Northern Trust Corporation

Good day, everyone, and welcome to the Northern Trust Corporation First Quarter 2020 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to the Director of Investor Relations, Mark Betty, for opening remarks and introductions. Sir, please go ahead.

Thank you, Katie. Good morning, everyone, and welcome to Northern Trust Corporation's First Quarter 2020 Earnings Conference Call. Joining me on our call this morning are Michael Grady, our Chairman and CEO of Jason Tyler, our chief financial officer, and Lauren Alnutt, our controller. Our first quarter earnings press release and financial trends report are both available on our website at northerntrust.com. Also on the website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This April 21st call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website at through May 19th. Northern Trust disclaims any continuing accuracy of the information provided in this call after today. Now for our safe harbor statement. What we say during today's conference call may include forward-looking statements which are Northern Trust's current estimates and expectations of future events or future results. Actual results, of course, could differ materially from those expressed or implied by these statements because the realization of those results is subject to many risks and uncertainties that are difficult to predict. I urge you to read our 2019 Annual Report on Form 10-K and other reports filed with the Securities and Exchange Commission for detailed information about factors that could affect actual results. During today's question and answer session, please limit your initial query to one question and one related follow-up. This will allow us to move through the queue and enable as many people as possible the opportunity to ask questions as time permits. Thank you again for joining us today. Let me turn the call over to Michael Grady. Thank you, Mark.

Let me join Mark in welcoming you to our first quarter 2020 earnings call. Amidst this crisis, I hope you and your families are healthy and well. I also want to acknowledge and thank all the healthcare workers, other first responders, and the entire community of essential workers for their heroic efforts during this pandemic. Inside Northern Trust, we often speak of our four key stakeholders, clients, employees, community, and shareholders. I know we'll devote a lot of this call to discussing the impact of the crisis on shareholders, but I'd like to take a moment to describe our actions and how they relate to the other stakeholders. We've been engaging with our clients more than ever. Despite the pandemic, markets have remained open, and our clients have needed to make investment decisions and complete important transactions. Turbulent times such as these show the importance of a strong capital base and liquidity profile, as well as robust technology and resiliency plans. We've been able to provide support to our clients and the exceptional service they have come to expect from us. We saw global transaction volumes increase 70% in March compared to February and 60% compared to one year ago. We were able to utilize our global operating model to transfer work around the globe to manage peak volumes. During the first quarter, in support of our clients, we saw a deposit growth of over $22 billion and funded loan balances increase by over $6 billion. In a short amount of time, our team also created a solution to provide access to the Paycheck Protection Program, and we began processing applications. Whether it's through video conferencing or phone calls and into boardrooms or living rooms, our clients want the advice and counsel of Northern Trust. The vast majority of our employees, who we call partners, made a significant shift to working away from our offices, with over 90% regularly working remotely. For the critical functions that require a small number of our staff to be in our offices, we are taking extra measures to ensure their safety throughout the duration of the crisis. For certain eligible partners, we are providing supplemental compensation to support them and their families during this difficult time. We are also offering increased flexibility for alternative work options due to mandated school closures and other impacts of the pandemic. The commitment, expertise, and professionalism of our staff has been extraordinary, so I'm pleased we've been able to provide this support. Northern's Trust businesses, and therefore the communities we reach, are truly global, with over 20,000 partners across North America, EMEA, and APAC. We announced philanthropic support to several nonprofit organizations around the world, and created a COVID-19 matching gift program to support the efforts of our partners. Our guiding principles of service, expertise, and integrity have guided our actions over the last several weeks and will continue to focus our efforts as we navigate the difficult environment we all face. Northern Trust has endured crises before, and we are extremely confident in the resiliency of our business and our staff. My sincere appreciation to everyone working so hard throughout this crisis and our sympathies to everyone impacted by this disease. Our annual meeting is taking place later this morning, so I'll have another opportunity to speak to our performance and strategy. But for now, I'll turn the call to Jason to review our results for the quarter and discuss the financial implications of this pandemic.

