Northern Trust Corp (NTRS) — Q2 2019 Earnings Call Transcript

Thank you, Paula. Good morning, everyone. And welcome to the Northern Trust Corporation second quarter 2019 earnings conference call. Joining me on our call this morning are; Biff Bowman, our Chief Financial Officer; Lauren Allnutt, our Controller; and Kelly Lernihan from our Investor Relations team. Our second quarter earnings press release and financial trends report 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 24th call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through August 21st. 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 2018 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 second quarter 2019 earnings conference call. Starting on Page 2 of our quarterly earnings review presentation. This morning, we reported second quarter net income of $389.4 million. Earnings per share were $1.75, and our return on common equity was 15.9%. This quarter's results included $4.9 million of severance-related and restructuring charges within expenses. This compares to $12.3 million in the prior quarter and $6.6 million one year ago. Before going through our results in detail, I would like to comment on some macro factors impacting our business during the quarter. Equity markets performed well during the quarter but were mixed on a year-over-year basis. Compared to the prior year, the S&P 500 ended the quarter up 8.2%, while the MSCI EAFE was down 0.1%. On a sequential basis, end-of-period markets were favorable with the S&P 500 and EAFE indices increasing 3.8% and 1.6% respectively. Recall that some of our fees are based on lag pricing, and those comparisons were favorable on a sequential basis but mixed versus one year ago. On a month-wide basis, the S&P 500 and EAFE were up sequentially 6.7% and 4.9% respectively. On a year-over-year basis, the S&P 500 was up 6.7% while EAFE was down 2.1%. On a quarter lag basis, the S&P 500 and EAFE were up sequentially 13.1% and 9.6% respectively. On a year-over-year basis, the quarter lag S&P 500 was up 7.3%, while EAFE was flat. U.S. short-term interest rates were lower during the quarter on average as seen by the sequential declines in average one-month and three-month LIBOR, up 6 and 18 basis points respectively. 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 4% and 3% respectively compared to the prior year. The year-over-year declines favorably impacted expense but had an unfavorable impact on revenue. On a sequential basis, the British pound ended the quarter down 2%, while the euro increased 1%. Let's move to Page 3 and review the financial highlights of the second quarter. Year-over-year, revenue was flat with non-interest income down slightly from one year ago and net interest income up 1%. Expenses increased 1% from last year. The provision for credit losses was a credit of $6.5 million in the current quarter compared to a provision of $1.5 million one year ago. Net income was flat year-over-year. In the sequential comparison, revenue increased 2% with non-interest income up 3% and net interest income down 1%. Expenses declined 2% compared to the prior quarter. Net income increased 12% sequentially. Return on average common equity was 15.9% for the quarter, down from 16.5% one year ago and up from 14% in the prior quarter. Assets under custody and administration of $11.3 trillion increased 6% compared to one year ago and were up 4% on a sequential basis. Assets under custody of $8.5 trillion were up 5% compared to one year ago and up 4% sequentially. Both the year-over-year and the sequential performance was driven by favorable markets and new business, partially offset by the impact of unfavorable moves in currency exchange rates. Assets under management were $1.2 trillion, up 3% on a year-over-year basis and up 2% on a sequential basis. The year-over-year performance reflected higher markets and new business, partially offset by lower period-end securities lending collateral. The sequential increase was driven by higher markets, partially offset by outflows. 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, flat compared to last year and up 2% sequentially. Trust, investment and other servicing fees represent the largest component of our revenue and were $955 million in the second quarter, up 1% from last year and up 3% sequentially. Foreign exchange trading income was $60 million in the second quarter, down 23% year-over-year and down 9% sequentially. Both the year-over-year and sequential declines were driven by lower volatility, as well as lower foreign-exchange swap activity in our treasury function. Volumes were also down on both a year-over-year and sequential basis, but the mix of trades had a favorable sequential impact. Other non-interest income was $73 million in the second quarter, up 3% compared to one year ago and up 15% sequentially. The year-over-year increase was primarily due to a valuation adjustment to visa-related swaps in the prior year quarter and income relating to a bank-owned life insurance program implemented in the current quarter, partially offset by lower brokerage and treasury management fees. The sequential performance was driven by the bank-owned life insurance program and lower visa-related swap expense. Net interest income, which I will discuss in more detail later, was $425 million in the second quarter, increasing 1% year-over-year but down 1% sequentially. Let's look at the components of our trust and investment fees on Page 5. For our corporate and institutional services business, fees totaled $549 million in the second quarter and were down 1% year-over-year but up 3% on a sequential basis. The translation impact of changes in currency rates reduced year-over-year C&IS fees growth by almost 1%. Custody and fund administration fees, the largest component of C&IS fees, were $385 million and were up 2% year-over-year and up 3% on a sequential basis. The year-over-year performance was driven by new business, partially offset by both unfavorable currency translation and unfavorable markets. On a sequential