Northern Trust Corp (NTRS) — Q1 2018 Earnings Call Transcript

Thank you, Paula. Good morning everyone, and welcome to Northern Trust Corporation's first quarter 2018 earnings conference call. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Aileen Blake, our Controller; and Kelly Lernihan from our Investor Relations team. For those of you who did not receive our first quarter earnings 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'll use to guide today's conference call. This April 17th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through May 15. 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 results. Actual results could differ materially from those expressed or implied by these statements due to many risks and uncertainties that are difficult to predict. I urge you to read our 2017 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 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 first quarter 2018 earnings conference call. Starting on page two of our quarterly earnings review presentation, this morning we reported first quarter net income of $381.6 million. Earnings per share were $1.58, and our return on common equity was 16%. As noted on the second page of our earnings release, this quarter's results included a net $6.8 million tax benefit associated with the true-up relating to the Tax Cuts and Job Act, a change in accounting method for software development-related expense deductions, and an $8.6 million charge associated with severance-related and restructuring charges. The quarter also included $23.9 million in fee revenue and $23.7 million in expense related to our acquisition of UBS Asset Management's fund administration units in Luxembourg and Switzerland, which closed at the beginning of the fourth quarter of 2017. Included in the $23.7 million in expense was $4.1 million relating to integration activities. Additionally, the adoption of the new revenue recognition standard resulted in an $8 million increase in both wealth management fees and outside services expense. Before going through our results in detail, I would like to comment on some macro factors impacting our business during the quarter. Equity markets were mixed during the quarter. Markets were favorable on a year-over-year basis with the S&P 500 and MSCI EAFE indices increasing 11.8 and 2.5 respectively. But on a sequential basis, both indices declined with the S&P 500 down 1.2% and the EAFE down 5.1%. Short-term interest rates continued to increase during the quarter driven by a rate hike from the Federal Reserve. Currency rates influenced the translation of non-U.S. currencies to the U.S. dollar, impacting client assets and certain revenues and expenses. The British pound and euro ended the quarter up 12% and 16% respectively against 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 expenses. Let's move to page three and review the financial highlights of the first quarter. Year-over-year, revenue increased 15% with non-interest income up 17%, and net interest income up 8%. Expenses increased to 11% from last year. The provision for credit losses was a credit of $3 million. Net income was 38% higher year-over-year. In the sequential comparison, revenue was up 3% with non-interest income up 5%, and net interest income down 1%. Expenses were down 1% compared to the prior quarter. Net income was 7% higher sequentially. Return on average common equity was at 16% for the quarter, up from 11.6% one year ago, and up from 15.1% in the prior quarter. Assets under custody/administration of $10.8 trillion increased 21% compared to one year ago, and 1% on a sequential basis. Included in assets under custody and administration is $607 billion relating to the acquisition of UBS Asset Management's fund administration units in Luxembourg and Switzerland. Assets under custody of $8.1 trillion increased 14% compared to one year ago and was up slightly on a sequential basis. For the year-over-year comparison, favorable market impacts, new business, and favorable movements in foreign exchange rates were the drivers. For the sequential comparison, the favorable moves in currency exchange rates and new business were mostly offset by unfavorable market impacts. Assets under management were $1.2 trillion, up 16% year-over-year and up slightly on a sequential basis. The year-over-year increase was driven by favorable markets and new business flows, while sequentially a negative market impact was offset by new business flows. Let's look at the results in greater detail starting with revenue on page four. First quarter revenue on a fully taxable equivalent basis was $1.5 billion, up 15% from last year, and up 3% sequentially. Excluding the acquisition, revenue was up 13% from last year. The favorable translation impact of changes in currency rates benefited year-over-year revenue growth by approximately 1.5%. Trust, Investment & Other Servicing Fees represent the largest component of our revenue, and were $938 million in the first quarter, up 16% year-over-year, and up 3% from the prior quarter. Excluding the UBS acquisition, fees were up 13% on a year-over-year basis. A change in presentation of certain fees resulting from the adoption of the new revenue recognition standard increased fees by $8 million during the quarter within our wealth management business. There was a corresponding $8 million increase within the outside services component of expense. Foreign exchange trading income was $78 million in the first quarter, up 63% year-over-year, and up 25% sequentially. The increases were primarily due to higher volumes and increased foreign exchange swap activity in our treasury department. Volatility, as measured by the G7 Index, was up sequentially but down from one year ago. Other non-interest income was $76 million in the first quarter, up 2% compared to one year ago, and up 6% sequentially. This increase from one year ago was primarily driven by higher security commissions and trading income, partially offset by foreign currency adjustments within other operating income. The sequential increase was primarily due to higher transition management and core brokerage revenue. Net interest income, which I will discuss in more detail later, was $393 million in the first quarter, increasing 8% year-over-year, and down 1% 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 $544 million in the first quarter, up 18% year-over-year, and up 2% on a sequential basis. The quarter included $23.9 million in fees relating to the acquisition of UBS Asset Management's fund administration units in Luxembourg and Switzerland. Excluding these fees, C&IS fees were up 12% compared to the prior year. The favorable translation impact of changes in currency rates benefited year-over-year C&IS fees by approximately 3%. Custody and fund administration fees, the largest component of C&IS fees, were $374 million, up 22% compared to the prior year and up 1% sequentially. This line does include the UBS acquisition-related fees. Excluding these fees, custody and fund