around the mid-30s, with the remainder typically allocated to stock buybacks. We are evaluating the present environment to determine the best outcome for our shareholders regarding this balance. We are in the early stages of the CCAR process while collaborating with our Board and other stakeholders. We are closely monitoring the dividend payout levels in relation to stock buybacks in the current environment, and we will provide more updates as we continue through this process and receive input from our Board and our regulator.

Okay. I understand. We are just starting the CCAR period. However, reflecting on the past, we have seen similar situations for a while. If we look back to before the 2008-2009 period, your dividend payout was over 40%. I'm curious if that is being considered in the expectations for the next year or two. I realize you can't comment on that, but that's the background to my question.

Thank you. Understood. Yes.

And then, just lastly on the FX revenues, really strong quarter, especially relative to peers. I know you mentioned that you took share. Could you just give us a sense of the drivers for that, especially given the volatility is relatively low?

Thank you. Our strong performance in foreign exchange trading was fueled by increased volumes, which can be specific to our client base or portfolio when compared to our competitors at any given time. Additionally, there was a higher level of swap activity involved. As part of our regular balance sheet management, we evaluate opportunities to allocate excess cash on a hedged basis. This quarter, we experienced greater benefits than usual from our FX swap hedging activities in our treasury balance sheet. Typically, these can generate around $4 million in FX per quarter, but this time, the amount was likely $4 million to $6 million above that normal range due to favorable swap opportunities, which may persist into the next quarter. This contributed to a significant part of the sequential increase in FX driven by our standard treasury activities. However, there's a slight offset as we traded cash out of dollars for sterling and euro, resulting in some reduction in net interest income since we were placing these into lower-yielding central bank assets. Nonetheless, the positive swap FX income allowed this to be a beneficial trade for the bank.

Maybe to circle back on the deposit beta. I think you mentioned in the wealth management division, Biff, since the December hike, you did see an uptick. Can you quantify that as we move into the first quarter? I mean, obviously, your fourth quarter deposit betas were pretty low. But as we look at the trajectory coming into 1Q, can you give us a sort of a sense of maybe how much of those rates, deposit rates have gone up, I guess for January or the trajectory into 1Q?

Yes. On our wealth management side, the betas remain low. But we establish a review and we look at a certain subset of our competitors in the wealth space. We target to stay within a certain range of that competitive landscape for our depositors, maybe sometimes at a premium or a discount to that, but we got a set of competitors that we view. So that beta will depend to some degree on how the competitive landscape unfolds in that space. As you rightly said, throughout 2017 that beta remained low. We did see, again, in December, we did see some increase in the beta. But still, if you looked at it on a yearly basis, at a really pretty low level in the wealth side. I don't know, I can't forecast how that will unfold during 2018 and kind of how that competitive landscape moves. But we've done very disciplined with that approach.

And these would be wealth management peers, other private banks plus the warehouses as well?

Yes. So, broad-based basket of competitors. Yes, absolutely.

As we consider our spending and the value of our programs, I’d like to hear your thoughts on tax reform as we progress through the year. While maintaining a focus on profitable growth, how do you view the timing and willingness to invest in initiatives that may require upfront costs but promise substantial long-term benefits? Looking ahead to 2018, what should we consider regarding the expense-to-trust fee ratio, which has improved this quarter to around 107 or 106 excluding bonuses? I would appreciate any insights on that.

Yes. As you said, we are focused on driving that expense to fee ratio further down. But not completely. If there are opportunities out there to actually improve that ratio, but require expense but can improve the expense to fee ratio by driving the fee line harder or faster, we obviously evaluate those on a regular basis. And I'm not really sure that the tax reform is going to impact how we think about that. Those are decisions that we think about in our business at its core. We do and we talked to you about our value for spend, we are striving and working hard to improve the expense to fee ratio during the course of the year. That doesn't mean that our normal business model does produce enough internal income, if you will, to reinvest in our business. And it doesn't always require additional returns from taxes or whatever to do that. It's a business model that produces enough to invest internally. So, that's how we think about it. I think if we were sitting around the table, we would say that the tax reform is beneficial in the sense that we’re going to pay 7, 8 points based on the range I gave you, less than our current effective tax rate, and that’s a benefit at all levels. But we still need to drive more leverage into the business, strategically and from an execution standpoint, and we’re committed to it.

