Northern Trust Corporation (NTRS) Earnings Call Transcript & Summary

Thanks, everybody, for joining us this morning. I have a disclosure to read, and then we'll hop into it. For important disclosures, please see Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. And if you have any questions, please reach out to your Morgan Stanley sales representative. With that out of the way, I'm very delighted to have with us today, Mike O’Grady, Chairman, President and CEO of Northern Trust; and Jason Tyler, CFO of Northern Trust. Gentlemen, thanks so much for joining us this morning.

Glad to be here.

Betsy, how are you?

Good. So Mike, why don't we start by talking a bit about your Wealth Management and Asset Management businesses. We've had great markets, relatively low risk over the past 8 months or so. And we've got markets at or near all-time highs. Within your Wealth business, how do you think about driving growth from that perspective over the next 2 to 3 years? And give us the sense as to what's differentiating you from your peers?

Sure. So I think that -- let's start with Wealth Management. And to your point, Betsy, and it is important, markets have been very strong. And that is definitely a part of the growth and a major driver of it. And I would say we strategically try to position ourselves to be able to take advantage of that growth. That said, we spend more time thinking about and focusing on how we grow the business organically. And on that front, I would break it into 4 primary components. The first is what I'll call the levels of growth. And what I mean by that is starting off with, we have a great client base, you want to retain that client base, right? So that the more if you can start with a solid foundation and maintain that and build off of it, that's great. So focus on taking care of the existing client base. Second is, if you have a strong client base, which we do, they're going to be successful as well, and they're going to be growing. And so how can we grow the relationships with those existing clients. And then the third part of it, certainly, is bringing on new clients. So how do we prospect and get new clients to then grow with them. The second big component is around how we would target the market and look at various segments. And as you know, For a long time, we've been focused on the upper end of the market and continue to be. So at the top end, global family offices, then ultra-high net worth and then certainly high net worth. And it's important because the needs of those clients are different than other parts of the market. And so it gives us an opportunity to differentiate what we can do and how we can compete. And I would say where we've spent more time recently, Betsy, is in addition to wealth level or even geography and where they are is thinking more about personas, and personas that are growing at a higher rate. So thinking about family businesses and what are their needs or business executives and how do we have a focused tailored offering for business executives. So that's been the incremental level of targeting that we're doing. And then third, to your point, you need capabilities to differentiate you. And so on that front, I would just highlight to that, again, these are longer term in the sense that we've been doing them, but we continue to invest to differentiate. The first is goals-driven wealth management, which is both an approach and a technology. And I would say the aspect of it that's different for us is that the needs of that target market that I talked about are different. And so our goals driven is much more than just an asset allocation or an investment strategy, but rather, what are the ultimate objectives for people who have multigenerational wealth. And so again, a more complex offering. And then the other aspect of it or other capability differentiator is the Northern Trust Institute, which we rolled out about a year ago, and that was really pulling together all the expertise that we have in these areas, and actually have 175 members of the institute, if you will, that are either estate planning experts, fiduciary experts certainly on the investment side, banking, so that we have each of the areas, and they both, I'll say, write white papers, if you will. So what are the cutting-edge ideas in those areas, but then also work specifically with clients to provide solutions to them. And then the fourth component of the growth strategy is marketing and sales. So how do you get out to those new clients, how do you make them aware of Northern Trust and then also then how do you develop new relationships, cultivate them and ultimately bring them on as new clients. And I would just say that's a very dedicated, focused effort. And we've switched a lot of what we've done from a marketing perspective to be more digital, and we expect to do more of that. And on the sales side, I would say having more dedicated what we call wealth strategists who are focused on finding that next client to bring them into Northern Trust. So overall, that's what we've been doing, driving a lot of the organic growth, and I think that's what's going to differentiate us going forward.

And what is it about the high net worth -- ultra-high net worth family office that differentiates them from other wealth sleeves, for example?

Yes. I would say the first thing, Betsy, is that they're likely to have, as I would call, multigenerational wealth. So beyond taking care of their own needs or their own direct family, it's likely they're going to have excess capital or sufficiency beyond that. And that just completely changes the dynamic around how to plan around that, how to think about that. And so a matter of do you set up trusts? Do you think differently philanthropically? And also it affects the asset allocation as well because once you have a certain level of sufficiency and you have a certain part of the portfolio that's going to be your risk control assets, then the remainder, you can think about differently as far as how you want to think about the risk seeking assets, if you will. So different needs, without a doubt, and more complex.

