Northern Trust Corp (NTRS) — Q4 2018 Earnings Call Transcript

Thank you, April. Good morning, everyone. And welcome to Northern Trust Corporation’s fourth quarter 2018 earnings conference. Joining me on our call this morning are Biff Bowman, our Chief Financial Officer; Michael O’Grady, our Chairman and CEO; Aileen Blake, our Controller; and Kelly Lernihan from our Investor Relations team. For those of you who did not receive our fourth quarter earnings press release and financial trends report via 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 January 23rd call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through February 20th. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Now for our Safe Harbor Statements, 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. During today’s question-and-answer session, please limit your initial query to one question and one related follow-up. This will allow us to move through the queue and enable as many people as possible the opportunity to ask questions as time permits. Thank you again for joining us today. Let me turn the call over to Biff Bowman.

Good morning, everyone. Let me join Mark in welcoming you to our fourth quarter 2018 earnings conference call. Starting on Page 2 of our quarterly earnings review presentation, this morning, we reported fourth quarter net income of $409.9 million. Earnings per share were $1.80 and our return on common equity was 17%. As noted on the second page of our earnings release, this quarter’s results included $5.7 million of severance-related and restructuring charges within expenses and $30 million in benefits for income taxes, primarily attributable to the adjustments recorded associated with the Tax Cuts and Job Act. 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 on us during the quarter. End-of-period markets were unfavorable on a year-over-year basis with the S&P 500 and MSCI EAFE Indices declining 6.2% and 13.4% respectively. On a sequential basis, both indices also declined with the S&P 500 down 14% and the EAFE down 12.5%. Also on a sequential basis, the average daily market value of the S&P 500 was down 5.1%, while the EAFE declined 6.3%. However, as you will recall, some of our fees are based on lagged pricing and in the prior quarter, the S&P 500 was up 7.2%, while the EAFE was up 1.8%. 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 and therefore impact client assets and certain revenues and expenses. The British pound and euro versus the U.S. dollar ended the quarter down 6% and 5% respectively compared to the prior year. The British pound and euro also declined sequentially. The year-over-year and sequential declines for the pound and euro against the U.S. dollar had an unfavorable impact on revenue and a favorable impact on expense. Let’s move to Page 3 and review the financial highlights of the fourth quarter. Year-over-year revenue increased 5% with non-interest income up 4% and net interest income up 9%. Expenses increased 2% from last year. The provision for credit losses was a credit of $4 million compared to a credit of $13 million one year ago. Net income was 15% higher year-over-year. In the sequential comparison, revenue increased 2% with non-interest income up 2% and net interest income up 3%. Expenses increased 2% compared to the prior quarter. Net income increased 9% sequentially. Return on average common equity was at 17% for the quarter, up from 15.1% in both the prior and prior year quarter. Assets under custody and administration up $10.1 trillion declined 6% compared to one year ago and were down 7% on a sequential basis. Assets under custody of $7.6 trillion also declined 6% compared to one year ago and were down 7% on a sequential basis. Both the year-over-year and sequential declines were primarily driven by lower equity markets and the impact of unfavorable moves in currency exchange rates, as well as the impact of one large domestic custody client transitioning out during the quarter. Assets under management were $1.1 trillion, down 8% year-over-year and down 9% on a sequential basis. Both the year-over-year and sequential declines were driven by unfavorable equity market outflows, which include the impact of lower period-end security lending collateral and the impact of unfavorable moves in currency exchange rates. Let's look at the results in greater detail, starting with revenue on Page 4. Fourth quarter revenue on a fully taxable equivalent basis was $1.5 billion, up 5% from last year and up 2% sequentially. Trust investment and other servicing fees represent the largest component of our revenue and were $934 million in the fourth quarter, up 3% year-over-year and down 1% from the prior quarter. Foreign exchange trading income was $78 million in the fourth quarter, up 24% year-over-year and up 9% sequentially. The year-over-year increase was primarily due to increased foreign exchange swap activity in our treasury function, as well as increased client volumes and higher volatility. The sequential increase was primarily driven by higher volatility. Other non-interest income was $75 million in the fourth quarter, up 4% compared to one year ago and up 36% sequentially. The year-over-year increase was primarily due to a net gain on the sale of non-strategic leases in the current quarter, partially offset by lower treasury management fees and securities commission and trading income. The sequential increase was also due to the net gain from the lease sale, combined with an impairment recorded in the prior quarter, as well as a lower Visa-related swap expense. Net interest income, which I will discuss in more detail later, was $430 million in the fourth quarter, increasing 9% year-over-year and up 3% sequentially. Let's look at the components of our Trust and investment fees on Page 5. For our corporate and institutional services business, fees totaled $536 million in the fourth quarter flat year-over-year and down 1% on a sequential basis. The translation impact of changes in currency rates reduced year-over-year C&IS fee growth by approximately 1.5% and the sequential growth by just under 1%. Custody and fund administration fees, the largest component of C&IS fee, were $376 million, up 2% compared to the prior year and flat on a sequential basis. Both the year-over-year and sequential performances were driven by new business, partially offset by the unfavorable impacts of currency exchange rates and markets. Assets under custody and administration for C&IS fee clients were $9.5 trillion at quarter end, down 6% year-over-year and down 7% sequentially. Both the year-over-year and sequential declines were primarily driven by lower equity markets and the impact of unfavorable moves in currency exchange rates, as well as the impact of one large domestic custody client transitioning out during the quarter. Recall that lagged market factors value into the quarters fees with both quarter lag and month lag markets impacting our C&IS fee custody and fund and administration fees. Investment management fees in C&IS fee were $105 million in the fourth quarter, were down 1% year-over-year and down 3% sequentially. The year-over-year decline was primarily due to net outflows, partially offset by favorable markets and a change to gross revenue presentation. The sequential decline was primarily due to outflows. Assets under management for C&IS clients were $791 billion, down 9% year-over-year and down 10% sequentially. Both the year-over-year and sequential declines were driven by unfavorable equity market outflows and unfavorable movements in foreign exchange rates. Securities lending fees were $22 million in the fourth quarter, down 14% year-over-year and down 10% sequentially. Both the year-over-year and sequential performances were impacted by lower volumes, as well as lower spreads. Securities lending collateral was $150 billion at quarter-end and averaged $158 billion across the quarter. Average collateral levels declined 9% year-over-year and 7% sequentially. Moving to our Wealth Management business. Trust, investment and other servicing fees were $398 million in the fourth quarter, up 6% year-over-year and flat sequentially. Within wealth management, the Global Family Office business fees increased 7% year-over-year and were up 2% sequentially. The year-over-year growth was driven by new business and favorable markets. The sequential performance reflects favorable markets and new business. Recall