basis, the impact of favorable markets and new business, partially offset by unfavorable currency translation. Assets under custody and administration for C&IS clients were $10.6 trillion at quarter end, up 6% year-over-year and up 4% sequentially. Both the year-over-year and sequential performance was primarily driven by favorable markets and new business, partially offset by the impact of unfavorable moves in currency exchange rates. Recall that lagged market values factor into the quarter's fees with both quarter lag and month lag markets impacting our C&IS custody and fund administration fees. Investment management fees in C&IS of $111 million in the second quarter were down 2% year-over-year but up 6% sequentially. The year-over-year decline was primarily due to adjustments in the prior year due to a change to gross revenue presentation, partially offset by favorable markets. The sequential performance was primarily driven by favorable markets. Assets under management for C&IS clients were $887 billion, up 3% year-over-year and up 2% sequentially. The year-over-year increase was driven by favorable markets and new businesses, partially offset by lower securities lending collateral levels. The sequential growth is primarily driven by favorable markets. Securities lending fees were $22 million in the second quarter, down 28% year-over-year and down 4% sequentially. The year-over-year decline was primarily driven by lower volumes, as well as lower spreads. The sequential decline was driven by lower spreads, partially offset by higher volumes. Securities lending collateral was $163 billion at quarter end and averaged $164 billion across the quarter. Average collateral levels declined 11% year-over-year and were up 4% sequentially. Moving to our wealth management business. Trust, investment and other servicing fees were $406 million in the second quarter, and were up 4% compared to the prior year quarter and up 3% sequentially. The year-over-year performance was primarily due to new business in favorable markets. The sequential increase was mainly attributable to favorable markets. Assets under management for wealth management clients were $293 billion at quarter end, up 2% year-over-year and flat sequentially. The year-over-year increase was primarily driven by favorable markets, partially offset by outflows. On a sequential basis, favorable markets were offset by outflows. The outflows were mainly within cash products and in part were relating to a change in our product offering where we discontinued the suite of client deposits into off-balance-sheet money market funds. Moving to Page 6. Net interest income was $425 million in the second quarter, up 1% year-over-year. Earnings assets averaged $106 billion in the second quarter, down 8% from the prior year. Total deposits averaged $89 billion and were down 7% versus the prior year. Interest-bearing deposits declined 4% from one year ago to $72 billion. Non-interest bearing deposits, which averaged $18 billion during the quarter, were down 17% from one year ago. Loan balances averaged $31 billion in the quarter and were down 4% compared to one year ago. The net interest margin was 1.61% in the second 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 balance sheet mix shift and the impact of higher short-term interest rates. On a sequential quarter basis, net interest income was down 1%, while average earnings assets declined 4% on a sequential basis as deposit levels declined 2% in the prior quarter. It is worth noting that more than 85% of the sequential decline in deposits was related to lower wholesale deposits, which we use for leveraging purposes within our treasury group. These accounted for approximately 3% of our non-U.S. office deposit balances in the second quarter. Client deposit levels were down less than one-half of one percent on a sequential basis. On a sequential basis, the net interest margin increased 3 basis points, primarily reflecting a balance sheet mix shift, partially offset by lower short-term interest earnings. We did not see the opportunity for foreign exchange swap activity within our treasury function to the extent we have seen in the last several quarters. The activity this quarter resulted in approximately $2 million of foreign exchange trading profit with a slightly less amount than what we gave up in net interest income. This quarter's results were more in line with business as usual results. For comparison, in the prior quarter, we saw additional foreign exchange trading income of $13 million, offset by $10 million less in net interest income. Looking at the currency mix of our balance sheet, for the second quarter, U.S. dollar deposits represented 67% of our total deposits. This is down from 69% in both the prior year and prior quarter periods. I wanted to highlight two items for you to know as we look at our sequential trends. First, during the quarter, we implemented a bank-owned life insurance program that had the effect of moving $1 billion from earning to non-earning assets. The program was in place for approximately one-half of the quarter and resulted in an approximate $3.5 million decline in net interest income and a $4.2 million increase within other operating income, as well as the tax benefit. On an annualized basis, we would expect the program to benefit net income by approximately $14 million with a $36 million increase within other operating income, offset by a decline of an estimated $29 million in net interest income and a tax benefit of an estimated $7 million. Second, as I referred to when we discussed wealth management assets under management. During the quarter, we had a change in our deposit products, whereby we discontinued the sweep of client deposits into off-balance-sheet money market funds. This change resulted in an increase of approximately $4 billion in period-end deposits that you should see on our savings, money market, and other lines within our balance sheet. Turning to Page 7. Expenses were $1 billion in the second quarter and were 1% higher than the prior