Northern Trust Corporation (NTRS) Earnings Call Transcript & Summary

Well, good afternoon, everyone. Next, I would like to welcome Mike O’Grady, President and CEO of Northern Trust; and Jason Tyler, Northern Trust's CFO. Given its differentiated capabilities in both Corporate & Institutional Services as well as in Wealth Management, Northern Trust has been delivering industry-leading organic growth over the years. Although the pandemic and lower interest rate environment has clearly been in near-term revenue headwinds, the firm remains focused on key growth initiatives while also controlling expenses. We look forward to hearing from Mike and Jason on how they are positioning the business into 2021. So welcome both to this virtual conference. I wish we were doing it live, but for time -- for time being, this we'll have to do.

Thanks. Good to see you, Alex.

Great. So why don't we jump in? I have a bunch of questions that I would like to ask you guys. [Operator Instructions] So first question is really a look back in 2020 and maybe thinking through some of the key priorities for 2021. And look, clearly, an unprecedented year. But curious how 2020 changed Northern's competitive positioning within the marketplace as well as from an internal kind of operational perspective because I feel like we've all learned new and different things about going about doing business. And some of them might stick around, some of them might not. But curious how that impacted you guys. And then looking forward, with rising prospects of economic recovery, how are you thinking about top priorities for the firm into 2021?

Great. So I'll start off, Alex. And again, thanks for having us. And as you pointed out, 2020, an eventful year for sure. And so plenty of things to reflect on, both internally and externally. So the first I would say is the importance of a strong, solid foundation. Clients are counting on us to be there regardless of the environment. We were able to do that, and it showed us in new ways. So that would be number one. Number two is we got a preview, if you will, a full preview of what it's like to operate in the digital world, just like we are now, but doing so with clients. And as much as we may think that we're in the pandemic now and maybe with the vaccine and vaccinations, it will go back, our view is that we're into a new world here that may not be just like we are right now, but will be very much more digital than it was before. Third, I would say is it really validated, I would say, the attractiveness of our businesses. So asset management, wealth management, asset servicing, if you just look at each of those businesses and the need for our services from our clients, both during the pandemic, but as we're coming out of it, it really validated these are great areas to be in for serving clients and growing businesses. On the wealth management side, it's a time where they're counting on their wealth management firm to take care of them. Asset servicing, how can we make sure that they're still up and running all the time? And in asset management, if you have a shift to liquidity, how can we take care of that, but then as you want to put more risk on, what are the alternatives on that front? So validated the corporate strategy of the businesses we're in. And then the last thing I would say is it also does demonstrate the pain of low interest rates. And so that's just a headwind that we've already caught a big portion of it, but we know we're going to face it for some time period. So a lot out of 2020. As we go into 2021, not surprisingly, as you think about those reflections, it's going to affect how we think about where we're focused. So yes, it's about strengthening the foundation, firstly, but it's also, Alex, about what we're saying is reimagining the foundation, which is you need to think about the basics of what we do differently in this new world. Second is around growth. As you highlighted, we've grown at an organic growth rate above our peers. That's a life blood of our company in many ways. And so how do we do that in the current and future environment? Third would be around digitalization, as we talked about. We are already, like others, on a path, but how do we accelerate what we're doing so that we can operate effectively there. And then the importance of productivity. This is something where with the low interest rate environment, if we're going to generate the type of profitability that our business model has generated over time, we have to ensure that we're getting meaningful productivity as well. So all areas where we're going to be focused going into 2021.

Great. That's helpful. Let's unpack some of this across different businesses, right? So one, let's -- probably starting with C&IS on the servicing -- on the services fee side. And again, zoning in on organic growth here a little bit, clearly, still industry leading, but the organic fee growth feels like it has been decelerating somewhat even pre-pandemic. Obviously, given everything that happened, it's not surprising that the business was going to slow down as people get disrupted, and it takes longer to just like make decisions, et cetera. But can you help us better understand what was beneath the surface, core dynamics in the business in terms of either pricing or things have been solely impacted by the pandemic or something else going on? And more importantly, how we should think about C&IS organic fee growth over the next several years relative to what's been the norm kind of pre-pandemic and yes...