that our Global Family Office fees are impacted by quarter lag market values. Within the regions, the year-over-year growth was driven by higher fees resulting from the adoption of the new revenue recognition standard, new business and favorable markets. Sequential performance within the regions was relatively flat as the unfavorable impact of lower equity markets was offset by new business. Assets under management for wealth management clients were $279 billion at quarter end, down 4% year-over-year and down 6% sequentially. Moving to Page 6. Net interest income was $430 million in the fourth quarter, up 9% year-over-year. Earning assets averaged $112 billion in the fourth quarter, down 1% from the prior year. Total deposits averaged $93 billion and were down 4% year-over-year. Interest-bearing deposits declined 2% from one year ago to $74 billion. Non-interest-bearing deposits, which averaged $19 billion during the fourth quarter, were down 10% from one year ago. Loan balances averaged $32 billion in the fourth quarter and were down 5% compared to one year ago. The net interest margin was 1.52% in the fourth quarter and was up 13 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 amortization and a balance sheet mix shift. On a sequential quarter basis, net interest income was up $12 million or 3%. Average earning assets declined only slightly on a sequential basis as deposit levels were only slightly lower than the prior quarter. On a sequential basis, the net interest margin increased 5 basis points due to the favorable impact of higher short-term rates and a favorable balance sheet mix. As we have discussed in our most recent quarters, we do continue to see the opportunity for foreign-exchange swap activity within our treasury function. This activity has the impact of reducing our interest income relating to Central Bank deposits as we swap out of U.S. dollars, but increase our level of foreign exchange trading income. For this quarter, we saw additional foreign-exchange trading income of $17 million, offset by $14 million less in net interest income. Looking at the currency mix of our balance sheet for the fourth quarter, U.S. dollar deposits represented 70% of our total deposits. This is equal to one year ago and up from 69% in the prior quarter. Turning to Page 7, expenses were $1 billion in the fourth quarter and were 2% higher than both the prior and prior year quarter. As previously mentioned, the current quarter included $5.7 million in expenses associated with severance and other charges. For comparative purposes, note that one year ago our results included severance and other charges of $17.6 million, as well as $12.9 million expenses related to special one-time cash bonuses paid in connection with the Tax Cuts and Jobs Act. The prior quarter included $2.7 million in severance and other related charges. Excluding the called-out charges, expense for the quarter was up 5% from one year ago. With respect to the remaining increases in year-over-year expense growth, the following items were key drivers within the categories. Compensation was higher primarily 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. Employee benefits were higher, primarily due to an increase in retirement plan expenses and higher payroll tax withholding, partially offset by lower medical expenses compared to the prior year. Outside service costs were higher, driven primarily by higher third-party advisor fees and increased technical service cost expense, partially offset by lower consulting expense. There was a corresponding increase to Trust investment and other 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 a software-related charge, higher software amortization and higher equipment-related costs. Occupancy-related costs were lower compared to the prior year, primarily relating to non-recurring lease adjustments recorded in the prior year. Other operating expenses were down from the prior year, primarily due to lower FDIC expense and staff-related costs, partially offset by higher costs associated with account servicing activities. Shifting to the sequential expense view. Excluding the expense charges in both the current and prior quarter, expenses were up 2% from the prior quarter. Compensation expense increased sequentially due to higher costs associated with performance-based incentives, salaries and other compensation costs. Employee benefits expense increased primarily due to medical costs. Outside services increased sequentially due to higher legal and consulting costs and higher technical services expense, partially offset by lower sub-custody and third-party advisor fees. The sequential increase in equipment and software was primarily attributable to a software-related charge. Other operating expense declined $8 million from the prior period, driven by lower business promotional spending due to the timing of the Northern Trust sponsored golf tournament during the prior quarter and lower FDIC costs, partially offset by various other miscellaneous expense categories, including costs associated with account servicing activity. Staff levels increased approximately 4% year-over-year and 1% sequentially. The staff growth was all attributable to staff increases in lower-cost locations, which include India, Manila, Limerick, Ireland, and Tempe, Arizona, partially offset by reductions within our higher-cost locations. Turning to Page 8, 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. And currently, 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 fourth quarter results reflect approximately $36 million in expense savings, reducing the year-over-year expense growth by approximately 3 points. This would equate to approximately $145 million on an annualized basis against the $250 million goal. We continue to cultivate a healthy pipeline of opportunities. Turning to the full year, our results in 2018 are summarized on Page 9. Net income was $1.6 billion, up 30% compared with 2017, and earnings per share were $6.64, up 35% compared with the prior year. On the right margin of this page, we outlined a non-recurring impact that we called out for both years. We achieved a return on equity for the year of 16.2% compared to 12.6% in 2017. Full year revenue and expense trends are outlined on Page 10. Trust investment and other servicing fees grew 9% in 2018. The growth during the year was primarily driven by new business, favorable markets, the acquisition of UBS Fund Administration businesses in Luxembourg and Switzerland, and the impact of revenue recognition. Foreign exchange trading income increased 46%, driven by an increase in swap activity within our treasury team and also growth from the client-driven trading. Net interest income increased 13%. The growth in net interest income was primarily driven by higher short-term interest rates coupled with earning asset growth. The net result was 11% growth in overall revenue on a reported basis in 2018. On a reported basis, expenses were up 7% from the prior year. Adjusting for the expense charges in both '16 and '17 that are on the prior page, expenses were up 8% from 2017, reflecting the UBS acquisition, the underlying growth within our business, and the impact of revenue recognition. Turning to Page 11, 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 12, our capital ratios remained strong with our common equity tier 1 ratio of 13.7% under the advanced approach and 12.9% under the standardized approach. The supplementary leverage ratio at the corporation was 7% and at the Bank was 6.4%, both of which exceeded the 3% requirement, which became applicable to Northern Trust effective at the start of 2018. With respect to the liquidity coverage ratio, Northern Trust is above the applicable 100% minimum requirement. As Northern Trust progresses through fully phased in Basel III implementation, there could be additional enhancements to our model and further guidance from the regulators on the implementation with the final rule, which could change the calculation of our regulatory ratios under the final Basel III ruling. Yesterday, we announced the $0.05 increase to our quarterly dividend from $0.55 to $0.60. This represents a 9% sequential increase and an increase of 43% on a year-over-year basis. During the fourth quarter, we also repurchased 2.5 million shares of common stock at a cost of $235 million. Now, I would like to turn the call over to Mike for some closing comments.