Got it. Okay. The follow-up question here is on the Asset Management side. On the Asset Management front, your total AUM, both C&IS and Wealth have been seeing an impressive 10% growth over the last 5 years. And I guess, I'm interested in understanding your growth strategies for moving that forward.

Sure. Well, one thing that we did benefit from over the last few years is the increasing amount of liquidity that's in the marketplace. And the reason why I mentioned it is because that was a very, again, focused strategy to say we manage a tremendous amount of liquidity for our clients. How can we make sure that we are leveraging those capabilities more broadly. So not just in direct channels, but also thinking about where we can participate in liquidity portals of others. And that strategy really played out well when we went through the pandemic and obviously, monetary policy came into place and you had significantly more liquidity. So that's one of the organic drivers there. The key will be, of course, as we go into the next stages of monetary policy, how do we make sure that we retain those additional assets under management. And there, I would say, I'll highlight 2 areas. One, certainly, ESG. Again, something that we've been doing for some time period, but also I don't need to tell you or anybody else about the trends in that area. So having both the historical track record, but also the capabilities and differentiated ways to approach ESG, we think is going to be a growth trend for us on that front. And we've seen our assets under management there go up from about $80 billion to $139 billion in the last year. So very healthy growth on that front. And then the other I would highlight is quant active, where, again, there, we're building on the fact that we've been working with clients, particularly institutional clients on the index front for decades. And this has been a capability, which we can then add an additional core area for them around quant. And although you've seen certain sector trends around quant, I would say, from our perspective, the business itself and assets under management have grown nicely. It's still off a lower base relative to our total assets under management, but something we expect to grow going forward.

Okay. That's great. We actually did a recent note on ESG and highlighted Northern Trust in there, given the success you've had. You really are standout, at least in my coverage. So congratulations.

Great. Thank you. We appreciate the attention.

So one of the questions we get often from investors has to do with the fact that your business model does integrate both Wealth and Asset Management. And maybe you could talk through some of the advantages of that as well as some of the challenges that, that brings.

Yes. So as you know, our strategy has always been very client centric. And that is a different approach. I mean, many other -- whether they're wealth managers or certainly asset managers are much more product oriented. And so we come at it from a different angle, which is how can we take care of all the needs of clients. Now if you said, what are 2 big trends, again, over a longer time period, one is towards having open architecture. So we're absolutely open architecture because we want to provide the best solutions for our clients. The second is more solutions oriented. They're looking for outcomes, not just give me -- tell me what you're going to do, but actually, I want to know how that performs for me. And so we have to own that. And I would say the combination of the two is what we've tried to build into our approach between integrating wealth management and asset management, which is we look to put together the best set of asset management solutions for the client, whether that's our own solutions or it's external providers, to provide the best outcomes. And when we look at that, it's what are the investment return expectations, certainly, but also what are the risks that would come with that and then cost. So how can we do it in a way that it's going to provide the best value or efficiency in putting together those solutions. So that's been a way for us, frankly, to be more accountable to the client and the performance and the experience that they have overall. So I would say that's the advantage, if you will, as they can think of us as just taking care of those needs. The disadvantage, if you will, of the challenges, we just have to make sure that, in fact, we are focused on what are the best alternatives for them. And we also want to make sure from a regulatory perspective that we have the right separation between the businesses. And importantly, I would say we need to be world class in both. So both a world-class asset manager as well as a world-class wealth management firm.

Now we've talked a lot about the growth drivers in asset management and wealth management, but let's take it from another angle with the lens of C&IS. Maybe you could give us a sense as to what you see as the key growth drivers with that lens? And how you can leverage it?

