Northern Trust Corporation

Good day, everyone, and welcome to the Northern Trust Corporation's second quarter 2020 earnings conference call. Today's call is being recorded. At this time, I'd like to turn the call over to the Director of Investor Relations, Mark Betty, for opening remarks and introductions. Please go ahead.

Thank you, Jennifer. Good morning, everyone, and welcome to Northern Trust Corporation's second 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, Lauren Allnut, our controller, and Kelly Lernaghan from our investor relations team. Our second quarter earnings press release and financial trends report are both available on our website at northerntrust.com. Also on our website, you will find our quarterly earnings review presentation, which we will use to guide today's conference call. This July 22nd call is being webcast live on northerntrust.com. The only authorized rebroadcast of this call is the replay that will be available on our website through August 19th. Northern Trust disclaims any continuing accuracy of the information provided in the 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 second quarter 2020 earnings call. As the current public health crisis continues, I hope you and your families are healthy and well, and I offer my condolences to all who have suffered a personal loss. At Northern Trust, we've remained focused on safeguarding our employees, serving our clients, and supporting our communities during these unprecedented times. We continue to operate in what we call resiliency mode, which means we are focused on providing continuity of service for our clients while over 90% of our employees are working remotely. Although we have developed plans to position ourselves to return to our offices when conditions permit, We will only do so in a particular geography when we are comfortable and confident in our ability to ensure a safe environment for all of our employees and clients. As a result, we expect to remain in resiliency mode for some time to come. In this operating environment, we have adapted how we serve and communicate with our clients, as well as how we prospect for new clients. In each of our businesses, this has resulted in engaging with clients and prospects more than ever and provided an opportunity for us to deepen our relationships. In the second quarter, our asset management business won several new mandates across different products and strategies, including receiving significant new inflows into our global money market fund complex, which we've strategically positioned over time. In wealth management, we launched a new Navigate to Now digital marketing campaign, which is showing early promise, and introduced the Northern Trust Institute, a research center with 175 faculty covering 34 specialty areas designed to harness our expertise and experience and elevate our advice by bringing predictive insights to our clients. In asset servicing, we experienced a modest deferral in implementations and new fund launches in the quarter. However, new business continues to be healthy as prospects become more comfortable conducting searches and due diligence virtually in the current environment. As Jason will discuss, the low interest rate environment will continue to create meaningful headwinds and pressure our financial performance. Through this environment, we will stay focused on our mission of being our client's most trusted financial partner and on generating organic growth and gains in productivity. I feel it's also important to note that at Northern Trust, we have always been mindful that we have a duty to serve our communities as well. Recent attention to the civil, social, and economic inequities black Americans face every day has provided us with an opportunity to reflect further on this service and the role we play to address inequity in our communities. Toward this end, we have committed $20 million over the next five years to reduce the economic opportunity gap. This opportunity gap encompasses all the obstacles created by race, ethnicity, gender, environmental, and socioeconomic status that too often keep people from achieving their full potential. Our goal is to help shrink this gap by providing increased access to essential human needs, food, housing, healthcare, and education, so that each person may grow and thrive personally, professionally, and financially. Finally, I want to express my sincere appreciation for our staff, whose commitment, excellence, and professionalism throughout these extraordinary times has been exceptional. Now, let me turn the call to Jason to review our financial results for the quarter.

