Northern Trust Corp (NTRS) — Q2 2018 Earnings Call Transcript

Thank you, Jonathan. Good morning, everyone, and welcome to Northern Trust Corporation's Second 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 second quarter earnings press release and Financial Trends Report via e-mail this morning, they are both available on our website at northerntrust.com. Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This July 18 call is being webcast live at northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through August 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 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 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. 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 second quarter 2018 earnings conference call. Starting on Page 2 of our quarterly earnings review presentation. This morning, we reported second quarter net income of $390.4 million. Earnings per share were $1.68 and our return on common equity was 16.5%. As noted on the second page of our earnings release, this quarter's results included $6.6 million of severance-related and restructuring charges. The quarter also included $22.1 million in fee revenue and $21.8 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 $21.8 million in expense was $2.6 million relating to integration activity. Before going through our results in detail, I would like to comment on some macro factors impacting our business during the quarter. Equity markets had a mixed impact for us during the quarter. End-of-period markets were favorable on a year-over-year basis with the S&P 500 and MSCI EAFE Indices increasing 12.2% and 3.3%, respectively. On a sequential basis, both indices increased with the S&P 500 up 2.9% and the EAFE up about 2.5%. Average daily markets for these indices were slightly lower on a sequential basis. As you will recall, some of our fees are based on lagged pricing. And in the prior quarter, the S&P 500 was down 1.2% while the EAFE was down 5.1%. The markets were also lower for some of our month-lagged pricing. Short-term interest rates continued to increase during the quarter driven by a rate hike from the Federal Reserve. Currency rates influenced a translation of non-U.S. currencies to the U.S. dollar and, therefore, impact client assets and certain revenues and expenses. Both the British pound and euro ended the quarter up 2% versus the prior year as compared to the U.S. dollar, favorably impacting revenue, but negatively impacting expense. On a sequential basis, the British pound and euro declined 6% and 5%, respectively, compared to the U.S. dollar. The sequential changes had an unfavorable impact to revenue and a favorable impact to expense. Let's move to Page 3 and review the financial highlights of the second quarter. Year-over-year, revenue increased 14% with noninterest income up 12% and net interest income up 21%. Expenses increased 6% from last year. The provision for credit losses was $1.5 million versus a credit of $7 million 1 year ago. Net income was 46% higher year-over-year. In the sequential comparison, revenue was up 2% with noninterest income flat and net interest income up 8%. Expenses were essentially flat compared to the prior quarter. Net income was 2% higher sequentially. Return on average common equity was at 16.5% for the quarter, up from 11.6% 1 year ago and up from 16% in the prior quarter. Assets under custody and administration of $10.7 trillion increased 15% compared to 1 year ago and decreased slightly on a sequential basis. Included in assets under custody/administration is $575 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 10% compared to 1 year ago and were flat on a sequential basis. The year-over-year growth was driven by favorable market impacts and new business. On a sequential basis, the benefits from favorable markets and new business were offset by unfavorable moves in currency exchange rates. Assets under management were $1.1 trillion, up 12% year-over-year and down 1% on a sequential basis. The year-over-year increase was driven by favorable markets and new business flows while, sequentially, the decline was primarily relating to lower end-of-period securities lending collateral levels as well as unfavorable moves in currency exchange rates. Let's look at the results in greater detail, starting with revenue on Page 4. Second quarter revenue on a fully taxable equivalent basis was $1.5 billion, up 14% from last year and up 2% sequentially. Excluding the acquisition, revenue was up 12% from last year. The favorable translation impact of changes in currency rates benefited year-over-year revenue growth by approximately 0.5%. Trust, investment and other servicing fees represent the largest component of our revenue and were $943 million in the second quarter, up 11% year-over-year and up 1% from the prior quarter. Excluding the UBS acquisition, fees were up 9% on a year-over-year basis. Foreign exchange trading income was $79 million in the second quarter, up 58% year-over-year and flat sequentially. The year-over-year increase was primarily due to higher client volumes and increased foreign exchange swap activity in our Treasury department. Volatility, as measured by the G7 Index, was down both on a year-over-year and sequential basis. Other noninterest income was $71 million in the second quarter, down 13% compared to 1 year ago and down 6% sequentially. The year-over-year decline was primarily due to nonrecurring net hedge gains recognized in the prior year and a decline in the current quarter relating to the valuation of existing swap agreements related to Visa Inc.'s Class B common shares. The Visa swap evaluations were also the key contributor of the sequential decline. Net interest income, which I will discuss in more detail later, was $423 million in the second quarter, increasing 21% year-over-year and 8% sequentially. Let's look at the components of our trust and investment fees on Page 5. For our Corporate & Institutional Services business, fees totaled $552 million in the second quarter, up 13% year-over-year and up 1% on a sequential basis. The quarter included $22.1 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 9% compared to the prior year. The favorable translation impact of changes in currency rates benefited year-over-year C&IS fees by approximately 1%. Custody and fund administration fees, the largest component of C&IS fees, were $377 million, up 15% 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 8% 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 