So on the institutional side, again, have been growing nicely. And I would say the approach is similar, but not the same. But let me break it down as follows. So first, again, great client base. So how do you make sure you retain those clients, which is back to again, Northern Trust, high level of service, get a high level of retention, build off of that. The second is, how do we target? How do we segment the market? And for us, we've targeted segments where we think that we can have an angle, if you will, competitively. So for example, within asset managers, we focused more into that middle market space, if you will, for asset managers, where we think we have a more compelling combination of capabilities to serve that kind of $10 billion to over $100 billion asset manager. Third is, that doesn't mean that we don't work with the world's largest asset managers. It just may mean that instead of going for the big $1 trillion custody or fund administration mandate, we're going to focus on different aspects of their business where we think we can do something, for example, on the alternative side, which enables us to differentiate ourselves. And then fourth, I would say is back to around solutions and innovative ideas, how do we come up with different things that we're not currently doing for our client base that will enable us to broaden the relationship. So more recently, over the last couple of years, Integrated Trading Solutions, where essentially we're allowing those mid-sized asset managers to be able to outsource their trading desk to us. So just one example where we've said, okay, that's a new capability that will give us incremental growth. And then the other thing, Betsy, I would say, if you just look at the institutional marketplace between asset owners and asset managers, what asset owners are looking for at this point as you think about their asset allocation, a large portion is certainly public equities and fixed income. But more and more, it's alternatives. So how can we make sure that as a provider, an asset servicer for them, we can give them an integrated view of that, what we would call front-office solutions, right? Because it's -- the front office can see everything. They don't have to see pieces and add it together. So that's a key aspect of it. The second thing for asset owners is, it's data. We talked about ESG here. Well, if you're an asset owner, you want to understand what you're doing on the ESG front. So how can we provide the data, the reporting to know that, in fact, the managers that they've hired are meeting the mandates on ESG. And then on the asset manager side, I would just say, think about all of the needs that they have. They want to focus on investment management, right? They don't want to be as focused on back, middle office. And so we're trying to make sure we cover all of that. So we call it whole office because we think about it all together in an integrated way, and we want to provide it with best-of-class capabilities. So many things that we would do, but if we need to partner with an OMS, for example, an order management system capability that's not our own, we want to be able to do that with the best-in-class for that asset manager. So that's the big thrust, I would say, in that area.

Okay. And you've been pretty active in building out that capability set over the past decade, I would argue at least, right?

Absolutely. And in building it out, the key has been there, one, similarly, I'll call it an open architecture structure to it because certain areas, again, we think it's best to partner with a best-in-class provider of one of those capabilities. Other areas, to your point, we're going to build it out ourselves and have, and then other areas where we can partner with a provider. So in foreign exchange, we've partnered with Lumint, as an example, made an equity investment with them as well, but that's enabled us to provide a certain FX capability for them. We've done acquisitions. So again, in FX, we acquired a company called BEx to be able to provide that capability. So to your point, we've been building this out for some time period. And now really, as much as anything, it's how do we present that comprehensive solution to the marketplace.

Okay. Great. I'm going to wave my arms a little bit here, maybe I'll lighten up, but maybe not, that's okay. I don't mind it, dark. There's a portal where investors can ask their questions. So if you do have a question, please, in the webcast, type in your question there. And we're going to move now to talk a little bit about what you're seeing in the business from a business perspective in terms of just how fee rates are going, investment spend, fintech, that kind of thing? So this is really a jump ball for Mike or Jason, as you wish. But I'm just interested in understanding what you're seeing in terms of the competitive pricing environment within asset servicing? And how are you able to manage your pretax margin when you consider those kind of asset pricing trends?

Betsy, you don't realize, but Mike is 6.6, and so he is going to win every jump ball if he and I compete though.

Okay.

You can make a joke of me, but I'm glad you made it. So I'll take the first one, Jason, on that. So Betsy, obviously, super competitive marketplace, et cetera. So of course, there will be fee pressure, if you will, for the marketplace. And we have to make sure that we're constantly becoming more efficient to be able to, as you say, kind of protect those margins. But I would make one just important, whether it's an explanation or distinction here in how the business is priced because I think there's the impression sometimes it's just price -- I'm going to call it from the top down. When in reality, it's much more priced from the bottom up. So we don't -- when we approach a new client opportunity or there's an RFP, request for proposal, we don't just say, well, it's $10 billion, how about ex bps on that, and that's the right pricing. I mean that you could get in a lot of trouble if that's the approach. Instead, it's the bottoms-up of what are all these services we're going to provide. We talked about them before. They're complicated. They're complex. They involve technology, they involve people. So you have to build up what is that cost of service going to be? And then to your point, what is the appropriate margin that we need to earn on that? And so that is how, over time, we do it. Now even with that, there's not perfection because you don't know the level of deposits a client's going to leave with you or you don't know how much FX they're going to do. And all of these services may have different margins in and of themselves, but just the overall concept, if you will, is a bottoms up in order to make sure that you, in fact, are growing profitably.

