Northern Trust Corporation (NTRS) Earnings Call Transcript & Summary

With our next fireside chat, we're very pleased to have the folks, the guys from Northern Trust, which many of you know is the 18th largest commercial bank in the U.S., has about $151 billion in assets. More importantly, it has $11.9 trillion of assets under custody. And similar to its peers, it has 71% of its revenues coming from fees, which is a real distinguishing factor between traditional commercial banks. Also, their CET1 ratio is just over 11% at 11.3%. And prior to this fireside chat, we had M&T talking, and I always like to tell investors that during the financial crisis, out of the top 20 banks, there was only 2 banks that didn't cut their dividends, Northern Trust was one and M&T was the other. But just -- Northern is a real high-quality company, as we all know. But with me on my far right is Jason Tyler, which many of you know, is Executive Vice President and Chief Financial Officer. He became the CFO at the end of 2019, and he's been with the company for -- since 2011, and has held positions in other financial companies prior to joining Northern Trust. To my immediate right is Pete Cherecwich, if I said that right, Pete.

Close enough.

Close enough. He is President of Asset Servicing, and he's been with the company since 2007. So gentlemen, thank you for joining me today here in New York.

Thanks. We really appreciate it.

Absolutely.

Maybe, Pete, we could start off with you with some questions about asset servicing. I think it was on the January call. Mike noted that Northern is focused on scalable growth. And can you provide more information on the strategy that you're using to achieve scalable growth and what that might mean for organic growth in the upcoming year?

Sure. I'll start off by saying how do we define scalable. And scalable is a code word for, let's get profitability right away and not have it take 2 or 3 years, right? So that's the first thing. And if I look back at how we've built the business over the last 10, 15 years, we have grown horizontally. And what I mean by that is we've gone into different markets. We've done different acquisitions. We've done different product launches. And all of those have been investments that then get amortized, et cetera, you need new clients to come on. So when we talk about scalable growth, we're saying instead of keep going horizontally and focusing on all new things, let's add clients on to the infrastructure we already have. So if they go on to the standard infrastructure, and let's do it vertically, that really is where we're focused. And so ultimately, that means we're going to be more disciplined around going horizontal and really [ hit ] the sales force to be focused on scaling vertically.

And when you scale vertically, besides core custody, are there other areas that are scalable?

Yes. So 2 things, really. First is, as a company, we have an asset management arm, right, and we have capital markets. Adding those 2 capabilities to whatever we're selling, absolutely is scalable. If someone buys custody from us and we can get them to buy index products, or we can get them to do all of the FX with us, that drops to the bottom line. And that's part of our relationship pricing that we'll do.

Scalable growth has been a term used by other institutions as well, where they're not all things to all people. And it sounds that way here. Is there a chance you could lose some customers if you're not all things to all of them?

Yes. So the short answer is no. The longer answer is, if someone says to me they want to have -- it's an RFP and they're going into every country in the world, I'm sorry, we're not in every country in the world. So we're not going to bid. So there may be sort of out cases that we are saying, you know what, that's too much for us right now. Let's focus on what is in our core and let's get profit up.

It's always been somewhat for us outsiders to really dig down to some of the factors that drive growth. But can you share with us the way you guys are looking at what are the biggest underlying factors that drive new business growth? And where are you winning? And why are you winning?

Yes. So I'll start with -- it's a little bit of segments and products, so -- and regions. So asset managers in Europe. We continue to win more and more business there. But it's not just getting the client on. It's they buy more and more products from us. So they will buy custody, they'll buy admin, they'll buy TA, they do FX, they'll outsource their trading to us. So that ability to bring the client on and continue to sell them more and more products is key. But it's also where the trends are. So private markets. Private markets is a big business for us, both on the asset manager side and the asset owner. So we have great momentum. Again, in Europe, we bought UBS business, their admin business, a number of years ago. That bumped up our capabilities in Luxembourg. And now we're winning more and more private markets in Lux. In the asset owner community, we have the ability to take private assets and the publics, put them together, so you do have a total portfolio review for a sophisticated asset allocator. We won Abu Dhabi Pension Fund recently, and that ability to show all their assets, so as an allocator they can understand their risk regardless if they're invested in a private market or a public market, that's differentiating. And we're seeing a lot of growth there, too.

Maybe, Jason, coming over to you for a minute, because Mike had spoken in the past about reinvigorating organic growth. So when you look at it in the bigger picture, not just for asset servicing, of course, can you speak to some of the tactical things that you guys are implementing to get that organic growth throughout the organization?