Well, thank you, Mike. Before I start, I want to take a brief moment to recognize all those affected by this crisis, especially those working on the front lines. Our thoughts are with you, and we hope you and your loved ones remain safe and healthy. I'd also like to express my sincere gratitude to all Northern Trust partners for their continuing hard work, resiliency, and flexibility in these uncertain times. I'm extremely proud to be part of this team that achieves greater for all of our stakeholders, no matter the adversity. Now let's delve into the financial results for the quarter, starting on page three. This morning we reported first quarter net income of $360.6 million. Earnings per share were $1.55, and our return on common equity was 13.4%. As you can see on the bottom of page three, the macroeconomic environment became more challenging during the first quarter. However, recall that a significant portion of our trust fees are based on quarter lag or month lag asset levels, and thus the current quarter's fees do not fully reflect the impact of the decline in equity markets during the quarter. Let's move to page four and review the financial highlights of the first quarter. Year over year, revenue on an FTE basis increased 7%, with non-interest income up 11%, and net interest income down 3%. Expenses increased 4%. The provision for credit losses was $61 million in the quarter, while net income was up 4%. In a sequential comparison, revenue increased 2%, with non-interest income up 5%, and net interest income down 3%. Expenses decreased 1% while net income declined 3%. The provision for credit losses of $61 million during the quarter was primarily due to an increase in the reserve driven by current and projected economic conditions resulting from the ongoing pandemic and the related market and economic impacts, with the largest increase in the commercial and institutional and commercial real estate portfolios. Return on average common equity was 13.4% for the quarter, down from 14% a year ago and 14.8% in the prior quarter. Assets under custody and administration of $10.9 trillion were flat compared to a year ago and were down 10% on a sequential basis. Assets under custody of $8.3 trillion were up 1% compared to a year ago and down 11% sequentially. Assets under management were $1.1 trillion, down 4% on a year-over-year basis and down 9% on a sequential basis. Let's look at the results in greater detail, starting with revenue on page five. First quarter revenue on a fully taxable equivalent basis was $1.6 billion, up 7% compared to last year and up 2% sequentially. Trust, investment, and other servicing fees represent the largest component of our revenue reaching a record $1 billion in the first quarter, up 8% from last year and up 1% sequentially. Foreign exchange trading income was $89 million in the first quarter, up 34% year-over-year and up 38% sequentially. The increase is primarily due to higher client volumes and increased market volatility during the month of March. The remaining components of other non-interest income were $87 million in the first quarter, up 37% compared to a year ago, and up 24% sequentially. Securities commissions and trading income increased 79% compared to a year ago, and 50% sequentially, driven by higher interest rates swap and core brokerage-related revenue. Prior quarter other operating income included a $20.8 million loss relating to the sale of leases. Excluding this prior period loss, the sequential decline was primarily due to lower income associated with supplemental compensation plans and a market value adjustment for a seed capital investment, partially offset by lower visa-related swap expense and the impact of a full quarter run rate of the bank-owned life insurance program. On a year-over-year basis, these categories increased primarily due to the bank-owned life insurance program implemented during 2019 and lower visa swap-related expense. partially offset by the market value adjustment for seed capital investment and lower income relating to supplemental compensation plans. The year-over-year and sequential declines relating to the supplemental compensation plan resulted in a related decrease in staff-related expense within the other operating expense line. And interest income, which I'll discuss in more detail later, was $416 million in the first quarter, down 3% both year-over-year and sequentially. Let's look at the components of our trust investment fees on page six. For our corporate and institutional services business, fees totaled $574 million in the first quarter and were up 7% year over year and up 1% on a sequential basis. Custody and fund administration fees, the largest component of CNIS fees, were $395 million and up 5% year over year and down 1% sequentially. The year over year performance was driven by favorable markets and new business, partially offset by unfavorable currency translation. The sequential decline was primarily driven by unfavorable currency translation, partially offset by favorable markets and new business. Access under custody and administration for CNIS clients were $10.2 trillion at quarter end, flat year-over-year and down 10% sequentially. The year-over-year performance reflected new business, offset by lower market levels and unfavorable currency translation. The sequential performance is driven by lower market levels and unfavorable currency translation, partially offset by new business. Recall that lag market values factor into the quarter's fees, with both quarter lag and month lag markets impacting our CNIS custody and fund administration fees. Investment management fees in CNIS of $121 million in the first quarter were up 16% year-over-year and up 4% sequentially. Both the year-over-year and sequential performance was driven by favorable markets and new business. Access under administration for CNIS clients were $843 billion, down 3% year-over-year and down 8% sequentially. Both the prior year and sequential comparisons were impacted by lower markets and favorable currency translation, partially offset by new business flows. The sequential decline was primarily driven by markets, partially offset by new business, and an increase in period-end securities lending collateral levels. Similar to custody and fund administration fees, note that lagged market values factor into CNIS investment management fees. Securities lending fees were $23 million in the first quarter, up 3% year-over-year and up 4% sequentially. The year-over-year increase was primarily driven by higher volumes, while sequential increase was primarily driven by higher spreads and volumes. Securities lending collateral was $167 billion at quarter end and averaged $171 billion across the quarter. Average collateral levels increased 9% year-over-year and 4% sequentially. Moving to our wealth management business, trust investment and other servicing fees were $429 million in the first quarter. We're up 9% compared to the prior quarter and up 1% sequentially. The year-over-year increase is driven by favorable markets and new business, while favorable markets were also the driver of the sequential growth. Both month lag and quarter lag asset levels impact wealth management fees. Asset center management were $277 billion quarter end, down 6% year-over-year and down 12% sequentially. The decreases were primarily driven by unfavorable markets, partially offset by new business flows. Moving to page seven, net interest income was $416 million in the first quarter and down 3% from the prior year. Earning assets averaged $111 billion in the quarter, flat versus the prior year. Average deposits were $95 billion and were up 4% versus the prior year. The net interest margin was 1.51% in the first quarter and was down 7 basis points from a year ago. The net interest margin decreased primarily due to lower short-term interest rates, primarily offset by a balance sheet makeshift. On a sequential quarter basis, net interest income was also down 3%. Average earning assets increased 3% on a sequential basis, while the net interest margin declined 8% – 8 basis points. Looking at the currency mix of our balance sheet, for the first quarter, U.S. dollar deposits represented 69% of our total average deposits. This was flat to a year ago and up slightly from 68% in the prior quarter. Turning to page 8, expenses were $1.1 billion in the first quarter and were 4% higher than the prior year and 1% lower than the prior quarter. Compensation expense totaled $500 million and was up 4% compared to one year ago and up 8% sequentially. Last year's compensation expense included $10 million relating to severance-related charges. Excluding these charges, the year-over-year growth was mainly driven by higher salary expense, driven by staff growth and base pay adjustments, as well as an accrual for supplemental payment to certain employees in response to the COVID-19 pandemic. The sequential increase is primarily due to higher expenses related to long-term performance-based incentive compensation due to the vesting provisions associated with grants to retirement-eligible employees and the current quarter, as well as the previously mentioned supplemental payment, partially offset by lower cash-based incentive costs. The quarter's compensation included $34 million in expense associated with the retirement eligible staff compared to $30 million in the prior year. Employee benefit expense of $98 million was up 14% from one year ago and 6% sequentially. Both increases were driven by higher retirement plan expenses and payroll taxes. The sequential growth was partially offset by lower medical costs. Outside services of $193 million were up 2% on a year-over-year basis and down 6% sequentially. The year-over-year growth was primarily driven by increased third-party advisory fees and technical service costs. The sequential decrease was due to lower consulting, legal, and technical services. Equipment and software expense of $162 million was up 9% from a year ago and down 2% sequentially. The year-over-year growth was reflected significantly by reflected higher depreciation and amortization and software support costs. Sequentially, the decrease is driven by lower software disposition charges, partially offset by higher depreciation and amortization. Occupancy expense of $51 million decreased 1% from a year ago and was down 11% sequentially. The sequential decline was primarily due to the renegotiation of a lease resulting in a $7 million reduction of a related asset retirement obligation. Other operating expense of $62 million was down 15% from a year ago and down 30% sequentially. The year-over-year decrease is primarily driven by lower staff-related expense, partially offset by increased contributions to the Northern Trust Charitable Foundation. Sequentially, the decrease is primarily driven by lower staff-related and business promotion expenses, partially offset by increased contributions to the charitable foundation. The lower staff-related costs were related to a decline in supplemental compensation plan expenses and resulted in a related decline in other operating income. As we've discussed on previous calls, through our Value for Spend Initiative, which we started in 2017, We've been realigning our expense base with the goal of realizing $250 million in annualized expense run rate savings. With our results this quarter, we surpassed that goal. While we've exceeded our goal of $250 million, our efforts around our value for spend and overall productivity will broadly not cease, and we further embed a culture of sustainable expense management across the company. Turning to page 9, our capital ratios remain strong, with our common equity Tier 1 ratio of 11.7% under the standardized approach and 12.9% under the advanced approach. Our Tier 1 leverage ratio is 8.1% under both the standardized and advanced approaches. In the first quarter, as previously announced, the proceeds from the issuance of Series E preferred stock were used to redeem all outstanding shares of Series C preferred stock. Deferred issuance costs of $11.5 million were recognized upon redemption, which were included in our first quarter results on their preferred dividend line and arriving at net income allocated to common shareholders. During the first quarter of 2020, the Series E preferred stock dividend was approximately $7.6 million, covering the period from November 5th, 2019 through March 31st of 2020. The ongoing Series E dividend will be approximately $4.7 million per quarter, with the Series E dividends still occurring semiannually in the first and third quarters of each year. Also during the first quarter, we declared cash dividends totaling $149 million to common stockholders. On March 16th, we announced temporary suspension of repurchases of common stock under our share repurchase program, consistent with broader industry efforts to mitigate the impact of the COVID-19 pandemic, by maintaining strong capital levels and liquidity in the U.S. financial system. Prior to the suspension, we repurchased 3.2 million shares of common stock at a cost of $297 million. Let me make a few comments just summarizing the quarter as well as comment on some of the headwinds that we're facing as we move through the remainder of 2020. Despite the impact of a mixed global macroeconomic environment, we performed well during the quarter, generating a pre-tax margin of 29.4% and a return on average common equity of 13.4%. Our performance reflects the momentum we carried into 2020, and we were able to generate positive fee operating leverage and positive total operating leverage on a year-over-year basis. Our balanced business model continued to generate organic growth. with each of our client-facing reporting segments of wealth management and CNIS contributing approximately 50% of our earnings. Looking ahead to the remainder of the year, the macroeconomic environment is going to certainly create headwinds for certain revenue lines. First, as it relates to lower expenses, we will, of course, see pressure on our net interest margin and net interest income as we move forward through the year. We're currently anticipating that second quarter net interest income will will decline 7 to 10% on a sequential basis. Next, as I've mentioned in my comments throughout the presentation, it's important to remember that lagged markets impact the calculation of our trust fees. While month lag and quarter lag equity markets were mainly favorable for first quarter, we'll see an impact on our fees going forward. One indication of this is our period end assets under custody administration and assets under management declining sequentially by 10% and 9% respectively. As a reminder, approximately three-quarters of our fees are sensitive to asset levels. Finally, the newly adopted accounting standard for credit losses makes our reserves for credit losses sensitive to changes in the macroeconomic environment. If economic conditions continue to worsen over the course of the year, we can expect to recognize additional provisions. We cannot ignore the macro headwinds pressuring our revenues as we move forward into 2020. We remain laser-focused on managing our expense base and driving further productivity improvement. It's times like these that show the importance of a strong capital base and liquidity profile to support our clients' activities, and we continue to provide our clients with the exceptional service and solution expertise they've come to expect. Thank you again for participating in Northern Trust's first quarter earnings conference call today. Mike, Mark, Lauren, and I are happy to answer any of your questions. Katie, will you please open the line?

