Northern Trust Corporation (NTRS) Earnings Call Transcript & Summary

Thank you all. Concluding day 2 of our Global Financial Services Conference. Very pleased to have Northern Trust with us. From the company, Jason Tyler, Chief Financial Officer. Jason, thank you.

Thanks, Jason. Congrats on the conference. Busy, a lot going on.

I'm going to sleep well. I was hoping maybe we could start out by running through what you're seeing in each of the main business units before kind of jumping into financials. So let me start with asset servicing first. Our sense is you're kind of shifting the sales focus to opportunities that require lower levels of incremental costs, while emphasizing approaches with multiple points of connectivity as well as bundling sales. It's something you kind of talked about, I think, more [indiscernible] earnings call. Maybe just kind of expand upon that?

Yes. Yes. We've grown this business quickly historically. And it's a business that you can grow quickly but we also wanted to make sure we were exhibiting excellent discipline in the incremental profitability. And so we took a deliberate approach to say we're going to -- we're actually going to be more disciplined and more focused on scalable opportunities. And that practically speaking, you and I have talked about this, a good example of an opportunity in that business is you go into a client and they say, we've got middle office, back office. They're doing that with 50 people, and we might be able to do that with 40 people and over time, change the mix and control the costs a little bit better with our efficiencies and economies of scale. And -- but you leave yourself exposed to inflation, if things go up or even whatever happens with asset values. And so we want to make sure we've got more margin of safety and are focused on more scalable products. And so that's led to us bidding differently a little bit less often and definitely with better margin of safety and the opportunity set that we're looking at.

So I guess that leaves the question, if you're bidding on less stuff and maybe being a bit more disciplined on pricing, does that kind of more focused approach lead to a lower -- a slower rate of growth?

It might. But in fact, this -- so far this year, the asset servicing is still seeing good organic growth, not where they'd like to be from a target perspective but good. And we don't have to do as well on the top line. If we're more disciplined on the scalability, we'll still get the incremental margin coming in that we have historically. And so it's about higher quality. And the business has had -- it's impressive to see the speed with which that's been reflected, and we're still getting good opportunities. And our win rate can be -- can also be stronger if we're more focused. And so we feel good about the long-term prospects even with this more deliberate, more focused scalability effort.

And one of the things you talked about, you mentioned mostly in the earnings call, you highlighted the kind of client loss in 2Q. You talked about an upcoming client loss in Q3. Anything common seems there anything we should be worried about? You maybe help size the impact of this and just more color there.

Yes. Well, cumulatively, between those 2 opportunities, it's -- run rate it will be about $10 million a quarter starting in the third quarter when they're both reflected. But it's something long term. The reason that we mentioned on the second quarter call is that it's something that's large, we get good visibility into it. And we've known about these for quarters or 1.5 years, which tells us also, not knowing about any others in the future, it's not like we see this as a trend at this point. We don't have any in the pipeline to comment on at this point.

Got it. And then maybe on Wealth Management. It's a 9% year-over-year growth in trust fees in the second quarter, just opened your New York office, 4 blocks away from here. But if you look, net new business was relatively soft in the region, Stanley office still continues to do well. Advisory fees are doing well but lower product utilization. Maybe just provide us some overall update on the business?

Yes, you depicted it the right way. The family office continues to grow well, and that's been multiple years that, that business has been growing at a high rate, well above our target. And so it's definitely been a bright spot not just for wealth but for the entire company. And we talked about the fact that we've got about 35% of the Forbes 400 as clients in that group. And there are other dynamics. From a dollar perspective, we're similar or even higher in terms of some connectivity but the takeaway is we're doing very well at the upper end of the market. In the regions, it's split. You alluded to the fact that the product utilization, and that's episodic that will come and go based on investment performance, client preference, that's added. It's been a little bit lower over the last couple of years. We look at more of a litmus test for how the business is doing. We're looking more at the advisory fees. And that's a core element of what are clients asking us to do in helping manage oversee and advise assets for them. That's been better, positive organic growth thus far this year, still not at the point of what we'd like to see from our overall financial model target.