And this is a discussion with your clients. So they're aware of the kind of margin that you feel you need to maintain not only your business model, but the health and quality of your financial position.

Yes. Because to be sustainable, they want us to be profitable, right? And so you're right. It is a -- in the same way, though, Betsy, they're not looking to be the client with the highest margin for the provider, if you will. And so you always want it to be at that level. And that's why, I think, again, over time with good relationships, you're constantly trying to have that dialogue so that it doesn't get out of balance one way or the other. And we've seen a cut -- when I say cut both ways, we're -- in the end, we're providing more services or it costs us more to do it, we need more on price and vice versa, where they come to us and say, okay, this has worked out well. But we, as a firm, we've doubled. And so the fees are up we should take a look at what the appropriate pricing would be.

Okay. Great. All right, the lights are back on here.

You're back in the light. The sun must have risen now. How about that?

It's that ESG thing, right? There's not enough movement in the room. Okay. So let's switch over to investment spend. And in describing what you just did about how you've been building your business fairly nimbly, right, to deliver solutions for your clients. Can you give us a sense as to what that requires in terms of investment spend? And how is it -- is it easier, harder, quicker, slower to earn appropriate return on that investment spend now versus, say, like 5 years ago?

So there's a lot in there, but let me try to address it all, which is -- first of all, in thinking about our businesses, I think it's really important to define what we mean by investment. And the reason why I say that is, to your point, I think in asset servicing, probably the biggest area of investment is in technology. And the way we would define it is we would have defined investment as expenditures today for revenues tomorrow, right? That's investment, if you will, as opposed to an expense. And so technology, we're building something like you said, you've been building up these capabilities straight out and the revenue is going to be in the future. And so that's where you see a large amount. But if you think about the Wealth Management business, it's going to be somewhat different because there, yes, you have some technology. But frankly, when you're doing marketing, and even sales, there's a bigger upfront expense to that in the Wealth business. But once you have the client, over time, that's going to be very valuable. And so that's where you've seen us invest in things like the golf tournament and whatnot. That's an investment to be able to generate future revenues on that front. In Asset Management, again, largely comes in the form of think about like product development. If you're going to develop that quant active strategy, standing start, you don't have the fees that you have to come up with the strategy, you have to do the track record, build out distribution, you may seed the fund. There's a lot of investment that goes into that than later. So we invest in all the businesses. And the job for senior management is to think about how we do it and how we allocate those investments. And so that's how we would think about it. I think to your point on what is it like today versus other times, particularly with regard to, I would say, technology. But just in general, I would say it's probably harder now. And the reason why I say that is there's more that can be invested not just by ourselves and others with a, I'll say, lower opportunity cost in the sense of returns elsewhere are lower. And so as a result, there is an incentive for others to invest in something today that's not going to return, but will return later. So it makes it more -- you have to invest more is kind of the point if you want -- and you have to be willing to do things that are long term. And then to your point of the turnaround, I wouldn't necessarily say it pushes out further. I would say the time period has been segmented in much shorter time frames. So there's less of, Betsy, the big build, right, 5 years developing this one big thing and then you're going to turn it on and all of a sudden it's going to work, instead in the digital age, it's much more, okay, here's the capability we're going to add, what is the business proposition that goes with it. And then did that work? Did it not work, then how do we do the next one? So we try to break that up into smaller chunks to be more efficient in how we think about making those investments.

And so given that, is scale as useful as it used to be? And does customization mean that it's a little bit harder to get to that ROI that you're looking forward?