Thank you, sir. If you would like to ask a question, please signal by pressing star 1 on your telephone keypad. If you're using a speakerphone, please make sure the mute function is turned off to allow your signal to reach our equipment. Again, please press star 1 to ask a question. We'll pause for just a moment to allow everyone the opportunity to signal for questions. And as a reminder, please limit yourself to one question and one relevant follow-up. Thank you. Our first question will come from Alex Bloesting with Goldman Sachs.

Hey, good morning, everybody. Thanks for taking the question. So I wanted to start with your guys' thoughts around the organic feed growth in the current environment. I think in the past you talked about low to mid-single-digit growth across institutional and wealth businesses, so wondering how the current sales cycle likely being extended, how is that impacting the fee growth outlook from an organic basis? And as a kind of follow-up to that, obviously, importantly, I want to get your thoughts on expenses as well. Again, similarly, you talked about aligning expense growth with organic fee growth, again, sort of call it 3% to 5% range. How low can you guys take that, given the current environment, and any thoughts around 2020 expense growth would be helpful. Thanks.

Sure. Good morning, Alex. I'll start on the first dynamic of organic growth. It was a strong organic growth period, and I think both year over year and then sequentially, it was nice to see we had organic growth both in the CNIS business And at a high level, it was a little over 1% of pure net new business that contributed to the growth in CNIS. And then we also had overall positive growth from an organic perspective in the wealth management side of the business. And you don't see it, but the asset management business on its own also provided some positive organic growth, which is nice to see. A lot of it was driven by very strong movement into cash. I was looking at over the weekend, I think there was over $30 billion in flows overall into that category. And our NIF treasury fund is number one in its peer group and investment performance. And just that set of funds alone has AUM of over $60 billion right now. So in a lot of ways, things are going well. I think it's also important to take a second to think about some of the interactions we've had with our business. And this, I think, feeds into your question about how we should think about this in the longer term. And just take wealth management, for example. I was talking to some of the leaders there and just some interesting notes. One, their call report volume, just activity with clients, has really skyrocketed. You know, over 100% increase in call reports just from our central region just gives a sense of the activity there. We do these webinars to teach clients about and talk more from our experts about what's going on. We typically get about 800 or 900 people show up for those virtually, and they're at record levels now. There's over 3,000 people consistently coming in to that. And then even the marketing material, we track things as granularly as the page views that we get from the marketing material we send out. That averages about 1,200 page views. And over the last several weeks, we've been averaging 6,000 to 10,000. And so I think in the short run, it was interesting to see that we were able to actually close good pieces of new business that was already in the pipeline. I think the very long term... bodes very well for us, given some of the statistics I just threw out, the engagement we've had with clients. I think if there's an area of caution, it's going to be in that midterm pipeline. I think there's just not as few clients that are going to be spinning up new opportunities, whether it's on the CNIS side, they feel the same way, or the wealth side. So I think we're going to close all the business that we can that was already in kind of the one not funded late in the pipeline and And I think the long term looks very good, and we can talk about the more countercyclical dynamics of outsourcing that lead into help on the new business side for CNIS, but the long term feels good. I think the short term, we obviously have to be cautious about. And then on expenses, I'll start, but maybe Mike or Mark will join in. As we think about that, we want to bucket it in a few different categories. And probably the best way to think about it might even be just to look through, if you go to page seven of the earnings release, that outlines expenses pretty well and in more detail. And first of all, we had a long list of different paths we could take on this from just saying let's let expenses play through to to let's go ahead and do a full replan of expenses. And we took the latter approach. We took a very aggressive, detailed approach to unwrapping our expenses based on what we knew the environment was going to look like in the short run, at least. And so we unbucketed things the way we traditionally do, inflation, productivity, business growth, and investments. And we've been very aggressive at outlining where we can address expenses. Now, if you look at page seven, the areas that are more related to client activity or markets have to do with outside services and equipment and software. And, you know, super high level, roughly, you get kind of 30 to 40% of those have that type, they have some correlation to markets and new business. Those are the areas we've been laser focused on. But even on IT investment, We're just re-rationalizing everything that we've committed to do.

