NTRS - NASDAQ

Good day, and welcome to the Northern Trust Corporation First Quarter 2023 Earnings Conference Call. Today’s conference is being recorded. At this time, I’d like to turn the conference over to Jennifer Childe, Director of Investor Relations. Please go ahead.

Thank you, Mike, and let me join Jennifer and Mike in welcoming you to our first quarter 2023 earnings call. Let's dive into the financial results of the quarter starting on Page 4. This morning, we reported first quarter net income of $334.6 million, earnings per share of $1.51 and our return on average common equity was 12.4%. On a year-over-year basis, currency movements unfavorably impacted our revenue growth by approximately 100 basis points, and favorably impacted our expense growth by approximately 130 basis points. On a sequential basis, currency movements favorably impacted our revenue growth by approximately 70 basis points and unfavorably impacted our expense growth by approximately 90 basis points. Our first quarter results were also impacted by two notable items. One, we recognized a $6.9 million pre-tax gain on the securities repositioning we announced last quarter and executed in January; two, we reported $9.8 million of pre-tax charges associated with various early lease terminations actions taken to further optimize our global real estate footprint. Notable items from previous periods are listed on the slide. Excluding the notable items in all periods, revenue was flat on a sequential quarter basis and up 1% over the prior year. Expenses were flat on a sequential quarter basis and up 6% over the prior year, reflecting an expense to trustee ratio of 120%. Pre-tax income was down 2% sequentially and down 13% over the prior year. Trust, investment and other servicing fees representing the largest component of our revenue totaled $1 billion and we're down 9% from last year, but up 2% sequentially. Excluding notable items, we had year-over-year and sequential declines in all other non-interest income, which is primarily driven by lower foreign exchange trading income. We saw significantly reduced volumes in the first two months of the quarter with a modest pickup in March. Net interest income on an FTE basis, which I'll also discuss in more detail in a few moments, was $544 million, up 40% from a year ago, down 1% sequentially. Our provision for credit losses was $15 million for the first quarter, reflecting growth in the size and duration of the commercial real estate loan portfolio. Given the increased attention being placed on commercial real estate loans, we want to provide some detail we felt would be of interest. Commercial real estate loans comprise 12% of our total portfolio and commercial office loans comprise 2% of total loans. Approximately 95% of commercial real estate loans are personally guaranteed and approximately 70% have a loan-to-value ratio of less than or equal to 70%. Turning to our asset servicing results on Page 5. Assets under custody and administration for asset servicing clients were $13 trillion at quarter-end, down 9% year-over-year, but up 4% sequentially. Asset servicing fees totaled $603 million, which were also down 9% year-over-year, but up 3% sequentially. Custody and fund administration fees, the largest component of fees in the business, were $414 million, down 9% year-over-year, but up 2% sequentially. Custody and fund administration fees decreased from prior year quarter, primarily due to unfavorable markets and unfavorable currency translation. The increase sequentially due to favorable markets, favorable currency translation and solid new business activity, particularly later in the quarter. Transactional activity, which comprises approximately 15% of our custody and fund administration fees, was generally weaker due to lower volumes and lower one time fees. Assets under management for asset servicing clients were $962 billion, down 12% year-over-year, but up 7% sequentially. Investment management fees within asset servicing were $126 million, down 14% year-over-year, but up 2% sequentially. Investment management fees decreased from the prior year quarter primarily due to asset outflows and unfavorable markets, partially offset by lower money market fund fee waivers. Investment management fees increased sequentially due to favorable markets and favorable currency translation. Moving to our wealth management business on Page 6. Assets under management for our wealth management clients were $368 billion at quarter-end, down 7% year-over-year, but up 5% on a sequential basis. Trust investment and other servicing fees were $461 million, down 9% compared to the prior year, but up 1% sequentially. Within both the regions and GFO the year-over-year declines were primarily driven by unfavorable market impacts and product level acid outflows partially offset by the elimination of money market fund fee waivers. Sequentially, the increase within the regions and GFO was primarily driven by favorable markets, partially offset by product level asset outflows. The upturn we saw in our AUM occurred later in the quarter was not fully reflected in our trust fees. Importantly, we continue to see modest organic growth in our core advisory fees. Moving to Page 7 in our balance sheet and NII trends. Given the attention being placed on balance sheet trends, we also thought you might be interested in some additional data points this quarter. We think about client liquidity in three categories; deposits, money market funds, and short term treasuries. With that background, we can provide some color and data on what we saw throughout the quarter and through the first