new business, partially offset by unfavorable currency translation and lower markets. Assets under custody/administration for C&IS clients were $10.1 trillion at quarter-end, up 16% year-over-year and down 1% sequentially. These results include $575 billion relating to the UBS fund administration acquisition. Year-over-year, excluding the acquisition, the increases primarily reflect favorable markets and new business. Sequentially, the benefit of markets and new business were offset by unfavorable movements in foreign exchange rates. Recall that lagged market values factor into the quarter's fees with both quarter-lagged and month-lagged markets impacting our C&IS custody and fund administration fees. Investment management fees in C&IS of $113 million in the second quarter were up 14% year-over-year and up 3% sequentially. The year-over-year and sequential growth were both impacted by new business as well as a change to gross revenue presentation for certain clients. Markets had a favorable impact to the year-over-year growth, but had an unfavorable impact on a sequential basis. There was a corresponding increase to third-party advisor cost in outside services expense as a result of the change to gross revenue presentation. Assets under management for C&IS clients were $862 billion, up 13% year-over-year and down 2% sequentially. Favorable market impacts and net new business were the drivers of the year-over-year growth, while the sequential decline was driven by a lower level of end-of-period securities lending collateral as well as unfavorable movements in foreign exchange rates. Securities lending fees were $30 million in the second quarter, up 23% year-over-year and 16% sequentially. On a year-over-year basis, higher volumes were partially offset by lower spreads. For the sequential comparison, higher spreads were the primary driver of growth. Securities lending collateral was $174 billion at quarter-end and averaged $184 billion across the quarter. Average collateral levels increased 38% year-over-year and 1% sequentially. Other fees in C&IS were $32 million in the second quarter, down 10% year-over-year and 7% sequentially. The year-over-year decline reflects lower sub-advisor fees. The income associated with sub-advisor fees has an associated lower expense in outside service category. This decline in sub-advisor fees is consistent with the prior 2 quarters when we discontinued the service offering. The sequential decline was primarily attributable to seasonally higher benefit payment fees in the first quarter of each year. Moving to our Wealth Management business. Trust, investment and other servicing fees were $391 million in the second quarter, up 8% year-over-year and down 1% sequentially. Within Wealth Management, the Global Family Office business fees increased 11% year-over-year and 1% sequentially. The year-over-year growth was driven by new business and favorable markets while the sequential performance was driven by new business, partially offset by unfavorable markets. Within the regions, the year-over-year growth was driven by favorable markets, higher fees resulting from the adoption of the new revenue recognition standard and new business. Sequential performance was impacted by unfavorable month-lagged markets. Assets under management for Wealth Management clients were $287 billion at quarter-end, up 8% year-over-year and down slightly sequentially. Moving to Page 6. Net interest income was $423 million in the second quarter, up 21% year-over-year. Earning assets averaged $114 billion in the second quarter, up 4% versus last year. Total deposits averaged $96 billion and were down 1% year-over-year. Interest-bearing deposits increased 1% from 1 year ago to $74 billion. This growth was offset by a 9% decline in noninterest-bearing deposits, which averaged $21 billion during the second quarter. Loan balances averaged $32 billion in the second quarter and were down 5% compared to 1 year ago. The net interest margin was 1.48% in the second quarter and was up 20 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 a balance sheet mix shift. On a sequential quarter basis, net interest income was up $30 million or 8%. Average earning assets declined 1% sequentially driven by decreases in deposits, partially offset by higher short-term borrowing. On a sequential basis, the net interest margin increased 10 basis points, primarily driven by the benefit of higher short-term interest rates as well as lower premium amortization. You will recall that premium amortization totaled $19 million in the first quarter as we shifted our remaining life assumption estimation methodology. That change will lead to a more consistent quarterly amount that we expect to be within the $10 million to $12 million range going forward. The prior quarter's results included a one-time $7 million true-up adjustment to align the remaining amortization. The current quarter reflects the new methodology with premium amortization at the lower end of the $10 million to $12 million range. Looking at the currency mix of our balance sheet for the second quarter, U.S. dollar deposits represented 69% of our total deposits. This compared to 71% 1 year ago and is unchanged from the prior quarter. Turning to Page 7. Expenses were $997 million in the second quarter and were 6% higher than the prior year and up slightly on a sequential basis. As previously mentioned, the current quarter included $21.8 million in expenses associated with the UBS acquisition. The current quarter also included $6.6 million in expense associated with severance and other charges. For comparison purposes, note that 1 year ago, our results included severance and other charges of $22.8 million while the prior quarter included $8.6 million. Excluding both the UBS acquisition and called out expense items, expense for the current quarter was 6% higher than a year ago. Excluding charges in both the current and prior quarter, expenses was up slightly. Now, keeping to total noninterest expense, I would like to break down the year-over-year growth further. Starting with the adjusted 6% year-over-year increase, approximately 0.5 point of growth was from the unfavorable translation impact of changes in currency rates, primarily the British pound and the euro. Excluding currency impact therefore, our year-over-year expense growth rate was approximately 5.5%. With respect to the remaining increase in year-over-year expense growth, the following items were key drivers within the category, compensation was higher driven by increased incentive compensation and this year's base pay adjustments, which were effective in April. The impact of staff growth on salaries was more than offset by staff actions and our ongoing 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 third-party advisor fees, sub-custodian costs, and technical services, partially offset by lower consulting and sub-advisor costs. There was a corresponding increase to trust, investment and servicing fees as a result of the higher third-party advisor fees due to the change to gross revenue presentation. Equipment and software expense was up year-over-year due to higher software amortization costs. 