Northern Trust Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 19, 2023

There are 13 speakers on the call.

Operator

Today's conference is being recorded. At this time, I would like to turn the conference over to Jennifer Child, Director of Investor Relations. Please go ahead, ma'am.

Speaker 1

Thank you, Jenny, and good morning, everyone. Welcome to Northern Trust Corporation's Q2 2023 earnings conference call. Joining me on our call this morning is Mike O'Grady, our Chairman and CEO Jason Tyler, our Chief Financial Officer Lauren Allnut, our Controller and Grace Higgins from our Investor Relations team. Our 2nd 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.

Speaker 1

This July 19 call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be made available on our website through August 19. Northern Trust Any continuing accuracy of the information provided in this call after today. Please refer to our Safe Harbor statement regarding forward looking statements on page 12 of the accompanying presentation, which will apply to our commentary on this call. During today's question and answer session, please limit your initial query to one question and one related follow-up.

Speaker 1

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 Mike O'Grady.

Speaker 2

Thank you, Jennifer. Let me join and welcome you to our Q2 2023 earnings call. Our results for the Q2 reflect solid sequential performance. Trust fees and assets under custody and management increased sequentially, which included positive organic growth in each business. Net interest income was down modestly on a linked quarter basis, reflecting higher funding costs associated with the highly competitive deposit backdrop.

Speaker 2

Expenses, excluding unusual items, were well controlled, reflecting the rigor of our cost discipline as well as the impact of various productivity initiatives. We reported $64,000,000 in charges in the Q2 associated with these steps. Our Wealth Management business modestly grew It's under custody and management and trust fees on a sequential basis. We continue to see strength in the higher wealth tiers and within our Global Family Office segment, where we captured several marquee wins. Our industry leadership position also stood out in the quarter.

Speaker 2

We held our 3rd annual Northern Trust Wealth Planning Symposium, bringing together legal and financial experts to share innovative strategies and insights to shape the future of wealth management. Sessions averaged more than 1,000 participants and included attendees from North and South America, Europe, Asia, Africa and the Middle East. We also released the 2nd Family Office Trends Report co authored with The Wharton School. Notably, we received a utility patent for our cloud based goals driven wealth management technology during the quarter and were named Best Digital Innovator of the Year and Best Private Bank for Digital Wealth Planning by the Financial Times Group. In Asset Management, we saw strong flows into our institutional money market We also won a number of key mandates across products, including outsourced investment solutions, Tax Advanced Equity and QuantActive.

Speaker 2

Our new product launches in the quarter focused on alternatives. Within Asset Servicing, we continue to have good momentum in core custody and fund administration, particularly with asset managers in Europe, And our pipeline remains robust. In the U. K, we are reappointed by Brightwell for middle office services. Brightwell is the primary service provider to the British Telecom Pension Scheme, which has more than $50,000,000,000 in assets under management.

Speaker 2

Among asset owners, we clinched several key multimillion dollar takeaway wins in North America, where our front office solutions, which provides a comprehensive view across public and private assets was cited as a key differentiator. As a testament to our capabilities, We are recently awarded 3 prestigious industry awards, including Best Global Custodian for Asset Owners by Asian Investor. In the Q2, we launched A Suite, our content community and collaboration hub for global asset owners. Within the 1st few weeks of launch, we've seen significant client engagement. Going forward, we expect this new communications channel to create relationships with key target audiences and further showcase our expertise in the market.

Speaker 2

In closing, Our balance sheet continues to be very strong with ample capital and liquidity. Our new business momentum is gathering steam and our pipeline remains robust. While there's still more work to be done, we're making solid progress following the trajectory of our expense growth. Rationalizing our cost base remains a top priority And the governance and control mechanisms we're putting in place today should drive sustainable improvements for both the near term and for years to come. We head into the second half of the year well positioned to support our clients and generate value for all of our stakeholders.

Speaker 2

I'll now turn the call over to Jason.

Speaker 3

Thank you, Mike. And let me join Jennifer and Mike in welcoming you to our Q2 2023 earnings call. Let's dive into the financial results of the quarter starting on Page 4. This morning, we reported 2nd quarter net income of $332,000,000 Earnings per share of $1.56 and our return on average common equity was 12.4%. Currency movements had an immaterial impact on our revenue and expense growth in both periods.

Speaker 3

Our second quarter results were impacted by 2 notable items. We recognized a $38,700,000 pre tax severance charge impacting both our compensation and outside services line items. We recorded a $25,600,000 pre tax charge associated with the write off of an investment in a client capability. Notable items from previous periods are listed on the slide. Excluding notable items in all periods, Revenue was up 1% on a sequential quarter basis and down 1% over the prior year.