few weeks of April. Most importantly, client liquidity was up meaningfully for the quarter in both asset servicing and wealth management. And it's continued to rise during the first three weeks of April. While we saw the kind of deposits for the quarter there was more than offset by increases in money market funds as clients continue to migrate into higher yielding products. Relative to the fourth quarter our money market funds are up $15 billion, or 7%. As mentioned, average deposits were $112 billion down 4% sequentially with wealth management deposits down 7% and institutional down 3%. Approximately three quarters of our average deposits are institutional. Within this segment, approximately 68% are considered operational, the stickiest as clients use these funds to run their ongoing operations. Across the organization, we experienced a $2 billion decline in non-interest bearing deposits as clients shifted to higher yielding alternatives. This reduced the mix of non-interest bearing deposits to 18%. We actively manage our assets and liabilities considering a wide range of possible stress scenarios, including interest rate risks, and how they may affect liquidity and capital. So let's shift to the asset side of the balance sheet to see how investments are allocated. Average cash held at the Fed and other central banks was up 12% to $37 billion. And we had $67 billion of immediately available liquidity reflecting approximately 50% of average earning assets. Loan balances averaged $42 billion and were down 1% sequentially. Our own 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 one year. Securities were down 3% sequentially reflecting the impact of both our repositioning early in the quarter, and the natural run off which we've chosen to reinvest at the short end of the curve. Our $49 billion investment portfolio consists largely of highly liquid U.S. Treasury, agency and sovereign wealth fund bonds. And it's split 50/50 between available for sale and held to maturity. In the aggregate, the securities portfolio has a duration of 2.3 years. The total balance sheet duration is 1.1 year. Net interest income was $544 million for the quarter, up 40% from the prior year and down 1% sequentially. NII reflected the impact of several dynamics many occurring late in the quarter. As mentioned, we saw continued improvement deposits from our balance sheet to money market funds and treasuries. Deposit costs increased with our interest bearing deposit beta during the quarter at 85%. And our cumulative data for the cycle as of March 31 of 65%. And finally, we have the impact from two fewer days in the quarter. Net interest margin was 1.62% in the quarter, up 57 basis points from a year ago and roughly flat with the prior quarter. The sequential results reflect the impact of higher short term market rates offset by higher funding costs. The prior year increases primarily due to higher average interest rates. For the second quarter, our NII will continue to be driven by client demand which is less predictable than it was 90 days ago. Our average client deposits thus far in the quarter are approximately $110 billion and subsequent to tax season, we've observed an incremental typical decline of a few billion dollars. Turning to Page 8. As reported non-interest expenses were $1.3 billion in the first quarter, 7% higher than the prior year but 3% lower sequentially. Excluding charges in both periods is noted on the slide. Expenses in the first quarter were up 6% year-over-year, but flat sequentially. Overall, we're focused on reducing the rate of expense growth and controlling those costs that are most under our control. I'll hit on just a few highlights. Compensation technology expense continued to be the areas of highest spend. Compensation expense excluding charges was up 6% compared to the prior year, and up 7% sequentially. The year-over-year growth largely reflects the annualization of last year's headcount expansion and inflationary wage pressure, partially offset by lower incentives. The sequential increases due to our annual payment of retirement eligible equity incentives in the first quarter. Equipment software, largely reflecting our technology spend was up 20% year-over-year, but up 1% sequentially. More than 50% of our spend is comprised of business driven investment, followed by spending on core infrastructure and modernization and to a lesser extent spending on information security, risk and regulatory areas. Turning to Page 9. Our capital ratios improved in the quarter and continue to be well above our required regulatory minimum. Our common equity tier one ratio under the standardized approach was up 50 basis points from the prior quarter to 11.3% despite resuming common stock repurchases. This reflects 430 basis point buffer above our regulatory requirements. As a reminder, as a category two institution under the Federal Reserve's framework, we already include unrealized losses on our available for sale securities in this calculation. Thus, mark-to-market losses occur immediately in our capital and capital ratios. Our tier one leverage ratio was 7.3% up 20 basis points from the prior quarter. Higher net income, improved accumulated other comprehensive income, the securities repositioning and lower loan balances were the primary factors in this quarters increase in capital ratios. We returned $259 million to common shareholders in the quarter through cash dividends of $159 million and after pausing meaningful share buybacks for the prior five quarters, we've repurchased over $100 million of common stock. And with that, Cynthia, please open the line for questions.