And longer-term, do you see the competitive environment changing because of tax reform outside of you in terms of pricing and other companies’ willingness to spend.

That's a good point. We're still in the early stages of tax reform, and we need to evaluate how others will utilize their financial benefits. If there are any pricing or investment changes in our industry, we're prepared to adapt. Currently, it seems that the returns from the tax benefits will likely enhance profitability, but we need to monitor how the competitive landscape develops. We're just three weeks into tax reform, and it's important to observe the strategies and approaches taken by other institutions.

Biff, if I could be more little more technical on the expense question. So, if you had 6.5% kind of core expense growth this year, what would you say the organic fee growth was this year?

So, we had 10% fee growth, and I think the range was probably about half was organic. So, the way we think about it is, if we're 5% organic, our organic expenses were probably like you said close to 6.5%, we’re not generating positive organic fee leverage. And that’s why value for spend and still continued focus on expense discipline.

And that’s really my question, then. So, accepting that as yesteryear and now moving forward, if you expect organic fee growth to still be in that four to five range as you expected before, is that where we should expect the range of core expense growth to be and would that be inclusive of any incremental restructuring charges you take?

So, I think that we've said last time that we’re trying to drive positive fee, organic fee leverage. So that’s where we're trying to get. So, what you just describe is what we publically said we want to try to drive organic fee leverage. And we remain focused on that. The second part again…

Is that inclusive of charges?

Is that inclusive of charges? As it relates to charges, I would say it is not inclusive of charges in our 2018 thinking. And while we don’t give guidance, there will be the need for some charges. We think they are largely in line with the magnitude of the charges you saw in 2017. They might fluctuate a little bit from that. So, on a year-on-year basis that won’t create much of the growth that you just described. But, we're in a process here where that could change if we see the right opportunities, but that’s where we’re right now.

Okay, I’m trying to understand if you can commit to that fee operating leverage regardless. Also, can you clarify next year’s growth rate considering the full year of UBS and how the Omnium purchase will impact that? Additionally, how much of the rest of the tech would contribute incrementally, separate from organic growth?

Well, this is Mark, Ken. Regarding the Omnium tech acquisition, I wouldn't necessarily consider it as adding extra expenses at this stage, and we'll provide more details as we progress. When assessing our organic growth rate internally, we exclude acquisitions from that analysis. For example, comparing the first quarter of 2018 to the first quarter of 2017, we would aim to filter out the expense growth and organic fee growth that excludes the acquisition. Of course, once the acquisition is fully integrated, it becomes part of our business. However, during those periods when there are year-over-year discrepancies, we make adjustments accordingly.

Right. And UBS already came on slightly positive on that front. So, hopefully on a full year basis, we would get that as an increment?

Yes. I mean, there’s about a 3 million drag on pre-tax, including integration.

I apologize for revisiting this, but I wanted to follow up on Ken’s point and the earlier discussion. It seems that 2017 was quite a turbulent year for your expenses, with various charges mentioned, including some related to severance. Additionally, we cannot overlook UBS. If we exclude that, it appears that the core expense base is just under $3.7 billion. Is this a reasonable perspective as we consider an expected organic expense growth of around 4% to 5%? What would you identify as the baseline for expenses, again excluding UBS since you've provided substantial information on that matter?

Yes, this is Mark. I would say that if you exclude the charges and make adjustments for the fourth-quarter acquisition, the number is approximately 3.7 billion. While we don’t provide specific guidance, the goal of our spend program is to reach a point where we have neutral to positive organic operating leverage by 2020. Looking at 2018 independently, there is certainly work to be done. Our aim is to align expense growth with organic growth by 2020. There may be quarters before then where we can achieve this, but by 2020, we are striving to deliver consistent results.

And then, the strategic question for you guys just around the Omnium tech transaction. So, it’s a bit of a wash on the expense side, sounds like. But any incremental opportunities that gives you on the revenue side? I mean I know that's been a pretty successful partnership for you guys in the past. That’s kind of how you got into the hedge fund administration business and that's been a big driver of servicing growth for you. But, as I think about it, you’re now doing that in-house. Any revenue implications that are sort of tangible you can point over the next 12 to 18 months?