Thanks, Biff. Good morning, everyone. Before we open up the call for questions, I want to offer some closing comments regarding 2018. The three primary objectives for our strategies are to continuously enhance client service, improve our productivity, and grow profitably. In 2018, we executed multiple initiatives and made significant investments in order to make meaningful progress on all three objectives. For example, we executed on an important initiative to realign some of our operations and technology functions in order to enhance the client experience by better aligning ourselves and our activities with client needs and our business strategies. We can see early benefits of this realignment as we can effectively and efficiently serve clients end to end and be more nimble in this rapidly changing environment. As Biff highlighted, we've made considerable progress towards our value-for-spend goal of achieving expense run rate savings of $250 million by 2020. Throughout the company, we have made a commitment to making a value-oriented mindset an ongoing aspect of how we conduct our business. We are investing meaningfully in technology and our talent. In wealth management, we are expanding the capabilities of our goals-driven wealth management platform and we continue to hire talent in focused growth areas. In asset management, we expanded our product offerings, including the development of new ETFs and alternatives products. In C&IS, in conjunction with the integration of the UBS asset servicing acquisition in Europe, we are investing heavily in building a future state fund services platform and we strengthened our technology capabilities by acquiring or making investments in BECS, Lumin, Parallax, and C Tech. Our shareholders benefited from the execution of our strategy through the company's financial performance and return on capital in 2018. As we began 2019, we are excited about our competitive positioning within each of our businesses. We remain focused on providing clients with exceptional service, improving our productivity and driving profitable growth. Thank you again for participating in Northern Trust's fourth quarter earnings conference call today. Biff, Mark and I would be happy to answer your questions. April, you can open up the lines.