year and down 2% sequentially. As previously mentioned, the current quarter included $4.9 million in expenses associated with severance and other charges. For comparison purposes, note that the prior year and prior quarter included $6.6 million and $12.3 million in charges respectively. Excluding the called-out charges, expenses for the current quarter were up 1% from one year ago. The impact of favorable currency translation benefited expenses by just under 1 percentage point on a year-over-year basis. Excluding charges in both the current and prior year quarters, the following items were key drivers within the expense categories. Compensation was higher, primarily driven by higher salaries due to base pay adjustments and staff growth, partially offset by lower expenses related to long-term performance-based equity incentives. Employee benefits expense was slightly higher due to higher payroll withholding tax, partially offset by lower medical costs and retirement expenses. Outside service costs were up slightly due to higher technical services expense, partially offset by lower third-party adviser and sub-custody expense. Equipment and software expense was up year-over-year mainly due to higher software-related spending. Other operating expenses were up from the prior year due to higher miscellaneous expenses, partially offset by lower FDIC premiums and lower staff-related spending. Shifting to the sequential expense view, including the expense charges in both the current and prior quarters, expenses were down 1% sequentially. Compensation expense declined, primarily reflecting lower expenses related to long-term performance-based equity incentives, partially offset by higher salaries due to base pay adjustments and higher cash-based incentives accruals. The prior quarter's equity incentive expense included $30 million in expense associated with retirement-eligible staff. Employee benefits increased sequentially, primarily due to higher medical costs. Outside services declined sequentially due to lower technical services and legal-related costs, partially offset by higher third-party adviser fees and sub-custody expenses. The lower level of technical services did benefit from approximately $6 million in one-time vendor expense credit during the quarter. Other operating expenses increased from the prior period, primarily driven by higher business promotion expenses. Staff levels increased approximately 6% year-over-year and 2% 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. As we have discussed on previous calls through our value for spend initiative, which we started in 2017, we have been realigning our expense with the goal of realizing $250 million in expense run-rate savings by 2020. We continue to embed 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 $47 million in expense savings, reducing the year-over-year expense growth rate by approximately 2.5 points. This would equate to just under $190 million on an annualized basis against the $250 million goal. Turning to Page 8, a key focus has been on sustainably enhancing profitability and returns. This slide reflects the progress we have made in recent years to improve the expense-to-fee ratio, pre-tax 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. We remain focused on continuing to drive organic growth in our business and managing our expenses to improve our efficiency and productivity. Turning to Page 9, our capital ratios remain strong with our common equity Tier 1 ratio of 13.6% under the advanced approach and 13.2% under the standardized approach. The supplementary leverage ratio at the corporation was 7.6% and at the bank was 6.9%, both of which exceed the 3% requirement that became applicable in 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 models and further guidance from the regulators from the implementation of the final rule, which could change the calculation of our regulatory ratios under the final Basel III rules. During the quarter, we repurchased more than 2.9 million shares of common stock at a cost of $271 million. As we announced in June, our 2019 capital plan received no objection from the Federal Reserve. In it, we requested authority to increase our quarterly common dividends by $0.70 per share. Yesterday, our Board of Directors formally approved the planned dividend increase, which represents a year-over-year increase of 27% and a sequential increase of 17%. The capital plan also provides the flexibility to repurchase up to $1.4 billion of common stock. The timing and amount of shares repurchased will depend on various factors, including, but not limited to, Northern Trust business plans, financial performance, other investment opportunities, and general market conditions, including share price. In closing, despite the impact of the mixed global macroeconomic environment, we performed well during the quarter, increasing our pretax margin to 34% and generating a return on average common equity of 15.9%. Our balanced business model continues to generate organic growth with each of our client-facing reporting segments of Wealth Management and C&IS contributing approximately 50% of our earnings. We are excited about our competitive positioning within each of our businesses. In Wealth Management, our holistic advice approach continues to resonate with prospects and existing clients. We continue to deepen our talent and expertise with key hirings across our business. In C&IS, we continue to have success in growing our asset servicing business as evidenced by wins announced during the quarter, such as Magnetar Capital, Anchorage Capital, and the World Bank. Our technology, operational expertise, client focus, and flexible operating model continue to support our strategy very well. We remain focused on providing our clients with exceptional services, improving our productivity, and driving profitable growth. Thank you again for participating in Northern Trust's second quarter earnings conference call. Mark and I would be happy to answer your questions. Paula, please open the line.