Thank you, Mike. Before I start, I'd also like to take a brief moment to recognize all those affected by this ongoing 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. The health crisis and cultural issues we're facing evoke both deep sadness, but also hope and optimism of what we can be. I'd also like to express sincere gratitude to all the 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 dive into the financial results for the quarter starting on page two. This morning we reported second quarter net income of $313 million. Earnings per share were $1.46 per share and our return on average common equity was 12.2%. As you can see on the bottom of page two, the macroeconomic environment was mixed during the quarter. While equity markets performed well during the quarter, 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 were unfavorably impacted by the lagged market performance. Interest rates have, of course, declined significantly, with one-month and three-month LIBOR rates down sequentially as well as versus the prior year. Let's move to page three and review the financial highlights of the second quarter. Year over year, revenue on an FTE basis was flat, with non-interest income up 4% and net interest income down 11%. Expenses increased 3%. The provision for credit losses was $66 million in the current quarter. Net income was down 20%. In a sequential comparison, revenue declined 5%, with non-interest income down 4% and net interest income down 9%. Expenses decreased 3%. that income declined 13%. The provision for credit losses of $66 million during the quarter was primarily due to an increase in the reserve evaluated on a collective basis driven by downgrades in the portfolio and more severe projected economic conditions. The largest increases are within the commercial and institutional and commercial real estate portfolios. Underlying credit metrics remain strong during the quarter with net recoveries of $2.6 million and a 6% decline in non-accrual assets, which totaled $99.4 million a quarter end. Return on average common equity was 12.2% for the quarter, down from 15.9% a year ago, and 13.4% in the prior quarter. Assets under custody administration of $12.1 trillion grew 7% from a year ago and increased 11% on a sequential basis. Assets under custody of $9.3 trillion grew 9% from a year ago and increased 13% on a sequential basis. Assets under management, or $1.3 trillion, up 7% from a year ago and up 12% on a sequential basis. Let's look at the results in greater detail starting with revenue on page four. Second quarter revenue on a fully taxable equivalent basis is $1.5 billion flat compared to last year and down 5% sequentially. Trust investment and other servicing fees representing the largest component of our revenue totaled $961 million and we're up 1% from last year and down 4% sequentially. Foreign exchange trading income was $71 million in the quarter, up 18% year over year and down 20% sequentially. The increase compared to a year ago was driven by higher volatility and increased volumes, while the sequential decline was mainly due to lower volumes. Remaining components of other non-interest income totaled $102 million in the quarter, up 38% compared to one year ago and up 16% sequentially. Securities, commissions, and trading income increased 41% compared to a year ago and was down 21% sequentially. The year-over-year growth was driven by success within our integrated trading solutions product, as well as higher referral fees and interest rate swaps. The sequential decline was driven by lower interest rate swap activity in core brokerage. Other operating income increased 46% compared to the prior year and 64% sequentially. Both increases were impacted by higher income associated with supplemental compensation plans and a higher market value adjustment for seed capital investment, partially offset by higher visa swap expense. The year-over-year performance also benefited from income related to a bank-owned life insurance program that was implemented during 2019. The higher income on the supplemental compensation plans resulted in a related increase in staff-related expense within other operating expenses. That interest income, which I'll discuss in more detail later, was $380 million in the second quarter, down 11% from one year ago, and down 9% sequentially. Let's look at components of our trust investment fees on page 5. For our corporate and institutional services business, fees totaled $566 million in the second quarter and are up 3% year-over-year and down 1% sequentially. Custody and fund administration fees, the largest component of CNIS fees, were $376 million and down 2% year-over-year and down 5% on a sequential basis. The year-over-year performance was primarily driven by unfavorable lagged markets and currency translation, partially offset by new business and transaction fees. The sequential decline was primarily driven by unfavorable lagged markets as well as the decline from currency translation, partially offset by new business and transaction fees. Assets under custody and administration for CNIS clients were $11.3 trillion at quarter end, up 7% year-over-year and up 11% sequentially. The year-over-year performance reflected new business and favorable market impact, partially offset by unfavorable currency translation. The sequential performance was driven by higher market levels, new business, and unfavorable currency translation. Recall that lagged 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 128 million in the second quarter were up 16% year-over-year and up 6% sequentially. Both the year-over-year and sequential performance was driven by strong flows within our money market fund. Assets under management for CNIS clients were $954 billion, up 8% year-over-year and up 13% sequentially. Both the prior year and sequential comparisons were impacted by strong flows, as well as higher markets during the quarter. Similar to custody and fund administration fees, note that lagged market values factor into CNIS investment management fees. Securities lending fees were $27 million during the quarter, up 25% year-over-year and up 17% sequentially. The year-over-year increase was primarily driven by higher spreads and slightly higher volumes, while the sequential increase was primarily driven by higher spreads, particularly in the beginning of the quarter. Securities lending collateral was $166 billion at quarter end and averaged $167 billion across the quarter. Average collateral levels increased 2% year-over-year and were down 2% sequentially. Moving to our wealth management business, trust, investment, and other servicing fees were $395 million in the second quarter and were down 3% compared to the prior year quarter and down 8% sequentially. Both the year-over-year and sequential performance were impacted by unfavorable lagged markets. For the year-over-year comparison, new business partially offset the market decline. Both market lag and quarter lag asset levels impact wealth management fees. Asset center management for our wealth management clients were $304 billion at quarter end, up 4% year-over-year, and up 10% sequentially. The year-over-year growth was driven by net flows, while the sequential increase was driven by favorable markets and net flows. Moving to page six, net interest income was $380 million in the second quarter and down 11% from the prior year. Earning assets averaged $125 billion in the quarter, up 18% versus the prior year. Average deposits were $111 billion and were up 24% versus the prior year. The net interest margin was 1.22% in the quarter and was down 39 basis points from a year ago. The net interest margin decreased primarily due to lower short-term interest rates as well as mixed shift within the balance sheet. On a sequential quarter basis, net interest income was down 9%. Average earning assets increased 13% on a sequential basis. The growth in the balance sheet was driven by a 17% sequential increase in average deposits. The net interest margin declined 29 basis points, driven by the impact of lower rates, as well as mixed shift within the balance sheet. Looking at the currency mix of our balance sheet for the quarter, US dollar deposits represented 71% of our total average deposits. This was up from 67% one year ago, and up 69% in the prior quarter. As we look at the third quarter, the impact of lower rates, particularly LIBOR, will be more fully reflected in our run rate. Both one-month and three-month LIBOR have come down significantly from their second quarter averages. Based on our current view of the balance sheet volume and LIBOR levels continuing at the current levels, we expect third quarter net interest income to be down 13% to 16% on a sequential basis. Turning to page 7, expenses were $1 billion in the second quarter and were 3% higher than the prior year and 3% lower than the prior quarter. Compensation expense totaled $460 million and was up 1% compared to one year ago and down 8% sequentially. The year-over-year growth was driven by higher salary expense due to staff growth and base pay adjustments, partially offset by lower cash-based incentive accruals and lower long-term performance-based equity incentives. The sequential decline was primarily driven by lower costs associated with long-term performance-based incentive compensation due to the vesting provisions associated with grants to retirement-eligible employees in the prior quarter, as well as lower cash-based incentive accrual, partially offset by higher salaries driven by base pay adjustment. Employee benefit expense of $90 million is up 1% from one year ago and down 8% sequentially. Both the year-over-year and sequential comparisons were impacted by lower payroll taxes and lower medical costs. The year-over-year comparison was impacted by higher retirement costs relating to pension expense. Outside services costs of $176 million were down 5% on a year-over-year basis and down 9% sequentially. The year-over-year decline was driven by lower costs across a number of categories, including data processing, third-party advisor fees, consulting, and sub-custodian fees, partially offset by higher technical services. The sequential decline was primarily due to lower technical services costs and third-party advisor fees. Equipment and software expense of $164 million was up 12% from one year ago and up 1% sequentially. The year-over-year growth reflected higher depreciation and amortization and software support costs. The sequential increase is driven by modest increases in software and equipment rental, support, and maintenance costs. Occupancy expense of $60 million increased 18% from a year ago and was up 17% sequentially. The year-over-year growth was driven by higher rent and the building operation costs related to our workplace real estate strategies. The sequential increase was primarily related to a $7 million reduction recorded in the prior quarter, resulting from a lease renegotiation. Other operating expense of $86 million was up 12% from one year ago and up 39% sequentially. Both of the increases were driven by higher staff-related expenses and higher charges associated with account servicing activities, partially offset by lower business promotion expenses due to reduced business travel. The higher staff-related costs were related to an increase in supplemental compensation plan expenses and resulted in a related increase in other operating income. Turning to page 8, our capital ratios remain strong with our common equity Tier 1 ratio of 13.4% under the standardized approach and 13.9% under the advanced approach. The second quarter increase in the common equity tier one ratio was driven in large part by a decline in risk-weighted assets as financial market conditions stabilized versus Q1. Additionally, the absence of share repurchases allowed further capital accretion from net income and other comprehensive income from the investment securities portfolio. Our tier one leverage ratio was 7.6% under both standardized and advanced approaches. During the second quarter, we declared cash dividends 70 cents per share, totaling $148 million to common stockholders. As announced yesterday, our Board of Directors approved our third quarter dividend of 70 cents per common share. As a result of the stress test published by the Federal Reserve at the end of June, our stress capital buffer requirement for the 2020 capital plan cycle was set at 2.5%. The 2020 stress capital buffer is effective October 1, 2020, and results in a common equity Tier 1 capital ratio minimum requirement of 7%. It's times like these that show the importance of a strong capital base and liquidity profile to support our clients' activities. We continue to provide our clients with the exceptional service and solution expertise they've come to expect. Our competitive position in wealth management, asset management, and asset servicing continues to resonate well in the marketplace. Thank you again for participating in Northern Trust's second quarter earnings conference call today. Mike, Mark, Lauren, and I would be happy to answer your questions. Jennifer, will you please open the line?