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. Other operating expenses were lower than the prior year, primarily driven by a lower level of charges associated with accounting – account servicing activities, lower FDIC costs, and lower staff relocation expense, partially offset by higher business promotion costs. Shifting to the sequential expense view. Excluding the expense charges in both the current and prior quarter, expenses were up slightly. Compensation expense declined sequentially primarily reflecting lower expenses related to long-term performance-based incentive compensation resulting from higher charges recorded in the prior quarter associated with incentive grants to retirement-eligible employees. This quarter's compensation included $11 million in expense associated with retirement-eligible staff versus $32 million in the prior quarter. Partially offsetting the decline from equity-based compensation were higher accruals for cash-based incentives and the impact of base pay adjustments, which were effective April 1. The impact of the base pay adjustments on salaries was partially offset by staff actions and our ongoing location strategy efforts. Outside service costs were up sequentially primarily relating to higher levels of third-party advisor fees, technical service, consulting costs, and sub-custody expense. Equipment and software expenses were higher sequentially primarily due to increased software amortization and software support costs. Other operating expenses increased from the prior period primarily due to higher business promotional spending and staff-related costs, partially offset by lower FDIC and other miscellaneous expenses within the category. Staff levels increased approximately 4% year-over-year and less than 1% sequentially. Approximately half of the year-over-year staff growth was the impact of the UBS 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, partially offset by reductions in our higher-cost locations. Turning to Page 8. As we have discussed on previous calls, through our Value for 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 betting on 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 second quarter results reflect approximately $23 million in expense savings, reducing the year-over-year expense growth rate by approximately 2.5 points. This would equate to approximately $92 million on an annualized basis against the $250 million goal. I'd like to highlight a few examples of our progress to date for you. We continue enhancing productivity by leveraging automation technologies such as robotics to increase efficiency of existing processes within our fund accounting and transfer agency businesses and we have optimized the organization of technology and operations to streamline processes and decision-making, enhancing productivity and more closely aligning these functions with our clients' needs. We continue to cultivate a healthy pipeline of opportunities. Turning to Page 9. 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 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 pretax margin and ultimately our return on equity. Turning to Page 10. Our capital ratios remain strong with Common Equity Tier 1 ratio of 13.2% under the advanced approach and 12.4% under the standardized approach. The supplementary leverage ratio of the corporation was 6.8% and at the bank was 6.2%, both of which exceed the 3% requirement that became applicable to Northern Trust effective at the start of the 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 second quarter, we repurchased 1.8 million shares of common stock at a cost of $191 million. As we announced in June, our 2018 capital plan received no objection from the Federal Reserve. In it, we requested authority to increase our quarterly common dividend 31% to $0.55 per share. Yesterday, our Board of Directors formally approved the planned dividend increase. The capital plan also provides the flexibility to repurchase up to $1 billion of common stock. The timing and amount of shares repurchased will depend on various factors, including but not limited to Northern Trust's business plans, financial performance, other investment opportunities and general market conditions, including share price. In closing, Northern Trust continued to deliver solid financial results in the quarter, growing earnings per share 50% over the prior year and achieving return on average common equity of 16.5%. Our assets under custody/administration and assets under management were up 15% and 12%, respectively, versus the prior year. Importantly, as we seek to drive profitable growth, we delivered positive operating leverage and positive fee operating leverage both on a year-over-year and a sequential basis. On an organic basis, our fee and expense growth rates were better aligned. Profitability continues to be strong in each of our businesses. Our Wealth Management business grew pretax income by 16% versus 1 year ago while improving the pretax margin from 39% to 41%. Our C&IS business similarly drove strong year-over-year performance with pretax income growing 41% and the pretax margin improving from 28% to 33%. Both businesses delivered strong year-over-year operating and fee operating leverage. This year's THE NORTHERN TRUST will again kick off the FedExCup Playoffs August 21 through 26 at Ridgewood Country Club in Paramus, New Jersey. THE NORTHERN TRUST Tournament remains a strategic asset for us as we continue to grow our business in the Northeast and, in particular, the greater New York area. Last year's business promotion expense increased approximately $17 million sequentially in the third quarter and we would expect a similar trend this year. Thank you again for participating in Northern Trust's second quarter earnings conference call today. Mark and I would be happy to answer your questions. Jonathan, please open the line.