Yes. But first, I'm going to say congratulations, because the conference has been great. And I know we're the tail end, but I heard you got almost 1,000 people here between companies presenting and investors. It's great.

Thank you.

So congrats on that. So to organic growth. You're absolutely -- Mike has been emphasizing that to Pete, me, everybody in the -- and the monitor that we're using inside Northern Trust is One Northern. And that applies to all areas of the business. And Pete talked about what he's been doing to engage together, but Pete's been traveling all over the world with the new head of our Asset Management business. And so they're not cross-selling, they are together-selling and going into some of the most sophisticated asset owners, literally across the world, and talking about what we can do as an organization, but together. It's impacting how Pete's thinking about bidding and responding to RFPs. Our Asset Management business is doing the exact same thing with Wealth Management. So they're talking to clients, they're talking to intermediaries and thinking about what we can be doing together earlier on. And it's -- we're already seeing meaningful impacts on that. In Wealth Management, in particular, inside the business, it comes down to trying to bring more clients in, is the best thing we can do. And so there's a strong effort to recruit more salespeople there. And at the same time, we're doing a lot more marketing and advertising and also talking to clients about what they have that might be elsewhere. So it's a lot of blocking and tackling, Gerard, to make sure that we're doing the right thing. Within Asset Management in particular, Daniel, who Pete referenced, is emphasizing -- Pete talked to this -- right to win. So where does that show up? It's a lot of strengthening existing relationships, but it's also -- if you think about what we can do with liquidity, we could do with beta and equity indexing, our outsourced CIO business, there are areas across Asset Management where we already show a very strong right to win. And if we can get focused on that and make sure that our clients see it, feel it, know that we want to be engaged with them in those areas, we feel like we can lift the curve.

Got it. And sticking with the broader organization, what are your top priorities for the upcoming year in 2024?

So there are 3 things that Pete and I and others have been talking about. One is, how we've spent the last 5 minutes, is optimize growth. And Northern is known as a growth company, and we're not walking away from that. We have -- are a growth company. We are going to deliver growth. And so that has to be a top priority for us. Two, is about strengthening resiliency. So much of the clients that we have, regardless of the business, our brand is about stability. And we have to make sure that they feel confident in that and that we can deliver that with evidenceable data and metrics, and when they come and walk around or we go to them, we can show the stability of the organization. We can't take that for granted. We have to constantly invest in that to make sure that we live up to that brand promise. And then the third thing is productivity. We have to be a productive company as much as we have to be a growth company. And we talked last year about initiating the productivity office. We did that. And we can talk about it more if you want, Gerard, but we got over $100 million in savings this year, and -- but we have to do that every single year. Every year, we have to find over -- we've got to find meaningful percentages of our business to do more effectively, more efficiently than we've done in prior years.

Got it. Maybe, Pete, coming back to you, this business has been interesting for many of us during our careers that there's always pricing pressure. And...

I don't know what you're talking about.

It's a recurring theme. And so -- can you share with us, do you continue to see pricing pressure, particularly in the custody and fund administration part of the business?

Yes. You always see pricing pressure. But the interesting about this business, it's really combination of commodity-type services with sophisticated solutions. Clients want the commodity-type service to be as cheap as possible, but they will pay for value in a sophisticated solution. You've got to be smart enough to sell them that we're actually providing a solution and not fall into the bucket of everything is the same in its commodity. We do a decent job at that, and we got to continue to work on it.

Jason just talked about the $100 million in savings. If we turn to the cost side within Asset Servicing, what are you guys doing to manage expenses and to achieve your targeted productivity gains through '24 and beyond?

Yes. So it's many things, right? So I would say a combination of, we'll say, stock standard, here's what you do, for instance, centralization of more tasks, span of control analysis. There's also transformational programs. Cloud-native tools are being developed which we can then put into our infrastructure that enable things to go faster, change to happen faster, and more productivity. We're leveraging things like Microsoft Dynamics. And so many of you might have Dynamics or Salesforce, right? But what we've been able to do is kind of wean ourselves off of a lot of e-mails from clients. And we have one team that actually has saved 1/3 of time that they have on e-mail traffic and got better service. So we're getting productivity and services improving. And then traditional automation. So we have something called the Northern Trust Digitizer, and so we've had -- the last year, we've automated 0.5 million instructions where previously we had someone typing them in. The clients were sending them, we had to type them in. Fully automated now, and that type of thing we can go. And I'll finish off, if you think about our business, what's exciting is, I have 14,000 people in the group. A huge amount of what we do is actually processing stuff and checking it to make sure it was done right. All of it can be automated. We just need to have the technology in place. We need standards in the ecosystem, the buy side, the sell side, right, everybody has to agree on those standards. But it's happening faster. The tech is moving at such pace where you can see how things can be automated more and more quickly versus huge projects. So I'm pretty excited about meeting Jason's goal.

