Northern Trust Corporation (NTRS) Earnings Call Transcript & Summary

Good afternoon, everyone. Thank you for joining us. This is our first fireside chat following lunch. And again, I want to thank Jason Tyler, Executive Vice President and Chief Financial Officer; from Northern Trust joining us once again. He's been a good friend of this conference over the years. So thank you, Jason. Now Jason joined Northern back in 2011, and he's been the CFO since 2020. And just a couple of stats for folks. Northern now -- about $155 billion, market cap of $20 billion. And even on an adjusted AOCI book value and tangible book value traded at about 1.7x stated book and 1.8x tangible book forward earnings base is about 13x, which is a nice multiple. But Jason, thank you so much for coming.

Absolutely, Gerard. Good to see you in person. I remember digitally last year being on screen -- but I want to hear about how the conference is going. This is year 27?

Yes, 27th year. And I was saying earlier that we started out and Martha's Vineyard 27 years ago with about 30 companies and 70 investors, and this is our best ever, over 300 investors have registered in over 120 corporates, and I want to thank you for being a part of that.

It's great. I always look forward to this -- congratulations -- it's also really great to see everybody in person. So good conversations this morning.

Great. Super. Maybe we could start off with interest rates. And obviously, your firm, like all of the custody banks have a very intense interest on what's going on with the yield curves as well as the direction of rates. Can you share with us what's the ideal interest rate environment for you guys? What's the Goldilocks scenario?

Yes, I do think about it as a Goldilocks scenario. And people ask about -- our Treasurer asked me about this a lot, what would be ideal -- so if I could pick, if I was a master for day, I'd say, one, low rates are bad. And so in general, when Fed funds gets below 1%, not good. And so the most important thing is we want to see rates above 1 point. The next thing that's important is to look at the steepness of the curve. And if you go back to a few years ago, the very flat yield curve also worked against us. There's just nothing you can do with the ability that banks have to extend. And then the third dynamic is the velocity of change in the yield curve. And so for us, we saw that rear itself in a tough way with rates going up so aggressively. And I think every bank got surprised by the velocity of the rate increases. This time, we'd all plan for those types of scenarios, but this is actually the closest to an interest rate shock scenario that you would have -- that you could imagine. So it's a slower pace but getting to attractive rates above 1 point and then -- but some steepness to the curve. The last thing I'll mention is that the why how rates have gotten to where they would be. And you can see in this hyper -- in this environment where the Fed is clearly fighting hyperinflation, you have to worry about the implications of the economy and of credit if things are -- if rates are at that point because of those negative dynamics?

Yes, absolutely. And when you look at this rate outlook or just how you're thinking about rates, how are you thinking you're managing the balance sheet now for the next year to 2 years. Is there maybe a rate cut and even though it didn't sound that way today, of course, but maybe is there a rate cut coming in '24? And just how do you guys approach managing the balance sheet?

The best way to approach it is to think about different scenarios and position the balance sheet so that you're following -- you have the ability to do what clients need. And we just -- we like to think that we're positioned for rates going up for rates going down. And so we're not picking scenarios. We're more picking a mid-spot in a range of what we think might happen. And if you think about our balance sheet, probably 2/3 of the securities portfolio is long the way we classify it. And so that in and of itself positions us well for movements in rates. But the biggest thing that we have done a that came to pass when the overall industry was under -- we would classify as stress scenarios, just quick movements. We were able to be there for taking on deposits and also providing loans to meet client liquidity needs. So that's our biggest litmus test.

Got it. I know normally doesn't provide earnings guidance like some other companies. But is there anything you'd like to say about what the quarter is looking like for the full year for Northern?

Yes. The only thing is it's relatively soon since we talked last time, but the capital markets activities have been light. And that's impacted. It impacts revenue for us in a couple of different ways. It hits custody and fund administration fees because part of what our clients do isn't just a custody for us, but they're working on through transactions that we often charge for. And then it hits in trading, obviously, but most directly, it will hit in foreign exchange revenue for us, and that's tracking meaningfully lower than fourth quarter. The way it's tracking right now would come in about $10 million lower than where fourth quarter FX was. But otherwise, in terms of expenses in the balance sheet, nothing to update.

Got it. When you look at the new business wins that you guys focus on as well as your peers, how important is growing the business from existing customers versus an entirely new customer that comes into the organization?