Sure. So I think you're right, Alex. You need to peel it back to actually understand what's happening there. And let's start with the fact that coming into the year, we had new business that we had onboarded at the end of the previous year. So you get the benefit of that. So we came in with a decent, I'd say, head of steam on that front. But then with the pandemic, the transitions, the onboardings of new clients, at one point, kind of paused. We were able to get some done in April. But definitely through second quarter, third quarter, you saw those transitions slow down. And that's something where you're not going to make up 3 quarters of transitions in 1 quarter. So it just kind of pushes things back. It's so important how we onboard those clients that it can only be done, I would say, at a certain pace. And then the second thing I would say is around distributive growth. So that's always been one of the attractive aspects of our model is we want to be aligned with clients that are successful. So when we're providing fund administration or custody to an asset manager, to the extent that they have inflows, we grow with that; to the extent that they launch new funds, we grow with that as well. And in 2020, many of our clients, most of them experienced the same thing we did, which is slowdown in those types of new launches and things like that. And then third would be the fact that some of the new business activity slowed down as well as people had to adjust to that new environment. And so you just saw that -- kind of the slowdown there on opportunities. But then I would say in the third quarter and certainly now, that has fully picked up as far as market activity. And it's caused, as you would expect, a lot of these asset managers and asset owners to kind of relook at their operating models and determine either, a, should they be looking to outsource more of their activities; and b is, do they have consolidation opportunities, where they're working with multiple providers, for one reason or another, but is it better for them to work with one, which again provides certain threats but certain opportunities as well. So we've seen that pick up. So if you take all that, you would say, that sounds more like, I'll call it, a pause in that. And then to take your question, say, okay, how does that roll into the next year? Again, we expect to continue to have healthy organic growth. But I would say, we're being very selective on that growth in the sense of we want scalable growth. And so as a result, what is the mix of business that we're going after? And how do we think about how we want to price new business that's competitive in order to bring that in? So yes, we want to grow at that above-average level, but we also want to make sure that it's, of course, profitable as it has always been, but also scalable for us.

Got it. Understood. And I guess similar line of questions on the Wealth Management side. I think on the last quarter's call, you mentioned that you had to shift your business development strategies, given the pandemic and not surprisingly. I was hoping you could expand on that a little bit and just kind of walk us through how the pandemic has impacted the wealth business, again, through the organic growth lens? How we should think about that business going forward? And then maybe within that, particularly hit on Global Family Office because that's the part of the model that feels like was underperforming a little bit relative to the growth rate it's seen in the past.

Yes. So if you just looked at the performance of the Wealth Management business year-to-date through the third quarter, you might not know that we've gone through a pandemic. And maybe a little bit, but revenue is up 4% year-to-date, assets under management are up 6%, deposits are up 25%, assets under custody up 16%. So again, very healthy numbers that sounds like, boy, this is a great business that's operating very well in this environment and the margins have largely held as well. So in that sense, great business continues to perform well. But as you highlighted, Alex, it has caused us to have the shift in how we grow that business. So more of the changes happen along the lines of that new business generation, where we have moved to more of, I'll call it, a person-to-person new business sales efforts, which we certainly still do, but given the obstacles that we're under, switched more to digital. So we did a little reorganizing within that group, and we closely aligned our sales and marketing efforts. We launched the digital marketing effort, which is to get out to a much broader audience in order to bring in more prospects that we wouldn't otherwise be able to get to. And we've tried to highlight some of the expertise that we have in different ways or at a minimum, much more frequently. So we previously would do various sessions with our expertise. But because we could do it similarly to what we're doing today, Alex, it enabled us to do it 3 times a week during the middle of the crisis and now once or twice a week. And that's not only good for clients, but that's a great prospecting tool as well for clients and prospects to be able to hear from our clients. So it's been a shift. I would say that it's one that has gone well, but there's still more to go on that front. And specifically, the Global Family Office, again, I would say a lot of the things I just talked about still hold, and we still feel very good about the prospects for growth in that business.

Got it. Okay. That makes sense. Shifting gears a little bit, I was hoping to touch on asset allocation trends, and we were talking about it right before the session started. But clearly, over the course of 2020, and I guess we should talk about the wealth side more so than the institutional side, just to keep things a little bit simpler. But on the wealth side, broadly for the industry, we've seen tremendous amount of capital moving to the sidelines. Money market fund assets are quite high. They started to come down a little bit, but they're still quite elevated. We've seen tremendous amount of money going into fixed income, et cetera. What are you hearing from your customer base because it's obviously been more unique, high net worth and ultra-high net worth with respect to their asset allocation trends into '21? And how do you think that could impact Northern's fee rates within the Wealth Management business if any of that remixing sort of occurs into higher-risk assets?

