NTRS - NASDAQ

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

Thank you, Mike. Let me joint Jennifer and Mike in welcoming you to our fourth quarter 2023 earnings call. Let’s dive into the financial results of the quarter, starting on Page 4. This morning we reported GAAP fourth quarter net income of $113 million. Earnings per share of $0.52 and our return on average common equity was 4%. As noted on the slide, our reported results included $176 million loss on the sale of securities related to a repositioning of the portfolio that we completed in November. They also included an $85 million FDIC special assessment. Our assets under custody/administration and assets under management were up sharply on both a sequential and year-over-year basis. Strong equity and fixed income markets coupled with favorable currency movements drove most of the improvement in both periods, offset slightly by asset outflows in both periods. Given the intra-period market movements and lag effects of our fee arrangement markets had an unfavourable impact on sequential trust fee growth and a favourable on year-over-year trust fee growth. On a year-over-year basis, currency movements had an approximate 90 basis point favorable impact on revenue growth, largely within our Asset Servicing segment, and 110 basis point unfavorable impact on expenses. On a sequential basis, currency impacts were immaterial. Excluding notable items in all periods, revenue is flat on both a sequential quarter and a year-over-year basis. Expenses were well-controlled, up 1.9% sequentially and up 2.6% over the prior year. Trust, investment and other servicing fees totalled $1.1 billion, a 2% sequential decrease and a 5% increase compared to last year. All other non-interest income on a FTE basis was down 6% sequentially and down 5% over the prior year. Net interest income on an FTE basis was $501 million, up 7% sequentially and down 9% from a year ago. Our provision for credit losses was $11 million in the fourth quarter. Overall, our credit quality remains very strong. Net charge-offs during the quarter were $2 million. Non-performing loan levels decreased to $64 million from $69 million in the prior period, and non-performing loans as a percentage of total loans remains stable. Turning to our asset servicing results on Page 5. Assets under custody/administration for asset servicing clients were $14 trillion at quarter end. Asset servicing fees totaled $612 million. Custody and fund administration fees were $420 million. Assets under management for asset servicing clients were $1 trillion. And asset management fees within asset servicing were $131 million. Moving to our wealth management business on Page 6. Assets under management for our wealth management clients were $423 [million] (ph). Assets and trust investment and other servicing fees for wealth management clients were $478 million. Moving to Page 7 and our balance sheet and net interest income trends. Our average balance sheet decreased 3% on a linked quarter basis, primarily due to lower borrowing activity. It declined 8% compared to the prior year due to lower client deposits. Average deposits were $102 billion, essentially flat with the prior quarter and meaningfully better than our expectations. We experienced a stronger than anticipated increase in deposits late in the quarter, ending the year at $116 billion. At quarter end, operational deposits comprised approximately two-thirds of institutional deposits and institutional deposits comprise 75% to 80% of the total mix. Despite significant leverage capacity, we reduced our average borrowings by $4 billion, relative to the third quarter or nearly 4%, reducing both our FHLB advances and Fed funds purchased. Shifting to the asset side of the balance sheet, $3.2 billion securities repositioning we completed in November involved the sale of both high-quality liquid assets and non-high-quality liquid assets available for sale securities with a weighted average maturity of two to three years. Earlier this week, we completed another $2.1 billion repositioning, which enhances our flexibility given the dynamic rate environment. We'll record an associated loss in the first quarter of approximately $200 million. The proceeds of both sales were invested in short floating rate securities, further reducing the duration of the portfolio, which is now 1.8 years. Average loan balances were $42 billion, flat both sequentially and relative to the prior year. Our end of period loan balances were up $4 billion or 9% over the third quarter, reflecting an increase in overdrafts related to higher levels of year-end trading and settlement activity. Our loans have since returned to $42 billion. The heightened activity at the end of the quarter did not have a material impact on net interest income in either the fourth quarter or first quarter. As a reminder, approximately 75% of the loan portfolio is floating. The total balance sheet duration continues to be less than a year. Our average liquidity levels remain strong. Cash held at the Federal