Yes. When we announced the agreement, we indicated that with Citadel, we are bringing the technology in-house. This provides us with flexibility and valuable talent, which is advantageous as we consider our competitive positioning. In some competitive scenarios, not having technology in-house could be a disadvantage regarding who owns and supports that technology. Being able to manage it internally will help us navigate those discussions more effectively. Additionally, integrating this into our IT infrastructure allows us to leverage the benefits of a broader IT framework. We're also excited about the talented individuals joining us, as they can enhance both the Omnium platforms and some of our Northern Trust platforms. Overall, we're optimistic about the transaction, and it is progressing well in the early months of the year.

Yes. And I would also add that over time, we do expect this transaction to be cost beneficial to us. And like Biff said, be able to create greater efficiencies in the future. But we will share what we can with you as we work through the process of closing.

I have a quick follow-up regarding capital. Previously, you mentioned that you are focused on shareholder returns and capital distribution to shareholders. I want to clarify something. You've stated that keeping capital ratios aligned with competitors is an important competitive factor, which makes sense. We’ve seen increasing discussions about relief related to the leverage ratio. If we observe such relief for peers, particularly for SIFIs and not directly impacting you, wouldn't that also be advantageous for you and alleviate some constraints you’ve faced in the past?

Yes. So, if you look this quarter, while our capital ratios are still strong as is our leverage ratio, our binding constraint would be the leverage ratio not supplementary but the leverage ratio. So, the relief that's been proposed or the reaction to price share quarrels, reports are earlier this week or late last week are positive directionally for us. And if those come to being, they do give us even greater flexibility in our capital thinking and returns than we already have, which is like I said in a position great opportunity, given the strength of where we are and our capital ratios. I'm not sure how fast those will come. They were thoughtfully put in. And I'm not sure how fast we will be able to change those, but if they do, we would benefit. I think some of our peers have supplementary leverage ratio concerns that’s less impactful for us, but the leverage ratio is absolutely impactful for us and would again give us even greater capital flexibility in our thinking. And you’re right to say, it is front and center in our thinking right now.

Great, thanks for that. I want to follow up on your comments regarding the NIM outlook. I have some reservations about the cautious tone. The deposit base is relatively low, and even with potential increases, it will still remain manageable. On the asset side, your exposure is skewed toward the front end of the curve, and eliminating premium amortization noise is a significant move. So, why not express a more confident outlook regarding rate leverage as you head into 2018, especially since the market is anticipating three rate hikes? Additionally, we should consider the potential for higher rates from the Bank of England, which could also be relevant for you.

So, Brennan, without providing guidance, we believe our net interest margin can expand. We anticipate it will expand, but we are cautious, considering that if betas rise to 1 with the next rate hike in a competitive environment, which is an unlikely scenario, it could impact our expectations. Should we convey that the net interest margin would significantly expand, that might not hold true. If our projections for net interest margins are realized, and if we observe the betas expand as we've seen, our net interest margin will indeed grow. The progression of our net interest income has been quite favorable compared to the industry, thanks to the strategies we implement regarding beta management. This has proven beneficial for the firm. Therefore, while we expect growth, we approach it with some caution.

On wealth management, some of your discount guys have pointed to significant activity pick up among retail investors, obviously not necessarily you're same. The high net worth space is not as a different customer base. But, if you’ve seen sort of the animal spirits getting better with your wealth management high net worth customers, you’ve seen flows improve. Just trying to get sense of how to think about organic growth, what you’re seeing in flows and activity levels among your wealth management client base?

Yes, we have observed strong year-end flows. Our clientele, which typically consists of individuals at the higher end of the net worth spectrum, appears to be responding positively to the robust equity markets. They are also considering the potential for lower personal income taxes, depending on their state. There seems to be an increase in confidence that encourages them to invest in their own businesses, whether that means taking those businesses public or selling them. Consequently, we have noticed an uptick in flow and new business. Additionally, there was a significant enhancement in our organic growth rates from 2016 to 2017 within our wealth management sector. This is reflected in the fee growth and overall performance of our wealth management business. With tax season approaching and the market showing healthy signs, we believe this confidence is still strong and we hope it continues.

And are cash balances at low points still reasonably high? I mean, what’s sort of the dry powder?