administration fees were up 14% compared to the prior year. The year-over-year growth was driven by new business, favorable currency translation, and markets. The sequential increase was primarily driven by favorable currency translation and markets. Assets under custody/administration for C&IS clients were $10.1 trillion at quarter-end, up 22% year-over-year and 1% sequentially. These results include $607 billion relating to the UBS fund administration acquisition. Year-over-year excluding the acquisition, the increases primarily reflect favorable markets, new business, and the benefit of movements in foreign exchange rates. Sequentially, the benefit of movements in foreign exchange rates and new business were offset by unfavorable markets. Recall that lag 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 $110 billion in the first quarter were up 17% year-over-year and up 3% sequentially. The year-over-year growth was primarily due to favorable markets, new business, and the favorable impact of movements in foreign exchange rates while the sequential comparison was primarily due to favorable markets. Assets under management for C&IS clients were $878 billion, up 19% year-over-year and 1% sequentially. Favorable market impacts and net new business were the drivers of the year-over-year growth, while the sequential growth was driven by new business flows partially offset by unfavorable markets. Securities lending fees were $26 million in the first quarter, up 9% year-over-year and 3% sequentially. On a year-over-year basis, higher volumes were partially offset by lower spreads. For the sequential comparison, the slight increase was driven by higher volumes. Securities lending collateral was $187 billion at quarter-end and averaged to $182 billion across the quarter. Average collateral levels increased 48% year-over-year and 6% sequentially. The growth in volumes was driven by demand for U.S. treasuries. Other fees in C&IS were $35 million in the first quarter, down 9% year-over-year and up 6% sequentially. The year-over-year decline reflects lower sub-advisor fees. The income associated with sub-advisor fees has an associated lower expense in the outside services category. This decline in sub-advisor fees is consistent with the prior quarter we discontinued a service offering. The sequential increase was primarily attributable to seasonally higher benefit payment fees in the current quarter. Moving to our Wealth Management business, trust investment, and other servicing fees were $393 million in the first quarter, up 14% year-over-year and 4% sequentially. Within wealth management, the global family office business had strong performance with fees increasing 17% year-over-year and 4% sequentially. Both increases were primarily attributable to new business and favorable markets. Each of the regions also performed well during the quarter. Both the year-over-year and sequential growth in the regions were driven by favorable markets, higher fees resulting from the adoption of the new revenue recognition standard of $8 million, and new business. There is a corresponding increase to outside service expense as a result of the adoption of the new revenue recognition standard. Assets under management for wealth management clients were $287 billion at quarter-end, up 10% year-over-year and down 1% sequentially. Moving to page six; net interest income was $393 million in the first quarter, up 8% year-over-year. Earning assets averaged $116 billion in the first quarter, up 6% versus last year. Total deposits averaged $98 billion and were up 3% year-over-year. Interest-bearing deposits increased 10% from one year ago to $76 billion. This growth was partially offset by a 14% decline in non-interest-bearing deposits, which averaged $22 billion during the first quarter. Loan balances averaged $32 billion in the first quarter and were down 4% compared to one year ago. The net interest margin was 1.38% in the first quarter and was up three basis points from a year ago. The improvement in the net interest margin compared to the prior year primarily reflects the impact of higher short-term interest rates partially offset by higher premium and amortization due to a change in estimation methodology and the balance sheet mix shift. On a sequential quarter basis, net interest income was down $3 million or 1%. Average earning assets increased 2% sequentially funded by increases in interest-bearing deposits, short-term borrowings, and non-interest-bearing deposits. On a sequential basis, the net interest margin decreased one basis point with the benefit of higher short-term interest rates offset by higher premium amortization due to a change in estimation methodology, and a balance sheet mix shift. Net interest income for the quarter included a $7 million sequential decline due to the accounting for certain tax-advantaged investments. This decline was fully offset on the fully taxable equivalent line. Premium amortization totaled $19 million in the first quarter, compared to $1 million one year ago, and zero in the fourth quarter. As we have discussed previously, beginning with this quarter, we are shifting our remaining life assumption estimation methodology for premium amortization, which will lead to a more consistent quarterly amount that we expect to be within the $10 million to $12 million range going forward. In the first quarter, there was a one-time $7 million true-up adjustment to align the remaining amortization. This was included in the total amortization amount of $19 million. Looking at the currency mix of our balance sheet, for the first quarter, U.S. dollar deposits represented 69% of our total deposits. This compared to 74% one year ago and 70% during the prior quarter. Turning to page seven, expenses were $995 million in the first quarter, an 11% increase compared to the prior year and a 1% decrease sequentially. As previously mentioned, and as outlined on the second page of our earnings release, the current quarter included $23.7 million in expense associated with the UBS acquisition. The current quarter also included $8.6 million in expense associated with severance and other charges. In the prior quarter, we had $30.5 million of severance and other charges, as well as a special one-time employee cash bonus paid in connection with the adoption of U.S. Tax Reform. Excluding both the UBS acquisition and called out expense items, expenses for the quarter were 8% higher than a year ago. Excluding charges in both the current and prior quarters, expenses were 2% higher sequentially. Now keeping to total non-interest expense, I would like to break down those growth rates further. Starting with the adjusted 8% year-over-year increase, approximately two points of growth was from the unfavorable translation impact of changes in currency rates, primarily the British pound and euro. Excluding currency impact, therefore our year-over-year expense growth rate was approximately 6%. The adoption of the new revenue recognition standard added an expense of $8 million but was partially offset by lower sub-advisor costs due to the discontinuance of a product line. Both of these items were within outside services and had corresponding fee revenue impacts. Combined, these two items drove just under half a point in expense growth, bringing our core expense growth rate to approximately 5.5%. With respect to the remaining increase in year-over-year expense growth, the following items are key drivers within the categories. Compensation was higher driven by increased incentive compensation and base pay adjustments from April of last year. The impact of staff growth on salaries was offset by staff actions and location strategy efforts. Benefits were higher primarily due to an increase in retirement plan expenses, medical costs, and higher payroll tax withholding compared to the prior year. Outside service costs were higher driven primarily by higher sub-custodian and technical services including market data costs. Equipment and software expenses were up year-over-year due to higher software amortization and equipment depreciation. Occupancy-related costs were higher compared to the prior year, primarily due to accelerated depreciation related to a previously-announced facility exit in one of our Chicago locations. Shifting to the sequential expense view, excluding the expense charges in both the current and prior quarter, expenses increased 2% from the prior quarter. Compensation expenses increased primarily reflecting higher expenses related to long-term performance-based incentive compensation due to divesting provisions associated with the grants to retirement eligible employees in the current quarter. This quarter's compensation included $32 million in expense associated with retirement-eligible staff. As a reminder, similar to last year, there will also be approximately $11 million in expense associated with the retirement-eligible employees in the second quarter. Additionally, next quarter's compensation will also be impacted by base pay adjustments of approximately $8 million, which were effective on April 1. Outside services costs were down sequentially, primarily relating to lower consulting, legal, and technical services expense, partially offset by higher third-party advisor costs resulting from the adoption of the new revenue recognition standard. There is a corresponding increase to trust investment and other servicing fees as a result, as I mentioned earlier. Equipment and software expenses were higher sequentially primarily due to increased software amortization and software support costs. Elsewhere, other operating expenses declined from the prior period primarily due to lower business promotional spend, staff-related costs, and lower miscellaneous expenses within the category. Staff levels increased approximately 5% year-over-year and 1% sequentially. The growth year-over-year includes the addition of approximately 240 partners as a result of the UBS acquisition; the remainder of the growth was all attributable to staff increases and lower-cost locations, which include India, Manila, Limerick, Ireland, and Tempe, Arizona, partially offset by reductions in our higher-cost locations. Turning to page eight, as we have discussed on previous calls through our value per spend initiative, we are realigning our expense base with the goal of realizing $250 million in expense run rate savings by 2020. Concurrently, we are embedding a sustainable expense management approach. We expect these efforts to slow our expense growth to be more closely aligned with our organic fee growth. Our first-quarter results reflect approximately $14 million in expense savings, reducing the year-over-year expense growth by approximately 1.5 points. This would equate to approximately $55 million on an annualized basis against the $250 million goal. I would like to highlight a few examples of our progress to date for you. We have focused on eliminating redundancy by strategically realigning employees and leveraging our location strategy. We continue to drive improvement and vendor pricing across multiple areas and remain focused on reducing our consulting spend. We continue to cultivate a healthy pipeline of opportunities that we expect to discuss in future quarters. Turning to page nine, a key focus has been on sustainably enhancing profitability and returns. This slide reflects the progress we have made in recent years to improve the expenses to fee ratio, pre-tax 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 pre-tax margin and ultimately our return on equity. Turning to page 10, our capital ratios remain strong with our common equity tier 1 ratio of 13.1% under the advanced approach, and 12.4% under the standardized approach. The supplementary leverage ratio at the corporation was 6.7% and at the bank was 6.1%; both of which exceed the 3% requirement, which became applicable to Northern Trust effective at the start of this year. With respect to the liquidity coverage ratio, Northern Trust is above the 100% minimum requirement that 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 first quarter, we repurchased 2.5 million shares of common stock at a cost of $263 million. In closing, Northern Trust delivered strong financial results in the quarter, growing earnings per share by 45% over the prior year. Our assets under custody and administration and assets under management were up 21% and 16% respectively versus the prior year. Our return on average common equity, up 16%, and expense to trust investment and other servicing fees of 106 were our best performance since the financial crisis. As we seek to drive profitable growth, we were pleased to deliver strong positive operating leverage of 3.6 points and positive fee operating leverage of 4.7 points. On an organic basis, our fee and expense growth rates were better aligned. While growth across our segments was strong, so too was the profitability of each business. Our wealth management business grew pretax income by 24% versus the prior year while improving the pretax margin from 37% to 41% and driving the expense-to-fee ratio down to 93%. Our C&IS business similarly drove strong year-over-year performance with pretax income growing 42% versus the prior year, and the pretax margin improving from 29% to 34%, and driving the expense-to-fee ratio down to 108. We are confident in our competitive positioning within growth markets and our ability to continue profitably growing our business. Before I conclude, as is customary for our first quarter earnings call, we will need to end today's call a bit earlier than in other quarters to allow sufficient time for all of us to get to our annual meeting, which begins at 10:30 A.M. Central Time this morning. Please accept our apologies in the event we have to close off the question-and-answer period earlier than our normal practice. Thank you again for participating in Northern Trust's first quarter earnings conference call today. Mark and I would be happy to answer your questions. Paula, please open the line.