Reserve and other central banks was down, reflecting the decrease in borrowings. But high-quality liquid assets comprise more than 50% of our deposits and more than 40% of total earning assets on average. Our net interest income in 2024 will continue to be driven largely by client deposit behavior, which has been less predictable given the unique aspects of this rate cycle. We expect the November and January securities repositioning to provide an incremental $30 million in net interest income per quarter in 2024 relative to fourth quarter levels. We currently expect first quarter net interest income to be in the range of $480 million to $500 million. This assumes deposits remain stable, but deposit pricing continues to be under some pressure. With further NIM compression possible, as long as quantitative tightening persists and the deposit environment stays highly competitive. Turning to Page 8. As reported, noninterest expenses were $1.4 billion in the fourth quarter, up 9% sequentially and up 5% as compared to the prior year. Excluding notable items in both periods, as listed on the slide, expenses in the fourth quarter were up just under 2% sequentially and under 3% year-over-year. I'll hit on just a few highlights. Excluding all notable items, compensation expense was up 2% year-over-year. This reflected the impact from 2023 base pay adjustments, partially offset by reductions in incentive compensation and headcount actions taken year-to-date. Full-time equivalent headcount was down 200 or 1% sequentially and down 500 or 2% over the prior year. Excluding notable items in all periods, non-compensation expense was up 3% year-over-year. Equipment and software expense was up 10% year-over-year, largely due to increased amortization expense. Recall, that as much as two-thirds of this line item is comprised of depreciation and amortization expense. And finally, we realized 200 basis points of trust fee operating leverage in the quarter. Turning to the full year results on Page 9. Trust fees were down 2% in 2023, largely due to asset outflows and weaker transaction volume, partially offset by the elimination of rate-driven fee waivers and new business generation. Excluding the impact of the two securities repositioning, other non-interest income was down 9%, reflecting weakness in foreign exchange trading and other capital markets activities. Net interest income was up over $100 million or 6%, which largely offset the decline in the other non-interest income categories. This translated to flat total revenue growth. Reported expenses were up 6% for the full year to $5.3 billion. Excluding notable items in both periods as listed on the slide, the expenses were $5.1 billion in 2023, up 4.8%, which compares favorably to 2022. As we've noticed previously, we expect to bring the expense growth rate down further in 2024. We have clear line of sight to two key areas of increase. Base pay adjustments within compensation expense and depreciation and amortization increases within equipment and software. On a blended rate, we expect to provide base pay adjustments of approximately $65 million in 2024, which will hit our compensation line beginning in the second quarter. This compares to base pay adjustments of $80 million in 2023. Within equipment and software expense, we expect a $65 million or 10% increase in 2024. Combined, these two-line items will drive approximately 3% increase in operating expenses above 2023 levels alone. That said, we expect to continue to generate meaningful efficiency gains from our productivity office and have identified further opportunities for improvement. As we look out to the first-quarter, we expect the following: first-quarter compensation expense will include our annual equity incentive payments, including those for retirement-eligible employees, along with modest employee headcount growth associated with growth in the underlying businesses. This should translate to a sequential increase of $50 million to $55 million. Employee benefits expense is expected to increase by approximately $10 million due to seasonally higher payroll taxes. Turning to Page 10. Capital levels and regulatory ratios remained strong in the quarter. We continue to operate at levels well above our required regulatory minimums. Our common equity Tier 1ratio under the standardized approach was flat with the prior quarter at 11.4%, as capital accretion offset a modest increase in risk-weighted asset levels. This reflects a 440 basis point buffer above our regulatory requirements. Our Tier 1 leverage ratio was 8.1%, up 20 basis-points from the prior quarter. At quarter-end, our unrealized pretax loss on available-for-sale securities was $924 million. We've returned over $300 million to common shareholders in the quarter through cash dividends of $156 million in common stock repurchases of $146 million. For the full-year, we returned approximately $980 million to common stockholders, including common stock repurchases of approximately $350 million. And with that, Ruth, please open the line for questions.