Thank you. If you'd like to ask a question, please signal by pressing star 1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Please allow yourself one question and one follow-up. Once again, press star one to ask a question. We'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll go first to Alex Losey with Goldman Sachs.

Hi, Alex.

Hey, good morning, guys. Thanks for taking the question. I guess my first question is related to money market funds. I'm curious if you guys can give us your latest thoughts on outlook for money market fee waivers. It doesn't look like there's really anything in the quarter so far, but clearly rates have come down quite neatly. So to frame this maybe as we think about the current prevailing market rate and second quarter money market fund balances, if you were going to go through the repricing mechanism out in the next few quarters.

Sure, Al. So first of all, you're right. The quarter doesn't have a lot. And so let me give you a couple of facts, and then I'll get to what the outlook could look like. So first of all, in second quarter, waivers were less than half a million dollars. As we think about the current run rate as we sit today, they're about $2.5 million a quarter. That said, we're going to start to see this ramp a little bit as the portfolio gets repriced. As we look out to the end of fourth quarter and even into next year, assuming rates stay the way they are today, we could see waivers getting in the $20 to $30 million a quarter range. Those are the facts. I also want to just provide a little bit of kind of significant framework to your question about how people should think about it. We've had a lot of growth in the money market fund business, obviously. We talked about that earlier. And even if you look at the Treasury Fund, that's among the top three in size and investment returns in the universe. It's grown from, it was at $55 billion at year end, and it's about $90 billion today overall. Overall, the complex has about 30 funds, and they total $275 to $300 billion in aggregate. Now, that whole complex is geared toward a very institutional and high network client base. That's very important to realize because it means the pricing, on average, is lower than a retail complex. That complex of funds has... a fee rate ranging, in general, think about a 15 to 20 basis point. There are exceptions on either side, but that's where the bulk of the assets are. If I take those 30 funds and boil it down to the ones that are most likely to have waivers, there's really a handful or half dozen funds that have both large AUM, but also have yields that are within 10 to 15 basis points of the fees. Those handful of funds total $125 billion plus or minus. The gross yield on those funds is about 30 basis points, and the stated fee on them, probably 20 basis points. Now, each one of those strategies is different in expected yields and fees, and so that's just a high-level guide to give you a sense of how the overall complex might come into fee waiver mode as they reprice the portfolio, but that's all given two caveats. One, the existing yield curve stays the way it is, and secondly, there are times when we will do promotional pricing in some of those funds. The analysis I just went through with you excludes that. This is purely waivers based on yield curve coming down.

Great. That's a super helpful remark. Thanks for being able to go there. And just, I guess, to clarify, the $20 million to $30 million that you mentioned, that's a gross revenue impact. Are there any expense offsets that are kind of, you know, more direct related to that before you guys take in any action from an expense perspective that we should be mindful as well, or, you know, the revenue impact is pretty much a pre-tax impact?

Super minor. Super minor. Okay. should really think about that, that gross impact as being pretty full.

Great. Second question around NIR, again, appreciate the guidance for the third quarter. Given the short-term nature of Northern's balance sheet, I'm just curious to think about how the trajectory could evolve from there. So, is most of the repricing going to be done in 2.3, so that should really be pretty close to trough NIR? for the business or you guys think there's incremental pressure on that?

Thanks. Sure. So, you know, on provision in general, actually let me give a couple numbers and then I actually think it'd be helpful to provide a sense of, you know, kind of the process because I think that's important. The good and bad of CECL is that it's a very forward-looking mechanism. And so let's try to separate the credit results from the most factual to the ones that are more forecast dependent. So start on the factual side. And on the extreme, you just say, we're going to look at charge-offs. And we had $2.6 million in net recovery in the quarter. So charge-offs were actually a benefit of $2.6 million. If you come in from that spectrum, the next thing you look at from a quantitative-only factor basis would be what a non-performing look like. And even their non-performings were down $4 million in the quarter, and they currently are less than $100 million on a 30, $35 billion loan portfolio. So it's just 30 basis points of loans. And then next, even look at delinquencies. And delinquencies in the period were actually down. And so all of the factors that are most quantitative only are all in very good shape but then you start to look further down the spectrum what are the qualitative related factors and what drove our increase in provision in our overall provision for the quarter were two big factors one downgrades in the portfolio that added about 40 million dollars to the reserve and then secondly the macro scenario which added 20 to 25 million and so all of the increase that we've had is related to more of these qualitative factors, and even the downgrades are instances where our credit team is looking and trying to be forward-looking about organizations, industries, dynamics that they think are going to reflect credit quality. So that's some background on how the provision number wound up, but Lauren, you spent a lot of time. I just wanted to give 30 seconds on governance and process.