Over time, super roughly 50% of the new business will come from new clients and 50% comes from existing clients. I think that surprises people. But if you think about what our existing clients are doing, in the asset servicing side of the business, they'll -- asset managers are opening new funds all the time. And that creates new activity for us, and they're also opening new locations. That creates new opportunities for us. So a lot of activity coming from our underlying clients growing. It's a big component of our growth. And then in wealth management, there's a lot of activity there. So a lot of our clients in wealth own successful private businesses. And as they're reaping rewards of dividends and growth, they're often sending us that liquidity to manage and that creates more growth opportunities for us as well. And so the growth of our underlying clients is you just can't be overstated in terms of our fundamental growth profile.

Yes. And you're unique compared to your 2 primary peers that you're often compared to, of course, Bank of New York and State Street in that you have a loan book and you've got corporate customers. And you just touched on that wealth part. How interactive is it between the wealth management side and your commercial borrowers? Is that an important link that you guys foster?

Yes. It's good to bring that up because I think the deposits we have are disproportionally they come from the institutional side of the business. And frankly, the foreign office time deposits come as, I think, probably a surprisingly high percentage of our overall deposit base. On the lending side, it's actually the reverse. The majority of our funded loans come from the wealth business. And it's a couple of categories I would mention or a couple of examples. One would be we've got a lot of clients that might be investing through us and they want to buy a second home or a boat or a third home or invest in a business and instead of liquidating the assets that they have with us, we can work with them to leave those assets in place, not take gains on those, provide the lending, that happens a lot for us. The second category will be a lot of our relationships do start with lending. And we want to make sure that quickly, we get into an extremely holistic relationship, but a lot of our wealth clients are still accumulating wealth. They're still running private businesses. And so we're lending to those businesses in the form of C&I loans, commercial real estate loans. Again, that's generally tied to liquidity that they have or we anticipate them having in short order.

Yes. And speaking of winning new clients and bringing them on board, -- what are some of the product areas that you have the most success, not necessarily just wealth management, but when you look at your entire organization.

Sure. So let's start on the asset servicing side and maybe 3 things all the out. One, integrated trading solutions is something that people have -- that you can see over the last few years has actually done really well for us. That's -- it's exciting for us because we're then working with clients in some ways, acting as an outsourced trading mechanism for them. And so they can focus on developing their best financial models or best investment models. We can help them on the execution of that. It's been a really nice growth vehicle for us over the last several years. And the client count now is getting -- is at an attractive level. And then secondly, in asset servicing, something like whole office, where we go to clients and effectively talk to them about everything they're doing from front office to back -- and third, investment data sciences is something that we've talked to clients about lately. It actually helps them the asset managers execute on their investment philosophy. And so that's been a lot of fun. Ultimately, though, Gerard, in the asset servicing business, the traditional custody and fund services, that's the core of what we do, and that's great. It's good. We implement that well. We're known for it. These other things are ways that we've evolved to work more with clients. And then super quickly in wealth, we've been talking about onboarding a lot with clients and trying to make that process less laborious. And so a lot of the technology investment that we've been talking about over the last few years, particularly in wealth management, has actually gone to making onboarding an easier process. And so it's been -- in wealth, that process can be fast and asset servicing onboarding can still be anywhere from 3 to sometimes 18 months. I know now of clients that are going to be onboarding in 2024. And so it takes a long time on some of those. So that's a big component of technology investment, too.

Sticking with wealth for a minute. We think of traditional wealth management people walking into the branches and sitting down, how important is technology and digitalization to keep those customers satisfied.

Yes. It's-- I mean, it's everything. And the 2 things that jump out at me about the wealth business. One, the importance of just top-tier world-class talent. And our advisers, our experts in different areas, it just makes it so much better for us to be able to interact with clients and add value. That's really what we're known for is the advice that we're giving clients. And then the second thing is we have to make those experiences user-friendly, and we have to make the company user-friendly. And so a big component, particularly over the last 3 years of what we've done from a technology perspective has been around improving technology for wealth clients. And it even helps us in the delivery of that advice. And so some people have seen us talk about the journeys that we've identified for clients as specific persona or specific thing that they're exploring with us. And recently, we launched something clients like me, and it gets it using our data and analytics to identify broad-based groups of clients that might have similar characteristics. And then we can go to one of those clients and say, this is what we've learned from our experience in dealing with clients like you in the past, it leverages the scale that we have. So we're not just saying we're $300 billion plus in assets, but we're actually using that to the advantage for our clients.