Thank you. [Operator Instructions] We'll go first to Glenn Schorr with Evercore.

Good morning, Glenn.

I definitely appreciate that. This one might be a little bit easier, the follow-up on fee operating leverage. I mean, just by means of pricing alone, or the markets alone, the markets had a strong end to the fourth quarter, so your fee run rate should probably be a lot better going into the first quarter, and with your comments on even more sharper discipline on expenses, do you expect to make some meaningful progress early on in the year in this fee to expense ratio?

Yes, you're right to call out that there is a lift, the launch point is higher coming into the year. And I don't know if I'd say meaningful, but it's definitely higher. And the lag effects will help us as we walk into the year. And so, that's the math of it. But then more strategically, we do feel positive about the pipeline in both asset servicing and in wealth management. And underneath both businesses, our asset management business is incredibly important. And as Mike mentioned in his commentary, there's some early signs of flows back in. And we always think just as we do on deposits, just keep the money in the house, keep the client assets in the house, but if our asset management business does better, then, that helps as well. And so I think the strategic component is also we're feeling early signs of some positive movement from an organic perspective.

Hi. Good morning. So, I was hoping to maybe just unpack, like, the deposit discussion a bit further and specifically just get a sense as to how you're thinking through the impact of ongoing Fed QT. It does feel like a lot of the liquidity in the system has come out of RRP that's provided a bit of stability or at least has helped drive better deposit resiliency over the last six months. But with the RRP expected to be exhausted over the next, call it, three to four months, just want to get a sense, once that happens, how you expect deposit flows to ultimately trend.

And Jason, can we just clarify what percentage of the securities book today is floating?

Yes, it's about a third of the book is floating.

I got it. Makes sense. I wanted to follow-up for my second one just around the expense outlook. 2023 was super noisy, there's a bunch of one-timers, obviously. So just want to clarify a couple of things. So, I guess, the ultimate message is that, 2024 expense growth is expected to be lower than 2023. I think the core expense growth in 2023 was about 5%, so just want to confirm that? And then the core base you're speaking to, is it still kind of $5.1 billion to maybe $5.2 billion in sort of core expense base, off of which we should think about 2024?

So confirm, the 2024 -- the 2023 number we think of is 5%, just a little bit less than that, right at about 4.8%. And we are working from a base in 2023 of 5.1%. And probably worthwhile to invest a minute and just explain, because you're right, there have been a few things. So if you walk the reported [52.84] (ph) and then you take out in the year severance-related charges with two occupancy charges that totaled about 13. There was that client capability write-off we mentioned in second quarter, 26, FDIC Special Assessment 85, and then there is a small equipment credit of $4 million in the third quarter that we mentioned as well. And the severance-related charge in Q2 is $39 million, just to make sure I give you the numbers on everything. And so, let's work with -- that tells us we'd work from a base of 5.1%.

Hey, good morning. Thanks for taking my question. Would love to follow up on that last question actually. So thanks for clarifying the base. That's helpful. Number one, just to confirm, you did mention that I think it would be inclusive of adjusting for the write-off of the client capability. I just want to confirm that. And just to clarify the message on the investing, super clear that you're looking to drive expense growth lower than you saw in 2023, but you also laid out an uplift of 3% from base paying software. So does that represent like a floor to growth or do you have sufficient levers to offset at least some of that?

It's not a floor, but it does give you a sense of what's already in the 2024 base from which we're working. And so, we've got to use productivity to get aggressively at that. Some of our productivity work is already reflected in that, but we've got to do more this year. And I just want -- we wanted to be super transparent in the things that we already know that are in the 2024 increase, so that you guys can predict what that level is.

Okay. And is the write-off of the capability that was in other operating expense part of the adjustments, too? Sorry if I missed that.

Yes.

Hi. Great. Good morning. Thanks for taking my questions. The sequential increase in the noninterest-bearing, that was a positive to see this quarter. Could you just touch on maybe some of the key drivers there? Was this supported by some of the new business activity that you referenced in the prepared remarks? And then, I appreciate the comments on the deposits and the potential for the stability here near term, but I guess focusing on the NIBs, can they stabilize at this level, either in terms of like an absolute dollar basis or as a percentage of the total deposits?