Sure, Jason, thanks. The provision methodology goes through a very robust governance process which builds upon best practices that we've developed in other internal forecasting exercises. Governance covers everything from the data that is used to the validation of models, to the forecasted assumptions, to the ultimate provision output. There are many levels of review and challenge throughout the quarterly process with participation from multiple disciplines around the company, such as economic research, credit risk, treasury, foreign exchange, controllers, and expertise for our business units. So we've unfortunately had ample opportunity to pressure test this process over the last two quarters, and we feel confident that the governance is robust and produces a reserve that is not only well supported, but also responsive to the change in economics.

Next question. Yes, we'll go next to Ken Euston with Jefferies.

Hey, thanks. Good morning, Jason. Question on net interest income, so understanding the reset of LIBOR into the third quarter and the guidance that you gave. Can you give us a sense of whether or not third quarter gets you towards stabilization of NII and how rates hold similar from here? Do you have any thoughts on how third to fourth would look? Thanks.

Sure. We have looked at that, frankly, closely, and the answer is it does get us very, very close to flattening out. I'll just provide a couple of thoughts to give you a little bit more color on that guide. If we take the 380 that we announced and the 13% to 16% down, it gives you kind of a $50 million to $60 million down. I think it's important for people to realize how much LIBOR has come down. In the first quarter, it averaged $139 million. In April, it was 69 basis points. In May, it was 19 basis points. In June, it averaged 18 basis points. So really flattening out. And as of today, it's kind of at that 18 basis point level, as we said, mid-July. And so it's very much flattened out at 18. But then you've got to compare that to what the average was across second quarter. And the average across second quarter was – 36 basis points. And so you just think about a loan portfolio of $33, $35 billion. We're assuming some of that comes out. And we've already seen, you can see from the average that's in the release and the period end, and I can tell you today we're sitting just under $34 billion in loans. And so if we come down a little bit more, we might see two, two and a half, maybe $3 billion in loan decline. You take an 18-basis point differential between second quarter and third quarter on that, and that in and of itself is going to get you over $10 million in the $50 million decline. And then you start to look at just the impact of... volume coming down 10, you know, rates in itself, again, 10. And then you, so, but just in the loan book, you'd end up with 20 billion, $20 million in decline. And then you got to look at the securities book and there it's, you got, you know, 50 to $55 billion in securities that are repricing. And the dynamic here that you're getting at is that a lot of the repricing is actually starting to happen now. We're experiencing it now, and we expected less going forward. And so we think third quarter is going to be the significant decline, and then we should start to see very, very much a level off, maybe not 100%, but very close to fully leveled off going forward from there.

Okay, thanks for that caller. And on the expense side, you know, with the decline in NII and then the fee waivers coming, that's a lot of kind of high margin revenues that won't be around next year on a run rate basis. You guys have done a good job getting the cost growth rate down to 3%. But how do you think about the dynamic, not so much in operating leverage, but just about absolute cost levels and cost growth and what levers are there to pull? How are you thinking about that as well? Thank you.

Sure. So maybe... Looking at page 7 of the release, it's where I always go to just think about how things are moving. If you look at that, first of all, you get a sense, to your point, things have, on an aggregate level, leveled off at 3%. I will say, in general, as you know, we went through a very full replan. That stripped out, call it around $50 million. in expenses, just to be open about it. And some of that was predictable from the macro environment, but some of it wasn't. We then went through a full capital investment replan. And then finally, just this past week, we reviewed with our board a strategic plan replan. And so we're taking this environment extremely seriously. And the value for spend, we hit it. The $250 million target was reached. But the foundations of that are far from over. We're talking about it all the time. It's very much embedded culturally. And if you were here, I think you'd get a sense that the priorities here are around, you know, first in this resiliency mode that Mike talked about, safety, two, resilience and preparation and support of clients, and then third, expense discipline. So you look at page seven of the release and it details the NIE, And you can see how a lot of these line items have flattened out. Even comp, which is down a lot, you take out the equity incentive from first quarter, offset by base pay adjustment, that line item flattening. And employee benefits, you see across the board some leveling in these areas. And all I can say is at this point, just laser focus on it. Value for spend has not stopped. And we understand that in this environment, organic revenue growth is going to be, it's going to be hard. It's, you know, money in motion is less. There are less RFPs that are going to be tossed into the environment. And so we have to ensure we're focusing in a laser like fashion on expenses.

Got it. Thanks. Sure.

Well, the next two, Mike Carrier with Bank of America.

Good morning. Hi. Um, Given the COVID environment and the work from home, just trying to get some color on the impact that it's having on client activity. Obviously, transactional activity has been strong, but more in terms of new business. If you're seeing significant delays or if the pipeline is still building and it's just prolonged implementations, just trying to get a sense on how much of a drag the environment is creating on the business.

Maybe I'll start with a couple headlines, and then it would be really good to hear from Mike on this. So particularly if I just split it on the wealth side, lost business is down, and I think that's really important to realize. Not that it was ever large, but it just gives a reflection that everything we've done, the engagement we've had with clients has cemented relationships. They're doing weekly online client events that are called Insights. Goals-driven wealth management is a great technology to be able to engage with clients, very customized approach in live time, on video, and it's going well. If I give just one anecdotal advice, I was talking to the head of our central region last night, and he was talking about this ultra-high net worth client that has a split relationship with us and one other institution. They had a session with him to explore how to take advantage of the low market values and low interest rates. They worked a very complex but unique wealth transfer opportunity with his kids and grandchildren. He executed it and was thrilled. He's consolidated his whole relationship now at Northern because he feels like we're the trusted advisor and he wants us to have a better lens into his whole financial picture. And then on the CNIS side, you know, we mentioned really early, you know, even things like integrated trading solutions starting to come on board. Pete Sherwood's talked about 10 onboardings, 10 new wins just in that environment. And so some good news there, but also some caution about what the future holds in terms of RFPs.