So it's been both interesting and I would say, reassuring as to what we've seen with the Wealth Management business. So I'll say, coming out of '19 and into '20, actually, on average, cash levels were low with our client base. And part of it's just because of the performance of risk assets leading into that. And then you have the crisis. And this is the part that is important and reassuring, which is we have a goals-based -- a goals-driven framework that we have instituted years ago with our clients, and yet this was the opportunity where it was really going to get tested. And importantly, as part of that framework, you have the portfolio reserve. And that reserve is such that when the markets do drop like they did, that clients don't at that point, say, boy, I need to liquidate, become more conservative and that, that is not the time to sell. And that's precisely what happened, which, again, very positive. So we activated the portfolio reserve, made it through this time period, therefore, retained the risk asset allocation through that and then have been able to ride that out. So for our clients overall, it's actually been, again, a relatively positive year based on the way that the equity markets have performed. Now in addition to that, Alex, there's been some tactical cash raising, whether it's because of the uncertainty of the pandemic or what happens with the elections. But as far as where they stand right now, decent cash levels. Again, taking into account that risk assets have performed very well up to this point, but also, I would say, a relatively positive positioning going into 2021. So from the standpoint of where we're weighted, we're still to the positive as far as risk asset allocation going into new year. And then we'll see how it goes from there. And I think, again, from a client perspective, that's worked well. And then to your question on fee pressure. So of course, there's fee pressure across all of our businesses, the entire industry. But within that, I think to your point around Wealth Management, Alex, that's where you have the investment product component and the advisory component. And I think what we're experiencing on the investment product side, similar to what you see across the industry, which is more of a movement towards passive products and absolutely looking for the most efficient way to fulfill and implement strategies. But then on the advisory side, this is where you have to earn your keep. And this is where, again, when we look at what happened through the pandemic, there was a tremendous amount of -- not just handholding to say, now remember, let's stick to our goals, which is part of it. But also a lot that we did as far as advice around estate planning and other things that our clients could do to be best positioned for potential outcomes. And that, as you know, is not, I'll say, just by chance. We formed the Northern Trust Institute earlier this year where it was launched, and that's all about trying to make sure that we have the best advice and capability and are leveraging that for our clients. And I would tell you that, yes, that helps with growth, it certainly helps with client outcomes, but that's also a part of earning our keep, earning that fee in a very tangible way for them.

Got it. So maybe building on that a little bit, I want to touch on the investment management business and really kind of go underneath the surface a little bit, and that probably can kind of cross both C&IS and the wealth business, the way the investment management organization is structured. But if we look at flows outside of money market funds, and you guys have been doing a fantastic job building the presence in that business, and you've gathered a lot of money market fund assets over the course of the last few quarters. But outside of that, flows have been sort of flattish over the last couple of years, but they have been improving more recently. Can we talk a little bit about what's going on underneath the surface? Which channel is really driving that within kind of the both elements -- both segments of the business? How sustainable you think that is? And again, any implications from that trend on the overall firm-wide kind of fee rate or revenues?

Sure. So as you started, from a liquidity perspective, we feel very good about a lot of work that's been done in previous years and then being in a position when something happens like this to be able to have the wind go into our sails, if you will. So it's worked out well. But you're also right, Alex, that once it's in the house, so to speak, then what can we do to be able to retain that as the investment profile changes. And so on that front, we've seen a couple of things. First of all, we've seen nice inflows into fixed income. Some of it, the ultra short from a duration perspective, but also active fixed income. So that's been a good, I would say, evolution of those flows in that direction. And then on the equity side, quant, which has been, again, another area of focus for us. We've seen very good both performance there, where if you look at some of our ETFs with the quant investment strategies behind them, they've performed well. So they're in the top quartiles from a Morningstar perspective. But then also as far as residence with our clients. And you asked the question on both the retail side, if you will, and the institutional, and it's both. The retail side through the ETFs, through flex shares. And then on the institutional side, really, from a global perspective, some of that is where these are clients that we're serving on the asset servicing side with C&IS. But a number of these are new clients to Northern, if you will, where the first thing we do with them is asset management, which, again, is another positive. So seeing some very good trends, which we would expect those to continue. And I would just add to that, ESG, of course, because we expect that, that broader market trend will continue, and it's one that we believe we're well positioned to be a part of.

