Northern Trust Corporation (NTRS) Earnings Call Transcript & Summary

Good afternoon, everybody. This is Gerard Cassidy with RBC Capital Markets, and I want to welcome everyone to our financial institutions conference. With us today, we're very fortunate to have Northern Trust. Most of us know Northern Trust as obviously one of the premier banks. I always remind investors that during the financial crisis, there was only 2 -- of the top 20 banks, there's only 2 large banks that did not cut or eliminate the dividend and Northern Trust is one of those banks. It just shows you the strength of this organization during volatile times and that's important to note in considering what we're seeing today. The company has about $18 trillion under custody. Its market cap is just over $22 billion and it trades about 2x -- a little bit over 2x book value and has a dividend yield that's about 2.6%. Many of you know Jason Tyler, who is the CFO. He's been with the organization a number of years. Thank you for joining us. And currently, as I said, he is the CFO, but was at one time, the Head of the Corporate Strategy as well as the institutional group in the asset management area. Joining Jason, we have Pete Cherecwich. I apologize, Pete, if I butchered your last name. He's the Executive Vice President of Northern Trust Management Group in Chicago. He's also President of Northern Trust Asset Servicing. He joined Northern back in 2007 and has multiple decades of experience in this business. So, gentlemen, thank you for joining us.

Thanks, Gerard, and congratulations, Gerard, on a great conference. You hit the timing right and I'm glad. I know you want to be in person, but I'm glad you've got such good attendance. That's great.

Thank you, Jason, I really appreciate that. And again, you guys being involved is never taken for granted, so thank you very much for the support.

Maybe we can open up the discussion with a broader macro question, Jason. The worst of the pandemic appears to be over fortunately for all of us, but they're still lingering labor and supply chain issues. I think I saw the JOLTS number today, still over 11 million jobs available out in the United States and we still have 6.5 million people unemployed, so that labor inflation is there. We all see what's going on with inflation in the price of oil. The conflict, of course, in Ukraine is terrible with Russia and that's also making things more volatile. So maybe starting off, can you share with us what you're seeing or hearing from your clients. And same thing, Pete, from your side, what you might be seeing and hearing from clients as well. But I'll pass it over to you, Jason, and we'll go from there.

Thanks, Gerard. And I'll focus my comments more on our wealth clients and then Pete can address that question more from his institutional clients. And from our perspective, clients when things are volatile, as much as -- look, it's heartbreaking to see what's happening. And -- but it's actually, in some ways, it helps cement our relationship as advisers for our clients on the wealth management side. When things are volatile and uncertain, even large sophisticated investors, they want advice from experts. And that's more than anything else, what we're sensing is people calling and saying what could happen next, what could go wrong? Am I positioned well? Are there things I should be thinking about either to react or to think more proactively? And we have this goals-driven wealth management framework that's extremely driven to think about long-term goals and to think about sufficiency of assets and it makes the conversations easier in times like this. So, a lot of inbound calls and us reaching out to clients to just recommit to the strategies we've put in place for them.

Very good. And Pete, what about -- from your side, what are you hearing from your customers and clients?

Yes, it ranges. And I guess I'll go through both tactically what's happening, a little bit strategic and then some of the opportunities. So tactically, obviously, clients are worried about cyber, ops resiliency, frankly, settling trades, but there's still a number of trade fields out there and doing FX. So, you're working through all that. But like OA was focused on capital after that crisis, with the pandemic and now the war we have, really, everyone is focused on ops resiliency, vendor management. Not only do you have people in Ukraine, but do your suppliers have people in Ukraine. So you've got to be able to answer all those questions. From an opportunity perspective, though, when there's always volatility in the marketplace, generally, people are looking at things like, well, inflation is going up now, so they have cost pressures. And that's creating more opportunity, more conversations around outsourcing. It's creating discussions around organizations that want to understand their risk and their liquidity. So they look to us say, "hey, can you provide this report? And I say, Gerard, what we're trying to do is we set up a new group really focused on what we call a whole office. And if I can simplify it, I would say it's all about creating solutions for clients, not selling products, but really going in and saying, okay, we have products and solutions from the front office to the back, what do you need and coming up with that solution, but we are seeing more and more clients take us up on that.

Very good. No, that's good to hear. Jason, when you look at what the Federal Reserve is moving to, obviously, we had monetary easing during the pandemic. Now we're entering a monetary tightening period that may even include a shrinkage of the balance sheet, quantitative tightening. When you look at it, what are the risks, as we shift, do you think for the markets and for your business maybe as we shift from an easing stance by the Fed to a much tighter stance that may lead to a shrinkage in their balance sheet in 2022 -- second half '22 into '23?