Not to put the cart before the horse, and I won't hold you to it, but when -- is it a 10-year project? I mean what you just described is incredible. So are we looking out 5 years from now, 10? I know it's a long journey and it's going to take a while, but...

Our goal for this year, we're trying in my business, trying to hold head count as flat as possible, right? Did it over the last year. I think we'll do it this year. The issue we have is every time we automate something, someone in an investment bank gets very creative and creates a new product which is not automated. And so then you have to race and do that. Someone creates Bitcoin and you realize that takes 18 decimal points. Well, wait a minute, the system only handles 12. So you always have to keep up with everything that's being innovated in this industry. So it never ends, but I'm hoping that we can pick up the pace and catch up more over the next few years.

And sticking with this topic, how does AI play into this? And where do you see the greatest opportunities for you folks using AI?

Yes. So. I mean, AI is a huge unlock for this industry. There's no question about it, all right? And it comes in different fold. So if we sit down and think about reconciliations, we use deep learning right now. We've automated 2 million touches in rec. So people have to touch something 2 million times, gone. That's automated. You have chatbots. So a traditional chatbot, how you're dealing with your clients, that can be automated. The Microsoft's earnings announcement this year, in their conference, they mentioned Northern Trust as an early adopter of Microsoft CoPilot. Working with them on how queries come in, we can actually use all the tools that we've bought from Microsoft to really automate that, look into our internal infrastructure and data and serve up the answers to the clients directly. So I just think it's going to be a fun few years as this gets implemented.

I've got a question for you. We heard a lot about blockchain like 5, 6, 7 years ago. It was going to revolutionize. And you don't hear much about it today. Any thoughts on why it's not front of table anymore?

Yes, I do. So simply -- simply put, blockchain, right, takes -- you, Jason matches, or you match, if you guys agree on something, it then says, okay, we have a deal, and it's immutable onto a distributed ledger. The problem is the two of you don't agree on standards. And so the reason blockchain isn't effective in our industry is that you have the buy side, the sell side, the depository and the custodian. All 4 players have to agree on a standard. Then it would work. Like, that's a lot of work. So where we're seeing take-up is on bilateral stuff. So with bilateral agreements, all right, that would work, we can get rid of the contract and we can go. So I still think there'll be a place for it in our market. It's just not going to be the panacea that people thought.

Got it. Okay. Got it. Jason, coming back to you, it seems like higher for longer on interest rates may be in the cards now versus what we all heard in January with the forward curve suggesting maybe 5, 6, 7 rate cuts. So -- when you think about higher for longer, maybe they cut rates in the summer and all in -- excuse me -- 50 to 75 basis points. How does that change -- or does it change your expectation on deposit levels, deposit pricing, NIM, all those interactions?

Yes. Well, first of all, we've been -- the whole time, we're not price makers in the space. We're more price takers. And so the way I think about it, we are going to play aggressive defense, and we want to make sure that when clients have deposits, they're at Northern Trust. And in terms of rate positioning -- the repositioning that we've done, for various reasons, we had an opportunity. We've had 3 opportunities now over the last 1.5 years to say where do we want to -- if we are going to reposition the balance sheet, where should it be? And we've gone shorter. We had a view that rates are going to be higher for a little bit longer. It wasn't an aggressive position that we made, but it played out well. And one of the big benefits of the repositioning we did is that this also creates a lot more flexibility for us. So now as we sit back and say what does the landscape look like in 2024 and beyond, what do we want to do with that flexibility, where do we see opportunities? And so -- we don't make -- as you know, you've followed us for so long, Gerard, we're not making aggressive market calls on the balance sheet. But around the edges, we can have those opinions. And so at this point, we're really happy about the flexibility that we have, given what's happened with the yield curve and reflective of the repositioning we did, which has enabled us to be able to stay at the short end of the curve and benefit for maybe a higher for longer scenario.

And this is tough for all banks. It's hard to kind of measure what quantitative tightening -- and we know from the industry it's taken deposits out. But have you guys been able to link any of your deposit activity to QT? It's tough, and most banks have not. So -- but I'm just curious.