My observation in looking at it is that, it's less percentage driven and more what is that base. And the reason I mention that was, a lot of that NIB, it comes from one of the channels in our institutional business. And it actually performed better than the rest of the institutional business in looking at it over the last few weeks. And so, it just tells me that that client, that sub-client channel behaves on its own. And it looks like that has flattened out somewhat, not necessarily calling it a plateau at this point, but it certainly behaved a little bit better than the rest of the institutional book. And another component is the wealth book which -- that deposit base increased in the quarter, it was not dramatically, but it was nice to see that up on average And, obviously, we saw overall the whole deposit book very flat, but nice to see that the wealth book doing well. Because even though the non-interest bearing is obviously highly attractive economically, the wealth deposits are very attractive as well. Not at zero, but they're very attractive and that component did well on the quarter.

We'll go next to Ryan Kenny with Morgan Stanley.

Hi, good morning. I have a question on capital. So your CET1 ratio of 11.4%, it's well above the regulatory minimum, well above last year's level. And then we got the comment letter from Basel Endgame a couple of days ago, and there's clearly a lot of industry pushback there. Your earnings generation from NII looks a little bit higher than consensus expected. So putting that all together, how should we think about how Northern's approaching buybacks this year and this quarter, is there any room to maybe lean in a little bit there?

Sure. So you're right in the tee-up of the numbers, there's obviously room. We did a fair amount of buybacks in the quarter, a little bit more than we do on average, and we're always looking at that relative to other opportunities we have to invest capital. And so, in the near term, we're thinking about does it make more sense to invest in RWA effectively to say we could grow the loan book more, we could do more in FX, we could do more in sec lending or do we want to reposition the -- take a different repositioning in the securities portfolio. The repositioning to be did this year were all helpful to capital, because in going shorter we -- and out of non-HQLA into HQLA on that, those are all helpful to capital. But you also know how closely we look at peers and we take pride in the capital levels we have. We think it's part of our financial model and our business model and talking to clients and being able to evidence to them how strong the capital base is. And so, there's definitely room, but we also got to have in mind that Basel Endgame, which you referenced briefly, it's still unclear. We did do a comment letter, which you referenced, but it's unclear what the impacts are going to be. We think we're in good position relative to peers, but want to keep an eye on that. But we'll also think about additional stock repurchases as we always do, given alternatives we have.

Okay, great. And can you also update us on your expectations regarding ability and timing to dispose of the Class B visa shares and would that potentially have any impact on capital and buybacks outlook?

Yes, so just for people who don't follow it as closely, we own just over 4 million Visa B shares, and the current exchange rate show that translates to about $1.7 billion. And there's a proposal that it can be voted on next week I think that would enable the B shareholders to monetize half of the holdings. So what are we planning to do? One, at this point, there's nothing to do. The proposal is still outstanding, and we've got to wait and see what the shareholder vote looks like. Even assuming it passes, there are timing restrictions to it. But that said, this is not a strategic asset for Northern Trust. And so, you should read into that. It's not something that we're saying we're going to hold on to beyond what the restrictions would enable us to do. And we're discussing all the options. There's likely going to be a combination of a few tools that we'll take, but early to give details on that at this point.

Great. Thanks. Hey, good morning. If I could just clarify, Jason, a couple things you gave guidance on earlier, just to make sure I heard it right. The incremental NII from the two portfolio security sales is $30 million annualized, and that comparison period is 1Q versus 4Q. Is that correct?

Yes, so you broke up a tiny bit, but I think I'm following where you are, but don't hesitate to tell me if I miss it. So the November repositioning helped in the quarter by, call it, $6 million, but that should be helpful going forward to the tune of -- in the neighborhood of $15 million a quarter. The January repositioning, which we mentioned for the first time a little while ago, that should help in the quarter about 15 -- round number is about $15 million a quarter.

$15 million per quarter, okay. And then on the expense side, maybe just I’m try to get some more clarity on the total expense growth. I think you said comp expense being up $50 million to $55 million in 1Q versus 4Q because of the retirement eligible option. And then employee benefits up $10 million versus 4Q. So correct me if I'm wrong on that. And then just translating that into expense growth through the year. Obviously, there's lots of different levers. But is the idea to try to improve on the 3% expense contribution from that, from a total growth perspective, or should we be thinking of expense growth, say, better than 5%, lower than 5%, but potentially higher than 3%? Can you improve that trust -- expense to trust fee ratio in 2024 from 2023?