Biff, maybe first one is just for you. You mentioned some of the lagging pricing on some of the assets and just given the period end just wanted to get maybe an update on how you are thinking about the expense outlook for 2019 and beyond? You gave the update on the value per spend. But just how maybe the lower revenue environment can you just dial areas back versus what you are going to remain in investment mode for longer-term growth?

Mike, I think it would be beneficial if I first discussed the lag and its impacts before addressing the expense responses. This information is quite relevant. Initially, looking at our fees as a firm, in our C&IS business, around 60% of the fees are sensitive to equity markets or to assets—they are asset-sensitive and fluctuate with market conditions, while the remaining 40% is different. For our custody and fund administration services, about 70% to 75% of the fees are based on a month lag, meaning that 25% to 30% rely on a quarter lag. Previously, we indicated a 50%-50% split in lag, but the mix has changed within our global fund service and IIG businesses. Now, approximately 70% to 75% fall under a month lag, with about 25% under a quarter lag for custody and fund administration fees. For C&IS investment management fees, about 40% are sensitive to equity markets, with around 50% on a daily basis, mainly in cash funds, about 40% on a quarter lag, and roughly 10% on a month lag. In our wealth management sector, it aligns more with our earlier discussions; it hasn't altered much. For our Global Family Office, roughly 65% to 70% of fees are on a quarter lag, 25% are daily, and 5% to 10% are on a month lag. In our wealth management regions, about 70% are on a month lag, 20% are daily, and 10% are quarter lag. I hope this sheds light on the lag aspect of our fee structure. Regarding your inquiry about expenses in this context, I'd like to share our perspective, and Mike may add his thoughts as well. From an expense viewpoint, we remain focused on the organic growth trajectory of our businesses, which is crucial for us. However, we also consider macro factors affecting our expense rates. We recognize inflationary pressures on our expense base, but we also aim to enhance productivity through value per spend and other productivity measures to counteract inflation in our model. This means our expenses are designed to support the organic growth rates I mentioned earlier and/or to invest in our businesses. We calibrate these expenses to create organic leverage in line with our anticipated organic growth rate. That’s how we approach expenses, and we believe that if we execute correctly, drive productivity fiercely, we can still achieve leverage, even amidst volatility in fees or market conditions.

Yes, I would just add to what Biff said that over time we have the financial model that Biff described there, and so it’s important that we continue to execute on that over time. Having said that, you also have to navigate the environment that you are in at that particular point in time. And clearly, the environment right now is more volatile than it was, say a year ago, and so that does mean being very careful in thinking about how we manage the expense base for the business as we go through this market environment. So being relatively tight if you will as we go through that and focusing on these longer-term productivity initiatives that we’ve had in place. Importantly, as Biff talked about a year ago or before that, the environment was relatively strong and that’s when we launched into value per spend. And the point is that we didn’t want to wait for a more challenging environment to say, okay now we need to come up with ways to reduce the expense base. So it’s both through cycles if you will, but then also trying to be mindful of the environment that you are in.

And then maybe just a quick follow up. Just on your organic growth outlook, I think you guys have been in that call it 4% to 5% range over time. Given what you’re seeing in terms of the investment opportunities and maybe some of the competitive dynamics in the industry. Are you still comfortable with that type of outlook just given some of the dynamics in the industry? Has anything I guess changed from that perspective?