Mike? Sure. I would just add to it that if you start with the question of, whether there's still a need for the service and what we do and the demand for it. Frankly, that's not only there, but in many respects has gone up in this environment. So there's pressure on every company and institution that's out there, and so just as we talk about how can we become more efficient, how do we rethink our operating model, well, our clients are doing the same thing, and that often presents opportunities for us, primarily around things like outsource services, whether it's on the trading front or it's in the middle office. So the demand is there for the services. And then second, I would say, you know, a static analysis would tell you that, you know, the environment changes, but the way that, you know, we or our clients and prospects go about things don't change. But the fact of the matter is, you know, people adapt. And so in the same way that, you know, We at Northern went from doing things in person and then maybe conference calls. Now, as you know, everything's on video. And in the same way with the search process, the RFP process, the due diligence process, these activities have moved online or in some way virtual so that they can continue. So as much as it's a different environment and it presents new challenges, I would say that we've changed. The prospect and client base has changed, and as a result, it's just a different set of opportunities.

Okay, that's helpful. And then as a follow-up, just give me your strong capital position and some clarity on the reg structure with the STP. Once the macro backdrop does get better and the industry has more flexibility and clarity, How are you guys thinking about capital management, including maybe a CP1 internal or management minimum or buffer, maybe investing in new growth areas and capital return?

Sure. Well, we always take our capital levels not just as a single topic, but we think about it in conjunction with our overall engagement strategy, our approach to the market, and So we want to ensure that as we look across, you know, peers, that's one lens to make sure we look good on that basis. And then we also are talking, thinking about the regulatory environment, the optics of what to do there. And then we have very meaningful engagement with our board of directors and about what we should do from a capital perspective. And I think even this past, these past several months has given indication that coming into an environment like what we experienced with strong capital levels, it helps us not just in the short run, but it provides really good illustration for clients and prospects of what a strong balance sheet means for us as we compete in the market.

Okay, next slide. We'll go next to Jim Mitchell with Seaport Global.

Hey, Jim. Hey, good morning. Maybe just a quick follow-up on your thoughts on deposit trends so far in the quarter. I hear you're sort of an AI guide overall, but maybe you can help us more specifically on the balance sheet. It seems like deposits have been sticking in how you think about the prospects for growth in a zero-rate environment.

Yeah. First of all, on that, you're right. Deposits are sticking. And I don't think I mentioned it earlier, but even post-close of the period, deposits are sticking at the same level. So if you look at our balance sheet and add the interest-bearing deposits plus the DDA, you'd see us somewhere at 110 range and 110 to 120. we're still actually at that level. Now, that's in some ways the good news, and that drives the size of the balance sheet for sure. That determines how we're going to end the quarter at $151 billion. It has much less of an impact on NII and NIM. On the margin, as we have that incremental dollar coming in, it's often going to go into IOER at the Fed at 10 basis points. Or even if it's in another currency, it's going to go to a central bank deposit with not a lot on it. And that's why I keep coming back to trying to encourage people to look at and start to predict what's going to happen with loan volume and rate. And super importantly, the info, the mini walk forward I went through earlier is It's super dependent on rates being the way they are today. Everything we're talking about is now. We were predicting accurately a decline in LIBOR as we said 90 days ago. At this point, we're assuming that LIBOR is flat from here and it has leveled out. Hopefully, it doesn't compress relative to Fed funds. If that happens, things will change. but the deposit will absolutely impact the size of the balance sheet, much less of an impact on NIM and NII. Okay, makes sense. And then maybe just a question on wealth. I know that's an area that you guys have been targeting for accelerating organic growth.

I think if you look at this quarter, the market impact, it was hard to kind of see a lot of organic growth there. I guess maybe just give us an update on how that effort to kind of accelerate growth and wealth is working. Maybe it's being slowed by COVID. That's it. Just curious.

Well, to start, we tend to look at organic growth on a year-over-year basis and much less on a quarter-to-quarter basis just because it's such a tight time frame on closed cycles that happen over a longer period of time. Secondly, to your point, within wealth specifically, the theme I want you to take away is that the GFO business is continuing to be the driver of growth there, and the regions are growing less quickly, and over short periods of time might even show areas of decline. Nothing that we're worried about from a strategic perspective, but within wealth, GFO is certainly the area that's continuing to grow more.

Okay, thanks.

We'll go next to Brian Bedell with Deutsche Bank.

Great. Thanks. Good morning, folks. Maybe just a lot of color on the . I appreciate that, Jason. Just one question on that for the loan yields repricing. I know they mostly, I believe, repriced to one month LIBOR predominantly and most of them repriced, I think, within a quarter. But if I recall, some do reprice with a lag of, I think it's three to four quarters. But if you could just talk about that and whether we could see some repricing down the road based on that, if that's true.

Yeah, in general, we think about that portfolio as about 70-75%. floating and, again, either 30-day LIBOR, 90-day LIBOR, or prime. And you mentioned yield at the beginning, which is something I actually am not sure I mentioned earlier, but I think it might be helpful because I would imagine you guys are going to try to dissect the balance sheet. Think about a yield in that component of the balance sheet, very roughly around 200 basis points. And so as you think about the impact of converting, if we do have a decline in loans and we see loan volume coming down and you think on net if that has to be reinvested in IOER, think about that type of difference in yield. That's why this dynamic of looking at loan volume is so important because the conversion of a dollar of loans to the alternative investment is significant.