Thank you. [Operator Instructions] And we will take our first question from Betsy Graseck with Morgan Stanley. Please go ahead.

Good morning. Thank you for the question. So I was hoping we could start with opportunities you guys are seeing in the wealth channel on the back of the dislocation in the banking space. Mike, you mentioned obviously a flurry of activity towards the end of the quarter. So maybe help us frame what that means in terms of maybe revenues. And I guess zooming out a little bit does what has been happening, and I guess continues to happen in the banking world? Does that increase your kind of organic growth prospects and to what extent in the wealth channel?

Sure, Alex. So as I did mention, there has been a lot of activity. And as we've talked about before, when there's more money in motion, we do have the opportunity to grow a little bit faster. And so we did see that pickup in the first quarter after the back half of last year. We've talked about the fact that there was less activity as a result of the interest rate environment. That said, this is something where the nature of the clients that we serve and that we work with and that we look to bring on Board are pretty meaningful. And so it's a longer-term process. And I would say business building process than what I would call a sales process to do that. I mentioned, some of the momentum that we saw in the upper part of the market above $50 million and the fact that we have a lot of prospects in that area as well. So we see this more as I would say a longer running opportunity rather than a one quarter, two quarter opportunity. And that's how we're approaching it.

Got it. Great. And then my follow-up just around deposits and talk about this in common. Thanks again, for the extra detail. So, 110, average so far in April, and it sounds like maybe down a little bit more on the back of the tax season where things is tending now. What's the mix, I guess, between interest bearing and non-interest bearing balances as the way you guys see right now in April? And when it comes to the wealth deposits, in particular, sounds like they were down a little bit more than institutional in the quarter. So I guess as you think about a rolling forward, what's their approach to the rate you guys are paying on wealth deposits from here, since it seems like a lot of it is ultimately still sorting into money market funds?

Sure. So let me give you a couple of incremental data points to work with. One, you're right, we - and it's typical, obviously, as you know well, Alex, for us to see a drop after the peak of tax season. And so it has come down a few in the range of $4 billion or $5 billion since that average relative to that average. And that said, we from a mix perspective, not seeing anything dramatically different early on. And we talked about the fact that the non-interest bearing mix is higher than even if last time rates were up. But as rates flattened out, probably less incremental shift from that mix, and then within wealth in particular, the - Mike mentioned the growth there and you're exactly right and calling out a lot of it going to cash. And I mentioned that there's a lift overall in client liquidity. So of the lift that we've seen in cash, about $5 billion of that was in the wealth channel alone over the quarter. And so and that more than offsets the deposit decline that we saw in that channel. And so you just get a sense that the flows in that business are positive, and give us a sense that there's good activity there.

Gotcha. Sorry. And just what's the rate on the wealth deposit that you guys are paying right now?

Yes, for sure. And thank you guys, for all the detail. Appreciate it.

Sure. Thanks Alex.

Good morning. I wanted to start off with a question on the non-comps. Looking at the component pieces you guys made some good progress there. A good amount of the beat was really an outside services. I know that that has a heavy variable or activity link component. Should we expect that to normalize as activity levels pick up consistent with what you saw at the end of March? Just trying to think about what's a reasonable jumping off point for us to be modeling for next quarter?

Yes. absolutely. You're right. And that line item can move around a lot. So let me give you a short term, and then maybe a longer term dynamic. In the short run, that line item it was impacted by call it two things; one, some timing. So we know that there's some of that improvement will likely come back online in second quarter. And then secondly, we've taken expense actions in that category. And so we've worked really hard to work down consulting, to work down other tech services, sub-custody, negotiating hard on third party advisory fees. And so some of it definitely is related to the expense measures that we talked about broadly related to the productivity office, but there's also some timing there too. And so as you think about second quarter, this is an area where you'll see a meaningful increase, call it $20 million, just quarter-over-quarter going into next year. About $5 million under that is just a movement from on-premise processing that would show up in equipment and software moving up into outside services. But there's also just business growth and timing related there as well. We're obviously not going to see $20 million lifts consistently. But that's one we're likely to see one going into second quarter.

Got it. And just for my follow up on NII. I know you had alluded to this in some of your commentary. And so I appreciate the additional detail on the deposit side. There's been some debate previously as to whether NII or NIM, had peaked at this juncture, whether it could eclipse level seeing last cycle. I was hoping you could give some perspective just on the NII trajectory, if it's peaked at this juncture, or if there's room for growth, and given the balance sheet repositioning you alluded to in terms of shortening the duration on the asset side, how we should think about the NII trajectory in a Fed easing cycle in particular would be really helpful.