So from an organic growth perspective, we still are targeting the range that you talked about there and I would say right now in the past year, we were towards the low end of that range. And there’s a number of dynamics around that and maybe just to break it down a little bit by our businesses. Starting with asset management, I don’t need to go through all the dynamics facing that business, but that’s a business that has seen its organic growth rate come down. And in the past year, basically we were flat as far as organic growth in the business. So a little bit negative on flows and picked up a little bit on fee realization through mix. But essentially at flat, that’s going to dilute the overall organic growth rate for us. If you look at the asset servicing part of the business, which has been growing at a higher organic growth rate, it continues to grow at the same level that it’s been at. In 2018, it was again towards the lower end of that range. But if you think about that as being roughly half of the fees and the range for them being 5% to 6% over time and towards the lower end, still a healthy rate for that business. And I would be glad to break that down further as to what we saw in 2018. And then the wealth management business again different set of dynamics, which I won’t go through but has been at a lower organic growth rate. And so even separating out the impact of asset management products in that business, the organic fee growth rate has been more in the 2% to 3% range for that and we were roughly in that range for the year. So when you do the weighted average of that that’s where you come out to again towards the lower end of what you’re talking about. But if you say strategically what are we trying to do, well, we are trying to execute on strategies and target markets where we think that we have an opportunity to maintain that growth rate.

You spoke to the lag effect, which is helpful to get a refresher on in great depth, thanks for that Biff. Just curious if you could comment on the fee rate. So we saw it rebound from the third quarter where you had some transactional headwinds. Thinking about that looking forward how should we consider fee rate in each of your businesses. Might the lag effect that you walk through not only have an impact on the calculation of the AUC dynamics and AUM dynamics but also the fee rate, and how should we calibrate that as we move into 2019? Both considering the drop in 4Q and then the rebound here quarter to-date that we’ve seen in March.

Brennan, it’s Mark. I'll start with that. Part of the situation stems from calculating true averages from September 30th to December 31st for AUCA and even AUM in wealth management. This involves using end-of-period numbers that tend to be lower for assets, even though the fees haven't fully adjusted yet. We did observe a slight increase in transactions in fund administration, particularly in custody, which should help as well. Looking ahead, as we've mentioned, analyzing fee rates for custody and fund administration is challenging due to the varying mix of businesses and the fact that not all assets are equal. It’s crucial to focus on the services provided and maximize the value for every dollar of asset. On the wealth management side, if we examine the regions split roughly evenly between product asset management and advisory fees, the advisory component has remained fairly strong, and we aim to remain competitive in that area. Additionally, on the product side, we haven’t experienced the declines seen approximately 18 months ago. Overall, I think one reason for the lag in fee realization could be that asset values are fully accounting for the fourth-quarter market conditions while the fees haven’t quite caught up yet.

So maybe we're going to be looking at some fee rate pressure that's subject to a lag, seems like that's what you're saying there, Mark thanks for that. And then I wanted to circle back on the expense question. Mike, it seemed as though you had said that and it seems like this is a bit of a different approach than what we've heard from Northern in years past. Is that while you guys came up with your value per spend program, making hay when the sun was shining, so to speak. As you enter into a period where you have a potentially more volatile equity market environment, maybe less helpful, better tailwinds. You are going to be diligent in investments and the expense line so as to adjust for potential headwinds that might come through. Is that a fair conclusion there or am I reading too much into what you said?

I don't want you to read more into my comments than intended. However, I believe it's a reasonable assessment. We understand the need to continuously enhance our productivity. It's not simply a matter of good or bad market conditions, which is why we aimed to add more structure and focus to our value per spend approach over the past year. When we face an environment like this, it's crucial to consider discretionary expenses, particularly regarding investment spending. While theoretically, one might choose to maintain investments regardless of the market cycle, another approach could involve reducing investments to manage expense growth. As you mentioned, we must assess not just whether to proceed with certain initiatives, but also the timing of these investments. Delaying any project means postponing potential benefits, and not investing poses risks to our future revenue. These are the kinds of decisions we need to navigate, keeping in mind the discretion we have to manage these choices based on our current circumstances.

I have a question regarding pricing trends in the servicing business. As you may have heard last week, there seems to be increased pressure on various aspects of the ecosystem. I'm interested in what you're observing in terms of pricing and institutional servicing. The mix is different, and there's always been some pricing pressure, but I'm trying to understand if you've noticed any acceleration in pricing degradation. Additionally, could you provide insights into the composition of your customer base within C&IS among U.S. and non-U.S. asset managers, hedge funds, and others?