Right, right. That makes total sense. And then maybe just walk through some of the, I don't want to call them one-off items, but things that influence the other operating income and other operating expenses, just trying to get a sense of what your more normal run rate is for those two. Instead of comparing in a year-over-year or sequential quarter growth basis, maybe just on sort of an absolute basis of what drove those two line items, you know, the $56 million and a half and the $85.8 million on the other expenses.

Yeah. Well, I'll do the expense side, Mark. Maybe you can do the revenue side. But on the other operating expense side, You know, we've got the supplemental comp there, and then we've also got, you know, when we have account servicing losses, that's where that line item shows up. And then business promotion, travel entertainment, those are the big buckets I think about for other operating expense. Mark, you want to do the other side? Yeah, Brian, this is Mark. You know, one thing to keep in mind is in the first quarter, if we talk about other operating income, we had a, negative drag from the seed investment mark to market. That kind of came back this quarter. Similarly, with the supplemental compensation plans that impact both income and expense, a negative last quarter because of the mark, a pretty significant positive this quarter. So one way, again, and I think we've talked about this a little bit, and one way you can almost average, look at the first and second quarter on other operating income more than average, but you do have other things like hygiene and visa-related things that happen there. But if you were to look at the average over time, and I think it kind of holds true, you're about in the mid-40s now that the BOLI program that we put in place is at a full run rate as of the first quarter and continues to that in the second quarter. If you stripped out the items we've called out over time and looked at the average, you're probably more in the mid-40s, which is actually... close to what the year-to-date average for the other operating income would be as well.

Right. And the seed capital positive, Mark, was how much in the quarter? Eight. Yeah, eight. Eight million. And then just lastly on the outside services, I forgot to ask on that one too, on that line item, anything one time in there or basically from a run rate basis, I guess.

Yeah.

Even with that big drop from one to two.

I wouldn't necessarily call out anything one time. That line will move around. Certainly, I think some of the drag impacts we saw on the revenue side that are a little bit lagged, that benefited us in outside services to a certain extent this quarter. So I don't know that I would look at this quarter as a run rate. And Jason, I don't know if you would add anything to that. But nothing one time necessarily to call out. But certainly there were some things that went our way with the revenue link lines. Data, third-party advisor fees. Yeah, nothing to add.

We'll go next to Brennan Hawkins with UBS.

Hi, good morning. Thanks for taking my question. I actually just wanted to follow up a little on that because the outside services expense line looked a little funky. It seems like what you're saying is that the run rate, this is not the right run rate. We should instead, does that mean we should instead look at like the average of the past four quarters? And can you give a little bit more color on some of the drivers of the downside to the quarter? It said like third party advisory fees. Is that what you meant, Mark, when you said the lag effect, as in it was a lag to the rally? Yes. Right, right.

I mean, there's a few things that we had. Some of the market data costs that we had were down. Again, some of that ends up being timing. Some of our data processing costs, we had, you know, consulting expense was down during the quarter. So it's hard to, it was a pretty favorable quarter there. It's just hard to pin down that that's the new run rate going forward because those will have some to them, certainly consulting based on timing of engagements, et cetera.

Okay. And then when we're thinking about investing services, investing services and the strength there, could you parse that out a little bit? Was that timing, too, or was there something more sustainable?

You're asking about the increase in investment management revenue in CNIS? Yes. Yep. Yeah, so it is an important dynamic, I think, because it really is added, I think, to the base of business. So first of all, I hinted earlier the treasury funds, but in that business, it's not just that we've had flows in. The asset management business has done a lot over the last five years to position the business for growth and the liquidity funds. First of all, everything starts and ends with investment performance, and their investment performance has been in the top five over the last several months. Secondly, size. Clients there want to ensure that they're investing in a fund that's got large size to it so that they don't represent a high percentage. They feel better about the liquidity. The Treasury fund set is $90 billion. They worked on cut off times to ensure they were more competitive. They hired a dedicated distribution team. They launched a portal, and that's up to almost $10 billion in assets, and a decent amount of that is with Northern Products. And then they re-approached the third-party portals to ensure when treasurers are looking at opportunities to park cash, we look very appealing. If you think about the increase that we've had there, focusing a lot on the treasury fund because that's where a lot of the growth has happened, but just in the last quarter, it's been $39 billion, $40 billion in growth into those strategies. About $34 billion of it was on the institutional side, and those funds are 15 to 20 basis points. So very, very meaningful. And now the flip side to it is those are part of that watch list that I referenced earlier that could be part of fee waivers. And so we're trying to maintain humility about what that might look like, but the very good news is that the base of business there has increased significantly.

Okay, yeah, and thanks for predicting my follow-up about the fee waivers. I appreciate that. Absolutely, yeah.

We'll go next to Betsy Gracek with Morgan Stanley.

Hi, good morning. Can you hear me?

Yep, yep, we got you all.

Oh, okay, thanks. I had two questions. First, on deposits, I think average deposits in the quarter was up somewhere in the teens, but end of period was down. I know you traditionally say, like, typically say don't look at, you know, end of period, but I wanted to understand how we should think about deposit growth over the next quarter at least, if not, you know, a little further out so we could talk about, you know, the drivers of what the deposit growth has been seem to be fading. So I would think it slows down, but we'd like to get your understanding of that.

Yeah, so you're right. We were kind of in the teens, in the one teens, and it's held in there. And you watch it on a daily basis, and we're still seeing deposits around that level. And so often we'll see a significant decline from quarter end, and certainly saw some come down, but have seen it level off around that level. We are still... anticipating that over time our clients will look to put some of that money to work in more risks on trades. And I'll come back to what I mentioned earlier, that it is important to watch to the extent you're trying to predict the size of the balance sheet, but those deposits, particularly that layer that we think is not necessarily as sticky, doesn't have as much of an impact on NII or NIMS.