To start with the balance sheet, we can observe some year-over-year growth trends. Deposit levels have decreased slightly compared to last year. Could you discuss the deposit behavior in the Wealth Management segment compared to the C&IS segment and how we should view balance sheet growth moving forward, considering your significant capital capacity? Additionally, your use of borrowed funds has doubled year-over-year. Could you explain the strategy behind that as well?

I will begin by addressing the balance sheet and growth, specifically regarding our Wealth Management deposits. We have noticed a slight decline in this area, influenced by several factors. First, we are now in a rising interest rate environment, which provides our clients, especially those with higher wealth, various opportunities to invest their cash. While we strive to offer competitive pricing and opportunities on our balance sheet, clients may also consider cash funds and other investment alternatives. Over the past year, we have seen more than half of those balances transition within The Northern Trust to cash funds or other products. Additionally, during the second quarter, we observed some shifts due to seasonal tax reasons, which is a pattern we have experienced in the past. Although Wealth deposits have decreased somewhat, this is primarily a reallocating of funds rather than a total exit, with some moving to other options within The Northern Trust, and approximately one-third may have transitioned to external products. We remain competitive and closely monitor our peers to ensure our pricing is attractive for these valuable deposits. On the institutional side, deposit balances tend to be more volatile due to our growth dynamics. As we grow, these assets may fluctuate as large, sophisticated asset owners can deploy their funds into the market as needed. While a significant portion of these deposits are for operational purposes, there can be noticeable movements from quarter to quarter and year over year. Although we face fewer competitors in this segment compared to Wealth Management, the pricing landscape is less transparent. We engage with our clients to set appropriate rates for these deposits, recognizing that some are on pre-negotiated rates while others follow standard rate cards. We consistently aim to be competitive in both segments and are committed to maintaining that stance. Overall, the growth we’ve observed in our balance sheet over time reflects the effectiveness of our business growth strategy, with our firm achieving high single to low double-digit growth rates, leading to a steadily increasing balance sheet.

Short-term funds.

Due to our strong capital levels, we are in a position to engage in some discretionary leveraging, which generates additional net interest income for our shareholders. Our financial strength and the minimal leverage constraints reflected in our results enable us to take advantage of this. The borrowed funds we utilize can also contribute positively to the liquidity coverage ratio (LCR) as we manage it, providing further benefits.

That's very helpful. I have a follow-up regarding organic growth. We've encountered some challenges on the foreign exchange side, and market returns have been mixed on a sequential basis. However, could you discuss the overall organic growth in Wealth Management in the second quarter compared to the first quarter and on a year-over-year basis?

Yes. I'll start with the overall firm first. The organic growth rate, which we have consistently discussed regarding fees, has been in the mid-single digits, approximately in the 4% to 5% range. We experienced a quarter where we were within that range. Specifically for Wealth, we observed a slowdown in the organic growth rate from the first to the second quarter, which was affected more by flows than by gross new business. The flows can be influenced by factors such as tax payments in the early second quarter, deployment of cash, investments in the markets, or loan paydowns, as second homes or other items have become less tax-attractive. These factors could create pressure on values and assets under management within our portfolios, but overall, the gross new business aspect of that organic growth remains very strong in the business.

Maybe just one more on the net interest revenue outlook. Just how should we be thinking about it for the rest of the year in terms of balance sheet growth given that it doesn't seem like maybe there's a lot of demand, but you're able to use the short-term funding? And then, if we do get another rate hike, what's the expectations in terms of that flowing through either to the NIM?