Got it. All right. Let's shift gears a little bit from some of the business drivers and bring Jason into the conversation on some of the more kind of near-term financial dynamics. I mean, given the time of the quarter, I was hoping maybe we can get an update on how Q4 is evolving for you guys so far. So any updates around revenues? And I guess, specifically, we can talk about NIR. On the last quarter's call, you guided to NII down 2% quarter-over-quarter, plus/minus sort of in that range. So maybe we'll start there, talk to us a little bit about how Q4 is shaping up on the NIR side.

Sure. So -- and you hear me, okay, Alex?

Yes, hear you great.

Yes. So I think NIR is -- that guidance still holds pretty well, and we haven't seen dramatic shifts that would influence that. And importantly, I think I also hinted that you got to look at volumes underneath that as much as rates. And the average balances for the balance sheet have held in about the same as what we were seeing in the last quarter. So I'd say that, that guidance still mostly holds in place.

Right.

And then I think if -- I can even give a couple of thoughts on a couple of different areas of the income statement if we're just thinking about revenue. FX has also been kind of flattish. It's actually -- I think everybody's seeing volumes in that space trickle down a little bit. And then even in sec lending, down, I'd say, more meaningfully there as we've seen the influence of rates in that business. So that's come down a little bit as well. And I'm sure even on fee waivers, I can give an update if you want me to do that now just to tick through it?

Yes. Just to maybe double check on where you stand around FX and sec lending. So flattish FX, are we talking about year-over-year or sequentially? And the same thing for securities lending, are we talking about year-over-year growth trends or the sequential?

Both, year-over-year. Thanks for asking me to confirm that.

Okay. Perfect. And then -- so yes. And my follow-up was, obviously, around the money market funds. You guys have given some pretty explicit guidance there. I think $20 million to $25 million was the number for Q4 and then kind of maybe $25 million to $35 million quarterly run rate thereafter. That probably needs to be adjusted for any shift in the AUM base with respect to money market funds as well. So maybe we can kind of hit on both of those.

Yes. It's interesting. I mean, you've seen -- and it's in the public markets, so people can follow it. We have seen outflows in the money market fund space. Interestingly, off the large base that we have, roughly, roughly $275 billion, $280 billion in the whole complex, that coming down $5 billion or $10 billion actually doesn't move the needle dramatically. What it's influencing much more on waivers is going to be what's happening with rates, and particularly the very short end. If you think about the high percentage of the assets that are invested overnight and overnight repo or even out to 30 days, it's a pretty high percentage of the assets. You get around -- roughly around half. And so I always encourage people to look at the very short end of the curve. And despite the fact that we've seen the 10-year up, we actually have seen the very short end of the curve come down and the overnight repo, obviously, being short. And so that's influenced things a fair amount. And so just to be specific about the run rate, I gave very specific run rate last time. And that is -- it's come up a fair amount to about $34 million on a quarterly basis as we sit right now. In quarter, for fourth quarter, the $20 million to $25 million is actually holding. We saw that over -- the overnight rates were coming down, and we baked that in. And so that $20 million to $25 million, maybe the worst side of that is still a decent look for fourth quarter. And then as we look to that $25 million to $35 million, the influence that we're seeing on the short end of the rate curve, we'd have to take the upper end of that to think about how we're launching into first quarter, if that all makes sense.

Got it. Got it. Can I just follow up on that? So assuming that rates hold now and asset balances hold at current levels as well. Because to your point, I mean, the short end of the curve is so low, and I would imagine everything would have repriced by Q1 of next year. So nothing else changes, does the kind of -- this $34 million, $35 million, is that the run rate to think about? Or could things get incrementally a little worse?