Yeah, this is Mike. I would just add to what Jason said, that there are near-term actions that we've already taken and can continue to take, which definitely looks to bring down the expense run rate from where we were in the fourth quarter and then where we are now. And then just given that the world has changed and will change, there are new opportunities for productivity over the long term. I mean, if you think about real estate costs and other costs that come with having everybody in facilities versus now, as I mentioned earlier, you know, we're roughly 90% people working from home. It's not going to stay at that level, but I also don't think the operating model will be the same, you know, once we get through this.

Great, great. That's helpful. And I don't want to put words in your guys' mouths, maybe just to clarify. I guess if in the past you talked about expense growth aligning with organic fee growth, and in the near term, organic fee growth sounds like it's obviously going to moderate pretty considerably. So should we think about the total expense base being flattish year over year, or is there a way to bring that down, just hoping to get some more granularity? Yeah.

So you are – Correct in characterizing the way that we have talked about the organic expense growth rate for expenses aligning with the fee growth. And so, yes, as that comes down, the fee growth comes down, the organic expense growth rate comes down as well. And then beyond that, as you're saying, Alex, yes, we're also saying outside of the organic part, just looking at total expenses, we're trying to bring those down. and I wouldn't put a specific stake in the ground as to, you know, whether that's, you know, flat or up or down because, again, some of those expenses are affected by the environment, but that's what we're trying to drive to. So it is, as Jason said, it's a replan. There's no part of this that says, you know, we're just plowing through with the same plan that we had, you know, at the beginning of the year.

Thank you. Our next question comes from Glenn Skor with Evercore.

Hi, thanks very much. I wonder if I could ask a question. I could use them both on this, on the provision and the loan book. So if you could talk generically what type of economic backdrop you wrote that provision to, because the world was changing a lot right around quarter end. And then if we could talk about the loan book that produced most of that I'm assuming it's almost all in CNI and CRE so maybe you could talk about you know what in say office retail and construction where that is derived from you know how much of it is clients that are across the firm versus you know some things that are syndicated I really appreciate we normally don't have much discussion about your loan book thanks

Sure, Glenn. Well, let me just start with some of the assumptions that went into the forecast. I think like a lot of firms, the SEC is very specific in saying you've got to use your end of period date, use your forecast at that point to drive your increase or decrease in reserves. And so we obviously followed that. If you look right at the end of the period, We were looking at unemployment of 10%. We had a peak to trough change in GDP of just over 6%. And then, as you likely know, that's not it. It's not like we have those assumptions and then it spits out the $61 million provision number. We have a variety, dozens of factors that go from there. and from the number of forecasts that we use, the weights and the priorities of those forecasts, the downgrade assumptions of the underlying credits, which drive the expected loss assumptions. And so you go through a very rigorous governance process to take the output of the forecast and the models to drive to a final number for provision. Now, after we did that, like all other financial firms, We went through a new forecasting period. The economic inputs in the market were changing dramatically. We're watching that closely. So within the next couple of weeks, we went through a forecast that went to an unemployment peak of 14.5% and a peak to trough GDP change of 7.5%. And so that gives an indication that directionally, the provision number, if we were to go through that same governance process, would have yielded a higher performance provision number at that point. That said, we didn't go through that same finalization of the governance process after that second forecast was run. We could do that every day. It's a very rigorous process, but we followed the letter of what the SEC and what the accounting guidelines provide us to do. And so we will continue to do those updates, as we always do with our forecasting process, and we'll have that rigorous process added to it as we get into the next reporting period. And then if we want to touch on the loan book itself, why don't we go through some headlines on it. I'll start, and then maybe Mark can jump in. I think the key is there's no dramatic difference between what we've told you before about the loan portfolio and what it is today. There's a lot of other even qualitative assumptions that go into the number that drives the CECL accounting provision number, but why don't we provide a little bit more information. Mark, I'll turn it over to you for that.

Yeah, looking at the entire loan portfolio, over 20% of the loans are to private clients secured by marketable securities primarily, and those are primarily custody at Northern Trust. You do have About 20% of the portfolio, which is residential real estate, again, the nature of those obligors is somewhat unique. I mean, for example, over 75% of those would have FICO scores of 740 or higher. When you start to look at the commercial and the commercial real estate, the commercial is predominantly investment grade. And on the commercial real estate side, you know, the lending is too – investors as opposed to developers. And over 95% of those commercial real estate loans have personal guarantees as well. So pretty high quality when we look at the C&I portfolio as far as where the high impact or low impacts might be from the current situation that we find ourselves in. We would say we're very much predominantly in what we would hope is in the lower impact when we look at the kind of industry segmentation there.

Just one tiny clarification. The GDP numbers that you mentioned, is that full year 20 or second quarter?

Oh, no, that's for the full year. That would be the peak to trough change for the full year. So at a high level, The assumption that we used had very sharp second quarter decline and then a relatively strong recovery, but not to the current levels of GDP.

Thank you. Our next question comes from Mike Carrier with Bank of America.

Good morning, and thanks for taking the questions. First, can you provide a bit more color on the net interest income outlook, particularly given the rise in deposits and expectations in this backdrop with a lot of liquidity out there? And then for the NIM, just how you're thinking about the portfolio and reinvestment rates?