Yes, I got my own my views about what drove deposits in the industry more. Our client base tends to react differently. It's a lot of very large asset owners, and a lot of Pete's clients, they're literally calling and depositing potentially hundreds of millions, and in some instances billions, of dollars. And so they're impacted less by QT. And -- but as a follower of the industry, I followed really closely the impact on QT, what was happening in the size of the Fed's balance sheet, what was happening with particularly the Fed's reverse repo facility and the pricing there, and how that had an impact on potentially money market mutual funds and the high percentage of assets in funds that were in the reverse repo facility. I think that had a big impact on deposits in general. But for us, we went from $90 billion, we peaked at something like $135 billion, $140 billion and have come back down somewhat. And I think that's much more our clients looking at what options they have given the rate environment than it is QT.

Got it. Yes. And speaking of deposits, how is the quarter shaping up on deposits or from a net interest income standpoint, or -- and also client repricing, what are you seeing there on the deposits?

Yes, I'll comment on both. On deposit levels, we're seeing -- in February, we saw deposits mostly in the $100 billion to $110 billion level, which was good. And then from a NIM perspective in pricing, it's calmed down relative to what we anticipated, and so NIM has been roughly flat. So we feel good about where the balance sheet is at this point.

Got it. You're one of the few banks that are in the good position of owning the Visa stock. We saw when Visa decided. So maybe can you give us some insights into maybe monetizing it or what you could do with it and so on and so forth? And how big -- and just remind us, please, just how big the position is and so on.

Yes. It's -- overall, we own a little bit over 4 million B shares, and it translates to, once we -- half of that position translate to somewhere $800 million to $900 million. That's half of the aggregate position because that's what we're able -- be able to monetize, right? And so it's very nice for us. And we feel like we're -- have been benefited from exhibiting patience, and to finally come into fruition, it's a real positive for us. And so from our perspective, there are a few things that are on our radar screen. We'll probably use a combination of them as we think about what to do with the proceeds. And Visa has been great, but it's not a strategic asset for us. And so once we'd be able to sell a position at par, we'll start to lean into that. And obviously, for us, some combination of share repurchase, but then also it provides a lot of benefit to the securities portfolio. That's really where, if you think about our balance sheet, as deposits come in, we've got to leave some in cash at central banks around the world. The second thing we do is fulfill very high-quality loan demand, and then the remainder goes to the securities portfolio, which is big for us. And so this would fit into the latter category. And it's not just adding that amount to the securities portfolio, but the fact that equity will be higher, provides higher market value of equity and higher overall capacity from a Tier 1 leverage perspective. And so it gives us even more flexibility from a balance sheet perspective. And then I do believe, lastly, that you'll see some banks that are in the same position, where we haven't needed this capital, even think about some things that are helpful culturally, but also economically. So something like funding a foundation that we have. It's helpful in a lot of different ways. So we'll be able to show more of a consistent capability to be able to fund some of the things that are important to us. And so a combination of those things. But as Pete says, the last one is the smaller. More likely a combination of the first two.

Could you consider repositioning the bond portfolio possibly? And then offsetting -- obviously then you don't have to pay taxes on the gain, if everything is done above the pretax line?

Yes, it's good for you to push on that. First of all, with -- another thing that the Visa proceeds do -- and first of all, the numbers I gave were pretax, and -- so thanks for encouraging me to clarify that too. But because even market value of equity will be -- we've got more equity, it provides more flexibility there as well. And so it enables us to do more with the balance sheet, more with the securities portfolio, not just necessarily layer it on the way it is today. We can do more things even with the existing base within the securities portfolio because the equity position will be higher. And so it really is a nice opportunity -- a good opportunity for us.

And if I recall, this is a classic buy low/sell high, because your cost basis is basically zero.

It's not basically, it is. Yes. So -- but that -- it also is a good reminder of the tax implication as well.

Right, right. Maybe turning to expenses all around. Can you talk to us about how you managed expenses in '23 and what you're thinking for expectations for '24 for the expense outlook? You talked about the $100 million in savings already, but maybe elaborate a little more.