Alex, it’s Mike, I’ll start off. So the way I would characterize the environment that we have been in and I think we are still in is an environment where there is more activity. And what I mean by that is whether it’s asset owners or asset managers for different reasons are definitely looking at what they’re doing and how they’re doing it and there are implications from that. So what does that mean? On the asset owner side of the equation, you have very large asset owners that have managed their capital or their investments in a certain way. In other words, have they completely outsourced it to external managers or have they done some internally. And frankly, we are seeing those types of organizations look at going both directions, and we’ve seen the impact of that. So some of the larger ones saying we are going to do more in-house, because we think that that’s a better way for us as a scale manager of investments. When they do that, they have different data needs and different capability needs. So a lot of time spent around the technology and what we can provide to them, APIs, think database things like that. And again, depending on what you can offer versus competitors, et cetera, it can change the dynamics but there is more activity around that. Second, I would say with other asset owners, they have actually looked at the opposite way. And we saw some of the impact of that in 2018, where as an asset owner that has done more in-house they’ve said, frankly, that’s not our business, if you will. In other words, large corporate pension plans saying we’re not going to continue to operate a large in-house investment team instead we’re going to go more external, we are going to go more passive that’s lower cost. And our objective is to get to the right answer for the client. And so in doing that, these are still clients but what we do for them is less and we will see some fee impact from that. As you shift to asset managers, there has been a lot of discussion on obviously the pressure on asset managers and therefore their primary objective of looking at the cost of these types of services. They have also, when they’re asset-based, have seen the cost go up in an absolute dollar perspective. So they do look to see if they can reduce cost. There are different ways to get there, whether it’s just negotiation with the provider or do they go out and do just an RFI or do they go to RFP, and what are the results of that. So as a result of all that, I would say more activity. Now if you looked at 2018 for us as a result of more activity, I would say our gross business one, if you will, was towards the high end of the rates that we have been at, so in essence good number. The next as I mentioned before towards the lower end of the range. And then if you say okay how do you break out the negative or the loss business in that. The largest portion of it, so say you are in the neighborhood of 3% from a rate perspective was more towards if lost or repositioned. And I should add into that certainly you see flows change and the impact of flow. So if we’re the custodian for a very large sovereign wealth fund that we do it for equities and they switch out of equities then we’re going to see the impact of that. So you did see more funds flow and more activity there. When you say loss business, so did you lose a lot and why did you lose it. Again, I would say every situation a little bit different. In certain cases, do we lose through the process because the competitor does a better job it certainly is going be the case. We’d like to win them all but we don’t win them all and obviously, we’re up against the best in this business. And at times could it be because of pricing, and let’s say either to retain the business they’ve gotten aggressive on pricing or in this case to win it away. That’s certainly part of it. But I would not tell you that we’ve seen overly aggressive pricing by competitors in order to win business on. I would say it’s consistent with where we’ve been. We’ve tried to be very disciplined around our own pricing. And again, I would say that we’ve seen some impact but not dramatic. So when you take the repricing component, it’s going to be more in the neighborhood of 1.5% to 2% of what we saw this year from a rate perspective. So you’re going to have that, as you mentioned, all the time in the marketplace whether it’s a little bit higher or lower. But for us, I wouldn’t say that part of it has been dramatically different. And then I’m going to let Mark address the second part of your question.

As far as the mix when we look at C&IS, and you’re right we don’t publish the actual segments within the C&IS. But when we look at it, roughly about half of C&IS is the fund services business, which is where our asset managers would be, and that’s we don’t breakout that between traditional. But within that, you have traditional asset managers, you have hedge funds, private equity funds. I would say that our GFS business is larger in EMEA than in the United States. So that hopefully gives you some flavor for the makeup of the fund services.

And then my second question is just around expenses and maybe I’ll frame it a little bit differently. But I guess if I look at your core expense base in 2018 net of the severance charges and a couple of other things you highlighted, looks like we are running a little bit below $4 million. And assuming that you continue to aspire to grow the business organically in the 4% to 5% range. Is that a fair way to think about the growth and expenses off of that sub $4 billion number for 2019?

At a high level, yes. We are accountable for all our expenses. We analyze and optimize them in every possible way. However, ultimately, we bear responsibility for all of them. We aim to surpass that target for the year, not due to value for spending or productivity, but because of various factors mentioned in Biff's commentary. That's the base to consider. Moving forward, expenses should align with the organic growth rate of our fees. If we stay within the fee growth range we discussed, then you can expect expenses to reflect that. If there are declines for any reason, we will need to explore how to bring down the organic growth rate of expenses accordingly.

Just if I might just clean up a couple of questions. So Biff, you mentioned in your prepared remarks when you're talking about the AUC that the quarter you had a transition out of a large custody client. And I was just wondering can you help us try to understand of the 7% decline roughly just how much that was? And if, in fact, the revenue from that client was also already out of the quarter's run rate?

Yes, we did have a significant client transition during the quarter, specifically a large corporate client in the U.S. This primarily involved a corporate cash custody relationship. In our trend report, you will notice a drop of about $91 billion in Assets Under Custody in fixed income within C&IS, which reflects the size of this transition quite well. Regarding the fees, the transition was partial, and as Mark mentioned, not all Assets Under Custody are equal, resulting in varying fee structures. This significant movement in the fixed income area warranted mentioning.