Sure. Thanks, Mike. I'll start. Well, first of all, the more time we spend around NII, I think what jumps out to me is that the key is actually less the size of the balance sheet, which is driven so much by the deposit growth. It has much more to do with what's happening with loan volume. And if you think about it, the size of the balance sheet and the size of average earning assets is going to be dominated by client deposits coming on. In a different interest rate environment, that's going to have an impact on NII. But in the short run, you think about it on an incremental basis, we're not investing those deposits long, and we're not investing them with credit risk either. And so the dynamic there is that effectively you're bringing the sizes driven by deposits that are going to be reinvested a lot in IOER at 10 basis points, and maybe something somewhat different than that, but not dramatically. The things that are going to drive NII more, it's going to be really two things. One, the volume of loans. And then secondly, we've talked about this before, but the spread of one-month LIBOR to the bottom end of Fed funds or IOER, very important. It really gives you a sense of the NII impact of a lot of the earning assets and how those are going to behave and contribute to NII. And so those are really the big factors. And so I mention that because I think it's just important to decouple and not try and predict NII based on where that 151 in NIM is going to go. I think you have to have more of a bottoms-up approach of thinking about particularly loans and then what is LIBOR going to do. LIBOR has been coming down a couple basis points a day effectively and and where you think that the trajectory there is going to go is a very important factor.

Okay, that's helpful. And then just as a quick follow-up, can you help us just in how we should be thinking about B waivers, you know, ahead in a 08 backdrop?

Yeah, we, you know, a lot of the information is out there. We'll help track that a little bit. But as we sit today... none of the large funds are in a position where their yields are below their fee rates. And if we look out on that a little bit, you guys can see as much as we can. Without a real contrarian approach, you don't see that changing, at least in the next several weeks or so. Now, that said, I mentioned early in the opening that our NIF treasury fund at $60 billion to $70 billion – You get at 15 to 20 basis points in fees. If we fall below those rates by even five basis points, you're talking about annual run rate, just from a math perspective, of potentially $30 million. And we're not there yet, but if we were to try and point you to something to track in between the time that we're able to talk publicly, those would be the line items to look at.

Thank you. Our next question comes from Brian Bedell with Doce Bank.

Great. Thanks very much for taking my questions. Maybe just staying with the balance sheet for a minute on that LIBOR to IOER spread. I guess down to 7% to 10% down, is that considering current LIBOR, one-month LIBOR rates, or are you factoring in LIBOR to compress further with that. And if you could just remind us again on the loan repricing mechanism, I think it's three-quarters of loans repriced quarterly to one-month LIBOR. Would the rest lag for one year, if you could just remind us on that?

Sure. So just to start with the end, it's actually a little higher than that. It's about 80% of the loan book is actually floating at this point, and that's tied down vary mostly to LIBOR. And then to what our assumptions are, the down 7% to 10% number we provided is reflective of a tightening of the spread between LIBOR and IOER. And so we've looked at that and continue to think that that's going to compress a decent amount. On a spot basis, I haven't looked at it this morning, but last week it was kind of that LIBOR at kind of 70, 72 basis points against an IOER at 10, and we think that could continue to narrow a fair amount. If you think about where LIBOR was just a couple weeks ago, it's significantly higher than that, and so we certainly feel like that's got to be part of any projection. Okay. Okay.

and deposit levels just in April versus the period end in the 7% to 10% guidance?

Down. You'll see at the last page of the press release even just where the balance sheet ended at, you know, $160 billion or so. And, again, that's all – the size of the balance sheet is completely driven by the size of client deposits. And there were significant increases throughout the quarter. And frankly, there were increases, significant increases, and we ended not at where it peaked. And so the balance sheet has had very strong growth. It's all about client activity. As clients de-risked and came out of larger equity positions or other fixed income positions, they wanted balance sheets that they were comfortable with. And they were comfortable with ours and we wanted to be there for them. And since then, we've had deposit levels come down significantly from those peaks. And I'll tell you, they've been more in kind of the 140 to 145 range. And in that type of area, over the beginning of the second quarter. And that's still elevated relative to where we experienced historically and at peaks or at the end of the first quarter.

Thank you. Our next question comes from Ken Houston with Jefferies.

Hi, thanks. Good morning. On the balance sheet, Jason, can you talk through where the floating fixed mixes of the balance sheet right now, what the duration of the portfolio is, and just how do you decide, based on your prior response about the ins and outs of deposits, where you're going with reinvestment yields so much lower in terms of, you know, the asset side of earning assets distribution? Thanks.

Yes, thank you, Ken. And, yeah, we're reinvesting short. is the quick answer to the question. And, you know, we don't feel that the potential need from clients to have very spiky, aggressive needs and desires to be on the balance sheet is necessarily over. And so we want to make sure we've got plenty of dry powder and plenty of capacity for them on both the loans and deposit side. And so... We're taking a short-term approach of being there for our clients. Now, our duration, I think at the beginning of last year of 19, probably it was around 1.1. We had stepped that out. We told the investment community we were going to step it out. We'd gotten all the way out to about two. And since then, very recently, as we're reinvesting maturing securities, that'll come in a little bit as we position the portfolio to maintain maximum capacity. That's not reflective of a long-term strategy, but it is reflective of our desire to be there for clients in the short run.

And could the fixed floating mix, do you have that available?

Yeah, Mark could answer.

Yeah, the split between the shorter securities book and the longer. It's been running closer to 50-50 historically. I think more recently the longer book was a little larger. And then, you know, as Jason said, as we reinvest, depending on where those reinvestments go, that can shift a little bit. But in balance, a little bit tilted toward the longer side is where it was on average during the quarter.

Yeah. And the funding side we think of is more 50-50, and we try and stay matched on that reflectively on the reinvestment side. I think as we continue to go shorter in the near term, that's going to lean a little bit more short. But in the long run, it's about kind of maintaining the hedge.

Thank you. Our next question comes from Mike Mayo with Wells Fargo.

Hi, just my question was answered, but just one follow-up. You said 90% of people are working from home. Can you elaborate more on what sort of more permanent business model change that might lead to?