Great. Thanks, good morning folks.

Hi, Brian.

Hi, good morning. Maybe just to start off with FX trading, obviously another strong result, can you talk about the portion that you think is due from the FX swap activity in the treasury business, and it looks like even adjusting for currency volatility, we’re in the last two quarters, now we're seeing a big step up in that run rate, so just like to sort of think about that going forward.

Yes, thanks, Brian. So we had really solid growth both sequentially and year-over-year in foreign exchange, as you highlighted. And that was really driven by two key factors. The first was that in our core trading, if you will, our core trading business volumes were higher, and we did see some higher volatility. And so that produced approximately $63 million to $64 million of the FX volume you see, which is above our traditional run rate there. The remainder, approximately $15 million, is from the treasury swap activity that we called out. And if I could I'd like to give a little bit of an explanation on that. As a part of our normal balance sheet management, we manage our currency and put it in the most effective currency. We have been able to, because of a demand for dollars from certain institutions, take dollars from our Fed balances, swap them into sterling and euro and place them with the ECB or the Bank of England. So when we've done that, the resulting benefit from the currency swap flows through the FX line. As you would understand, we gave up some net interest income to get that. So the $15 million improvement you have seen in the FX line that's attributable to treasury trades, there was about $10 million of net interest income give-up to do that, but that's still a good economic trade for our shareholders if you think about that. And right now that's because of the widening we've seen in that swap trade because of the demand for dollars. So it's hard to project where that trade and that spread will go, but we've taken the right currency decisions and the right balance sheet decisions in the first quarter of this year, and even a bit of the tail end of 2017. So about $63 million to $64 million was core FX and $15 million was driven by the treasury swaps. You'll be able to see that in the 10-Q as well that shows up under the treasury trading line in the segment reporting.