Yes. Well, it's interesting, you posed the question in a good way because I think there's subtle differences between policy tightening versus quantitative tightening and it's a subtle nuance, but the policy-oriented actions, I think, are more predictable. And I think the Fed is going to -- it's very easy for banks to react to that. I think that we all have played through scenarios of shocks and what's going to happen. And -- but I think when the balance sheet of the Fed is shrinking significantly, that's an area we haven't had as many repetitions looking at and the extent to which that could pull money out of the system. One of the things is it just causes banks to have to be more thoughtful about liquidity and make sure that they're not just poised well for a rise in rates, but also a potentially reduction in size. And I tell people the rate impact plays through, but it's the volumes that we all have to watch to be careful. And so that's the one thing that we're watching closely just to make sure that things go in a way that we anticipate and we don't have these 3 standard deviation move. That's why having good liquidity and capital is helpful.

Absolutely, very true. Maybe shifting over to Pete for a second. It looks like the growth in your business in asset servicing has been pretty diversified coming from multiple geographies and client types. Pete, can you discuss how you think about the overall growth strategy for the asset servicing area at Northern?

Yes. So I'll start off by saying if we think about last year and I think C&IS asset servicing fees were up around 15%. And obviously, that growth was helped by the macro environment. But more than a third of that was organic, which is us winning new business and growing our business with existing clients. So, that's first. And how do we do it? We really have a 4-point strategy. Number one is you have to retain your existing clients. It's hard to win clients in this business. If you can't keep your current clients, you have a problem. You've got to keep your clients happy, you got to focus on service. Number 2, you have to innovate and create new products. So, our outsourced trading solution called Integrated Trading Services; Front Office Solutions, which is the new product that enables an asset owner to look at risk and performance across asset classes, both public assets and private and that's a nirvana. Can you truly look at your risk and everything, not only at the fund level, but actually on all the underlying holdings for all of your private equity investments, et cetera, putting that into a vehicle that an asset manager can understand, we've built that. Third piece is you have to win new clients and we need to basically really be the premier provider for the middle market. And when I say the middle market, I'm going to define that really loosely $1 billion to $150 billion, right? But really, it's more those organizations that will buy a huge suite of our products, where we could go in and sell a solution to, they're looking for a solution for everything we can provide, not looking for the cheapest price from a commodity products. And the last piece is there's a lot of big organizations out there that have trillions and trillions of assets under management or their sovereign wealth funds, we need our fair share. So we want to be in those relationships. They may have 5 custodians, they may have 3. We want to be in the game, getting our fair share and ticking that box. So that's our 4-point strategy.

Got it. And maybe just following up on that. When you look at the new business wins over the years or the last few years, how much of it was the existing clients adding to the product suite that you've offered to them versus just new customers or new relationships that you have developed?

That's a good question. So, we're approximately -- 60% of our organic revenue growth is coming from existing clients and 40% is the new clients. But if I can expand on that a little bit, I guess, I would say on price, we don't win on price. We're never the cheapest. We're not the most expensive. We try to be in the middle, all right, and be competitive. Where we win is on service and quality. And we did a statistic. We went back the last 18 months and we looked at every time we get an RFP, to be fair, there are lots of times where a client may not have an RFP or we may not get it, right? But if we got an RFP and then the client made a change because there are times where clients do an RFP, they just stay tight, right? But if the client made a change and we got the RFP, our win rate is 74%, which is astronomical. But then you say, well, why is that true? Well, it's because when a client in this industry makes a change, generally, they're unhappy because of service. Now there may be a good capability that they're moving for maybe something else that happens, okay? But a lot of them is because of service. So if you're going to make a change, you're going to go to. You kind of go to the organization that's known for service. And if you don't mind, a few more points. back to the 40% of new clients, we're really trying to get more names on the roster. And what's really interesting is how the innovation and getting their names on the roster has changed. So, having grown up in this industry, we always thought about cross-sell, right? A cross-sell was always, you win the custody mandate and then you cross-sell them. But if I told you that, for example, Fundsmith, big asset manager in Europe, they were first a brokerage client. They used us for their integrating trading solutions. They outsource brokerage to us and then we cross-sell them custody. So we can coin a new term, the reverse cross-sell. But that is what it's all about because it doesn't matter what product you sell, you just build a relationship and then good things happen. But the other thing is we have to get creative in terms of how we get new relationships. Another example will be Wilmington Trust. So Wilmington Trust, a platform for DC. We won them last year. They have 42 underlying asset managers on their platform, 23 of those were new relationships for us. Now, it's only a few funds each. But you know what, we can now knock on the door, talk to them, do a good job, maybe it takes 2 years, maybe it takes 10 years, but we will slowly break in, get more revenues and build that relationship. And if I can just conclude in terms of the variability, I think just over the last few weeks, different things that we've won. We won an EMEA custody client, where we just launched our Swiss branch license on the back of our UBS acquisition. We now have a custody license in Switzerland. And so they're going to do outsourced brokerage custody and FX. A asset manager, bought another one. They're going to move on to us. We have a new client in Ireland. We won an asset management in the U.S. for the middle office. They just awarded us their -- won a big U.S. defined benefit plan. And a university endowment bought Front Office Solutions from us. And that's all in the past couple of weeks. So very, very, very global and those are all new to us. Some takeaway, some brand new.