Mike, this is Mike. In the way that we've thought about the operating model over time, It's never been one that we thought in a stabilized way that we would be at 90% working outside of facilities. Frankly, what we've learned through this crisis is that we can meet client needs and be able to operate the business, execute the business, even at that high level of remote working. Having said that, this is not the level that we want to sustain. We'll have to be you know, careful as we have people returned to the office. That'll happen in a phased approach. But frankly, you know, longer term, as I mentioned, I think that there are opportunities because if you even went beyond just the ability to serve our clients and think about efficiency, we may have lost some efficiency during this time period, but frankly, it's also I would say demonstrated that there are inefficiencies in having everybody come in and out of the facilities around the globe, and that there is certain work that is easier to have our partners, our employees, do remotely. Or even if it's not completely remotely, do they come into a facility for a portion of the week, things like that. And That also aligns with some of the things we've been doing over time about our workspaces. As you would expect, it's not all about everybody having an office or even a cubicle. It's more about open spaces and flexible workspaces and things like that. And that fits in with not having everybody reporting into the office at the same time. We don't have the complete long-term operating model at this point. But, again, I don't believe it will go back to the way it was. And I think, frankly, it will present opportunities for both greater efficiency and, I think, for our employees, additional satisfaction on their overall work life.

And as it relates to customers, I mean, you see schools going online. You're seeing Zoom meetings. You're seeing telemedicine. On the other hand, your customers are at the very high end, and they probably want face-to-face service, but what's your flexibility there?

Yeah, without a doubt. And as you point out, you know, we have a high engagement model in wealth management, and yet if someone thought it was all about the facilities, then we would have been going the opposite direction for the last several years, right, in the sense of, you know, we actually have fewer people offices now for wealth management than we did five years ago, ten years ago, and that's because that engagement at the higher level often happens at the client's office, at the client's home, and also through technology, through using video conferencing and just the ability for clients to interact directly with their account online, on their phone, etc., So it's a multifaceted engagement model and one that, again, we think we can differentiate ourselves in this. Jason talked about some of the calling statistics. If you talk to our partners in wealth management, as we said, they've been more engaged over this time period than the three months, let's say, prior to it. A lot of that because of all the activity, but also they've used different ways to do it. So we look forward to when we can meet more with clients, but that doesn't necessarily mean it has to happen in an office.

Thank you. Our next question comes from Stephen Chubak with Wolf Research.

Hi, good morning. So you noted earlier in a question relating to credit that you have lower exposure to the higher risk industry categories of Given some of the stress in energy markets, I was hoping you could speak to any direct exposure to the energy sector, maybe what specific energy categories in particular, such as EMP, midstream, et cetera.

Yeah. So, at a high level, the exposure to energy is very, very low. And, you know, a lot of our – we've got a lot of clients that have garnered their wealth from the industry, but our lending exposure specifically to oil and gas is very, very low.

Okay, and just one follow-up from me, Jason. You gave lots of detail on deposits, just given the significant growth, how the bulk of that's being deployed into IOER. If I look at the balance sheet during the prior three QE cycles, Now, you had a lot of QE-driven deposit growth. A lot of those deposits actually stayed on the balance sheet. And your approach was pretty balanced in terms of how much was deployed into securities versus IOER. I'm just wondering, why would things play out differently this time? Maybe just how you're thinking about the mix where for every incremental deposit, how much of that should we assume goes into IOER or versus securities that admittedly are going to be short-dated to IOER? ensure that you have greater flexibility from a liquidity standpoint?

Well, you know, frankly, this is about, you know, trying to ensure we're there for clients in the long run. And we could make a, you know, short-term call saying, you know, let's extend a little bit. And even if we miss the yield curve a little, you know, we don't have stories from our clients where we weren't there for them. We've We have been able to do a lot. We've got ample room from a tier one leverage perspective, from liquidity perspectives. But we talk all the time about our balance sheet being there for clients. And so we want to live up to that and not fall to temptation of trying to use the deposits and go very long. Now, you're absolutely right that there is an element of these deposits that's going to stick around a while. And That will enable us, particularly the wealth deposits are very valuable. Once those season and are here, it enables us to extend more and invest those more, whether it's in loans or non-high-quality liquid assets. And that creates a lot of value for us. We just want to be patient and make sure that we don't do that too early and But some of the growth that we've had on the deposit side over the last year even, not just the last month and a half, but over the last year, it reflects a higher base level of deposits and a lot of it on the wealth side, which is very, very valuable.

Thank you. Our next question comes from Brennan Hawkins with UBS.

Good morning. Thanks for taking the question. First question is a follow-up on the expenses. So you talked about some of the actions taken. You helped us understand the, you know, the pieces that were subject to volumes. And when I take a look at the midpoint of that, I think you said it was outside services and equipment and software, 30 to 40 percent. So if you take the midpoint, that's about 10 percent of your annual expenses. Does that mean that things outside of that bucket of expenses you're going to be able to calibrate and that 10% we should grow maybe at an elevated rate given some of the things that are going on. Can you help us think about what at least logically might come into play when we try to calibrate how to forecast your expense growth for the year?

Yeah, sure. So if we come back to that framework, that page, I'll give you a little bit more of how I think about the subcategories in there. So the outside services and some of the headlines, some of these things are going to be mixed. Some will be able to moderate lower and some are going to have more activity as we've invested to make sure that we've got good operational resiliency. And so within outside services, for example, a lot of that is consulting and legal costs. Well, On the consulting side, there are going to be projects that we had planned to do. We went through our original planning process that don't necessarily chin the bar at this point or that we're just going to delay for a period of time or that we're going to do with a reduced scope. And so those are the types of conversations we have there. On legal, we actually... hinted very quickly, I think, in the script that we've had some benefits, some things go our way on some legal matters, and so that's part of the benefit that we've had in there. If you think about equipment and software, it's an interesting line item because even within there, there are items that will go both ways. We've also invested more heavily in infrastructure there, but at the same time, that's where there are some capital IT projects that we might not do. And then there's also an overlay on both of these where we have to think about what's related to the core business, either from an assets perspective or just client activity. Things like market data, third-party advisory fees, subsidy, brokerage clearing. Those are some of those line items that will add up to that kind of roughly 30% to 40% number that we're thinking about. And then in occupancy, just to refresh your memory on some of the things we've talked about, we had already been in late stages of some larger transitions and investments. And we talked about the fact that in the short run, we might have some overlap in rent and investment. And we think that's going to peak around second quarter. And then we should get the benefit of that more in the second half of the year.