Thank you for the great insights. To follow up on expenses, it was an excellent quarter for expense control. You’ve managed to achieve just over 25% of the 250 programs so far on a run rate basis. Could you discuss the trend heading into the second quarter and the remainder of the year? Was the first quarter a peak performance for this year, or do you anticipate this trend continuing? Also, you mentioned reinvesting in other growth initiatives; could you provide more details on that?

Let me discuss the expenses. Our core expense growth rate is about 5.5%, which reflects our core performance for the quarter. If I examine specific expense lines, I would note that other operating expenses may show some seasonality, particularly because our business promotion typically decreases in the first quarter. Additionally, staff-related expenses, often linked to ex-pat hypothetical tax, can also be lower in the first quarter. Overall, the trend in other expense lines generally aligns with historical patterns, but the only line that appears lower than usual is other operating expense. It might be more insightful to evaluate that expense line over a calendar year, especially with the upcoming opening of Northern Trust in the third quarter. There may be some seasonality to consider. Moreover, equity compensation tends to be higher in the first quarter compared to later quarters, and I’m sure you can factor that into your models. While I'm not certain where we previously mentioned investments, we continue to reinvest in our business where opportunities arise, and we are committed to maximizing value for expenditures, as noted in this quarter's highlights. This careful execution must persist throughout the year to create investment opportunities for the company.

Hi, Alex.

Hi, guys. Good morning, and thanks. So first question is around the NIR and some of the funding dynamics we saw from you guys in the quarter. I guess two questions there. First on the balance sheet side itself, so continued nice growth in average earning assets up 2-ish percent I think quarter-over-quarter. How much of that is due to new customer business versus some of the discretionary leveraging you've done in the past?

Yes, it's a bit of both. So we have continued to see strong new business, but there was also some increased discretionary leverage.

So, yes, Alex, the discretionary leveraging was actually down about $1 billion sequentially, on a year-over-year basis though it was about $3 billion last year and closer to $7 billion this year.

Got you. Please continue.

I'll just say it's a bit of both.

Yes, I understand. More importantly, let's discuss the funding side. When we examine the deposit betas and the level of non-interest bearing deposits, we should consider both aspects. Looking at the deposit beta, it appears that costs have only increased by about three basis points sequentially, which is encouraging given that rates continue to rise. Could you help us understand what's happening there? Additionally, the non-interest bearing deposits have shown a nice sequential increase for the first time in a while. Could you elaborate on what contributed to that, how sustainable you believe it is, and whether there might be a chance to reduce some of the short-term borrowings you implemented, considering that the deposits seem to be performing better? I know there are multiple elements to address, but they're all interconnected.

Let me start by addressing the liabilities and the betas. It's generally more informative to consider the betas over a longer timeframe rather than focusing on any single quarter. There can be instances where our betas appear lower than expected, but we may have outperformed the market during those times. Conversely, there are periods when we might see a catch-up effect, but reviewing the data over time provides a clearer picture. Additionally, we closely monitor the markets for both retail and institutional deposits. The institutional side is particularly competitive, and we keep a close eye on our rivals to adjust accordingly. On the retail and wealth management deposit levels, we have noticed heightened competition and increased rates from some peers in that space. We have a systematic approach to assess the rate environment and adjust our betas as needed. As of now, the betas we've presented are accurate, and we'll likely continue to align with market expectations. Regarding non-interest bearing deposits, there was a modest increase this quarter. However, I would hesitate to assert that this level is the new standard. We've seen some funds that could be sensitive to rates coming in during this quarter. For the last three quarters, those deposits have remained in the range of $21 billion to $22 billion, which we monitor closely—especially the portion we consider the most rate-sensitive, around $5 billion to $6 billion. The remainder consists of wealth deposits and other elements that generally support our core operating businesses. We maintain regular communication regarding the $5 billion to assess its long-term sustainability and rate sensitivity, and it has remained stable for three quarters.

Good morning.

Good morning, Brennan.