Yes. So we obviously don't give guidance, but if I look at the impacts of a future hike, what I would say is the first thing we've got to look at is the asset side of the balance sheet for us. And I would say you can see that we remain asset-sensitive. We are heavily impacted by short-term rates, 1-month LIBOR primarily and 3-month LIBOR moving. So if those move up with a rate hike, which they would likely, the asset sensitivity remains in the balance sheet as you can see via a relatively low duration. So I think the asset side still has sensitivity to rate moves. Then we go to the important factor, which is what happens with the liability pricing in that. And what I would just say there is we're doing our best to be both disciplined in our pricing on the liability side, but we also need to be competitive. So we have to be both. And you have a view on what the competition is doing and others do. We monitor them as well, and we remain competitive. It's important for us to be competitive in that landscape. I think we want to be a disciplined firm. I think you can see that in our betas and others, but we also have to be competitive. Our clients expect and deserve competitive rates, and we will be mindful of the market when we do that. So the betas haven't reached one. So they are expensive to at least the NIM. And then the second part of your question was on the balance sheet side. That's a reflection of our new business opportunities and some of the nuances of where our clients are either deploying cash or elsewhere. So I'm certainly not going to be able to give you a projection on that, but I did give you some of our thinking on how we think the asset and liability side could move.

Got it, okay. As a follow-up on the foreign exchange regarding trading income, you mentioned the swaps again this quarter. I'm not sure if you discussed the magnitude, but I wanted to get more insight because we observed the activity. However, I recognize that it can be volatile and uneven during the quarter.

Yes, you're correct. Looking at our total foreign exchange amount of $78 million to $79 million, around $18 million of that came from the treasury swap. As we mentioned last quarter, this was largely due to converting dollars into euros, which resulted in a positive foreign exchange variance. However, this also negatively affected net interest income by approximately $14 million. So, while the trade generated $18 million in foreign exchange, it came at the cost of about $14 million in net interest income. If you examine the euro-dollar swap curve, you'll notice that the spread has narrowed somewhat. If this trend continues, there may be some reallocation between foreign exchange and net interest income in the quarter. We'll provide more details as the quarter progresses. Overall, our core foreign exchange services for our clients increased by 20% year-over-year when we look at our traditional foreign exchange support within our asset servicing business. So, we are seeing positive trends in both areas.

So a question on expenses for you guys. So I heard your $92 million of annualized kind of run rate expenses against $250 million in 2Q. I think that's up from $55 million last quarter. So I guess, can you walk us through the pace of realizations for the remaining of this year and how we should be thinking about it for 2019? And I guess, secondly, as I think about it, I guess, sort of the jumping-off point for expenses, backing out severance, it looks like you guys are around $990 million for this quarter. Other than the Northern Open, is there anything else we need to be mindful of as we think about 3Q expenses specifically?

I will address this in two parts. First, regarding Value for Spend and the run rate, we have a robust pipeline of opportunities that we are actively pursuing. You may have noticed some acceleration in this area. Our team is committed to moving as quickly as possible. We previously indicated that our approach would be fairly balanced over three years. We are pushing to exceed those expectations and are focusing on opportunities that can provide the quickest returns. We remain dedicated to achieving that $250 million goal, but I cannot provide further details on that. As for the third quarter, we mentioned the Northern Trust Open. Additionally, there has been a modest decline in equity incentives; we reported 11 in this quarter.

That's right.

And then we should see some modest decline in the equity incentives as they ratchet down during the course of the year. I'd say other than that, it would be nothing that you wouldn't jump off. And your run rate of jumping off at $991 million was $990 million, $991 million is reasonable.

Got it, great. And then just as a quick follow-up on cost but slightly on the cost. Credit, not a huge deal, obviously, but we've seen you guys put up a negative provision for many quarters. The first time it turned positive. Obviously, credit remains quite benign. So maybe just kind of what's going on there would be helpful.

Yes. So we had one credit that we had a specific reserve for that drove it, one individual credit. So we would not see any trends unique, and credit quality remains at very strong and positive levels. And that's about all I could say that we have very, very strong credit quality right now in the cycle.

Just one more question on the expense growth rate. So you showed on the slide 6% year-over-year growth, and I believe that would also be inclusive of the change in accounting presentation.

Yes.

So I'm just trying to understand if you adjust for that change in FX translation what you really saw as the underlying core growth rate in expenses on a year-over-year basis?

Yes. Ken, let me walk you through that real quick, if I could. I think that's a good question. If we took the charges out of the second quarter from last year and the charges out of this quarter, we think the expense growth rate would have been closer to 8%. I would take two points of that out for UBS is attributable to UBS. Currency is about 0.5 point. And then revenue recognition or net-to-gross presentation, however you want to call it, is about another point of that. And that point is also offset by some of our.