Okay. That helps. Thank you. And when we think about, I think you mentioned the legal benefits that you've been receiving in some of these lines. Could you help us maybe calibrate how much that helped 1Q if we should think about any of that? I would think legal benefits are somewhat episodic, but is that the right way to think about it? Or is there some sustainability to those benefits? I mean any noise calibration would also be helpful. Thanks.

At Brandon, this is Mark. I mean, I would start with with the outside services category. You do get consulting and legal as two expenses that I would say will fluctuate based on engagements. So and and when you look at. In general, how much they make up of the category, it's actually a fairly small percentage. It's just that they can be volatile from quarter to quarter, They might make up 15% to 20% of the expenses, if even that of the category. But they do, based on timing of engagements, they will go favorable or they might pop up in a given quarter. I would say this quarter was one where the engagements were lower and there was some benefit in the expense that we realized. But I don't know that I would necessarily portray that as a trend. But contractor expenses and things like that that go into things like consulting certainly That's something that can be an area that we can focus on managing.

Thank you. Our next question comes from Brian Klinhazel with KBW.

Okay. Thanks for taking my questions. I hear what you're saying about the NII being down in the second quarter, but how do you think about it then after the second quarter? Is there a period of time that the liabilities will catch up on the repricing side and kind of how we think about deposit betas moving forward?

Well, I think there's two competing factors there. One is our desire in the short run to make sure that we're maximizing loan capacity effectively for our clients. But in the longer run, this base of business, this base of deposits that's more core, we'll be able to invest in a better way. The counter to that is that the duration that we built in the portfolio will start to dissipate. And so the more we're reinvesting of the portfolio that we had coming into this year, the more we're going to experience the impact of lower nominal rates. And so even if we're taking... longer duration into even if we're extending the portfolio from a reinvestment perspective, we'll be doing so within a lower interest rate environment. And so those competing factors will operate, and I think it's up to everybody to have their own determinations of what they think the interest rate environment is going to look like in the intermediate term.

And then just a second question on the custody and fund admin fees. Is there any way to tease out what the pickup and activity meant for fees in the quarter, like comparing fourth quarter to first quarter? I know some clients are priced based on activity levels.

Thanks. Yeah. Brian, it's Mark. So I would say that when you look at the sequential performance for custody and fund services, there was a There was some market benefit. Again, there's month lag and quarter lag fees. There are more month lag than quarter lag, and actually the IFA local was slightly negative on a month lag sequential basis. So there was a little bit of market pickup, but there was also, to Jason's point earlier about, you know, the 1% sequential kind of organic, 1-ish percent organic growth. We usually look at organic on year-over-year, but sequentially that's that's probably in the right range, a little more than that. There was a drag from currencies. So that's kind of, those are the largest factors. There's also some other non-asset level fees that were a little bit down sequentially, things like account level fees and things like that. But, you know, so overall kind of balanced out to Flattish, I would say.

Thank you. Once again, please press star 1 now if you would like to ask a question. Our next question comes from Brian Bedell with Doce Bank.

Great. Thanks for taking my follow-up. I just wanted to just go over that, the pricing on the custody business and the wealth management business. I know the mix has changed over time because you've been servicing more people on the administrative basis, particularly in alternatives, and that's created a little bit more of an averaging mix than it used to be historically. But if you could just review within the CINS, um, asset servicing business, what portion of that book is priced on a quarter end lag versus more of a, uh, you know, an averaging basis and then just same within wealth management, what portion of that is priced on that one month lag? I think the custody part of that, that you don't manage in wealth management, I think that's on a prior quarter lag, if I'm not mistaken. Maybe if you're able to just review that price missing.

Yeah, Brian, this is Mark. So, yeah, it's pretty similar to what we've said before. So with custody and fund administration, first, and this is in CNIS, there's about 35 to 40, call it 40% of fees that are not asset value sensitive. So that's the first part. of the fees that are asset value sensitive, so the remaining 60%, about three quarters of those are month lag, and a quarter of them are quarter lag, which is similar to what we would have updated a year ago. I think last time we had a change in markets when we gave that update. And then remember, as far as the asset sensitive, it's not all equity exposure, because we have an allocation across multiple asset classes. When you get to the Wealth management side, I would probably divide it between the regions and the global family office. The global family office business, you're right, that is probably more leaned toward the quarter lag. It's similar to the asset servicing business in CNIS. And there's also about a quarter of those fees that aren't asset sensitive, more like what you see on the asset servicing side of CNIS. And the regions, and I would combine the regions together, then you're looking at about three quarters or more of those fees being month lag. So hopefully that gives you an idea. Not a significant change though from what we've said before there.

Okay. Yeah, that's perfect. And I just missed the comment on the GDP assumption that you had for the credit provisions. If you could just reiterate that.

Sure. The baseline that we went with for the March 31st for the reporting cycle had peaked a trough down a little over 6%, 6.1%. And then the update subsequent to that is it down 7.5%. Thank you.

Our next question comes from Betsy Grasick with Morgan Stanley. Hi, good morning.

Good morning, Betsy.

I had two questions. One, just on the comments that you made earlier in the call around the medium-term caution in the pipeline, could you just give us a sense as to the drivers of that and how long you think that – well, what your view of medium-term is, and then maybe you could give us a sense as to – you know, this is really just a push-out, not an evaporation. So maybe you could speak to, you know, how that comes back into your run rate as things open up.

Sure. Betsy, it's Mike. I'll add on to what Jason said earlier. So if you think about the flow of new business, there's business that we've won, and it's a matter of transitioning that business on. And one of the things that – again, I want to give credit to our team on is the fact that even in the month of March, with everything that happened, we were able to transition the majority of the business that was scheduled to be transitioned. So in that sense, that's why we say, you know, right now, you know, that will look good. Having said that, there are new mandates that were to transition in April, for example, or May or June. that it's not only that we're in, you know, I'll call it the work from home mode, but that the clients are as well. And so they've said, let's move our transition back further. So they're deferred transitions. So when Jason talked about in the medium term, that would be new business that would come on, for example, in the second or the third quarter that now has been moved back. And then if you then also think about what's happening with the client base, You know, certainly winning new clients is new business for us, but it's also the flow activity that they have, whether that's an institutional client and what they're doing with their funds. You know, are they more in a spending mode, if you will, utilizing mode, if they're a sovereign wealth fund that's being impacted by the environment, or if they're an asset manager, are they in a part of the market that is, you know, a net gainer of flows or a net outflow. And that, of course, then will impact us as well. And then the last piece is just, well, what about new business activity where you're in the process of winning? Yes, there's some slowdown in, I would say, mandate-type decisions, but also with a lot of activity like this, you know, we do see plenty of our clients that are saying, you know, we've been talking about outsourcing for some time period, whether that's the whole middle office or that's trading. You know what? Now that we've gone through this time period, we can see that you're in a better position to do that for us than for us to do it on our own. So let's continue that dialogue and then we can figure out when we'll decide to do it and hopefully do it with us as well. And so that happens. That's why we say longer term, we see a lot of opportunities, but that's not going to impact the third or fourth quarter of this year.