Right. Very good. You mentioned the assets under custody or the amended assets under administration as a core -- obviously, a core part of the business. And we have heard for years, there's always pricing pressure in that business. What are your thoughts on that? Is there a certain level of new business you need every year just to kind of mitigate that pricing pressure?

First of all, the pricing pressure is -- I mean it's intense. And I don't -- I don't think it's higher or lower than what it has been before. It's just intense. And I think about how to offset that a little bit differently. Some people think about it in terms of how many -- what do you need to bring in a new business. I think about it separately because it more is how much market lift do you need to offset it? Because a lot of times, our clients are thinking about the rebate activity and price pressure, they're thinking about it because their assets have gone up. And if they're paying us based on assets, they're saying, you've gotten effectively a price increase. And so in my mind, it's how much equity lift do we need? How much market lift do we have to offset that? And -- so for us, it's just beneficial that, in general, a typical equity market lift more than offsets that price pressure that we talk about getting every year.

Yes. Got it. Maybe pivoting a minute to capital, which is always important. You guys have always maintained very strong capital levels. What's the thoughts on -- when you look at your capital and then you look at your annual earnings, how much do you like to give back to shareholders in dividends or buybacks?

So start with dividends, that's actually been the one that's much more stable time and I think you've commented on that a lot as you've written about us over many years. But it's -- for us, we try to stay in a kind of 30% to 50% of earnings. And we think that's about the right ratio to give back in terms of dividends. It gives us flexibility on the other ways we consume capital. And we've tended to see -- so 40% plus or minus kind of right about where we are now. That's not coincidence. And then you get into the other forms of capital giveback, in our minds, we're thinking heavily about share repurchase in the form of competing against other ways to deploy capital. And so we don't say, well, whatever is left, we just want to buy back shares, we're thinking what does share repurchase look like in terms of return on equity relative to other ways we can invest in the business. And a lot of times, those other ways can be in the form of expenses, but it can also be in RWA. And so you remember, you and I have talked about it over the years -- a couple of years ago, we intentionally saw an opportunity where our clients weren't using us for lending as much as we thought they could. That was actually -- the discussion we had internally around that was very much about should we use that RWA capacity for -- to increase lending? Or should we use it effectively in the form of stock buyback. And so we like to talk about those share repurchases as a healthy competition between other ways to invest in the business.

Sure. And maybe share with us the binding constraint on capital ratios, CET1 and the impact of AOCI and just how that's moving?

Yes. No, you're right. And that's why we talk about CET1 is that for us, it's a binding constraint. It's not very bound, but everybody at this point, but that is the binding constraint, and that's how -- that's why we talk about it all the time. And a couple of dynamics there, just as you mentioned, AOCI, we -- 2 things. One, we did take a pretty large percentage of the portfolio, and we moved it to held to maturity. So that insulates us from further impact of AOCI. And then in terms of how we think about the existing component of AOCI, we know that call it, $60 million a quarter is going to be pulling to par there. And so just as if we knew that there was something external that was going to be negatively impacting our capital ratios, we would be thinking about that as we analyze what to do. Conversely, it's obviously on our mind that we know we're all other things equal, we're going to have the $60 million of order pulling to par. So those are the big headlines on how we talk about it right.

Got it. Good. Moving over to deposits. Obviously, quantitative easing is over quantitative tightening every way. What kind of impact have you guys seen from quantitative tightening on your balance sheet?

Yes, it's been an interesting journey. If you go back, we were at, call it, $90 billion in deposits, and we went up to $135 million, $140 billion, somewhere in that range. And the Fed was up $5 trillion. And so if we were up 40, it tells you $40 billion, it tells you we're probably at $8 billion per trillion. And that relationship worked on the way up on the way down -- and by the way, the timing was pretty much aligned too, because the Fed went really quickly. On the way down, clients could clearly see that, that was about to happen. And so we started to see the decline in deposits a little earlier. But even if we just rewind to January when we were talking about deposits, you could see about half of that increase had come off, and that's probably in the neighborhood of where the Fed has signaled that they're going to be in the short run. And so the relationship seems to be correlated well, but I always -- I always caveat or the deposits and loans for us super, super spiky and chunky. And so it's hard to tell, but it seems like the correlation working the same way up and down.