And then just a couple of little ones, there are a couple of good plusses and minuses throughout the fees and expenses. And I'm wondering can you help us to the extent that you can clarify what leasing gains, software charge and the magnitude of what it sounded like a little higher servicing errors perhaps on the other expenses? Seem like there was some lumpy stuff and a bunch of items. Any help you can help us in trying to get some starting points?

On the leasing side in the quarter, there was approximately $5 million worth of the gain. And we didn’t call that out explicitly, because over the course of the year, there are gains and losses of that in the quarter. And interestingly enough, over the course of the year, they wash through. So we at that magnitude haven’t necessarily called them out given their size. On the expense side, the items that I would call out on the software charge that we talked about. If you look at the sequential increase for us, which I believe was just under $7 million in equipment and software, I think it’s fair to say that that was essentially all attributable to the software charge. So that gives you some idea of the magnitude of the charge, but it was largely that was driven there. And then in terms of the costs associated with client servicing, we tend to look at that line item, which as you know it sits in other expense over the course of the year. It is fair to say that in this quarter that was higher than our normal run rate and meaningfully higher than that. But if you look at that line over the course of the year, it reverted closer to where we see it. It was a little higher we called it out. And the fourth quarter was indeed higher. But hopefully that gives you some color on what those were. Inside of other expense, which is a copulation of a lot of different moving parts, we had FDIC expense move in our favor by let's say $5 million to $5.5 million in the quarter, but we have these larger expenses associated with servicing clients meaningfully above the normal run rate and they are more than offsetting that. And then we have a lot of other items like value-added tax that all moved that item around. I think it's probably better to look at other expense over the course of the year and look at the average of those run rates.

Maybe just a question on the balance sheet and deposit flows. Seems like noninterest-bearing and interest-bearing both stable quarter-over-quarter. Do you think the flows, the outflows particularly non-interest bearing are starting to come to an end? Should we start to think about deposit growth yet or do you still think given where rates are, the deposits continue to trend down? Just wanted to get a sense of how you are thinking about it?

So we did see the stabilization, particularly in the non-interest-bearing line item in the quarter. I think it was down about $200 million, so essentially flat non-interest-bearing movement. And as we discussed last quarter when we look at that bucket and the nature of the makeup of that bucket, we think that a lot of the most rate-sensitive money had already sought other return-seeking products, whether those were within Northern Trust or somewhere else. So we feel reasonably confident that that bucket has reached at least the current level where rates are right now. And in particular, if we don’t have any future rate hikes, we think that there could be some stability in that. In the interest-bearing portion of the deposits, while it was flattish from what you can see here, there was some movement down in interest-bearing that can bolster with wholesale funding or others, not a lot, a little over between $1 billion and $2 billion. We view that more as normal operational movements but we would see that amongst our clients as they reposition their portfolios, reposition their cash. That is much more a function of the interest-bearing to us, is much more a function of the growth of our business where we’re growing our asset servicing relationships and we just generally see our balance sheet growth. Can we see deposit growth? I think we can see deposit growth if we see our asset servicing businesses continue to grow and our wealth businesses continue to grow we should be able to see that. Counterbalancing that is any actions that maybe going on amongst the fed in terms of its own balance sheet management activities, which can put some pressures on it. But generally, we’ve seen now a couple of quarters of some balance sheet stabilization in terms of balances.

Quick question if the fed does pause given where we're at with the deposit pricing and still seeing some upward pressure there, I mean if Fed doesn’t move next year. Do you still think that you can see some margin movement I mean just assuming that the balance sheet stays flat? Or at this point in time, we're almost liability-sensitive?

If all things being equal here, if everything else is equal, we do think that there could still be some NIM expansions with no fed rate hikes. But the pace of that growth and the pace of that will be subject to the asset re-pricing that we have. We still have some assets that will roll some that need to repriced, so we do think there could still be some NIM expansion, but probably at a more measured pace. In terms of liability pricing with no future fed rate hikes, we don’t see at this point a meaningful need to continue to have see upward pressure on deposit pricing. There might be some modest amount somewhere in the portfolio on the margins, but not broadly across the portfolio. We think we're at or near market competitive levels.

And then just a separate one on tax, looks like you ended the year at the low point for the tax rate and that's excluding some of the one-time items you called out already in the presentation. How are we thinking about the tax rate then as you go through 2019? Are you able to adjust your go forward tax rate down, because of the guidance that you put out?

Yes, I still think at this point in time the 23% to 24% range that we've given you, is where we would suggest you think about for 2019.

Can you share how much further you can transition employees into lower-cost markets from your higher-cost labor markets? Are you currently halfway there, 90% there, or is there limited capacity left for transitioning people into these lower-cost markets?