Got it. And then maybe on Asset Management, we've seen kind of mixed trends there, positive liquidity flows for 6 to 8 quarters, strong performance with active fixed income. You've been raising assets in the private equity space, still index flows have been soft. Last year, you brought in a new head of Asset Management from BlackRock. Maybe just update on your thoughts and kind of growth opportunities you're most excited about?

Yes. Let me start at the end. Daniel Gamba came in from BlackRock last year, and he's been super energetic guy, and he is an absolute industry expert and knows the space so well. And he quickly embraced the relationship that we have internally and the connectivity of dealing with asset servicing and wealth management. And so they're doing a lot of calling activity together. He's encouraging that for his teams and just thinking about how to bring things together. So even as they're bidding on new pieces of the business, they're thinking about that collaboratively with asset servicing to ensure the clients and prospects know that there's benefits from dealing with Northern. And so it's very -- and his leadership has been -- it's been great. And the core product areas, the liquidity business for us is great. It's not the most fun thing to talk about but our 2a-7 fund business is great, and we're close to $300 billion. The investment performance is outstanding. And so I feel really good about that. And so there's some good opportunities to -- for us to continue growing in that area, still want to get that organically at a higher rate than what it's been now.

Got it. And then before jumping into the financials, one of the things that set out to me was you and Mike both use the word resiliency, we counted 10x on the second quarter earnings call, referring to investments you intend to make. And it just kind of brings a bunch of questions to mind. Is it something the regulators suggested? Are you behind peers? And just maybe talk to that? And then where is this money going? What are you trying to accomplish?

Yes. I was -- it's a great topic. It doesn't necessarily resonate as well for people. But first of all, it is, in our minds, is about modernizing and adding resiliency to where we are from an operations platform perspective. And to answer your question, nothing happened. But you can also see kind of clients are more demanding about this. They're asking questions about resiliency and you have redundancies and what's your uptime and different -- in different platforms and technologies. And of course, I mean, if you look at regulators, they want to ensure that the system is safe and sound. And we've got to remind people, we're a category 2 institution. And so the expectations for Northern are very, very high in this area. And so we want to make sure we don't fall behind. And there are some areas where it's catch up, but overall, this is about making sure we don't fall behind. And I think the Visa monetization, in particular, it gave us an opportunity to say look, we're not going to be overly aggressive in looking at acquisitions. We're not going to -- there's a pace with which we can do additional stock buybacks. What we can do is invest and get some of the infrastructure work done faster. And if we can get that done in 2024, early '25, it sets us up much better going forward. But just in reading how other banks are talking about their investments. In some ways, you can take off the name, and it's the exact same conversation that firms are having. And that's part of why I think a lot of it is client driven, clients are now asking the same questions to us all. We've got to make sure we respond to that.

Helpful. Maybe we'll put up the first ARS question after you, Jason, don't worry. But I hope maybe we shift gears and flip to the financials and maybe run through the income statement. Maybe start with deposits. I think they were up in the second quarter, I think better than I would have expected. Deposit costs increased slightly due to appear to be a handful of large, thinly priced deposits. Maybe talk to kind of what you're seeing this quarter? And then assuming that Fed cuts 25 basis points next week, just how you expect deposits to behave? And maybe if you can talk about kind of the asset servicing deposits and then the Wealth Management deposits would be helpful?

Yes. So first on levels, we usually see a dip around this time of the year but we've instead see deposits holding well, a little better than we anticipated. And so overall, not -- no significant change to what we were anticipating to note quantitatively at this point, but definitely better than we had -- definitely better than we anticipated, particularly given the predicted August lull. And then in terms of the Fed actions, we saw other currencies move already, and we saw really high betas, which is good on the way down. And so I think if the Fed going in soon, presumably, it will be -- we feel it's going to be similar. We'll be able to see high ability to pass that along the reductions. And so we feel like the betas will be particularly high. The institutional space, we think, very high. A lot of that business is priced off of central bank minus. And in the Wealth segment, it's similar that it's on determined rate cards on a spread to central bank. But we expect that we might have to not pass on as much of the cost reduction we might have, that might hurt spread a little bit but not a lot. And then, of course, you've got to remember that 15%, 16%, 17% of the deposit base is noninterest-bearing. And so there's some spread squeeze there as well.