Sure. So on the first. The reality is even this quarter, you could see there's a new factor introduced into NII which is just client preference. And you can see just how often even this morning on this call, we don't talk about just deposits in isolation. We talk about them in conjunction with money market funds. And a part of that is that culturally, we have an incredibly strong focus just on providing advice to clients across whatever is appropriate for them. And there are advantages to being an in deposits. There are advantages to being in money market funds. There are advantages to being in short term treasuries. And we think about that. We tracked inside the company, that's what we were looking at very, very closely on a very periodic, on a very frequent periodic basis. And so I think that's important for people to understand we're not nudging clients in one direction or the other; just talking to them about the advantages of each. And so the reality is from here NII is going to be based on more than on interest rates. It's going to be based on volumes and volumes last quarter, we were talking about the impact of QT, and we were talking about taxes. Now, this new factor that's been introduced is what is client preference between those three pillars of client liquidity, and we could see that going in either direction. And for us, that's totally fine, as long as we're continuing to grow client liquidity. And so it's hard to model in the short run. But if we think about the traditional factors, Fed rate increases, the institutional business, which is called 70% to 80% of our deposits, we're at about 100% beta there. And that's kind of flattened out. In the wealth channel, the betas are meaningfully lower. They are call it 30% to 40%. And so still with Fed action, because that's all impacted in U.S. dollars, there's benefit from that lift still. And then you've got to introduce the other factors what happens with QT and then what happens with client preference across the pillars. And then from a NIM perspective, just the last comment I'll make is that you saw our leverage ratio is strong, and it's in the mid 7s. And it gives us an opportunity if we want to take advantage if there's a positive carry, to do more leveraging and still maintain great liquidity for our clients. That's helpful to NII. But it's obviously, it brings down NIM.

Really helpful perspective Jason. Thanks for taking my questions.

You bet. Thank you, Steven.

We will take our next question from Glenn Schorr with Evercore. Please go ahead.

Good morning Glenn.

Good morning. Question on the other borrowing side. I think most of that is wholesale funding. And I know it's not a huge number, but it's also grown to be not nothing. It's up 43%. And the rate paid on that is up 450 basis points. So I'm just looking for is that a temporary filling of the gap of the gap down and deposits? How do you think about that line item intermediate term say? I know you got to do what you got to do in the short term?

Yes. Part of it is the higher bar, but part of it is the entry is doing more in the, I think part of the reason that that the cost of that is elevated is the [thick] is us doing more [thick] repo for clients and just providing more liquidity options for them. And the way the accounting works for that with the netting it just leads to a higher, it makes it look like a higher cost than what it is. And so we're going to talk about whether maybe even break that out separately and provide more detail on the future on it because it's becoming to your exact point, it's just becoming a little bit larger. But that's the reason you see that movement in the short run.

Okay. Yes. That'd be helpful. Because then it's actually a distraction for you. Okay. And then maybe, big picture, you talked about capturing client liquidity and you talk about more holistically than you have in the past as money trends to money markets and treasuries. How much of it is it advise versus clients just self selecting in? And are there things that you could that you're tracking to see what you're actually capturing? In other words, is it actually your dollars from deposits going into your money market funds, as opposed to plusses and minuses coming from different directions?

Yes. Sure. So a couple thoughts. One, we're much more accurate and being able to track the money market fund than we are treasuries. And let me just give an example or two to illustrate why that's the case. We could and we actually did have a small number of very large institutional clients that might say, might have said, a quarter ago, we'd just like to park some money on the balance sheet. We've worked with them on what rate that is. And then they might say for a variety of reasons we want to go to short term treasuries. If they do that they might use if, it's a financial service, that's fine. It could be a hedge fund, it could be an asset manager, if they have a prime broker, they're more likely to use their prime broker to manage that. Is that really us? It's certainly not us losing a lot of net interest income because the pricing on the deposit is going to be really tight, but difficult for us to track and really confirm where that's going. The other end of the spectrum is in wealth management financial advisors are literally calling their clients and saying rates are higher. You're sitting on $750,000 in cash. Let's talk about what you'd like to do with that. Would you like to move that into a money market fund? Would you like to move it into a CD? Would you like to start building out and ladder a treasury portfolio? We can track that much more accurately. And so different components but in general, the statistics that we gave are biased toward the information that we can track and that we know stayed in house. And so if there's an information bias, it's toward us ensuring that the numbers we're telling you are reflective of what stayed here.

We will take our next question from Brian Bedell with Deutsche Bank. Please go ahead.

Good morning Brian.

We will take our next question from Ken Usdin with Jefferies. Please go ahead.

Hey Ken.