So curious about the thinking about interest-bearing cost for the non-U.S. office line. You had called out the reduction in wholesale deposits, which I'm sure was helpful. But just wanted to confirm whether or not there was any of the noise flowing through that line that we should think about? And then thinking about deposits broadly, how should we think about the deposit costs for those $4 billion in interest-bearing that you flagged in your end of period, resulting from the termination of the money market fund program?

Regarding the foreign office deposits, in addition to the decrease in leveraging that we discussed, we had two specific clients who accumulated significant deposits in the first quarter and used them in the second quarter. This is a typical operational flow that we experience from time to time and between quarters. We can clearly observe that movement in foreign office deposits, apart from those affected by reduced leveraging in a few clients, specifically the two I mentioned. It’s not unusual for us to see increases during certain periods followed by their deployment later, so I would describe that as a normal flow. As for the pricing of deposits in the retail sector or our wealth management services, we provided attractive rates to individuals affected by the closure of our anchor-sweep product, which enables us to maintain our position. This is a temporary arrangement, and once it expires, those deposits will shift to competitive market rates.

And Brennan, I would just add. If you look at the savings, money market, and other line, you did see an increase sequentially in the cost, which is partly reflective of what this indicated but then also the set increase in December, there was a lag pricing impact in the retail deposits. So that wasn't quite fully reflected in the first quarter yet. So that's another part of the sequential impact.

Biff, do you still expect that deposit betas will be quite high in the event of a Fed rate cut near 100%, as you mentioned during a presentation? Is your expectation still that they will be that high? Why do you think betas will be much higher on the way down compared to what we have seen in previous historical periods of rate cuts? Thanks.

It's still our view that the betas will be quite high for institutional deposits, which comprise the majority of our balance sheet. We believe that the same favorable betas we experienced on the way up will apply on the way down, although not necessarily at 100%. This will depend on the competitive landscape, but we expect them to remain high as we move downward. In the retail sector, the competitive landscape plays a significant role. Retail betas increased slowly at first, benefiting from the early stages of rate hikes, and have continued to rise over time. We anticipate a similar symmetrical path down for retail betas, but it’s essential to stay competitive in that transparent market. To summarize, we still believe that overall betas will remain high and decline quickly. As we approach a zero for U.S. dollars, there could be some compression, but there are still a few hikes before we reach that point.

I have a quick question regarding fee caps. Mark, it's a very strong year-to-date, and I'm curious about how breakpoints and fee caps in the U.S. impact our ability to analyze custody fee rate trends. Additionally, could you provide some insight on the fee rates for new assets that are being brought in?

There is a lot that goes into that. So we don't specifically look at fee rates internally, because of really the mix of business can be quite different. So you could have a very large custody mandate with that that's where the fees might be small compared to a small assets-under-administration mandate, where the fees are larger. So as far as the trends go there, it's hard to pin down something there. I would say though that as we've highlighted before when we look at that line, about 40% of the fees are not asset value related. So, in general you would get the fees moving less than what you would get the assets, assuming that asset mix is coming out at the same rate, which it's not. I would say that some of the places where we're winning are in places that we do have and we talk about hedge fund services and areas like that that do usually generically would have higher beta or a higher fee rate than what say domestic custody would have for instance.

Glenn, I want to add to the second part of your question regarding the new assets coming on board and the fee rates. Mark's point is important because we are experiencing wins in areas like Magnetar and Anchorage hedge funds, which continue to provide good value in terms of fees. Additionally, there are significant wins in pure asset servicing custody, although the competitive landscape may mean a slightly lower yield. Therefore, it's essential to consider the mix of new business. We have a strong mix both globally and in our product offerings, which means we're receiving a balanced range of rates; not all of it is just from lower margin company rates.

Maybe a one quick follow up to Brennan's question, I hear you loud and clear on the high betas on the way down on the institutional side. I'm curious, is there difference in client segments, by client segment in the retail side? I'm surprised to see such rate sensitivity. It's not what I think of when I think of Northern Trust Wealth Management.

I think what you have to look at there is you've got to look at the beta over a much longer period than just one quarter, because we could have been behind the market, slower to the market over periods of time. And you can see beta moves in certain periods that larger than a data than you would expect, because we're catching up from some competitive landscape. And I will still say it is still competitive for even high net worth deposits. You've got sophisticated investors who are looking when yields get to some differential with the market that are seeking at least for the cash portion of their business balances, they're looking for market rates. And so we need to remain competitive. It may not be quite as competitive as those that are relying on retail deposits, but it remains credible.

Could you provide some insight into the expense growth? It appears to be aligning well with the organic growth rate this quarter and year-to-date. Should we anticipate any new expenditures in the second half of the year, or could spending potentially decrease? This is particularly relevant given the current revenue environment and some uncertainties, including foreign exchange rates and interest rates.