Got it. And then one of the surprises, I guess, not for Northern but from others last quarter, was particularly the wirehouses was increasing pricing to advisory account fee products, and a lot of that's facing kind of lawsuits and regulatory actions. I know Northern kind of has a different approach, and maybe kind of expand on kind of what you do and then maybe kind of what you think what other is doing and how it all plays out?

Yes, I'll try to stay us on it. But yes, we've got 3 different platforms. We've got the banking platform, which is where obviously -- virtually all the deposits are. Second, our trust account business. And that's where the $400 billion in AUM is. The cash component of that, it all goes to money market funds. None of that -- where we have discretion across the organization, we are not sweeping any discretionary or any advised dollars onto our balance sheet. And then the third area in the brokerage business, in particular, which is where this issue arose for other institutions, is brokerage advisory accounts. Again, nowhere in Northern Trust, are we sweeping or moving client cash to our balance sheet, all goes to money market funds.

Well said. May open up the next ARS question. But I think that's the wrong one. But anyway, Jason, you previously pointed to kind of 3Q NII flat. But I think when you kind of gave that guidance, you're talking about modestly lower deposits, seasonality offset by some security repricing, [ just ] go fast forward today, it sounds like deposits are behaving a little bit better than expected. So repricing let you tell me but maybe a little bit worse than expected. Just how do you kind of think about near-term NII?

Yes. Yes. No quantitative update from what we said and nothing outside a range of what we would have -- we wanted people to interpret coming out, which is we felt it would be flattish. But again, it is important to note, I think at this point in the quarter, deposit level is a little better than we anticipated.

Got it. And then I guess as we kind of to think about 2025, maybe talk to some of the puts and takes in net interest income and just given maybe the forward curve, which I'll the change tomorrow?

Yes. In general, as we look at it, first all, it's a little early for us to give too much commentary. But as presuming rates come down, NII should come down for us but it's just difficult to tell. There could be offset with volume. From a deposit perspective, there's an argument that with rates lower clients prioritize convenience more of how they deal with their deposits. And so that might mean you have -- you do better from a deposit volume perspective. And -- but ultimately, we also have to look at what's happening with the industry and with our peers. We -- and I've always said, we are a follower when it comes to spread. We protect deposit volumes very aggressively. We think we want to be a liquidity provider for our clients. We're somewhat agnostic whether it's in money market funds, the balance sheet, treasuries but we want those assets inside Northern Trust. And so to the extent we have to adjust, we will. But -- and again, agnostic about where they go. But -- and that's why it's hard for us to tell further out because I think the market is going to have a decision to make with rates coming down not 1 or 2 cuts. But if we get 7, 8, 9, then we'll see what happens strategically in the marketplace, and we'll respond to it.

Got it. And then on the fee income side, you talked earlier about the impact of lost business. The market's with some volatility in here. It seems like FX volumes of volatility have been up. Just maybe expand on kind of what you're seeing within the fee income area?

Yes, I'll separate it in a couple of areas. One, on FX, I mean, we definitely saw volatility up higher, that didn't translate from our perspective. It's not huge dollars but it didn't lead to any type of meaningful increase in FX. And again, those are smallish dollar amounts in the much larger trust fee area that the business is continuing to perform well. And so that's been good. It's been solid. Nothing to update in terms of guidance or anything but definitely feel good about how the business is doing.

Got it. And then maybe on expenses. At the start of the year, you were thinking expense growth 5% or less. Growth will close in the 6% in the first half of the year, probably make 5% or less challenging. Sure, I think you were talking to expenses up 1% in the third quarter. Just maybe how you're thinking about the full year? I know at one point, you were talking about positive fee leverage in the third quarter and kind of overall positive operating leverage in the fourth but maybe kind of update us on your expectations?