Yes, sure. So first of all, 2022, it was a really tough year for us from an expense perspective, a high inflation year. We had to get a lot done -- we got a lot done and it worked, but high -- high year. So that's how we came into 2023, and we took a much more aggressive approach, and every quarter we did better and better. But it came down to tackling the expense base in 3 different categories. Our biggest cost, first, is people. So we were -- we had good success in making sure that we didn't have the historical increase in head count. And for the first time in a long time, we actually saw decline in head count from the beginning of the year to the end of the year, and that reflected a lot of hard work, a lot of tough decisions. And I've got to give Pete credit, because he's got over 14,000 of our 23,000 people, a lot of hard work took place in his business. We couldn't have done that without the success, the diligence, the rigor that he personally took in addressing the expense dynamic. The second component is technology. That's in the middle, and it's another big cost. We did a lot there as well, adding more governance, more discipline, more rigor, and tracking and analysis to how we think about technology. And then we -- the bottom stack of the expenses is occupancy and everything else. And Gerard, you've seen we did a lot there, too, to rationalize our real estate footprint. We took charges there to commit to getting to lower amounts early. We made tough decisions to ensure that we were maximizing that portfolio. Those were all reflective of what we were doing in the productivity office and led to a lot of those savings. And so as we come into 2024, we've got to do the same thing. And we said last year, we were coming off of almost 9% growth year. We were looking at 7% at the beginning of the year. We got to below 5%, and we've got to do that again this year. We got to be below 5% this year. And we're still chewing on a big component of the base pay increase we did that were -- this is the last quarter we're lapping a big pay increase when we were in that heavy inflation year. But once we do that, we feel like we'll be able to continue to grind down more. So it is a super high priority for us.

And speaking about the inflation in the base employee compensation, are you seeing less -- is it -- the rate of increase decelerating in compensation, or is it still as tough as ever?

Yes. And it would be good to get Pete thoughts on this, too. It's -- first of all I'd say turnover is lower. And we also did reference, and people could back into it, a lower base pay relative to the prior year that we've done. And so those pressures are lower relative to what we were experiencing in 2022.

Yes. I totally agree. The only thing I would add is talent still gets paid, right? So that people can still jump and there's plenty of opportunities out there for your most talented folks.

You touched on technology a moment ago, Jason. What are you thinking on technology spend for the next 3 to 5 years? It's so critical to your guys' businesses, Pete's business, of course, and so can you frame out what you think might be reasonable?

Yes. So if I -- I'll give you our framework to frame it out and then go from there. Three big categories. The first is what's business unit driven. And so Pete has talked about the successes we've had in his business, and a lot of that is because he was making investments in technology over the last several years. And that's roughly 40% of the total. It's a little over 40%. The second is what we reference is as foundational. And so that's where we're modernizing the applications we have,more moving to the cloud, ensuring that there's good stability there. That's another roughly 40% and a little bit over. And then the last, it's about 15%, is just ensuring that our cyber defenses match our brand. And so everybody -- it's prudent for us to spend on that. And if I think about the growth rates of those, the growth rates of the business unit driven has been lower than our target amount. And so we're trying to -- we're ramping that up to do even more from a client perspective. The middle, the modernization, that's what that has been at a higher growth rate. The best practices have changed over time. And so we're following those and making sure that we're doing everything we can, migrating quickly to the cloud. We've got a good percentage there now, but we want to accelerate that more. And then we've made great progress, we feel, in cyber. And so we think the growth rate there should be able to -- we'll still have that base, but the growth rate should be a little bit less than it has been.

Got it. When you look at your organization, margins are very important, operating margins, and -- what do you think it would take to get back to that 30-plus percent operating margin? And -- or has the business structurally changed so much that -- maybe it's just -- it's not there anymore?

Yes, it's there. And it's going to take time because we -- the inflation layered in some expenses that we just weren't able to match with revenue growth, and the revenue growth came from an increase in NII, which is great, but that didn't grow -- and we can't rely on that to stay there. And so we've got to have growth in the foundation of the business, coupled with significant reduction in that growth rate and getting more to that below 5% that we talked about.

And I'll add, back to scalable products, in our Capital Markets group, they added 181 new clients last year. Half of them had never been a client of Northern. And so that ability to do more FX, to do more brokerage, more FICC repo. And we did get that bet right on quantitative tightening, right? So that's helped out. That's what we have to do more of.

We're running out of time here, but maybe one last question. Obviously, Basel III end game, they're working on it, and then you probably saw the headlines out of Washington today with the testimony by Chairman Powell about he thinks real changes are coming to the initial proposal. Any thoughts on just how it's shaping up? I know you've got plenty of capital, so we're not worried about you guys. But any color on that?

Yes, it is important for the industry. And I could, Pete -- I could say we've got plenty -- we do, we've got a lot of capital, but at the same time, we want to make sure the industry has got the right lens and oversight from it. And so it's not just the amount of capital, but we've been spending a lot of time on where the changes are and how much more is going to be required for operational risk and other areas. And there's puts and takes for us, because it will have an increase from an operational risk perspective because of the dynamic Pete talked about earlier. But then we'll benefit from other areas or the more tailoring that's done around our loan portfolio, for example, is going to help us. Net, it will be more. So the devil is in the detail on this, and everybody, all of my peers, we're all following it super closely.

With that, we have run out of time. Thank you very much, both gentlemen here from Northern Trust. Thank you.