Yes, good morning. Thanks for taking the question. So just wanted to circle back to, I believe you highlighted in your commentary, Biff, about a balance sheet mix shift on the NIM front. And I know that you had talked a little bit about the FX swap. Was that what you were referring to? Was there something else? Could you maybe provide a little bit of additional clarity on what was behind that, and what was behind that comment?

Sure. That is one piece of it. And as you've also seen the loan portfolio as a portion of the balance sheet has gone down over time as our loan growth has flattened out or even gone slightly negative. So if you look at those two items. Plus, there's also some currency mix shift; some of that was caused by the swap as we moved out of dollars into other currencies. But the combination of those two essentially was the mix shift that I was talking about in the earlier question.

Sure, can you provide an update on the loan book and its proportion? Specifically, how much of that book is set to re-price at the start of the year? How should we consider the re-pricing of the loan book in light of rising rates, as suggested by the forward curve, and how that could impact your strategy moving forward? Thank you.

In terms of seasonality, it is quite limited. It's better not to think of it as seasonal given the changes in our loan portfolio over time. A more accurate indicator would be the movements in loan yields from December to March this year, which showed a significant increase in spreads. Our funding for these loans is generally short-term, around overnight to one month based on LIBOR, and the asset spread has been able to adjust more rapidly due to the widening linked to our funding levels. It's important to focus on the sequential changes as a clearer indicator of the yield increases in those loan instruments. Additionally, it's worth noting that our residential real estate portfolio has been declining for some time and is being replaced by investment management account secured loans, which are secured by the portfolio. These loans typically have lower yields but also comes with reduced credit risks, so this should be considered when thinking about pricing.

Hi, Jeffrey.

Hi, good morning. Thanks for taking the question. Thank you for giving that 5.5% figure for core expense growth. Can you help us think about organic revenue growth, clearly an important target for you to run with that in line with or above expense growth, but what do you think that is right now?

Yes, in the quarter, we would estimate it was about 5%. Regarding the 5.5% core growth I mentioned, it's important to note that it includes some inflationary or inorganic factors, as our sub-custody fees and expenses are linked to market levels. There are other elements in those expense bases as well, so our actual organic expense growth rate is likely somewhat lower than the 5.5% I provided. Nevertheless, the 5.5% serves as a solid benchmark for expense growth from our perspective, and you can adjust from that based on your own organic or inorganic considerations. On the organic revenue or fee side, I can clarify that it was roughly 5% in the quarter.

Thanks very much. And then on the target ROCC range of 10 to 15, clearly this quarter you came ahead of the top end of that range. I mean, how do you think about that in an environment where the tax rate is lower? Is it time to think about moving the 10 to 15 up?

Yes, I think the change that's happened with the Tax Cut and Jobs Act has caused us to look at the target range, and we will go through that process and look at that. We also want to see that unfold for a bit though, right. We're one quarter in. We want to see how the markets react. It is one quarter, as you saw in this quarter. The benefit of that tax cut flowed largely through to our shareholders in this quarter. But I think we'd like to observe the behavior of the competitive landscape for some time. But we are taking all of those factors into play. I do believe this is the kind of secular change, much like when we all had to add capital coming out of the crisis when we revisited our ROE target. This is the type of secular change that causes that revisitation. But we'd like to have some observation of the marketplace to help inform that process.

Thanks, good morning.

Hi, Ken.

Biff, on the capital front you've mentioned the willingness to leverage the balance sheet a little bit more. And then also, given that we've got this notice of proposed rule-making and that you're not a GSIB, can you talk about just how you think that might change your view of what's binding and how much excess capital you truly have to hold versus minimums and versus peers? Does it give you any flexibility upon first glance?

If I consider the NPR, regarding the CCAR release, I would say it aligned with our expectations and reflects what Governor Tarullo had previously indicated. From our perspective, we support it as it enhances our flexibility in capital planning. However, it does not significantly impact our operations since we have been adhering to the capital rules for some time. In terms of flexibility, regarding leverage and the supplementary leverage ratio, we are not constrained by it, which seems to have a greater effect on GSIBs than on us. If there are changes to tier 1 leverage, that would be our binding constraint. As for our capital levels, we would be limited by tier 1 leverage, but not overly constrained, as you can see from our current capital levels. Lastly, we have submitted our capital plan and are awaiting feedback in June. We approached this from a position of strength, and we are considering how to use our capital—either by deploying it on the balance sheet or returning it. We have made a request to our regulator and will see their response.