Hey, everyone. Thanks. Coming back on the expense question. I know you talked about moving, the trustees ratio is positive from here. The 6% adjusted cost growth rate is the best we've seen in like six or seven quarters. I'm just wondering, just philosophically, are you thinking about managing more towards absolute levels of costs? And is there a way to help us think about like how you're thinking? I know, it's tough to generate operating leverage in this type of environment just given what's happened and what you've walked through. But what's the right way to just think about absolute cost growth and how you're managing that on its own in this environment?

Sure. It's good to take a step back on this because it is how we've been talking about it internally recently. And one way to frame this Ken is, if you think back to charges, I'm going to because that's just the way we were not ignoring the charges. But the way we've talked about them internally, X charges, we had 9% expense growth last year. And then we don't, that's not acceptable for us. And so we've got to bend that curve aggressively. We know we're carrying part of that forward with what we know about the impact of hiring and merit increase and off cycle adjustments given the labor environment last year. But that said, we're targeting getting two points out of last year's growth rate for the full year of 2023. And in general all the expense areas are going to be addressed collectively to get to that 7% or better expense growth rate. And so you look at a couple of couple that are notable, because they've got big movements to them. One, look at comp and that look good for first quarter. You look into second quarter, we know there's about $40 million coming out, because of the seasonality of the retirement eligible grants and some other dynamics there. But we also know we've got $20 million in merit coming online in second quarter. The incentive accrual is also in that line. And that varies is profitability. And then from there, everything else is going to be driven by what happens in business from hiring and other actions and expense measures and things like that. And then we talked about outside services and how that's got a big step up next quarter. And then maybe the last one, I'll highlight equipment software, even though we've got that move from equipment software into outside services. We've got clear visibility on some incremental depreciation coming online, maybe not in second quarter, but in third. And so you can see a $5 million step up in that line item in second quarter, but then we know we've got $10 million in depreciation coming in third quarter. So those are the big pieces at a super high level and then as well, a couple of the big moves underneath it.

Okay, and if I guess one more kind of bring it all together question. You talked about a lot of balance sheet changes happening towards the end of the quarter. You talked about where deposits are. We can see where the beta is went to do you have a way to help us understand just what range of expectations of what of what you think NI can do in 2Q versus 1Q to help us put that all together?

We've been given a lot of information. I would hope to give you a really good answer on this one. But I think we got to leave it with where the deposit levels are, where the balances have been, where the deposit levels are. And then it look from there on, there's just so many factors moving around and particularly just client preference, and you were being so emphatic and saying we're not going to try to nudge in any direction just provide good advice there. So it's hard to bind it. I have to say the big factors that we see from here, with volumes being down so far, it's hard, I'm hard pressed to see how we match the 544 of second quarter. And so I am going to say down, but not do too much more than that to give an anticipation just given the volatility in the market about client preference and where deposits are going.

Okay, that's fair. Totally understood. Thanks, Jason.

Sure. Thank you, Ken.

We will take our next question from Jim Mitchell with Seaport Global. Please go ahead.

Hey Jim, good morning.

Okay, yes. Thanks.

Sure.

We will take our next question from Brennan Hawken with UBS. Please go ahead.

Good morning Brennan.

Hey good morning Jason. Thanks for taking my questions. Just want to try and make sure I understand something on expenses. You had spoken to getting below 7% expense growth. And I believe that was on a number that was X one timers. Do I understand that right? And what is that based on 2022 if we back out the one time was just so I can kind of fully level set and understand how we'd be really thinking about that?

Yes. Think about it as 4893 to be very, very specific.

We will take our next question from Vivek Juneja with JP Morgan. Please go ahead.

So in those numbers that you gave us should there be some benefit from that coming through Jason in Q2 or not or 3Q. Any color on that?

Yes. all along I think we said we think the meaningful impact should be visible by third quarter.

Okay. Shifting gears completely different one. You talked about the diversity want to separate from that your other borrowings went up from about $3.5 billion a year ago, $8 billion last quarter to now over $11 billion. It doesn't seem like you're making much of a spread on that. Any color on how we should think about that and what's driving that increase?

Yes. That's also where the FICC repo activity is going to be reflected. But --

I see not just in the repo line, but in on top of that, and the other borrowing line, is it?

I think in the other borrowingsind you also have some of the Federal Home Loan Bank borrowings, which, during this time period, we term some of those out, which previously was more all overnight and just in this time period, with the uncertainty wanted to add additional liquidity to the balance sheet.

There was about $3.5 billion in that increase FHLB line item. That's the [indiscernible] that's sequentially not year-over-year.

That will conclude today's question-and-answer session. Ms. Childe I will turn the conference back to you for any additional or closing remarks.

Thank you Cynthia and thanks everyone for joining us this morning. We look forward to speaking with you again soon.