On the fee side...

No, while it's offset on the fee side, it's what we got out of our GFS business.

Subadvisory.

Excuse me, subadvisory, thank you. So if you do that walk, Ken, you go from 8% down to about 4.5% as a core expense growth rate in our expenses. So that...

Okay, got it. And that's all right. We'll see what happens moving forward regarding your points about the comp comparisons, but Northern Trust and the comps are year-over-year figures that were already accounted for, right? So it's really just about how the business grows in terms of that growth rate from here?

Yes.

That's right.

Okay, great. Can you discuss the core business and any recent wins? The markets were down, and it seems the global aspect negatively impacted the assets under custody. Can you share what kind of quarter it was in terms of new assets? Any updates on the growth pipeline would also be appreciated.

Yes, we continue across both businesses to see a strong new business opportunities, and we highlight some of those with press releases, very strong. In the AUC piece, particularly the sequential comparator, the currency was really a pretty meaningful driver of what was flattish sequential. It was, I think, about two points of a currency impact. As you remember, we have a fairly significant global custody asset mix of our AUC, so we have a lot in other currencies. I think about 65% is in dollars but 35% isn't. And so the currency impact was pretty meaningful. So I know you asked about the new business trends, but in the AUC specifically, I would say that the currency was a meaningful driver. It more than offset market and new business uplifts in the quarter. We continue to have a significant pipeline and healthy, healthy growth opportunities in both businesses.

So you know where I'm heading. If you look at your NII number, it only represents 28% of your revenues, but it actually generates about 82% of your bottom line pretax profit. So it's a pretty important portion of what you manage. We've got the data now that show that look, interest-bearing deposits rates haven't increased precipitously. You may get a little bit more as we think you will get elasticity from here forward, so you'll get that low curve. DDAs have been relatively sticky, so there's not like they're running off in big portions. And yet, we still have $25 billion sitting in cash, and we got a duration on our securities portfolio that's probably about a year and a half. So at some point in the cycle, we need to defend against the next cycle, which is when rates come down and which that 82% of our profits get squeezed. So I just wanted to kind of put that back out there again and see how you're thinking about that now and what timing of that you might be looking at.

Yes, thank you, Marty. Well, what I would say is all of the points you made are factors that we contemplate in our ALCO committee. And we meet regularly, and we think about duration management. We think about liquidity management. We think about credit and quality in the portfolio. We have active and regular dialogues. And I'm certainly mindful of your views on those, and we continue to have active debates about what we should be doing to that portion of the balance sheet on a regular basis. So appreciate your comments.

You have been reducing expenses related to your core business, with core fees decreasing. While expenses are still 6% higher, this is a significant improvement compared to previous periods. The efforts you are making should help push that ratio closer to 100% over the next couple of years. This is another aspect of the initiative that adds considerable leverage to the income statement.

Yes. We are very focused on that measure because we believe the majority of our expenses, although not all, are related to generating trust fees. We see it as a sensible measure to assess operating leverage and performance leverage in our business, and we are committed to reducing that. In our Wealth Management business, the calculation actually comes in below 100%, which is reflected in a 41% pretax margin for that segment. However, there is still room for improvement, which we have discussed in our Value for Spend options. We are dedicated to continuing our efforts to optimize this further.

That's been impressive improvement, so appreciate that. And that other leverage piece we have on the balance sheet with 3% yields out there in the marketplace, there's a lot of income that can still be kind of garnered through this process and yet still derisk and not risk the balance sheet anymore.

Thank you, Marty.

I apologize if you've addressed this previously, but I don't believe you have. Could you provide an update on the nonoperating balances, which I believe you previously referred to as the $5 billion to $6 billion typically seen in interest-bearing deposits?

Yes, we haven't provided any updates on that. We maintain regular communication with those large clients associated with our Global Fund Services business. This dialogue has remained consistent for 4 to 5 quarters, indicating that a significant portion of those balances is likely tied to operational or liquidity needs. We haven't observed any movement in these balances, although it's possible. During our discussions with our relationship managers and the owners of these balances, they indicate that they still require them for liquidity or strategic investment purposes. There hasn't been any change in this situation for the past 4 quarters.

That's encouraging. I believe you mentioned that around 69% of the deposits are not in U.S. dollars. Are you still primarily focused on pounds? Can you remind us of that mix? Also, given the signals we are receiving, expectations for an August rate hike from the Bank of England are looking positive. How should we approach that? Additionally, what are our expectations for beta considering that the Bank of England is just beginning to raise rates?