Yes. In the last couple of years, we feel like we've accomplished a lot. And a lot of the accomplishment, I think historically, we -- particularly in asset servicing, we come into a year anticipating growth in the business, and we would hire in advance of that. And that usually worked out for us because you've seen the growth that we had in the business. But as we became -- as we become more disciplined about what types of business to bid on and it being more scalable, we -- the first thing we did say, that's not the way we're going to handle head count in the business. And so in the last 18 months or so, you see a very different trajectory in head count for Northern Trust, much flatter than it has been historically. So that in '23, you see it in early '24. And that's big of that relative to history, that's a meaningful shift that we've had in head count growth, which is very strong. So we came into this year feeling very good about where we're going to be from an expense perspective. Then first quarter hits and you see equity markets up 11%. And by the way, that's great. But because even though we're going to have expenses up, our revenue is going to be up by much more than that in terms of dollars. But if you just -- if we're isolating expense trajectory, it increased expenses more than we were anticipating for the first quarter. Then you go into the second quarter, Visa gets done. We decide to take a more aggressive approach in investing of what we knew were going to be future expenses to address modernization, infrastructure, resiliency, let's get some of those things done faster. And so all for what we think are good reasons, expense growth has been higher than the 5% but it also does set us up better going forward for better expense growth into 2025.

Got it. Maybe go to the next ARS question. I think I missed one. You could skip this. Let's go to the next one about 2025 expenses. So you mentioned kind of accelerating some of this investment spend. You also did some pension repositioning. There's been some severance of lead, it's front loaded some donations with this Visa gain. So it sounds like all that combined should, over time, lower the expense growth rate of the company. I guess, as you kind of put together in the 2025 budget, can you get back to that 5%, you do better than 5%? Just how are you thinking about that? Is it going to be return to positive operating leverage where you going to point this to? It just gets -- because expenses have kind of been something that certainly weighed on the story for sure.

No, we should get back to and do better than 5% in 2025. It should be -- we should be somewhere below 5%. And a lot of that is we have set us up ourselves up well. We have pulled some things forward. Now I should give all the caveats, if we see equity markets up, and I hope they are by 20%, then that will be different, and we'll see elevated expenses again, and we'll be happy about that. But if you take the markets in a normalized way, based on what we see now, we should be able to do better than that next year. And again, back to what has been the journey of expenses for us, it's been good for us to get the head count story in the right shape. Technology is another element that we've got to make sure we're working that down over time. It's been elevated. I think about expenses in terms of 3 different buckets. I think about them in terms of what's labor cost, what's technology cost and what's everything else. And labor, I feel like we can have below 5%. I think we can -- all the way down, I think we can get that at a 4% rate in general. That's hard to do. It doesn't leave you a lot of room for head count growth, but I think we can do that. And then if you think about everything else, we've got to use productivity there to ensure that we're well below even that 4%. That should be in the 3% or lower. That's travel, occupancy, things like that. And that leaves that middle big chunk of technology, which has been elevated for the last several years as we're trying to get all this stuff down and we know that's going to be elevated for a while but we can -- we're continuing to bring that down every year, and we've got line of sight to see that being at a better level.

Got it. And maybe looking a bit further out. I know in the past, you kind of used to talk about this 105% to 110% expense to trust fee ratio. I think you're 116% in the second quarter. I mean do you think you can get to this 105%, 110% range? And if so, when?

Yes. Yes. Absolutely, we can get there. And it's important for us because that reflects the earnings power of the company. When that ratio is really high, we're heavily reliant on net interest income to drive profits for the company. When that ratio is low, then -- if we have a decent NII, then we can be really profitable. The reason that it went up was largely because of inflation. And we had expenses go up, but the revenue increase was in trust fees. It was -- it came in NII. And that's why we were able to maintain decent profitability, good returns and decent profitability even though expense trust fees went into the mid-120s where we do not like to see it. But you have to earn your way down on that by being very disciplined on expenses, growing the business and hopefully getting some help in the markets. And all those things are happening. And so that's why you've seen it reduced. And so if we get more years of being disciplined on expenses, help from the markets, decent organic growth, we'll be in good shape there. But the answer to your question is it depends on largely -- if you think about the math, it depends a lot on the equity markets. And that's why it's just difficult to say when will it occur. But there's nothing in the model to say we can't get to that point again. And so we're not -- at this point, definitely not coming off of that target.

Got it. And then I usually don't have to talk to you about credit quality. But we do read the 10-Qs and we do see watch list loans jump 30%. I know it's up a low base, but I just have to ask....