So here, I would say the environment we're operating in its not lost on us. So a net interest income environment that looks like it'll become more difficult in terms of where the rates are moving. So we really want to continue to drive our organic revenue in our franchise. But we have to be mindful of the macro headwinds that we're facing. We can't just singularly focus on that. So that means I think the disciplines that you've seen in the first six months of this year and I think even longer term than that, they are vital to our profitability. They have to remain. So we are focused on certain disciplined capital deployment for projects, return-seeking projects, disciplined expense management around occupancy, procurement, business promotion, location strategies, automation driving it, organizational design, all things we talked about. Those are even more in focus. They have been in focus. You've seen the benefits of our focus on them. But they are even more in focus as we are recognizing the environment that we're entering. And I can tell you that I think some of the cultural behaviors that we've embedded as a part of value for spend, are now part of the disciplines that will help us we think continue to execute on that in the second half of this year and in the future. So, there is not a planned ramp in those expenses, because we are certainly cognizant of the environment we're operating in. And there is a strong focus on maintaining those. What I will say though and want to be clear is we think our organic growth rate is still a very important governor, if I could say that, on what is allowable for that expense growth rate. So we still want to grow our franchise organically. And there is some expense needed to fuel that organic growth. But as long as that's proportional and appropriate with enough spread in it, we think we can move it forward and move the profitability of the firm forward.

And then just as a follow up on NII. So you mentioned your expectations on deposit betas. And then just, if we go down the path of getting a fed cuts. Just anything from a positioning or duration, the balance sheet, anything change or do you expect anything? And just, so I'm clear on deposits, you mentioned on the institutional side some of the activity that you saw on the non-U.S. You mentioned some of the things that you guys do on the leveraging. And then it sounds like on the retail side you're seeing some money move on. When we just think about the start to jump off on, is that roughly unchanged, because you had the depression-like conditions of the institutional, but you're having the retail come on board?

Let me break that into two parts. One, you're talking about the balance sheet jump-off point from a size. And then the first is sort of I think more of an outlook on net interest income, and I think we will give a little color there. If you looked at our net interest income from Q1 to Q2, when we stripped the data of some favorable impacts from the lower FX swap activity, but we implemented BOLI, which we took our earning assets down. If you netted those out, our sequential decline was probably just under 3%. I know we reported 1% but those factors moved it around. If we look at the current implied curve and reassume two rate cuts in July and September, we would think in the third quarter that we would see about a 2% to 3% decline in net interest income from this quarter's reported net interest income. And that includes the impact of BOLI and other things in there. So we would see somewhere around 2% to 3%. In the fourth quarter of this year, we would say flat to slightly down from there. And again that's relying on a whole series of factors: how do the betas play out, how does our balance sheet play out over that time in terms of volume and mix. There's a lot of factors. So based on our best modeling and our best forecast, at this point, we're expecting a relatively modest decline in the net interest income in Q3 and flat to slightly down in Q4 based on our current thinking in there. In terms of the balance sheet size, Mark, if you want to?

I guess if you look at the average balance sheet, and you're thinking about that as your starting point, which is probably the best thing to do, because we do have period end deposits flows that spike up. The one thing I would point to is this change in the sweep product in wealth management where that was really only a partially quarter, it happened at different points throughout the quarter. So for that line, the savings, money market, and other looking at the end of period for that might be a little bit closer to where it might run during the quarter, but that remains to be determined. But that's how I would position as far as balance sheet jump off plan.

Good morning. A couple of follow ups to that, one, if your rate cuts were all in July, if you got your rate cuts in July. Is there a material change to the numbers you just described, or not really?

Not really. In fact, it might be very, very modestly better to get 50 basis points than 225s, 50 and a 25 we would probably have to get back to you what that is. But we know what it is but it might be a little bit more impactful. But a 50 is very modestly better. So I could say roughly for your projections probably about equal over two quarters.

And then can you just give us some color as to what the decisioning was behind the BOLI? What was the reason for that? And should we expect more, either BOLI-like type of transactions going forward, or other securities asset repositioning that you might be doing in a changing rate environment?

We have started a program focused on optimizing our balance sheet and have been evaluating certain asset classes or yield opportunities. Our lack of BOLI investments made us stand out in the market. Given the current and declining yield environment, the advantages of this situation have been significant. We reported a $14 million increase in net income for the franchise, which impacts our net interest income budget and will be reflected in the other income line. This positive effect was noticeable even within just a brief period. We continually seek optimization opportunities, and while I can't specify whether we will increase or decrease BOLI investments in this instance, this was our initial attempt at it.

I was just curious about how you determined the size of the investment. Since it seems you were the only one without it, was there a comparison to your peers, or are you just trying to understand why it's set at $1 billion?

There are several factors to that, A, limit a size. There are regulations as to how much is a percentage of capital that you can have. But remember, we have counterparty credit exposure then that we have to go out to with very high credit quality carriers that we know have this credit exposure to. And so our credit group also is providing input as to the sizing of the portfolio. And when we put all that together, it added up to a $1 billion for now.

So I should take from that that you're optimized on the BOLI positioning?

As we sit here today, we have $1 billion in place. We're always exploring those opportunities. I can't predict whether we'll increase or decrease that in the future, but I believe we'll be maintaining this position for some time.