Speaker 3

Expenses were down 1% on a sequential quarter basis and up 5% over the prior year. This reflects an expense to trust fee ratio of 116%, down from 120% in the Q1 and 122% in the Q4 of last year. Pre tax income was up 13% sequentially, but down 9% over the prior year. Trust, investment and other servicing fees, representing the largest component of our revenue, totaled $1,100,000,000 which reflected a 3% sequential increase, but a 4% decrease as compared to last year. All other non interest income was flat sequentially, but down 10% over the prior year.

Speaker 3

Net interest income on an FTE Te basis, which I'll discuss in more detail in a few moments, is $525,000,000 down 4% Sequentially, but up 12% from a year ago. We had a $15,000,000 credit reserve release In the Q2 due to improved credit quality on a small number of larger loans, which was offset in part by expectations For higher future economic stress in the commercial real estate market. Turning to our Asset Servicing results on Page 5. Assets under custody and administration for asset servicing clients were $13,500,000,000,000 atquarterend, up 2% sequentially and up 5% year over year. Asset servicing fees totaled $621,000,000 which were up 3% sequentially, but down 3% year over year.

Speaker 3

Custody and fund administration fees, The largest component of fees in the business were $427,000,000 up 3% sequentially, but down 1% year over year. Custody and fund administration fees increased on a linked quarter basis for the 2nd consecutive quarter due to solid new business activity, Higher transaction activity and favorable markets. They decreased from the prior year quarter, primarily due to unfavorable markets. Assets under management for Asset Servicing clients were $990,000,000,000 up 3% sequentially and up 4% year over year. Investment management fees within asset servicing were $134,000,000 up 6% sequentially, but down 10% year over year.

Speaker 3

Investment management fees increased sequentially, primarily due to asset inflows and favorable markets. A decrease from the prior year quarter primarily due to asset outflows and unfavorable markets. Moving to our Wealth Management business on Page 6. Assets under management for our wealth management clients were $376,000,000,000 atquarterend, up 2% sequentially and up 7% year over year. Trust, investment and other servicing fees For $475,000,000 up 3% sequentially, but down 5% compared to the prior year.

Speaker 3

Sequentially, the increase in fees in the regions was driven primarily by favorable markets. Sequentially, the increase in GFO fees was driven by net inflows. Relative to the prior year, The decrease in fees in the regions was primarily due to unfavorable markets and product related asset outflows. Within GFO, the decrease in fees was due largely to unfavorable markets. Moving to Page 7 and our balance sheet and NII trends.

Speaker 3

Our average balance sheet decreased 1% on a linked quarter basis, Primarily due to lower client deposits, partially offset by higher leveraging activity. Earning assets averaged $134,000,000,000 in the quarter, down 1% sequentially and down 4% versus the prior year. Money market assets primarily absorbed the decrease. Client liquidity continued to grow during the Q2. While we saw a decline in average deposits, Was more than offset by increases in other categories.

Speaker 3

Relative to the Q1, our money market funds were up $8,000,000,000 or 6% And our CDs were up 29%. Average deposits were $106,000,000,000 Down $6,600,000,000 or 6% sequentially, but remain consistent with late April levels. We experienced a $2,600,000,000 sequential decline in non interest bearing deposits, mostly within the institutional channel, as clients continue to shift to higher yielding alternatives. This reduced the mix of non interest bearing deposits to 17%. At quarter end, operational deposits comprised approximately 2 thirds of institutional deposits.

Speaker 3

These tend to be the stickiest deposits as clients use them to operate their businesses. Approximately 3 quarters of our average deposits are institutional with the remainder related to wealth clients, including GFO. Shifting to the asset side of the balance sheet. Average securities were down 2% sequentially, reflecting the natural runoff, which we've seen to reinvest at the short end of the curve. Our $50,000,000,000 investment portfolio consists largely of highly liquid U.

Speaker 3

S. Treasury, Agency and Sovereign Wealth on Bonds And it's split approximately evenly between available for sale and held to maturity. The duration of securities portfolio continued to edge Down in the Q2 to 2.1 years. The total balance sheet duration is now less than a year. Loan balance has averaged $42,000,000,000 and were up 1% sequentially.

Speaker 3

Our loan portfolio is well diversified across geographies, operating segments and loan types. Approximately 75% of the portfolio is floating and the overall duration is less than 1 year. Our liquidity remains strong with cash held at the Fed and other central banks up 9% to $43,000,000,000 More than 45% of our overall balance sheet is comprised of cash, money market assets and available for sale securities. This translates to $73,000,000,000 of immediately available liquidity for more than 60% of the total deposit base. Net interest income on an FTE basis was $525,000,000 for the quarter, down 4% sequentially, but up 12% from the prior year.