And speaking of deposits, with the deposit betas today with the elevated interest rate environment, how are they performing relative to expectations and maybe your past cycles?

This -- overall, so far, the betas have been about 60%. And we've talked about the fact that the institutional side at this point, incrementally from here About 100%. And so wealth is meaningfully lower than that average. And it's performed about as we anticipated. And our whole approach has been hold on to the assets, hold on a decline activity. And we knew that -- and we have an aggressive cycle. But as you know, we care so much about client retention. And so it's been less about can we squeak out another dollar here and there? Or can we hold on to 5 basis points of NIM and more in the spirit of make sure that we hold on to the deposit.

Moving over to asset servicing. Obviously, it's a big part of your business with asset servicing, trust, investment and other servicing fees. And -- when we look at the U.S. business, there might be a perception that it's a mature business. And I don't know what your thoughts on are about that. Is there some growth opportunities or no, it's fairly mature.

There's no doubt that it's very mature. And that -- but we found that to be okay. I mean, first of all, we're still going to get benefits from the equity market lift that I talked about earlier, and that's a very good component of the financial model to know that you're going to get that kind of lift over time. And then secondly, we've been able to innovate and add around the edges of what we're doing for those clients. And so I talked earlier about integrated trading solutions and about what we're doing in the whole office. And those are meaningful improvements. And so -- and then at the same time, the asset manager sleeve, right, the institutional climate is growing really nicely over time. And so -- and -- but fundamentally, I think that we should use as a litmus test, what is the pretax margin in the business. And that's been -- for any given interest rate environment, it's actually been relatively stable. And so I think it tells you that the innovation that we've had, the clients' usage of other products and services. And most importantly, productivity is -- the combination of those things has enabled us to maintain margin. And that's important, and that's part of the reason why such a strong sense of urgency right now on productivity and making sure we get it that and embedded in our culture well.

Sure. And when you look at this business, what percentage of it is priced off of the asset values almost like a variable pricing model versus a flat fixed rate fee.

Well, just by category, if you take the costing and fund administration and investment management fees, that's where those are the areas that are tied to assets. But -- and that's 90% of the overall asset fees. But even within that, not all are -- those are the categories. But ultimately, about 40% are truly sensitive to equity and fixed income market movement.

Got it. When you take a look at pivoting back to the wealth management business, which again sets you apart, you've had some nice expansion from 20 years ago when it was primarily in Chicago 30 years ago to around the country. When you look at it, what are the drivers for gaining new clients, everybody knows our Chicago, obviously, but outside the Midwest, but what's that success that you've had.

Well, we just -- ironically, we just had our Board meeting in Florida last week, and we took our leadership team down there, and we've been in Florida for over 50 years. Yes. That's right. And so we started there in Miami, and we've got as much as we're known in the Midwest, we've got 20 offices around the coast, and we separate it into 3 markets. And so when there's money in motion in Florida, I think we do well. And then -- and secondly, I think growth in wealth, there are some just categorical things that benefit us. And so a lot of it is when clients have liquidity events, they've been managing a business, growing a middle market business for 20 years. They sell it for $150 million, and their attorneys and their accountants are very likely to encourage and to call us, particularly in those markets where we're well known. And then on at the same time, the complexity of what's happening in taxes and other ways. And then we've created the Northern Trust Institute, another mechanism to get to clients and leverage the expertise we have which I just can't overstate, and that's what really has generated a lot of the success over time. And then, of course, our family office business that people have noted, we report that separately. And you can see how well that's done over the last several years as a driver of growth and wealth.

Sure. Is there any evidence -- again, you've been in Florida for a very long time. And there's a migration, it seems like to some of our lower cost states, Florida being one of them. Have you -- and especially for your customer base of wealth, that's a natural attraction, obviously, there's probably been benefits. Have you guys seen any pickup in that because of some of the changes we're hearing about?

Yes. And I think particularly as clients go through the move, they know that we've got tremendous amount of expertise and repetitions and helping clients make that type of move. And there are friends of mine that call all the time and say, thinking about redomiciling or retiring and going can you guys help me think through what I need to do. And it's something that with all the experience we have of all the clients that have done that, we're able to put together that and leverage it in ways that can help the next client well.