Yes. Somebody said 30%.

It's -- anything to note, you have obviously, a very strong customer base.

Yes. Now there's a couple -- a very small number of loans in that space. We're not worried about it. I mean, over 90% of the loan book is personally guaranteed, the office component is less than 3% of the book. And it's just we -- and the credit quality in general, if you think about look at nonperformers, not just those because you look at nonperformers and lower than I can remember and following this company for 15-plus years. And so the loan book is in very good shape as we look at it today. That is not to say that we are not constructively paranoid about what could happen in credit at any given point in time. So we're not waving the all clear but at the same time, there's nothing today in the book that gives us a sense that the quality of the book in general has changed. We feel excellent about it.

Got it. Maybe throw up the next ARS question while I ask mine. But you did pick up, the CET1 ratio, the second quarter went up like 120 basis points, obviously aided by the Visa gain. So you talked about maybe accelerating some spend but it's still a lot of capital in an environment, where I don't think banks are expecting a ton of balance sheet growth. You stepped at the buyback a little bit but clearly, capacity do more. Just any talks in terms of how you're thinking about capital?

Yes. A couple of things. One, just earlier today, you and I were talking before we sat down about comments from regulators, and it doesn't make sense to jump too aggressively in front of that and then have to retrace. Now that said, we obviously have a lot of capital. And the more we learn, the more confidence we get that there's nothing that is going to be dramatically different for us. Also, the things -- the way things are breaking, it seems to be in our favor. And that if we are -- if things are more benevolent or less malevolent in terms of operational risk, and we benefit from a less blunt instrument on credit, it favors us. And so that doesn't mean that RWA won't go up. We anticipate. In general, we've talked about a 5% to 15% increase. We're -- I think it's safe to the decent estimate to say take the top and the bottom end of that range down 5%. So that means it's up. But to your point, we're in a great position from a capital perspective, a great position from a liquidity perspective. I mean if you look at us from a liquidity lens, 1/3 of the balance sheet is in cash, 1/3 is in loans, 1/3 is in securities. The security -- the duration of the securities is less than 2 years. The duration on the loans is less than a year. So the balance sheet is short. It's high. The loan quality is strong. The securities book is strong. So at this point, it's about saying, okay, what is the right pace of share repurchase and ensuring we stay not just good on an absolute basis but good on a relative basis when we look at capital and liquidity. Our clients care about that.

Fair. I guess the last question we asked the audience was, what's holding you back to someone more constructive on Northern? And it looks like expense management and competitive pressures in pricing. We talked a bit about expenses. We haven't really talked about the competitive environment and pricing pressures. Maybe that's something you could address before let you kind of maybe circle back on expenses and trying to get your message across.

Yes. Thanks. So on the pricing pressures in general, I'll separate it across the businesses, and maybe I'll just -- then I'll start with Asset Management. I mean as this audience knows, better than any that there are pricing pressures in Asset Management. And that is not -- for us, it's been okay. But every year, we come into it anticipating that we're going to give up some pricing to stay competitive. And it is not huge dollars. If you think about our Asset Management business, in general, it's to $1.5 trillion. So it's over $1 billion in revenue on a $7 billion base but it matters. And then if you look at the Wealth Management business and you separate it, portion of the business and product is exposed to the Asset Management dynamics I mentioned, but on the advisory component of our wealth management business, the fees have held in -- the fee rates have held in extremely well. And I think our clients value the advice that we give, and we haven't had pressures there. And in Asset Servicing, every year, we budget for some level of compression, that level has not changed over time. And so there are pressures in the business, don't feel that they're increasing relative to history. And then from a competitive pressure perspective, and I'll just talk about Wealth. Everybody, obviously, is talking about wanting to be and everybody wants to do more in wealth management. And particularly at the high end where we're focused, we are more and more focused on the upper end of the market. And we're going to continue to be there. Yes, we see a lot of pressure, a lot of commentary, a lot of marketing to that client base. But our client relationships are excellent. Back to what I mentioned earlier, 35% of the Forbes 400. And so you just get a sense, we're highly embedded there. The higher you go in client here, I think the more concentrated the market share gets. And so their competitive set, it narrows a lot when you're dealing not with $2 million and $5 million accounts but you get up to $100 million, $200 million, $500 million. And for the billionaires, they're very selective and there's only -- there are a few firms that do very well there, and we're definitely one of them. We've been in the Family Office business, we started over 40 years ago. And so -- and the level of technology, the dedicated resources, we talk a lot about the tax expertise across wealth and there's something called an ACTEC fellow, you've heard us talk about this, the American College of Trust and Estate Council. And we've got 15 to 20 ACTEC fellows in Northern Trust. So across the country, when clients want dedicated experience on trust planning or taxes, they're able to get the best in the industry coming to talk to them. That's still differentiated. It resonates very, very well.