Yeah. So a couple things. One, confirm your numbers are right on first quarter and the step up. Remember, both of those are fully seasonal, Brian, so the step up in first quarter just because that's when -- that's the booking of our retirement eligible equity grants. And so that in and of itself is represents the vast majority of that step up and then similarly we've got a higher payroll tax in first quarter, just as we hit the caps on that level. But both of those numbers come back down for second, third, fourth quarter. That said, second quarter, got to build in the base pay adjustments that we referenced, which is that $65 million, that will be second, third, fourth quarter. So all that said, the goal is to do better than roughly 5% we did this year. The 3% was not seen as the -- again, back to, it's not seen as a floor, but also that's a big difference to go from 5% down to 3%. And so we're using the productivity to do everything we can to get materially better than the 5%, but the fact that we're walking in with 3% already in the base is just going to make it difficult. And so, I think it's the -- And the last thing I'll mention is, for us, we're anticipating organic growth. We target -- we have organic growth targets for each of the three businesses. And we want to continue to be a growth company. That is important. And that drives some expenses in addition to expectation of what we're doing from a revenue perspective. And so it's hard to fine tune much to say is it between 3% and 5%. If we're not doing as well from an organic perspective, we're going to be working really hard to say what else do we do to make sure we're doing the right thing and we get positive operating -- fee operating leverage.

That's really great color Mike. And maybe just a quick follow-up on deposit pricing. Jason, you talked about still some pressure on overall deposit cost. Is that lags still on pricing or is that an assumption of a negative mix shift out of NIBs? What's kind of driving further pricing pressure and deposits?

It's lags and we actually in the end fourth quarter made some agreements on pricing that will come into play in first quarter more than they did in fourth quarter and didn't drive deposit volumes higher in fourth quarter, but it is something that as we try to do more fine-tune predictions of what first quarter would look like, it's something that we factored in. We think that cost could be -- cost will be higher. And that's part of the reason why even though we ended it at $501 million and I indicated that December was better than November and October, we think we're still going to be flat to down a little bit in first quarter, largely because of that pricing element. And in general, we do -- our view is that as the Fed does reduce rates, we're going to have client conversations about it. And again, we're not a price setter, but highly committed to making sure our clients leave their deposits here.

Good morning, guys. One more question on expenses. I'm curious how you would approach a hypothetical year where revenue growth comes in a lot better than expected and what that might mean for expense growth? I guess the core question is, what takes precedent, your expense to fee ratio or the absolute level of expense growth this year?

Okay, thanks. And then on NII, I would just love to get your thoughts on the sensitivity there as it relates to different scenarios from the Fed. What's the impact of, say, one or two Fed cuts this year as opposed to, say, six Fed cuts?

Yes, those are the scenarios we're looking at, but I come back to this theme, it's just going to depend on how well we're able to hang on to spread. And there's just been highly variable, and I think our ability to predict it just over the last couple quarters has been really hard. But I feel I feel really good about the volume that stayed in place. And so I think our approach has worked, but it makes -- it's going to make it less predictable. It's the opposite of what we just talked about on the expense side, ironically, where we're saying, we want to be more predictable in the expenses to try and get that expense to trustee ratio where we want it to be. On the deposit side, there's more flexibility and more willingness to follow where the market goes to make sure we're holding onto client assets.

And as I look at just the underlying details of how we did, I think you're leaning more toward the asset servicing business. The net new business for the year was positive. And I'm just thinking year-over-year for the quarter. And asset servicing hit its mark on net new business. The issue with the company is some of the other things happening as we get into transactions and then what we referenced earlier in our clients going through their asset levels declining. But much less of a repricing story relative to prior years and the business is winning. If we just look at their win rate in the market, it is strong. So a lot of this year the impact came from these other dynamics of lower transaction volumes and same number of clients, but less assets.

This does conclude the question-and-answer portion of today's call. I would like to turn the call back over to Jennifer Childe for any closing comments.

Thanks, Ruth. And thanks, everyone for joining us today. We look forward to speaking with you again soon.