Yes. So on the scale part, I absolutely need to get scale with these investments. So just meaning whether it's big or small, so much of it is, if you have to replicate that expense straight through constantly, then you're not going to get the return. And I would say, again, digital lends itself to scalability. And so I see this as all positive in the sense of making the business more scalable overall with the types of investments we're making. And then to your point on customization, I think you have to be really careful on not trying to customize everything for everybody because you'll never be successful in that. And so you have to be careful. But once again, I think digital, a big part of digital is the ability to kind of customize at scale. And we have to do that just like I'll say the largest technology providers have found a way to customize something to you as an individual. We have to be able to provide something where the client, whether it's a Wealth Management client or institutional client that says, "Wow, this is just the way I want it." But from a data perspective, the anticipation of my needs, but then how I want to interact with that technology. And a very good example of that would be the whole digital effort that we have underway in wealth management is trying to make it much more oriented towards how a user interacts with us as opposed to the other direction where it's like we're building a platform, everybody needs to use it the same way.

Got it. Okay. That's super helpful. I have a question on tokenization, which if we have time, we'll come back to that. Mike, but I'm going to give you a little breather here, a little sip of water time for you, and I'm going to move over to Jason. And just a couple of nuts and bolts questions that we have, Jason. The first is regarding just where rates are, right? We've got the front end of the curve down another 2 to 3 bps from 1Q '21. And just want to get a sense as to whether or not that's big enough to move the needle on revenues for you?

Short answer, yes, it is. A lot of what we do for our clients is around liquidity and the rates have a big impact. And so it probably has less of an impact in intra-quarter or a sequential quarter move at the very short end on the balance sheet, frankly. But if you look at something like waivers, and at the end of last quarter, I think we were at a $65 million to $70 million run rate. And now if we look at where we are, rates are down, we've got overnight repo down printing, 0, minus 1, minus 2, that run rate is closer to $80 million to $85 million on a quarterly basis. And so again, that's not a -- that is not a guide or a prediction of what the quarter will be. It's just a sense of as of today based on the AUM we have and what the yield curve is and what yield we're getting on the portfolio, that's what we're waiving on a quarterly basis as of those functions today. So it does have an impact. And then in other ways as well, but the biggest one and the one I think people have followed mostly is on waivers.

Okay. And then in this low rate environment, you've got some pressure there like you just mentioned. But on the expense front, I just -- I guess, I wanted to understand a little bit more about some of the actions that you took at the beginning of the year. And how you think about expense management as we navigate through this period?

No, it's a good way to think about it, I think, sequentially going back to the beginning of the year. And I always try and think through the expense components, and we all internally talk about them in a few different ways. We think about operating leverage and fee operating leverage. And obviously, at the top of the house with rates being so much lower, it's not just waivers, but obviously net NII is down. And so getting full operating leverage is going to be virtually impossible given how -- given the significant decline that we've had in rates. Now that said, if you continue to think through the announcement we made in January, we're executing on that program well. And you saw actually from fourth quarter to first quarter, we actually saw a head count down for the company. And so the execution of that program continues to go well. If you keep going down the income statement and think about things like equipment and software and particularly outside services, that's an area where we are seeing an increase, and part of it is the technology journey that we're still on. And so in outside services, you're going to see subcustody, you'll see market data, you'll see clearing costs, you'll see consulting. And we break those down into being driven by probably 3 different factors. The first is macro factors. And so that's going to be markets and FX rates, and that has put upward pressure on that line item. And secondly business growth. And we've talked about the fact that business growth has been good. We've seen good organic growth. That in and of itself is going to put upward pressure on some of the line items I mentioned, things like subcustody, market data, in particular. And then the third element within outside services, think about underlying investment in the business. And that might be where we're investing in technology, other dynamics, that's seen a step up as well. And so you put all 3 of those dimensions together, and we've seen a meaningful uptick in that line item. So fourth quarter, we were at $205 million, $208 million. We're going to be above fourth quarter run rate, I think, in second quarter, at least that's what we've seen so far coming into second quarter. And so different components of the income statement from an expense side are performing differently. I think the continued execution around head count management and compensation and benefits in general, but then seeing that uptick in things like outside services and equipment and software.

And some of those expenses, like you mentioned, are investment spend oriented, some of them are supporting the higher level of activity that clients are doing with you and new clients. So you've got some fee line items that should be reflecting some of that activity as well. Is that fair?