Yeah, and what percentage of the deposits is that, in your opinion, that's not as sticky?

That's really hard to tell. I mean, it's... And, you know, you go back to maybe the beginning of the year, and we saw client deposits in the mid-80s and billions. And so, you know, an absolute worst-case scenario, you could take the delta there, but... A lot of our clients are clearly exhibiting more stability and stickiness, at least thus far.

The stickier, the more operational, you can take duration with that. I guess I'm wondering how much of the deposit inflow that you've gotten over the past quarter or so has been deemed operational and put into duration versus over the next quarter or two, would there be incremental opportunity to extend duration with deposits as they stick around more than expected?

Some of that determination of whether they're operational or not is actually a time test. And we talk about those deposits having the season. And so we can't make a prediction or determination absent just time. But you're right in that at a point, we can start to leg out on those or go into non-HQLA and think about term and credit and achieve more at that point. We did talk on the last call about the fact that we wanted to be patient about doing that to ensure we weren't in a situation where we couldn't be there for clients if particularly loan demand increased significantly.

And what kind of time test is it? Like, is it, you know, three months, six months? Is that something you can share with us?

It depends on, you know, different tests. And also there are tests of, you know, different if it's a retail deposit versus if it's institutional.

And so... Yeah, so there's a range depending on which type.

And even within the institutional side, the type of... depositor also influences the categorization of it. And then on the wealth side, the size. So there's a lot of different factors that go into it. It's not a single test just based on time.

But should my takeaway be there is opportunity to extend duration if deposits meet the time test as we go into 3Q and 4Q or not?

Yes, there's opportunity there. I certainly wouldn't think about it as the 110 minus 85, that volume level, but there would be some opportunity to identify situations where we would want to extend more.

And then just my other follow-up question is regarding just agency RMBS. When I think about the securities book and where spreads could compress further you know agency rms kind of goes to the top of the list because you know we recently got to um i think historical is in in the mortgage rate so i'm wondering what how much did agency rms yield compression impact your second quarter results how much do you think it is

embed how much is it contributing to the outlook you have for third quarter and I decline just you know get a sense of that would be helpful sure not sure we've done that level of detail about the exposure and yield in that book so wouldn't want to comment on it yeah okay all right thank you

We'll go next to Glenn Shore with Evercore.

Hi, Glenn. Thanks very much. Hello there. Okay, so I hear you loud and clear on your comments all around net interest income, little loan demands, and low yields in the public market. And you're not alone there, but many investors, whether it be pension funds, private wealth funds, insurance companies, they've looked to the private credit markets for a source of you might have to give up some liquidity, but not necessarily taking on worse credit. You're probably the most conservative management team I've ever met, but curious if you've put thought into the private credit markets.

Yeah, we look at a very broad range of asset classes that we consider for investment. And at this point, there's such a focus on ensuring that we're We are there for clients. We're not taking incremental risk because the yield curve has come down. That's the prevailing theme as we sit and think from an investment strategy perspective. That said, we're constantly thinking about risk and return and also the categorization of the different asset classes and whether they're HQLA, non-HQLA, level 1, 2, and and trying to come up with a mosaic of thinking about and evaluating those opportunities on a risk and regulatory adjusted basis. But at this point, we want to make sure we're not looking to grab yield just because the yield curve has come down.

Just a follow-up. You mentioned the growth in spec lending, and we can see that fill up in your quarter-on-quarter. You mentioned spreads as being a big impact. Some of the spreads there have come in. Can you talk maybe about an exit rate or a forward thought on spec lending for both spreads and volumes as we look forward from second quarter? Yeah, I mean, it's interesting.

You're right. At the beginning of the quarter, the spreads were much wider. And frankly, volumes weren't great. And then as we got later in the quarter, the spread started to thin, the volume came back. I think his clients felt more comfortable. And so it's a tricky dynamic to triangulate. And I think the volumes and the spreads are actually correlated. And So it's hard to give a sense right now of where that ends up landing. Mark, I don't know if you have other thoughts on it. One thing you can look at is three-month LIBOR versus overnight. And if you plotted that out, you would certainly see that, like we've been saying earlier in the quarter, particularly early April, was a significant benefit there. And then where you're exiting the quarter is certainly at a much tighter spread there. So that would be one way to look at it, Glenn. And our view is, you know, LIBOR, at least since May and June, both 30- and 90-day LIBOR has flattened out.

Okay. Thank you for all that.

We'll go next to Rob Wildhass with Autonomous Research.

Rob? Good morning, guys. A little bit more of a big picture question. I think back to the fourth quarter earnings call when you talked about a demand for increased scalability from some of your larger clients.

And I was hoping you could give us an update on your efforts there and what you've done and are doing to kind of meet that demand.

Sure. It's Mike. I'll take that. Absolutely, you know, a critical objective for our business, I'll say overall, but particularly within asset servicing. And so we are battling out every day to make sure we can provide continuity of service for our clients as Jason and Mark have gone through here and trying to navigate the financial environment. But at the same time, we are looking forward two, three, four, five years ahead with the business model trying to determine how can we not only take care of clients and what their needs are, but build in more productivity into the business model. And as you have highlighted, that's going to be through scalability, particularly in asset servicing. And on that front, we've made investments that have begun to change the nature of the way that that business will operate. And what I mean by that is Primarily, our investments have been in what we're calling Matrix or Matrix Platform, which essentially is a data-driven architecture that essentially takes all of the data in through one place, if you will, ensures that that is clean, accurate data, if you will, and then from there, we're able to utilize it in multiple platforms for multiple services. And it also shifts the service model to one that right now requires a fair number of employees to provide that service to a model where there's more either automation in how things happen and how they're processed, but also self-service. And self-service in a way that is a positive from a client satisfaction perspective. that they don't need to call in or fax in or email in a transaction or order or anything like that, but rather they can put it in and it gets processed essentially straight through. So that improves both the efficiency of what we're doing, the scalability because we can put more business on it, but also the accuracy and consistency and reliability So we're pretty optimistic on that. We have rolled out two releases, you know, over the last several months here, you know, despite the environment. So that continues to progress.