Thanks for the NII guidance, and I know you guys typically don't get into explicit guidance. But given where we're in the cycle, I think it was definitely appreciated. So thanks for that. Question for you guys around expenses, again. So given the fact that historically you've been sort of aiming to align expense growth with organic, fee growth, so call it, 4-ish, 5-ish percent, or something like that. In light of a tougher backdrop from NII, and obviously it tends to be a much higher margin type of business for you guys. Is there an emphasis to potentially bring that down below the organic fee growth levels? In other words, could we still anticipate some of the positive operating leverage or dynamic even with your current NII outlook?

I think we are looking at that hard, Alex. Like you said, we can't ignore the backdrop we're in. And pressure on one of our important revenue lines, net interest income, may put additional pressure that we have to look at on our expense line to widen out that leverage that you're talking about. Some things will naturally happen there. I think it's important, for instance, I'll tell you. Certain cash-based incentive plans. If net interest income goes down, they're going down. So that will give us some natural reduction in our expense lines, if that's the backdrop. But then the discretionary items I described, we may have to continue to push harder and harder on some of those levers to widen out, if you will, the organic leverage in our business to overcome, if you will, some of the pressures we see on net interest income, for instance.

Regarding foreign exchange trading, last quarter there was a $13 million swap benefit in that area. Compared to the previous period, there has been a sequential improvement despite a challenging environment. I'm interested in understanding what's happening behind the scenes in that part of the business, especially since it's a key area for driving organic initiatives and gaining market share. Additionally, how can we better conceptualize the outlook moving forward?

So you're right. At the core, the core FX actually did pretty well, if you'd strip the swap impact out of that. I think there's a couple of factors in there. One, as we saw our share of FX transactions, we got more client-based increases from quarter-over-quarter. So we're communicating, marketing better products and capabilities to capture the higher percentage of share of trade even in a lower volatility environment we captured more share of trade. And we also saw a little bit higher volume in some of the emerging market currencies in the quarter from our client base. I don't know if that's true for everyone. But, from our client base, back in and itself, also has a little wider spread. So the combination of those two, I think, actually drove a relatively good core FX performance quarter-over-quarter.

So I just wanted to ask a follow-up on the securities book. I appreciate all the detailed NII guidance. And as we model the securities yield and layer in the forward curve. Can you just remind us what percentage of the book reprices each quarter? And where does the overall duration of the books at today, given some of the extensions you've been doing?

So the overall duration of the book, let me answer the second part is at 1.3 years. And we have been adding some duration, you're right. But duration that we've added has been somewhat muted as the longer rates have come down and obviously, creates a view of faster prepayments. And so that has the impact of shortening the duration. So we're lengthening it with our purchases but the actual come down of the rates in the long end of the curve mutes it. But we're still longer at 1.3 than we've been traditionally where we've run probably closer to 1, or 1.1 in terms of the duration. As far as the repricing goes, we've talked about before how our securities portfolio can be divided between a shorter or longer. The shorter book is probably a little bit less than half of the total securities book, and that's where you would get mostly when you think about one-month LIBOR and three-month LIBOR, that repricing would happen fairly quick, obviously, within a quarter. And then the other part of the book, the longer book, that's as you get securities rolling over, you put something on two years ago it rolls over and then you reinvest that. So that would happen on more of a staggered basis across a period of time.

And just one follow-up for me on some of the deposit growth commentary, and I think there is a big debate about how much of the rate headwinds can be offset with volume growth. And you noted that deposit betas should be elevated on the way down, but just given overall and more sophisticated client base. How are you guys thinking about the pace of organic deposit growth that you can generate within both retail and institutional? And just looking out to the forward curve, you gave some very helpful detail on '19. Just as we look out to 2020. Do you believe there is a path to generating sufficient NII or volume growth to offset some of those rate headwinds?

Looking ahead to 2020, I believe we will increasingly rely on the organic growth rate we've previously discussed in our asset servicing business to support the growth in custody and deposits. We might adopt a more aggressive pricing strategy to attract deposits, but due to the structure of our balance sheet, any funding approach needs to be economically viable for us, especially since we do not have a significant loan portfolio. Therefore, I anticipate that most of our deposit growth will stem from the organic growth we've experienced in our fees. While we project a growth rate in the range of 4 to 5, only a portion of that will come from deposits, as we also engage in fund administration and other services that do not necessarily result in custody deposits on the balance sheet. However, a substantial part will derive from custody deposits, which I believe sets a benchmark for our balance sheet growth. Regarding your point, depending on how interest rates fluctuate, it might be challenging to compensate for this with volume. If the Federal Reserve implements more than two rate cuts, which is something we could project, it could resemble a scenario of quantitative easing. Historically, custody banks have benefited from the liquidity injected into the system during such times, allowing us to see deposit and balance sheet growth accelerate more significantly if we move beyond a couple of rate cuts.