The all-in yield on the securities book came down and governments moving up and everything else moving down, it's a little counterintuitive as people think of high rates and also how much of your business is growing. So maybe we can just get an update on pictures floating in the securities book, what does it float off of, and just if we should expect it to move up from here?

Yes, so let me walk you through the securities portfolio, because it is intuitive that it would've gone down, but it'll be, I hope, more intuitive when we walk you through that. First of all, in the securities portfolio, about 16 basis points was premium amortization. So that in itself would've started to move the securities yield to where you wanted. We also had about 5 basis points of drag from FTE, which is offset in the FTE line. But we had about five basis points of drag from that. And then we had about five basis points of drag from the mix shift that I talked about earlier. That was really then offset by about 20 basis points for rates and offset by day count, because obviously we had fewer days, so that improved the securities yield. I hope that's better color, because if you add all of that together, that securities yield very much moved the way you would've thought. In fact, it would've been one of the biggest moves we've seen in the securities yield sequentially. It just was masked somewhat particularly by the premium amortization in the quarter. So I think that's a pretty good walk.

And Glenn, regarding the portfolio mix, we consider it to be about half short-term and half long-term. The short-term assets are influenced by both one-month and three-month rates, with a slightly greater emphasis on the one-month. For the long-term assets, we're referring to maturities of two, three, and five years, which overall averages out to just above one year for the entire portfolio. I hope that clarifies things.

Maybe just one follow-up on the asset yields and then the overall NIM, if I put everything together and just think of a starting point for Q2, is it really just the premium amortization change and I think you mentioned it might've been 7 million yield increase in the first quarter. So should we normalize for that or are there other components you mean that we should be normalizing and thinking about it like a starting point for this second quarter?

Yes, I would say if you think about the NIM sequentially from fourth quarter to the first quarter, the things that impacted it, that you could factor in as the NIM benefited by day count. So there could be some drag, if you will, because the day count will be higher in the second quarter, but that was about 1 basis point. Premium amortization was about seven points of NIM drag in the quarter and then you can subtract what you think is a normalized impact. That's the total impact, but I'll let you do that and then there was some from the FTE adjustment, about two bips of drag, and then there was about 5 basis points of that currency and mix shift that I talked about on the balance sheet. But rates themselves probably would've added about 12 bips. If you do all of that math and you go back, I think you can get to probably a NIM that's a better launch point mark. I don't know if you got anything to do with that.

No, I don't think so. However, to reiterate the point that Biff made regarding the FX trading line, we experienced a $15 million benefit from our treasury swap activity. Without that benefit, we estimate we would have seen approximately $10 million more in net interest income for the quarter, which contributed to the changes highlighted sequentially.

Hi, thanks for taking my questions. Can you hear me?

Yes. Hello.

Could you provide more details on the $250 million cost cuts, including where the savings will come from and the timing? We were hoping to get more detailed information on this.

Yes, so as we said in our prepared remarks, in-quarter we had $14 million of savings, which on a run rate basis would be approximately $55 million. The categories that those savings would've come from were in some cases what we would call 'organizational alignment,' that's things like aligning our staff to the right locations, aligning our staff from eliminating redundancy, et cetera. So those programs are underway and they're producing the savings we see. But we also have savings in areas like procurement where we negotiated different contract arrangements with a variety of vendors that also provided some of that $14 million in savings in-quarter. And then we are continuing to get what I would call, 'process optimization opportunities,' where we are utilizing robotics and other artificial intelligence opportunities on things like document ingestion et cetera. All of those are starting to contribute to that, and we have a portfolio of opportunities that on a regular basis we will update you with how they help drive those savings. As we said consistently, we anticipate that that savings will be roughly evenly distributed across the three years, and as you can see we're off to a pretty good start with $55 million in the first quarter this year.

When you mention that the savings will be evenly distributed over three years, I want to clarify that from the $250 million, if I round it to about $80 million, we should expect to see roughly $14 million this year. This does not include the annualized figure of $55 million; rather, it is $14 million plus any additional amount we will see in the next quarter and the following three quarters, all of which should total around $80 million. Are you referring to some kind of annualized run rate?

Vivek, this is Mark. I believe your approach is correct in that we should consider the total impacts over the quarters. It's still early in this process and we won't see consistent trends right away. As we gain more clarity moving forward, we will keep you updated. For now, the way you described it seems to be the most appropriate way to think about it.