Thanks, Mike. You know, just quickly, the integration you announced with BlackRock and Aladdin, would you bucket that as part of that scalability goal? And then I know it's early, but any sense for how clients are responding to the partnership so far?

Yeah, broadly speaking, I absolutely would put that in the same, it's a part of the same strategy because what we're doing with BlackRock in that case is essentially further integration with Aladdin provider, in which case by being more directly connected, it provides greater efficiency. So what's happening between our platforms, if you will, and Aladdin is directly linked, in which case you get the same types of benefits that I just talked about there.

Great. Thank you.

We'll go next to Vivek Duneja with JP Morgan.

Hi, thanks for taking my question. A quick one, which is just an update on the Northern Trust Open. Given the environment, should we expect a similar kind of increase as you've guided to in the past? Any color on that? And then I have a bigger picture question.

Headline is it won't see a significant decline relative to prior years. And we typically see $16, $17 million sequential increase in business promo as we look into the quarter. A few thoughts on it. One, the tournament is going to be players only, as you know. Secondly, we don't get into specific costs about the tournament, but people should know most of the costs associated with the tournament are about television and the expenses associated related to tournament production, and those actually aren't going to come down significantly. And then the reality is the television ratings for PGA have actually been very, very good. And so there will be a modest savings as we think about reduction in travel and entertainment and some other things, but the reduction won't be meaningful. Okay.

shifting gears to a bigger picture question as I look at over the last year and if you look forward if you think about your mix of asset servicing clients what does that look like by type of client pension fund versus long only versus insurance versus hedge funds and alternatives what is that mix and what is the change you've seen over the past year or two and what do you expect to see

I'll take it, and I'm going to do this, Vivek, without a specific breakdown with the numbers and percentages of our client base because I don't have it in front of me, but generally speaking, over the last several years, and that would continue through last year, the proportion of our business that is coming from asset managers as opposed to asset owners has gone up. That's been a combination of just the business strategy over time but also because the demands of asset managers for our types of services have been growing at a higher rate you know from a market perspective and then also as you know we're taking share as we continue to expand that business both you know geographically but also within particular segments so geographically if you think about what we did in Luxembourg and Switzerland, that primarily is going to drive business with asset managers. And then, you know, Switzerland is a mix between asset managers and asset owners. So that's where our focus has been, and that's where the greater growth has come from. You know, the thing I would say about the asset owner side and subsegments within that, it really does vary with what's happening across the globe, just broader macro factors, because as you would expect, things like sovereign wealth funds and governments, we're working with them. Their needs to deploy investments into the economy changes over time versus their ability to invest those. And it's when they're invested globally that we see higher asset levels from them. And it's when they deploy them into the economy that they'll reduce those levels. So it's just a higher level of variability. And I would just add, sorry, but one other thing is just, you know, and then in the U.S. where the asset owners are largely pension funds, you know, that dynamic, it's more of a share game than it is a market growth game. And so there, again, we've been able to pick up share, but, you know, you're doing it in a slower growing market.

Mike, any plans to break this kind of data out at least once a year in a 10K or something to give us a sense of where you're going and providing remote anonymity?

Vivek, that's definitely something we can take on to consider because obviously it's something that we track closely. So if we can do it in a reliable way, it's something we'll consider.

Thank you.

We'll go next to Brian Bedell with Deutsche Bank.

Great. Thanks for taking my follow-up. I just wanted to come back to expenses in the second half. Some of those were answered with the Gulf open. But typically, we do see that seasonal increase in the second half in outside services and certainly equipment and software expense. I just wanted to check in and see if you still think that's the case. Obviously, you know, with the COVID environment, that could be fluid. this time around, but I just wanted to check in on that, especially since we saw the downtick in outside services in the second quarter.

Yeah, a couple things. One, you're right in that there are some, there's some bounciness. So on one hand, there's COVID-related expenses that are impacting things a lot. We've got investments to make there. Some of that will come through in capital, but some of it will come through the income statement as And we've spent decently at this point and continuing to ensure that in a resiliency mode, we're doing everything we can to make sure we're there for clients. Secondly, we want to make sure that we're investing appropriately and in a disciplined way, particularly around things like technology. And some of that will show up in outside services. Some of it shows up in in equipment and software, but some of it will show up in outside services. And so we've got a high bar for where we're investing, but the traditional view of what expense ramps look like in the third and fourth quarter I think are going to be less reliable. It's much more about what do we think is necessary to ensure resiliency and our strategy of being there for clients.

Okay, that's a good color. And then just lastly, just on the provisioning, and thanks for all the color on that, you talked about some internal downgrades across the book. I guess just as we go into the second half as well, if we do have a situation where there's a second wave of COVID-19, that's hopefully not, but worse than people are expecting. Is that a significant part of your... your credit assessment, even if you think the credit qualities are relatively good, but nevertheless could drive higher provisioning in the second half.

We've run multiple macro scenarios and some of those scenarios will incorporate that type of worsening or W type as opposed to a V. And so as things approach, we play with the weight of those factors And that has heavy influence on what the output is. And so we monitor that closely. If things worsen significantly, just like we experienced last quarter, frankly, things worsened from the end of March to the beginning of April. And this time we haven't seen that type of dynamic shift between the end of the quarter and the time we're talking to you. But there's so much time between now and then We're reliant on what those macro forecasts look like, and they'll always have influence, particularly in the CISO environment, on what provision looks like.

Okay. Great. Thanks for all the color on that. I appreciate it.

Sure. And at this time, there are no further questions.

Thanks, everyone. Stay safe, and we'll look forward to talking to you about the third quarter.

This does conclude today's conference. We thank you for your participation.