Yes. One of the big clients for both of us is moving to my…

That's the rumor.

There you go. Maybe coming back to expenses, it's something that was discussed on your fourth quarter call. Maybe -- and you talked about bending the curve of expenses. Can you share with us what's going into that effort to bend the curve.

Sure. We talked about productivity office. And it starts there, but the big categories for us, if you want to just frame it, it comes down to really people, people cost, our workforce and then secondly, technology. And so let's double-click into it from that framework. And so in people, we have to have strong analytics and data around where we need people, how we think about even replacing people when there's turnover and at what wages are we going to replace them. And so building analytics around that and thinking about what the outputs are for different groups, where should we deploy resources. There's a lot of analysis that can go into that to help us become better. And then in terms of technology, it also comes down to thinking about a big cost or it's vendors. And so we've got to negotiate well. We've got to make sure we understand what our demand is, what our consumption is for different products and services. what are we paying on a per unit basis and make sure there's efficiency both in what we're consuming and what we're paying for them. And so a lot of this obviously gets down to leveraging some of the work we've done in technology to build systems where we can say this is where we need to deploy resources. This is where we don't have to. But even moving a lot of what we did and we talked about in January is getting the work done in the right places. And so there's opportunity we have to get work that might be done in North America. Should it be done in Asia and work that's being done in Continental Europe or in the U.K., should it be done somewhere else. And there's still opportunities for us to identify those things and create good savings. And then some of it, obviously, last year, fighting inflation, fighting a very difficult labor force environment. A lot of those things pushed really hard, but we feel like these efforts can start to get at those categories in a meaningful way.

Have you seen any benefits from -- obviously, Silicon Valley is struggling. There's a lot of layoffs of very skilled people and tech people. How has that affected your hiring of tech people or keeping your tech people? Is that you guys seeing any benefit…

It comes into play, Gerard. I mean it comes in more in the latter in lower turnover -- and so there's a lot of what happened last year was people always want to hire from Northern Trust. And we want to be -- we want to -- we talked minutes go about the importance of talent. And so we want to retain our talent. Well, it's a big component of what we do from a human resources perspective. And so people know that if there's somebody that's been working on technology in Northern Trust with the client base, we have that's attractive. And so all these things is the labor market changing should help us.

And then speaking of technology, what's the annual investment in technology? Or how do you measure that to be confident you're spending the right amount of money for your company?

We spend in the neighborhood of $1.3 billion a year in technology. And it shows up in equipment software. It shows up in our -- some in our outside services, and it shows up in compensation. And so categorically, it's an enormous investment for us. And so we have to -- that's why I mentioned it as the core component of the productivity office and getting that right, vendors, demand management data and analytics and making sure that we're getting also returns on what we're doing, justifying the projects that we're going to launch, there's a lot of good work that we can do there.

In the last minute here, I do want to touch on the Commercial Banking business. It's -- I don't know if it's -- there you go. But anyway -- Can you share with us just how is that business going? You guys are always very good on credit underwriting. You mentioned a moment ago that 2 years ago, you guys stepped it up. So maybe just share with us what's going on in commercial banking?

Yes, it's core for us. And it is just being in Florida and hearing our market leaders talk about how credit has been able to deepen relationships early on and then lead to great trust and investment relationships is fantastic. And you know the culture that we have. We've done well in growing loans, but we haven't changed our credit appetite or our underwriting standards. And so a couple of years ago, it was all about make sure our clients know that we're not a reluctant lender. We want to be providing those loans. That work that created a big step up. From here, it's probably business as usual, if not better, but that's what we want it to be. We're in that business. We find it's very attractive and leads to a good relationship.

Is Florida one of the growth areas for you in commercial lending now? Or is it still your Heartland in the Midwest?

Yes. No, Florida is an area for us and where we're seeing good activity. The culture there of our teams down there is strong in that area. And so obviously, in Chicago, we do really well there. But Florida is there -- it's a really strong market for us, and we know it's not -- you don't get the welcome to town loans if you've been in the market for 51 years.

Right, right. Yes. We've run out of time. So you ended it on a good note. So I appreciate that. Jason, please join me in a round the before thanking Jason for coming.

Thanks. Great.