Hi, just two questions. First, maybe one last one on the deposits, and non-interest bearing actually was flat on a sequential basis. A lot of your peers were down and have been highlighting declines, going forward. I guess is that organic growth you're talking about. What's keeping your non-interest bearing flat and how do you think about that over the next, I guess, looking over the next couple of quarters?

Let me explain that again. We had approximately $18 billion in average non-interest bearing deposits this quarter. Around 85% of those deposits are in dollars. Of the dollar non-interest bearing deposits, 25% come from wealth management, which has historically been very stable and continues to be so. Another 25% comes from our treasury cash management business, where the funds are maintained for balances, fees, and such. These segments have also been stable. So about half of our dollar-based non-interest bearing deposits have proven to be resilient. The other half relates to core institutional asset servicing, much of which we believe is tied to operational requirements. We estimate that between $3 billion to $4 billion represents yield-seeking deposits in the non-interest bearing category. We maintain regular communication with those clients and believe they are also keeping their funds for liquidity. While we have observed some decline in non-interest bearing deposits throughout the year, we think that most of the decline is from the yield-seeking segment, as it has already pursued yield. We've noticed a bit more stability in non-interest bearing deposits over the last two quarters.

And maybe just bigger picture, I know you guys have been talking about efforts to boost organic growth and wealth. Maybe you just can update us on what you've been doing there. Any evidence you had of that on accelerating that would be helpful. Thanks.

Our wealth management reported strong figures, showing a very strong quarter with healthy margins and good year-over-year fee growth. This growth is partly driven by market conditions and partly by organic factors. We are continuing to explore geographies where we aim to increase our market share, and we've demonstrated that it's not always necessary to have a physical presence. In certain cities and markets, we have successfully grown our market share without that physical presence, which allows us to operate with lower overhead costs. Our services can be delivered from locations like Chicago, Florida, or New York. Additionally, our product offerings, especially our holistic advice and Goals Powered solutions, have resonated well, particularly in a more volatile environment. With uncertainties in interest rates and favorable market conditions, many people are reassessing the landscape, including the geopolitical aspects. We believe that our technological tools have contributed to significant organic growth in this sector as well.

So is there any hard number you can point to in terms of new account openings, or flows picking up to help us?

We don't disclose that. I mean you could look at the fee growth rates in the business and make your own assessment on the market impacts of that and you can probably get to an underlying core growth rate.

I wanted to ask you about the leverage this quarter. It appeared that there were deposits from outside the United States, which you may be using as a way to access very low wholesale funding and then reinvest it in the United States at a higher rate. Is some of this related to FX translation, or was there another reason for this decision? What prompted you to move away from the leveraging strategy you had in place?

I will share this question with Mark. The strategy for exiting this situation revolves around wholesale funding, which has seen returns drop to nearly zero. This means that even marginal returns from wholesale funding and the investments associated with it yielded very little, if any, return in the current environment. Consequently, we decided to reduce some of the leveraging. Regarding the currency and its position on the balance sheet, these are euro-dollar deposits. Therefore, the wholesale deposits we transitioned to a money fund or similar are indeed wholesale deposits. Mark, I'm not sure about a euro-dollar deposit…

We are maintaining everything in U.S. dollars and not involving other currencies. You can observe this in short-term borrowings and other lines related to Sprint bidding, as well as some of our home loan bank borrowings. Additionally, wholesale deposits are reflected in the non-U.S. office line. We use a combination of these two for leveraging purposes. Both our liabilities and assets are in U.S. dollars.

We have discussed at length the importance of extending the duration to safeguard net interest income, especially in light of recent declines. What are your thoughts on this approach as you navigate the current economic cycle? Additionally, why haven't we taken a more proactive stance to protect this crucial aspect of our income stream, which is net interest income?

So Marty, over a year ago, we began discussing the extension of the portfolio duration and have been implementing that. I know that a duration of 1.3 might still appear to be relatively short, but for our portfolio, it's a significant increase. We manage that duration primarily through treasury duration adjustments, not through credit additions. We've been making those adjustments periodically, and we also have other hedges, swaps, and tools we can use to enhance the portfolio. We've been considering a rate adjustment for at least a year based on our outcome ALCO and have been taking actions behind the scenes. This has contributed to our net interest income holding up reasonably well. We are continuously evaluating this, and some of our current decisions are influenced by the current yield curve shape. There is some net interest income trade-off in protecting against a long-term decline in rates, given the discrepancy between the short and long ends of the curve right now. Nonetheless, we have made some of those decisions. Thanks.

Biff, just one more thing on the NII first. So if I take the 3.5 impact from the BOLI and then the 29 for the year. Effectively are you saying that the decline in 3Q is really just from the BOLI, and that core NII dollars are basically going to be flattish? Is that the right way to think about it?

Well, this is Mark. We also had a benefit from the FX swap. But in a way, you're right. I mean, if you added back BOLI, you would be flat but that was because of the fact that we had a benefit from the FX swap, which was basically offset by what we saw play out with the interest rate environment.