Yes. So to clarify, 69% of our deposits are in dollars. I think you said aren't... 69% are in dollars. So the 31% that aren't, I think, pound is our largest next balance 12%...

About 12%.

Our clients with pound balances would benefit from another rate hike from the Bank of England. Our betas aren't aligned with that scenario. We have clients in various currencies with negotiated rates and some on standard rate cards. The betas for the standard rate cards are typically predetermined. Most clients on standard rates will see their betas affected throughout the cycle, although we're starting from a low base. If the behavior mimics that in the U.S., there should be opportunities for growth.

You've now have been above the top end of the 10% to 15% ROE range for a couple of quarters. Can you give us an update on what you're thinking there given lower taxes? And we seem to be in a bit of a higher rate environment when you were kind of down at the lower end or even below the lower end of the range a few years ago.

Yes, so we don't have any change or nothing that we would comment on as of today. But we continue to look at this, and we'll keep you posted. I think, the one item that you pointed out in there that we look at is a truly secular change is if the tax rate is changed. So that will certainly be one of the important factors as we consider that range that we will contemplate. And a quick example would be, in this quarter, you can do this calculation, but effectively, it added about 1.7 points of ROE. So ex that, we would have been at the very high end of our existing 10% to 15% range. But as I said, we'll keep you posted as we look at that.

What's kind of held you back from changing that sooner? I guess, we're kind of 7 months post-tax reform now, and the tax impact at least is fairly mechanical. So what stops you coming straight out and adding 1.7 points or whatever the number is to that range?

I think, Geoff, your comment assumes that all of those dollars flow through. The competitive landscape didn't change. The people didn't choose to price that away. We're six months into the tax reform here. Our view is we certainly wanted to observe how the tax reform was absorbed into the economy and to our clients and to our P&L before we raise to make those changes because you don't know exactly how it would end up flowing through financial statements until you looked at the competitive landscape. We're taking that time to observe that, absorb it and observe it, and then have the right strategic dialogues with all of our key constituents.

I have a couple of questions. I want to revisit the topic of short-term borrowings and leverage. Let me approach it from a different angle. How much additional leverage can you take on? What capacity do you have for that?

That's a complex question because some of our borrowing is reserved as dry powder for liquidity purposes, and we prefer to keep it available for various reasons in the marketplace. Additionally, this situation has somewhat limited our net interest margin, although it is generating incremental net interest income, which we find valuable. We consider the overall balance of these factors, including our leverage ratio, which is not particularly tight; however, we evaluate all these elements when deciding on the amount of discretionary leveraging we choose to pursue.

And would you say you still can bump this up a little bit further?

Our ratios would allow it, but we have to put it into the calculus that I just gave you where we're looking at a whole series of factors, like liquidity and other items. So we can move it around and contemplate that from quarter-to-quarter.

Okay. It's completely a different question. Technology investments, can you give us an update on where you are in that trajectory of investing? Because I know you've been trying to automate and digitize. And where are you? And any color, any details on that?

Yes. So we continue to have significant investment in the business. This is a technologically intensive and capital-intensive from that perspective business. I think we published in our K. We spent somewhere around $2.5 billion on both CapEx and expenditure on a rolling 3-year kind of program. So I think we've given about $2.5 billion from '17 through '19 that we would contemplate in terms of technology spending and/or expense associated with that. And that's meaningful against our revenue base. It's meaningful against the competitive landscape in which we operate. And we think that our technology efforts are certainly competitive and we hope, in many cases, leading the competition. But I know it's a primary focus and discussion point amongst our board and our management team.

I just wanted to confirm once more how you view core revenue growth and core expense growth year-over-year. What I believe I heard you say is that if we exclude the accounting impact, foreign exchange, and the UBS deal, core revenues increased by 12% year-over-year, and core expenses rose by 4% year-over-year. Is that accurate, or would you like to adjust my assumption?

No, you're pretty close. I would say core revenue was up if I exclude any year-over-year currency impact or the acquisition, it would be up mid-11%, so a little over 11%. And you're right about expenses. So that's what we would look at for core revenue and core expenses, around 11% and 4.5%, something like that.

I believe you will achieve the highest operating leverage for the quarter, measured in that way. How should we consider this moving forward? Should we expect some of these expenses to vary significantly? It seems unlikely to have a 700 basis point increase in operating leverage in one quarter without anticipating less favorable operating leverage in subsequent quarters. You mentioned the $17 million in marketing for the third quarter, which will influence this, although you still have the year-over-year comparison to consider. What type of operating leverage are you aiming for this year and into the future?