Speaker 3

NII reflected the impact of several dynamics. We saw continued client migration out of deposits and into higher yielding alternatives, Non interest bearing deposits as a percentage of total deposits slid to 17% and deposit costs increased With our interest bearing deposit beta during the quarter reaching 88% and our cumulative beta for the cycle at 68%. The net interest margin on an FTE basis was 1.57% for the quarter, down 5 basis points sequentially, but up 22 basis points from a year ago. The sequential decline reflects the impact of higher funding costs, partially offset by higher short term market rates. Our NII in the Q3 will continue to be driven by client behavior, which has been less predictable given the speed and velocity of this cycle's rate hikes.

Speaker 3

Our average client deposits thus far in the quarter are approximately $106,000,000,000 Deposit outflows are expected to continue in part due to seasonality as August is typically our low point in the year as European activity slows materially. The pace of the outflows is expected to moderate. Turning to Page 8. As reported, Non interest expenses were $1,300,000,000 in the 2nd quarter, 4% higher sequentially and 9% higher than the prior year. Excluding charges in both periods as noted on the slide, expenses in the 2nd quarter were down 1% sequentially, But up 5% year over year.

Speaker 3

I'll hit on just a few highlights. Compensation and technology expense continue to be the areas of highest spend. Compensation expense, excluding severance charges, was down 5% sequentially, but up 4% compared to the prior year. Was down sequentially due to the payment of our annual retirement eligible incentives in the Q1. This is partially offset by the impact of this year's base pay adjustments, which are granted in the Q2.

Speaker 3

The year over year growth in compensation expense largely reflects the impact from inflationary wage pressures and last year's employee expansion, partially offset by lower incentives. Excluding charges, Non compensation expense was up 3% sequentially. Primary driver of the increase was growth in the outside services line, which is up 9% sequentially. The increase is largely due to timing as we reported a sequential decline in outside services of 9% in the Q1 due to delays in technical services projects. With our heightened focus on expense control, we expect our operating expenses to grow more modestly and our Thanks to trustee ratio to show further improvement.

Speaker 3

Turning to Page 9. Our capital ratios remained strong in the quarter and continue to be well above our required regulatory minimums. Our common equity Tier 1 ratio under the standardized approach was flat to the prior quarter at 11.3% despite continued common stock repurchases. This reflects a 430 basis point buffer above regulatory requirements. Our Tier 1 leverage ratio was 7.4%, up slightly from the prior quarter.

Speaker 3

We returned $257,000,000 to common shareholders in the quarter through cash dividends of $158,000,000 And common stock repurchases of $99,000,000 And with that, Jenny, please open the line for questions.

Operator

Thank And I do have a question from Steven Chubak, Wolfe Research. Please go ahead.

Speaker 4

Hi, good morning. This is actually Sharon Lunds filling in for Steven. Just a question on deposit betas. They came in a little bit better than expected this quarter. Can you help us understand on how to think about the incremental betas from here.

Speaker 3

Sure. So Datas have continued to increase. And from here, I think we still have to separate the institutional client base from the wealth client base. We noted that we're cumulatively across the platform within this quarter in the high 80% range. The institutional channel is likely going to be at 100 at this point.

Speaker 3

The wealth channel still provides Some benefit. There's the betas there are a lot lower, but at this point, we're seeing about 100% in the institutional channel and Still much less than that and well. And that seems to those both of those trends seem to be continuing as we've seen early signs

Speaker 4

Great. And then as a follow-up, you noted you're at about 17% non Just bearing deposits today. I think you had troughed closer to about 15% in the 2004 to 2006 cycle. Can you help us think through where that potentially goes from here? And once that starts to normalize, where you see NII exiting the year.

Speaker 3

Sure. Well, like you, we've looked back a lot at where it's troughed. The data we have showed it a little higher than the 15% you mentioned, I think at 16%. But I don't think about that as a floor. There's nothing structural in the base to consider that a floor.

Speaker 3

Now that said, It has been moderating significantly and we don't see we haven't seen much movement at this point. Obviously, there's a step down this quarter Of another percentage point, but it seems to be leveling off at this point.

Speaker 4

Great. Thank you.

Speaker 3

Thank you.

Operator

Next question comes from Alex Blostein from Goldman Sachs. Please go ahead.

Speaker 5

Good morning, Al. Hi. Good morning. Hello, everybody. So a couple of questions around expense trends.

Speaker 5

I guess, one A little bit more near term, you guys announced some action obviously over the course of the quarter. There's a severance charge. So maybe help us quantify Hi, what it means in terms of savings and your just updated views on the overall sort of firm wide expense growth for the year, I guess, Excluding the charges occurred in the Q2, I think last time you talked about bringing that down to below 7%, but maybe an update there would be And then bigger picture question, you guys are running at a kind of high 20 ish percent pretax margin That used to be north of 30%. So as you kind of think about the fee environment getting a little better with the market, but NII has clearly peaked as we talked about before. Is there an opportunity to get back to that 30% plus and how do you see sort of achieving that if that's the goal and what's the time frame around that?