Yes, they’re not at low points; they’re actually still high. I think there are people exploring where the opportunities are. Our cash balances within our firm have increased across our asset management portfolios year-over-year, both institutionally and personally. When I looked at our traditional wealth portfolio, we reached the highest equity level as a component of that portfolio since 2009, when we hit bottom. So, individuals with equity investments in their portfolios are back to high levels, averaging in the low 50% range across their portfolios.

Look, I’m going to give a little windup to my question. So, on the positive side, look, Northern had the best top-line growth among peers in 2017. You guys played the long game, you did very well through the crisis. So, I don’t want to take anything away from you guys. But, did I hear it correctly that you’re not committing to positive fee operating leverage until 2020? In other words, I think you said, you did not get it on a core basis in 2017 and you’re not planning on that for either this year or next year because it’ll take time for the $250 million of savings to come through?

No. That isn’t what we said. So, we’re going to work hard to do what we can on that front over the next 12 months to get to that level. Obviously, the organic fee part of that equation requires a lot of execution. But, I can tell you that we’re committed to getting to that before 2020, all things being equal.

And Mike, when I was commenting earlier, I was focused on the organic leverage. So, we’ve been running at about 6.5%, even if you adjust for things on expenses, our organic fees or let’s say 4.5 to 5%. And the value for spend initiative has the intention of closing that gap.

Yes, for sure.

I have a question for you. You have done a great job of increasing the return on equity, although not the return on tangible common equity. Currently, your goal is to keep that number in the range of 10% to 15%. Reflecting on your previous targets, you aimed for a long-term return on equity of 16% to 18%. I realize we may not reach that target, but with tax rates decreasing and both your profitability and that of your peers improving as a result, should we expect to see this range increase? How are you planning to push it higher as your profitability continues to rise?

Thank you, Gerard, for the question. When we first set the range of 10 to 15, the industry was undergoing a significant change. We were all required to increase the capital on our balance sheets and examine how we could return value throughout the cycle, which is when we defined that range. At this time, if tax reform is indeed a significant change, as we believe it is, we need to consider how it affects our targeted range and its overall impact on us. This kind of significant change will lead to a reevaluation within the firm.

I wanted to follow up regarding capital. I appreciate that you're currently evaluating this and it’s clear that shareholder returns and returning capital to shareholders are top priorities. I want to clarify something. Previously, you've mentioned that maintaining capital ratios similar to competitors is an important competitive factor, which makes sense. There's been increasing discussion in the media about potential relief on the leverage ratio, particularly for certain institutions. If we observe that relief for your peers and it's not directly applicable to you, wouldn't that still benefit your company and provide some easing on a constraint that has affected you in the past?

Yes. So, if you look this quarter, while our capital ratios are still strong as is our leverage ratio, our binding constraint would be the leverage ratio not supplementary but the leverage ratio. So, the relief that's been proposed or the reaction to price share quarrels, reports are earlier this week or late last week are positive directionally for us. And if those come to being, they do give us even greater flexibility in our capital thinking and returns than we already have, which is like I said in a position great opportunity, given the strength of where we are and our capital ratios. I'm not sure how fast those will come. They were thoughtfully put in. And I'm not sure how fast we will be able to change those, but if they do, we would benefit. I think some of our peers have supplementary leverage ratio concerns that’s less impactful for us, but the leverage ratio is absolutely impactful for us and would again give us even greater capital flexibility in our thinking. And you’re right to say, it is front and center in our thinking right now.

I just want to clarify something. Regarding MBS premium amortization, you mentioned a one-time charge that brings you to 20 to 25, so the increase is between 10 to 13. This implies that the remaining amount would be around 10 million to 12 million. Since you said you plan to keep it fairly consistent quarter-over-quarter, does that mean you expect the 10 million to 12 million to continue on a quarterly basis for the rest of the year?

Yes.

Even though the long end has gone up so much?

Yes. As we sit here today, that’s our expectation. Yes.

And lastly, going back to, I think Gerard’s question earlier, which was the ROE goals. I mean, from what I can see, the guidance that you’re giving on taxes, ongoing taxes should add a good 1.5 points to your ROE levels. So, at the very least, shouldn’t we expect that 10 to 15 to go up by that 1.5 percentage points?

We will assess that as mentioned on the call regarding the ongoing change that supports it. The calculations you've done are reasonable and can be replicated, but we need to consider these alongside several other strategic factors, and that's our current position.

Thank you.