Yes, so the right way to think about it is how much -- the way I think about it, how much of the portfolio effectively is there now that was priced before the yield curve came down. And there's really -- as you know, we've got to keep a duration that's less than 50 days effectively, but there can be tails that are out longer when you think about the weighted average. It's like a couple of percent maybe that has yet to reprice. And so we're -- as we think about that launch point into first quarter, that should get us the most part there. But this dynamic of what's happening at the very short end of the curve, that's going to influence things a lot. And so I think people should realize how -- and there are other funds, too, that are -- might have been priced lower and now that those yields have come down, they're getting -- they're the last ones getting into waiver mode. And so that launch point is a good one to think about. But even there, if you have a more bearish view of what's going to happen on the short end of the curve, you might even tick that up a little bit.

Got it. Okay. That makes sense. So since we're on the topic of rates, let's hit on NIR a little bit as well. I know you talked about the fourth quarter. But as you highlighted, the yield curve steepened a little bit. I mean it's not a whole lot to get excited about, but low base, right? So everything gets us a little excited nowadays.

Everything helped.

Right, everything helped. So you guys are seeing a lot of excess liquidity. I mean, by our numbers, you guys have seen deposits up $20 billion, $25 billion year-to-date. Now I know you guys are obviously very much centered around the short end of the curve. So the fact that the 10-year steepening end shouldn't matter as much to NIR. But help us think through the framework of maybe reinvesting some of the excess deposits on the balance sheet into just a little bit of duration to pick up some spread relative, I guess, to what is still repricing, right? Because there's a little bit of maturity in the balance sheet as well. So when you look at the curve today and the forward curve, plus what's repricing, is that enough to keep NIR maybe at like sort of the run rate levels we talked about starting, call it, Q1, Q2 and then sort of stabilizes? Or it could actually be a little bit better or a little bit worse?

I think the most specific answer to your question, it's probably not enough. That incremental repricing is still going to influence things, particularly since if you actually split the yield curve and you think about what's an overnight to 2 years, again, that's actually come down a little bit. It's really the 2 to 10, 5 to 10 that's actually come up a decent amount. And even -- you're right in that even though we were 2, 2.1 in terms of duration, there is some -- obviously, we're buying some securities longer than that, but not at the 5 to 10 component of it. And so we're still overall exposed to repricing in a yield curve that's still coming down a little bit. Now that said, I think there are other dynamics, the volumes that we have in the balance sheet, and importantly, what happens with client loan demand. And that's so important because even though we run a -- what we think of as a safe securities book, the yield on the client loans is going to do better than that. And so that's where you can actually have more of a needle-moving dynamic in the balance sheet that can offset that repricing that we're still going to experience.

Got it. Got it. Makes sense. So why don't we shift gears a little bit and talk about expenses? And on the last call and really throughout our conversation this afternoon, Mike, you really stressed the need to invest into profitable growth. And you really -- and both of you guys really highlighted the urgency that exists within the organization now to push expenses lower where you can, given the more challenging interest rate backdrop. So help us understand what that ultimately means relative to kind of the framework you've outlined in the past, right? So mid-single-digit, call it, organic fee growth, so that will be supported by mid-single-digit organic expense growth. Does that dynamic change if organic fee growth is lower? Could expense growth on an organic basis be at a lower end of the range, low single digits? Kind of how do you think about that into '21? And obviously, COVID is making things complicated too, right, because some of the expenses that weren't part of the run rate this year might come back next year. So lots in there, but I think you know where I'm going with it. So I'll let you guys answer.

So I think even though there was a lot in there, Alex, you laid it out very well because we have talked about this for some time as to the financial model that we have. And that model works in different environments. It just presents different challenges. And as you've talked about, we are in an environment not only because of what happened in 2020, but as we go into 2021, where that organic growth rate is going to be at the lower end of what we've done, and that does require us to get that organic expense growth rate down below that. Like everybody, we go through a pretty rigorous planning process, which we're, I'll say, in the midst of, but we know where we're trying to get it to, which is that dynamic. And you're right. We don't know what's going to happen in 2020. Is travel going to go up again? So you have expense line items that you just don't know, but that's exactly what we're trying to do. The other part of it I would just say is we've been on this for some time period. And so you constantly have to find new ways to create this productivity. For us overall, with the growth we've had, we've had a reasonably high-growth rate in FTE and people. And so that's certainly an area that we know we have to control the growth rate of our workforce in order to ultimately deliver that type of expense growth overall. Do you have the technology aspect of it, yes, and outside services and -- you have all those in market data, we're wrestling with all of them. But you have to start also with your largest expense item, which is around people and compensation. So how do we make sure we're efficient around that?