Speaker 3

Sure. So let me tackle the expense, the compensation related first. First, I'm sure people are curious where is the base from here. So let me just provide some background on kind of Q1 to Q2, 2nd quarter to 3rd quarter. I think from here, we'd say flat to down from 2nd quarter ex The severance charge in the compensation line.

Speaker 3

So if I go back to last quarter, we explained that the significant movements for Q2 would be The $40,000,000 seasonal decline in equity awards and then the $20,000,000 increase in the base pay coming online. That would have put comp at about $575,000,000 for the quarter. And obviously, ex the charge, we ended up About $8,000,000 better than that, including currency. So two factors led to that. First, We pulled a lot of levers in the quarter to flatten compensation, including accelerating and Close to completing the actions that we launched in Q4 of last year.

Speaker 3

So in January, we communicated that the projected reduction by Late 'twenty three would be about 300 rolls and about $5,000,000 to $7,000,000 in quarterly comp benefit net of reinvestments. So we got a portion of that work done in the Q1 and we mostly finished it in Q2 and that was a big part of the reason it put us ahead of schedule. 2nd, as we saw the timing of that first program accelerating and coming to completion, We launched a new effort during the Q2 specifically related to what you've referenced, Alex, in the severance charge that we announced this morning. We've already gotten some benefit of that within the quarter and that's reflected in the results. So overall, this new program, to your question, should impact about An incremental 600 roles.

Speaker 3

Many of that will be backfilled based on a lens of skills or geography, but Same goal. We should be able to get $5,000,000 to $7,000,000 a quarter in run rate savings and A portion of that got embedded in the Q2. So we've got to remember that we did pull the lever hard this quarter. So there's some hiring that's in the queue, but we also pushed a fair amount back. And so That's why with various puts and starts, it's good to think about a flat to down from the comp levels you see in 2nd quarter Ex charges going into Q3.

Speaker 3

So that's a hopefully helpful background there to get to your questions For the rest of the year, where do we see expenses? At a high level, we've taken about a point Out of the curve for the year based on the trajectory that we're on. If you take out to your point, if you take out the notable items This year on each quarter has been under 6, and we think we've taken that Point out of the curve at this point and that should continue through the rest of the year. To margins, you're right that we And we've been in the 30s and now in the 20s. Our target has us One of our key performance indicators is for us to be in the 30s and no way have we lost sight on that.

Speaker 3

That is where we're trying to get. That gets impacted largely by what's going to happen in our minds. We can control the expense side. And obviously, we're doing a lot of work there. And we're also getting good benefit because we saw good organic growth in the quarter.

Speaker 3

And so both levers are working in the right way, but We have definitely not changed our target of being in the 30s from a margin perspective.

Speaker 5

Got it. Thanks. Super comprehensive. Just a quick follow-up around deposits. So good news, you guys were kind of in line with what you Updated us on around 105.

Speaker 5

It sounds like deposits are fairly stable. I think you said 106 right now with a kind of similar non interest bearing mix as we saw over the course of the quarter. Can you help just frame the seasonal deposit outflows and any other kind of client conversations you're hearing That could give us a sense where deposits could ultimately trough in the cycle. It sounds like there's a little bit more to go, but just curious to hear what the endpoint might be.

Speaker 3

Yes. You heard right. It's held in quite well so far in July And we didn't June, you see the end of the quarter and there's a spike there. But in general, June July have been at about this level and have been holding in well. Our client activity is good.

Speaker 3

We've taken action here to make sure we're talking to clients aggressively and Telling them we want to continue providing good liquidity services for them, whether it's lending or holding on to their Deposits, but we've got we talked last quarter about the fact that we think about liquidity broadly, it's about client liquidity And it was good to see money market funds up this quarter. That adds to margins really well too. And even as we think about what clients are holding in brokerage and so All of the client liquidity seems to be holding in well. On the seasonality dynamic, August is a low point, but it's not it doesn't go down dramatically. We've looked back several years.

Speaker 3

And so, We've looked back several years. And so we're feeling that deposits at these levels Seem to be holding in okay. So I can even give a little bit of thought from our perspective at this point based on our outlook. I think it's prudent to think about Another decline, even though deposits are holding in pretty well, but we see the competition. And so we think it's Prudent to think about another NII decline of about 5% for the quarter.

Speaker 3

Again, June July Volumes have held in at about $100,000,000,000 to $110,000,000,000 but we just have to be conscious of the competitive environment and what the summer tends to hold in terms of volume pressure.

Speaker 5

Understood. Great. Thanks so much.

Speaker 3

You bet. Thanks, Alex.

Operator

Our next question is going to come from Brian Bedell from Deutsche Bank.

Speaker 6

Great. Thank you, Brian.

Speaker 7

Good morning, Brian. Good morning. Hope all is well. Maybe just to go back to expenses, Appreciate the color you gave, Jason. Normally, you start to talk about the seasonal lift that you typically get in the second Path in things like equipment and software and outside services.