No, very thorough. That was very good. Shifting back to Jason for a moment. It seems very obvious that the Fed will raise interest rates as you pointed out in your earlier comments about monetary policy. And can you share with us -- I think on the fourth quarter earnings call, you mentioned that a 25 basis point increase would lead to about a $35 million increase in net interest revenue. I don't know if there's any updates to that. But the second part of the question I wanted to ask you was you also indicated that investors should recognize, it's not a linear relationship in further rate increases. Maybe if you could expand upon your thinking there as well?

Sure. So first of all, no update to that number, it's still directionally right. And then secondly, I think the first rise has a very meaningful impact. And it's frankly not even just on net interest revenue, it's also a big impact on fee waivers, which we can come back to if you'd like. And -- but incrementally beyond that, the next ones have less of an impact. And after a few, it becomes -- the net interest margin will level out and it will -- and the incremental lift will be close to zero at that point. So the first one really important; the second one, very helpful; beyond that, very, very diminishing incremental benefits. And that just comes from the fact that as we've compressed down and our funding cost and our client yields and costs are effectively at zero. And as we start to lift the clients, we're likely to have most of that first rise. But we're going to share. And frankly, we'll share in the increase differently in the businesses. There are some clients that are -- where they've got money that's more in an investment mode, and they're thinking, where can I get the highest yield. And there are other tranches of deposits that are more operational, where the deposits are there because of our capabilities and they're less fee sensitive and less yield sensitive.

Yes. No, very helpful. Actually, since you brought up the -- and I know you've discussed this already, but to remind everybody about the fee waivers, just how sensitive they are to rates? And if you can remind us that trajectory of rising rates and what it will do to eliminating the fee waivers?

Yes. Well, I think to level set we're -- how ours are priced, a lot of the clients in Pete's business, even in our asset, even in our wealth management business, they're very large tickets and they're very large depositors. And so they're all priced very institutionally. And so that will mean that, in general, we've got instead of 50 basis points in fees that we're waiving, we might be waiving 15 or 20 or 25. And so, it only takes one hike for us to start to be able to eliminate those waivers once we've played through the duration in those funds. And we get some benefit leading up to it because the yield curve is anticipating and then it takes a little bit of time afterwards. But once one hike is in place, we get close to done. Now, there may be instances with the funds or we put one or 2 on sale, and we continue to discount fees, but that's not meaningful. The vast, vast, vast majority of the fees will go away once we're able to reinvest through one hike. And just -- I can give an update if it's helpful on numbers where we sit right now in the quarter, we've waived already this quarter $45 million to $50 million in fees. You extrapolate that to $65 million-ish, but our run rate on a quarterly basis is already down to $45 million. And so you tell, we're already starting to -- the rate itself is already improving based on the anticipation of rate hikes coming.

Got it. No, very helpful. Coming back to something you mentioned when we were talking about quantitative tightening when the balance sheet of the Fed shrinks. Is there any kind of correlation that you can give us? Because you mentioned operational deposits, which are sticky, they're not going anywhere. But we all know the system saw a huge surge in deposits due to QE. Do you have a sense that if that balance sheet of the Fed by the end of, let's call it, 2023 was to decline by $1 trillion, what type of deposit impact? Do you sense some of your deposits would run off?