Okay, because what I'm trying to understand is how much more incremental this year, given that you are already at annualized 55?

Right.

My point is that the annualized figure is already at 55. If you have 25 left and manage to achieve a bit more in the second quarter, you could potentially wrap it up. I'm trying to figure out whether it's truly a third of the total each year, or if there are some delays this year that might push some of the savings to the second year. Alternatively, could we interpret this as even a small incremental addition of about $5 million per quarter might mean we're slightly ahead of the one-third target?

Vivek, I think we have got a portfolio that will unfold over quarters and over years. And we are going to continue to execute on it. I don't think you should interpret that we are largely done for the year because we are at 55. I think you should anticipate that we will give you updates. And we are continuing to progress on our portfolio of opportunities.

Hi, just following up on the last question. So, your pre-tax margin of 33% is the highest in several years. Do you expect the pre-tax margin to stay at that level? Or, is there more investment spending that we should expect going forward?

We are committed to enhancing the firm's profitability across all key metrics. We believe that by focusing even more on improving the expense-to-fee ratio, we can gradually enhance the pre-tax margin. Our current plans allow us to execute effectively on value per spend while also pursuing investment opportunities within our business. We see potential for further improvements. This quarter, we made significant progress in reducing the expense-to-fee ratio, and we believe there are still opportunities available. Additionally, our wealth business significantly improved its margin this quarter, as did our Corporate & Investment Solutions business. So, yes, we see opportunities for continued growth.

And is the expense to fee ratio is still the right measure as opposed to expenses to total revenues? I mean, you get paid in compensating balances in a period of higher rates. I mean at some point do you want to look at that more holistically? And then one of your competitors recently said let's look at performance excluding the market impact. Just questioning whether you are exploring some alternative ratios to evaluate your performance?

Yes. Good question. So, I would say there's not one absolute perfect ratio. But given that fees are our largest revenue line, we've kind of anchored to the expense to fees as an important ratio. We absolutely though care about operating leverage to your point as well because obviously we saw the power of net interest income and foreign exchange flowing through the revenues. And we are not dismissive of that. So we do look at operating leverage. But we look at core fee operating leverage because FX and to some degree net interest income can have a bit more volatility to those earnings streams. In terms of the second part of the question around the organic, we've been talking for several years now about how important we think the organic growth rate is in the firm. And so, we do internally look at what type of leverage we are getting organically. So how are we growing our fees versus our expenses on a more organic basis, we have not published anything about that externally. But I would say that is absolutely internally one of our key drivers and metrics. It's something that I can tell you that management team and our board look at, not only our absolute financial performance, but they look at the organic performance on a regular basis. And that's the way we report it to them so they can understand what management drove versus what the macro environment drove. And under consideration, they both are impactful to our business.

Hi, Biff, thanks for taking the question. I want to drill in on this premium amortization and think of a more as you roll forward because when rates are low, you have to buy securities that have premiums not just because rates are rolling lower. So, it kind of just creates that phenomenon. Now, rates are going higher so those securities you can buy really won't have that kind of premium. So, as you are thinking of this rolling off, you have such a short duration this premium amortization while a new setup in a negative to net interest income has a finite life and should be kind of replaced with bonds that don't have as much premium on them. So, just want to see what you thought about that?

Yes. So, as we said it was $19 million in the quarter because of the true-up, and we think we will be $10 to $12 million going forward. To your point, it depends on where we are buying those instruments. If your premise which is right quantitatively if that continues, then we could potentially be buying in that lower premiums which could move that $10 to $12 and will give you updates if we think it moves off of that. I would also say though another factor, Marty, is if we change the total amount of those securities that we hold on our portfolio, so even though it may be a lower amortized amount, it's on a bigger balance that could indeed create that still $10 million to $12 million range. We will give updates. But, right now our best thinking on that based on the current environment is in that $10 to $12 million range for premium amortization.

And the securities that you are buying now, do they still have like you said the securities get bigger but they will have significantly less premium than what you bought over the last couple of years I would think.

I can't say for sure, but that seems logical to me. However, we need to verify that. It does make sense given the rate environment you've described. Mathematically, I'm not certain if the team is acquiring portfolios or instruments with a different premium amortization profile than what the markets would indicate. I would assume that’s unlikely. My intuition is that your assumption is correct.