Speaker 7

I wonder if you'd want to comment on any projection there?

Speaker 2

Sure. Well,

Speaker 3

it's good to call it out. I think in equipment and software, in particular, We were better than what we thought we were going to be, but that was really two factors led to that. 1, we did have some delays in projects Coming from WIP into being depreciated, those will come online. So that's more timing. And then Secondly, we've been working very aggressively as far as the productivity office to just negotiate on and then try and push inflation down and we had Some good results there, bringing cost down.

Speaker 3

And so from here, we think Q3 up $5,000,000 to $10,000,000 in that line item. 4th quarter, we can even tell because some of it's baked an additional $5,000,000 to $10,000,000 lift from that perspective. And outside services, no update to make there.

Speaker 7

Okay, great. And then Mike, you started off the call talking about some of the new business wins in Asset Servicing and Wealth Management. I guess, how should we think about that contributing to organic revenue growth? Maybe just broadly, If we're in a, say, a flattish market situation, would you expect this to have a positive impact in the next couple of quarters and going to 24 On revenue.

Speaker 2

Yes, Brian. So the answer is yes. And to your point, we only consider it organic growth once it's Transitioned and in, and yet we know the pipeline of business or mandates that we've won, that have not transitioned in yet. And in each of the businesses, it's a little bit different. There's more of a, I'll call it, forward pipeline with asset servicing, But the pipeline looks very good based on recent activity that I mentioned there.

Speaker 2

Within Wealth Management, There's not as much of a forward pipeline, if you will. But similarly there, I would say, very steady, Steady activity. And as much as anything with Wealth Management, keeping in mind that this, I'll say company, but also that business has been built on doing what's right for the client. And sometimes That results in different financial implications for the company, but over time is best for the company and the shareholders. And my point being, The discussion around deposits and money market funds and treasuries and managing things like that, They all have different implications for us, but the client activity has been very good and we're, I would say, optimistic about How some of the shifts with rates will have implications on where those funds get redeployed.

Speaker 2

So again, positive on the wealth management front in a steady fashion. And then asset management, as Jason mentioned, We've seen strong flows into the money market platform there, but that also in some other areas as well. And Likewise. I'd like to see those get redeployed in other ways over time. So good across the board.

Speaker 7

Is it fair to say the revenue growth on the fee side is definitely better than the NII side for the organic growth equation, No, at

Speaker 2

least not. Yes. That's right, Brian. And I view it as you're kind of implying there. On the fee side, it tends to kind of Grind up more gradually, subject to the markets and NII can be more volatile.

Speaker 2

And the only other area I would just highlight is Around our capital markets activity, FX and brokerage and trading there, which has been relatively subdued during this time period With lower volatilities, lower activity, which that can also change and that has different implications too, Just meaning those can be more profitable.

Speaker 7

Great. Thanks for all the color.

Speaker 2

Sure.

Operator

And Robert Reichow from Wells Fargo. Please go ahead.

Speaker 8

Hey, good morning. Thanks for taking my question. I guess the first question is on fee growth kind of more broadly. You Sort of indicated that your the 5% expense growth rate, does that go down, but do the fees where do you see fees growing to get up to that expense level so that she could grow fees faster than expenses.

Speaker 3

Well, I mean in the short run, I think we're still I don't think we're still absorbing an inflationary environment from an expense And so would like to be able to do better even than what we're doing right now in the long run from an expense growth perspective. On the revenue side, as you know, the lift the financial model enables us to have lift from 2 different areas. One is the market lift and that's tended to provide low single digit growth rates, but It's a very strong component of the financial model. And then secondly, the organic growth and if we can have low single digit growth in wealth management organically and Then mid single digit growth in asset servicing, that provides a good model for us to get well above The expense rates that we think we can lead to in the long run and provide good operating leverage.

Speaker 8

Okay. And if I could follow-up on wealth, you've improved growth there as well. Are there any differences in the competitive dynamic among the top end and the low end? Are you having more success? You said you're having more success in Global Family Office.

Speaker 8

I guess, can you talk about the funnel of new clients sort of in the middle tier And what you're doing to grow that?

Speaker 3

Yes, it's interesting. It's actually not just the family office, But the very top end of Wealth Advisory and those clients can be similar size. They just happen to not have a family office and Or leaning more toward us for wealth advice as opposed to the broader set of more The operational and reporting services that the Global Family Office provides, we are doing better at the top end. And looking at the new business that came on board and at the pipeline, the accounts above $20,000,000 just that was where there was more velocity and that's been consistent for a while in that business. And so There is something to that dynamic.

Speaker 3

We seem to be doing better at the top end. That's where a disproportionate percentage of the growth has come from.

Speaker 7

Okay. Thank you. You bet.

Operator

And our next question is going to come from Brennan Hawken from UBS. Please go ahead.