Absolutely. That's the second component that I mentioned, the business growth. We should not only -- there should be good leverage in there, frankly. And so there's definitely revenue attached to that, and so we should see profit relative to that expense growth. But -- and then also the macro factors, sometimes that's going to lead to higher revenue as well. If you think about market levels being higher, we're obviously going to see trust fees also higher as a result and to the extent we've got our pricing tied to equity markets. And then the third element is more where the investments are. And so each one of those in different ways are performing differently. But I think it's a good way to approach those line items, both equipment software and then outside services, which I talked about a lot more directly.

Okay. Great. Thank you. So we do have 2 questions. One on -- from the audience here, just regarding the outlook for how you're thinking about your capital stack, especially as we move towards the CCAR next week? We know that you have a history and a goal of having extremely strong capital. But how should investors think about what you're going to do with that and utilize that extremely strong capital as we move into this new framework, this new SCB framework next week?

I think it's we -- I don't want to be too repetitive in how we've talked about it recently. So let me do that super fast. But we think about 4 components, mostly one, we think about the absolute level of capital. We talk a lot about where we want to be. And secondly, we think about things a lot on a relative basis. We keep a strong eye on where our peers are. We want to be able to go to clients and prospects and evidence quantitatively that our capital levels are strong. And then we also are engaged with regulators, obviously, looking at what -- at the landscape, which gets a little bit to your question. And then obviously, we've got a capital adequacy committee of the Board, and we don't want to be presumptive in assuming that we can inside do something and that's not aligned with what they would want. We've been 100% aligned with them historically. I just don't want anybody to think that we're acting unilaterally. Now that said, as we think, going forward, I think there's been something good learning as you think about Northern's balance sheet, which is that oftentimes people think about the ratios just as the top number and what's happening with capital, what are you doing with share buybacks or dividends. But the denominator can move as well. And for us, if you think about what happened with RWA from fourth quarter to first quarter, and you saw an uptick there, and that was driven by client activity. It was driven by clients who wanted to do more borrowing with us. And obviously, the deposits that come on creates more RWA impact as well. And so part of the way we think about our capital management isn't just how much capital we're going to retain, but the amount of business activity we're doing with our clients that's reflected on the denominator, and that's reflective of the growth that we've had in the business. And so it's another way to think about capital, not just share buybacks, dividends, but it gets back to the how do you invest in the business in growth in a way that actually reflects your capital levels.

So we'll need to wait for your announcement on buybacks.

Yes. You would need to wait for any announcement on buybacks.

Okay. All right. Last, Mike, just to wrap up here. The reason I have this question on tokenization is, I do feel that tokenized assets is something that could impact you across Wealth, Asset Management, C&IS. Maybe you just give us some thoughts on how you're strategically looking to incorporate tokenized assets into your work?

To your point, Betsy, it absolutely affects us across all of our businesses. And that's the nature of working with clients on their investments and managing and administering those is that the capital markets constantly evolve and innovate. We have to be in a position to both be able to help them do what they want to do, but also have a perspective and provide on that front. So I would say, in asset servicing, it is all around the capability to be able to administer those assets. So we are already a fund administrator for, I'll just call, those types of assets. I'm going to use the broader digital assets as opposed to just picking out one aspect of it. So we need those capabilities. And as you know, we've, I'll say, done things on our own, where we have our own proof of value on something like private equity where we did distributed ledger technology, and we're working with Broadridge on that. We've done it in partnership except -- we'll continue down that path on that front. I think with our Wealth Management clients, you heard me talk about goals-driven wealth management and either risk control or risk assets. And candidly, right now, we're not sure where something like a cryptocurrency or NFT fits in that. And we don't see it -- for a lot of reasons, we don't see it fitting in one or the other. And so at this point, it's not part of, I'll call, that asset allocation. And then I would say from an asset management perspective, you heard where we are focused, we try to stay focused. And my point is to just come out with an NFT fund or whatever, even a crypto fund, like you could try to do that just because that may be a trend, but it may not be the right trend for Northern Trust Asset Management. So think very consciously about this. And I would say it's going to evolve over time just because the markets evolve over time as well.

But importantly, you're well underway in several of your businesses to enable?

Absolutely. Absolutely.

Okay. Great. All right. Mike, Jason, thanks so much for joining me today. I appreciate your time and hope you have a good rest of your day.

All right. You too. Thanks a lot Betsy.

Thanks Betsy. Congratulations on the conference.

Thank you. And look forward to next year in person, hopefully.