Well, a couple of things. It's -- I mean, first of all, this is the question we -- Pete and I and others debate a lot over as we sit around and have lunch and talk about what's going to happen with rate rises. But there's a lot of factors that play into it. And so even the equity market levels, Gerard, I think, play into it. And some of this is just asset allocation. And I think people have failed to appreciate the impact of that and how the Fed putting so much money in the system led to more money supply, but at the same time, people have more assets. And investors had more assets, so they were just allocating more to cash and that will persist. Those higher levels persist relative to pre-crisis levels. And then secondly, just the yield environment. And we -- a lot of investors were seeing zero interest rates, not only overnight, but through a year. And you look now and you see one year at 110, and that wasn't the case. And so now the decision point of do I keep money in cash or not? So it's all these things play in. And so I actually think this concept of quantitative tightening is one important factor, but I think we've got to appreciate the others as well. Luckily for Northern, so much of our business is providing and managing liquidity for clients. So, if a client decides they're going to leave overnight and they're going to go to a 6-month duration, we've got ultrashort funds and we've got really good fixed income capabilities. And so, we still capture that. The economics are different in those funds. But our whole thing is we want to continue providing those services for clients. So, it's not as if the economics for us, if a client decides to move money out of cash go from the 2% margin -- some margin to zero.

Okay. Got it. Very helpful. You touched upon the money market fee waivers in the quarter. Maybe if I know and Northern doesn't give long-term guidance, of course, but are there any updates you'd like to share with us on the quarter, as well as any comments on loan or deposit trends?

Maybe I'll start at the end there. And deposits, actually to the conversation we've been having over the last few minutes have been relatively stable relative to the prior trends we've seen. And I think that's of note. And then the loan is different. And I always try and remind people just how spiky our volumes can be because our clients are so large. And what the activity, if you have one, 2 or 3 ultra-large clients moving in the same direction, it will show up. And we have similar trend and particularly in that very upper end of wealth management in loan volume, where we've seen some payoffs there. And that payoff has been -- it's been moderately mostly offset by organic activity that continues to show growth. But I always say on both loans and deposits, we'll see those spikes, and we've seen more large concentrated payoffs in GFO than we have historically.

Got it. Very good. Pete, coming back to the servicing business, with the U.S. focused portion of that business, many investors kind of look at it as a mature business and not many growth opportunities. Do you agree with that kind of assumption? And what areas in the U.S., do you see some opportunities for growth?

Yes. So it is a mature business. There's no -- I'm not going to argue with that front, right? But I think we're in a unique situation to still have some growth. So, if I think about our funds business and we're #2 in Ireland, #2 in Australia, right, great book of business, at top 3 and maybe #1 in U.K., I forgot. So -- but if you go into U.S., very small footprint in the U.S. funds business. So we're underrepresented. So taking away business is still a big possibility for us. And frankly, on that asset manager side, middle office is still growing. So, the pie is getting bigger from middle office outsourcing. It's getting bigger for the outsourced trading. So, there's still opportunities there. But for us, the asset owners, too, there is a trend over the last few years where asset owners have moved from -- especially endowments, for example, have moved from hiring HR, the HR person hiring consultants and doing their endowment whatever, to proper CIOs, who now want the infrastructure, I'm doing all the investing. And so our service model, combined with all of our technology is really hitting the mark with a lot of these CIOs that are in asset-owner organizations. So we feel there's a big growth opportunity there as well.

Got it. How is your business, even though I know you could argue that there are obviously 3 publicly traded custody banks and then you have the 2 giant universal banks, J.P. Morgan and Citi. So there's 5 major players. And so sometimes people get the misunderstanding that it's not a very competitive business, which in fact it is, as you guys know, being on the front lines. Can you share with us the pricing dynamics? Or what are you seeing on the competitive front from pricing? And how that can maybe compare us to 4 or 5 years ago? And then as part of that answer, too, did the pandemic changed the pricing dynamics at all in either a favorable or just favorable way?

Yes. So nothing's changed. It's been competitive. It continues to be competitive, all right? I would say our -- we've gone out there and we've raised these in some cases, right? We've put inflation adjusters in some cases, but they're on the edges. all right, in terms of where you're successful. The overall trend is pricing continues to go down a couple of points a year on average that you've just got to be able to absorb. And on the competitor side, there's a lot more competitors out there now that the technology companies want to do servicing. So they're all starting to try to take a little away from. So it's not just even the trust banks, everybody wants to play in a piece and you've got to decide as an organization where you're going to play, what's the solution set, sometimes maybe partner with somebody, right, and have them do a slice, sometimes try to do it yourself.

Sure. Very good. Jason, coming back, you mentioned, obviously, the loan topic on the quarter with some large clients paying down loans. But in 2021, you guys had some really good loan growth. I mean, it was like a reinvigoration of loan growth for Northern Trust. But on the January call, I think you just kind of talked about '22 being a little slower. Can you talk to us about what was one of the philosophies behind the '21 growth and how that might be changing a little bit in 2022?