Speaker 7

Good morning, Jennifer.

Speaker 9

Hey, how are you doing? Just a quick clarification point. Jason, you referenced a Point of expense benefit, is it right to interpret that as coming off of your prior 7% or better Tation or was that meant in a different way?

Speaker 3

It is correct to interpret that as saying We don't see 7 at this point. We've said 7 or better. And at this point, we should be doing 6 or better. We've done that first half and we see path to that in the second half as well.

Speaker 9

Perfect. Thank you for clarifying that. Thank you. Sure. You guys had a write off of a client capability.

Speaker 9

I don't remember seeing that in the past. Just a little confusing to me. So maybe if you can help me understand it, when did you build that capability and then what happened that caused you to write it off?

Speaker 3

Yes, I can give you some thoughts on it. It's just from a timing perspective, it's been in the works Many quarters, but one of the tellers of the Productivity Office is to look

Speaker 2

at What we

Speaker 3

refer to as internal investments to ensure that they're on track to meet our hurdle rates for returns and margins. The charge was a project to build out a new client capability in asset servicing, Specifically in the asset owners channel. So after working and eventually discussing with different stakeholders, We didn't reach commercial agreement on terms that would meet our hurdles, and so we halted the project. I think it's importantly, I would presume you'd ask, are there others like this in inventory? Absolutely not.

Speaker 3

We don't this is a large project endeavor that we've been working on And didn't reach resolution that got to our hurdle rates and so stopped the project.

Speaker 9

Okay. Did something happen in the Sort of like revenue opportunity that diminished it versus where you planned, because I'm sure you guys went through the process before you Broke ground, so to speak, at least metaphorically. Or was it that it was really pricey? It turned out to be more expensive Build, was it the expense side that hurt the outlook versus plan or was it the revenue opportunity?

Speaker 3

Yes. It was more costly to build than we thought, and the revenue dynamics were not, At that point, going to get to our hurdle rate. And this it really is reflective of us Taking an extremely disciplined approach on items like this where we're not going to devote resources to areas where we're not going to achieve our hurdle rate. And so, well before we talked about this, Even internally, one of the pillars that we've talked about for the productivity office was looking at our internal investments. And this It fits squarely in one of those areas.

Speaker 3

We define that as areas where we're allocating resources, whether it's capital or expense dollars, And we're not at our hurdle rate. And so this is one where we were disciplined in saying we're going to stop now, halt it And not invest more into this.

Speaker 9

Yes. Thanks for explaining that, Jason. It's actually A lot more encouraging than I interpreted it on paper. So thanks for the color.

Speaker 3

No, thanks for asking. Probably, if it's helpful you to clarify, it's helpful to others. So thank you.

Operator

The next question comes from Rob Wildhack, Autonomous Research. Go ahead, please.

Speaker 10

Good morning, Rob. Good morning, guys. Good morning. Just a bigger picture question on expenses. Where do you want or what's your target, I guess, for that Expense to trust ratio over the long run and then what are the sort of necessary ingredients to get there?

Speaker 3

Yes. If we can be in the 110 to 110 range, Then that's 105 to 110, then we feel like we're in good shape to do well. And we're grinding to get down there. We got down there before. We've been well above it.

Speaker 3

We got down into that range. In fact, even slightly below it for a quarter or 2. And now all the factors we've talked about, higher inflation, markets coming down And the effects of NII going up not helping that metric, we're outside that range, but it is an important part of Our financial model to be in that range. And so we're it's the first thing it's first thing I look at is where are we and it's It's good to see us getting back toward the number that we the range that we've articulated. It's another one of the key performance indicators that we talk about internally.

Speaker 10

Got it. Thanks. And just one follow-up on the positive organic growth Commentary this morning. If you saw a big acceleration in organic growth or a sustained Period of strong organic growth, multiple quarters, even several years, how do you think that would impact expense growth,

Speaker 2

Yes. So Rob, your two questions relate to each other, Which is the primary way that we can drive that ratio to the range that Jason talked about It's through organic growth on the fee side and a controlling organic expenses, All right. And to your point, if you have higher organic growth, that is going to require more resources. And to the extent that you don't achieve that, then you have to make sure that you're reducing the organic growth on the expense side to get there. But those are the 2 areas that we control the most.

Speaker 2

And then you say, okay, but beyond that, as Jason mentioned on the fee side, it's going to have the impact of markets and Sometimes currency. And on the expense side, you're going to have the impact from inflation and to some extent currency. And so You try to focus on what you can control the most, which are those two items, organic growth on fees and organic growth on expenses To ultimately drive it to the target range.

Speaker 3

Okay. Thank you both. Sure.

Operator

And Betsy Gerstinck from Morgan Stanley is next. Please go ahead.

Speaker 6

Good morning, Betsy. Hi, good morning. This is actually Connell Schmitz filling in for Betsy. How are

Speaker 3

you? Good.