Got it. And then.

You want to talk about the 38.9%?

If you want to. We spent some time on it but I feel like not all of it resonated.

I think we can -- we're coming off of a year in '22 where it was 9. In '23, it was below 6. It was 5. We came into this year thinking it was going to be somewhat below 5, and it looks unlikely that we're going to be able to deliver on that. Again, for reasons that we feel okay about. But we've got to show that we can deliver expense growth at lower than what we have. And the good news, I feel better than I have in years that we're going to be able to do that. We've done the hard work. We put the things in place to be able to do that. We're going to get through what we're investing right now, and I think '25's going to be a better year.

I guess there are kind of the step-up cost and resiliency spend. I mean how many quarters do you think that lasts?

Yes. It's sometime mid-25, some give or take, but it will be a few more quarters. And -- but at that point, and I can see that some of that spend, and I feel now it is elevated and we've just got -- we got to get through this, get some of this work done and get to the point where this acceleration is actually in implementation mode and then it's much easier and less expensive to manage going forward.

And I guess, given kind of Asset Servicing and asset -- and Wealth Management, it seems like just the ability to further leverage technology in AI, it seems like it'd be ripe for that. Kind of where are you in that journey?

Yes. We use it in different areas of the business now but we're dedicating resources to it. And a part of this spend that we're embarking upon is to ensure that we're getting automation in the business. And so it's not just AI but in general, the first step of that is automation. And we're doing that in Asset Servicing. We're doing it in Wealth Management, where we can take complex trust documents, we can -- we're starting to digitize those, have those read in that capacity, deliver the information to our planning, our trust advisers in ways that makes them highly efficient. And the same thing happening, we're starting to do processes control functions in much more of an automated way in Asset Servicing. So it's showing up already.

Helpful. As we kind of wind down the clock and maybe conclude, a year from now when you're kind of back at this conference, I mean, what are some of the themes you're going to be talking about? And as you kind of embark on the 2025 budget, anything kind of jumping out to you as you take the first cut?

Yes. The 3 things we've been talking about, it's organic growth, it's productivity, resiliency. And that's what we -- everything we talk about internally comes back to 1 of those 3 things. And so if we start with organic growth, obviously, it's Wealth Management. We've got to make sure that we are instituting programs and initiatives to grow that business better. It's scalable. We're doing well. We've got the brand, the reputation, the clients to do very well in that segment, and we can invest there and do better. And the organic growth component of Asset Servicing is evidencing that we're living this scalability dynamic. And early signs are great on that. And then in Asset Management, getting a lot of the initiatives that Daniel is putting in place from infancy into place, and so feel good about it. And when you talk about productivity, we're trying to get at least 2% productivity a year, at least 2%, really should be closer to 3%, but at least 2%. We've got dedicated resources to that and ensuring that we're willing to do -- to make the hard decisions to make that happen. This year, we're above that target for the first half of this year. And it's high-quality items that we've identified plus the back half of this year, some of the workforce discussions that you referenced earlier will start to come into play. And so we'll get even more savings there. So productivity is becoming more ingrained in the company as part of our culture. And then the third is this concept of, call it, modernization and resiliency but making sure that we can stand up to the biggest peers in the world, saying that we're just as strong as they are in terms of having redundancies, resiliency in place and up times and being able to deliver for clients what they want. So I think those are the things that we should talk about again next year.

Any thoughts on -- initial thoughts on the budget?

No.

Fair enough. On that note, please join me in thanking Jason for his time today.