I’m glad to start on that one, Gerard. So I think it’s a appropriate observation and one that we have had for some time because it has provided a significant benefit to us over the last several years meaning going back 12, 13 years ago when we first started what I would consider location strategy to actually move functions into different geographies. And that has matured over time how we think about that. So Biff in his commentary had mentioned some of the different locations, those locations are not all the same. So what we do in Bangalore, for example, is different than what we may do in Manila or what we do in Limerick or Tempe. And so we've evolved it in that way. The third thing I would say is that we’ve been growing as we've talked about. We have a higher growth rate in our businesses and particularly in asset servicing, which requires more people for it. And so really what it’s enabled us to do as opposed to moving positions over, it’s that we essentially absorb the growth in those locations. And then to wrap up with the answer to your question, there is still opportunity, both because of the growth and where it happened but also certain functions that still have not fully matured into where their appropriate location is. But acknowledging that and saying well then what does that mean if you are closer to the end I’ll call it of location strategy and then in the beginning. And that’s why we talked about automation and robotics and what we can do from that perspective. And we have a number of initiatives underway that are part of value per spend where we are looking to automate the functions as opposed to necessarily moving them to a different location. And the view is that that creates even more scalability than in our model. So, as we've discussed, we are very aware of the many challenges that come with volatile or declining markets. That said, having a robust capital base is especially beneficial right now, as it aligns with our strategy and gives us the flexibility to take advantage of opportunities, such as attractive acquisitions, and to manage our capital returns. To answer your question, yes, we are continuously searching for acquisitions that can enhance our strategies. However, market conditions, like high valuations, often hinder execution. Currently, we may find opportunities arising from the market, where certain companies face challenges that create potential for us, or where pricing becomes more favorable.

Whether you intended to or not, I think you're coming across a little cautious on this call. So I just wanted to ask you, was that your intention going into the call. And specifically, when you add it all up, do you guys expect to show revenue growth faster than expense growth in 2019? And your ROE target, I'm not sure if you updated that are not, but it was 10% to 15% and you reported 16% in 2018. So is there caution? Is that the reason why you're not raising your ROE target or am I just missing something here? Thanks.

Sure. It’s Mike. I’ll address both of those. So first of all, as far as the tone, we didn’t come in with an objective for a particular tone. This is just the way that we’re looking at the business and the environment etc. But needless to say, I mean, I would say we’re certainly optimistic about our position from a competitive perspective and our ability to serve clients and to continue to grow and produce attractive returns for our shareholders. More specifically, to your questions with regard to organic growth, fees and expenses, I would say in 2018, the objective was to have those in line, as we’ve talked about and we came up a little bit shy of that. So we did not meet our target. Now, almost were there and there were certain aspects of as to why that happened. And again, we own all the expenses, so it’s more reasons as opposed to excuses. And then coming into this year, absolutely the objective is the same on an organic basis. Now, there’s a lot of things we can’t control. We talked about the markets, how it effects our fees things like that. But the view is, if we can produce it on an organic basis and you have a year like 2018 that produces, I think 1.6 points of fee operating leverage. So that remains the same and that’s our objective. And then as far as ROE, we haven’t changed the range per se, but I would definitely say that has not limited us in our aspirations or targeting. So we had 16% this year and certainly are not afraid to target for ourselves doing better, absent knowing what is going to happen in the environment. And I would say, now it’s a particularly difficult time to say, all right, should you recast the range when part of the reason why we’re above the range frankly is because of tax reform a year ago, which boosted the ROE. Hopefully that stays in place, but again there is nothing certain on that front. And then also the markets and everything we’ve talked about here, we tried to have a range that was through the markets. Hopefully we’re not at the top end of that for it, but we don’t find the range itself to be constraining on our activities or aspirations. And finally, I would say for shareholders, we’re trying to produce the most attractive combination of growth and returns. So as I’ve said many times, if it was just about the returns there is probably some things we could do to pull back on spending and investing and things like that. And in the short-term get it up, but over the long-term not create as much value for shareholders. And so, how do we make sure we’re balancing growth with returns, particularly when we’re at a relatively attractive level.

I would like to add that there was no tone of caution in our discussion; rather, we were simply addressing the current environment in which we operate. As Mike mentioned, he is optimistic about the positioning of our businesses and the opportunities for organic growth. Both he and I, along with the Board, are optimistic about our financial strength as we navigate this period of uncertainty and volatility. We have a solid balance sheet, good liquidity, and we are well-prepared to leverage the opportunities that this type of volatility can present. Whether you view this as caution or optimism, it provides us with a wide range of opportunities. However, we are entering a different period compared to the previous several years of positive equity growth, especially given the upward trend in rates we've seen recently. There was no intention to sound cautious; we were being factual about our operating environment. Both Mike and I agree that our financial strength, along with our strategic product positioning and execution capabilities, are strong.