Speaker 6

How are you? So just one question, a little bit nuanced on the credit portfolio. It seems like a little bit of an outlier. I know it's Small, but on the reserve release, it seems like an outlier that there's improved outlook on your CRE book. Can you just explain what's going on there and where you see this line item from here?

Speaker 3

Yes. So actually, the Just to clarify, there was the release. The release is a result of some improvements in A small number of borrowers in that book, but that more than offset And actually worsening outlook that we have overall for CRE. And so, it's not dramatic, but Our outlook on that portion of the book actually would have caused an increase in the reserve.

Speaker 6

Got it. Okay. That makes more sense. Sure. I guess one other question on the investment portfolio.

Speaker 6

You And the duration is still sub-1 year and you're mostly in cash. At what point Just given the context of potential future rate hikes, where do you see like this duration heading in the coming months and how are you planning to Make shift this book in that context to protect NII.

Speaker 3

Yes, absolutely. So the duration of the securities book is at 2:1. The duration of the balance sheet is just under 1. And you're absolutely right to call out that this is an interesting time in what we think of as the evolution of The yield curve. And so we've been allowing the maturity of securities To go to become more liquid as we reinvest them, that's brought down duration.

Speaker 3

At this point with the yield curve, we are talking about where to go from here. That's not indicating it's going to go up, but it's not on a at this point, we are thinking about where is the yield curve, where is it going and how does that Influence what we want to do as the large securities book continues to mature and provide opportunity for reinvestment.

Speaker 6

Okay. And then I guess one follow-up on that same topic. How should we think about earning asset growth in the context Of deposit outflows potentially, should those flow out on a one to one basis or will you maintain certain balance sheet Yes.

Speaker 3

Our as the deposits come down, The securities can act as obviously the funding mechanism for it. It doesn't that doesn't move very quickly. And so The deposit size is always going to influence the earning asset size. And so what we have to then think about the constraining factor at that Point becomes what does leverage look like. And we've got a lot of room from a leverage perspective.

Speaker 3

And so That's what sometimes will lead us to think about discretionary leveraging just to make sure that we're not missing opportunities to pick up Some NII, even if it's a very thin NIM based on where the size of the balance sheet is because it doesn't flex super quickly.

Speaker 6

Got it. Okay, that's helpful. All right. That was it for me. Thanks a lot.

Speaker 6

Thank you. Sure.

Operator

And our next question is going to come from Mike Brown from KBW. Please go ahead.

Speaker 3

Good morning, Mike. Thank you.

Speaker 10

Good morning. Maybe just actually following up on that question there. We noticed that the complexion of your balance sheet has been Shifting on the funding side, naturally that makes sense. But your deposits, they declined by 6%, But we saw that the higher cost Fed fund purchased balance actually jumped meaningfully quarter over quarter, it's been growing This year, I guess, why not just let the balance sheet decline more, like what's kind of going on there in terms of the mix? And how could that Progress from here should if the deposits continue to trend down as you talked about, will that balance can Did the Fed funds purchase balance continue to grow as an offset to fund the assets?

Speaker 3

Yes. And part of it is that in this The deposits have just been so volatile. And so you don't want to commit to significant movement In shrinking the balance sheet and we want to be there for our clients. We've got plenty of capital. We've got plenty of But I'll have got plenty of room for a leverage perspective.

Speaker 3

And so just not anxious to quickly do any significant moves. And so to that extent, As deposits come down, you have the opportunity to then say, maybe we want to use some discretionary leveraging. Again, We printed a 7.4 Tier 1 leverage, which is it leaves you a lot of room. And so if we hadn't done Leveraging that incremental leveraging would be even higher in the 7s and at a point you just have to say it is prudent to make sure you're taking advantage of Tuneries that

Speaker 10

exist. Okay, great. Thanks for the color there. And then I guess maybe just following up on that Point there on the capital side. You guys increased the share buyback or you bought back about $100,000,000 or so of stock this quarter.

Speaker 10

Any expectation on how that could progress from here? What should we think about in terms of your capital return?

Speaker 3

Sure. Well, the overall theme of what you saw in this quarter makes sense in the near term Or CSB in the market, for share repurchase. The thing that worked against us, the AOCI actually worked Slightly against us this quarter. Usually in a neutral rate environment, the pull to par will give us some lift there, It didn't this quarter. That's fine.

Speaker 3

But even so, the $100,000,000 we did is about what it's kind of that's the model we're thinking about in the short run. Big caveat is that the FDIC special assessment coming online presumably in Q3, That would be a similar dollar amount. It's what we did from a repurchase perspective this quarter. And so you could see us saying Hold off for a quarter, get that payment done and then get back to your game plan.

Speaker 10

Okay. Thank you for the color.

Speaker 3

Sure.

Operator

Next question comes from Gerard Cassidy from RBC. Please go ahead.