My second question is about costs. We expect the value for spending to stabilize by the end of this year, and it's contributed three percentage points to the cost growth rate. Looking back to 2019, it's anticipated to maintain this run rate next year. Since a significant portion has already been realized, will the level of support remain the same moving forward? Can we expect a consistent three percentage points of support, or will there be a need to revisit the plan at some point to keep the right balance? Any thoughts on this would be appreciated. Thank you.

So your thinking is right. The 2% to 3% per annum benefit that you've talked about is what we're seeing. In terms of will we re-up value for spend. Let me frame it this way. The answer to that is, to meet the financial model that we've talked about, which is set an organic fee growth rate, we've talked 4% to 5%. Then we look at our expense base beneath that and we say we've got certain inflationary price expenses coming at us. We've got certain investments that we want to make and we've got certain expenses that we need to fuel that 4% to 5% growth rate. If we want to get leverage in that equation, I guarantee you, you need a productivity offset to make that math work. So if you've got 4% to 5% growth rate, you add in inflationary expenses, you add in investment needs, you add in the expenses needed to grow that 4% to 5%. You probably produce something higher than the 4% to 5% expense growth rate. What we're saying is that needs to be the productivity we need to get on an annual basis in our franchise to drive leverage into that business. And your magnitude is in the area code that we're thinking about, the 2% to 3% range every year. A good way we think about it is it's got to be at least as much to offset inflation. So if our expense improvements have to be at least enough to offset inflation, then you have your cost to drive the new business. And you've got some available for investment. And that's the way we think about it, the more we drive productivity the more we share and profitability and investment opportunities for the firm.

Biff, I understand that modeling is difficult and no one can accurately predict future interest rates. However, I realize we are all concentrating on the short end of the curve. What would your outlook be if the long end of the curve actually increases, perhaps due to trade with China or a stronger economy, resulting in two and three quarters for the 10-year yield as we head into the beginning of next year? How might that impact your discussions regarding net interest income?

I think, Gerard, the answer to that is, it probably depends on how the steepness of the curve moves between the short and long end. So if the long end moves up and the short end moves up in parallel, it's a different impact than if the short ends stay where it is and the long end moves up when we get steepness in the curve. From a loan book perspective, we don't have nearly as much mortgage-based credit that's going to be impacted by the type of move you're talking about in the long end of the curve. So I would say less impactful to us in that space. But the investment opportunities along with the curve and the spread they offer from the short end of the curve does matter to us. So I guess I would have to say it depends on how the rest of the curve shifts with that move in the long end.

I was thinking your end might drop with the long end steepening, so I appreciate your clarification. Moving on to my second question, when you consider the challenges companies typically encounter and the opportunities ahead, what are some of the challenges you anticipate needing to address in the next 12 to 18 months, aside from interest rates, which we've already discussed?

There is consistently strong demand for technological investment within our business, especially in the asset servicing sector, which is heavily technology-driven. It is crucial for us to make the right technological investments to stay competitive. We operate in a competitive marketplace and have experienced similar fee pressures as mentioned previously, with a compression of 1.5% to 2%. We need to closely monitor the competitive landscape. In the wealth management sector, I see significant opportunities. The key challenge lies in identifying the right areas for growth, where we currently have lower market share than desired and how we can reach those clients. In markets where we are already established, we perform well, and there is potential for us in certain areas where we are not adequately represented.

Quick question on the expenses, the trust and investment fees came down again this quarter, it's been trending lower over the past couple of years. But given your pullback on expenses, are you still expecting that to trend lower from here, or is it just that it's more challenged environment and we should expect it to flatten out for a while?

So that question, I would say, we do hope that over long periods to evaluate that that we want to continue to drive more productivity in. So we've not achieved nirvana in terms of that rate. What I think we have to be cautious of is we have seasonality in our business. For instance, next quarter we have the Northern Trust open, which puts pressure on expenses in a quarter. And obviously, markets can do volatile and drive the fee line. And our expenses can't necessarily react in 90 days to a market that can move. But if you look over longer periods of time, the answer is there is continued focus on driving that down. And I would give you an example. If you do these calculations between our two businesses, they're quite different. And the mature wealth management business does drive that expense-to-fee ratio lower than the low of 500, for instance. And so I would say the answer is over long measurement periods, they're still absolutely focused inside the firm on continuing to improve that. You may see quarterly moves that go up or down just based on seasonality and/or market volatility.

And a separate question on the agency MBS portfolio are they going to see a drop off in yields like the other banks are seeing from premium amortization. What was the impact on premium amortization this quarter, or is there something of a lag effect for you?

So I think we've talked to you about premium amortization being somewhere around the $10 million to $12 million in a quarter, and it was inside of that range in this quarter. So the nature of our portfolio and the way we've modeled that and everything, it produced premium amortization that was much in the range we've guided to.