Well, there are clearly both revenue and expense factors to consider. It depends on market performance and rate changes. However, our main objective is to enhance operating leverage in the franchise, especially focusing on fee operating leverage. When we analyze our figures, our fees grew approximately 7% after adjusting for various factors, compared to 4.5%. Thus, we achieved about 2.5 to 3 points of fee leverage, which is a key area of focus. Additionally, we are concentrating on organic leverage, meaning the rate at which we can increase our fees compared to the rate of organic expense growth. If our expenses grew at 4.5%, some of that was due to inorganic factors, making the organic growth rate lower. Conversely, our fee growth is projected to be in the 4% to 5% range, indicating that we are moving towards achieving organic fee leverage. Overall, discussions around organic fee leverage, fee operating leverage, and total operating leverage are central to our priorities.

And to be clear, so that 7% year-over-year fee growth excludes the UBS impact? And if it doesn't, what is the growth year-over-year excluding UBS?

So excluded.

And how is UBS doing in terms of retention, cross-sell, kind of the metrics that you guys had internally? Is it above, in line, below?

Yes, it's exceeded expectations to date in terms of revenue growth and performance.

Yes. And the one thing, Mike, I would add is the AUA related to the UBS that we called out was $575 billion, which is down sequentially from $607 million, and that was really a currency factor there. So not a lost business this year or anything like that. So everything is going along really well.

Sticking with the comments on M&A, can you give us your outlook for opportunities? Obviously, the UBS transaction sounds like it's going well. You guys have done a number of deals over the years. Is there anything that you see in the horizon that could look interesting to you, whether it's in a different product line or just enhances an existing product line?

If you look at some announcements that were public, we closed, what I will call, the CTEC technology, Omnium technology acquisition in the quarter. We talked about an investment in Lumint and others. What we've done is found opportunities, I think, to partner with or work aside or acquire some products and capabilities to get to market quicker and to, I think, create some speed and solutions for our clients. So rather than a large acquisition, that's where we have over the last two quarters focused more of our energy and some of our capital is those types of moves. We obviously stay attuned to the market. And should opportunities come up, we pay attention and we get the people that call on us that give us those advices, but I'd say what you've seen in the public domain is more of a targeted smaller acquisitions or investments in products and capabilities or technologies that I think help can move us forward.

Very good. And then just going into the organic side, over the years, you've obviously grown organically the private wealth business by expanding into different geographies outside the home base in Chicago. Can you give us an update on what your thinking over the next 12 to 18 months of potential organic expansion of the private wealth, personal wealth business geographically?

Yes, we are definitely exploring all areas with significant opportunities in the wealth markets, particularly along the East Coast where we see high net worth prospects and are currently underpenetrated. It’s important to note that we don't always require a physical presence in these locations. In some cases, our virtual teams have successfully managed markets, achieving great results in cities where we've employed this strategy. We feel confident about our current coverage in the wealth sector, but we will keep seeking out opportunities where there are geographical gaps. Overall, we are optimistic about our model's ability to address these gaps.

Just real quick on the new business wins. I know you don't want to quantify the numbers. But can you at least directionally say if it's up or down quarter-on-quarter?

On a year-over-year basis, I would say yes, there has been a positive impact on the fees, particularly in the institutional business from quarter to quarter. However, the actual new business recognized can vary significantly from quarter to quarter. Nonetheless, there were both sequential and year-over-year benefits from the new business.

And just as you look out for the organic revenue growth, I mean, when you look out at the asset servicing, what's the driver of this organic growth that you're seeing? Is it coming from client switching from other providers? Is it really just the new phase of outsourcing you're seeing picking up? I mean, can you help us give a better understanding of where it's coming from?

We have observed significant activity in our institutional sector, particularly with clients that are asset managers, as they seek our asset servicing solutions. Many of these clients are reassessing their cost structures in a challenging environment, which has led them to explore opportunities for outsourcing or collaborating with partners. It's worth noting that some of the right asset managers are still experiencing growth, resulting in distributed growth for us as well. This is especially evident in our hedge fund services, where we have been fortunate to collaborate with clients who have successfully expanded their portfolios, leading to organic growth when they launch new funds or increase their assets under management. Geographically, we've seen strong growth not only in Australia but also in regions like the Netherlands and through our new office in Seoul, South Korea. This illustrates that by partnering with the right entities, we can achieve distributed growth. Furthermore, the current macroeconomic conditions are pushing some clients to consider outsourcing and other opportunities, which has contributed significantly to our growth in Commercial and Institutional Services. In the more traditional pension sector, while we perform well in gaining market share, it's mainly about capturing existing market share since there aren't many new defined benefit plans emerging.