Speaker 6

Good morning, Gerard.

Speaker 3

Hi, Jason. How are you? Very well.

Speaker 11

Jason, can you share with us, I think you gave us the cumulative beta through the cycle Of 68% and then the incremental beta of course is higher. And I think you touched on it this quarter maybe 100%. The question is this, how is the beta behaving relative to past tightening cycles? I don't know if 2016 to 2018 is A cycle that really is that comparable, maybe you have to go back a little further. And then second, how quickly if the Fed does start cutting rate Excuse me, cutting Fed fund rates in 2024 sometime.

Speaker 11

How quickly can you guys reduce your deposit costs?

Speaker 3

Sure. On the first, just to make sure I said it right earlier, The 100% going forward would be for the institutional side of the business, not for the overall deposit base. Okay. Got it. Yes.

Speaker 3

And to the question of how does that compare historically, This is higher than it has been historically. And there's different dynamics that you and I Could talk about, I think that are driving that, but there's just there's a very strong competition for deposits right now and for various reasons. And so we want to make sure that we're there for our clients. And we still we've got the ability to do that. And so we want to make sure that we're holding on to our fair share and providing that liquidity capability for clients.

Speaker 3

To think about reductions, the reductions can they can come quickly. And our the way we price, The way we the way our agreements work, we get fast movement on the way down. And so We should be able to get deposit costs down quickly as rates come down.

Speaker 11

Very good. And then as a follow-up, you also touched on the volatility of deposits. Is it more based on your guys' experience at Northern, are you finding that this period's volatility is even greater than past periods? And is it because of quantitative tightening or Fed actions that is causing greater volatility in your guys' estimate?

Speaker 3

Well, it is more volatile, not just over the long run. We went from 90 to 138 down 106. But even within the quarters, a lot of volatility. But I think that's driven by some of the macro factors And what we saw in early March spooked a lot of depositors, obviously, and then another trend of Debt sealing and then leading to another trend of deposit competition, all of those things are Having or driving significant different preferences that clients have, not just between which bank to go to, But whether to use banks versus money market funds versus treasuries, I think all of those factors are what's leading to the heightened volatility we're seeing.

Speaker 11

Got it. Okay. Thank you.

Speaker 7

Sure.

Operator

And next question comes from Vivek Anujja from JPMorgan. Please go ahead.

Speaker 12

Hi. Good morning. Thanks. Good morning. A couple of questions.

Speaker 12

I'll start with non interest bearing deposits. The big outflow you saw in the 2nd quarter, Which segment did that come more out of and where what are you seeing in that trend? Sorry, if I'm repeating the question. There have been overlapping calls, it's made it I hope I'm not doing that.

Speaker 3

The significant movements are almost always going to come well, not almost So in this case came from Asset Servicing.

Speaker 12

Okay. And the stabilization, Where are you seeing more of that? Which segment?

Speaker 3

The asset Servicing segment is actually overall been relatively stable. We'll see big Chunky movements in and out, but the overall level has been about the same. The Wealth segment is more granular. The GFO client base has is much chunkier, but you just think about The amount of clients in the wealth segment, it just makes it more granular.

Speaker 12

And on the Wealth Management segment, the low single digit expense growth, is that Because that's where you've done a lot of the headcount cutting that you all talked about and what are the implications for service there?

Speaker 3

Service has been great. And we didn't provide detail in the Expense allocation between the business units, but just in general, you'll note that the Headcount is down, but no impact to service levels whatsoever. The low single digit Growth I referenced was related to organic growth within Wealth Management. Okay.

Speaker 7

All right. Thanks.

Operator

Next question comes from Robert Reichow from Wells Fargo.

Speaker 8

Hi. Just a quick follow-up. You mentioned that equipment and software, you had some projects being delayed. Does that mean that non comp expense will see some upward pressure in the second half of the year?

Speaker 3

Yes. In certain categories, it will. And so in equipment and software, we'll see in that line item in particular, we'll see upward pressure $5,000,000 to $10,000,000 3rd Q4. But not I didn't reference Other line items, we mentioned outside service is relatively flat. So that's really the only Forward looking information we provided except for the comp number which you referenced.

Speaker 7

Great. Thank you.

Speaker 12

You're welcome.

Operator

And Brian Bedell from Deutsche Bank. Please go ahead.

Speaker 7

Great. Thanks for taking my follow-up. I just wanted to clarify on the CIC Special Assessment. Is that included in that expense guide of 6% or better? And I don't know if you're able to frame the size of the special

Speaker 3

assessment yet. It's not included in the 6%. And we haven't talked publicly about what the number is.

Speaker 7

Okay, fair enough. Thank you.

Speaker 3

Sure.

Operator

Okay. Thank you very much

Speaker 1

for joining us today. We look forward to speaking with you again soon.

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Earnings Conference Call
Northern Trust Q2 2023
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