Right. So the medium term and the pushout of the pipeline install is really a function of when you can get back into clients' offices, which is a little bit TBD, but it's a pushout, not an evaporation.

Correct.

And then could you speak a little bit to how you're thinking about the buybacks? I know that you stopped them, but you obviously have a significant amount of capital. I'm just wondering how you're thinking about what the triggers will be for you to restart that.

It's Mike again. So with regard to capital management and specifically share repurchases, I've As you know, there's been a tremendous amount of attention and rigor around capital management going back to the financial crisis. So in that sense, I would say we feel very good about the process around capital management and how we think about capital actions and the stress testing that we do, et cetera. And the reality is that now we're in an actual stress situation. And so it is an opportunity to be able to demonstrate that we can execute then on our capital actions the way that we thought of when we were going through various stress scenarios. So being able to pull the lever on share repurchase like we did and say tremendous amount of uncertainty, we can stop that very easily. That's the benefit of share repurchases. And we've said, you know, for the foreseeable future. And that's just because, you know, the environment can change. And there are many factors that go into it, as you know. You know, but looking at our capital levels, looking at the profitability levels, the stress testing results with the Fed, you know, all of that plays into the board's decision on how they think about capital action. So just as it was easy, I would say, to pull the lever to stop share repurchases, You know, technically it's very easy to push the lever the other direction. It's more just being able to assess the environment and the outlook at the time to be able to determine when that's appropriate.

Thank you. Our next question comes from Gerard Cassidy with RBC.

Thank you. Good morning. I'd like to follow up on the credit comments. Northern Trust is obviously very well regarded when it comes to credit. You guys have done a phenomenal job in the last 20 years. It was interesting, in 2001, there was exposure to Enron, which surprised everybody that Northern would have that kind of credit. And what we discovered was, as part of the employment benefits processing that you did for Enron, you were asked to join the Revolva line, which they did at the time. Are there any of those outside situations today that we just wouldn't expect Northern to have accredited exposure. I'm not asking for specific names, but just to XYZ companies like, wow, you know, how did that happen? Is there any of that on the books today versus what it was in 01?

Well, I appreciate the historical perspective on that. Going back to 2001, and I would say as far as the nature of how we think about credit, it's still very similar. It's aligned with our overall business and with holistic relationships. So that has not changed. And specifically to clients where we are the custodian for their pension plan, we often then are participating in their credit facilities. Now when you look at that portfolio of companies, you know, it still goes through a very rigorous credit process, and so it's a very high-quality set of companies as well, and high-quality set of credits. You know, there's no way that, you know, we can necessarily predict, you know, which sectors are going to be impacted by a particular stress scenario, and so we wouldn't make the type of statement to say, you know, we have no exposures to any sectors that are troubled right now. Certainly we do, but all of that we try to manage the size of the exposures for that. You've just identified one area which is on the corporate side. Certainly we work with asset managers, so we're providing credit to the different types of asset managers. And then on the wealth side, you know, the nature of where wealth is developed. And so that can either be, you know, the companies that are owned by families, but also, you know, the individual credit needs. As Mark mentioned, about 20% of our portfolio overall is, you know, basically, you know, margin lending. It's collateralized by their investment portfolio. And so that would reflect, you know, the nature of the credit needs for that part of the client base.

Mike, thank you very much. I appreciate it. Sure.

Thank you. Our next question comes from Brendan Hawkins with UBS.

Hey, thanks for taking my follow-ups. Just quick on fee waivers. Could you give us a breakdown of your money fund AUM mix in between Prime, Govie, and Muni?

Not sure I have it. as handy. Why don't we... Yeah, we can follow up with you.

I mean... Because it's publicly available. Yeah, a lot of it will be public on the Northern Funds, Northern Institutional Funds website. But, you know, we could follow up with that, Brennan.

Thank you. Our next question comes from Steven Chubak with Wolf Research.

Hi. Thanks for accommodating the follow-up. I just wanted to make sure it's a quick modeling question. The other income line, there was a lot of noise this quarter. As we think about the right jumping off point for 2Q, you know, given with some of the bully tailwinds, how should we be thinking about, you know, the appropriate runway beginning in the second quarter?

Sure. Mark?

Yeah, Stephen, I can try to take that. So it is a hard one because there is a lot that moves around within that category, I guess. One way that I've kind of talked about, I think even on the last call we kind of talked about it, certainly you have BOLI that has come in incrementally in each of the last four quarters, with this quarter being about $13 million. So if you took BOLI out as well as some of the things that we've had, like last quarter we had a lease loss of $20.8 million, if you adjust taking BOLI out of the last four quarters and adjust for the things we've called out, and you kind of did the math, you're probably looking at an average run rate of call it 33, 34 million. And then in theory, you could then say, okay, well, let me add the full run rate of bully in and add 13 million to that. So maybe that gets you to the 45, you know, 47 range. I would just caution though, it is a very, there is volatility in that line. So it's a hard one. There's things like currency hedging that flows through that. that line. You know, we've talked about some of the things that this quarter, some of the marks might flow through that line. The visa-related income expense type of swap marks flow through that line as well. So it certainly does move around, but if you looked at it over a longer period, you could use that potentially as kind of an average run rate.

Thank you.

Great. And really quick, I'm going to say mark a follow up call because I do have the AUM breakout. Okay. So cash AUM at about $235 billion at period end, fixed income, about 150 billion. And I'm going to lump index and active equity at about 425. and then call the rest other and leave it there.

Thank you, ladies and gentlemen. This concludes today's Q&A and teleconference. Thank you for joining us. You may now disconnect.