Got it. All right.

Last time this year, I think we started to talk about the things we do have more visibility on. And couple of areas jump out there. One, as we think about employee benefits, in particular, we're still seeing that same kind of ramp up that we had in the third quarter. As things like medical and other areas start to come back online. So very similar trend of increase that we saw from -- in third quarter. And then secondly that Mike has hinted, the equipment software is an area that shows up on the expense line that reflects the investment we're making in technology. And we thought we were looking at kind of a 10% to 12% increase year-over-year, '19 to '20, and that still looks like it's going to come into play, that same expense increase on a year-over-year. So those are the line items we have more visibility into at this point in the cycle.

Got it. And your comment is with respect to Q4 dynamics, right, how we should think about in terms of comp expense with medical stuff and...

That's precisely right. Yes.

Got it. Okay. Great. All right. Well, we'll stay tuned for more, I guess, when you guys report earnings, talk about '21 a little more then. Shifting gears. We have a couple of minutes left, and I'm going to try to squeeze a couple of questions into this one, including one that's coming through the webcast. Capital, not surprisingly. You guys are really well capitalized. You've always been really well capitalized, even more now so than before. How are you guys thinking about your binding constraint? Because the regulatory framework has been evolving to some extent. And in the past, it almost feels like you guys were really benchmarking itself against your peers as opposed to what was really applicable to Northern Trust as an organization. So how should we think about the binding constraint now? How much excess capital do you guys think you ultimately have? Are you thinking about returning that capital? And then if I could throw in an M&A question in there as well. Just given the fact that there's been more consolidation in the asset management space, is that an area where you see Northern Trust being perhaps a little bit more active?

Why don't I do this? Why don't I take the acquisition question, and then, Jason, why don't you take the capital? So we certainly are looking at the activity that's out there that you've highlighted, Alex. And as you know from our acquisition history, we look at acquisitions as a way to accelerate our organic growth strategy. And it's worked very well for us. And frankly, if you looked over that history, we've often been very opportunistic when we've done that. So yes, it's good to be in a strong position so that you can look at things. Now with that said, I would say where we're seeing more activity, the first place you mentioned it, asset management. So yes, that's an area we would look to grow, but it has to fit with the strategy. So I talked through things like quant are of interest to us. Things that would add distribution that's outside of what we already do with the institutional side of Northern and the wealth management side. Those are things that could help accelerate our growth in asset management. And then in asset servicing, frankly, we feel pretty good about our footprint. So there isn't a need to do something. And I would say it's a higher bar there right now just given the fact that we have a lot going on in that business, and we're able to grow nicely from an organic perspective. And then finally, wealth management, there's probably fewer opportunities that are out there because the space has done reasonably well. But we do believe if we have opportunities in that area, we know the business well, we know how to treat clients well, we would feel pretty confident that we can do an acquisition there and generate a fair amount of value.

And then quickly on capital. The framework we think about is the great engagement we have with our Board, we take very seriously. And we want to make sure we're not being presumptive, and so that's part of it. They'll -- and they care about the same factors that we talk about. What's the stock price from a valuation perspective? What opportunities do you have internally for reinvestment? Secondly, we think about things on an absolute basis. So what does that look like? Third, to your point, Alex, relative matters to us. As we're thinking about going to sovereign wealth funds or to superannuation funds, large multibillion-dollar investors, they think about deposits on our balance sheet, not as just depositing funds, but as lending to us effectively is what they're doing. They want to know that they've got a strong balance sheet that they're placing their funds on. And then at the same time, we're thinking about the regulators as well and making sure that -- and so all that in the construct of where are interest rates, where is valuation. It's a mosaic that's hard to just pinpoint here is exactly the rate we want, but that is the framework we're constantly talking about. And each of those, we want to make sure we're reflecting strength from a capital perspective.

Got it. Well, great. Listen, that took us pretty much right to the end of the hour here. But thank you both very much. Always a pleasure to see you, hopefully, next time in New York and in person. So I hope you had a productive day, and we'll talk to you soon.

Thanks.

Thank you, Alex. Take care.

Thanks.