Yes, sure. So we felt that our clients' activity was being done. And I think sometimes they wonder what we really want to be doing with them. And if lending was something that we were doing reluctantly. I've talked about the fear that our clients thought about it as reluctant lenders and we wanted to debunk that. And so we extremely deliberately went back to clients with the message that when they're growing, when they have activity and they need a source of liquidity that we want to be a provider for that. And so it was zero change to our risk appetite. It was no change at all to the type of lending that we were doing. It was all about messaging and about a more concerted effort around that. And there's just a natural progression where we knew that there was some activity there that we'd get. And at the same time, there's a life to that. And so we feel like that's -- we've gotten a lot of that step up. The message is out there, and I think we're still going to have higher growth over the long run, but not nearly to the extent that we had last year. And we went from mid-$20 billion in loans to $35 million, $40 million. This is a significant growth and it was great to see our clients felt, who really need to be able to participate with our clients in that environment. And so -- but this year is going to be different. And we know there's a lot of different things across the income statement that are changing. And I think net interest income, net interest revenue will be a positive and -- but not with the same growth that we've had.

Got it. No, very good. I know one of the hallmarks of Northern is the strength of the capital. It's just -- that is one of the -- something that's dear and close to your guys are. So maybe you could just talk to how you manage capital to capital allocation? What your thoughts of share repurchases are, dividends, et cetera?

Yes. A lot of it is us wanting to be -- we want to be strong relative to our peers, we want to be strong for our client. Even the conversation Pete's having, he's going to clients and they're contemplating putting potentially hundreds of millions or billions of dollars on to our balance sheet. And the sophisticated ones don't think about that as a deposit. They think about it as they're lending money to Northern Trust. And it's not insured. And so we want to look as strong as our brand is in that area. And so that's one. And then secondly, if you think about it quantitatively, the first thing we have to do is look at what our earnings look like, what a dividends cost. After that, we can look at what's happening with OCI and we can look at what's happening with our opportunity to buy back stock or not. And then where do we want to target the balance sheet to be based on the growth in the business. And so it's a perfect question because the growth that we had in the loans, it consumed a lot of capital. It consumed a lot of the earnings that we had last year that was deliberate on our part. We got good returns from it and more importantly set up very well for future growth and with those clients strategically. And so that's the way we think about it, is to where do we want to target a good CET1 and Tier 1 leverage, what do earnings look like, take care of the dividend, take care of OCI and then what business growth is leading. And then you can say, what do we have left for stock repurchase. And so those are good conversations for us to have. Even as we think about this coming year, we think earnings will be strong. We're still going to have growth in expenses that will come from the -- even the inflation we talked about before, that will play through. We hit it on the comp line and that will continue to play through. The first quarter has -- it's got retirement eligible compensation, which is more seasonal elevated levels. We saw compensation increase last year. So, we'll see natural progression there. We're continuing to invest in technology, but we've also managed expenses to trust fees in a way that we think the profitability of the business is as strong as it has been in the last 10 years. And so a lot of good things going on across the income statement and capital management.

Got it. We're running out of time, but I do want to try to get one more question in, which is -- and it kind of ties into capital. What kind of -- what are some of the M&A opportunities that might be out there? What might Northern be interested in? Obviously, you've been an acquirer as we all know. So maybe to close out on your thoughts on M&A.

I'll do it super fast on wealth, and I know we're at time in wealth and in asset management open for business. And I think particularly in the wealth side, it's about finding high-quality, very large clients. And we feel really good about our capability set. And so filling in the right geographies, but finding the right clients. We feel great about the offering we have, the quality of the people. So we should -- we're so interest there if the right thing comes up at the right returns on capital. That's key for us. Asset Management, similarly, strong focus on ETFs and strong focus on growing the business in other areas strategically consistent with what they've been looking for, particularly around third-party distribution and in other areas. Pete, you're going to wrap this up?

Yes, we get a scale from technology and frankly what we do and don't do. We're not going to try to compete and try to be a $35 trillion asset custodian. So, we will look for not just add-on assets but add-on capability. There's a small capability we need, small geography, happy to look and do that, but we're not going to go out there and just grow it for growth's sake.

Well, with that, Pete, thank you. And Jason, this has been a really good content. And once again, greatly appreciate you guys joining us this year. And if you can join us again next year, hopefully, it will be in person and then that would be great.

Congratulations, Gerard, on a great conference. I'm really happy to be here.

All right. Thank you, Jason. Okay, we'll see you. Take care.

Thanks.